Block: Focus on Profit Growth and Risk Management

Below is the summary of Block's Q1 conference call. For the financial report analysis, please see "Block: Strong and Resilient Amid Adversity?"

  1. Management Commentary

Currently and in the long term, there are three macro challenges impacting all enterprises.

Firstly, the ongoing global crisis. Secondly, decentralized regulation. Thirdly, changes to the global financial system.

The world seems to be transitioning from one global crisis to another, and is burdened by an abundance of information, from the COVID-19 pandemic to inflation, the war in Ukraine, and bank failures.

At the same time, regulatory agencies around the world are offering slightly or vastly different solutions to issues facing their citizens. We have not established global standards, but instead have developed different rules for each market, which actually slows down development.

This makes developing global internet business extremely challenging, especially for small companies. Part of our work will be to help customers cope with this complexity. Finally, the global financial system faces many challenges, from new global reserve currency candidates, through the destruction of small banks and the concentration of banking, to the adoption of central bank digital currencies with new functions.

These all affect our core business and are trends that we need to carefully grasp. I believe there are some technology trends that can help us do this. The three trends we are focused on are artificial intelligence, open protocols, and global centrality.

If we consider the fastest-growing internet population, we must look at countries in Africa, Latin America, Asia, and the Oceans regions, where most of humanity resides. The region is adopting open protocols at a faster pace than Western countries.

We chose to focus on these markets because we believe that over time, the entire potential market will be larger than any market we currently occupy.

I want to ensure that you are all aware of how we will drive our roadmap and business in the future. With our investment framework, we have the right accountability, and "unity" is the keyword here, as our true value comes from our multiple ecosystems, which work actively together and provide resilience in challenging times. I am incredibly excited about the future development and direction of our company.

2. Financial Performance

  1. In Q1 of this year, we achieved strong growth in the entire ecosystem, with gross profit reaching $1.71 billion, a year-on-year increase of 32%. If the impact of the Afterpay merger is excluded, Q1 gross profit increased by 27% year-on-year, higher than last quarter's 21%.

We also continue to achieve diversified profitability flows throughout the ecosystem. In Q1 of this year, we had 14 revenue sources in Square and Cash App, up from 11 a year ago, with an annual gross profit of over $100 million.

2. Cash App monetization rate is 1.41%, not including the gross profit contribution from our BNPL platform, higher than 1.19% in Q1 2022. Benefiting from the growth of monetization products and pricing changes to be implemented in 2022, the monetization rate increased slightly from 1.39% in the fourth quarter, including interest income. Our financial services products are a key driver for cash inflow and help us maintain relationships with our active users, especially Cash App card users.

In March, our monthly instant deposit activities reached 2 million. We promoted the adoption of direct deposit through unique enhancements, and recently provided free ATM withdrawals to users. Earlier this year, we also launched Cash App deposit, which was the most requested feature by our customers, providing a simple and flexible way for customers to manage their savings balances. Since its launch in January, by the end of April, more than 3 million savings enthusiasts had added funds to their savings balances.

Square generated US $770 million in gross profit in the first quarter, a year-on-year increase of 16%. Excluding the impact of consolidation, Square's gross profit increased by 12% year-on-year. In addition, excluding the gross profit brought by PPP loan forgiveness, Square's total gross profit in the first quarter increased by 21%, higher than the previous quarter's 16%.

The drivers of Square’s Q1 performance. First, we will continue to drive the growth of our payment business. The gross margin of these products grew 19% year-on-year. Among them, we performed well in vertical sales points such as retail, restaurants, and appointments, with a year-on-year gross profit increase of 42%. Overall, the gross profit growth rate of offline channels is faster than that of our online channels. We have seen that online growth rates have normalized compared to pandemic levels.

Second, we continue to grow with larger sellers, and the gross profit of mid-market sellers also increased by 19% year-on-year. We remain focused on driving our software products for the three major vertical markets of restaurants, retail, and beauty offered to large-scale sellers within those markets. We recently introduced vertical-specific landing pages on our website to provide customized experiences for sellers. The updated website will aggregate demand to our sales team, and we will also thematicize it to further support our market entry efforts.

Third, we continue to expand worldwide. The gross profit growth of our international market exceeded that of the overall gross profit, with a year-on-year increase of 29% (excluding the contribution of the BNPL platform). We remain focused on Square's omnichannel software, high-end, and global strategic focus, and we will position our roadmap and investments in these meaningful growth areas.

Finally, our BNPL platform generated US $56 billion GMV in the first quarter, an 18% year-on-year increase. The loss of accounts receivable by consumers accounted for 0.7% of GMV, which improved both year-on-year and quarter-on-quarter. 8. Latest Trend in April: For April, we anticipate a 24% year-on-year increase in total gross profit, with the second quarter expected to remain relatively stable.

We expect Square's gross profit to grow by 14% year-on-year in April. For the BNPL platform, we anticipate a 20% year-on-year increase in GMV in April, an improvement from the 18% in the first quarter.

We have raised our expectations for profitability for the rest of the year. We expect an adjusted EBITDA of $1.36 billion and an adjusted operating loss of $115 million for the full year 2023, mainly due to our plan to shift some expenses originally planned for the first quarter to later this year, resulting in a strong first-quarter revenue performance. Through 2023, we will continue to focus on efficient operations and drive operating leverage in recruiting, sales and marketing, and corporate management expenses. For the year, we continue to anticipate improved profit margins for adjusted EBITDA and adjusted operating income compared to last year.

Stock-based compensation: In the second quarter of last year, our stock-based compensation expenses increased by $47 million on a quarterly basis, and we expect similar quarterly increases in the second quarter of this year.

Q&A

Q1: With the current turmoil in the banking system, will you change your near-term priorities or risk management strategy?

A1: As you mentioned, there have been many events in the financial and banking industries, and we must consider and ensure appropriate investments based on customer needs.

One of the key focuses is how our customers trust us, and how our partners, including banking partners and regulatory agencies, trust us. This is important and always has been.

Block's business is highly regulated, and to achieve this, we must maintain a culture of compliance and responsible risk management, including investments in projects, processes, controls, and teams, as well as in-depth compliance expertise.

In recent years, we have significantly increased our investments in compliance. At the company level, we expect to invest approximately $160 million in compliance by 2023, which means that our investments have increased by more than five times since 2020, exceeding the operational growth rate during the same period by about two times. Particularly for Cash App, the growth rate of compliance investment is even faster.

Q2: How is the investment, distribution, and sales situation of vertical products in the retail, restaurant, and beauty fields?

A2: We have over 30 products, including some vertically specific software and a development platform, and if our customers cannot find the tools they need on our platform, they can build their own tools or hire developers to do so. We provide flexible vertical software for people, allowing us to serve the specific needs of more complex sellers.

We see great growth potential in vertical sales points and developer solutions. Profits from medium-sized merchants increased by 19% year-on-year in the first quarter, exceeding our 16% overall Square gross margin growth rate. Our vertical point system sales showed strong growth with a year-on-year increase of 42%, and the gross profit of our development tools also exceeded the overall profit growth.

As we optimized our channel mix and improved our business in the first quarter, we significantly reduced sales, marketing, and advertising investments year by year.

Q4: Is there sustainability in the growth of Cash App profits? How do you see the future?

A4: By breaking down the performance of Cash App based on inflows, we've seen strong growth in three variables - whether it's active transaction volume, inflow rate, or profit margin.

Monthly transaction activity in March was 53 million, a year-on-year increase of 17%. This was driven by viral effects of peer-to-peer networks and marketing efforts to push new customers to use more products.

The key driver of inflow is the adoption of products, such as Cash App Cards, and as time goes on, customers will flow more funds into Cash App, leading to a further increase in transaction volume.

At the same time, as our target audience and Generation Z become the ones who master income and expenses over time, we will see strong growth in inflow.

The third key driver is profit margin, which has been rising as monetization channels and monetization rates have increased.

Q5: How do you consider the growth drivers for gross profit and GPV? Are there any other driving factors?

A5: Our software and integrated payment tools, as well as the solutions we provide to vertical merchants. We have also seen huge growth in the personal channel compared to the online channel. We have also seen the benefits of a bank-like ecosystem, where the gross profits of loans, instant deposits, and the Cash App Card are growing faster than Square.

When we observe the overall growth rate of key verticals, the volatility of the food and beverage and retail markets has been relatively stable since mid-November.

In addition, due to the breadth of Square's ecosystem, our business is very resilient. We serve multiple verticals and various types of customers, and have entered the high-end market.

We are expanding globally with a product-centric approach, and our primary task is to continue to push for the same product to be used in all markets. We will pay more and more attention to products launched globally.

Q6: How should consumer spending changes be considered on Square? Have you been affected by unemployment or the trend of consumption on Cash App? Could you talk about sensitivity to credit business and credit cycles?

A6: From the perspective of the loan product, our core products have some common attributes that make them more resilient in an uncertain macro environment. First, we use a data-driven approach. Risk in the underwriting model is updated in real-time based on a wide range of customer data sets, including both personal customers and millions of other similar customers.

In fact, some of our core borrowing products, such as Cash App borrow and Square Loans, are provided to customers based on specific eligibility criteria determined by us. These products also have unique structures that truly simplify the process of obtaining funding. They usually shorten the term and streamline the repayment process. This is partially why we have seen healthy repayment behavior across different types of credit.

The total loss of accounts receivable in the first quarter actually improved, both quarterly and year-on-year. Finally, we see strong reuse. These customers are well known to us, they have a repayment history and the ability to secure better underwriting.

Q7: What are the latest thoughts on the product roadmap regarding Cash App and savings products? What other types of adjacent financial services may be considered? What's the most attractive?

A7: Earlier this year, we launched savings products that allow customers to hold savings and bonds separately in Cash App because our users want more budget and fund management tools. It enables our customers to easily set and track financial goals. Moreover, they can easily add money to their savings accounts via cash payments, linked debit cards, or cash. So far, this is one of our fastest-growing products.

Although in its early stages, this feature can bring more funding into our ecosystem over time. As of the end of April, we had over 3 million active people adding funds to their savings bond accounts, with over half of them saving through cash cards.

Q8: Regarding Opex, can you talk about the efficiency areas you may benefit from in this quarter or the time factors that may affect annual operating costs? How do you view the growth of operating expenses for the year, what are the investment areas worth noting this year, and whether there have been any changes to the operating expense plan compared to the previous quarter?

A8: The situation for the year and the view of the profitability. Our goal has always been to invest responsibly to achieve profit growth. For the year, we raised the adjusted EBITDA profit target to $1.36 billion, with an annual growth rate of over 35%, an adjusted loss of $115 million, and both profit margins are increasing.

This mainly reflects the strong growth of our first quarter gross profit. In terms of expenses, we postponed some investments originally planned for the first quarter to later this year. In the long run, we follow the previous path and strive to achieve the 40 rule.

We still expect the cash profit margin to expand, which is the trend we saw this quarter and the continuation of the profitability improvement over the past few years. If we see growth slowing down, we will reduce expenses in the plan.

However, we intend to slow down the pace of recruitment, and expect that the number of employees will increase by about 10% in the time after the restructuring, and the growth rate of sales and marketing personnel will be far lower than the 25% growth rate in 2022.

Looking at some quarterly changes in the second quarter, sales and marketing were relatively stable compared to the same period last year. Sales and marketing expenses increased by 9% due to the increase in point-to-point transaction losses and issuance costs. But other sales and marketing businesses have been declining year after year. Product development expenses have increased, mainly driven by the cost of team members. Investment in compliance and customer support is also increasing year by year. HR risks are increasing year by year, and we must abide by discipline throughout the business.

Q9: Any further comments on the growth of BNPL's gross profit and the company's comprehensive growth of 24% in April?

A9: In the first quarter, GMV increased by 18%. Due to the shift of our portfolio to enterprise sellers and new markets, the growth rate of GMV in gross profit continued to accelerate in the first quarter. The growth of gross profit was slightly lower than that of GMV, but we expect a 20% growth in total commodity transactions in April.

We are encouraged by this situation, and high-quality user acquisition continues to grow, with repeat stickiness and healthy repayment rates. We found that 98% of purchases did not generate late fees, and 95% of installment payments were paid on time.

When we launched BNPL offline and online at Square, we saw encouraging early adoption and focused on leveraging the integration of our ecosystem.

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