Marqeta, Inc. (MQ) Earnings Call Transcript & Summary

Very pleased today to be kicking off the 2023 Morgan Stanley TMT Conference. Thanks to everybody for joining us in this opening session with Marqeta. Today, we have Mike Milotich, CFO. Thanks for joining us today. And before I get started, make sure that I don't get in trouble. For important disclosures, please see the Morgan Stanley research disclosure website at morganstanley.com/researchdisclosures. And if you have any questions, please reach out to your Morgan Stanley sales representative. So with that out of the way, Mike, thanks for joining us. Excited -- like I said, excited to be kicking off with Marqeta here this morning.

Maybe help us level set, if you will. It's been a couple of years since the company became public and where is Marqeta today? How is the business progressing and really kind of what are your key to-do items for the future?

Yes. So I think the business is in a very good place. We've been scaling very rapidly in a really incredible way. If you go back to the first 2 years of the pandemic, so from 2019 to '21, those 2 years, the business grew over 4x. And even if you just look at our TPV in 2022, the year we just completed, it approached $170 billion, which is just about 3 percentage points smaller than '20 and '21 combined. So the business is getting big quickly, and we're getting to the point where we're scaling and that has a lot of trickle-down benefits for us, both from a market perspective in terms of attracting customers as well as in terms of our cost structure and getting to profitability. I think the other thing that's great about where we are is, just in the second half of last year, we really sort of rounded out our platform. We launched our credit products, we launched Marqeta for Banking. And then just earlier last month, we made a acquisition in credit. So we really feel like we have the comprehensive platform that we need at this point. And so we feel like we're in a good place. In terms of focus areas, I think there's 2 key areas. One is, the embedded finance opportunity is really picking up momentum, and I'm sure we're going to talk a lot about that this morning. And the second thing is just starting to do things in a much more structured repeatable way as a company so that we just get more efficient and effective. So many of the things when you're in hyper growth and you're a relatively young company, you tend to throw bodies at problems to get things done. And we're at the point now where we're starting to get a lot more structured and that should be -- help us going forward.

So wanted to touch, you highlighted embedded finance. But with Simon coming in now as CEO and having been named recently, et cetera, what are the key aspects of the strategy that we expect -- should expect to be different with him? I mean I know that in kind of his initial public statements, he has talked a lot about embedded finance. Is that the key thing? Or are there other areas that you think will allow him to define his own strategy?

Yes. I think the -- what I think won't change is -- the big picture strategy is not something that will change, only because it's very clear the direction we should be going. We have great product market fit. We hear very consistently from our customers what they want from us. And even just in this past fall, we completed our first multiyear planning effort. And Simon is a big part of that from a product as well as a go-to-market perspective. And so I think sort of where we're going is not going to change. I think the biggest things that are going to change with Simon at the helm is sort of how we do things, not what we do. And so I think -- and it's a couple of key changes. So one is more of a solution orientation. So with embedded finance, what's happening is it's rather than smaller, narrower focused companies, it's much more established players who are looking to have comprehensive offerings, which means -- and now that we've rounded out our platform, it's about how do we put those pieces together, take our highly configurable and flexible platform and put it together in unique ways for solutions that meet our customers' needs. So that's a one big change. Another big change is just continuing to innovate, but within the economies of scale we've already achieved. So we think we're going to be able to slow down our incremental investment significantly and you leverage the resources we have with our platform now largely built out. And so that focus on profitability, that focus on solutioning, is, I think, really the big difference you're going to see in terms of how we approach the market going forward.

So I want to -- I definitely want to talk about some of these products and what you're doing to build on those. But one of the big questions that we get from investors universally right now is on macro. And just -- what are you seeing generally across your platform, maybe from a verticals perspective, any macro sensitivities that you think are important to -- for us to be aware of?

I would say things are stable and healthy. If you look at our key verticals, financial services, the growth remains stable and strong. It's growing faster than the overall company. Block is a big part of that, which is their incredible user engagement and growth. The expense management vertical is still growing over 100%, so that's scaling really rapidly. On-demand delivery has been stable. Really all 4 quarters of the year, grows double digits. It's our most mature vertical, but it's healthy growth. And then Buy Now, Pay Later, this quarter, the growth slowed really for 2 reasons: one, just growing over an incredible holiday season from 2021. And the second thing is, we did lose a portion of one of our programs from one of our customers in the Buy Now, Pay Later space in Q3. If you adjust for that volume loss, Buy Now, Pay Later, which is growing a little bit slower than the overall company. So most of the verticals are healthy. I'd say when we look at the categories of spend, what we see is the highly discretionary areas of spending, which is roughly a 1/6 or so of our volume, and we look at nondiscretionary, which is about 1/3 and then there's sort of the medium bucket of sort of everything in between. When we look at those 3 categories, each of them are growing at roughly the same rate. So everything is growing fairly consistently versus in past quarters, the discretionary spending was growing faster -- was growing the fastest. And so that is a slight change. But overall, we're not seeing a big pullback in consumer spending. We're seeing Buy Now, Pay Later customers tighten their credit profiles a little bit. In expense management, we're seeing businesses tighten up a little bit. But -- so I would say, very small headwinds, nothing significant.

So let's turn to the theme of embedded finance. You mentioned it this morning. It's been a topic on at least the last couple of conference calls or earnings calls. How does that trend contribute to the sustainable profitable growth? Is there something beyond just volumes? Or is it just volumes? Like how should we think about like the sensitivities and levers there for Marqeta?

Yes, I think the biggest change with embedded finances, one, as I mentioned just a few minutes ago, they want a comprehensive solution. So if you look at the fintech boom that really fueled our growth and our sort of path to the scale we have today, it was well-funded, relatively narrow focused companies doing something very specific. And Marqeta did a great job at solving very specific needs for customers in a very specific vertical, whether it's on-demand delivery or Buy Now, Pay Later, expense management, et cetera. But now what we're seeing is either our existing customers are looking to expand, get more comprehensive offering or the new players, the momentum-embedded finance is much larger established companies that already have a user base, and they're looking to embed financial services into that. And so what that means is that, one, they're going to use our whole platform, and they're much bigger, so they can be bigger customers, not many small customers. That helps from a profitability perspective. The second thing is because we've already built a lot of that part of the platform, we do think that we're not going to have to invest as much incrementally and we can leverage our economies of scale. And then the third component really is that we are at this point where we are quite significantly -- quite significant in size for being a modern player. And so for these larger embedded finance customers, scale matters a lot. So when they're making a decision, they say, "Can you help me 2, 3 years from now, when I get big, given the size of my user base already?" And so that plays into our favor. And so all those things, we feel, will help us not only continue to drive great growth, but do it in a more profitable way on our path to profitability.

So a question I have on embedded finance is, like how do you -- how does -- what's your sense of potential partners and their embedded finance aspirations, how sensitive are they to things like interest rates and cost of capital, et cetera, right? Because this is -- it's one thing is like we can start to embed finance and provide embedded financing to customers when interest rates are low and delinquencies and all these other credit-related aspects are performing well. But as those normalize or even get worse than normal, how is that affecting the conversations you're having with them?

I would say not as much as you might think. And again, it goes to the fact that these are more established companies who have a much bigger sort of investment pool to draw on. So it's not as much large net new incremental investment for them. They have a certain investment capacity, and it's all about prioritization for them. So what we're seeing, like a big difference between our embedded finance customers versus maybe our previous customers of a couple of years ago is, when a customer was looking to launch, before we really had to work closely with their -- they had a handful of engineers, this product was critical to their product market offering. And so it's really about getting it up to speed as soon as possible. With our embedded finance customers, it's much more about, okay, where do I fit you in on my road map? I have a slot in May, and I have a slot in October and do you think we can get this done by May or should I really be thinking October for you? So it's a very different kind of conversation because the companies already have a lot of resources and scale to put behind these programs.

Got it. Got it. So turning to one of the products that you've been focused on is credit. And that's obviously been a focal point for your team recently. But can you walk us through the acquisition rationale for Power Finance and just wondering what you're seeing in the market that made that -- makes sense from a product fit perspective, was this just like a time to market versus build internally? Just kind of the things that went into making that decision.

We feel there's a huge opportunity in credit and that it's been really held back by legacy technology in terms of the way people want to engage their -- either their consumers or their business customers with more of an embedded offering. And that's really what Power is bringing to Marqeta is, for debit and prepaid, we can offer you program management solutions where we take everything off your plate. And in credit, we were really just a processor, and we are using partners to satisfy the program management. And we had some success doing that. But what we found is that by inserting another party into the discussions, it just slowed down our ability to solution and sort of the creativity that we could cutting-edge solutions. And so we were hearing pretty consistently from customers. We'd really love in credit, what you offer in debit and prepaid. So that was really the rationale. We could have built it ourselves. We're on our way to doing that. But we thought that was probably about 2 years out to be realistic. And if you think about the momentum that embedded finance has, just in our pipeline, we literally had tens and tens of deals in the credit space. And what investors love about our business, and we love about our business is, it's pretty sticky. So if people are going to be making decisions over the next 2 years, we'd like to offer a comprehensive program management credit solution and then build that business and grow with that customer for many years to come. And so that 2-year window, to your point in terms of accelerating time to market had a lot of value to us, and that was really what drove us to do the deal.

And we talked about the ability to accelerate, what you can do with embedded finance and some of those other credit products. What about like more traditional issuers and credit opportunities, I mean what does that look like? And does Power Finance fit anywhere within that solution set? Or is that something that if you're going to address that market, you're going to have to continue to develop more internally?

Yes. I think it's -- we look at it -- or I guess I look at it as a means to an end. So we don't need the program management capabilities to serve the larger FIs, which is really what you're referring to, who really control the credit space today because they will do their own program management. But it allows us to get to a scale that makes us more viable for large FIs. So the way we look at it is the larger embedded finance players, whether it's a consumer-oriented program because a lot of you probably have co-branded cards out there, and you don't really think about how you go to the bank app to manage that, right? We just don't think that's necessary. And on our platform, it wouldn't. You could -- our customers could truly embed the experience in their app and in their user experience in a way that doesn't really happen in today for credit. And then on the commercial side, there's also large opportunities. If you think about the payment facilitators, sort of payment aggregators, marketplaces today, a lot of them are extending credit to their small business customers who are using their platform. And we think a card solution to be a very creative and efficient way to do that, and there's a lot of interest. So we think both opportunities are large as we close those, grow that business, then our $165 billion, $170 billion volume now gets much bigger, and then large FIs would say, okay, now they're at the scale and capacity that it's more reasonable for us to leverage their platform and not feel like it's a risky decision.

Got it. So turning to customers, on the most recent earnings call, you highlighted a large number of renewals that occurred in 2022. Can you talk a little bit about what was the driver behind those renewals? And how we should expect that, that will impact 2023 in your outlook?

Yes. So we typically had 3-year deals in the past. So about -- roughly about 1/3 of our business should be coming up for renewal in any given year. What we've done since May of last year, so in about the last 9 months' time, is renewed 4 of our top 8 deals, about half of our top 30 and it's about half of our non-Block volume. So it's a good amount of activity. And it's really being driven by, I guess, 3 factors, besides just some of them were just up for renewal, that's normal course of business. The second is, as customers are looking to expand on our platform, then it's quite common that just as we look at it, they say, okay, well, my volumes are getting a lot bigger, I'd like to add a couple of tiers on the [ air ], so that I capitalize on that much larger size in your platform. And in exchange for that, I'm willing to commit for a longer period of time. So that's the second big driver. And then the third is just in these times, like every business is looking at what are my costs, what are my opportunities and a lot of customers who are coming to us, who are more of the winners in their space, saying, I'm willing to commit and commit to your platform from the long term and I -- but I would like to redo our deal and get the opportunity to hit those better terms faster. And in exchange for doing a 4- or 5-year deal, we're happy to do that so that we can work in partnership with our customers to grow their business, which is in our interest. So that's really what drove it. The impact, I would say, the incremental impact will be above and beyond the normal 1/3 of our volume that would be up, is probably a couple of points on our gross profit growth in 2023. So that would be the rough impact of all this additional activity.

So -- and I want to get to Block, but on the non-Block customers, what is your sense in terms of their own ability to accelerate growth trajectory? And like how are you anticipating and formulating your plans around that?

Yes. I mean I think it just comes down to working closely with our customer with their plans and leveraging a lot of our experience and expertise in terms of what it takes to successfully launch a card program and what we're seeing in the marketplace. So we try to be as helpful to our customers as we can and pass along our knowledge. And then, of course, they know their users very well and do a lot of analytics themselves. And so between the 2 companies working together, it maximizes the chances of success.

Got it. So I do want to touch on Block is -- I mean, anything incremental for us to keep in mind regarding that renewal? Just remind us when it is -- comes up for renewal. And on the earnings call, Simon was confident that -- or expressed some confidence that a renewal could get done this year, like what's -- can you help give us some idea what's leading into and feeding into that commentary.

Yes. So the Cash App deal is up essentially at the end of Q1 of '24. And then the [indiscernible] and Afterpay deals are later in 2024. So all the contracts are up sometime in 2024. And what gives us confidence in the renewals, first, we have a very tight relationship. And it's not just at certain executive levels, it's -- every aspect of the company has a counterpart on the Block side that they support. Even people within finance, within risk management, product, platform technology, so there's a very close relationship and we support them in many aspects. So that one thing that gives us confidence. The second thing is, their success comes from a relentless focus on user experience and what they do well and they leverage experts like ourselves to help them execute. And so we feel like, as long as we continue to deliver and execute and we add the value we are for what we consider to be a very fair price, then we should be able to renew and extend the relationship. And that's really where the -- this confidence comes from.

Got it. We've hit on a lot of things already this morning. I want to take a breath here and if there are any questions from the audience, please just raise your hand and we'll get you guys a microphone that you can ask us. We have one here.

Your comment about Buy Now, Pay Later slowing this quarter. Is that this 2023 quarter in progress or last quarter?

Oh, sorry, that's Q4 of '22.

Okay. Q4 of '22. And then, so how are you thinking about pricing these contract renewals? Everybody is looking to be more aggressive on the cost side. So that's going to be a headwind for you guys. How do you expand margins in that environment?

I think one of the benefits we have is that we do serve a large number of customers in each of the verticals that we operate in. So we have a good understanding of the market and the competitive dynamics and have a lot of value to add to our customers. So that's one thing. Another thing we look at is, it needs to be accretive for both sides. So we try to solve for a win-win. And we're fortunate enough to be in fast-growing businesses, generally speaking, which makes it a little bit easier to find those win-wins but that, that's really the way we approach it. We try to find what we think is a reasonable deal for both sides so that everyone is happy, and it's a fruitful 4- or 5-year relationship.

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And so, just so everybody could hear, the question is, like, has that been the case with the deals that you've signed and the progress so far?

It has. It has. That's exactly what we're seeing in the market is, everyone has -- as the market matures, right, we're not where we were 3 years ago where things were booming. And so people have a good understanding of the price points and the value we're bringing. And so yes, we do feel like we can reach those points of win-win.

Got it. Like I said, if anybody else has questions, raise your hand and we'll get you a microphone. So Mike, I want to turn to margins and like the evolution if you will, the profitability. Maybe I'll just give you the floor to talk about where we stand on gross margins and can you remind us of kind of the incremental complexities surrounding the -- especially the network incentive adjustments that surprised at least a lot of us.

Yes. So we've said that we would expect our gross margins to be 40%, 45% since the -- prior to the IPO. And in 2022, we're sort of right in the middle of that range. For 2023, we expect to be on the lower end of that range. And that's really driven by a change in our network incentives, is really the biggest impact on that. And what it comes down to is, the way the network incentives work is, the level of incentive is tied to the nature of the relationship between us, our customer and the network. So there are large customers we have where the network already has a pre-established relationship and a lot of times even refer that customer to us. And in those cases, we won't make any incentives. And then there are many customers where we initiate the conversation, the relationship. We bring that customer to the network and that's how we maximize our incentives. And then there's a few variations in between. And there -- although this hasn't happened before in this case, 2 of our larger customers, the nature of the relationship is changing because of a much broader relationship they have with the network. And that is impacting the level of incentives that we are receiving. Now this is not something -- in 4, 5 years, we've been working with the networks that we've seen. So this is a relatively new, I guess, impact to us. And the -- in the new deal that we just did with Visa, we also feel like we have minimized the chances of this happening going forward. And so we feel good about the renewal that we did. Just to, again, put it in perspective, our previous deal with Visa had been done in about 3 years ago. And so just given the incredible pace at which we've grown our volumes, what was happening in the last program year on our old contract, we were already in the top incentive tier within 3, 4 months. So the big value that we got in this deal is that is to add several more tiers so that we can continue to, I guess, get the value for all the volume we're bringing to the network for the years to come.

So is that -- so with this kind of reset, et cetera, is that how we build back to the middle or even the upper end of the gross margin structure? And can you kind of walk us through like the drivers of that?

Yes, there's really 3 main drivers. So one is selling incremental services on the existing TPV that we already capture. So if you think about our credit offering, so that would be incremental value that we add, that we would charge for, a lot of our banking capabilities would be similar. It's an incremental charge. Also as our Powered By Marqeta business continues to grow at much faster pace than everything else, that is also a much higher-margin business. So the revenue profile is different on a kind of basis point basis on volume, but the gross profit is similar. So that's something that will also help the gross profit. And then the last thing is, just as we continue to grow in scale, that will positively impact our network incentives as well as our bank contracts that we have where we also get rewarded for growth. So those are the reasons why we feel we can definitely stay in that range in the long term and continue to improve our gross margin.

And then on adjusted EBITDA margins, obviously, you're aiming for 20% plus over time. How should we think about that? Is it effectively around 40% to 50% conversion of gross profit to adjusted EBITDA? And I guess maybe more importantly, at least for our purposes, do you have a general sense of the scale required from a volume perspective to reach that type of conversion and ultimately, those margin levels?

Yes. So you're right. It is roughly that 40% to 50% sort of dropping down from gross profit to adjusted EBITDA to hit that margin. And we feel we are approaching the scale that we need to do that. And we talked a lot about on our earnings call last week is that we feel like we are reaching the economies of scale we need, where we have the investment capacity required to keep innovating without a lot of incremental investment. So we are about 1,000 people now and roughly 2/3 of those people are in product and technology. So we have a size of business now and resources that we feel that with having launched credit, having launched Marqeta for Banking, now having acquired credit program management, that we have the pieces in place, and we can of course, keep improving and refining and delivering incremental value for our customers, but without a lot of incremental investment. And that's why we believe our expenses in 2023, we can grow in the high single digits on an organic basis. We'll have about 2 points from Power coming in starting in February, 2 points of additional growth but that is how we're achieving that. And so if you go forward then a year or 2, what you start to see is that the incremental gross profit growth sort of in dollar terms exceeds the incremental expense growth by $100 million and then the next year, $150 million, and the next year, $200 million. So with that economies of scale we've reached, once we get to EBITDA positive, it's going to start increasing actually relatively quickly. It won't be sort of a steady climb. It will increase rapidly. And that's what makes us confident that we can achieve that 20% plus EBITDA margin in the reasonable future.

And then on the OpEx side is that since you've joined, you've managed to streamline a lot of the costs in the business, and you talked about that even at the outset of this morning's conversation. What are -- not only the OpEx growth for this year, kind of what you're anticipating, but how do you project that into the future then, especially as you're looking to add additional programs and capabilities and customers.

Yes. I mean I think the first thing that positioned us to deliver what we're delivering in 2023 actually goes back to the beginning of 2022. When I first came on in February of '22, we -- you could see the sort of warning signs macro-wise, and we immediately started reducing our investment level and our hiring, where I think a lot of people at that time were still sort of plowing ahead. And then we, again, in Q4, so just a few months back, also then slowed down even more. So -- and then in that time throughout 2022, we were investing a lot in processes, tools, systems so that we can change the way we get our work done and be less people-dependent and a little more structured and automated. And so that is what is putting us in a position for where we are in 2023. I mean, just the full year impact of the '22 hires that we made, the merit increase we made in this fairly high inflationary environment we're still in, as well as some of our contractual commitments we have with some of our technology tools, just those 3 things had our expense growth growing in double digits before we did anything else. And so we actually feel like we've done a very good job at taking a lot of costs out of the business by getting a lot more efficient. We're going to -- our headcount growth is going to be in the single digits. We have re-negotiated a lot of our contracts with a lot of our suppliers, we've optimized our usage. So there's a lot of things that you can do with your cloud [ profiles ] and tech tools where we started really looking at, okay, what are we spending? What drives that? Is that really critical? Or can we just get more efficient, take costs out without impacting the business. And we've also looked at how much we use outside help and professional services, things of that nature. So that's how we've pulled a lot of the costs out of the business to keep our expense growth down.

Well, that's great. Mike, that's all the time we have this morning. Thank you very much for joining us and look forward to catching up again soon.

Thanks so much for having me.