Green Dot - Earnings Call - Q2 2020

Transcript

Operator (participant)

Good afternoon and welcome to the Green Dot Corporation second quarter 2020 earnings conference call. All participants will be in a listen-only mode. Should you need assistance, please signal a conference specialist by pressing the star key followed by zero. After today's presentation, there will be an opportunity to ask questions. To ask a question, you may press star then one on your telephone keypad. To withdraw your question, please press star then two. Please note this event is being recorded. I would now like to turn the conference over to Shaun Rowan, Senior Vice President of Marketing. Please go ahead.

Shaun Rowan (SVP of Marketing)

Thank you and good afternoon, everyone. On today's call, we'll discuss Green Dot's second quarter 2020 financial and operating results. Following the remarks, we'll open the call for questions. For those of you who haven't accessed our earnings release that accompanies this call and webcast, it can be found at ir.greendot.com. As a reminder, our comments include forward-looking statements and our expectations regarding future results and performance. Please refer to the cautionary language in the earnings release and in Green Dot's filings with the Securities and Exchange Commission, including our most recent Form 10-K and 10-Q, for additional information concerning factors that could cause actual results to differ materially from the forward-looking statements. During the call, we'll make reference to our financial measures that do not conform to generally accepted accounting principles.

For the sake of clarity, unless otherwise noted, all numbers we talk about today will be on a non-GAAP basis. Information may be calculated differently than similar non-GAAP data presented by other companies. Quantitative reconciliation of our non-GAAP financial information to the directly comparable GAAP financial information appears in today's press release. The content of this call is property of Green Dot Corporation and is subject to copyright protection. Now, I'd like to turn the call over to Dan.

Dan Henry (CEO and President)

Thank you, Shaun. Welcome, everyone, to the Q2 earnings call for Green Dot. I've had the pleasure and responsibility of being CEO here for just a bit more than four months, and we have been pretty busy. In addition to dealing with the occasional pandemic, we have been moving very quickly to realign the organization, bring in some great new leaders, and focus on driving efficiencies and uncovering opportunities, even with some legacy issues and a few negative surprises, as one would expect. I'm very pleased with all the early signs of the progress we are making. During our last earnings call, we were still in the early stages of the coronavirus pandemic. Team at Green Dot really came through in dealing with such unprecedented challenges.

We enacted business continuity plans in Shanghai and across the U.S., mandated work from home for all employees, and implemented strict travel restrictions to help protect the health of our employees and their families. Our employees have been successful in maintaining our operations in a remote work environment, and our offices in Shanghai have since reopened. During all of this, employee engagement and productivity have been high. Like most other financial institutions, we did experience a disruption in staffing levels at our third-party call centers across the globe during March and through the second quarter of 2020, resulting in longer-than-average wait periods for our customers and increased costs for the quarter. I'm pleased to report that we and our partners have since restored our staffing to appropriate levels and are currently meeting or exceeding SLAs established for our call centers.

During this incredibly unfortunate pandemic, we are proud that our products and services were used and relied upon by millions of consumers and small businesses directly and through our partners to receive much-needed funds and support from various government entities, and to do so safely with limited to no contact. This unprecedented crisis also clearly illustrates the strength of the diversified business of Green Dot, as well as the long-term opportunities for widespread digital payments adoption. While Jess will provide you with the specific details related to our financial results, I'd like to start by providing my perspective. Overall, non-GAAP revenue increased 13% compared to the second quarter of the prior year. This higher revenue and increase in active accounts are primarily due to new and existing customers using Green Dot products to electronically receive COVID-related government stimulus payments. Non-GAAP revenue also benefited from significant growth in our BaaS business.

It is important to note that COVID caused revenue pressure in other areas of our business, namely one of our more significant BaaS partners and our PayPal program. Our total operating expenses for the second quarter of 2020 increased by $64.4 million compared to the second quarter in the prior year. It is important to highlight that a big component of such an increase is related to growth of our BaaS business, as well as increased revenue share with one of our key retail partners. We also suffered from COVID-related operational expenses and transaction losses. We expect the COVID-related operational expense and losses to be temporary, and related expense lines will revert back to normal by the end of this year. I'm very optimistic about the potential we have and thrilled about the leadership team we have put together over these past three months.

We are focused on five key initiatives here at Green Dot, with the overall objective of delivering bottom-line growth and strong free cash flow. I will speak more about this after Jess provides more detail on our financial results. Jess, over to you.

Jess Unruh (Operational CFO and Chief Accounting Officer)

Thanks, Dan. Good afternoon, everyone. Overall, our consolidated results significantly exceeded our expectations. We're pleased that the scale of our platform and our market reach enabled us to help consumers, directly and indirectly through our partners, to receive financial support through the government programs and weather the effects of COVID-19 on their livelihood. The continued uncertainty regarding the duration and the related impact of COVID-19 on our economy and any government response limits our ability to provide a thoughtful forecast at this time. As such, we won't be reinstating our guidance for the year. However, I will provide color on recent trends during the call. As Dan mentioned, our Q2 2020 non-GAAP revenues grew 13% to $300 million, and we delivered adjusted EBITDA of $45 million and non-GAAP EPS of $0.43. We experienced a few significant tailwinds as well as headwinds in the quarter that I'll walk you through.

Overall, we were pleased with the strength of our consolidated performance. Our revenue results for the quarter were largely bolstered by significant growth in our BaaS business, as well as new and existing customers utilizing our platform to receive stimulus funds and unemployment benefits. As we discussed on our Q1 call, we experienced a slowdown in our business in March as the impact of COVID-19 intensified. Customer acquisition and spending levels were adversely affected, and we experienced delays in certain initiatives and BaaS product launches. During Q2, we saw a strong recovery from the combination of stimulus funds and incremental unemployment benefits provided under the CARES Act and the acceleration of many of the digital payment trends that existed pre-COVID. This resulted in a higher demand and usage of our products and services that has persisted into July. During the second quarter, many of our KPIs experienced accelerating growth.

Specifically, the number of direct deposit active accounts grew year over year by 35%, and our gross dollar volume and purchase volume grew by 51% and 31%, respectively. The year-over-year revenue headwinds we expected in our retail and direct-to-consumer channels were largely offset by strong growth in account acquisition and gross dollar volume. Likewise, we experienced growth in our BaaS programs from a significant influx of gross dollar volume and BaaS fees we charge our partners, despite one of our key BaaS partners in the ride-sharing business being significantly disrupted by the effects of COVID-19. It is important to note that the percentage interchange rate we earn on purchase volume declined despite a shift in purchase volume to online spend. This was due to the fact that the average ticket size per transaction increased by approximately 20%.

As we discussed on our prior call, we experienced a year-over-year decline in net interest income due to lower yields on our cash and investment balances as a result of rate cuts by the Federal Reserve earlier this year. In terms of our processing and settlement services, the number of cash transfers grew 11% year over year as customers of our Reload Network partners utilized our cash transfer services, and it's attributable to the accelerated digital payment trends we're seeing in the industry. The number of tax refunds processed was down 25% year over year as a result of the deferral of the tax return deadline. We do not expect the deferral to materially impact the total number of tax refunds we will process in 2020.

The deferral is a timing matter, as some of the volume that we would typically see in Q2 will shift to the second half of 2020. Let me turn my attention to our expenses and margins. Our total non-GAAP operating expenses in Q2 grew by $64 million, or 35% year over year. Of this increase, 38% related to volume increases in processing expenses, which is in line with corresponding revenue increases in our BaaS business. Approximately 25% related to transactional losses from higher volumes of customer disputes and reserves for credit to be issued for previously denied disputes. COVID-19 created operational challenges that negatively impacted our ability to address dispute volumes, and as a result, the basis points of loss on purchase volume increased. We believe these transactional losses will normalize in future quarters.

Approximately 22% related to volume increases in revenue and supply chain costs, an increased revenue share rate associated with the renewal of the Walmart MoneyCard program, and an 8% increase in marketing spend. Our marketing spend in 2019 was concentrated in the back half of the year, whereas we are spreading the spend across 2020, and during the second quarter, we took advantage of the stronger environment for customer acquisition. Approximately 6% of the increase related to incentive compensation for our employees, net of cost reductions we made during the quarter. We recorded a bonus accrual for non-executives in light of our employees' efforts to serve our customers and execute on our priorities during these unprecedented times. In Q2 2019, we had no bonus accrual. The remaining 9% of the increase related to smaller items that grew for a variety of reasons.

We continue to be disciplined with our spending and focus on reducing the overall complexity of our operations, with the goal of providing operating leverage in the years to come. Depreciation expense in Q2 increased 19% year over year due to increased capitalized development costs over the past several years to support our strategic initiatives. We expect depreciation expense to increase in the short term and then begin to flatten out as we reduce the level of overall spend on development by consolidating some of our products and focusing on prioritizing our development based on strategic impact and incremental operating margins. I want to spend a few moments on liquidity. We generated operating cash flows in Q2 of $58 million. In March, we drew down the full $100 million available to us under our revolving credit facility as a precautionary measure.

We have since repaid the entire balance drawn as of June 30, 2020, as we feel comfortable about our cash forecast and the strength of our debt syndicate. At June 30th, our cash at the holding company was $143 million. The $100 million revolver is available to us should we need to invest in strategic initiatives. Now, I'd like to focus on expectations for the remainder of the year. While we're not in a position to reinstate guidance, I will briefly share a few trends that we're observing in the general themes. Key metrics such as account acquisition and gross dollar volume have continued at a strong pace, growing double digits in July. However, the incremental federal unemployment benefits are set to expire in July, and it is unclear whether the government will extend this benefit or take additional action, such as another round of stimulus funding.

We'll be monitoring the level of gross dollar volume per account during August to determine if there will be a slowdown in the year-over-year growth of gross dollar volume. While historically, Q3 is typically a lower-margin quarter than Q1 and Q2, principally because of the seasonality of tax refunds, it is difficult to predict the overall impact on margins without an assumption related to an extension of government benefits and whether the soft opening in various markets is sustainable. Indeed, there are many moving pieces that are out of our control. We'll continue to have margin compression from known headwinds, such as the revenue share increase with Walmart and the loss of high-margin interest income. Additionally, on our Q1 call, we mentioned that we expected to reduce our planned SG&A spend by $30 million. The decision to reduce such spend was predicated on the uncertainty surrounding COVID-19.

With the strong momentum we saw in our key metrics in Q2 and July, we will claw back a portion of those cost reductions in order to improve our operational capabilities around customer service, invest in the future growth of the business, and incentivize our non-executive employees for the great work they're doing. As a rough framework, absent new stimulus funding or an extension of federal unemployment benefits, we believe Q3 2020 will look something like current consensus, with an upside bias on revenue at approximately $240 million of non-GAAP revenue in a mid-to-high single-digit margin. With that, I'll turn it back to Dan.

Dan Henry (CEO and President)

Thank you, Jess. Okay. Now, let's talk about some of the key things we accomplished in the second quarter. In the past few weeks, you may have seen a number of exciting announcements by some of our newest BaaS partner programs. Last week, Intuit formally announced their QuickBooks Cash bank account, an industry-leading small business bank account that is uniquely integrated into the QuickBooks ecosystem. We are very proud to be working with Intuit to give small businesses faster access to funds, great account visibility and convenience, as well as an industry-leading interest yield. Kabbage also announced our new partnership to launch Kabbage Checking. We are thrilled to be partnering with Kabbage, a company that has done so much to help the small business community during these particularly trying times, facilitating nearly $6 billion in PPP loans this year.

The new product offers convenient and modern money management tools and high-yield interest for their customers. Through these new partnerships with Intuit and Kabbage, we are positioning Green Dot to serve America's 30+ million small businesses. We're also pleased to share that in the last quarter, we launched our innovative new product with Wealthfront, linking our issued debit cards and banking functionality with their high-yield cash account for their investors. It's a beautiful and seamless user experience integrated into the Wealthfront app, and we are very encouraged by the initial feedback on the product. Working with all these partners not only grows and diversifies our business, but all of our partners make us at Green Dot better. I would like to thank QuickBooks, Kabbage, Wealthfront, and all of our partners for their trust and giving us the opportunity to work with them.

Last quarter, on my first earnings call for Green Dot, I laid out five key initiatives in areas of focus. Number one, keep the bank. Grow it, integrate it, and leverage its capabilities. Number two, get much more efficient, resulting in bottom-line growth and free cash flow growth. Number three, our core businesses: tax processing, money processing, and pay card. Growth and stability. Number four, consumer business, both direct and retail. Renewed growth. Number five, BaaS partnership business. Here, we want to be an innovator, not an order taker. Declaring these five areas of focus is easy. Executing on such is much tougher. It requires hard work, driven and maintained by a lot of dedicated people. Pretty simple, right? Just get clear on what you're going to focus on, then make sure you have the right people to get the job done. Simple, but not easy.

The most important thing we accomplished in the second quarter was a complete rebuild of the leadership team here at Green Dot. Through internal promotions and external hires, we have fielded one of the strongest teams I have ever had the pleasure of working with. We started with Daniel Eckert, who used to run financial services at Walmart, to come in as our Chief Product Officer and help us deliver innovative solutions to our BaaS partners. We added Philip Lerma, our new Chief Risk Officer, with experience from great companies such as PayPal, Netspend, and EML. We then brought in Greg Quarles, former CEO of H&R Block Bank, to focus on our first initiative of growing and better integrating Green Dot Bank.

We then added Brandon Thompson as Executive Vice President of Retail, Tax, PayCard, and Money Processing to help us focus on delivering renewed growth into our consumer retail business. I've worked with Brandon before at both Euronet and Netspend, and he has always delivered above and beyond. We also made many internal changes and promotions in legal, IT, project management, compliance, operations, marketing, and others. As the leadership organization stands today, the only senior executive leader still in place as when I arrived is my Head of HR, Jason Bibelheimer. And boy, is he tired? He's done a tremendous job over these last three months of assisting me in rebuilding this leadership team. A lot of credit goes to him and his team in assisting me in delivering this much-needed change so quickly.

Now, keeping that momentum in mind, this last piece of the people side of the equation is very exciting. Last week at Green Dot, we declared a work-from-anywhere approach for the remainder of 2020. We have found that with our current work-from-home environment, we are maintaining a high level of productivity. As we embrace this new normal, we are developing guidelines and practices to keep our sense of teamwork strong while reinforcing a performance-driven mindset. For the past 25 years of building companies, I have said that people are not our most important asset. The right people are. From a recruiting standpoint, work-from-anywhere has dramatically increased the quantity and caliber of applicants we are receiving for open positions. As I just described, over the past three months, we have built a tremendous leadership team here at Green Dot.

Now, add to that our ability to hire talent from all over North America without requiring relocation. I got to tell you, I am ecstatic about the powerful team we are going to put on the field. Every company on the planet, big and small, is made up of people, and every company deals with the same challenges, be it pandemics, economic pressures, political climate, competitive challenges. At the end of the day, the degree of long-term success always comes down to the people in that organization: their attitude, their commitment, their capabilities, their performance. I'm thrilled to be working with and supporting this tremendous team we have put together, and I can't wait to see the talent we can add to our ranks as we continue to recruit with the work-from-anywhere approach.

By the energy and focus of our team, with the valuable assets of Green Dot, we have an opportunity to create some tremendous value. I want to thank all the great employees at Green Dot, the Board of Directors, and the investors for this opportunity. I look forward to what we can accomplish together. With that, I'll hand it off to the operator for questions. Thank you.

Operator (participant)

We will now begin the question and answer session. To ask a question, you may press star then one on your telephone keypad. If you are using a speakerphone, please pick up your handset before pressing the keys. To withdraw your question, please press star then two. At this time, we will pause momentarily to assemble our roster. Our first question comes from Bob Napoli of William Blair. Please go ahead.

Bob Napoli (Senior Director)

Good afternoon, Dan and Jess. I don't know, Dan, you come on board and all of a sudden, revenue growth goes to 20%. That's a pretty nice acceleration you put in in a few weeks during the pandemic to help out, I guess.

Dan Henry (CEO and President)

Magic time.

Bob Napoli (Senior Director)

Yes. Of the five, I guess, your five key points in growth, congratulations. I mean, you really have rebuilt the team. What are you most excited about? I mean, there's a lot going on. I mean, partnerships with Wealthfront, expansion with Intuit, and Kabbage, new. From what you see, what are you most excited about on the growth front? Where do you see the biggest opportunity to enhance growth and profitability over the next couple of years?

Dan Henry (CEO and President)

Hey, Bob, thanks. I can take no credit for this revenue growth. You know that. Yeah. Thanks nonetheless. If you're talking significant growth over the next two or three years, I kind of look at things like short-term, medium-term, and long-term. I think in the short term, just kind of getting some of the fundamentals back in order on our what I call the tried-and-true businesses we have here of tax and pay card and retail and even the Green Dot Reload Network. I think I'm very excited about with Brandon here, that new leadership and the things that he's seeing and able to kind of quickly turn some dials is real helpful.

Medium term, what we're going to be doing in terms of just kind of driving growth through traditional retail that we have, as well as what I mentioned on the last call, kind of reclaiming the banner, if you will, of a direct-to-consumer digital offering predominantly to low- to moderate-income consumers in this country. That's going to give us noticeable growth next year, and that's a long-term grower for us right there, just in and of itself. What I get excited and stack on top of that, really the potential and the BaaS partnership initiative. We are very uniquely positioned that we own the bank.

We've got 20 years of experience of digitally opening up accounts for consumers, providing the customer service, having the platform to run the transactions, and then having 100,000 locations where consumers, no matter how digital the world gets, for quite a while, they're still going to have the need for physical locations to load cash. That combination is unique to anybody in the country. I think that our existing partners and conversations we're having with other potential partners just tells me that we execute well. We've got lots of growth for years to come at Green Dot.

Bob Napoli (Senior Director)

Great. Just one follow-up question. I've seen a number of Unlimited commercials, I guess, on what I would consider to be probably expensive time slots with us on CNBC or I think some Sunday morning shows. Is the Unlimited product, I think you were going to simplify the products. Are you simplifying the Unlimited product, and then that is going to be the key marketed retail product for the company?

Dan Henry (CEO and President)

Yeah. We're not disclosing our detailed strategy on that right now, but as you can, the Unlimited product is now at two and two, not at three and three. So it's a better product for us economically, and it's still having really good uptake. As for the cost of commercials, to run a TV is surprisingly affordable. The way we run the TV, you buy blocks and you don't necessarily pick and choose which shows you get on. I don't think you're our target market, Bob, but I'm glad you got a chance to see the commercials.

Bob Napoli (Senior Director)

Yeah. Thanks, Dan. Appreciate it.

Dan Henry (CEO and President)

All right. Thank you.

Operator (participant)

Our next question comes from Ramsey El-Assal of Barclays. Please go ahead.

Hi, guys. This is Damian on for Ramsey. Thanks for taking the questions. Jess, it's helpful that you provide the framework for Q3. I'm hoping maybe you can talk maybe more broadly about how you think about the stickiness of the customers that may have been acquired through government stimulus and maybe how you're attempting to keep some of those customers longer term. Maybe that sort of leads us to how we can think through Q3 as well. Just your high-level thoughts on sort of the stickiness of those customers.

Dan Henry (CEO and President)

Sure. Sure. Certainly, we do not want to squander the opportunity that we have had around customer acquisition. We are putting lots of efforts internally trying to lifecycle market to folks to retain them as long as possible. I would say in terms of stickiness, one observation would be our balance sheet as of the end of Q2. The deposit balances are up roughly $1 billion year over year. What we are seeing with customers is we see an influx of customers. We are seeing an influx of GDV. Those balances are a little more sticky. I think people are being prudent about their spending habits. At some point in the future, that deposit balance will come off in the form of purchase volume, etc., which will earn interchange. There is a bit of stickiness in the fact that people are holding on to balances longer.

I wouldn't say there's a material trend in uptick or trend in churn, for example. I think you're going to see probably a bigger active set in Q2 than you will in Q3, but I think you'll still see year-over-year growth, which is something we haven't seen in the total active base in quite some time.

That's great. Yeah. Maybe a follow-up, I think I'd ask about the cost levers here. I know, again, Jess, you gave some helpful breakout in the sort of contribution of the expense growth, but maybe for Dan as well, you can speak more broadly about how you think about the cost levers that are available to you. You spoke about the work-from-anywhere initiative. Maybe can that lead to longer-term cost savings on the real estate consolidation? Now that you've had more time in the seat, if you have uncovered any new cost savings initiatives, we'd just love to hear about that. Thanks.

Yeah. Thanks. Yeah. Go ahead, Jess. Go ahead.

Jess Unruh (Operational CFO and Chief Accounting Officer)

Okay. I was just going to quickly say, I mean, with the work-from-home or work-from-anywhere, certainly that's providing additional opportunities, not only from the recruiting side of the house, but also from a cost perspective. As you can imagine, we're taking a hard look at all of our properties and leases and trying to come up with the best possible model. I think there could be leverage there in the future. I think we talked about in Q2, we had a heightened amount of what we call transaction losses or dispute volume. It was at such a level that higher than anything we've seen in prior years. I don't expect that level of disputes to continue. That should help out with margins on a go-forward basis.

Yeah, look, we have some continued headwinds in Q3 and Q4 related to the rev share for Walmart and the loss of high-margin interest income. As you can imagine, we're still sort of uncovering cost opportunities. We're looking at a whole slew of vendor negotiations in the hopes of providing operating leverage in the future. I think the big thing that I'll call out, and I think Dan touched on this, is there's a fair amount of complexity in the system that's built up over the years, and there's plans internally to streamline some of that, and that will help out with operating leverage as well. Dan, I don't know if you want to add any color.

Dan Henry (CEO and President)

No, I think you covered it, Jess.

All right. Appreciate it. Thanks.

Operator (participant)

Our next question comes from Andrew Jeffrey of SunTrust. Please go ahead.

Andrew Jeffrey (Analyst)

Hi. Good afternoon. Appreciate you taking the call.

Hey. Dan, I wonder if you could spend a couple of minutes talking about the Walmart relationship, inclusive or exclusive of TailFin, and what you'd expect from the retail business, which I think is predominantly Walmart. Is there a change in the go-to-market and the strategy and how you plan to monetize? Can that still be a growth driver for Green Dot?

Dan Henry (CEO and President)

Yeah, Andrew. Yeah. I want to, in the world of retail, and especially when you talk to retailers, they kind of look at the world as there's Walmart, and then there's everybody else. This, of course, is bricks and mortar retail. I think that with Green Dot, we have a very meaningful retail business outside of Walmart. We have Green Dot. When I say outside of Walmart, that includes Green Dot cards that are sold through Walmart stores as well as our other 95,000 retail locations. There is growth in retail in total with Walmart MoneyCard in partnership with Walmart together with retail in general. Brandon Thompson, who I've already mentioned a couple of times on this call, he ran retail for Netspend. He's very knowledgeable, hit the ground running, fresh set of eyes, and knows the assets that Green Dot has.

We're in really interesting conversations with not just Walmart, but with other retail partners about what we can do for them in payments beyond just the plastic card. If you think about leveraging the skills and capacity of Green Dot with the bank and with the platform and our expertise, we're excited with the discussions we're having with Walmart of where we can move with payments, like I said, just beyond the plastic card. There have been changes at the leadership at Walmart. We're very encouraged with the new President of Walmart U.S., as well as the product team that he's building there and some of the early discussions that we're having.

Andrew Jeffrey (Analyst)

I guess we'll stay tuned in that regard. I wonder if, Jess, maybe you can help out and elaborate and maybe talk about the BaaS businesses that evolved. I was inferring from the press release and maybe some of your comments that there may have been a shift in mix within BaaS in terms of those customers that generate interchange versus those that generate program fees. I just wondered if you could elaborate on that and talk about which is more scalable and if there's a strategy going forward as to the way you structure contracts around the mix.

Jess Unruh (Operational CFO and Chief Accounting Officer)

Yeah. Yeah. That's a good question. Yeah. There's quite a few flavors within BaaS in terms of the contractual agreement. Some look very standard like similar to a Walmart relationship where we earn cardholder fees, and then there's a rev share on the back end. Whereas the other side of the spectrum is really going to be us as a platform behind the scenes powering it, but really the BaaS partner is the one sort of front-facing with the consumer and earning the cardholder fees and interchange, etc. There's quite a few different models underneath the hood. Certainly what we're seeing is, in particular, that platform business is really expanding and growing. You're seeing that in some of the results here as BaaS fees increase. I think it's fair to say now with the new leadership team in place that we're going to take a hard look at what we want to do from a contract structure perspective and how we want that to evolve over time.

Andrew Jeffrey (Analyst)

Is one business more one type of revenue more scalable intrinsically than another?

Jess Unruh (Operational CFO and Chief Accounting Officer)

I would say they're different. One is one where we're earning fees from the BaaS partner. I would say that's more, I would say, traditional subscription-based. They control the acquisition funnel. We're behind the scenes earning a fee for transactions versus the other model where it looks similar to what we do on our retail and consumer side or direct-to-consumer side where we're trying to incentivize cardholders, but we don't necessarily control customer acquisition, which is a bit of a challenge as you think about how to model and price those programs. I think our thoughts on BaaS will continue to evolve, and we'll share some more as the quarters go on.

Andrew Jeffrey (Analyst)

Okay. Appreciate it. Thank you.

Operator (participant)

Our next question comes from George Sutton of Craig-Hallum. Please go ahead.

George Sutton (Senior Research Analyst)

Thank you. On QuickBooks, first, congratulations. I would scare you if I explained what we came up with as the TAM for that opportunity. I wondered if you could address that opportunity from your perspective.

Dan Henry (CEO and President)

All right. I'm not going to take a shot at quantifying the potential size of it. No, as you alluded to, 30 million small businesses in partnership with Intuit QuickBooks is very exciting for us. To be able to serve just a low-income individual consumer and build our expertise around that, and then thinking of how we can leverage a lot of those tools and learnings to serve small business, especially if we're able to leverage the power of our bank together with partners like Intuit QuickBooks and even Kabbage. Yeah. I think there's some real growth potential for us there.

George Sutton (Senior Research Analyst)

I wondered if you could bifurcate the impact that you were seeing from the stimulus money going to consumers versus the government benefits through the unemployment side. I ask that in the sense that as we look forward to whatever the next stimulus is going to be, where do you benefit more?

Dan Henry (CEO and President)

Yeah. I kind of look at it all as one large stimulus. If you think about the increased amount of unemployment benefits combined with any sort of one-time benefits, it's all, to me, a very welcome and noble effort of the folks in D.C. to keep a lot of employees in this country in a good state as we get through this hopefully once-in-a-lifetime event. George, it's the question that is kind of out there, I think, across all companies in terms of if COVID didn't happen, what would the world look like and vice versa? Another version of the CARES Act or stimulus that comes out later this month, of course, that'll be better for us than if it didn't come out at all. I think probably like most everybody, I would have preferred that COVID never happened.

George Sutton (Senior Research Analyst)

I understand. We'd probably not all be sitting at home right now.

Dan Henry (CEO and President)

Yeah.

George Sutton (Senior Research Analyst)

Thanks for your help.

Dan Henry (CEO and President)

Sure. Thanks, George.

Operator (participant)

Our next question comes from Andrew Schmidt of Citi. Please go ahead.

Andrew Schmidt (Lead Analyst)

Hey, Dan. Hey, Jess. Thanks for taking my questions. The account growth in the quarters, I wonder if you could break that down between BaaS and consumer. I know you had some comments in your prepared remarks. As a follow-up to that, whether there's a difference in retention that you see on the consumer platform versus BaaS platform. I know the programs vary in BaaS, but just at a high level, that would be helpful.

Jess Unruh (Operational CFO and Chief Accounting Officer)

Yeah. We haven't broken out consumer versus BaaS. I will say that if you were to go back to our commentary at the beginning of the year and what we thought about expectations, this was even before COVID happened, that we expected the consumer business, which is retail and the direct-to-consumer channels, to be down on revenue double digits, while the platform business, which is made up of PayCard and BaaS and money processing and tax processing, would be up high double digits. The expectation there was that the consumer business would be down in actives and then start to moderate while the BaaS and PayCard business continue to accelerate. Now, obviously, COVID has disrupted some of those trends. I would say that at a high level, the stimulus activity has helped sort of mute some of those headwinds we thought we would see on the consumer business.

Secondarily, I would say BaaS continues to grow at a healthy clip. I would say that stimulus continued to be helpful not only for the consumer business, but for the BaaS business. We have a few programs that were dedicated to sort of the tax space, and they benefited greatly from stimulus funding. We have had some other programs that continue to grow healthily. PayCard, obviously, was impacted from unemployment issues across the U.S., and that slowed down quite a bit. I would say without giving you specific numbers, the year-over-year trends in actives on consumer business were way better than we thought they would be, and BaaS continues to grow, certainly offsetting any headwinds we had on PayCard.

Andrew Schmidt (Lead Analyst)

Got it. That's helpful. Maybe a higher-level question on pricing. Obviously, there's a variation of pricing out there for other products in the marketplace, but many other digital banking products don't offer account fees and things like that. Just wondering if whether on existing or new products, you see the mix of pricing changing going forward, whether maybe relying more on interchange versus account fees or other value-added services, other types of products can maybe account for more revenues versus account fees. Just curious, just higher thoughts on potential evolution in product pricing.

Dan Henry (CEO and President)

Yes. Andrew, I appreciate the question. I'm going to try to be open with you, but I also don't want to be tipping my hat in terms of what we'll be rolling out with at some point. Customers, in my opinion, don't always value free. From our experience of many, many years of being in this space, if you want to drive numbers that show you've got a lot of accounts or a lot of cards issued, you can lead with free, and you can have a lot of "customers" and accounts with very little to very limited engagement. My belief philosophically is that a BMW is worth more than a bicycle.

If a consumer really wants a product that serves their money needs and their financial needs and is not just a simple transaction tool or a mad money tool, then they are more than happy to pay a monthly fee of $5 or $9 for that product. Even in the neobank space that's out there, you see a lot of very companies I think are making great traction where they have a monthly subscription model where they may charge $1, $5, or $9, and they call it a subscription, but it's still a cost that consumer pays for getting a great service and that great product. I'm rambling a little bit, but really I think the message is that I don't ever want to be in a business where I am only competing on price.

As far as I can tell, we're really one of the few digital banks that can really claim that we truly are a bank and not a marketing company. Anyway, I think people are willing to pay for value, and we're going to offer real tremendous value for our customers.

Andrew Schmidt (Lead Analyst)

Okay. That makes sense, Dan. Thank you very much.

Dan Henry (CEO and President)

You're welcome. Thank you, Andrew.

Operator (participant)

Our next question comes from Mayank Tandon of Needham. Please go ahead.

Kyle Peterson (Senior Analyst)

Hey. Good evening. It's actually Kyle Peterson on for Mayank. Thanks for taking the question. I just wanted to see if you could get an update on I know you've established some more leadership within the Green Dot Bank. You talked about kind of taking advantage of that too, whether it's launching additional products, just overdraft protection. Just wanted to see if there was any update on some of the traction you guys are getting with that.

Dan Henry (CEO and President)

In terms of rolling out a consumer-friendly overdraft solution, that requires a technical build on our side in terms of so that's the long pull on the tent there. As Green Dot Bank, as a bank, we feel that we have the ability to roll out that product. And Greg Quarles, who I mentioned on the call, he's still relatively new. I think about a month into the job. He's had numerous meetings with our regulators and with our team at the bank and feeling very optimistic about the value and discipline that Greg can bring to Green Dot Bank.

Kyle Peterson (Senior Analyst)

Great. That's helpful. Thanks. Just real quick follow-up on the competitive environment, particularly with some of these neobanks. Have you guys seen any fake-out or disruption? Obviously, your account trends have looked really strong this quarter. Just wanted to try to tease out what's stimulus and what might be some of these smaller startups maybe experiencing a little bit of pressure with some of the market volatility caused by COVID.

Dan Henry (CEO and President)

Yeah. I can't really comment on what other neobank startups are feeling. I've gotten a couple of pitches from bankers about some startups in the fintech space that are in need of some capital. I don't know. It seems to me like the capital markets are still working really well. I don't think COVID has brought positive and negatives to the space. I think it's across the board, it's almost neutral.

Kyle Peterson (Senior Analyst)

All right. Sounds good. Thanks for the call. Thanks, guys. Nice quarter.

Dan Henry (CEO and President)

Thanks, Kyle.

Operator (participant)

Our next question comes from Ashish Sabadra of Deutsche Bank. Please go ahead.

Ashish Sabadra (Analyst)

Thanks for taking my question. Congrats on the solid results. I was just wondering if it's possible to quantify the benefit of the stimulus on unemployment in the quarter. Or maybe another way to think about it would be just the indicative framework for the third quarter, which implies a $60 million sequential decline. How much of that is seasonality versus some of that benefit that you're not accounting for right now in the framework? Thanks.

Jess Unruh (Operational CFO and Chief Accounting Officer)

I'll take a stab at that. I think if I want to talk about stimulus funding and GDV associated with it during the quarter, that was roughly $2 billion. So that's $2 billion of the $5 billion year-over-year increase. Unemployment benefits, certainly something we're looking at in Q3 is whether it sounds like Congress is making some progress here around the unemployment benefits. If they are successful in doing so, then clearly our Q3 framework will improve on a revenue basis. Now, there's always a sequential step down in both revenue and margins when you go from Q2 to Q3 because there's a fair amount of, in a normal time, there's a fair amount of tax refund volume that still comes through in Q2. Now you've added on stimulus funding. You've added on an additional $600 per week from the federal government on unemployment benefits.

As we head into Q3, right, that stimulus funding's gone. Potentially, the federal unemployment benefits will be gone, but all that could change in a matter of a week here. I'm not sure if I'm answering your question, but that's probably the best I can do for you.

Ashish Sabadra (Analyst)

No, that's very helpful. Thanks. Maybe just Dan, a quick question on capital allocation priorities. The company has a good amount of cash. How do you think about capital allocation priorities going forward? Thanks.

Dan Henry (CEO and President)

We have a handful of initiatives here at the company that we're focused on. One is stabilizing our TPG platform. We're investing some capital there. The other is building what we're calling the challenge to challenger banks, call it Green Dot 2.0, 3.0, 4.0, whatever you choose. We're spending a good amount of time and energy on really improving our customer experience anywhere from IVR to card services to sign-up for the products across the board. Most all of that effort and work is being done by existing employees in the company. From a capital allocation standpoint, as we are generating free cash flow, my intention is to bank that free cash flow and not try to find ways to spend it. I really think that we have just really at our doorstep tremendous opportunities.

All we need to do is execute on those opportunities with our existing resources on hand to really see some meaningful growth for the company. It's actually quite a nice position to be in.

Ashish Sabadra (Analyst)

That's helpful. Thanks, Dan. Again, congrats on the solid result.

Dan Henry (CEO and President)

Thank you very much.

Operator (participant)

Our next question comes from Steven Kwok of KBW. Please go ahead.

Steven Kwok (Director)

Hi. Thanks for taking my questions. Just the first one I have is just around the operating margin. I know you guided to the mid to high single digits for the third quarter. I was just wondering, once all of these third-party activities normalize, what's the appropriate normalized margins that we should be looking at? I guess as a follow-up, it's just around what's the incremental margins on your business to the extent that stimulus does happen and unemployment does happen in the third quarter? How should we think about the incremental margins on that piece of revenue? Thanks.

Jess Unruh (Operational CFO and Chief Accounting Officer)

There's a lot going back there. Let me see if I can answer your question. I would say maybe just to focus on the stimulus funding. Absence. We don't expect to have the same issues we had, operational challenges with dispute volume in Q3. The margin on the flow through of any stimulus funds that would come through and any additional federal unemployment benefits, we'd certainly be at a higher margin than what we experienced in Q2. I would say, I call it some headwinds and tailwinds in Q3. You've got the headwinds of rev share on Walmart, interest income. You get some tailwinds from the shift in some of the tax volume from Q2 to Q3. You've got some marketing timing, etc. I would say there's a fair amount of puts and takes there. Normalized margins.

Look, we're going to lap the rev share on Walmart in 2020, 2021, excuse me. And we'll grow off that base. I would say, Steven, a lot of the initiatives we have underway is obviously about increasing free cash flow. That means more profitable products and services. One example of making sure we're right-sizing economics is the Unlimited. We've changed it from three and three to two and two. Clearly, the focus there was to increase the economics for us and make it a more profitable product. I would say, look, it's hard to say right now, standing where I am, to tell you what the normalized margins will be. Clearly, the focus internally is about profitability and free cash flow. Our goal clearly is to drive margins up. Dan, if you have anything else you want to comment on.

Dan Henry (CEO and President)

Yeah. I just think we're going to be working on this over the next couple of quarters to make the job easier for you guys. We have a different margin in our BaaS business than we do in our Walmart business, which is a different margin than we have in our direct-to-consumer business, which is a different margin than we have in our Green Dot retail business. Depending on which one of those is growing faster kind of has an impact on our margins. I think that, again, we'll work to provide you with some guidance to make your job easier, but I just want to make sure we're not dodging the question here. It's just hard to just kind of simplify it to, "Hey, here's the standard margin we get on every dollar of revenue.

Steven Kwok (Director)

Got it. Understood. I was just wondering, is there a target of margin expansion going forward on a yearly basis? How should we think about the pace of improvement? All of these four.

Dan Henry (CEO and President)

Yeah. There's not a target in terms of it's just not that I guess this is one of the things they don't teach at business school. I mean, you just can't say, "Hey, let's do a target margin increase of x." What I can say is that the target is that every year our free cash flow grows and our margin expands over the prior year. That's what I'm used to doing. That's how I'm used to operating. I've said 100x is that the beautiful thing about a payments business is once you get to a level of fixed costs where you can serve the customers at scale, just keep your fixed costs fixed. If you keep your fixed costs fixed, your margins will expand.

Back to your question about capital allocation, I'm not sure, but I suspect that there was a time before I showed up that, "Hey, whenever there was profit or free cash flow, everybody came up with ways to spend it." That is a mindset that I am just emphatic about changing around Green Dot. We're going to keep our fixed costs fixed. If we do that and then we pay attention to variable costs, whether we've got a contribution margin from a deal that's 3% or 30%, if we keep our fixed costs fixed, our overall margins will grow. I'm not going to endeavor to predict by how much, but growth is what we're going after.

Steven Kwok (Director)

Got it. Thanks for the response.

Dan Henry (CEO and President)

Thank you.

Operator (participant)

Our next question comes from George Mihalos of Cowen. Please go ahead.

George Mihalos (Managing Director)

Hey, good afternoon, guys. Thanks for taking my question.

Jess Unruh (Operational CFO and Chief Accounting Officer)

Hey, George.

George Mihalos (Managing Director)

I just wanted to ask, if we looked at—hey, Dan—if we look at direct deposit as a percentage of your accounts outstanding first half of the year, it's north of 50%. It's up meaningfully from the first half of last year. Is that above 50% sustainable? And where do you think it can go as you kind of look out over the next couple of quarters?

Jess Unruh (Operational CFO and Chief Accounting Officer)

Yeah. I'll start with that, Dan, and you can add color. I would say, look, in the quarter, certainly the direct deposit base was bolstered by unemployment benefits and, to some degree, stimulus funding. I think our goal internally is to be hyper-focused on direct deposit customers because they're, by and large, the longest lifetime revenue and lifetime contribution for us. I think maybe Q2 was a bit anomalous. I would suspect that the direct deposit penetration and the overall active base will continue to grow, especially as we get into next year as we have additional products that were designed for long-term usage with additional functionality for the consumer.

Dan Henry (CEO and President)

Yeah, George. I guess when it comes to direct deposit accounts, I'm going to be focused more just on the actual net number of those accounts as opposed to percentage of total. The reason being, as we move into more and more BaaS partnerships and there's going to be a—the number of accounts could grow pretty substantially if we just become an embedded account in one of our partners' apps. That's where I would just kind of caution from the standpoint of a percentage of total is not, to me, as important as the actual net number of direct deposit accounts. That number, I fully expect we will be seeing that growing year on year for many, many years.

George Mihalos (Managing Director)

Yeah. That's very helpful, Dan. Just one more, if I could sneak one in. Just going back to the competitive question, maybe asking it a bit of a different way. You sort of had the neobanks that have been competing against you. It seems you've got some, I guess, of the digital wallet operators now that are making a more aggressive push, if you will, around direct deposit, layering more functionality around core payments functionality. Curious how you're thinking about them competitively in the market. Maybe not so much how you defend against BaaS, that's obviously an integrated model, but how much of a challenge will that be on maybe some of the more traditional businesses?

Dan Henry (CEO and President)

Yes. George, you cut out a little bit there at the question, but I think I get the gist of it. If I look back, I think I've been kind of in this space starting—that's been 12+ years ago. Even then, what I saw was some of our biggest impediments to growth was ingrained consumer habit in terms of utilizing cash, lack of awareness in terms of the product and what it could do, and also maybe kind of lack of credibility, if you will. What we found back then when folks like American Express and Chase jumped into the space was they spent hundreds of millions of dollars educating the market on the value of a prepaid card.

Again, today, what I see, which I'm very encouraged by, is really the number of players jumping into the space either directly or kind of around the room competing with us. I don't really see them as much as competitors because the total available market is so large. I see them as helping us communicate the message that there are very viable and useful and competitive alternatives out there to traditional bricks-and-mortar banks and finance institutions. I think we've all seen just over the last three months what COVID has done to drive digital adoption by a lot of consumers who had literally been making purchases in cash. I really—to be honest with you, I have mixed emotions when I read the same things you do about other companies kind of jumping into the space. On one hand, I believe in competition.

I'd rather not have it, to be honest. That competition, they take some of their funding. They spend marketing dollars. They build awareness in consumers' mindset of other ways to do your payments and your banking. That benefits all of us as a rising tide lifts all boats. I go back to what I've said for years and years. If you look at the size of the total available market, it's not a zero-sum game. There's plenty of room for a number of companies in the space to be very, very successful. I guess I cut George off.

Operator (participant)

Our next question comes from Bob Napoli of William Blair. Please go ahead.

Bob Napoli (Senior Director)

Thanks for the follow-up. Just a quick one. The revenue per account, active account, has gone up the last two quarters by like 14% every year, even as the active accounts went up. I mean, the first quarter, even before COVID, much affects from COVID. I just wondered if you could give any color on why the revenue per account is up as much as it is.

Jess Unruh (Operational CFO and Chief Accounting Officer)

Yeah, Bob. I would say I would not give a ton of credence to revenue per active. The reason I say that is because we have certain programs in our BaaS channel where we do not report actives. If you are looking at the face of the P&L, for example, and you are taking card revenues and other fees and interchange, or you are looking at the account services segment revenues and you are dividing that into active base, there are both some BaaS programs as well as gift card revenues, for example, that do not have a corresponding active. I would not give a lot of credence to revenue per active.

Bob Napoli (Senior Director)

Okay. Great. Thanks. Appreciate it.

Jess Unruh (Operational CFO and Chief Accounting Officer)

All right. Thanks, Bob.

Operator (participant)

This concludes our question and answer session. I would like to turn the conference back over to Dan Henry for any closing remarks.

Dan Henry (CEO and President)

Thank you, operator. I want to thank everybody for the call. I just want to thank all the new team members at Green Dot and all those that are still here while I'm showing up. Everybody knows I'm real excited about what we're going to be able to do. Thanks, everyone.

Operator (participant)

The conference has now concluded. Thank you for attending today's presentation, and you may now disconnect.