2023-03-09 16:11:03 ET
Affirm Holdings, Inc. (AFRM)
CFO Fireside Chat
March 09, 2023 11:00 AM ET
Company Participants
Michael Linford – Chief Financial Officer
Conference Call Participants
Tim Chiodo – Credit Suisse
Moshe Orenbuch – Credit Suisse
Presentation
Michael Linford
All right, everybody. I wanted to welcome everybody to our Quarterly Fireside Chat and thank Tim and Moshe from CS, who have graciously offered to help lead the Q&A section for us today. We have a number of questions. We're going to try to get through today and really appreciate everybody dialing in to listen.
So I'll hand it over to my friends at CS. Maybe? Tim, are you there? Moshe?
Tim Chiodo
I am Moshe. Okay. Well, I'll hop in there.
Moshe Orenbuch
Can you hear me?
Tim Chiodo
Now we can. Yes, go ahead, Moshe.
Moshe Orenbuch
Oh, I'm sorry. I apologize. Okay. Very good for our first question, which is the most popular question from the Say Technologies platform. [Indiscernible] asks, where do we see Affirm in five years? So, Michael, over to you.
Michael Linford
Thank you. I love this question because I've actually been at the company for a little over four and a half years now, and looking back on what we've done over the past four and a half years, for me, really frames where we're going to go for the next five years. And we've done a lot of work in the past four and a half years that I'm really proud of. We now have an integrated merchant relationship with over 60% of U.S. e-commerce. We have a market leading business in Canada. We've proven our ability to manage credit through incredibly volatile macroeconomic times, both what happened in the early stages of COVID, but also in the inflationary environment we've had over the past year. And when I joined the company, we had a little over a million users. We now have 15 million users, consumers on our platform, taking advantage of the honest financial products that we build.
And I think that level of progress is just so incredible, but we still have a lot of work to do. The team here has kept its mission and vision so big, and I expect us to make similar world-changing progress in the next five years. We have built the business that gives access to consumers. It gives access to honest financial products to consumers. But today primarily focused on larger transaction sizes, think over $100 a transaction, and primarily online. That leaves smaller transactions and offline purchases as a really big opportunity for us. And in light of that need to get offline and address everyday spend, Debit+ is a major priority for us. Debit+ allows us to serve the offline purchases by giving the consumers a physical card. And we think about it as really just Affirm on a card, which is really exciting. But it also allows the consumers to use it for any transaction size, widening up the kinds of transactions that we're able to serve.
And we still have a lot of work to do. We mentioned that we're penetrated at 60% of U.S. e-commerce, but we have an opportunity to continue to expand that. For example, we recently launched on KAYAK.com, and we're continually adding new merchants and products to our portfolio to address that. And then lastly, while we're proud that we're market leading in Canada, our international aspirations aren't done. And so, we have talked about the UK as being our next major market, and we're very excited to work on that over the coming years.
Tim Chiodo
Excellent. Thank you for that, Michael. This is Tim. I'll jump in with the next question, which comes from Richard A. Richard is asking what distinguishes Affirm from other buy-now-pay-later companies in the industry?
Michael Linford
I think the biggest difference is that we offer a much wider set of products than most of our peers. We have a product, our Pay in 4 product, which addresses the competitive set that is very common in our category, but we also address higher ticket items and can extend terms and duration much longer, which means that we can serve more transaction types. As I mentioned before, though, we're not super happy that we haven't addressed all the transaction types. We want to mean something to every transaction. And so to do that, we've got to really make progress on products like Debit+ and we're really excited for that reason. And if you think about where we are versus our competitors, they're focused on a product that can do one thing and one thing pretty well, which is divide payments, divide a purchase into four pieces, and we can do that. We have a really good Pay in 4 business that we're very proud of, but it's not as broad of an ambition as ours is, which is to really be able to address every transaction size and type.
Moshe Orenbuch
Great. We've got another question here from a retail holder, [indiscernible] who wants to know, can Affirm survive a higher federal funds rate environment and a possible recession? And if so, how?
Michael Linford
Yes, I appreciate the question. And starting about a year ago, we began communicating to the market how we thought rates were going to affect our business. And so while it – we have definitely been experiencing truly unprecedented rate environments. It's not the level of rates. It's the pace of change in rates, which has truly been unprecedented. So despite that, we have been very thoughtful about building the business to be able to withstand itself. The easiest way to think about it is as rates go up, we do have additional costs in our system. The cost either shows up in our funding cost or it shows up in less gain on sale when we do sell the assets we generate. And so the problem for us is, well, how do we take those cost increases and offset them either with some other cost decreases or with additional revenue?
And so the team has been focused over the past year and in particular the past six months on making sure that our prices are set correctly for merchants and consumers to offset all of the macroeconomic headwind. We feel very confident about operating in the higher rate environment. And it is fair to say though that the pace of change caught us a little bit off guard. We had a really volatile period last year in both the debt markets, but also in just digesting the pace of change. And the good news for us is while there is still a lot of volatility out there, things are beginning to stabilize and we feel a lot more comfortable with the level of change in rates that we're seeing embedded in the forward curve going forward.
Tim Chiodo
Great, Michael. Thank you for that context around the rate environment. This is Tim again. We're going to move to another question around the GMV guidance. So the outlook was reduced a little bit at the last earnings call. Can you talk a little bit more about the underlying drivers that went into the guidance reduction, whether it would be from a macro perspective, whether it would be company specific, that would be a great place to start?
Michael Linford
Yes, so, first and maybe most importantly we did see a meaningful deceleration in consumer demand for discretionary categories like electronics and home furnishings. And we expect those categories to remain pressured in the near-term. Some of that is just the way the comps work, where throughout all of 2021 and much of 2022, there were still really robust demand for things in and around the home. I think merchants were generally having inventory availability issues that caused demand to actually go up and those kinds of fad moments where we were having folks really having to chase supply. And so as a result, it was a situation last year where there's a really strong level of growth in those categories and so those comps are pretty tough. But there is also a very measurable, sequential slowdown in those categories where you see consumers rationalizing their additional stress that they see from inflationary pressures and things that fall off the bottom are those larger discretionary purchases, which are really important to us. And so we wanted to reflect that into the guidance.
And additionally, as you have seen in our quarterly letters that we send out, there has been a real focus on managing credit very tightly. And we do that for two reasons. The first is we always want to make sure that we're extending credit that in a manner that is good for all involved, which means that we have to have a certain level of loss of business.
We talk a lot about how we control credit. And I think that that controlling and the performance was really on display last quarter. But the second reason we've been managing credit tightly is over and above the need to make smart credit decisions, we know we have to continue to perform very well in order to enjoy access to the debt capital markets. And that causes us to be more cautious in how we run the business than we would be in times when the debt capital markets, how we fund the business is more stable. And it is really fair to say the last year has been very, very volatile there. And that causes us to be more cautious in terms of where we extend credit to ensure that the asset we generate is valuable to the debt capital markets.
And that's a risk posture that we're okay with. And as I started the conversation off, we made so much progress in the last four years, and we have so much opportunity ahead of us. We know that we managed [ph] this business thoughtfully in this particular environment, it's going to pay very big dividends for us in the long run.
Unidentified Analyst
Thank you, Michael. As a follow-up to that, so the Amazon business has been ramping and it's now become an impressive, fast-growing and now large portion of the GMV, most recently disclosed as roughly in sort of the 23% range of GMV. Can you talk a little bit about the, the growth or the opportunity with Amazon, and then also a little bit about what's implied for the ex-Amazon business for the remainder of the fiscal year?
Michael Linford
Yes, so the growth of the business is obviously very exciting for us. We would actually believe that we're still underpenetrated there. Amazon's share of e-commerce should be closer to 30% rather than the 2023. And so, it is not until we get to that level that we would have Amazon having a representative sample of a firm as it does to the rest of e-commerce. And that's actually before you consider that we haven't actually distributed our product to all of U.S. e-commerce. We talk a lot about that 60% number and we're slightly above that now. But think about Amazon being somewhere between 30% and 33% of U.S. e-commerce, it should be something as large as half of our business if it were just getting its share of our total portfolio. And so we feel like there is a lot of runway left there.
And similarly, if you think about the penetration that we have in that non-Amazon business, we always talk about our largest merchant partners. We're very proud of the enterprise relationships we have. And our three biggest partners make up about half of U.S. e-commerce. And they are only about a third of our business.
And so if you think about what that implies about the last 10% of the U.S. e-commerce, we address driving a significant portion of our business, it really does point to the opportunity across the board. What that means is that our share of card is actually a lot higher on those other surfaces, which gives us a lot of optimism for both adding new distribution outside of the biggest relationships, but also achieving a higher share on our biggest relationships. And both of those two things point to what we think is a lot of opportunity in the longer term.
And in the near term, the guidance really does, does reflect the headwinds that we think a lot of these categories that we're currently exposed to are showing right now.
Unidentified Analyst
Great. Thanks Michael. You alluded to the ability to reprice – could you – and the fact that your costs, particularly interest costs have gone up. Could you talk a little bit about pricing both on the consumer interest side and the potential on the merchant side? And what things need to happen for that to be in effect?
Michael Linford
Yes. So today we price all of our loans, and I should back up a second to make sure everyone understands what our loans are. We have two different kinds of loans, broadly speaking, loans with interest and without. And where loans don't have consumer interest, the merchant is the only source of revenue on that transaction. For loans with consumer interest, the merchant pays us a merchant discount rate, and then we also earn interest income on the loan. The nature of our interest is capped, non-revolving, fully amortized into the loan, which means that when a consumer checks out with a firm, they are able to see an exact dollar cost associated with financing that purchase.
So they may be able to go online and see that the purchase price including $10 or $15 of interest over a three- or a six-month loan, for example. And we express that in dollar tournaments because that is the most the consumer can ever actually pay us back, because we cap it, there's no revolving, never any additional interest, no late fees and the like. And that posture allows us to, while we're still communicating an APR, have a very different conversation with consumers around the cost of financing expressed, again in a fixed dollar amount. That, through a lot of testing and studying for us, has really proven to be very inelastic.
And so there is a set of consumers who are pretty sensitive to APRs, but the majority of our consumers are really not. And in this environment in particular, they are very open to additional interest expenses associated with their purchases because oftentimes the kind of price changes we can make there amount to like $0.10 or $0.20 a month very, very small additional monthly amounts.
But for us, aggregate up to very big numbers. You think about the scale of a firm, it's not because we do a few big loans, we do lots and lots of loans that are very small, and it's the scale of transaction count that allows us to build our business.
And so we've been working since last summer to begin to adjust the cap, the most we can charge consumers at a site. And to do that, there was some work we needed to do on the infrastructure side, and there is work we needed to do to get the merchants websites and marketing materials correctly updated. And that work took longer than we thought and ran into the Black Friday, Cyber Monday, Code Freezes that most merchants go through, most merchants don't want to update their websites going into the biggest sales season. So we kind of ran into to a pretty tough window of time and that deferred a lot of changes that we're making. And yet we feel really good about where we're at right now and how that rollout is going right now. And by adjusting that cap that allows us to more accurately price the risk and get compensated for it again in aggregate with a real, little amount of consumer elasticity.
Similarly on the merchant side, there is an opportunity to think about price there. I think we've always talked about it as our product is really important to our merchant partners. And the way we approach that relationship is to make sure that we're adding a lot of value to them and earning that every day. And that does cause us to be very careful right now, while we have had cost increases that are obvious in our business right now, so have our merchant partners.
I can't think of a single merchant partner who's not had significant pressure on their cost of goods, on their cost of labor and how they run their businesses. And so we're mindful of not being too aggressive there. And so that's a more measured pace where we know there's value being added and we want to make sure we get compensated for the value that we add, but we're careful to not push too hard on merchant partners who are also trying to figure out a way to run their business in this higher rate environment.
Moshe Orenbuch
Got it. Thanks. And just as a follow up, Michael, you had kind of alluded before to the idea that credit and credit risk had kind of been something of a damper on your ability to have higher levels of GMV, just the pricing also fit factor in there so that now that as you get that pricing, the consumer pricing kind of fully phased in, will that help from the standpoint of being able to authorize a higher level of GMV as you go forward?
Michael Linford
Yeah, that's right. These things are all interrelated, right. So if you think about our business model, we take revenue from many sources and we apply that revenue into various units and offset the cost of what we're building. One of our costs is funding costs that we've been talking about now, one of our costs is credit costs, but they're highly interrelated in that the more revenue we have for a given transaction, the more funding costs we can withhold, withstand, and therefore the more we can improve.
And so if you think about the growth of the business, the more revenue we're able to earn, the more we're able to approve because for the same level of credit losses, obviously the profitability of the portfolio goes up, the more revenue you put into it, that allows us to approve more and be more growthful.
But that's also a key insight as to how we manage credit in these environments and what will almost certainly be continued pressure on the consumer into the future. And that is, it's not as linear, I think, as people think. Credit cost is just one of the costs that goes into the equation. And sometimes we can be compensated for that risk with additional revenue, and sometimes you can think about reducing credit risk to generate better asset quality. And sometimes you can think about holding credit costs flat and finding other ways to improve the asset quality up to and including, for example, changing the duration of the loan that we're able to offer, allowing us to have less funding costs for the same level of GMV.
Moshe Orenbuch
Excellent. Thank you, Michael. Tim, again, I'll jump in with the next question that we have here around gain on sale margins. You alluded to this topic a little bit earlier, but your partners, what are their expectations in terms of what they're expecting to earn in terms of their return? And how does that influence how a firm responds or reacts in the current environment?
Tim Chiodo
That's a great question and let me recap first how we fund the business because it really does inform how we think about engaging with that particular portion of our funding strategy. So we fund the business today with three different funding channels. We have our securitization program where we go off and engage the debt capital markets and deals are those deals are usually multi-year revolving deals. That means we can borrow money for a few years and we're constantly putting more assets in there. But those are almost always fixed rate deals. So we are borrowing money at a known in certain expense, and then we have a revolving period at the end of which the loans amortize out.
And everyone who's invested in that particular securitization earns their economics through the end of that deal, that is a market that has been really volatile, right. So that has been a thing that starting about this time last year, as rates began to move, you started to see that market go through, fits where it would shut down or seize up and certainly would become more difficult for issuers who are relatively new like a firm.
And that was a thing that we were still able to do deals last year, but it was, I think, a little bit less reliable as a funding channel. And what that meant is we had to be more reliant on the other two funding channels throughout most of last year. In particular, the really the last quarter and/or two of last year. And that is our forward flow deals and our warehouse lines. Both of those are what we call bilateral in that we're working with one counterparty. On the warehouse side, it's actually very simple.
We go to usually banks and we set up warehouse lines where we borrow money to fund the assets. That borrowing happens against the asset in a very specific way that ensures a safe level for the bank. And we pay a floating rate obligation, a floating rate debt to the banks in order to enjoy access to that capital. That funding market has really, for us, really never been under pressure. It remains widely available to us. The business that the banks do with us, we think they like it very much, and we certainly appreciate that.
But that business for us is pretty expensive and it has a lot less, a lot more equity in it. We talk about equity capital required, and that business requires us to put somewhere between 15% to 20% on a given deal of our equity into the loans.
When we sell loans, the last funding channel, we sell the whole loan to a counterparty. What that means is the counterparty takes on the entire thing and the case of we put it in our warehouse, we still own the loan, and we simply borrow against it. In the case of the forward flow deals, we've sold the loan in its entirety. The investor there needs to look at, okay, I'm buying a loan and they're going to buy it for some amount, and they want to make sure that after they buy it, they get a return. And the return for them is some combination of how much revenue is in the loan and how much cost is in the loan, and they try to do the math to get to a targeted yield number.
And so if you think about where we were kind of two years ago or a year and a half ago, when rates were zero and credit performance was perfect across the board for any other player generating consumer assets, you had forward flow partners who were willing to do deals at very, very low yields because their costs were low and the cost embedded in the loan was more certain and very low. I think over the past year for not a firm but for some other unsecured consumer lenders out there.
The drift in credit quality combined with the rising rates put a lot of pressure on managers who bought this asset class across a wide set of managers, and that caused credit to come and start focus. So I think we've talked a lot about credit at a firm over my time here as our public company CFO and certainly as a private company as well. And that focus was well deserved. It's a really important question for investors to understand how a firm manages credit outcomes, and that's true on both the debt and equity capital markets.
So the conversations with the forward flow partners today is really around looking at how we have managed credit today and then looking forward on how we will manage it going forward. And we talk about really making sure that we protect the quality of the asset, it's for those investors.
Because it's one thing to talk about the yield and investor needs, there's a market for it, and you can think about credit costs and a spread, and there's just a number you can get, let's call it, there's a 9% yield expectation. That's fine. You can talk about yield expectation, but embedded in that is also what your outlook on our performance and credit is.
And when we do the things that we did last quarter, when I talk to these forward flow partners, they really value the tone and posture that Affirm has taken and how we run the business. For those of you who haven’t, I really encourage you to check out our shareholder letter. In my section of the letter, we actually show a chart that I’m really proud of, and it shows how delinquencies have flowed through the Affirm system as compared to what a traditional credit card company might see.
And you’re seeing constant and continued rising in delinquencies across most of the other credit issuers, because of the nature of their product and their underwriting, they don’t have the same underwriting approach that we have and they don’t do it on a transaction basis. And so they’re going to continue to see drift up.
And if you leave the consumer credit world and you – or the unsecured consumer credit world and you move over to some other assets, there’s other companies out there, some of them who are public who actually extend credit to consumers, again using different underwriting models. But in longer duration, they’re seeing their delinquencies continue to drift up as consumers get stressed.
And if you see here, we’re – we stand out in that we’re pointing down, and that’s by design, that is us being in control of credit. And so we talked to these forward flow partners as much about what yield they need to get as it is about them buying into our approach. And our best forward flow partners know that we’re always going to make the right decisions. It doesn’t mean there won’t be stress on the consumer, we obviously saw that, but our ability to be reactive to that, to make the decisions we need to make, to ensure that we protect the quality of the asset, really does stand apart.
And that allows these investors to think about not just the yield that they need, but also some level of quality that they get. And I would say the level of differentiation we were earning in those conversations was low. Not because it shouldn’t be, but because there were asset managers who I think were really dealing with a wide set of companies who didn’t have the same features and approach that we had.
And that differentiation is now really beginning to come to light for many of these investors. And our commitment to them is that we’re going to keep generating assets that make sense for them and for the equity shareholders. That’s a really important thing. You want us to run the business that way, that way we guarantee access to those markets and to the future.
Moshe Orenbuch
Great. Great, Michael. A lot actually to unpack there maybe two separate things, first, you mentioned that you’d had to fund in some ways that were a little less optimal in the short-term. Are you seeing signs of being able to get back to closer to that normal or historical kind of mix of funding over the course of this year?
Michael Linford
Yes. What we talked about is in our fiscal second quarter, we used more warehouse funding. And that resulted in both a growth in loans held per investment on the balance sheet. It resulted in therefore more provision for credit losses and it resulted in less gain on sale proportionally with earning those revenue units over time in the form of interest income.
That, that we’ve been talking about is more of a one-time change. So you saw a big jump in Q2. We think we want to hold that mix throughout the balance of this year. I think that the way I would describe things is that the New Year really did a lot of good for us on the debt markets. You saw us do our ABS deal. In January, you’re going to see us be pretty active here.
And yet, it’s really volatile out there. When Jerome Powell, I think gets on the microphone and talks about the things he’s challenging – the challenges he’s facing and how he hopes to try to land the plane, it does cause a lot of volatility in our markets, which encourages us to continue to be flexible.
We have never relied on one funding channel and we never will. And so we’re going to be a little bit flexible and nimble here in managing through volatility. And yet, you did see signs of what I would call green shoots. We saw signs of the ABS market coming back. I would say the bilateral conversations on the forward flow side, feel just fundamentally different than they did six months ago, which is very constructive conversations focused on the long-term with really world class asset purchasers, so that those feel better.
But I would really caution everybody that we are definitely not done with volatility in the macroeconomic sense. We are operating the business assuming that we’re going to continue to have healthy amount of volatility here.
Moshe Orenbuch
Got it. And you mentioned the better performance than many other extenders of consumer credit, some of whom have been doing this a lot longer than Affirm even. Maybe just talk for a minute about other – what factors that you’ve been able to achieve to get that performance and how does that influence your growth plans?
Michael Linford
So on – let me answer the second question first. I think it’s really important. We have an enormous market opportunity. The market for consumer credit and for consumer purchases is just so enormous. And those are the pools that we’re playing in. We’ve always talk about nominating our business, for example, in the percentage of U.S. e-commerce as we shift to more payment tenders and get offline and go to more transaction sizes and types.
You’re going to see us address just a very, very wider set of market opportunity that’s before we leave the U.S. shores. And so like we feel, like the markets we’re playing in are enormous, and we talk about it internally as the market is consumer credit. The market is the credit card industry writ large, the very, very big markets. So feel really pretty unconstrained there.
And yet, in the near-term decisions around the capital markets and credit do drive our levels of being willing to be more growthful or not to the consumers. And that’s in part because the riskiest transaction for us is the first transaction with the consumer. And so we are going to be very careful about consumers who – we don’t know yet on that first application, that allows us to be slightly more conservative and thinking about underwriting on those first transactions with the preference towards making sure that the consumers who are performing well on the system are taken care of and continue to enjoy access to the Affirm platform.
So it has impacted us, but I think in the scheme of things, we play in an enormous market, so we don’t really feel constrained yet. It’s about the challenge for us is how we’re building products to address that, like data plus [ph]. And then a brief moment on this – on why we’re so good at this. There’s really two things. One, we are really good at underwriting and we have I think the world’s best data scientists and machine learning teams.
And I can go on for days singing their praises. And yet, I know that for a lot of investors and people in the consumer credit space, they’re very skeptical on the idea that we’re just better at it. I would stress that we don’t think we’ve found some sort of magical insight or hacked the code to find one particular thing that drives out performance.
But we are really good at it and we are constantly seeking out marginal benefits that focus on constantly working our credit models to eek outs and benefit, puts us ahead of traditional underwriting models. But even if you don’t really believe that we’re good at that and of course, we really are and can spend days on that.
We have a tremendous advantage, a business model advantage in how we think about approving credit at the transaction level. We don’t have legacy lines that are dragging credit performance. We can look at every transaction with the consumer and the merchant, and say, that is a good piece of credit risk or that is a not good piece of credit risk.
And that’s a really important insight. There’s no such thing in our eyes as good consumers and bad consumers. There are consumers who go through changes in their life, both good and bad, that put them in positions to be able to take on credit at some times and not at others. And the fact that we’re sitting at the transaction level, making transaction level decisions and can still achieve the scale we achieve given the distribution that we have set us apart. And so many other credit providers are making credit decisions that are far less frequent, far less engaged and less current. And what we make our money, we differentiate ourselves by being able to prove those tens of millions of transactions, not the couple of million consumers a year applying for a card. We’re talking about tens of millions a quarter.
Tim Chiodo
Excellent. Thank you, Michael. Our next question actually comes from one of the investors. Stephen M is asking the question. Michael, how would you respond to those that who claim that a firm offers subprime lending to a large number of no credit and bad credit individuals who would likely default on their loans? Again, that question is from Steven M.
Michael Linford
So Steven, I think it is the case that a large number of our consumers have low FICO scores. But if you think that that is an indication of probability to repay, I think you’re just not paying attention to the actual results that we’ve been able to generate. Part of the reason we put the chart that Rob had up earlier up is, it’s truly differentiated. We do have 43% of our receivables are have low FICO scores. But we don’t think about those as subprime loans, I mean, they’re obviously low FICO scores.
But those are actually really good credit risks that performs really well. But they happen to have a low FICO score that could be a function of a random occurrence in your credit bureau file. It could be a function of a legacy waiting that’s dragging down your credit score, not really reflective of your actual ability and willingness to repay.
And again, I think those are fancy words. If you look at the facts, they’re pretty stark. Look at the results here is that the credit underwriters who have a substantially lower portion of low FICO users in their portfolio, low FICO assets. They are continuing to see delinquencies rise, and we’re the ones who can control them down. And that’s where the reasons I discussed above. It’s a mistake to think about consumers as being good and bad.
I assure you, if you have a low FICO score, you’re not a bad person. And I think that some investors sometimes want to think that those folks shouldn’t enjoy access to credit. The trick is for lenders to be able to identify the portion of the market that has that ability and willingness to repay. And we do a really good job of that as evidenced by the recent credit performance.
Moshe Orenbuch
Michael, we talked a little earlier about your success and relationship with Amazon and that had been an exclusive agreement. I think, I believe that exclusivity has ended, but you still kind of talked about being able to kind of penetrate deeper. Could you talk in a little more detail about what sort of things you’ll be able to do to – to be able to increase that penetration as we go forward?
Michael Linford
Yes. Our position on the Amazon has always been competitive. One of the pieces of feedback that we got from investors when we first launched with Amazon was they would go on amazon.com and they would see lots of other offers for financing credit cards, you name it. And we were quick to point out that, that was always going to be the case. It is the case that Amazon is so big, so complicated and so focused on the consumer that they’re not going to let their options be curtailed.
And so we know that, and we’ve built a business that can win its fair share there. So what does that mean for us? Well, it means doing the basics, right, making sure that we’re doing the core job of underwriting the transactions of being able to communicate the offer to the consumer on the right way and continue to prove that the consumers who take our offers are delighted.
I can’t tell you how much of a huge surge of adrenaline we get, when we read the reviews consumers have for our product on the Amazon and what we’re able to do for those consumers. And for a company like Amazon who’s so focused on consumers, it really does allow us to have a conversation about how we can do more of that for those consumers. They care an awful lot, and I think that they know that we are talking to a user who maybe isn’t likely to take up the other offers on their site.
And so the basics have to be done well. And then there’s a bunch of work that we can do that’s really cool and exciting above the basics. And I think that involves everything from working with the category managers to make sure that we’re building offers that make sense for the categories that we’re shown on. It means working with even brands to think about how we can grow the product set that we’re offered on Amazon today. Our primary product is the majority of our business there, and it’s an interest-bearing loan, and I think there’s a lot of opportunity for us to continue to expand the product set there and address, again, more transaction types.
Moshe Orenbuch
Okay. Thank you.
Tim Chiodo
Excellent. Thank you, Michael. We talked a little bit about Amazon during this conversation, but maybe we could switch gears a little bit more to Shopify. Maybe you could start with just a little bit around the background on the contract and when you launched with Shopify in 2021, but recently extended that. Maybe just talk about the relationship and how it’s evolved over time.
Michael Linford
Yes. We’re really proud to partner with the world’s like leading e-commerce companies and no greater example than Shopify. We actually I think first signed that deal in 2020 and spent the – basically the first year of the contract building the product, testing it and launching it. And I remember when we were taking the company public, I would get on the phone with some really good analysts like yourself, Tim, and we would talk about where we’re at on the rollout. And our answer was really unsatisfactory to a lot of you all, because you kept saying, well, when is it going hit here? Why isn’t it here yet? And we would say, look, we’re – it’s in flight. We’re working on it. It needs to be right. There’s a lot of work that goes into it, and we’re building it with Shopify.
We’re not building a product and turning it on. We’re building a product with Shopify. And that collaboration across two companies definitely adds complexity, but also makes a killer product when you do it right. And I would say that, we had really high expectations and we’ve been blown away with the traction that we have had with that product at Shopify. Both in terms of the economics we can create for ourselves in Shopify, but also for the merchants on Shopify and the consumers on Shopify, who are getting a really awesome product.
And so we’re really pleased with the progress, the depth of the integration, the quality of the partnership and continue to focus with them on how we can continue to grow our relationship.
One of the things that we did back in 2020 was ensure that we had aligned incentives with them and they became a shareholder with some warrants that we gave them in 2020. And that alignment of incentives served us really, really well. When we did the renewal extension for them it was, we want to continue to make sure that Affirm is going to be there to support our product, but also that they are truly invested in our success. And I think the reality is, it’s a competitive market and we have to earn our position with every partner we have, including Shopify. But the quality of the relationship and the tone and posture of the partnership is that they want us to succeed and that’s because we ensure that they succeed as well.
Tim Chiodo
Excellent. Michael, I think we tackled it. There was actually a question from Joseph V. Joseph was asking, in terms of the direct economic benefit to Affirm if the partnership has exceeded, met or failed your initial expectations. It sounds like things are going quite well. Maybe you could touch on that briefly, but maybe we’ll wrap in the final question around Shopify and we could tackle them two at the same time. It’s around the business being largely U.S. at the moment, and if there have been any discussions around potentially expanding to additional Shopify markets around the world?
Michael Linford
Yes. So again, we’re actually really impressed with the economics of the program fully loaded. We always talk about our economics internally in a very conservative sense. So much of how we think about building a business is, each transaction has to make sense. That’s why you see the credit outcomes you see for Affirm. We really have in our DNA the idea that it needs to make sense or it won’t be sustainable at scale.
You can maybe run out and do some unsustainable business in the near-term and look generate some GMV that might look good. And certainly some of our competitors have tried to do that. But at scale, if you want to do what we’re doing in the $50 billion to $100 billion scale, the only way to build that is to be smart about making sure every transaction, every merchant relationship makes sense that way you want more of it.
And we’re – so we started off with that pretty high bar on that program to begin with and I think we’re blown away by where we actually got to. If you think about annualizing our margin or that product, because it turns over so fast, it’s one of our top performing products in the whole portfolio. So really, really proud of that.
And in terms of international, look, I think the conversations we have with pretty much every merchant and every partner and every – whether that’s a payment process or an e-commerce company involves where they’re in our shared global plan sit. We know that the U.S. market is enormous and we know that winning it is the most important thing for us to do. If you look at some of our global competitors, they have the same priority. So for us, winning the U.S. is and will continue to be priority number one.
And yet, we know that we need to be global in scale over the next five to 10 years. And so that means that we’re going to address more markets. And the best way to do that is to find a partner who can help, who’s aligned with your interest and that can help you achieve some level of scale. So of course, we’re having conversations with all of our partners and we’ll continue to do so, but obviously nothing specific to talk about here.
Moshe Orenbuch
Thank you, Michael. And maybe kind of as segue to talk about international expansion a little bit in a slightly different way. In the past you’ve made acquisitions that how you started in Canada. I think there was a notation that you’ve made a small acquisition in the UK. Can you talk a little bit about how you think about both using M&A and how it will be potentially a part of that international expansion?
Michael Linford
Yes. I mean, I think we’re mindful of and we’re humble enough to know that we don’t have all the answers, we can’t do it ourselves. And so, any approach – any inorganic approach comes with it, some thought process around what capability are you acquiring and what you get out of it. In the case of PayBright, which a business that we bought in 2021 that business was the market leading business in buy now pay later in Canada and has really continued to grow and exceed our expectations. And so we were buying both a business there, a team and a good set of consumers and merchants that we thought we could build from. And it was really the accelerant we needed to cement our leadership position there.
I think that isn’t always what you buy. Sometimes you’re buying just a team, sometimes you’re buying local market expertise, sometimes you’re buying a set of folks who can help you seed a business. And I think that’s probably as much as anything what we did – with the small acquisition we did, where we bought some folks who can really help us seed our UK efforts smartly much more so than buying a market leading business like we did in Canada. And both approaches make sense.
Obviously, the ladder you’re buy market leading business, you’re going to pay more for that. And I think that’s certainly a way to do it. When we look at the international opportunities, we constantly evaluate whether or not there’s a player there to acquire, to give us that kind of jumpstart. And sometimes you’re just buying more of a seedling that can help you grow the tree you want.
Moshe Orenbuch
Got it. Thank you. And in the last earnings announcement you talked about a reduction in the workforce. Can you talk about how that’s been manifested both in terms of the things that you’re able to do and continue to do as well as the impact on your expense lines?
Michael Linford
Yes. I think it was obviously very hard for us. We – one of our core values here at Affirm is that people come first. And when we talk about that that’s both our people, but also all of the people in and around what we do, so our consumers, our merchants, our people too. And we think about all of those human beings and we think about everything we do with an eye towards the impact it has on human beings and obviously true for our internal team as well. It was a really hard decision, but one that we felt like we needed to do to get that. We knew that we were hired for a level of volume that we weren’t seeing flow through the system, and this was our opportunity to take a pretty big step in right-sizing the team.
I think the focus that we have had continued. A lot of the focus that we had gotten in the back half of the year was already focusing on making sure we protect the quality asset that allows us to continue to enjoy access to the capital markets, which allows us to be more growthful. And that focus was there even before we took the action. I think that has heightened it and will continue to heighten it.
But I also think it’s important to put a little bit in context the level of reduction that we did. I think the engineering headcount, which is the primary unit of productivity at Affirm. As engineers, we write software to solve these problems and we set back the engineering staffing level to something about mid-summer of last year.
And so while it was a step back, I think that we were feeling like we could conquer the world last summer. And I think we still do, and I don’t feel like we think that we’ve shut any doors down. What we are doing right now is living up to our commitments and making sure that we’re focused on prioritizing the highest value work right now. And some of that is being responsive to where the market is at. And some of that is just a recognition that in a higher rate environment capital is more scarce and you have to focus your investments on fewer things. And that’s okay, that’s a healthy thing for us to be doing. And that’s what you’re seeing reflected right now. And it will have a big benefit on all parts of our P&L in that there will be obviously less payroll expenses and less stock-based compensation expenses flowing through.
Tim Chiodo
Great. Thank you, Michael. We’re going to move to another question from one of the retail shareholders. We have Neil P asking the question whether Affirm in his words will initiate any stock buybacks?
Michael Linford
We laid out our capital priorities in the bottom of my shareholder letter. I would encourage folks to look at it. The first thing when we think about capital, first thing we’re going to do is ensure that we continue to have capital available to invest in what we want to invest in to build the business we want and get to profitability. The second capital allocation framework was to proactively manage our liabilities. We’ve done two transactions already and buying back our convertible bonds. We’ve purchased a small amount in both transactions. There’s 8-Ks for both of them. And that’s really us saying that we have a lot of cash and we have a liability that’s coming due in a few years, and we want to be proactive at managing that liability to the benefit of the shareholder. We’re able to repurchase those bonds at roughly $0.70, $0.69 on the dollar.
And being able to do that creates a lot of value for the equity shareholder. And we’re going to focus on that well before we consider any stock buybacks as that liability flows through on a net market cap basis, obviously. And then lastly, we’re going to think about M&A as an area of capital allocation. But you didn’t see us list on our capital allocation framework with stock buyback because we think that’s a pretty far away thing. And honestly, I think if we, managing liabilities is a thing we have to do anyway, which causes us to do it, otherwise we would seek to be investing that in the business as we think the opportunity is still pretty enormous here.
Tim Chiodo
Got it. Michael, one of the elements, and we’ve talked a little bit about this already is, the transaction processing costs that Affirm incurs. Are there any changes that you can make or things, ways to achieve efficiencies and improve that transaction cost as we go forward?
Michael Linford
Yeah. So our payment processing and servicing line item includes both the fees that we pay to process payments on the other side. So repayment for us happens either with ACH or debit or with a small amount of credit repayment as well. And that’s for some very specific reasons, down payments and also for one particular product. So majority of our payment is ACH and debit. And obviously the mix substantially influences the payment processing costs. One of the many, many reasons we’re so excited about Debit Plus is as a feature of that card connectivity directly to the bank is an important feature there and being able to ensure that we have been connectivity does allow us to more efficiently process repayment for that product and many others. And that being a catalyzing a product that encourages users to connect the ACH direct link to their account does help us.
And we feel like that’s a really big opportunity for us in the long run. It’s never a thing you’re willing to do at the harm of [ph] repayment. First and most important thing is to let consumers repay you, then you want to try to make it as efficient as possible. And I think there’s a pretty big set of opportunities we have on making it more efficient. It’s not something that’s gotten a lot of focus in the company historically. But it is definitely on our list of initiatives today and all in the spirit of making sure we’re doing everything we can to make our unit as efficient as possible that allows us to obviously be more growthful and improve more units going forward.
Tim Chiodo
Great. Michael, I think we can probably wrap with this last one. You sort of just tackled it a little bit. Maybe we could hit a little bit more, but in terms of the whole debit versus ACH, in terms of the transaction processing, you mentioned you want to remove as much friction as possible. What about the non-sufficient funds risk associated with ACH? Are there ways that you can avoid that or minimize that and for a repeat customer, it would seem that you would’ve a preference for ACH over debit? Is that fair?
Michael Linford
Yeah, I mean I think for any customer we’d have a preference where we knew that the funds were available. I think the ability to think about short-term risk so if you back up a second. Our unusual product has call it monthly or even biweekly repayment dates. And so it’s not that we’re constantly drawing on an account, it’s that we episodically receive a payment and there if for whatever reason funds aren’t available there, the consumers can cure it. And there’s a natural process to do that. And that leads itself to being a really attractive payment method. It’s why the majority of you on the line I’m sure use your bank account to pay off your credit card, for example. So that’s a very, very common and well understood thing for us.
And the risk there are a lot narrower. Where I think the heightened risk that we’ve had to manage and build products to deal with is really around debit, debit plus where you’re not hitting the account like once a month, you’re now hitting it every 48 hours where transactions accumulate for a couple of days and then end up being swept out of account. And there it’s really important that you’re thinking about the risk there in a way that you didn’t really have to think about before and in a pretty novel way because Debit Plus does allow you to be writing on any bank account.
And so you’re not having to have an account here, a typical bank will just look at your balance and then make the approve or decline decision on the debit card based upon what’s there. We do have to have some level of underwriting as short term as it is, and that’s been a new thing for us. And yet we feel like we have a really good handle on it. And part of the reason why we’re so excited about the product right now is we do know that the program economics are going to be really solid and that’s a problem that we definitely have had to tackle, but we feel like we’ve tackled it pretty well.
Tim Chiodo
Excellent. Well, thank you Michael. So on behalf of Credit Suisse, myself and my colleague Moshe Orenbuch, we want to thank you and the whole team at Affirm for giving us the opportunity for hosting this session today. We thought it was quite productive and thank you for making the time for everyone in the audience.
Michael Linford
And a big thank you to you two and thank you to the retail shareholders who logged in. And we’ll talk to you next quarter.
Tim Chiodo
Thank you, everyone.
Question-and-Answer Session
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Affirm Holdings, Inc. (AFRM) CFO Fireside Chat Transcript