Business context and reporting period
This is Square, Inc.’s unaudited Form 10-Q for the quarter and six months ended June 30, 2016. The company, now identified in the request as Block, Inc., reported under the name Square, Inc. in this filing. Its business included payment processing, software and data products, hardware, Square Cash, Caviar, and Square Capital. About 90% of revenue came from payment processing services.
Financial performance and position
Amounts below are in millions of dollars except per-share data. Year-over-year comparisons are with the corresponding 2015 period.
| Metric | Q2 2016 | Q2 2015 | Six months 2016 | Six months 2015 |
|---|---|---|---|---|
| Net revenue | $438.5 | $310.0 | $817.8 | $560.6 |
| Gross profit | $149.0 | $90.3 | $259.2 | $164.6 |
| Operating loss | $(27.4) | $(28.1) | $(124.5) | $(74.4) |
| Net loss | $(27.3) | $(29.6) | $(124.1) | $(77.6) |
| Adjusted EBITDA (non-GAAP) | $12.6 | $0.9 | $3.5 | $(19.3) |
- Revenue increased 41% in Q2 and 46% in the first half. Gross margin was approximately 34.0% in Q2 versus 29.1%; first-half gross margin was approximately 31.7% versus 29.4%.
- Gross Payment Volume, excluding Starbucks, rose 42% to $12.5 billion in Q2 and 43% to $22.7 billion in the first half. Adjusted Revenue, a non-GAAP measure excluding transaction costs and Starbucks revenue, grew 54% to $170.8 million in Q2 and 59% to $317.0 million in the first half.
- Q2 operating loss narrowed slightly year over year, while the first-half operating and net losses widened. First-half results included $48 million of expense related to the Morley litigation settlement. Share-based compensation was $68.1 million for the first half, versus $28.7 million a year earlier.
- Cash and cash equivalents were $342.4 million at June 30, down from $470.8 million at December 31, 2015. Short- and long-term investments totaled $80.6 million; cash, cash equivalents, and investments totaled $423.0 million. Restricted cash totaled $36.7 million.
- First-half operating cash outflow was $35.8 million, investing outflow $105.2 million, and financing inflow $10.0 million; cash declined by $128.3 million. Operating cash flow included significant loan purchases and sales: $212.7 million purchased and $183.7 million received from sales and principal payments.
- Total assets were $933.3 million and total liabilities $461.8 million at June 30. No borrowings were outstanding under the $375 million secured revolving credit facility, which remained available through November 2020. The filing reported no material change in contractual obligations and no off-balance-sheet arrangements.
- GAAP gross profit divided by revenue is used above for gross margin; Adjusted EBITDA and Adjusted Revenue are company-defined non-GAAP measures and are not substitutes for GAAP results.
Material changes versus the prior comparable period
- Transaction revenue increased 40% in Q2 and 41% in the first half, broadly tracking GPV growth. Software and data product revenue increased 130% and 156%, respectively, led by Square Capital and Caviar. Hardware revenue increased 209% and 371%, primarily reflecting shipments of the EMV/NFC reader.
- Operating expenses rose 49% in Q2 and 61% in the first half. Product development expense increased 50% and 56%, respectively; first-half general and administrative expense increased 145%, substantially reflecting the settlement and higher share-based compensation and operating support costs.
- Starbucks transaction revenue was down 2% in Q2 but up 14% for the first half. Starbucks had announced a transition to another processor; Square continued processing a portion of its payments at increased rates under an amended agreement.
- The company had fully transitioned Square Capital from merchant cash advances to bank-originated loans held for sale to third-party investors. Short-term and long-term investments, absent at year-end, totaled $80.6 million at June 30.
Outlook, commentary, risks, and unusual items
- Management said existing cash, marketable securities, and available credit were expected to cover working capital and planned capital expenditures for at least the next 12 months. No revenue, earnings, or margin guidance was provided.
- Management emphasized continued long-term investment, including product development, international expansion, and Square Capital. It cautioned that interim results may not indicate full-year performance.
- Starbucks’ expected departure represented a revenue risk; the company was negotiating a possible extension to allow more time for the transition and did not intend to renew the agreement upon expiration. The agreement’s termination could materially affect reported revenue.
- A $6.0 million out-of-period adjustment was recorded in Q2 2016 to transaction, loan, and advance losses to correct an understatement of transaction-loss reserves in prior periods. Management stated it did not believe the adjustment was material to current-year or previously reported financial statements.
- The Morley/REM dispute was settled in June 2016. The aggregate settlement was $50 million, including contributions by the founders; Square paid $48 million, and the complaints were dismissed with prejudice. A Caviar courier classification case had been dismissed, but an appeal was filed; a PAGA claim was being pursued by a different courier.
- Principal disclosed risks included fraud and chargeback losses, data security and service interruptions, competition and pricing pressure, dependence on payment networks and processors, regulation of payments and lending, execution of new products and international expansion, and the expected Starbucks transition. The filing also cited dual-class voting control and potential stock-sale dilution. Disclosure controls were reported effective as of June 30, 2016.
Important facts for investors to verify
- Track the completion and financial effect of Starbucks’ processor transition, including any extension of the agreement.
- Assess whether GPV growth translates into durable gross profit and progress toward GAAP profitability, while accounting for transaction costs, ongoing share-based compensation, and investment spending.
- Monitor Square Capital loan sales, third-party investor demand, loan valuations, and credit and fraud losses as the business shifts from advances to loans.
- Review cash consumption and liquidity, including the distinction between unrestricted cash, investments, restricted cash, and the undrawn credit facility.
- Follow the Caviar courier litigation and other legal or regulatory matters, and evaluate the scope and treatment of the transaction-loss reserve adjustment.