Sezzle Inc

ASX:SZL

Earnings Call Transcript 2022-Q2

[Operator]

Thank you for standing by, and welcome to the Sezzle Inc. Second Quarter 2022 Results Call. [Operator Instructions] I would now like to hand the conference over to Mr. Charles Youakim, CEO. Please go ahead.

[Charles Youakim, executive]

Thank you. Good morning, everyone, or to those joining us from our home here in the U.S., good evening, and welcome to the Sezzle Inc. 2022 Second Quarter Presentation. My name is Charlie Youakim. I'm the CEO and Executive Chairman of Sezzle, and I will be leading the presentation today. I'm joined on the call by our CFO, Karen Hartje; our President, Paul Paradis; and our Head of Investor Relations, Lee Brading.

2022 has been a unique year for us and also for many of you listening. In 2020 and 2021, investors and management team aggressively pursued growth. Investor sentiment has been shifted and so have we. We know investors are looking for profitable companies, not just growth, and we have taken that message seriously.

We recognize this is a natural part of our evolution as a company from a scrappy start-up trying to get a foot in the door to an established leader. It is a cultural shift that requires reindicating our team that it's not just about growth at all costs. A key part of our monthly town hall to Sezzle is educating the team on the bottom line. Growth is no longer the top driver at Sezzle, its profitability.

I'm happy to announce that we expect to hit a run rate of profitability by year-end, in which our total income will exceed our transaction-related expenses and our adjusted operating expenses, which as far as we know, would make us the first pure-play BNPL provider in North America to do so. We've taken a great number of steps to get there, and we have a few more left to complete. We're going to outline that plan to you as we give you our updates on our second quarter numbers. We'll now move on to our presentation. If you'd like to follow along, you can find a post on the ASX website.

Let's get started, and please keep in mind that all dollar amounts shown here are USD. Please move forward to Slide 4, where you can see our quarterly results on the right side of the page. We're really happy with our financial scorecard for the quarter. The results here speak to the efforts taken during the first half of 2022. Our underlying merchant sales continued to grow despite economic headwinds, a shift away from e-commerce back to in-store shopping and tightened underwriting due to our focus on profitability. These efforts also led to a record quarter for us, both in total income and what you're used to us calling net transaction margins, which came in at 2.3% of underlying merchant sales.

On Slide 5, we show a significant amount of growth in our active merchants and active consumer accounts as well and repeat usage is still growing. But being here, our product is attracting new stakeholders, and we're also sticky. Slide 6 reflects our product evolution from a company connected to consumers through our merchant partners to one connecting directly with consumers.

Earlier in our company's existence, we knew that our merchant stakeholders had to be a first focus because without their buy-in, our products would not reach the consumer. So we put a focus on the features that we felt would make Sezzle attractive to those merchants. But as we have evolved, we've been putting more and more focus on the consumer. Our loyalty program and Sezzle Premium, are recent examples of that. We have a few more additions coming to the platform in the next 12 months if you round out the feature set that our customer is looking for. We'll be adding pay now and pay in 2 for smaller purchases, and a physical card tied to a more traditional revolving credit account, which we call Sezzle Flex. When we complete the launches of these products, our future set will be one of the most complete among North American payment platforms.

We've been busy over here as Sezzle. Slides 7 and 8 will show you that. On Slide 7, we're going to run through some enhancements and extensions of our core products. First, our long-term product has gained traction through improvements through the user experience and the addition of a more capable lending partner in Bread Financial. We are experiencing 9x volumes through that product after the switch on lenders, and we expect even more growth to come as the long-term product gets opened up to our entire merchant base.

We also have 2 more lending partners coming on board with Opportune and Genesis joining our platform. Opportune and Genesis expand our addressable customer base by accepting lower consumer credit bands within our products. We expect a step change improvement to volumes with their additions alongside Bread Financial.

Next, our in-store offering continues to gain momentum. This momentum is coinciding with the move back to in-person shopping, which we timebound. Merchants can add Sezzle as a payment method at their physical stores using an entirely self-serve process initiated within our online merchant dashboard. And it's even easier for our consumers to use us in store at our integrated merchants. They just tap their mobile device at the register to transact with us through our virtual card program.

These user-friendly systems have led to an in-store program that has reached 10% of our total profit environment. Our marketplace also continues to improve. Over 18% of our processing volume in the quarter originated from our marketplace. Just last week, marketplace represented almost 23% of our processing volumes. To say we're excited about that progress is an understatement. As Sezzle Premium matures, we expect the volume through our marketplace to grow.

This solidified Sezzle as much more than a payment solution to our merchants, but a significant lead generation channel. Meanwhile, our recently launched loyalty program will help us promote positive consumer behaviors within our products and increase engagement.

Slide 8 provides the key highlights of our new premium product, which was launched less than 2 months ago. In that short time frame, premium has acquired over 47,000 active subscribers, and those subscribers account for over 10% of our processing volume since launch. The way the product works is simple. In exchange for signing up for our premium subscription, the customer gets access to our affiliate and gift card programs, which opens up important retailers for that customer, including Amazon, Walmart, Lowe's and many other large retailers in the U.S.

Premium members get a higher level of customer support, more rewards and many other benefits that don't come with our core products. The value prop is strong for the consumer. We give you more access to our products and more features in exchange for a small monthly account fee. This account fee plus affiliate revenue, gift card revenue and interchange revenue from our virtual card have helped us earn around a 10% effective rate for the product so far. And needless to say, we're excited for the value that we're bringing to consumers and the growth we are seeing in subscribers suggest that they agree with us.

On Slide 9, you'll see that we're not quite done. We want to round out our platform with a full feature set of payment options. Over the next 12 months, we'll be adding [ pay in 2 ] and pay now to the checkout and shipping our customers a physical and virtual Flex card, which allows the customer to put payments onto a more traditional revolving account and uses anywhere.

Telex will be a true anymore product for us. With these products, we believe our platform will be ready to serve all the payment needs to our customers, truly empowering them financially. Before I hand over the call to Karen, I want to review the initiatives that we completed and plan to complete in 2022 on the road of profitability. Please flip ahead to Slide 11 for that discussion.

First, let's go through the initiatives we completed through 2022 thus far. But before we get started, I want to explain that we traditionally believe in the concept of exchanging upfront costs for long-term gains. Yes, we do believe in the CAC for LTV exchange. But in early 2022, we identified this was not a sustainable approach given the changing market conditions. The cost of capital has gone up dramatically. It was no longer worth the cost of spending that dollar to try to make $2 later. We know that every action in the company had determined immediate profit.

This decision led us to off-board or renegotiate merchant accounts that weren't [indiscernible] for us. And trust me, we didn't take this initiative lightly, but we knew that it was necessary. We feel blessed that the vast majority of our merchant partners agreed to repricing to help us capture more of the value that we are giving to them through the partnership.

Second, on the revenue optimization front. We also renegotiated our supplier contracts. The key supplier change to call out is our renegotiation of our virtual card offering. We launched with a lower revenue share because we wanted to get to market quickly as a start-up company, and we didn't have any volume to negotiate with. But as our product volume has grown in scale, we are now able to capture more of the revenue for our efforts. Lower on the completed initiatives [ list ], you'll see the additional revenue stream popping up. That's Sezzle premium, which we went through earlier on the call.

It's a top line winner for us with a high effective rate. And since was only just launched at the end of Q2, we think most of the momentum from this product will be captured in Q3 and Q4 of this year, further assisting our path to profitability. Let's go to the cost side of the equation next. We undertook a number of activities that helped us towards our goal of cash flow positively by year-end. First, we had to execute a reduction in force. This was completed in March of this year. Between our reduction in force and eliminating back sales and physicians, we were able to reduce employee operating costs by 20%.

We also scaled back international operations, payment processing and [indiscernible], and we're working to spin off our EU and Brazilian [ FP ] so we can focus on our core North American market. Finally, we are in an internal program to reduce third-party spending within the company. We shut down a number of services that weren't found to be cost effective, which led to a significant savings for the company. And by the way, those are the biggest needle movers, if not the empower list.

As I mentioned, our entire team is rowing the boat towards profitability. So there are countless other activities that we've achieved and are yet to achieve as we meet this journey. We've even removed an expensive sparkling water machine in the office. Sorry, Jake and Tara. Keep in mind, the work you're hearing about occurred over the quarter we're reporting. So while you're seeing a great quarter result before you, I can also assure you that we're getting closer to profitability by the month. We still have some work to do, though.

One major outstanding item includes making adjustments to our product to offset the cost of payment processing. If you take a look at our income statement, yields opinion processing costs are significant. They are about 35% of our total income. And that's before we account for any other expenses. So we're putting a big focus on this. First, because of the lower transaction costs of ACH, we have created incentives for consumers to have their bank accounts for payments instead of choosing card on deferred payments, where our card really isn't necessary.

We've implemented the incentive system, whereby a customer can only see their spending power in the mobile app if they add ACH per payment. Early results are positive, but this was launched late in the quarter, so you won't see the benefit just yet. Next, we'll be adding a payment preference speed to installments 2 through 4 for customers that still insist on using their card instead of.

Between the 2 initiatives, we believe we'll make significant inroads against the roughly $10 million in quarterly transaction expenses. We plan to pass over the coming 2 months and then fully implemented during Q4. Altogether, these initiatives will propel us on our path to profitability, which is something that we're incredibly proud to present to you today.

I'll now hand over the call to Karen Hartje, who will cover our financials. Karen?

[Karen Hartje, executive]

Thanks, Charlie, and hello to all. Before starting the presentation, just a reminder that our quarterly results are unaudited and are presented in U.S. dollars. Starting with Slide 13. As Charlie highlighted, we've sharpened our focus in pursuit of profitability, and the numbers on this slide reflect our strategic direction. Second quarter '22 UMS was up 1.9% over the same period last year, while total income was up 6.8%. Second quarter '22 UMS totaled $419 million, with in-store sales comprising almost 9% of the total.

In-store continues to outpace online as we are seeing a return of the shopper to physical locations. For us, in-store rose 263% from last year. From a macro standpoint, U.S. online spending for the second quarter was generally soft. According to MasterCard spending costs, U.S. e-commerce retail sales declined in the low single digits for the month of April and May before rising just 1.1% year-over-year in June. As a percentage of underlying merchant sales, second quarter '22 total income improved to 7% versus 6.7% for second quarter '21 and 6.1% last quarter.

The percentage increase reflects our recent initiatives to drive profitability, including renegotiating with or offboarding unprofitable merchants. This strategy applies to prospective merchants as well. We are not going to enter marginally unprofitable contracts with new merchants, even if it means walking away from some big name marquee deals. Moving to Slide 14. Transaction expense as a percentage of UMS totaled 2.4% in second quarter '22, down 21 basis points and $1.7 million from last quarter. Transaction expenses comprised primarily in payment processing costs and the cost as the percentage of UMS decreased because the proportion of lower-cost ACH payments relative to card payments increased. As Charlie mentioned earlier, this is the largest component of our unit costs and also one of our biggest opportunities. We are highly focused on lowering its costs in coming quarters.

The provision for uncollectible accounts as a percent of UMS in second quarter was 1.9%, reflecting 44 basis points improvement from last quarter and 149 basis points improvement year-over-year. While the second quarter was marked by rising interest rates and surging inflation, we continue to refine our underwriting strategies at the expense of unprofitable growth. Total income, less transaction-related costs, including transaction expense, provision for uncollectible accounts and net interest expense totaled $9.6 million or 2.3% of UMS for second quarter '22.

This measure reflects record quarter performance for Sezzle in terms of both dollars and rate. The same calculation was $3.8 million or 0.8% last quarter and $3.2 million or 0.9% in first quarter '21. Let's just take a moment to enjoy these record results. Just kidding, there's no time for taking a moment. We are on a mission to profitability.

On to Slide 15. Second quarter '22 other operating expenses totaled $24.8 million compared with $31.5 million last quarter and improved to 84.8% of total income in second quarter of '22 from 114% of total income last quarter as represented in the top chart. The lower chart reflects adjusted operating expenses, a non-GAAP measure, which excludes equity-based compensation, depreciation and amortization, impairments and other nonrecurring expenses, such as merger-related costs.

This chart is further broken down by key line items. In second quarter '22, adjusted operating expense totaled $20.7 million or 65.6% of total income versus $23.1 million or 84.2% of total income last quarter. Second quarter '22 adjusted operating expense was down by 10.7% from first quarter -- excuse me, from first quarter '22 and the decrease was driven by reduced personnel expense resulting from our workforce reduction in March, lower professional fees, partially offset by higher co-marketing spend with enterprise merchants.

Slide 16. With the profitability initiatives launched this year, you can see the impact on results. We are closing the gap between total income, net of transaction-related costs as represented by the bottom line on the chart and adjusted operating expense represented by the top line on the chart. The profitability gap of $24.5 million in fourth quarter '21 decreased to $19.4 million in first quarter '22 and further decreased to $11.1 million in second quarter '22.

We expect this gap to improve in third quarter as initiatives develop and mature. In third quarter, we will have the benefit of the full quarter impact of merchant contract renegotiations would occur during the second quarter, increased ACH utilization as a repayment method and testing of the payment preference fee initiative during third quarter. The goal is for the 2 lines on this chart to intersect to reach profitability and positive free cash flow generation. We are diligently innovating and monitoring our progress towards this goal.

Slide 17. At the end of June 2022, cash totaled $63.3 million, was $57.8 million drawn against our line of credit and $10.1 million in unused borrowing capacity. This compares with our first quarter results where cash totaled $60.6 million with $52.8 million drawn against our line of credit and $39.7 million in unused borrowing capacity. These amounts do not include the $11 million reimbursement payment that we received from ZIP in July.

As of June 30, the weighted average interest rate stood at 6.7% on our credit facility. As a reminder, the $125 million committed line of credit facility matures in June 2023. Now I'll pass it back to Charlie to close out the presentation.

[Charles Youakim, executive]

Thanks, Karen. One final topic to cover and we'll be brief. It's the termination of our merger with Zip. First, I want to say that we wish the best of luck to the Zip team. The people we met were phenomenal, and our 2 teams have been a great cultural fit. We wish them the best. We entered into this agreement with high hopes and some of those are still valid, scale and growth through M&A is a valid path forward in our sector, but the timing was just not right.

As we [ row ] our boats together, storms developed and it became clear that it was [indiscernible] to hold the 2 boats together. In the end, we came to believe it was better to be in control of our own destiny. We believe we can weather the storm better on our own, and we hope you will agree after seeing all that we've accomplished in the past quarter. We'll now hand it back to the moderator for Q&A.

[Operator]

[Operator Instructions] Your first question comes from Phil Chippindale from Ord Minnett.

[Phillip Chippindale, analyst]

Charlie, first question, just on that Slide 11 and your $40 million of revenue and cost savings that you're targeting. Can you just talk to that in a little bit more detail. Does that include the $10 million of cost savings that you identified earlier in the year? I think you went out in March.

[Charles Youakim, executive]

In terms of the reduction in force?

[Phillip Chippindale, analyst]

Correct.

[Charles Youakim, executive]

In that announcement. And in that press announcement where you also mentioned reduction in force?

[Phillip Chippindale, analyst]

Correct. Yes. So there was a $10 million reduction in annualized that you announced back in March. I'm just trying to understand if this is -- as this is [indiscernible] in addition? Or does that include the $10 million?

[Charles Youakim, executive]

I believe we included that. Karen?

[Karen Hartje, executive]

Yes, it includes the $10 million.

[Phillip Chippindale, analyst]

Okay. Could you give us a bit of a sense of the split then? So you said the $40 million is both revenue and cost savings. Can you give us a rough split between how much of this is going to come from cost out and how much from revenue? Is it a 50-50 sort of split? Or again, can you just give us a bit of a sense of that source split?

[Charles Youakim, executive]

Karen, do you have the number? Or Lee?

[Karen Hartje, executive]

I think it would be -- go ahead, Lee.

[Lee Brading, executive]

No, Karen, sorry. Go ahead.

[Karen Hartje, executive]

It's just going to say, Phil, I think that 50-50 split is generally reasonable.

[Phillip Chippindale, analyst]

Okay. And does that include this potential savings from transaction expenses that you've also identified further down the page about this -- the preference for, et cetera?

[Karen Hartje, executive]

No. That's what -- no, it does not include that. The $40 million includes initiatives that we've already undertaken.

[Phillip Chippindale, analyst]

Okay. I.

[Charles Youakim, executive]

And then I guess the...

[Lee Brading, executive]

And the natural follow-on then is if you're spending $10 million in transaction expenses in the quarter just gone, and you're undertaking this change on a forward-looking basis, how much of a saving you could potentially get on that transaction expenses line? I mean moving to ACH is a significant saving depending on the uptake. Yes, it depends on the fee on the other side. But could this see a halving of the transaction expense?

[Charles Youakim, executive]

Our goal is to completely offset that number. That is the goal of the company. I would say probably a reasonable estimate would probably be somewhere between 75% to 100%, that's a 75% reduction.

[Phillip Chippindale, analyst]

Okay. Just moving on to one of the things that you've identified. You've completed already a renegotiation of fees with merchants. We saw a similar comment in Zip's recent disclosures for the U.S. business. Is it your view that this is a pretty common discussion point at the moment in the buy now, pay later sector? Do you think between BNPL operators and retailers?

[Charles Youakim, executive]

Paul, you may be the best question we take that one.

[Paul Paradis, executive]

Yes, I do think that's common, Phil. Can you hear me?

[Phillip Chippindale, analyst]

Yes, we can hear you.

[Paul Paradis, executive]

Okay. Yes. So I do think that's becoming more common place. I think the industry in general is settling it down a bit when it comes to going out and bidding on merchant deals. I think for a long time, we were all going after acquiring customers from these merchants. But as Charlie mentioned earlier in the presentation, as the cost of capital has gone up, I think we all have to be a bit more conservative and conscious of the deals that we're putting in place with these merchants. Not only merchants that we're already working with, but new merchants that we're going out and talking to.

[Phillip Chippindale, analyst]

Okay. Paul, while you've got the floor, you can probably address my last question, which is a combination of people and marketing expenses. So I suppose one of the concerns would be that you're cutting costs in your business. And so I guess I'm just wondering about the impact that, that is having day-to-day in terms of whether it be onboarding merchants, providing customer service or whatever. So could you talk to that? And the second thing I wanted to just touch on is marketing expenses. Clearly, the outlook has changed for the sector. I'm assuming that current marketing commitments are really pretty modest going forward. Is that a fair assumption?

[Paul Paradis, executive]

So to answer your second question, Phil, yes, that is an accurate assumption. I think, again, we're not shying away from putting marketing incentives into deals when we think the deal is profitable. But we're looking at every activity we undergo as being independently profitable. We're not having the same approach of acquiring merchant A and the shoppers that come with it, in the hopes that they go shop at merchant B where we might have a better profit margin, right? So I think we are taking a different approach in that respect. And then going back to your first question, Phil, was it in regards to the reduction in force and how that's affected our growth and support? Is that accurate?

[Phillip Chippindale, analyst]

Yes, it's really -- I guess you are identifying and have already cut headcount. So I guess I'm just wondering about the impacts on your business from those headcount reductions and where do you think that that's having an impact on your ability to onboard merchants or your customer service levels, et cetera.

[Paul Paradis, executive]

Yes. I think in some respects, I think the reduction in force was actually overdue. And I think we actually have a very strong cohesive team now, and I think it allowed us to cut some poor performers that ended up actually bolstering our company in some respects. But when you do lose staff, especially in the growth areas of business like sales and marketing, I think you will see a little bit of slowing in terms of merchant acquisition.

We're in the middle of a pivot toward profitability and also direct-to-consumer products. So growth may slow a bit in the short term, but we do expect to pick it back up once we have all our new products in market. And additionally, we're focusing on capturing more share of wallet from our existing customer base. through products like premium, pay now, pay 2 and the Flex Card. So although I think there is a slowing in the short term on growth, I think we expect it to be short-lived and then can get back to faster growth in the future.

[Phillip Chippindale, analyst]

One comment there. I actually think there are really good true addition by some traction and streamlining the team, streamlining the company, even like on our product and [indiscernible] teams. We've actually pushed more coach production over the past few months than we ever have with a leaner team. And on the sales front, I'd say the challenges of growth over the last -- as you see our numbers, I would say that's less due to the team size and more due to the fact that we are in a merger where we were being acquired.

And the merchants that we were speaking with, some of them knew that. And in some cases, we didn't get invited to RFPs or they looked to the acquirer, instead of us. And that does affect your growth when that happens. So I think I'd actually point to that growth side, more of an effect on that than on the team size itself.

[Operator]

[Operator Instructions] Your next question comes from Siraj Ahmed from Citi.

[Siraj Ahmed, analyst]

Charlie, just a couple of questions. Just following up the question the UMS growth expectations. And just keen to understand, right, you are taking measures to sort of reduce loss rates, focusing on the product, et cetera so I appreciate that maybe the growth was impacted by the merger. But should we expect potentially a [ modest ] decline because you are focusing on much more profitable customers and merchants.

[Charles Youakim, executive]

I think basic strategy, we made that move during the past few months here and because of the merger, we were limited a bit. Yes, I don't think we're expecting the growth that you've seen in our past in terms of a percentage basis. But I do believe that now that we've unlocked a little bit more about our product and the capabilities and our team is out from under the merger, I do believe that you'll start to see UMS growing again. [indiscernible] other thoughts?

[Paul Paradis, executive]

I would add that I think underlying merchant sales are going to become of decreasing importance to our overall growth on the revenue and profit side of our business, right, as we introduce some of these new kind of consumer-facing products and the fees and revenue associated with those.

So I don't expect a decline in underlying merchant sales, especially as we approach the holidays here, where spending will pick back up. Certainly, there's some macroeconomic conditions that are bringing retail sales down, especially e-commerce sales right now. But I think we're focused on supplementing those with new revenue streams.

[Siraj Ahmed, analyst]

That makes sense. My second question, this one in terms of Sezzle Premium. I mean, previously, when you said these nonintegrated merchants, there was a higher loss rate. Just make us you understand how you're seeing that since you launched with these [ 4,000 ] subscribers? Is it the loss rates higher? Or is it actually better?

[Charles Youakim, executive]

Yes, it's too early to tell for sure, Siraj. But I say early indications that we probably would expect a slightly higher loss rate for that group. [indiscernible] as you pointed out. Yes.

[Siraj Ahmed, analyst]

Okay. And lastly, just to pay now and pay in 2, the expansion of products. Are you getting a [ trade ] for the merchant for those 2 things?

[Charles Youakim, executive]

I didn't hear the question. Can you repeat?

[Siraj Ahmed, analyst]

The pay now and pay in 2 options, in addition to pay in 4, are you getting -- is the merchant paying a same take rate for that?

[Charles Youakim, executive]

Yes. We certainly will be launching the same payment platform. So we will get the same take rate. But when we launch products within our platform, we always have -- we build in levers that allow us to adjust. So we'll have the capability to adjust on a platform level or a payment method level, but it will launch initially under the same envelope.

[Paul Paradis, executive]

To clarify, though, those products are not live in market yet. So we don't know the...

[Charles Youakim, executive]

Yes, they're not there yet.

[Paul Paradis, executive]

So we don't know the take rates of the product yet.

[Operator]

There are no further questions at this time. I'll now hand back to Mr. Youakim for closing remarks.

[Charles Youakim, executive]

Thank you. I'll be quick here. I really just wanted to say a big thank you to the Sezzle team on this quarter. I think they've done a phenomenal job through a lot of adversity to get our company into a great place. So thank you all very much. And also to our investors, thank you for your time and interest, and have a great rest of your day. Thank you all.

[Operator]

Thank you. That does conclude our conference for today. Thank you for participating. You may now disconnect.