Square, Inc. (now Block, Inc.) — Q3 2017 Form 10-Q
Reporting period: Quarter and nine months ended September 30, 2017. The filing was submitted under the company’s then-name, Square, Inc.; interim financial statements are unaudited.
Business context and financial performance
Square operated a commerce and payments platform spanning payment processing, seller software and services, Square Cash, Square Capital, Caviar, and hardware. Management reported one operating segment.
| Metric | Q3 2017 | Q3 2016 | Nine months 2017 | Nine months 2016 |
|---|---|---|---|---|
| Net revenue | $585.2 million (+33%) | $439.0 million | $1,598.2 million (+27%) | $1,256.8 million |
| Gross profit | $218.6 million | $150.3 million | $599.5 million | $409.5 million |
| Gross margin | 37.4% | 34.2% | 37.5% | 32.6% |
| Operating loss | $(14.9) million | $(32.0) million | $(41.2) million | $(156.5) million |
| Net loss | $(16.1) million | $(32.3) million | $(47.2) million | $(156.4) million |
| Adjusted EBITDA (non-GAAP) | $34.3 million | $11.6 million | $97.8 million | $15.1 million |
Q3 basic and diluted GAAP loss per share was $0.04, versus $0.09 a year earlier; nine-month loss per share was $0.13 versus $0.46. Gross margin figures above are calculated from reported revenue and gross profit. Adjusted EBITDA is a company-defined non-GAAP measure and should be considered alongside GAAP results.
Revenue drivers and changes versus prior periods
- Transaction-based revenue rose 31% in Q3 and 32% year to date, broadly tracking GPV growth of 31% and 32%, respectively. Larger sellers—defined as more than $125,000 in annualized GPV—grew GPV 43% year over year and represented 48% of total GPV.
- Subscription and services revenue increased 84% in Q3 and 95% year to date, led by Instant Deposit, Caviar, and Square Capital.
- Hardware revenue grew 23% in Q3 but declined 17% year to date. Management attributed the year-to-date decline in part to unusually high reader shipments in the first half of 2016.
- Starbucks had completed its transition to another provider in Q4 2016; Square reported no Starbucks transaction revenue in 2017 and did not expect it to recur. This reduced the 2017 comparison-period revenue and costs.
- Operating expenses increased 28% in Q3 and 13% year to date. Sales and marketing rose 42% in both comparisons; product development rose 17% and 13%, respectively. Year-to-date 2016 G&A included a $48 million legal settlement, so reported G&A declined 7% year to date in 2017; excluding that settlement, it increased.
Cash flow, liquidity, debt, and balance sheet
- For the first nine months, operating cash flow was $130.3 million, compared with $23.2 million in 2016. The filing attributes cash generation partly to noncash expenses and increases in customer and settlement payables; working-capital movements included a $271.2 million increase in settlements receivable.
- Investing cash outflow was $360.5 million, including $485.5 million of marketable-security purchases, a $25.0 million investment in Eventbrite, and $19.6 million of capital expenditures. Financing cash inflow was $431.1 million, including proceeds from convertible notes and employee equity activity.
- At September 30, cash and cash equivalents were $658.4 million; marketable investments were $401.3 million; and restricted cash was $35.1 million. Together these totaled $1,094.8 million, including restricted cash. Cash, cash equivalents, and marketable investments excluding restricted cash were $1,059.7 million.
- Current assets were $1.687 billion and current liabilities $930.7 million. These balances include substantial payment-settlement and customer-fund amounts that fluctuate with processing activity.
- Square issued $440 million principal amount of 0.375% convertible senior notes due 2022. Their September 30 carrying amount was $354.2 million, while estimated fair value was $616.0 million. The company also had a $375 million secured revolving facility undrawn and available; it reported covenant compliance.
- Management said cash, marketable securities, and available credit were expected to cover working-capital needs and planned capital expenditures for at least the next 12 months.
Outlook, risks, contingencies, and unusual items
- No specific revenue, earnings, or GPV guidance was provided in the filing. Management described continued investment in products, personnel, marketing, and international operations and cautioned that interim results are not necessarily indicative of full-year results.
- Square recorded $19.9 million of transaction, loan, and advance losses in Q3. Loan fair-value charges were $3.4 million for the quarter and $6.1 million year to date; management linked the increase to the growth and maturation of Square Capital lending.
- Q3 hardware costs included $3.2 million of inventory reserves, revaluations, and write-offs, including a $2.3 million charge related to a distributor’s bankruptcy.
- The company paid Starbucks $54.8 million to terminate its warrant. The convertible-note hedges cost $92.1 million and warrant issuance generated $57.2 million; these arrangements were intended to mitigate dilution up to an effective price of approximately $31.18 per share.
- A Caviar courier misclassification matter had reached a global settlement, subject to court confirmation; the company accrued an immaterial expected settlement amount. For other legal matters, the filing said a reasonable exposure range could not be estimated and outcomes could affect results in a particular period.
- Key disclosed risks include payment fraud and chargebacks, credit and funding risks in Square Capital, reliance on payment networks and processors, cybersecurity and service interruptions, regulation of payments and lending, competition and margin pressure, seller retention and growth, and potential dilution or cash requirements related to convertible notes.
- The company planned to adopt the new revenue-recognition standard in 2018 using the modified retrospective method. Its preliminary assessment was that the standard was not expected to have a material financial-statement impact, although evaluation continued.
Important facts for investors to verify
- Whether GPV growth and the increasing contribution from larger sellers and subscription/services products can be sustained, and how these trends translate into gross profit.
- Whether transaction, loan, and advance losses—and Square Capital loan performance and third-party loan funding—remain manageable as the lending business expands.
- The quality and cash implications of operating cash flow, particularly the large settlement-receivable and customer-payable movements.
- The company’s ability to meet future note conversion, repurchase, or maturity obligations, and the potential dilution from the notes and related warrants.
- The status and financial exposure of the Caviar settlement and other litigation, regulatory, and compliance matters.