Katapult Holdings, Inc.

Thank you and good morning. Welcome to the Catapult Third Quarter 2021 Earnings Conference Call. With me today are Alanda Dias, Chief Executive Officer, Derek Mandlin, Chief Operating Officer, and Krista Cuperto, 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 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 reflected 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 financial information that constitute non-GAAP financial measures under SEC rules. These include measures such as adjusted EBITDA, adjusted net income. These non-GAAP financial measures should not be considered replacements for and should be read together with our 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're 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 non-prime 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 non-prime consumers. Our long-term vision of supporting this underserved segment is coming into sharp focus And we are pleased with our progress on our platforms and partnerships that enable ongoing growth. Turning to slide five, you can see the addressable market for durable goods e-commerce is already substantial. As the leading e-commerce financing platform is focused solely on non-prime consumers, we believe we are well positioned to capture a significant share of 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 non-prime consumer. We pride ourselves on delivering a seamless customer experience with flexible and transparent payment options. Looking ahead, we'll deliver incremental opportunities to our customers and merchant communities, bringing more financial possibilities to the non-prime consumer. As you can see from the quarterly highlights on slide six, 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, spending on services and wants like entertainment and travel has increased. However, demand for durable goods that are needed on a daily basis 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 add merchant partners, with 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 more normal macro environment. Our strong balance sheet with $100 million of 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 a strategic investment in new product and technology initiatives, setting 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 in early stages of building a large and durable financial service enterprise with dramatic incremental profit opportunities as we scale. I will now turn it over to Carissa, our CFO, who will provide more details on our third quarter performance. Carissa?

Thank you, 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. Growth originations were $61 million in the third quarter of 2021, up 1% year-over-year. Growth 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 to fill orders in a timely manner, which leads to lower sales and conversion rates. These headwinds did mute third quarter origination growth from our merchant partners that we believe would have been higher absent the challenging macro environment. Despite these difficult macro factors, we were able to slightly increase overall growth originations in Q3 as our merchant partners worked through these supply chain disruptions. Breaking down our Q3 growth originations. Our largest merchant partner reported third quarter U.S. sales down 21% year-over-year. However, we actually increased our penetration rate, defined as growth originations, as a percentage of U.S. sales with this merchant, and our growth originations with that partner were down only 6% year-over-year. Our growth originations with our other merchants grew 17% year-over-year, spurred by new merchant ads. We believe the overall trajectory of our revenue and origination growth should accelerate as we continue to add new merchants to a healthier baseline of existing growth originations. Though 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 5 period, which is Thanksgiving through Cyber Monday. and historically brings in 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 lease payment 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 Friday 8, the stimulus payments that occurred during 2020 and early 2021 in response to COVID led to historically favorable credit performance for prime and non-prime consumers alike. As we move through 2021, the credit environment is beginning to normalize to pre-pandemic patterns. Our lease payment performance is following that track in both lower early buyout levels and higher write-offs. Our 90-day early purchase auction rates have trended down through Q3, and delinquencies for the period increased year-to-year but are stabilizing at pre-COVID levels. Our third quarter bad debt expense was up compared to a year ago when the issuance of stimulus checks led to historically low delinquency rates. However, bad debt expense is actually 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 in our lease-to-own business is our revenue model is 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 rates over time while maintaining least performance that meets our hurdle rates. Finally, I would note that there are some elements that counter sick locality to our business. As we discussed on our last call, historically high savings rates and low delinquency rates earlier this year led to prime providers slightly stretching down the credit spectrum to capture some consumer transactions in our highest score band. 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, leaving the 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 and 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 revenues as we scale new growth originations. We expect investments in growth to continue into 2022 as we invest to capitalize on the massive scale of the addressable market opportunity ahead of us. We believe that the potential payoff to those investments is significant over time, as Orlando will discuss further.

Thanks, Carissa. 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 omnichannel experience through technology and product enhancements that are aligned to 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 six team members who joined during the third quarter. Each new team member is onboarded during a 90-day period and is then able to start generating leads and bringing in 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 expansions to support new and emerging merchant demand across all channels. Two, operating infrastructure that will support large-scale expansions. 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 the growth will accelerate into the coming year, particularly as we expand more diverse end markets. In addition, our Affirm partnership on their Connect platform continues to expand. We have recently identified more retailers where the Connect platform 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 smaller 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 sales and onboarding cycle for merchants can be quite long. We continue to build our merchant base while we manage our business with an eye towards sustainable long-term growth. Catapult provides strong value to merchants. Our variety of integration options ensure that 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 a large segment of underserved, non-prime consumers driving higher conversion rates and higher sales. Many of the transactions enabled by Catapult are incremental to merchants, as these customers would have otherwise been declined by traditional financing options. We also drive repeat business for our merchant partners by providing 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 before, and as merchants resolve their 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 Catapult platform and our customer-centered approach. Our lease applications are straightforward and provide our customers with flexible and transparent payment options. Whether applying for a lease through our direct integration, or one of our waterfall partners like Affirm. Our customer satisfaction continues to be high with a net promoter score of 60 as of September 30th, 2021, which is up 23% year over year. In conclusion, as we head to 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. To ask a question, you will need to press stars and one on your telephone. To withdraw your question, please press the pound key. Again, that is star then 1 if you would like to ask a question. Our first question comes from the line of Ramsey LSL with Barclays. Your line is now open.

Hi there. 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 sort of more normal macro environment, does that mean sort of a return back to that high double-digit growth we saw previously?

Yeah, you know, 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 You know, the credit normalization, our lease performance is stabilizing, and those things, you know, are obviously going to help us as we see, you know, the credit tightening on the prime side. You know, you've probably noticed 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're pretty excited that things are starting to get back to normal. And then from a growth perspective and growing the business, we continue to capture market share and we're 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, you know, we see kind of the door starting to open a little bit as we get through the holiday season and into next year. Yes, Derek?

Yeah, Ranjit, this is Derek. I'll just add that we've been continuing to progress on our path. We're really consistent with our broader strategic goals of building a durable enterprise here for the non-farm consumer. And that includes investing in our channel partners and our channel investments so that we can scale up rapidly. I've seen some of the announcements that we added different platforms and different channel partners. And this is really critical for us to be able to scale quickly. And in addition, we've been running many controlled experiments and tinkering at the margin with our R&D about improving conversion and improving personalized offers for individuals. And we are really excited about the results that we're seeing, and that's how we believe that we're going to continue to gain share. And as the growth comes back in some of these areas where it's been depressed, we'll be a gainer in that space.

That's great. That's 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 starting to loosen up or remains somewhat of a bottleneck.

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

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

You know, we believe that. Not only that, but I think there were also, you know, between the supply chain disruptions that they're trying to manage through and then some of the BNPLs, which, you know, kind of got the shine started, This year, you know, now the prioritization, I think we're moving up the prioritization level with many of the retailers we're 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. Hi, Josh. Thanks. Hi. Yeah. My first question is around the increased penetration at your largest – partner. I'd love to get a little more detail around what we're describing factors behind that and do you believe that can continue in the future?

Yeah, 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, you know, how you position the product to the customer online. It's much different than in-store where a salesperson may be taking over the narrative. And we've been testing, you know, many options on trying to improve that conversion rate. We see the conversion rates improving. We're pretty optimistic. thrilled with the fact that our top retailer was 21% down, and we saw some gain share there. Derek, do you want to add anything?

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

Excellent. Yeah, that color is very helpful. Thank you. And then, you know, we've 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 non-prime customers and lease to own, and simply it's just a matter of progressing down the chain? I'd love to get a little more color on that.

Yes, no, that's exactly right, Josh, you know, Right now, BNPL is hot. And not that it won't be hot for a while. It will be. But I think it's just a prioritization level with many of the retailers. And as we see, they're managing through the supply chain issues. and they're working through the holiday season, that we continue to drive, they continue to prioritize things further up the chain, if you will. So we'll see that, I think, happening after the first of the year. You know, BNPL is really easy to implement because it's just splitting the payments over four. It's not as, you know, let's just say complicated as ours could be. And also can drive quite a bit of incremental business. But I think once that's done, the next step is how do I drive even more incremental customers, and that's through lease down.

Yeah, Josh, I'll just add one thing, is that the process of going from a BMTL into an LTO conversation or into catapult conversation is just an evolution of understanding the power of giving payment flexibility to the customer set. and the non-com customer is on these retailers' websites or in their stores already and just have not traditionally been able to transact or not transact at the level that they'd like to. And so 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 and 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 guys have been hiring fairly aggressively and building it off the team. Any updates there would be helpful.

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

That's helpful. And just one quick one. In terms of, I know you had mentioned, it seems like overall broader consumer credit default rates are starting to tick 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 Expect them they're willing to go. And do you anticipate maybe that tightening back up if credit default rates start to tick up a little bit and stimulus isn't as robust?

Yeah, no, Mark, that's exactly what we believe is going to happen. I mean, the early signs were the recent announcements that delinquencies on the crime side are starting to increase. So that's a natural tendency is for them to tighten up, especially in the lower credit bands. And those are the customers that will flow to us, and that's why we stated in the prepared remarks that we're 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 with Loop Capital Markets. Your line is now open. Hi, Anthony.

Good morning. So a couple questions. I guess first question. Thank you. was on gross profit. You know, 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's any additional color you can give in terms of the drivers for the lower gross profit. Thanks.

Yeah, absolutely. Hi, Anthony. This is Carissa. You know, what we spoke about in the prepared remarks, and I think what we're seeing across the board, is that credit is normalizing, and so if you look at last year versus This year on gross profit, last year we were in the midst of stimulus and lowest delinquency use in the history of the company. And so now we're 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's continuing into Q3, is that we are testing and working through pricing promotions, offers, other personalized incentives to – to really, you know, see how we can drive conversion rate, which obviously if you charge less, you're going to have less revenue that you're booking. So it's a function of both of those, credit normalization and then some of the promotions that we're testing.

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

Yeah, Anthony, you know, I think we're a – I know, and I don't think – we're a growth company. And, you know, we had a lot of discussions around what do we – And really, we're focused on growing the business. And, you know, we're adding a ton of salespeople. You know, we have more than double the number of salespeople that we had last year. We're investing on the tech side so that not only do I have, you know, the platform, you know, stabilized, but also, you know, we're working on some new initiatives that will help continue to drive that growth to support those salespeople. So I just think it's wise to invest in the company at this stage. and that's what we've chosen to do.

Got it. That's helpful. Thank you.

As a reminder to ask a question, you would need to press start in one of your telephones. Our next question comes from the line of Hal Goach with Luke Capital. Your line is now open.

Hi there. You mentioned that loss rates had normalized at pre-COVID levels, and that was just Curious to get your thoughts on how that transpired and were your collections well-staffed, your collections people well-staffed, and what are some of the other drivers why you think it has normalized at pre-COVID levels?

Yeah, good question. So thank you. This is Derek. So just when we look at delinquency and we look at the trends, when we talk about our loss rates and and what's been happening in the portfolio, certainly we have to look back now many, many months to see trends that look like pre-COVID. And what we're seeing is essentially pay-through rates and execution that looks much more similar to late 2019 than it did to anything in 2020 or early 2021. And these are areas that we're very familiar with. We're very familiar with having the right amount of staffing the right amount of resources. And 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're very customer communication centric. We're very clear on having technology drive our solutions so that we support customers in curing. And that's 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. And so we're really proud of how the team has responded to these shifts, both on the data science and the policy side, as well as on the collections execution side. So this is just kind of part of everything that we do on a day-to-day basis.

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

Thanks, Sarah. So we continue to be really excited about our long-term growth of the company. We're starting to see some green shoots in the aggressive hiring of our sales team, the penetration rate improvements that we're seeing, the build-out of our tech team to disrupt what we're doing from both on an e-commerce perspective and the omni-channel experience. So we're excited going into 22 that, you know, we have the team very energized on providing financial inclusion to our underserved community and that this disruption of e-commerce continues. Our customers, our merchants rely on us to continue our mission through the next several years. So we're excited that you've joined us and 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.