Good day, ladies and gentlemen, and welcome to the Katapult Second Quarter 2021 Earnings Conference Call. [Operator Instructions] As a reminder, this conference call is being recorded. I would now like to turn the conference over to Mr. Bill Wright, Vice President of Investor Relations. Sir, you may begin.

Thank you, and good morning. Welcome to the Katapult Second Quarter 2021 Earnings Conference Call. With me today are Orlando Zayas, Chief Executive Officer; Derek Medlin, Chief Operating Officer; and Karissa Cupito, Chief Financial Officer. We will all be available for Q&A following today's prepared remarks. Before we begin, I would like to remind everyone that this call will contain forward-looking statements regarding future events and financial performance, including statements regarding our market opportunity, impact of our growth initiatives and our future financial performance and should be considered in conjunction with cautionary statements contained in our earnings release and the company's most recent periodic SEC reports. 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 information that constitute non-GAAP financial measures under SEC rules. These include measures such as adjusted EBITDA and adjusted net income. These non-GAAP financial measures should not be considered replacements for and should be read together with GAAP results. Reconciliations to GAAP measures and certain additional information are also included in today's earnings release, which are available in the Investor Relations section of our company website at www.ir.katapult.com. This call is being recorded and a webcast will be available for replay on our Investor Relations website. I would now like to turn the call over to Orlando.

Thanks, Bill. Good morning, and thank you for joining us. On today's call, we will review our second quarter 2021 results, share what we're seeing in the current macro environment and provide an update on our near-term outlook. Lastly, we will go into greater detail on our long-term growth strategy in this addressable market. We are enthusiastic about our market-leading technology that is delivering on our mission of financial inclusion for the non-prime consumer. We believe it's extremely powerful to enable this customer base to get the items they need and for e-commerce and omnichannel merchants to access a new market. Karissa, our CFO, will provide more details on our second quarter performance in a few minutes, but let me give you some second quarter highlights. Total revenue for Q2 2021 was $77.5 million, an increase of 28% year-over-year. Revenue year-to-date reached $158.1 million versus $103.6 million last year, an increase of 53% year-over-year. Gross originations were $64.4 million in Q2 2021, up 1% compared to Q1 2021 and down 17% year-over-year. Our compound annual growth rate for gross originations is 75% from Q2 2019 to Q2 2021. As we previously indicated in our first quarter earnings call, the second quarter represented a difficult comp due to the pandemic-related surge in demand for e-commerce durable goods in the spring of 2020. Nevertheless, originations were roughly flat sequentially versus Q1 2021 and have been steady in the $60 million to $65 million range over the past 4 quarters. Our adjusted EBITDA for Q2 2021 was $3.9 million, down 65% from $11.1 million in Q2 2020, reflecting our increased investment in growth initiatives, more normalized seasonal lease payment performance, new hire cost and incremental public company costs. On the macro front, it is a rapidly changing and complex environment that we have…

Hello. This is Derek Medlin, Chief Operating Officer here at Katapult. As Orlando mentioned, we are confident in the progress of our platform, our distribution and the offering. As you can see from our new merchant results, our platform is scaling smoothly with the arrival of new merchants across diverse integration platforms and methods. This flexibility that is inherent to our platform allows us to quickly react to merchant needs and activate the Katapult solution across all kinds of retail environments. It also gives us operational leverage as more volume has come on the platform and our automation matures. This has led to improved servicing cost margins. We believe that this will continue to be a strategic advantage as we reinvest our earnings for customers and merchants. In terms of distribution, as Orlando called out, we are pleased to see that our investments in sales and marketing are attracting new retailers at a faster pace. Comparing Q2 2021 versus Q2 2020, our active merchant base increased by 89% and the progress continued in July with another 15 adds. We're finding great adoption in categories such as outdoor sporting goods and automotive-related goods, which both more than doubled in merchant count year-over-year. And as Orlando mentioned before, our partnership with Affirm continues to expand, having also doubled our mutual merchants year-over-year. We have been able to activate dozens of new channel partners as well, expanding our footprint of distribution and allowing us to access a wider net of omnichannel opportunities for long-term growth. These new partners are seizing the opportunity to provide expanded payment options for non-prime consumers, and our platforms make it easy for merchants to incorporate Katapult as a checkout option on our website. That said, we are a fintech company, where we focus most of our investment dollars…

Thank you, Derek. Q2 2021 gross originations of $64.4 million were down 17% year-over-year, which was consistent with our previous expectation that we provided in the Q1 2021 earnings call. As a reminder, in the second quarter of 2020, gross originations were positively impacted by a combination of COVID-19, stay-at-home orders and temporary closures of physical retail stores that shifted consumer spending online. These consumer spending trends, coupled with the CARES Act stimulus checks, surge online transactions, better merchants and ultimately, our growth origination. As a result, Q2 2020 was our highest gross originations quarter last year and did not follow the traditional retailer seasonality we typically see. In Q2 2021, we are pleased with our progress at both Wayfair and the continued development of our other valuable merchants. Wayfair continues to be a strong partner, and we completed a direct integration with our system during the quarter that deepens our relationship. While we did observe a lower Wayfair U.S. sales penetration rate this quarter as a result of the prime provider stretching down to the credit spectrum to capture volume in our highest score bands, we do believe we are continuing to maintain or grow our position in the nonprime bands. Turning to revenue. Total revenue grew $16.7 million or 28% year-over-year as we continue to see strong payment performance. Gross profit margin for Q2 2021 was 28% versus 30% in Q2 of 2020. Gross profit percentage was 260 basis points lower year-over-year due to a combination of factors, including investments and various customer acquisition offers and an acceleration of our depreciation curve. As part of our deployment and growth in investment capital, we are testing various unique offers with our consumers. As Derek discussed in his comments, we see tremendous opportunity to differentiate ourselves with personalized offers that…

To wrap up, we want to reiterate our sincere appreciation for all our stakeholders. We appreciate our shareholder support, our merchants' trust and our customers' business and loyalty. And while we are operating within an environment of uncertainty, we remain focused on a much bigger future and are convinced that our market-leading position, strategic investments and long-term focus will equate to continued strong growth and improving profitability for many years to come. Derek, Chris and I will be happy to take your questions. Operator, please go ahead.

[Operator Instructions] Our first question comes from Ramsey El-Assal with Barclays.

I wanted to ask about the competitive environment. And I guess, specifically about your comments about prime providers sort of moving down market into the -- into your traditional kind of lower prime base. What is your view about the degree to which this is a more sort of permanent shift? I guess, in other words, has the competitive environment become more challenging on a lasting basis? I know that's a bit of a crystal ball question, but what's your view there?

Randy, it's Orlando. Thanks for the question. If you look at what has happened in the last year, even beginning at COVID, many of the prime lenders tightened up pretty dramatically. They -- which we were the benefit of because it waterfall down to us. And I think right now, the prime lenders -- and you track a few of them, so you know their delinquency rates are at all-time lows, and they've opened up to try to hit volume. So we think it's temporary, not knowing what's going to happen in the fall. Obviously, that's a question. But this is not -- I don't think it's sustainable necessarily as kind of things get back to normal.

Okay. And I also wanted to ask about the bad debt expenses stepping up in the quarter. I think you mentioned it was related to an increase in gross originations. And forgive me if I missed it, but something to do with account receivable balances. I'm just trying to understand here whether we should be modeling a higher kind of loss rate going forward or whether there was a bit of an anomaly in the quarter. If you could just elaborate on the drivers there, it would be great.

Sure. Yes, Ramsey, this is Karissa. So bad debt expense, it's definitely seasonal. In Q1, it was at the 6% mark. In Q4, it was 8.8%. So it really depends on the seasonality. But in general, in Q2, we had a few different dynamics. One, it was -- the bad debt expense as a percentage of revenue was just on a lower denominator because we have been testing customer promotions and pricing offers. So our revenue was a little bit -- intentionally a little bit less than normal. And then our gross AR just continues to grow as our base growth. And so that's what the bad debt expense is really a function of, it's reserving on our lease payments that have come due that we have not collected quite yet. So as the gross AR grows, we're going to see that bad debt expense grow in proportion. But I would say a good bad debt expense run rate, if you wanted to build one that covers all the seasonality in all the quarters to probably be around 8% to 9% at this point.

Okay. Terrific. Let me sneak one last one in. I was just curious, are the headwinds you're seeing, and I understand this is sort of a macro overlay, is it really manifesting itself mostly at Wayfair, your largest partner? Or is this something that you're seeing across the board sort of more broad-based across the business?

Ramsey, this is Derek. I'll take that one. So certainly, our largest retailer not providing revenue guidance and having some headwinds in the front and the durable goods space is certainly one area. We are seeing the impact of inflation and other pricing that has impacted some conversion rates in other categories. But I think in general, our view is that some uncertainty in the market right now, people are shifting their spending to other categories, and we're just expecting it to come back as soon as things settle down.

Yes. And Ramsey, if I can add, if you look at some of the e-commerce lender -- I mean, lenders and retailers that have announced recently, including one of the largest ones, they've all signaled that e-commerce has slowed. And so we're seeing that across the board with many of our retailers because we are focused on e-commerce and 90-something percent of our business is e-commerce. And I think it is a shift of spending. It started in the mid-June was when summer vacation started. You see the airports crowded as can be. People are spending money on travel and getting together again and durable goods and e-commerce sales have slowed and the stores are open. And so these are shifts that we believe are temporary and that we'll get back to normal, hopefully, depending on what happens with the Delta variant sometime either later this year or early next year.

Our next question comes from Kyle Joseph with Jefferies.

Just wanted to follow up on Ramsey's question on kind of the -- on the prime kind of stretching a bit. Would you say that's kind of traditional providers or more of like the new entrants into the prime financing market that you're seeing stretch?

I would say -- Kyle, it's Orlando. Thanks for the question. I would definitely say it's more the traditional providers. And you're right, some of the NPLs have jumped into the space, but I think they're focused on a much different customer. They're really not -- while you can stretch out the payments over 4, for example, with Afterpay or others, we don't really think we're competing with that because our AOV is higher. And that's not something usually somebody can split over for. But we definitely see it in some of the retailers where we have a waterfall with -- at Wayfair and Citi. We obviously have the Affirm partnership on the waterfall. And we've looked -- starting in the spring, we looked at our score bands and how many score bands are flowing to us, especially in the waterfall. And we're seeing that the higher score bands are minimized a little bit. So we have evidence that they're definitely buying deeper because some of our higher score bands are -- I don't want to say disappearing, but they've been minimized. And so it's clear evidence that they've gone deeper. And I think if you just look at any of the major prime providers, they've all talked about delinquencies being down and their profitability going up and they've released some of the COVID restrictions that they've had before. So again, I think it's temporary. It will get back to normal probably at the end of this year or into next year. And depending on what happens. I mean there's a lot going on.

Understood. Helpful. And then one follow-up. I just want to get a sense for really kind of portfolio performance on the heels of stimulus, also recognizing that child tax credit started to go out last month. But just walk us through whether it's payment rates or early buyout activity, kind of any trends you've seen kind of on the heels of stimulus, but in front of child tax credits.

Sure. So I mentioned in my comments that we had accelerated depreciation curve because the last round of stimulus at the end of March did spur a bit of early buyout activity, so it accelerated our curves accordingly. For the child tax -- sorry, child tax credit payments that started on July 15, we didn't see as big of an impact. And we think that's probably because, as we mentioned, starting in July, especially July 4th weekend, we did see consumers probably spending their money in other categories. So rather than coming and making a self-service payment to buy out or to pay down their lease, we think they're spending that in other avenues at this point. So we didn't see as big of an impact with these child care credits, but it will be interesting to see. Obviously, these are coming out monthly now, how that trend evolves going forward.

Kyle, this is Derek. I'll add one more thing to it. So we have seen a slight uptick in delinquency over the last couple of months that is very typical during the seasonal period. And so nothing out of the ordinary. Again, taking into account all the different ways of government stimulus and the supply and demand activities and shifting consumer behaviors, everything on the portfolio front operating within expectations.

Our next question comes from Anthony Chukumba with Loop Capital Markets.

Not to beat a dead horse with this issue of prime lenders sort of dropping down, but I cover Aaron's and Progressive and Rent-a-Center. And they haven't said anything about that phenomenon. So I guess I'm trying to understand why is that unique to Katapult when Aaron's progressive and Rent-A-Center are seeing no such phenomenon.

Anthony, one thing that's really unique about the Katapult Solution is that in many of our environments, we're in a waterfall environment, where we are receiving declines from prime providers. And that allows us additional insight as we can see trending and detailed analytics as to what's happening in our base through application flow, all the way through conversion. And really simply, there's been various outside stimulus. The trends in supply and demand have changed what has been needed or changed the character of what those above us are proving. And just like last year, when we saw tightening during uncertainty for core stimulus hit, we have seen that loosening occur. And this is something that we've seen before off and on throughout the years. I think this is fairly common, but in our position in the waterfall, we just have more visibility into it.

Got it. That's helpful. And then my second question, I understand there's a lot of moving parts here and there's a lot of uncertainty. But when you talk about the COVID-19 variant, I would think that would be a positive for your business, right? I mean you had your best ever lease originations in the second quarter of last year because of widespread shutdowns and the shift to e-commerce. So why wouldn't people getting freaked out about the COVID-19 Delta variant be good for your business and not bad for your business?

Anthony, this is Derek. I'll continue on that, and maybe [ Orlando ] can jump in. So on that front, there's puts and takes. And so when we talk about the uncertainty associated with COVID-19 and what that has done, one of the areas I'd like to emphasize is how that's impacting some of our retailer rollouts. Their ability to get IT support to be able to do integrations as well as the priorities that they have and in response to what's going in the macro environment is just shifting priorities for our releases. And so what's great is that there's still a heavy amount of interest and a lot of activity on that front. Many of these rollouts have been delayed. And so that's one impact on our business. Now on the consumer front, if there were more extreme activities that does tend to favor the e-commerce activity or purchasing behaviors. That said, that's not something that we're modeling in for the last half of the year.

Yes. Anthony, this is Orlando. If I can add, many of the discussions, and I think I've mentioned this on a previous call, that July and August are our biggest month in terms of retailer additions in preparation for the holiday. And resoundingly, what we've heard, and I'll give you an example, I was speaking with one pretty large retailer who is requiring everybody to come back to work soon, and many of their IT resources have quit because they've moved to another area, they can work from home. And so there seems to be across the board at many of these retailers is just an IT constraint issue that is unforeseen. And they can't get enough resources on the tech front and that the ones that they have are leaving for work from home, if necessary. And so while we normally see a really big uptick on new retailer additions, and we've had quite a few smaller ones, some of the larger ones are a little bit tougher to get done because of those IT constraints.

There are no further questions at this time. Please proceed with any closing remarks.

All right. I want to thank everyone for listening today. We're excited about the long-term growth aspects of Katapult. We continue to work hard to get the retailer integrations that we need and enjoy the strong pipeline that we have. There are constraints, but we're working hard to try to help alleviate some of those issues by simplifying our integrations with the retailers. And I think we're looking forward to the second half of the year and into next year as some of these retailers get back to normal and they can integrate our platform pretty quickly. So again, thanks, everybody, for listening, and have a good day.

Ladies and gentlemen, this does conclude the conference. You may now disconnect. Everyone, have a great day.