Block, Inc. (NYSE:SQ) Q3 2023 Earnings Call Transcript

Block, Inc. (NYSE:SQ) Q3 2023 Earnings Call Transcript November 2, 2023

Block, Inc. beats earnings expectations. Reported EPS is $0.55, expectations were $0.44.

Operator: Good day, everyone, and welcome to the Block Third Quarter 2023 Earnings Call. Today’s call is being recorded. All lines have been placed on mute to prevent any background noise, and after the speakers’ remarks will be a question-and-answer session. [Operator Instructions] I would now like to turn the conference over to Nikhil Dixit, Head of Investor Relations. Please go ahead.

Nikhil Dixit: Hi, everyone. Thanks for joining our third quarter 2023 earnings call. We have Jack and Amrita with us today. We will begin this call with some short remarks before opening the call directly to your questions. During Q&A, we will take questions from conference call participants. We would also like to remind everyone that we will be making forward-looking statements on this call. All statements other than statements of historical fact could be deemed to be forward-looking. These forward-looking statements include discussions of our outlook and guidance, as well as our long-term targets and goals, and we may decide to shift our priorities or move away from these targets and goals at any time. These statements are subject to risks and uncertainties.

Actual results could differ materially from those contemplated by our forward-looking statements. Reported results should not be considered as an indication of future performance. Please take a look at our filings with the SEC for a discussion of the factors that could cause our results to differ. Also note that the forward-looking statements on this call are based on information available to us as of today’s date. We disclaim any obligation to update any forward-looking statements except as required by law. During this call, we will provide a preliminary estimate of performance for the month of October. This represents our current estimate for October performance as we have not yet finalized our financial statements for the month of October, and our monthly results are not subject to interim review by our auditors.

As a result, actual October results may differ from this estimate and may not be reflective of performance for the full fourth quarter. Moreover, this financial information has been prepared solely on the basis of currently available information by, and is the responsibility of, management. This preliminary financial information has not been reviewed or audited by our independent public accounting firm. This preliminary financial information is not a comprehensive statement of our financial results for October or the fourth quarter. Within these remarks, we will also discuss metrics related to our investment framework, including Rule of 40. With Rule of 40, we are evaluating the sum of our gross profit growth and adjusted operating income margins.

Also, we will discuss certain non-GAAP financial measures during this call. Reconciliations to the most directly comparable GAAP financial measures are provided in the Shareholder Letter, Historical Financial Information spreadsheet, and Investor Day materials on our Investor Relations website. These non-GAAP measures are not intended to be a substitute for our GAAP results. Finally, this call in its entirety is being webcast on our Investor Relations website. An audio replay of this call and the transcript for Jack and Amrita’s opening remarks will be available on the website shortly. With that, I would like to turn it over to Jack. One moment. We’re just getting Jack to reconnect.

Jack Dorsey: I’m sorry, I was on mute. So, we’re going to do something a little bit different this year. Thank you all for joining us. We wrote — I wrote a shareholder letter to you all, which you’ll find on our website, and we’re going to focus our call to maximize questions. So, we’re going to start with Amrita providing more detail into what I wrote, most notably, reaching our Rule of 40 goal in 2026 and authorizing a repurchase of $1 billion in shares to offset a portion of dilution from share-based compensation. If you haven’t yet, please read that letter for all the details and what I’m focused on going forward. And with that, I’m going to turn it over to Amrita.

Amrita Ahuja: Thanks, Jack. There are four topics I’d like to cover. First, our strong performance in the third quarter and increased profitability expectations for the remainder of the year. Second, a preliminary view of 2024 and where we’re demonstrating discipline on our investments to drive margin improvement. Third, our path to achieving Rule of 40 in 2026. And lastly, our capital allocation strategy to deliver value for shareholders. In the third quarter, gross profit was $1.90 billion, up 21% year-over-year. We delivered our highest-ever quarterly adjusted EBITDA of $477 million, or 25% margin on gross profit. Adjusted operating income, which as a reminder includes expenses related to stock-based compensation and depreciation, was $90 million and 5% margin on gross profit, compared to $32 million a year ago.

Our strong profitability during the quarter demonstrates our focus on efficiency in pursuit of our investment framework. Cash flow generation has also been strong and improving. Adjusted free cash flow was $427 million in the quarter compared to $88 million in the prior period. For the last 12 months, adjusted free cash flow was $945 million, up from negative $99 million in the prior period. Let’s get into Square and Cash App. Square generated $899 million in gross profit, up 15% year-over-year. Square GPV grew 11% year-over-year, or 12% on a constant currency basis. We’re committed to serving sellers locally and through our banking products. In the third quarter, we experienced strong growth from our vertical points of sale products with gross profit up 29% year-over-year and our banking products up 20% year-over-year.

Cash App generated $984 million in gross profit, an increase of 27% year-over-year. Looking at the components of the inflows framework, as of September, there were 55 million monthly transacting actives, up 11% year-over-year, with growth driven by our peer-to-peer network. Inflows per transacting active averaged $1,132 in the third quarter, up 8% year-over-year, and relatively stable compared to the first half of the year. Monetization rate, which excludes gross profit contributions from our Buy Now Pay Later platform, was 1.43%, up 8 basis points year-over-year, driven primarily by pricing changes over the past year and relatively flat quarter-over-quarter. Turning to our BNPL platform, which contributed $94 million of gross profit to each of Square and Cash App in the third quarter.

GMV from our BNPL platform was $6.7 billion in the third quarter, an increase of 24% year-over-year. Losses on consumer receivables were 0.84% of GMV, an improvement quarter-over-quarter and year-over-year. As Jack noted in his letter, in the fourth quarter, we restructured our commerce efforts, moving our BNPL platform into Cash App, as we believe combining the two ecosystems enables us to provide consumer experiences others can’t, especially for commerce. From a financial reporting perspective moving forward, we will no longer split 50% of our BNPL platform into each of Cash App and Square. Instead, to reflect the recent organizational change, we’ll include 100% of our BNPL platform in Cash App’s results beginning in the fourth quarter. During the quarter, we experienced an outage to our services across Block, which impacted both Square and Cash App systems.

We know the reliability of our systems is crucial for our customers and are working hard to rebuild trust. The outage lasted about 15 hours on certain products and we estimate it impacted gross profit by less than 1% during the quarter. Our offline capabilities for Square and Cash App enabled our customers to continue to process some transactions during this time. Looking ahead, we are accelerating our efforts to expand offline capabilities to all of our Square products, so sellers won’t be worried about missing a sale and are prioritizing building our technical infrastructure with greater redundancy and resilience. Turning now to the fourth quarter of 2023. We are shifting away from monthly trend disclosures in favor of reinstating quarterly and annual gross profit and profit guidance.

We expect to continue with this updated approach until we achieve and sustain the Rule of 40. We expect to deliver between $1.96 billion and $1.98 billion in gross profit or 19% growth at the midpoint. For Square, we expect gross profit growth to improve from the third quarter’s 15% growth rate as we lap more favorable comparisons from the prior year, and we get the first full quarter benefit from pricing changes on Square Invoices we implemented in the third quarter. For the month of October, we estimate Square GPV was up 9% year-over-year. Our growth has moderated due to both GPV per seller and lower contributions from new cohorts of sellers. We believe GPV per seller has been impacted by macro trends, in discretionary verticals, which continued through October.

Although we’ve achieved positive customer acquisition through the first three quarters of the year, gross profit from seller cohorts onboarded over the past two years are not contributing as much to growth as anticipated, and we’re focused on evolving our go-to-market strategy to improve this. For Cash App, we expect gross profit growth to moderate on a year-over-year basis from the third quarter’s 27% as we lap stronger growth from the prior year. We continue to expect all three components of the inflows framework to grow on a year-over-year basis in 2023. From a product perspective, we’ve seen particular strengths in Cash App Card and Borrow, as we drive continued growth in our financial services products. While we’ve experienced softness in growth from Cash for Business accounts and expect Cash App Business GPV to decline in the fourth quarter.

Compared to our prior expectations, growth in the fourth quarter was primarily impacted by expectations for our BNPL platform and, to a lesser extent, Cash App Business GPV and Square GPV. Looking at profitability, we expect to deliver $430 million to $450 million in adjusted EBITDA, and $40 million to $60 million in adjusted operating income in the fourth quarter. And we are raising our full year 2023 profit guide. We expect adjusted EBITDA of $1.66 billion to $1.68 billion, and adjusted operating income of $205 million to $225 million. These are increases of $170 million and $190 million, respectively, at the midpoint compared to our prior guide. For the full year 2023, the midpoint of our guidance implies gross profit growth of 24%, and adjusted operating income margins of 3%, leading to Rule of 27 this year.

This reflects meaningful margin expansion in 2023, with the midpoint of our guide reflecting 5 points of adjusted operating income margin improvement and 6 points of adjusted EBITDA margin improvement compared to 2022. Turning now to our path to achieving Rule of 40 in 2026. As a company, we remain focused on balancing growth and profitability. As we look longer term, we’re bringing a renewed focus to efficiency, exercising discipline with our expenses, and thinking critically about how we operate to drive leverage. We’re going to do all this while also focusing on how we can continue strong top-line growth to capture more of our addressable market. We introduced our investment framework at the beginning of the year and, today, we want to provide more context on when and how we expect to reach our goal.

As Jack shared in his Shareholder Letter, we plan to reach Rule of 40 in 2026 with an at least mid-teens gross profit growth and approximately mid-20% adjusted operating income margin. This guidance is based on current trends in our business and does not factor in changes to the macro environment. As we learn more and trends change, our expected mix of growth and profitability may change over time as well. We will continue to monitor trends as we periodically update this view. We see a long runway for continued growth ahead, and in our long-term planning, we’ve refined our priorities for each of our Square and Cash App ecosystems, which are captured in Jack’s Shareholder Letter. We believe we are still less than 5% penetrated against our $200 billion total addressable markets, one which we will work to expand over time in a disciplined way with new products and audiences.

In balance with our growth priorities, what you’re hearing from us today is a significant commitment to profitability and efficiency across three key initiatives. The first area is through the efficiency of our teams. As Jack outlined in his letter, we are implementing an absolute cap on the number of people we have at our company. We expect to be a smaller team by the end of 2024 compared to where we are today. Our cap of 12,000 people compares to our current size of just over 13,000 people as of the end of the third quarter. We believe constraining team size will enable us to be more effective in how we drive performance and service of our customers and accountability on our business strategies. We expect to reach this cap by the end of 2024 with steps towards this goal throughout the year through a combination of performance management, centralizing teams and functions to reduce duplication, and strict prioritization of our scope, aligned with the priorities outlined in Jack’s letter.

We expect to hold firm at 12,000 people until we feel the growth of the business has meaningfully outpaced the growth of the company. With greater constraints on team size, we expect to drive meaningful leverage on stock-based compensation as a percentage of gross profit in the years to come, starting in 2024. Second, we are also in the midst of a broad-based effort to reduce our spend across corporate overhead areas. We’ve identified a number of areas where we expect to find savings such as real estate, process improvements using automation, discretionary spend areas like T&E, and certain vendor relationships across software, data, cloud, consultants, and contractors. Third, within our ecosystems, as we’ve shared in the past, we’ve been identifying opportunities to continue improving our cost structure as we optimize unit economics and partnerships by leveraging our scale.

Moving to our initial outlook for profitability in 2024, which we expect to be our strongest year of profitability yet. While we are still in the planning process for next year, we expect significant margin expansion as we implement these constraints. We expect to achieve profitability on a GAAP operating income basis in 2024 and to deliver $875 million in adjusted operating income, up approximately 4 times compared to our 2023 guide. We expect to deliver $2.4 billion in adjusted EBITDA, an increase of more than 40% relative to our 2023 guide, and to deliver strong adjusted free cash flow growth next year as well. We plan to share more about our gross profit growth expectations for 2024 during our fourth quarter earnings call in February. Lastly, I wanted to touch on capital allocation and our focus on prioritizing shareholder return.

As we progress towards Rule of 40 in the coming years, we expect our margin profile and free cash flow generation to improve, which means we can return more to shareholders over time. Today, we are announcing an initial share repurchase program of $1 billion, which will offset a portion of dilution from share-based compensation and allow us to act opportunistically when we believe our shares are undervalued. We consider share-based compensation in our financial targets as we measure our progress towards Rule of 40, and we want to be responsible in managing the impact of dilution as our company grows. What you hear from us today is an increased commitment to delivering value to our customers and to our shareholders as we execute on the opportunity ahead of us.

And with that, I’ll turn it back to the operator to start the Q&A portion of the call.

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Q&A Session

Operator: Thank you. [Operator Instructions] We’ll take our first question from Tien-Tsin Huang with JPMorgan.

Tien-Tsin Huang: Hey, thanks so much. Really appreciate the cost discipline comments here. Jack, question for you. Just with all this cost framework now laid out, do you think there’s still room here for innovation and outsized growth that we’ve come to know from Block for quite some time? Especially with all the changes and the focus, can we see gross profit growth accelerate between now and 2026? Love to hear your thoughts. Thanks.

Jack Dorsey: Yeah, I think there’s even more room for innovation and invention and growth. To be very frank, I believe we’re getting in our own way throughout the company. As I’ve dug in through both the lens of Square and also our investment framework, I just found a lot of silos, a lot of redundancy, a lot of kind of a lack of desire for teams to work together. So, I think a lot of what’s been holding us back is cultural in that we need to reinvest in why we’re building an ecosystem of ecosystem model and how powerful that is. And then number two is around just our structure. We had unclear decision-making throughout the company which led to a lot of slowness especially on the Square side. So, we’ve been spending the past few weeks just looking at all of that and looking at all of our intersections with our foundational teams, that’s our HR and council and financial teams, and making sure that we approach that work very lightly so that we can focus a lot more on getting products and features to our sellers and to our Cash App customers much, much faster.

So, I believe we’re about to enter a phase of re-acceleration as we look to really hit our goals in R40. And I want to maintain that we’re looking to really focus on our customer and retaining our customers as well. So that will always be a checkpoint on all the moves that we make and ultimately how we think about shifting and iterating and experimenting much more.

Amrita Ahuja: Tien-Tsin, I’d just add that, in many ways, we think constraints can make us stronger. I think that’s what you’re hearing from Jack. And this people cap, the absolute number cap on the number of people we have is meant to address and enable these key decisions around our priorities, around our structures, centralizing teams to reduce redundancies in places, enable faster decision-making with clearer accountability, and help us create higher-performing teams across our ecosystem. We’ll release the team size cap constraint when we feel it constrains growth of our customers or our business or when the growth — when our top-line growth outstrips the growth of these teams. We’re not there today. Our focus also is on cost areas outside of the personnel costs that don’t touch customers, such as with corporate overhead.

And we think there’s lots of opportunity here to address, to streamline our operations without impacting the customer experience. And then finally, just a word from me on our planning process. We have more to do. So far, during our planning process, I think we’ve been appropriately focused on cost efficiency opportunities, but we have so many opportunities from a growth perspective across our ecosystems as well, some of which from a strategic prioritization perspective, Jack outlines in the letter. So, what you see here with 2026 growth, what we’ve shared so far really is based on our current run rate trends. And of course, we’ll periodically update this as we learn more, whether it’s from a macro perspective or based on our own execution and ability to accelerate.

And relative to that current view of at least mid-teens growth, we’d expect Cash App’s growth to be slightly above that and Square’s growth slightly below. But our focus is on exploring new growth initiatives, and then we’ll incorporate those as appropriate into our outlook over time. We have a history here of unlocking new innovation on products and across new audiences to continue driving outsized growth and we’ll continue that work.

Tien-Tsin Huang: Great. Thanks for the candid reflection. Thanks.

Operator: We’ll take our next question from Timothy Chiodo with UBS.

Timothy Chiodo: Great, thank you. I want to touch on some of the local sales efforts and the move up markets for the Square ecosystem. In the context of the 12,000 headcount cap, do you feel that there is ample room to show meaningful leverage on both product development and G&A, but at the same time, again, leaving that room to really lean into sales and marketing and specifically in building out some of those local in-market sales teams to help drive seller up market?

Jack Dorsey: Yeah, I do think there’s room. I do think there’s a lot of areas that we can make more efficient within Square. And I think where we’ve been lacking on the go-to-market is much more experimentation, and experimentation driven by AI tools as well. We put a focus, as you saw in the letter, it’s our number three priority is to utilize and grow with AI. For us, that means increasing the probability of positive outcomes for sales, customer service, which is focused a lot on retention and sales within the ecosystem, and also marketing to make all of those efforts much more efficient in terms of reaching sellers where they are. And it allows us with those efficiencies to experiment a lot more. So, we made a really good move with verticalization of our sales force.

We’re going to prioritize two verticals in particular, food and beverage, and also services such as beauty. They’re inherently local. Our strength is in local. And when we have that in-person strength, whether that be an upmarket seller or a small seller, we can expand our ecosystem through that relationship. So, we’re going to continue to focus on that strength. And then, through all those efficiencies that we create with these new AI tools, we’ll continue to roll out to our sales staff, to our support staff, and to marketing. I do believe we can experiment and experiment with new things that we haven’t tried yet, such as field sales, and learn from them quickly so we can iterate to really good answers.

Timothy Chiodo: Thank you, Jack.

Operator: We’ll take our next question from Darrin Peller with Wolfe Research.

Darrin Peller: Hey, thanks, guys. It’s great to see the outlook going all the way into the Rule of 40 in ’26. But really for now, we get a lot of questions on the sustainability of your Square, the seller business, really just understanding the drivers to the double-digit growth we hope to see. International verticalization, software services, cross-sell, just give us a sense of what the building blocks are to keep that up to those rates? And then also just an add-on to that would be to touch on where you see the success. I know, Jack, you alluded to the company’s culture working on the ecosystem. But I guess we’d love to hear more about where you see the success on ecosystem potentially kicking in, where you can see the benefit of that? Thanks, guys.

Jack Dorsey: Yeah. So, I think first and foremost, this goes back to the prioritization that we laid out. So, my first two weeks with Square, again, running Square was focused on like what are we working on and why, and doing a significant stack rank so that we — as an organization, we know what’s most important, why it’s most important, and how it’s going to impact. But the platform that we’re building is critical, not only for enabling new features that have left us out of the conversation for some sellers and not market sellers, but also to make sure that we’re realizing our ecosystem of ecosystem strategy and especially around our third-party developers so that they can continue to build where we’ve left off and we have more information on what we can partner with and build next as well.