Business context and reporting period
Square, Inc. (the issuer named in this 2016 filing) reported unaudited results for the quarter and nine months ended September 30, 2016. Its business included payment processing, point-of-sale hardware and software, Square Capital, Square Cash and Caviar. Payment processing generated approximately 90% of net revenue. Results are consolidated and reported as one operating segment.
Financial performance and position
| Metric | Q3 2016 | Q3 2015 | Nine months 2016 | Nine months 2015 |
|---|---|---|---|---|
| Net revenue | $439.0 million | $332.2 million | $1,256.8 million | $892.8 million |
| Gross profit | $150.3 million | $96.3 million | $409.5 million | $260.9 million |
| Gross margin | 34.2% | 29.0% | 32.6% | 29.2% |
| Operating loss | $(32.0) million | $(52.2) million | $(156.5) million | $(126.6) million |
| Net loss | $(32.3) million | $(53.9) million | $(156.4) million | $(131.5) million |
| Adjusted EBITDA (non-GAAP) | $11.6 million | $(15.8) million | $15.1 million | $(35.0) million |
For Q3, net loss per diluted share was $0.09, compared with $0.35 a year earlier; nine-month loss per diluted share was $0.46, versus $0.88. Adjusted EBITDA excludes specified items, including share-based compensation, and should be considered alongside GAAP results.
For the nine months, operating cash flow was $42.2 million, investing cash flow was $(120.4) million and financing cash flow was $42.8 million. Cash and cash equivalents ended at $437.9 million, down from $470.8 million at year-end 2015. Cash, cash equivalents and short- and long-term investments totaled $529.8 million; restricted cash was additional but not freely available. The company had no borrowings under its $375 million revolving credit facility, which remained available through November 2020. Total liabilities were $541.8 million, including $364.4 million payable to customers; this is not presented as funded debt. Current assets were $843.0 million and current liabilities $486.0 million.
Material changes versus comparable periods
- Q3 revenue increased 32%; nine-month revenue increased 41%. Gross payment volume, excluding Starbucks, rose 39% in Q3 and 41% for the nine-month period.
- Q3 transaction revenue rose 38%, while software and data product revenue rose 140% and hardware revenue 94%. Management attributed software growth mainly to Square Capital and Caviar, and hardware growth mainly to the EMV/NFC reader launch.
- Starbucks revenue declined 78% in Q3 and 17% for the nine months as Starbucks nearly completed its previously announced transition to another processor.
- Q3 net loss narrowed year over year, but nine-month net loss increased. Nine-month general and administrative expense included a $48 million legal settlement and higher share-based compensation and public-company compliance costs.
- Share-based compensation was $36.8 million in Q3 and $104.9 million for the nine months, up from $20.8 million and $49.5 million, respectively.
Outlook, commentary, risks and unusual items
Management said existing cash, investments and available credit were expected to cover working capital and planned capital expenditures for at least the next 12 months. The filing provides no specific numerical revenue or earnings guidance. Management expected international GPV and revenue to grow as the seller base expanded, while noting that Starbucks’ transition would affect revenue. It also emphasized continued investment in products and operations, potentially at the expense of near-term results.
- Funding and lending: Square Capital transitioned from merchant cash advances to bank-originated loans intended for sale to third-party investors. Continued growth depends on investor demand, the bank partnership, loan repayment and credit-risk management.
- Unusual items: The company recorded a $48 million payment for a litigation settlement in nine-month general and administrative expense. A separate $6 million out-of-period adjustment to transaction-loss reserves was recorded in Q2 2016 for prior-period understatements; management stated it did not consider the amounts material to the periods affected.
- Legal matters: The Morley complaints were dismissed with prejudice after settlement. A Caviar courier’s appeal concerning arbitration remained pending; a related PAGA claim could be pursued by another courier.
- Principal risks: Starbucks revenue runoff; persistent losses and uncertain path to profitability; fraud, chargebacks and credit losses; dependence on payment networks, processors and third parties; data security, privacy, regulatory and litigation exposure; competition and seller retention; hardware supply and inventory risks; and reliance on third-party purchasers and a partner bank for loans.
- The filing said disclosure controls were effective at September 30, 2016, with no material change in internal control over financial reporting during the quarter. Management noted ongoing public-company compliance efforts.
Important facts for investors to verify
- How much revenue and margin remain after Starbucks’ processing transition, and whether growth in other sellers and products offsets the loss.
- Whether GPV growth converts into durable gross profit and operating improvement, considering transaction costs and ongoing investment.
- The sustainability and cash-flow quality of positive operating cash flow, including the effects of loan purchases and sales, settlement balances and customer payables.
- Loan-sale demand, economics and credit performance under Square Capital’s bank-partner model.
- The scale of recurring share-based compensation, dilution and the remaining unrecognized compensation cost ($272.4 million at quarter-end).
- Developments in the Caviar courier appeal and any further material legal, regulatory, fraud or security exposures.