Affirm Holdings, Inc. Q1 FY2023 Earnings Call

Good afternoon. Welcome to the Affirm Holdings First Quarter 2023 Earnings Conference Call. Following the speakers' remarks, we will open the lines for your questions. As a reminder, this conference is being recorded, and a replay of the call will be available on our Investor Relations website for a reasonable period of time after the call. I'd now like to turn the call over to Zane Keller, Director of Investor Relations. Thank you. You may begin.

Thank you, operator. Before we begin, I'd like to remind everyone listening that today's call may contain forward-looking statements. These forward-looking statements are subject to numerous risks and uncertainties, including those set forth in our filings with the SEC, which are available on our Investor Relations website. Actual results may differ materially from any forward-looking statements that we make today. Forward-looking statements speak only as of today, and the company does not assume any obligation or intend to update them, except as required by law. In addition, today's call may include non-GAAP financial measures. These measures should be considered as a supplement to and not a substitute for GAAP financial measures. For historical non-GAAP financial measures, reconciliations to the most directly comparable GAAP measures can be found in our earnings supplement slide deck, which is available on our Investor Relations website. Before turning the call over, we want to briefly note our shift to a quarterly shareholder letter instead of a lengthy press release and prepared remarks. We believe that this format will enable us to spend more time answering questions from the investment community. As such, we encourage you to review the shareholder letter for commentary that we would typically include in our prepared remarks. In addition, we believe that the shareholder letter, when read in conjunction with our earnings supplement, will enhance our ability to communicate with the investment community. Both documents are available on our Investor Relations website. This change was also influenced by feedback that we received from investors. We hope you find the shareholder letter informative, and we welcome any feedback. Hosting today's call with me are Max Levchin, Affirm's Founder and Chief Executive Officer; and Michael Linford, Affirm's Chief Financial Officer. With that, I'd like to turn the call over to Max to begin.

Thank you, Zane. We appreciate everyone taking the time to join us. Our results reinforce the confidence we have in our strategy and Affirm's ability to capitalize on our opportunities. Two years ago, that was a time we were preparing for a journey as a public company. We're now completing our eighth quarter as a publicly traded company, and it seems really good time to compare our results for the 12 months ending September 30, 2022, versus the 12 months ending December 31, 2020, which was the last calendar year as a private company for us. Since then, with comparison, we've more than tripled active consumers. We quintupled transactions almost. We grew transactions per active consumer 1.5 times, per transaction frequency by 50%, and nearly tripled our trailing 12-month GMV. Both have doubled our revenue and almost tripled revenue less transaction costs, growing at up to $732 million. All while, we've been in control of our credit results. Delinquencies and net charge-offs remain at or below pre-pandemic levels, which is very important to us. We remain focused on the long term while making sure to navigate the present macro volatility. We're continuing to obsess over risk and transaction costs to maintain strong unit economics. We will shift features that improve network scale and profitability like we always have. We're going to manage our OpEx carefully while investing in our highest conviction product opportunities. We're building deep connections with consumers and merchants who need us now more than ever before. Both sides of our network can navigate economic uncertainty, and we see this as an opportunity to solidify our position as a trusted and reliable partner. Back to you, Zane.

Thank you, Max. With that, we will now begin our question-and-answer session. Operator, please open the line for our first question.

Our first question comes from James Faucette with Morgan Stanley.

I want to talk first about this path to profits in 2023. Obviously, you reiterated that, but nevertheless, you're looking for a little bit lower GMV and associated performance on the top line. How are you thinking about the evolution of that timing and what you need to do to make sure you get to breakeven or profitability in 2023?

James, thanks for the question. Yes, we are still very much on time and on pace to achieve the profitability goal that we outlined, which, just to recap everybody, we talked about getting to profitability starting on the first day of our fiscal '24. We said on a sustainable basis, meaning that we'll intend to do it repeatedly most of the time and looking at adjusted operating income. For us, the challenge is some pretty simple math. We need our revenue less transaction costs to be greater than the adjusted operating expenses that we have below the transaction cost line. The key things for us then are making sure we're doing everything we can to maximize the unit economics in the business. If you look at our back half of the year roadmap, we have a lot of focus on ensuring that we're doing all we can and should do there, as Max outlined in the letter. We're going to be mindful about controlling our operating expenses. That means being very careful, particularly on hiring, but also ensuring that we're not having any pockets of waste in the business. As we continue to scale the business and make the right investments, we also don't want to have wasteful dollars in the system. If you look at our guidance, the back half of the year and the adjusted operating expenses that are implied by that, we feel like we'll put this in a really fit shape so that we'd be exiting right where we want to achieve that goal for next year.

Let's start with delinquencies. You mentioned in your prepared remarks that you are still slightly below pre-pandemic levels. However, it seems that you are getting closer to those levels now. I’m curious about your approach to managing this, particularly since there may be more repeat customers in 2023 compared to pre-pandemic. It would follow that repeat customers might exhibit better behavior in terms of delinquency. What should we expect in terms of managing those rates? How do you plan to handle it, and when do you anticipate achieving those goals, along with the conditions that would contribute to that?

I'll start, and I think Michael can probably help quantify the second half of the question. So just to set the stage, the most important thing to take away from us is that we are not just managing credit outcomes; we set them. The whole point of these ultra-short-term 4.6 months weighted average life of every loan is underwritten. We have full control of transactions requiring down payment or not—we control the amount of down payment, et cetera. So we have lots of levers we can use to control risk. We've mentioned this many times, but it never gets old. That gives us a lot of very nimble controls over the actual credit outcomes. We set a number we want to hit. Obviously, every week, we get a stack of new formations going back all the cohorts that are still active, and we adjust credit that we are managing quite actively to ensure that we get to the numbers that we require. Because the back book runs off very quickly, we have a lot of control. This compares pretty favorably with the rest of the industry that does things like credit card consolidation loans or personal loans that go back years, and there's nothing you can do about it. So that's just a really important thing to understand. And again, I apologize for those who from this sounds like just an old repeat, but this really is how this business works. The reason our numbers are strong today, and you can see this in the letter, is not an accident. It's not as though the world hasn't changed. There's plenty of stress on the consumer in the lower income brackets and lower credit quality. We're just good at managing, and we do underwrite every transaction, and therefore, we have a lot of control. The counterpoint to this is the demand for BPL is increasing. We serve our consumers; we see demand in the application side of things. Generally speaking, people are shifting—not just going to look at credit cards; people are turning to more than they used to do that. I mean, we're not done in the higher income brackets spending through pandemic stimulus, but they’re getting closer, probably sometime mid-next year is when we'll see the exhaustion of those savings. But today, the lower income groups are already done, and they're trying to turn to various forms of debt. We believe very firmly we have done the best alternative out there. We have 85% repeat transactions from existing consumers to support that. We have enough demand, and we do have a lot. We have enough diversity of merchants where folks shift out of connected fitness and finance into homewares—they go for big box, more commodity purchases. We are there to help them with all those things. Demand is still quite strong. If we have control, as we do all of our credit outcomes, we can manage to the number that we need.

That’s right. And it varies by product, and it varies by merchants that we have. So I think your point is well taken that we do see substantial improvements in credit quality as we see more repeat usage. I'll note that we're still acquiring new users at a pretty good clip, and the business is still feeling, and we're not done with the acquisition side of the equation, certainly not on a gross basis. The additional disclosures we’ve got now in the shareholder letter would really encourage folks to spend some time with them, looking at the delinquency trends, which we now show 30, 60, 90 days, as well as our net cohort ties, net charge-off curves for our monthly loans, and providing you some trending that you can see. The biggest takeaway for all of those is that we are dialing in where these things are. It’s going to be a week or a month that varies up or down, but we get to dial in where those losses are, and that is such an important strategic piece of this business—that we can take that loss, then we can have confidence in how we think about the credit losses concerning our capital partners. We have confidence in how it affects our P&L, and this allows us to confidently approve up to a very deep level. If you put us up against most traditional financial institutions or most people who do unsecured consumer lending, our results are really good, and we feel like that is a real strength for us, and we're not going to treat it lightly.

Strong plus one to Michael, please have a look at what we put out in the letter. We really wanted to communicate very clearly to our investors that this is one piece of the business that matters to us, should matter to our investors, and we are in full control. We look at these things on an over-debt basis as we think you should.

Our next question comes from the line of Moshe Orenbuch with Credit Suisse. Please proceed.

In the past couple of quarters, we've talked about the potential to change price to consumers. Does the fiscal '23 guide for revenue less transaction costs assume any pricing changes? And if not, what would it take to get you to start that process?

Excellent question. So the short answer is there's a number against across merchant, consumer pricing, and the rest of our transaction cost line items that are not reflected in our guide. Those remain as upside and a little bit, if you will, in how we think about the guidance, we want to be really careful to put in the guidance things that we are certain about, as opposed to things that we hope will deliver and help close the gap. That's why we, for example, look at the current forward curve. We don't have a proprietary house view of rates, and we try to look at the current shift and live features of the product. There is some aspect of higher APR, but the majority of the opportunity for higher APRs to consumers is not reflected in the guide, as is the opportunity we have on the merchant side from a pricing perspective.

And as a follow-up, given the funding stresses that you and others in the industry have seen this quarter, could you, and maybe Michael, talk a little bit about what your plans are, obviously, going into a quarter where you're going to generate a lot of interest-bearing loans? Do you have an outlet for them? And you mentioned in some of the text here about the potential for lower gain on sale. Could you maybe put some numbers around that and how should we think about it?

Yes. The thing we're pointing out in the letter is that we think we'll be slightly above the 5% equity capital required, which, as you know, we've been running substantially lower than that over the past several quarters. That does reflect what we think will be a higher usage of balance sheet, in particular, with health financing into this quarter. Let me answer the broader question by assuming all the way out. We have a lot of conviction and confidence in our ability to fund the business. I don't think we're worried about that at all. The question for us is going to be the shape of the P&L as it goes through the various funding models that we have. It is the case that we will have slightly more on balance sheet, which means that, as you see in the Q2 guide for that revenue less transaction costs, you have two factors affecting that number in the quarter and the reason for the back half of the year acceleration. They are the late in the quarter origination, late November into December origination of interest-bearing loans that end up on the balance sheet. That creates a lot of vertical pressure, meaning that the Q2 results will be depressed on a percentage of GMV. When you look out to the back half of the year, we're implying a meaningful acceleration in revenue less transaction costs. This is an assumption of a material change in the economics of the business that simply the stuff that we'll originate in Q2 flowing through the P&L in the back half of the year. The opportunities you alluded to at the very top have actually just been on top of or in addition to the acceleration.

Our next question comes from the line of Ramsey El-Assal with Barclays. Please proceed.

I was wondering, on the changes to guidance, if you could disaggregate the impact from Peloton, I think that you called out in the shareholder letter, versus other factors?

Yes. There are two drivers, and there's some math you can do. The biggest drivers are Peloton, both and most acutely in our second quarter. To give you some context, in our second quarter, we talk about a GMV growth rate that would be 40% instead of the guided 31% in the second quarter. And we'd estimate that on a revenue basis we would be up 29% in the second quarter instead of 16%. Obviously, that's a very material headwind with respect to the top line measures in the business. Back half of the year, that starts to attenuate quite a bit. But in the back half of the year, we are modeling the impact of the movement in rates. We talked a lot about there being roughly 30 basis points of headwind, of which we're mitigating roughly half of that in our guidance in terms of the RLTC take rate. Those are the two biggest drivers. It's important to talk about the causes—those are the effects and the root causes. One of the important things as we were just discussing is as we use the balance sheet a little bit more in Q2, you're going to, again, change the shape a little bit of that margin, and that will continue throughout the year, but we think it's more of a one-time change in terms of the warehouse usage we’ll see next quarter, and we'll run the business at that level for the next couple of quarters, which will result in more revenue that we'll earn later for originations and that trend will show up as you'd expect.

Okay. And one follow-up for me. You also mentioned in the shareholder letter that your sensitivity to additional interest rate increases has decreased since you initially gave us a look at that in February. What are the drivers there? What is helping that number come down?

Honestly, I think it's as much anything actually observing the impact that our counterparties are flowing through rates. When we gave that initial framework back in February of this year, we were taking into account a lot of the potential first and second-order effects. We were doing it—we gave you a framework to think about it as every 100 basis points, there's a second or third-order effect too, because the set of the curve begins to affect decisions, and I think it's just as we've observed and seen the impact, we're updating the range for everybody.

Our next question comes from the line of Mike Ng with Goldman Sachs. Please proceed.

I just have two. First, Max, I was just wondering if you could give us an update on new product development for things like brand-sponsored promotions and whether or not the CFPB report and things like that change the product roadmap strategy at all. And then second for Michael. I was just wondering if you could talk about what GMV may have looked like excluding Amazon. And I hear you loud and clear on the RLTC and AOI margin path for the rest of the year. As we go into the back half, is that improvement in margin really driven by, I guess, like gross take rates on interest income and then servicing income because of that late fiscal second quarter originations?

So probably the most important thing to respond to the CFPB point—I don't know if you had a chance to read it. From my point of view, it's a great document describing the state of the industry. I think they did a pretty thorough job both interviewing and summarizing what the industry is doing. It was gratifying to have my S1 letter quoted in the CFPB report; that was an interesting highlight. No, I don't think our roadmap has changed at all. In fact, if you look in many ways, the letter essentially highlights that there are lots of companies in the BNPL space, and there's one that's very different. They didn't go as far as naming us, but we're the only ones who don't charge late fees, don't have a sort of other practices that regulators really dislike. I feel pretty great about what I said there. Probably the most interesting material thing in their note is coming in the industry essentially to help consumers build their credit history and credit scores through NPL loans. We've been working pretty closely with the accredited reporting agencies and various other participants in the industry to help further that along. We'll definitely continue listening to what the regulators have to say and our own ideas, et cetera. But generally speaking, I felt that it was a very positive thing for the industry and certainly for Affirm. Our roadmap is not impacted. Brand-sponsored promotions are something you will see more of going forward. It has two components to it. One is the build-out of the – which takes engineering; the product has to be actually fully built, and we are making pretty great progress there. I don't quite have all the building blocks that I want, but it's a feature that's live in a bunch of places. Then it becomes a matter of sales where you actually have to bring it to merchants and manufacturers and brands. We're getting on that. Like everything else we do, these things will take time to build. I think we'll, at some point, break them out to sell off just how cool they are and how margin-rich they become, but that's probably a conversation for another time. I feel like I may have answered the question. Was there more to it? Yes. No. Thank you. I think I covered it. I don't have to say more.

In terms of the kind of back half of the year, and I understand the question correctly, you're talking about that LTC as a percentage of GMV, improving pretty meaningfully in the back half of the year. It's really just really simple math. As you put more interest-bearing loans on the balance sheet, you defer or earn the revenue as those interest payments are made throughout the course of the loan. If you take a 12-month loan that's originated in December, for example, most of that income happens in the back half of the year. What's important, though, is the provision for credit losses for those loans will happen upfront. That means that as you get less revenue and less transaction costs in the period, even though those loans are very good and profitable for us throughout the year. But then more broadly, I think it's just really important to remember how early we are with these large partners and with the program overall. We talked about some mitigants earlier that are things we're working on right now but don't yet have reflected in the forecast. That's on top of the very long list of projects we have that focus on the unit economics, as Max talked about in the letter. That's the ordinary course of business. There's something special about that, but it's something we would and will continue to do regardless. Those can range from settling optimizations that we have on the process play page, to tweaks that we can make to how our app search feature works, to really drive better revenue take in the period and the list goes on. Those optimizations and opportunities represent a lot of the upside here. But the primary driver in the guidance is the flow-through of the larger balance sheet in experience.

Our next question comes from the line of Andrew Jeffrey with True Securities. Please proceed.

This is Julian on for Andrew. Just want to talk—go back to the credit side. I know you just mentioned that the provisioning would kind of be more front half-weighted and then we'll see kind of it come down in the back half. Is that the right way to think about that?

Yes. So we always provision at the time of purchase—strictly speaking, when we own it. That’s always the case. The difference is as we—on the margin, we'll have less marginal growth dollars being sold versus placed on the balance sheet, you'll just—the income profile just changes a little bit as you think about those loans being on the balance sheet versus off.

And if I can just get one more in. Can you kind of quantify maybe the non-Amazon growth versus Amazon growth embedded in GMV this quarter? And then also, it seems like it's a pretty good 2Q guide, all things considered. So just kind of maybe quantify that a little bit.

We can't quantify. We're not disclosing GMV by partner here. What I would point you to is we do disclose the near 500% or over 500% growth in the general merchandise category that does pick up a number of merchants, including Amazon, Walmart, and Target. Those are big, all of which had growth and strong growth, but we're not breaking out GMV by partner.

And our next question comes from the line of Reggie Smith with JPMorgan. Please proceed.

You have a slide in your presentation that shows 30-day delinquencies. I wanted some help kind of interpreting the data. When I look at kind of pre-pandemic, it appears that DQs kind of declined as the year progresses. But when I look at '22, it increased as the year progressed. And so what conclusion should we draw from this change? Should we expect things to kind of follow the arc of pre-pandemic? Is that what you're suggesting, or are DQs going to continue to kind of increase? I have a follow-up.

Yes. There is a seasonal pattern to credit performance in our experience that relates to both the purchasing patterns consumers have, as well as certain key cash flow milestones like, for example, the tax refund timelines. What you saw during the pandemic was a big surge of available monetary supply and liquidity given to consumers, which really did affect quite substantially what was in the ordinary pattern that you'd expect to see. As we're shedding all that excess consumer liquidity, I think you're going to see a more normal pattern for consumer credit trends in terms of the seasonality. That's why we're referencing back to the pre-pandemic period. If you see on Page 10 of our letter, you'll see us sitting around on top of the FY '20 pre-pandemic trends, which we feel is, again, right where we’d like the business to be.

There's another slide. I think you guys hinted at the potential of raising kind of merchant fees. Obviously, interest rates have gone up a lot this year, but you've held your zero-interest take rates relatively constant. Can you talk about, I guess, the process for raising those? Is it kind of like a bolt-on that goes out? Do you have a sense that there may be some merchant pushback? And everybody recognizes that rates are higher, but how—mechanically like how would that actually play out? And again, sensitivity—how sensitive do you think merchants are to higher zero-interest rates?

You're right; we have generally not moved prices on either consumers or merchants to date. Everybody understands that our largest supplier increased their price threefold, as Michael put it the other day. At some point, one does pass the cost on to their customers. The process with merchants is a little bit different based on the type of the partnership. Some of our largest merchant GMV segments come from platform partnerships like Shopify. Others are individual platforms like Editis, Walmart, and Amazon. There are also directly any rigs either on the platform or not that we have a direct relationship with. Those are probably the buckets. In the case of fully directly integrated folks, it's a notification that there's different contractual timelines we've committed to giving them notice for a change of price. They obviously have some ways of reacting, like a virus in some cases, in other cases, they can try to negotiate, et cetera; in the platform and the really large quantity platform merchants, obviously, it's a little bit more of a conversation because they're responsible for a host of underlying merchants and have other financial relationships with those folks. A lot of times, it depends a little bit on their schedule for raising their own prices, which they may or may not be thinking about. The merchant side of the equation is a little bit slower moving. The consumer side, we obviously have quite a lot more control because every transaction is underwritten and the price can improve based on credit quality and what we're seeing. We have to follow their lending laws, so we can't change on one person or the other. We’ve done this before; at the beginning of the pandemic, we went to our merchants and told them we have no idea what's going to happen next, but we expect our risk to go up very substantially. We will price it in. I think at that time, zero merchants pushed back. They said they understood and wanted to continue selling. I feel strongly about our ability to command a price for our products and include fluctuations we see in our supply. It's not an instant switch, but it's something we've done before, and I'm confident we'll execute if we decide to do so.

I’d say the tone from a lot of merchants right now—there are two pieces tugging around this conversation. One is that a lot are focused on margins. All of our merchant partners, clearly, anything that's perceived as an additional cost is under a lot of scrutiny. On the other hand, many merchants are looking at their outlook for the holiday season and into early next year, and they are looking for ways they can regain some of that growth in volume they had before. Those two things always net out to a good deal that allows us to achieve the economics we need and drive the volume we need to them. It is a constrained environment; merchants are dealing with real margin constraints right now.

Got it. Can I sneak one more in real quick?

Yes, go ahead.

You report your reserve rate, and it was down sequentially. Thinking about how to explain that to investors, the things that come to my mind are you've got more repeat customers, and you have a better view of the customer. I also noted your average life of your portfolio was only 9 months. Is there anything else I'm missing there? What else can we add to address concerns about a declining reserve rate?

Yes. First, just how we think about the reserve. Some financial institutions have a team of economists thinking about the state of the consumer and trying to make a forecast with their reserves. If we did that, by the time we figured it out, the loans would have been paid back. Instead, we look at the actual performance of the loans, and we look at the credit score we give loans when they're originated, and use those two things to indicate how those loans will perform. Then we look at whether those predictions of performance are holding up. That's very math-driven. We're not sitting here with a lot of judgment up and down or prognostication about future trends and deterioration in credit. It’s very math and model-driven. If you look at, for example, on Slide 11, our Page 11 of the letter, you see a pretty material reduction in the credit losses we have for our pay-for-products. While it does turn over very fast, it isn't the biggest part of our allowance; it is all on the balance sheet and will continue to be. Therefore, as you improve the quality of losses in that product, you're obviously going to see less allowance needed. Similarly, a lot of the stress we talked about in our last fiscal year mitigated, resulting in us originating a higher quality asset going into this quarter and into the back half of this year. That higher-quality asset suggests it has lower loss content. It's a good thing. It's not a bad thing; it's a very good thing that we estimate less losses in the loans that we originate.

Our next question comes from the line of Chris Brendler with D.A. Davidson.

I'll start with another one on the credit side. Can you quantify at all sort of—obviously, it's a more difficult environment across a number of issues. But for consumer credit and sort of the tightening you've done, the trends are really impressive just given all the concerns we hear about the consumer. But how much of an impact has that had on your growth forecast maybe for this year? I don't think you really changed your guidance that much on GMV. So is that a factor, or is there enough demand that that's offsetting the tighter product conditions?

There's definitely an impact of credit on our volume. It's just nowhere near as substantial as I think some folks might think. The far bigger impact in the update in our guidance is the impact that we saw from Peloton. When you take a business that has a lot of headwinds like that, we thought we were being pretty conservative in our outlook for that business this year. It has underperformed even where we had set that bar. That's the biggest driver of the reduction in the guidance for the year. We haven't given a way to quantify it, but we don't think the movement in the guidance is because we sequentially tightened our view on credit.

Okay. Great. Super helpful. A follow-up on the areas of demand and on their side, competition. I have to believe, I think we've really heard some competitors are struggling a lot more than Affirm is. Are you seeing any benefits yet as you talk to merchants of the froth coming off in an improved competitive environment? I'd love to hear sort of your take on this. Is that going to be a conversation that you've already started? Or is that still one to come?

I'm going to try hard not to sound glib and spike the football and take victory laps, etc. The short answer is yes. I've been saying for a long time that we're about to quote about tides coming out and noticing that some people are swimming without trunks on. I wouldn't classify our state of affairs as struggling, but I believe some of our competitors are. This is accretive to us. We have merchants coming in and saying, 'Hey, would you guys consider us side-by-side with a competitor?' Where in the past, we would come in and ask if they would consider it, and they'd say they were fine. Approvals were good, and now approvals are not. Ours are still doing quite well. That just makes it easier to take share. Sometimes we’re side by side; sometimes, I could rattle off brands that are choosing us alongside some of our esteemed competitors because they feel they need to continue driving their top line, while the competition no longer can approve as well as they used to. Yes, it's been quite helpful to us so long as we continue hitting our numbers on credit, which we absolutely intend to do, and keep approvals high. This should give you a sense that, all these quarters, I've been promising that the curve is really steep. We need to move our GMV just a little bit to reduce our prospective losses by a lot. It seems to be working out as we promised. As long as it keeps going, we will continue taking share.

Awesome. Congrats on a tough environment, and also thanks for all the disclosures on the credit. It's really helpful.

Our next question comes from the line of Kevin Barker with Piper Sandler.

I just wanted to follow up: considering your guidance, you've tightened underwriting. Growth is slow to pay, but obviously a lot due to Peloton. When you look at 2023, are you assuming what the base case is for unemployment and whether it's slowing in spending? Are you starting to put in place additional measures to assume that unemployment is going to spike, or is there going to be something worse than what we expect beyond what most economists have in their forecast? Is there something you're anticipating and managing for?

I'll start on the credit side, and Michael probably has comments on the rate side of things. We are anticipating some degree of worsening on the credit side of things. That said, we really concern ourselves with the next 4.5 months of volume. It's really, really important to mitigate. Our ability to manage credit to the numbers we choose is a consequence of our ability to underwrite and get the data sources we need and make it happen very quickly. One of the most important structural parts of how we're different from everyone else in the market is that we have very short-term products. We're not granting lines, meaning that a credit decision made today, even if erroneous, will be the last time we make that mistake. We can deal with a lot more demand than we decide to lend. If consumers feel more stretched, they come to us more often. That does not change that we apply the same diligence and care to every loan we underwrite. We focus on making sure that our data sources are fresh and that our models react correctly to changes in consumer behavior, which we've seen, given over the last 5-6 years of operating, including the last 6 months of the current macroeconomic volatility. Our ability to weather whatever incoming storm might be headed our way is deeply rooted in the fact that we make very, very short-term, relatively speaking, credit decisions. We have no shortage of demand for our product. I'll pause there; I just want to add another point to make, but Michael has a few.

No, just look, the way we approach it is always to take the current consensus, to take the forward curve or rate assumption. We don't try to grow, and there are several scenarios that could play out very differently. As you point out, we could enter a recession and have more employment; that would probably come with less pressure on rates than what we’re currently modeling. The flip side is rates could get worse, and employment could continue being very robust. We’re trying to be middle of the road here and be very close around current macro consensus, recognizing that these forecasts can be wrong, but we have to make some assumptions. Just like we did when we gave our guidance at the beginning of the year, we're pegging it to the rate curve, and as rates move, you should expect that to impact our business per the framework we've given.

One last point—sorry, on that point, the point I was going to make, I've blanked on. Another thing we have because of the Adaptive Checkout, which we had the presence of wanting to launch about a year ago, is the menu of terms the consumer will see is programmatically determined by us. We have enormous control over this, a 4.6% average; the product isn't just short, we also get to decide whether a particular credit quality applicant sees the longest or shorter durations. One of the things we could be preparing to do, although we don’t have to act on it right now, if we felt that unemployment is about to spike or starting to go up very rapidly, we would pull in terms and make the 4.6% average go down just to ensure fewer opportunities for our borrowers to default. That’s another level of control we have. This typically corresponds nicely—our research and past lives with the shift from luxury buying to general merchandise purchasing. People don’t need to borrow quite as much, making shorter terms make more sense for cash flow. This should not impact our take rate on the consumer side, but will reduce our risk.

Sorry, Max. Go ahead.

Yes, I was just saying there's quite a bit of advantage to having rapid velocity on your lending and being able to shift. When you think about the RTLC guide for the back half of the year implying quite a bit of improvement, do you feel like you could continue to hit that if things get worse? Obviously, maybe there's a little slowing growth and tightening underwriting, but are you going to focus more on profitability? Or does that goal get pushed out a little further but still remain something you can see in the future on hitting some of those guidance? We'll hit profitability as scheduled. We are not postponing profitability. The products we're focusing on are about creating more RLTC and lessening some rate volatility. Ultimately, we feel very good about our schedule. We are not suffering from any need to postpone on our deal with destiny. I think I’m not supposed to say that, but I like the alliteration.

And the last thing is we take our guidance really seriously; we grow our thoughts onto it. If our guidance moves because we think something has changed, you saw the GMV outlook here, as we talked about, a pretty big impact from Peloton. We are digesting a headwind in rates. There are certainly macro conditions that could make that goal and objective not come through, but as we sit here today, we feel very confident.

Acts of God are not included in our guidance.

And our next question comes from the line of Bryan Keane with Deutsche Bank.

Just want to ask on two popular questions we get. Just on approval rates, it sounds like they stayed high, but maybe they were down a little bit in the quarter. Can you clarify that and then the outlook on approval rates, what do you expect?

The approval rate has actually stayed relatively flat throughout the quarter. In fact, they basically stayed flat for the last 9 months, if memory serves, with a slight uptick in the interim—in the 3 months in between. The first 3 and the last 3, we actually increased the approval rate a little bit. Maybe this quarter, it went down a tiny bit. This is sort of back to the products that we offer consumers. We have enormous control over the actual shape of the risk we're going to take on. We generally have a way of finding a way to say yes to a consumer. If somebody comes in and says, 'Hey, I want to borrow $100 over y months or weeks,' in some situations, the answer is no, that's not going to happen because we just don't think you can carry this much cash flow burden monthly. However, we're very happy to help you with a lower monthly number if you’re willing to prepay the delta, basically. And that has a dozen other levers that allow us to shape the risk we take and ensure we meet consumers without adding unnecessary burden to our provision. We have been very active in using those levers. We do this at the merchant-by-merchant level, sometimes SKU by SKU level because we can infer which products are getting prioritized for repayments. To date, we haven't needed to slam the brakes on approvals. Again, credit is job number one. We will always prioritize managing to the numbers we must hit to ensure capital partners see us as the best yield, predictable yield generator for them, but that does not mean we turn people away at the door. It does mean that some people will have a slightly larger down payment request. In some cases, we’ll ask for more information, which is somewhat burdensome but better than being told no. We have confidence in our ability to maintain rates. While we don't generally speak and contractually agree to guaranteed approvals with merchants, the reason they keep us hired over our competitors is that we always deliver on approval rates, first and foremost, which helps them drive top line sales that wouldn't have happened without Affirm.

Got it. No, that’s helpful. And then maybe just an update, Max, on the Debit+ product and the rollout there.

Thank you for asking. I was wondering if somebody might remember. I’m actually trying not to be glib. So one of the things I could do as the Product in Chief a year ago and don’t feel I can now, is roll out a product with economics that I don't feel are fundamentally accretive to the business. Sometimes in the beginning of last quarter or right around that time, we’ve taken a list we generated and given a meaningful number of people—tens of thousands of active cards—to observe the usage. As with every new credit product, you end up with economics you don't really like. We spent the last 3 months chiseling away at all the various fraud vectors and loss possibilities and the new types of losses that come with debit losses. There's pre-transaction, which is very similar for many products we have inside the SuperApp; then there's the post one, which is where you swipe, and you choose to split. This is a 24-hour limbo where the transaction might turn into pay now or could become pay later. There are also inhibition funds, which is where pay now can become a default and be written off. There are various loss vectors, both intentional and unintentional; we’ve spent the last 3 months making sure that we feel good about the unit economics of this product. We're almost there. I feel very good about it, and probably January 1 is a realistic timeline when we're going to start pushing this forward. The day you see your Affirm app enter a tile saying hey, get yourself a Debit+, you will know we’re starting to promote this product quite aggressively. We’re not including anything in our guide about what Debit+ will do for us in volume or revenue on RLTC basis because it's a bit too hard to model that right now, but we’ll probably talk about it more starting next calendar year. We will not risk our unit economics just to launch a cool new product sooner than we’re ready. Today’s concern about profitability reminds us that we could amend those economic risks.

Our next question comes from the line of Mihir Bhatia with Bank of America.

I just want to ask just a couple of questions. First was in your Q1 results in the first quarter, I think you mentioned higher interest rates impacting gain on sale with pricing with certain forward flow buyers. Can you talk about that a little more? Obviously, I understand interest rates are up, but just trying to understand how often that pricing gets adjusted. Is the lower pricing going to stay until I think these agreements tend to be 2-3 years? Just trying to understand, does the lower gain on sale now mean you're locked into those lower gains for the next couple of years? How does that work?

That's a good question, yes. The commentary is really about the year-on-year comparison. The agreements vary; some are locked in for the duration of the contract, and others have regular repricing triggers that vary from 6 months to even floating arrangements. So we have lots of different flavors. But I wouldn't say I'm worried about being locked in at the worst rate; I think a decline in rates would be good for us.

Okay. I just wanted to ask about adjusted operating margin. The first quarter came in better than your guidance, but obviously, the top-line guidance is coming in a little bit lower. However, you're also slowing down hiring. Just trying to understand, was there something unusual about the first quarter, like some expenses got pushed to the second quarter or something? What's happening there? Anything to call out?

No. We did have a little bit of a benefit associated with some items that aren't repeatable throughout the course of the year, but the strength in revenue less transaction cost combined with slightly below hiring plan were the biggest drivers for us. In the first quarter, the reduction in the hiring plan is as much about managing the fiscal '24 number as it is about managing '23. Just think about the timing of the hiring we have in the plan. An employee we hire on the last day of the fiscal year doesn’t really affect profitability in that year, but it is extra costs that carry into the next year. Our focus is to get our units as healthy as possible and to get the operating expense as right-sized as we can going into next fiscal year when we want to be as fit and lean and strong as possible.

Our next question comes from the line of Eugene Simuni with MoffettNathanson.

Just got one question on the consumer engagement platform. Your transactions per active user keep going up, which is great—a sign of better engagement. But if we do the math on sort of dollars spent per active consumer, that keeps going down. I understand that there might be some mix factors, and perhaps Peloton is influencing that. Can you talk about that trend a little bit? Do you see a path to getting consumers to spend more dollars with your platform over time? What levers might you be able to use to encourage them to do that?

There are two competing vectors here. To be completely honest, I track slightly different metrics. I care about average ticket size for every transaction and the number of transactions per active user. Those are contours of our consumers engaging. It is, in fact, the case that if you ask someone to spend more money through you, you are absolutely signing up for smaller tickets. People aren’t going to buy an exercise bike every quarter; they might buy a couch once a year or so, but then you're trying to get high frequency, which is certainly what we're chasing here. You're looking at things like apparel, maybe tickets, travel. We’re very active in those industries. General merchandise is an umbrella name for everything you buy often. AOV is expected to continue coming down, and I think the growth of transaction frequency per user indicates increasing spend in the payment category, which is uniquely suitable for these shorter-term lower AOV transactions. That’s where a lot of the growth is coming from. As you might expect, we’ve dominated high AOV longer periods in the U.S. markets. We're expanding into the short-term lower AOV transactions. I think in the long term, I care about trying to get to the most transactions possible. That will result in the highest total spend with Affirm by any one active consumer, but for now, we’re focused on being there for the consumer with monthly payments. If the average ticket size decreases, that trend signifies success.

Just real quick on the math. I think the average is maybe—I'm not quite sure what math you're doing and how you're looking at it, but the averages can really lie here. One $2300 purchase can look like a lot longer share of wallet even if it’s not repeatable, as opposed to those consumers who might never entertain that $2300 purchase. For consumers engaging on our platform today, we definitely believe we have a higher share of their spend.

Thank you. And our final question comes from the line of Andrew Bauch with SMBC Nikko Securities.

Just looking at the Affirm share of U.S. e-commerce spend, and this kind of dovetails with the prior question, is growing above the 2% in fiscal '23 and beyond and the trajectory of that. Is that more a function of you making progress on the consumer side, or is it more about the continued expansion of wallet within merchants? I know they likely go hand in hand, but any other color you could provide would be great.

We are building a network, and one begets the other and back. I assume we're around 2% of e-commerce, and now I feel I’ve got to shop more soon. The good news is that we're currently integrated at about 60% of all U.S. e-commerce. We can increase that 2% penetration by getting more and more share of wallet with the merchants. Our merchants really depend on us in these inflationary times because consumers need to stretch their dollar, and we're there for them. We have a healthy business that is generated from our own services in our app, some of which is merchant integrated, but a lot of it is not. I'm excited about what less will do for us, extending us to areas like daily purchases where we don't play today. Importantly, it also gets us to offline, which isn't included in that 60% number and remains a nicely growing but very trivial amount of volume. We have lots of ways to get above that, too. When we get there, I expect that growth will continue.

Just looking at the industry mix—a sizable opportunity that could grow over time would be the travel and ticketing segment, thinking about getting further into airline purchases or hotels. Could you speak about that vertical and what obstacles or potential pathways you foresee taking that 2% up over the next few years?

It's a great opportunity. Travel is a wonderful place to apply what we have to offer. We have partnerships in the travel industry today, both in airlines and hotels, which are probably least penetrated from our viewpoint. We have online travel agency integrations that have performed extraordinarily well for years. Direct integrations with airlines are newer, and more work is needed. The cool thing about travel is kind of a sweet spot for what we know how to do—something that other teams don't do well. All these integrations with large retailers and platforms, now with hotels and expanding our work with OTAs, requires building products that are fine-tuned for each industry. This is crucial for doing this right—ensuring we convert a lot of consumers and deliver the value our merchants expect. I feel very strongly about it. For a long time, I’ve said Affirm is a machine—engineers in, RLTC out. We’re being very careful with hiring. These opportunities may grow bigger and faster, and we'll incorporate discipline to ensure they align correctly.

Thank you. Ladies and gentlemen, this concludes our question-and-answer session. I would like to turn the call back to Zane Keller.

Well, thank you, everybody, for joining the call today. We look forward to speaking with you again next quarter.

This concludes today's conference. Thank you for your participation. You may now disconnect.