Buy-now-pay-later company Affirm (AFRM 5.31%) beat analyst estimates across the board when it reported results for the fiscal fourth quarter, which ended on June 30. Gross merchandise volume rose 25% year over year to $5.5 billion, revenue jumped 22% year over year to $446 million, and the company reported an adjusted operating profit in positive territory.
But while Affirm's report looked generally positive on the surface, there are two warning signs that investors shouldn't ignore.
1. About that revenue growth
Affirm's revenue grew at a solid double-digit rate in the fourth quarter, driven by higher volumes running through the company's platform and higher interest rates on loans. The percentage of loan originations that carried an APR above 30% topped 20% in the fourth quarter as Affirm rolled out its 36% APR rate cap.
Affirm's revenue from interest on its loans grew even faster than total revenue in the fourth quarter, jumping 56% to $214.8 million. Revenue from its merchant network and card network grew more modestly.
While Affirm is successfully pushing higher rates on its users, the company is paying far more to secure funding for these loans. Affirm's funding costs more than tripled on a year-over-year basis in the fourth quarter. And while delinquency rates remain healthy, Affirm's provision for credit losses jumped 30% in the fourth quarter to $94.5 million. Accounting rules require Affirm to take charges based on the company's expectations of future losses on loans it makes today.
The cost to process and service loans also rose far faster than revenue. Processing and servicing costs were $71.2 million in the quarter, up 50% year over year. Meanwhile, the company cut spending on sales, marketing, general, and administrative functions.
Affirm reports a non-GAAP metric called "revenue less transaction costs," which takes total revenue and subtracts losses on loan purchase commitments, provision for credit losses, funding costs, and processing and servicing costs. This metric is a gauge of the economic value generated by the transactions processed on Affirm's platform.
The problem for Affirm is that revenue less transaction costs is sinking even as total revenue surges. This metric was down 1% year over year to $182 million in the fourth quarter. As interest rates have risen, Affirm is paying a steep price to keep its top line growing.
2. Adjusted profit is even more adjusted than usual
It's common practice for technology companies to report non-GAAP profit metrics that back out stock-based compensation. While stock-based compensation is a non-cash expense, it's still a real expense. As Warren Buffett has said, "If compensation isn't an expense, what is it?"
While Affirm reported an adjusted operating profit of $15 million in the fourth quarter, its GAAP operating profit was a loss of $243 million. Part of this enormous gap was due to the $103 million in stock-based compensation expenses that are ignored in the non-GAAP figure.
Affirm goes a step further. The company has struck multiple deals which involved handing out warrants and stock appreciation rights in exchange for partnerships. One such deal was with Amazon, which brought Affirm's loan products to its massive customer base. The price for this partnership was steep. Amazon received warrants to purchase 7 million shares of Affirm stock at an exercise price of $0.01 per share.
The costs associated with the equity Affirm has handed out for partnerships are realized over time. In the fourth quarter, on top of the stock-based compensation charges that Affirm's adjusted profit metrics ignore, another $110.5 million of costs associated with warrants and other stock-based expenses is backed out as well.
It's hard to see how anyone could argue that these warrants don't represent a real expense. Affirm is exchanging something of value for access to platforms that are driving gross merchandise volume and revenue higher. The company's adjusted profit metric captures the benefit without accounting for the cost of realizing that benefit.
The bottom line: While Affirm is profitable on an adjusted operating basis, this metric is largely meaningless. The company remains profoundly unprofitable when all costs are considered.
