Earnings Transcript for KPLTW - Q4 Fiscal Year 2023

Operator: Greetings and welcome to the Katapult Holdings Fourth Quarter 2023 Earnings Call. At this time, all participants are in a listen-only mode. A brief question and answer session will follow the formal presentation. If anyone should require Operator assistance during the conference, please press star, zero on your telephone keypad. As a reminder, this conference is being recorded. It is now my pleasure to introduce your host, Jennifer Kull, Vice President of Investor Relations. Thank you Jennifer, you may begin.

Jennifer Kull: Thank you, and welcome to Katapult's fourth quarter 2023 conference call. On the call with me today are Orlando Zayas, Chief Executive Officer, Nancy Walsh, Chief Financial Officer, and Derek Medlin, Chief Operating Officer. For your reference, we have posted materials from today’s call on the Investor Relations section of the Katapult website, which can be found at ir.katapultholdings.com. I would like to remind everyone that this call will contain forward-looking statements based on our current assumptions, expectations and beliefs, which are subject to significant risks and uncertainties and which include our future financial performance and financial results for the quarter and year, our relationships with merchants, growth from new partnerships and our ability to acquire and retain existing customers, and use of generative AI to optimize our processes. These forward-looking statements should be considered in conjunction with cautionary statements contained in the earnings release and on Form 10-K for the year ended December 31, 2023 that we intend to file in the coming days, as well as the subsequent periodic and current reports the Company files with the SEC. 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. The information contained in this call is accurate only as of the date discussed. Except as required by law, the Company undertakes 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, the Company will provide certain financial information that constitutes non-GAAP financial measures under SEC rules. These non-GAAP financial measures should not be considered replacements for and should be read together with our GAAP results. A reconciliation of non-GAAP financial measures to the most directly comparable GAAP financial measures is included with today's earnings release and is available on the Investor Relations section of the Company’s website. Finally, all comparisons are year-over-year unless stated otherwise. With that, I will turn the call over to Orlando.

Orlando Zayas: Thank you Jennifer, and thank you to everyone joining us this morning. We are excited to discuss our fourth quarter performance, which greatly exceeded our top line expectations. We achieved gross originations of $67.5 million, representing growth of 13% year-over-year, and revenue of $56.7 million, which represented 16% growth and just below breakeven Adjusted EBITDA. Not only did we record our second highest quarter for gross originations volume ever, we also delivered double digit revenue growth and positive Adjusted EBITDA that improved by $4.9 million year-over-year. Today, my comments will focus on the drivers of our outperformance during the fourth quarter; progress on our merchant and customer strategies and a brief update on our tech position, and finally I'll give you a brief overview of our top focus areas for 2024 and the initiatives we intend to prioritize to drive growth this year. I’ll then turn the call over to Nancy, who will provide you with more insights on our fourth quarter financial performance, our outlook for performance in the fourth quarter and full year 2024, and what we’re seeing in the macro environment and our competitive landscape so far this year. Before I jump into our Q4 performance, I want to take a quick step back and reflect on the very strong year we’ve had. First, we delivered strong gross originations and revenue growth during a period in which most of our competitors saw their businesses contract. This underscores our belief that we are not only offering the right product to the market, but we are offering a highly differentiated for both merchants and consumers. Second, we changed the trajectory of our path forward by significantly enhancing Katapult Pay during 2023. Katapult Pay accounted for approximately 19% of our total gross originations in 2023, and we are very excited about the future of this game-changing application. Finally, we accomplished all this within the rigor of our disciplined expense strategy, which allows us to improve Adjusted EBITDA substantially as we grew the top line. We are proud of the strong year we had and of our future potential, neither of which would be possible without the hard work of our Katapult team. I am so grateful for their contributions, and on behalf of the entire Management Team, I want to thank them for their dedication to our success. With that as a backdrop, let’s talk about our strong performance during the quarter. As we entered the fourth quarter, we believed the uncertain macro environment could have an impact on our core non-prime consumer. While inflation had come down, student loan repayments had resumed, savings rates were low and credit card balances were high, creating an uncertain macro environment. Despite this, we saw strong and steady growth in gross originations during the fourth quarter, and importantly, gross originations volume growth was achieved during a year in which our dynamic underwriting model risks and controls led to an approval rate that was more than 400 basis points below our 2022 approval rate. This strength was driven by originations coming from our direct integrations as well as Katapult Pay. Within our direct channel, we believe we benefited from merchant advertising and discounting which we leverage in our own marketing campaigns, driving better than expected increase in demand. This strength extended across our core retail categories, including automotive, electronics, furniture and tires. In addition, we benefited from performance of new direct merchants, such as Grown Brilliance and Xotic PC. Katapult Pay was an important business driver as well during the quarter. First, customers continued to leverage the feature to originate new leases with more than 20 merchants that were available on our marketplace heading into the fourth quarter. Second - this was a big driver of our performance - we added Wal-Mart to our Katapult Pay marketplace sooner than we anticipated. We saw a very robust response from our customers and approximately 6% of the leases that originated in the fourth quarter were for durable goods from Wal-Mart. We believe this demonstrated our ability to drive demand by offering merchants that our customers really want, and we are one step closer to transforming Katapult into a true shopping destination. Overall, we are reaping the benefits of our investments in our direct integration capabilities and Katapult Pay. Our goal is to leverage both these channels to grow our merchant base and overall consumer reach. Let’s now dive into the progress we’ve made executing our merchant strategy, which are rooted in three key areas

Nancy Walsh: Thank you, Orlando. I’m excited to talk to you today about our strong fourth quarter results, which have added to our track record of growth. For five consecutive quarters, we have grown our gross originations year-over-year, and in the fourth quarter, our revenue growth was 16.1%, which accelerated from the revenue growth rate we achieved in the third quarter. We also reduced our write-offs as a percent of revenue, and with our focus on disciplined expense management, we delivered a $4.9 million year-over-year improvement to Adjusted EBITDA during the fourth quarter. With that as context, let me provide you with some financial highlights for the fourth quarter and full year 2023. Before I discuss the rest of our P&L, I wanted to mention that we made out-of-period adjustments to correct immaterial errors related to cost of revenues and rental revenue in our P&L. This also impacted property held for lease and sales tax payable on our balance sheet. There will also be a $1.2 million cash impact associated with sales tax payable. We have reflected these out-of-period adjustments in the Adjusted EBITDA reconciliation table in our press release for your reference. The revenue, write-offs as a percent of revenue, and Adjusted EBITDA data that I'm about to present also reflect these adjustments. As I mentioned, we have now grown gross originations for five consecutive quarters, and as Orlando touched upon, our fourth quarter results came in significantly better than we were expecting. Gross originations increased 13% to $67.5 million. Our performance was driven by strength with our existing merchants and our ability to onboard Wal-Mart into Katapult Pay during the fourth quarter, sooner than we expected. New and existing customers engaged with Wal-Mart through Katapult Pay during the quarter, resulting in higher than expected gross originations. In addition to this driver, we also saw strong performance during the Cyber 5 period of the holiday season. Gross originations during this period grew double digits compared with the same period of 2022, and Katapult Pay was a key driver of this growth. For full year 2023, we achieved gross originations of $226.6 million, up approximately 15%. While this headline number is a result we are very proud of, our business excluding Wayfair grew even faster during 2023. Excluding Wayfair, gross originations grew nearly 28%. While we are very pleased with our partnership with Wayfair, we are also pleased with our progress toward diversifying our sources of gross originations and revenue. For 2023, non-Wayfair gross originations were 48% of our base, up from 43% in 2022. We believe this demonstrates that we can continue to leverage Wayfair to drive growth even as we diversify our gross originations base. During the quarter, 59.9% of our originations came from existing customers. This is an all-time high for us, and we believe this reflects our obsession with striving to give our customers the best experience we can at all times. For the full year, 54.2% of our originations came from existing customers. As we have discussed, we are continuing to see a large number of repeat customers come back to us through Katapult Pay; in fact, for those customers who generate a lease through Katapult Pay, be it their first, second or third, approximately 29% of the time, these customers will generate another lease within 60 days. We continue to believe that engagement with the app and our targeted marketing efforts are helping us drive our very strong repeat customer growth rates. Q4 revenue increased 16.1% to $56.7 million, exceeding the 13% to 15% growth outlook we provided last quarter. This performance reflects the trends driving gross originations, the volume performance we saw in the first three quarters of the year, and strong collection efforts. For full year 2023, revenue grew about 5% compared with 2022. Write-offs as a percent of lease revenue continued to improve and remained within our 8% to 10% 11 target range. For the fourth quarter, this metric was 9.6%, 10 basis points lower compared with 9.7% in Q4 2022. Moving on to profitability, our disciplined approach to expense management coupled with our top line growth allowed us to deliver another quarter of substantial Adjusted EBITDA growth. As a reminder, late in 2022 we instituted a number of cost savings measures, and we are now at the tail end of anniversarying these benefits. Our fourth quarter total operating expenses were impacted by a $7 million net expense we recorded in connection with our negotiation to settle the two class action lawsuits that have been pending in New York and Delaware since 2021 and 2022, respectively. This may be satisfied with a combination of cash and shares. In addition, we have recorded a $5 million receivable for our insurance policy payment. In total, we recorded a $12 million liability in connection with the potential settlement. I should note that we have not yet and may not reach a settlement with these parties on these terms, or at all. Further, any settlement agreement is subject to court approval by the Delaware and New York courts. Although the settlement negotiations are ongoing and not final, given the status of settlement talks, we are required under GAAP to accrue for the potential settlement. We will provide additional updates as appropriate in the future. During the fourth quarter, our total operating expenses increased by 14.5%, primarily driven by the $7 million net one-time estimated litigation settlement expense. Excluding this expense, total opex for Q4 would have decreased by 27.8% year-over-year. For the full year, we reduced our total operating expenses by 8.5% year-over-year and, excluding the one-time estimated litigation settlement expense, full year 2023 opex would have decreased by 19%. Excluding underwriting fees and servicing costs, which are variable, the one-time expenses related to our estimated legal settlement and depreciation and non-cash stock-based compensation expense, our fixed cash operating expenses were $8.5 million, down 35.6% compared to last year. Based on our top line performance and the structural and sustainable benefits we are realizing from our operating efficiencies, we were able to improve our year-over-year Adjusted EBITDA performance for the fourth consecutive quarter. For the fourth quarter, we recorded just below breakeven Adjusted EBITDA, an increase of $4.9 million compared with the $5 million loss we reported in the fourth quarter of last year. As a reminder, expenses related to our estimated legal settlement are an add-back to our Adjusted EBITDA. For the full year 2023, our Adjusted EBITDA loss was approximately $1.9 million. Excluding approximately $1.8 million for immaterial out-of-period adjustments, we delivered Adjusted EBITDA that was slightly below breakeven. This means that we delivered approximately $16.6 million more in Adjusted EBITDA compared to full year 2022. As of December 1, 2023, we had total cash and cash equivalents of $28.8 million, which includes $7.4 million of restricted cash. We also had $60.7 million of credit facility debt. During the fourth quarter, we identified an issue with our third party lease verification vendor. This issue led to Katapult over-funding $9.6 million in leases during the fourth quarter that should have been funded by our lending partner. This meant that our cash to use should have been about $9.6 million lower during the quarter and our debt should have been $9.6 million higher. We corrected the issue in early 2024, recovered the cash and normalized our cash and debt levels. On an adjusted basis excluding this issue, we would have ended the quarter with total cash and cash equivalents of $38.4 million, which includes $7.4 million of restricted cash. We would also have reflected $70.4 million in outstanding debt on our credit facility on an adjusted basis. Let me explain the issue in more detail. We have a third party lease verification vendor that verifies and then approves the new leases to be included in our borrowing base. In December 2023, this vendor had a timing error in their validation processes. This created a situation where a number of new leases each day were not validated and therefore were not added to our borrowing base. This in turn led to us funding these specific leases at 100% with our own cash instead of at 10%, which is our normal practice. Our credit facility provides a 90% advance rate for funding each valid lease. This issue only impacted Q4 and, as I mentioned, we have already received the cash from the underfunding. In addition, once we alerted our lease verification vendor, together we implemented enhanced controls and processes to prevent this from recurring in the future. We are continuing to navigate an evolving macro environment. While inflation remains stable, it is still having an impact on the spending habits and budgets of our core target consumers. U.S. retail traffic is down, interest rates, while stable, remain elevated, savings rates are low and credit card usage is high. Currently, it is unclear what impact these dynamics will have on prime lending standards and how they will affect the U.S. consumers’ access to credit. We continue to believe that we have a large addressable market of underserved non-prime consumers, and it’s important to note that lease-to-own solutions have historically benefited when prime credit options become less available. Based on these dynamics and the operating plan in place for the full year 2024, we expect the following for the first quarter

Operator: Thank you. We will now be conducting a question and answer session. [Operator instructions] Our first question comes from the line of Josh Siegler with Cantor Fitzgerald. Please proceed with your question.

Josh Siegler: Hi guys, good morning. Thanks for taking my question. Nice to see the strong gross originations this quarter. First, I wanted to touch on your guidance. Your guidance implies acceleration in originations as we progress through 2024, so to that end, I was wondering if you could comment a bit on your merchant pipeline and if you expect that acceleration to really be driven by new merchant adds, or do you think penetration with existing merchants? Thanks.

Orlando Zayas: Hi Josh, thanks for the question. Our merchant pipeline continues to be robust. We’re looking and we’re having more meaningful conversations, obviously, with the retail environment, especially in January being what it was. Obviously bringing incremental customers to these merchants is becoming more and more important, and some of the issues that we had in the past, like shipping constraints and things like that, have gone away, so I would say we’re in more of a normal operating standpoint with our merchant. The issue with the merchants is really getting through their tech stack and getting the integration completed, so we expect that some of the growth is going to come from new merchants that we’ve already identified in the pipeline, but that most of the growth is coming from the growth in Katapult Pay as well as our current merchants and really continuing to do what we’ve done with Wayfair with our other merchants to grow the business.

Josh Siegler: Got it, that’s helpful color, thank you. Then I wanted to talk a little bit about reinvestment. As we’re progressing through 2024, how are you thinking about allocating incremental dollars towards either the Katapult Pay app or your more traditional lease-to-own model, either integrated into a company’s website or in-store?

Nancy Walsh: We continue to evaluate all investments based on the return that it’s going to provide and deploying those investments where we think it will have the biggest and quickest impact, so whether that be continuing our marketing testing, whether that means continuing to invest in our technology, all of those are things that we’re incorporating into the plan, but really using the return on investment as our basis for what we do and how quickly. We do have a scalable, low-cost tech stack that really gives us an advantage to be able to not have to make huge investments to continue to drive the business forward.

Josh Siegler: Yes, and Josh, this is Orlando. I’ll add, one of the things that we see in Katapult Pay is a strong customer performance from a returns perspective, and so obviously that--we want to continue to grow that business. That doesn’t mean we’re not going to focus on direct. We really want to do both, and we think that we’ll put investment dollars where we think it’s important, but what’s going to bring us the best return.

Orlando Zayas: Got it, makes sense. Thank you.

Operator: Our next question comes from the line of Anthony Chukumba with Loop Capital Markets. Please proceed with your question.

Anthony Chukumba: Good morning, thanks for taking my question. Congrats on a strong end to the year as well. I guess my first question, I was just a little confused, I thought you had pre-announced your revenues, and the revenue number that I saw today was--I mean, unless I’m going crazy, which is entirely possible, was different from what I saw in your pre-announcement, so I was just wondering if you can reconcile that.

Nancy Walsh: Sure, hi Anthony, it’s Nancy. Thank you for the question. You are absolutely correct - we did pre-announce 19%. As a result of those one-time out-of-period adjustments we needed to make, that impacted revenue, as we indicated, and that’s purely the difference between what we pre-announced and what we announced today, but still very pleased overall with not only the gross origination growth but the revenue growth, and with our continued outlook into 2024.

Anthony Chukumba: Okay, great to hear that I’m not crazy.

Nancy Walsh: No, you’re not crazy.

Anthony Chukumba: Okay. Second thing, so obviously there’s this CFPB, you know, with the reduction in late fees on credit cards. Would love your thoughts in terms of, first off, do you think that there’s going to be litigation? Are you building into your guidance at all, and I guess most importantly, if let’s just say that it holds up and late fees do get reduced, what would be the impact on you, if any?

Nancy Walsh: Nothing.

Derek Medlin: Yes, hi Anthony, this is Derek. I’ll take that question. What we see in terms of the changes to what’s happening the credit stack above us with prime credit cards and near-prime credit cards and other financial products is that any time that there’s a reduction in their financial returns, that that could create opportunity for us in terms of a change in their underwriting criteria or a change in their approval rates, so there is a potential there, however we have not built that into any of our planning. In general, what we see is that consumers are savvy, they are looking for financial products and payment plans that are very transparent to them, that they can understand the total cost, and so we take all these insights and learnings as to what’s happening and we implement them into our stance in terms of how we serve our customers, and we think we stand up well in terms of being very transparent and clear. In general, we’ll have to see how this all settles out. The last thing I’d say, though, is that these partnerships in the prime space that we have, have certainly heightened as different credit providers are looking for ways to increase their overall approval rates by having a waterfall partnership with someone like Katapult. We saw that last year with different partnerships that we already announced, and we think that there is continued interest in partnering with Katapult to improve the overall options for merchants.

Orlando Zayas: Anthony, this is Orlando. Thanks for the question. Yes, I just wanted to reiterate, we don’t and we haven’t for a number of years, we don’t charge late fees, and so we’re pretty proud of that because we try to work with our customers and they see that as an advantage, and I think that helps our repeat rate, but we’re kind of ahead of the curve from a regulatory perspective if they start going down to lease-to-own.

Anthony Chukumba: Right, yes. I was aware you guys didn’t charge late fees, I was just thinking more about the impact on the guys above you, but that’s helpful. Then I guess this is my last question, I just want to make sure I heard that Wal-Mart number correctly. You said Wal-Mart accounted for 6% of your fourth quarter - was that total leases, was that gross originations? What was that number exactly?

Nancy Walsh: It’s total leases, not the gross origination dollars. Total leases.

Anthony Chukumba: Got it, okay. Well, that is a very impressive number. When exactly in the quarter did you on-board them?

Orlando Zayas: The week before Cyber 5. We had expected--the tech team was trying to get it done before--they were anticipating getting it done after Cyber 5, they exceeded expectations and got it done right before Cyber 5, and so really it’s about six weeks’ worth of business in the fourth quarter, and we were very, very happily surprised at the response by our customers.

Anthony Chukumba: Okay, and Orlando, just one last thing, because I am a boomer - Cyber 5, we’re talking about the week before Thanksgiving, right?

Orlando Zayas: You’re a boomer, really? Yes, the Thanksgiving--the five days--

Nancy Walsh: Starting Thanksgiving, so it’s Thursday-Friday, going through Cyber Monday.

Orlando Zayas: Through Monday - right.

Anthony Chukumba: Got it. You learn something new every day, even when you’re a boomer. Okay, thanks guys.

Nancy Walsh: Thank you.

Operator: Thank you. There are no further questions at this time. I would like to turn the floor back over to CEO, Orlando Zayas for closing comments.

Orlando Zayas: Thanks Operator. I just want to reiterate how proud I am of our team. We had a great year. We delivered top line growth during a time when our competitors declined. We grew while adhering to our disciplined expense management philosophy. We believe we are well positioned to build on the success of 2023, and we are looking forward to extending our track record of growth this year. To everyone listening, thank you very much for tuning in to hear about the progress we’ve made over the past year. We are proving our ability to grow while providing our customers with fair, transparent and accessible lease-to-own products, and our merchants with a growth channel that has much potential. Thank you again for your support and the interest in our story.

Operator: This concludes today’s teleconference. You may disconnect your lines at this time. Thank you for your participation.