Block: Trading balanced investments for long-term growth.

I. Management Discourse

1. We have 3 principles guiding our investment framework:

   • Ensure our investments are focused on customer retention and growth.

   • Accurately measure the ongoing costs associated with our business, including equity-based compensation.

   • Use industry standard conventions with simple communication and understanding.

   Our adjusted revenue applies the Rule of 40. This is an ambitious and unrealized goal.

2. We have long-term customer retention capabilities. Historically, Cash App and Square have positive gross profit retention rates.

   Due to macroeconomic changes, we may not achieve this goal in every period. For example, Square's retention rate dropped in 2020 and recovered in the second year. However, in the long run, our ecosystem's average annual gross profit retention rate is 100%. We will strive to effectively attract new customers, increase customers' lifetime value, and adjust customer acquisition costs appropriately. The combination of effective customer acquisition and retention has brought greater gross profit growth to our ecosystem.

3. We mainly focus on gross profit growth and adjusted EBITDA profit margins. The gross profit growth and adjusted EBITDA profit margins of the company in 2022 are 52% and 42% respectively (excluding Afterpay).

   According to the Rule of 40, our goal is to achieve a gross profit growth and adjusted operating profit margin of over 40% in the long run. This goal applies to the overall level of the company and each of our ecosystems.

4. Cash App had 1 million transaction activities in December 2022. By 2022, Cash App achieved a return on investment of 6 times or more in 3 years. The investment payback periods in 2021 and 2022 were less than 1 year.

5. Room for growth

   Looking at the gross profit opportunities of nearly US$200 billion in our potential market, we only have less than 5% of the market share. We will continue to invest discipline to promote the growth of each ecosystem.

   This includes launching new products, expanding to new customer groups, and improving our promotion methods globally. For our emerging businesses, we will seek the path for these ecosystems to achieve and maintain the Rule of 40.

6. Profit expectations

   We plan to accelerate the pace of recruitment for the entire company in 2023. In the past few years, our business and expense base have grown significantly. In 2023, we will focus on efficient operation, and we expect our spending growth rate to slow down compared to previous years. We expect to achieve an adjusted EBITDA of about US$1.3 billion in 2023, with growth of more than 30%. We expect Cash App's profit margin to expand year by year, while we expect Square's profit margin to remain relatively stable year-on-year.

7. Expense Forecast

Employee expenses are the biggest driver of our spending base. We expect the number of employees to increase by about 10% YoY by 2023, and overall personnel expenses to increase by about 20% YoY.

Next, we expect overall sales and marketing to grow by 5-10% YoY in 2023, slowing from about 25% YoY compared to the previous year. We expect variable costs for P2P in Cash App and Cash App card issuance to increase faster, while other sales and marketing costs will remain relatively consistent with the previous year.

1. 2023 Q1 Guidance

It is estimated that gross profit for Block's existing business (excluding BNPL) will increase by about 33% YoY in January and February. We expect growth for the entire first quarter to be a few percentage points lower than this number.

For Square, we expect gross profit to increase by about 15% YoY as of January and February.

Looking at recent transaction volume trends, we see that the growth rate of GPV in some parts of the US has slowed since November, mainly in the food and beverage and retail businesses. These trends have continued into the first quarter.

The bad debt loss rate usually experiences seasonal growth in the first quarter, but we expect it to remain around 1%.

1. Q&A

Q: What is the progress of the vertical sales team? What are Square's further market choices?

A: We aim to maintain a target of 4x return on investment (ROI) and a 6-quarter payback period. In the past few years, expenditures and sales plans have been dynamic, and 2023 will continue to be dynamic.

The company has already established vertical sales teams in three key areas: restaurants, retail, and services.

Meanwhile, we expect overseas sales to contribute more to obtaining merchant customers. Gross profit from medium-sized sellers (annual sales>$500K), excluding BNPL, increased by 16% YoY from medium-sized sellers.

Q: What macroeconomic assumptions is the 1.3 billion EBITDA profit based on? What are the prospects for further development of Cash App?

A4: From a growth perspective, we expect Cash App's growth rate to be faster than Square's, and overall spending trends on Cash App to remain relatively stable, while some optional consumer sectors have eased.

We do expect Cash App and Q2 gross profit growth to slow in March, as we catch up with some pricing changes made last year from a market driver's perspective.

We have seen that payments + software has become an important part of Square's business, accounting for 75% of Square's gross profit. We will continue to focus on our high-end, omni-channel, and international strategic areas. From a profitability perspective in 2023, we are focused on efficiency and as you have heard, intentionally slowing the pace of cost growth.

Q: What is the meaning behind changing the focus of the profit indicator from Adj.EBITDA in the company's strategic framework to adjusted operating profit?

A: We need to focus on customer-centric indicators, namely gross margin retention rate. Ensuring that we retain customers brought into the network and purchase more services in the ecosystem.

Secondly, we need to consider the actual cost of the business and consider equity-based compensation expenses in the profitability indicators. This is a meaningful change because we believe that SBC is an important component of our compensation model and we want our employees to become shareholders. This structure allows us to attract and retain amazing talents and invest in high-performance teams. With regard to the impact on existing shareholders, the dilution level from historical SBC share numbers has always been in the low single-digit percentage range, and we expect this level to continue in the future.

Q: How do you choose between pursuing cash inflows and profits with Cash App?

Let's break down the cash inflow framework for our Cash App.

The first is that there were 51 million transactions on Cash App in December, with a year-on-year increase of 16%, and as the number of transactions on the platform increases, more funds will be retained.

In the fourth quarter, the average cash inflow per active user was $1048, and we believe there are two main channels to increase the scale of cash inflows:

The first is new products. Cross-selling existing products and launching new products can drive more cash inflows. We note that the self-inflow brought by Cash App Card is twice that of P2P activities.

When users use instant deposits and other deeper financial services, the cash inflows of users will increase.

It is also important to increase investment to enhance users' trust in us and increase the upper limit of funds that users can use on Cash App, which can drive us to gain a larger wallet share and expand to a wider customer base.

It is worth noting that in the Z era, young customers, who are our target, generally do not have a lot of cash inflows at an early stage. However, these customers are the consumers we hope to have in the next few years.

The third component of the cash inflow framework is the monetization rate. The realization rate can affect our profits and the frequency of users using our products. We have many free products to attract users and profit from other paid products.

Q: What are the prospects for gross margin rate and ecosystem integration?

A: We expect Cash App growth to exceed 50% in January and February. We expect the growth rate to slow down in March this year. From Square's perspective, we expect gross profit to grow by 15% in January-February. Square grew 19% in Q3. We saw optional consumer spending in the fourth quarter, so we expect Q4 to be 17%. As for ecosystem integration, what we're focused on is clearly Afterpay. We're still in the early stages of product integration, such as Cash App payments, which can collaborate with merchants on Afterpay, and then continue to develop within the Square ecosystem.

Risk Disclosure and Statement for this Article: Dolphin Analyst Disclaimer and General Disclosure