Katapult Holdings, Inc. Q3 FY2021 Earnings Call

Thank you and good morning. Welcome to the Katapult Third Quarter 2021 Earnings Conference Call. With me today are Orlando Zayas, Chief Executive Officer; Derek Medlin, Chief Operating Officer and Karissa Cupito, Chief Financial Officer. We issued our earnings release and presentation this morning and we will be referencing these during the call. Both can be found on the Investor Relations section of our website. We will be available for Q&A following today’s prepared remarks. Before we begin, I would like to remind everyone that this call will contain Forward-Looking Statements regarding future events and our financial performance including statements regarding our market opportunity, the impact of our growth initiatives and our future financial performance. These should be considered in conjunction with Cautionary Statements contained in our earnings release and the Company’s Form 10-Q for the quarter ended September 30, 2021. These statements reflect management’s current beliefs, assumptions and expectations and are subject to a number of factors that may cause actual results to differ materially from those statements. Except as required by law, we undertake no obligation to publicly update or revise any of these statements, whether as a result of any new information, future events or otherwise. During today’s discussion of our financial performance, we will provide certain information that constitute non-GAAP financial measures under SEC rules. These include measures such as adjusted EBITDA and adjusted net income. These non-GAAP financial measures should not be considered replacements for and should be read together with GAAP results. Reconciliations to GAAP measures and certain additional information are also included in today’s earnings release, which is available on the Investor Relations section of our website. This call is being recorded and a webcast will be available for replay on the Investor Relations section of our website. I will now turn the call over to Orlando.

Thanks Bill. Good morning and thank you for joining us. On today’s call we will review our third quarter 2021 results, share what we are seeing in the current macro environment and provide an update on how our strategy for sustainable growth within our large addressable market is progressing. We are confident our highly scalable technology is delivering on our mission of financial inclusion for the nonprime consumer. We see growing evidence of the value and satisfaction that we bring to our customers as well as incremental sales opportunities we enable for our merchant partners that allow them to reach a very large and unpenetrated market of nonprime consumers. Our long-term vision is supporting this underserved segment that is coming into sharp focus and we are pleased with our progress on our platforms and partnerships that enable ongoing growth. Turning to Slide 5, you can see the addressable market for durable goods e-commerce is already substantial. As the leading e-commerce financing platform focused solely on nonprime consumers, we believe we are well positioned to capture a significant share of the durable goods e-commerce market, targeting underserved consumers as we continue to grow strategically. Our proprietary technology platform combined with our sophisticated risk and decisioning model is designed to allow us to deliver value-added solutions to our merchant partners and offer innovative lease financing solutions to underserved nonprime consumers. We pride ourselves on delivering a seamless customer experience with flexible and transparent payment options. Looking ahead, we will deliver incremental opportunities to our customers and merchant communities, bringing more financial possibilities to the nonprime consumer. As you can see from the quarterly highlights on Slide 6, our team continues to execute well in the face of a difficult macro environment. Consumer spending habits are changing as we begin to emerge from the pandemic, with people starting to move about more freely in public, and spending on services and wants like entertainment and travel has increased. However, demand for durable goods that are needed daily remains strong. In addition, significant supply chain disruptions are creating challenges for our merchant partners to secure inventory and fulfill orders in a timely manner, which is pressuring their sales and consequently our revenue and gross originations. In spite of these ongoing macro challenges, we continue to capture market share and had 25 new merchants added in the quarter, bringing our total to 82 new merchants year-to-date. Our merchant retention rate also remains strong, while our customer satisfaction metrics such as our net promoter score and repeat customers are up significantly year-over-year. We expect that after a few more quarters of recovery from the pandemic, we will see a return to a more normal macro environment. Our strong balance sheet with 100 million dollars in cash supports our growth strategy which includes expanded business development that is driving the addition of new merchants that can be onboarded more quickly as strategic investments in new product and technology initiatives set us up for an exciting year ahead as we seek to accelerate the growth of our business. Despite the current macro challenges that are impacting our merchant partners, we are executing well against a challenging sales backdrop. We have established a solid operating foundation from which to execute our longer-term growth strategy and believe we are at the early stages of building a large and durable financial services enterprise with dramatic incremental profit opportunities as we scale. I will now turn it over to Karissa, our CFO who will provide more details on our third quarter performance.

Thanks, Orlando. As detailed on Slide 7, total revenue for the third quarter of 2021 was 71.7 million, an increase of 1% year-over-year. Revenue year-to-date reached 229.8 million versus 173.8 million last year, an increase of 32% year-over-year. Gross originations were 61 million in the third quarter of 2021, up 1% year-over-year. Gross originations year-to-date are 189.1 million versus 175.3 million, up 8% year-over-year. As Orlando highlighted, significant supply chain disruptions are creating challenges for our merchant partners to secure inventory and fulfill orders in a timely manner, which leads to lower sales and conversion rates. These headwinds did slow third quarter origination growth more than we believe would have been higher absent a challenging macro environment. Despite these difficult macro factors, we were able to slightly increase overall gross originations in Q3 as our merchant partners work through the supply chain disruptions. Breaking down our Q3 gross originations, our largest merchant partner reported third quarter U.S. sales down 21% year-over-year. However, we actually increased our penetration rates defined as originations as a percentage of U.S. sales with the merchant, and our gross originations with that partner were down only 6% year-over-year. Our gross originations with our other merchants grew 17% year-over-year spurred by new merchant additions. We believe the overall trajectory of our revenue and origination growth will accelerate as we continue to add new merchants to a healthier baseline of existing growth originations. So we are optimistic these industry trends will ultimately prove to be transitory; we anticipate supply chain disruptions will continue to create uncertainty for our merchant partners throughout the remainder of 2021. Given these macro headwinds, it remains difficult for us to have sufficient visibility for the balance of the fourth quarter and be in a position to provide guidance at this time. As a result, we plan to update you on our fourth quarter progress in the beginning of December after the Cyber Five period, which is Thanksgiving through Cyber Monday, and historically gains record shoppers and sales for many retailers. Looking longer-term, trends in e-commerce sales remain extremely encouraging. Our adjusted EBITDA for the third quarter of 2021 was roughly breakeven at 122,000, reflecting three areas of year-over-year expense increases. One, more normalized seasonal leasing performance; two, some level of incremental public company costs, and three, our increased investment in key new hires and growth initiatives. We will dig into each of these categories more specifically, but at a high level, we feel our profit margin profile is poised to grow nicely as we gain economies of scale through our growth strategy. Looking at Slide 8, the stimulus payments that occurred during 2020 and early 2021, in response to COVID, led to historically favorable credit performance for prime and nonprime consumers alike. As we move through 2021 the credit environment is beginning to normalize to pre-pandemic patterns. Our leasing payment performance is following that track in both lower early buyout levels and higher write-offs. Our 90-day early purchase option rates have trended down through Q3 and delinquencies for the period increased year-over-year but are stabilizing at pre-COVID levels. Our third quarter bad debt expense was up compared to a year ago when the issue of the stimulus checks created historically low delinquency rates. However, bad debt expense came down sequentially from 8 million in Q2 of 2021 to 6 million this quarter. Our provision for impairment on our lease assets, which is a proxy for write-offs, was 3.4 million in the third quarter of 2021 versus 4.4 million in the third quarter of 2020. We do anticipate this to normalize back to our pre-pandemic levels going forward. In regards to the credit normalization that we are seeing, one crucial distinction between buy now, pay later and our lease-to-own business is our revenue model driven by customer lease payments. We don’t rely on merchant discounts but rather higher margin lease economics and therefore we have more capacity for variations in our delinquencies. In addition, our proprietary credit algorithms are constantly becoming more effective as we learn from additional data and sophisticated machine learning tools, which allows us to increase our approval rate over time while maintaining lease performance that meets our hurdle rates. Finally, I would note that there are elements that counter cyclicality in our business. As we discussed on our last call, historically high savings rates and low delinquency rates earlier this year with the prime providers slightly stretching down the credit spectrum to capture some consumer transactions in our highest score bands. Now as the credit environment normalizes, any modest deterioration in macro consumer credit levels can be positive for our company, as we expect prime credit providers will tighten their underwriting, leading to higher quality consumers coming down into our market and improving the overall quality of our customer pool. Turning to Slide 9. Overall operating expenses were up 10.3 million year-over-year. This operating expense growth can be largely split into two categories. First, additional expenses of being a public company including D&O insurance premiums, accounting and legal expenses. Second is investments for future growth, focused on technology and product enhancements and additional business development staffing. Our technology headcount, including contractors, is up from 32 professionals a year ago to 69 today, and our sales and marketing headcount is up from 19 to 37 full-time employees. We anticipate that these expenses will shrink as a percentage of our revenue as we scale new growth originations. We expect investments in growth to continue into 2022 as we invest to capitalize on a massive scale of the addressable market opportunity ahead of us. We believe that the potential payoff from those investments is significant over time as Orlando will discuss further.

Thanks, Karissa. We continue to maintain the strength of our balance sheet which gives us the flexibility to invest in organic growth initiatives; we closed the third quarter with nearly 100 million in unrestricted cash on hand and 57 million available from our asset-backed revolving line of credit. We are putting our strong balance sheet to good use by continuing to strategically invest in our business in order to capture greater market share. Our investment focus continues to disrupt the omni-channel experience through technology and product enhancements that align with our mission statement of financial inclusion and to support a clear and transparent shopping experience. We recognize the need to expand our sales team and continue our investments in marketing and accelerate our growth. We have doubled the size of our business development team over the past year to 30 people, which includes 16 members who joined during the third quarter. Each new team member is onboarded during a 90-day period and has been able to start generating leads and bringing on new merchant partners. We have also more than doubled the size of our technology and product team year-over-year. Our team is working on three key fronts. One: platform enhancements to support new and emerging merchant demands across all channels; two: operating infrastructure that will support large-scale expansion; and three: customer and merchant solutions that expand access and transaction opportunities. We are already seeing the results of these growth initiatives as we continue to steadily add new merchants. We added 82 merchants year-to-date compared to 54 new merchants during the full-year in 2020. We anticipate that growth will accelerate into the coming year, particularly as we expand into more diverse end markets. In addition, our firm partnership on their Connect platform continues to expand. They have recently identified more retailers with a Connect platform that will bring new incremental customers. We continue to be excited about this partnership, as it gives retailers a simple platform to acquire new loyal customers. While the bulk of our recent merchant additions have been small partners, our dialogue with medium to enterprise-sized merchants continues as well. We believe that the growing evidence of our distinctive customer-centric approach is accelerating discussions with larger volume partners. Although it's worth a reminder that the sales and onboarding cycle for merchants can be quite long. We continue to build our merchant base while managing our business with an eye towards sustainable long-term growth. Katapult provides strong value to merchants. Our variety of integration options ensure that the integration is achieved efficiently in as little as 30 days. In addition, our proprietary and differentiated technology and highly predictive risk model offers merchants the opportunity to access our large segment of underserved nonprime consumers, driving higher conversion rates and higher sales. Many of the transactions enabled by Katapult are incremental to merchants, as these customers would have otherwise been declined by traditional financing options. We also drive repeat levels for our partners by providing the needed service of excellent customer service and support. We are truly built for long-term relationships, and we see it in our customer data; repeat customers are up 42% year-over-year, with more than 50% of new gross originations coming from repeat customers. Our merchant pipeline is larger than ever, and as merchants resolve a variety of near-term challenges and constraints they are facing such as supply chain issues and shortage of IT resources, we anticipate our growth trajectory to accelerate over time. Our customers appreciate the ease of use of the Katapult platform and our customer-centered approach. Our lease application is straightforward and provides our customers with flexible and transparent payment options. Whether applying for a lease through our direct integration or one of our waterfall partners like a firm, our customer satisfaction continues to be high with a net promoter score of 60 as of September 30, 2021, which is up 23% year-over-year. In conclusion, as we head towards the end of the year, we are proud to be providing high levels of both customer and merchant satisfaction. We are also pleased with our ability to weather the storm of continuing macro headwinds. We believe our near-term investments in new customer solutions and multi-channel merchant opportunities will open up even more growth potential in 2022 and beyond. I’m excited about our positioning and ability to take advantage of the long-term secular trends of e-commerce and retail, which matched with our strong balance sheet will provide us with ample liquidity to strategically grow our company. With that, I will now take questions.

Thank you. [Operator Instructions] Our first question comes from the line of Ramsey El-Assal with Barclays. Your line is now open.

Hi, thanks for taking my question this morning. I appreciate it. I wanted to ask if you could sort of help us think through the P&L implications of a return to a more normal macro environment. Does that mean sort of a return back to that high double-digit growth we saw previously?

Sure. I think if we step back a little and we look at the macro environment, it continues to pose challenges. But we are seeing some green shoots around the credit normalization or at least performance stabilizing, and those things are obviously going to help us as we see the credit tightening on the prime side. You have probably noticed that prime lenders have been talking about or posting that their delinquencies have been increasing lately. That means that would lead to more tightening, which should generate kind of normalization of what we talked about last time and the better credit customers coming to us. So we are pretty excited that things are starting to get back to normal. And then from a growth perspective, we continue to capture market share, and we are steadily adding new merchants. Some of the merchants have been pretty distracted in the last quarter around getting integrations because of the supply chain issues that they face. So we see kind of the door starting to open a little bit as we get to the holiday season and into next year. Yes, Derek.

Yes. Ramsey, this is Derek. I will just add that we think continued progress on our path is really consistent with our broader strategic goals of building a global enterprise here for the nonprime consumer. And that includes investing in our channel partners and our channel investments so that we can scale up rapidly to some of the announcements that we are adding to different platforms and different channel partners. And this is really critical for us to be able to scale quickly. In addition, we have been running many controlled experiments in tinkering with our R&D to improve conversion and personalized offers for individuals, and we are really excited about the results that we are seeing. That is how we believe that we are going to continue to gain share as the growth comes back in areas that have been depressed; we will be a gainer in that space.

That is great. Thank you. And I wanted also to ask about an update on the IT constraints with your partners. I’m just trying to gauge whether that is certainly starting to loosen up or remains somewhat of a bottleneck?

Yes, I mean, we are starting to see it kind of normalize, I think is the way to describe it. Obviously, during the holiday season, many of our retailers who are holiday-driven are in pretty cold freeze. So what we are seeing is kind of more response around, let’s talk after the first year, let’s put your integration later. So I believe after the first year, we are going to see that open up.

And would you characterize that as sort of some pent up implementations that would then disproportionately benefit next year, you get pushed into next year and therefore provide a little bit more of a tailwind next year, is it that big of an impact?

We believe not only that, but I think they were also between the supply chain disruptions that they are trying to manage through and then some of the BNPLs which kind of got assigned this year. Now, the prioritization, I think we are moving up the prioritization level of many of the retailers we are talking to.

Got it. Terrific, thanks so much.

Thanks, Ramsey.

Our next question comes from the line of Josh Siegler with Cantor Fitzgerald. Your line is now open.

Hi guys. Thanks for taking my call. My first question is around the increased penetration of your largest partner, I would love to get a little more detail around what were the driving factors behind that, and do you believe that can continue in the future?

Yes. I mean, the team works really closely with our top retailers. And actually many of our retailers around how do we drive conversion rates. And we do a lot of marketing, a lot of testing. Obviously, our return customer base is really strong and continues to grow. So that helps drive that penetration rate even higher. But it is about how you position the product to the customer online which is much different than in store where a salesperson may be taking over the narrative. We have been testing many options to try to improve that conversion rate, and we see the conversion rates improving. We are pretty thrilled with the fact that our top retailer was down 21% and we saw some gain share there. Derek, do you want to add anything?

Yes. Great question. Really, we have got a vision of being able to deploy personalized offers for every consumer given their situation and at whichever retailer, whatever kind of type of transaction they are looking to execute, many of the investments we made earlier this year give more capability around that space. And so our ability to test and give relevant offers and campaigns are really showing some early signs of fruiting, and the team is really excited about those results, and we think that is going to gain share.

Excellent. Yes, that color is very helpful. Thank you. And then we have seen a lot of big box retailers start implementing traditional buy now, pay later offerings into their checkouts. Do you see that progressing over time as they eventually move to the nonprime customers even lease-to-own, and simply it is just a matter of progressing down the chain? I would love to get a little more color on that.

Yes, no. That is exactly right, Josh. Right now BNPL is hot and it will be for a while, but I think it is just a prioritization level with many of the retailers. As we see they are managing through the supply chain issues and they are working through the holiday season. They continue to prioritize things further up the chain. We will see that I think happening after the first year. BNPL is really easy to implement, because it is just splitting the payments over four, and it is not as complicated as ours could be and also can drive quite a bit of incremental business. But I think once that is done, the next step is how do I drive even more incremental customers, and that is through lease-to-own.

Yes Josh, I will just add one thing: the process of going from a BNPL into a lease-to-own conversation or into a Katapult conversation is just an evolution of understanding the power of providing payment flexibility to the customer set. The nonprime customer is on these retailers' websites or in their stores already and just have not traditionally been able to transact or transact at the level that they would like to. We just see this as a journey that retailers are going through of awareness of what different payment options and financing can do for them, and how that powers loyal and recurring transactions from great customers while accessing new markets.

Excellent, thank you very much.

Thanks Josh.

Our next question comes from the line of Mark Argento with Lake Street. Your line is now open.

Hey good morning guys. Just a quick question on where you guys are in terms of your sales team. I know it seems like you have been hiring fairly aggressively and building out the team. Any updates there would be helpful?

Yes, we have been real aggressive. Actually, we had I think a team of seven new business development representatives start this week. We have been real aggressive at hiring. Surprisingly, I know that hiring has been tough, but I think we are able to attract really strong talent on the sales side, and right now we are up to 37 people. This includes lead generation support and account management, but is mostly focused on those business development roles that take about 90 days to get onboarded. So, once they are onboard, we start generating leads for them; they start doing the outreach and some from an SMB perspective, it is relatively quick. We should start seeing the fruits of that labor into next year. And now on the enterprise side, we have added a couple of heads, so that they are out talking to the larger merchants that do take a little bit of time, but we believe that we have got to be out there, talking about the mission, talking about the company and getting our name out there. And it is going to be done with that large team. We are going to continue to add; I think by the end of the year, we will have over 50 people in that group. We believe that is a really good capital allocation because we have some really strong processes around how we are generating leads and how we are reaching out to leads, along with the marketing support that goes along with that. We are starting to see some green shoots, if you will, on conversion rates.

Okay that is helpful and then just one quick one. In terms of I know you had mentioned it seems like overall broader consumer credit default rates are starting to pick up a little bit, partially as a result of probably less stimulus in the market to a degree. In terms of the buy now, pay later guys, it seems like maybe they were stretching their bands a little bit in terms of how far down the credit spectrum they were willing to go. Do you anticipate maybe that tightening back up if credit default rates start to pick up a little bit and stimulus isn’t as robust?

Yes, no, Mark, that is exactly what we believe is going to happen. I mean the early signs and the recent announcements indicate that delinquencies on the prime side are starting to increase. So that is a natural tendency for them to tighten up, especially in the lower credit bands. And those are the customers that will flow to us, and that is why we stated in the prepared remarks that we are starting to see more credit normalization.

Great. thanks guys, good luck through the holidays.

Thanks Mark.

Our next question comes from the line of Anthony Chukumba from Loop Capital Markets. Your line is now open.

Good morning. So a couple of questions. I guess, the first question was on gross profit. Obviously, it was down pretty significantly year-over-year. Now, obviously, part of that was bad debt expense. But I was just wondering if there is any additional color you can give in terms of the drivers for the lower gross profit? Thanks.

Absolutely. What we spoke about in prepared remarks and I think what we are seeing across the board is that credit is normalizing. If you look at last year versus this year on gross profit, last year we were in the midst of stimulus and the lowest delinquencies in the history of the company. Now we are just right-sizing to a more stable gross profit percentage. On top of that, our revenue, and we spoke about it last quarter, and it is continuing into Q3 is that we are testing and working through pricing promotions offers, and other personalized incentives to really see how we can drive conversion rates. Obviously, if you charge less, you are going to have less revenue that you are booking. So it is a function of both of those: credit normalization and some of the promotions that we are testing.

Got it, that is helpful. And then I guess my second question, when I look at your balance sheet, you have over 100 million dollars in cash and obviously, your stock dislocated pretty significantly after your second quarter earnings release. So I guess, I was just wondering what is the thought process in terms of not aggressively buying back stock? You just saw one of your competitors announce a pretty large tender and the stock reacted pretty well to that. So I guess, what is holding you guys back from buying back stock?

Antony, we are, I know and I don’t think we are a growth company. We had a lot of discussions around how do we deploy our capital? We are focused on growing the business. We are adding a ton of salespeople; we have more than doubled the number of salespeople that we had last year. We are investing on the tech side, so that not only do I have the platform stabilized, but we are also working on some new initiatives that will help continue to drive growth to support those salespeople. I just think it is wise to invest in the company at this stage, and that is what we have chosen to do.

Got it. That is helpful. Thank you.

[Operator Instructions] Our next question comes from the line of [indiscernible] with Loop Capital. Your line is now open.

Hi there. You mentioned the loss rates had normalized at pre-COVID levels and I was just curious to get your thoughts on how that transpired and what your collections staffing and what are the drivers why you think it is normalized at below pre-COVID levels?

Yes, good question. So thank you. This is Derek. When we look at delinquency and we analyze the trends, when we talk about our loss rates and what has been happening in the portfolio, we have to look back now many months to see trends that look like pre-COVID. What we are seeing is essentially pay-through rates and execution that looks much more similar to late 2019 than it did anything in 2020 or early 2021. These are areas that we are very familiar with. We are very familiar with having the right amount of staffing and resources. Just to emphasize, most of what we do in terms of how we drive performance and curing of accounts that go delinquent is all in the digital space. We are very customer communication centric; we are very clear on having technology drive our solutions, so that supports customers entering and that is a very data-driven approach. So staffing is not a major issue for us whenever we go through the seasonality of these ups and downs. We are proud of how the team has responded to the shifts, both on the data science and the policy side, as well as on the collections execution side. This is just a part of everything that we do on a day-to-day basis.

Okay. Thank you.

Thank you. There are no further questions. I will now turn the call back to Orlando Zayas for closing remarks.

Thanks, Sara. So we continue to be really excited about the long-term growth of the company. We are starting to see some green shoots in the aggressive hiring of our sales team, the penetration rate improvements that we are seeing, the build-out of our tech team to disrupt what we are doing from both an e-commerce perspective and the omni-channel experience. So we are excited going into 2022 that we have a team very energized on providing financial inclusion to our underserved community. The disruption within e-commerce continues. Our customers, our merchants rely on us to continue our mission over the next several years. We appreciate the questions, and thanks for your time today.

Ladies and gentlemen, this concludes today’s conference call. Thank you for your participation. You may now disconnect.