Jack Dorsey Shareholder Letter Q1 2017 – Square

To Our Shareholders:

Our first-quarter results demonstrate our continued ability to grow the business at scale while balancing investment and margin expansion.  Improvements in net loss and Adjusted EBITDA reflect strong top-line growth, coupled with ongoing operating leverage and improvements in transaction loss rates. Similar to previous quarters, we saw strong
momentum across our products, with revenue growth driven by both transaction-based and subscription and services-based monetization.

We launched in the UK, our fourth international market, where small and
medium businesses (SMBs) generated £1.8 trillion of revenue in 2016.

Square is a great fit for the UK market, which has 5.5 million SMBs2 and a thriving entrepreneurial scene. The annual revenue of SMBs in 2016 was £1.8 trillion, which is 47% of all private sector UK revenue.  In the UK, the average adult now carries less than £25 in cash and 70% of shoppers prefer to pay by card, yet industry research estimates that half of UK small businesses still do not take card payments.3 Our contactless and chip reader aims to meet the needs of the UK market, where there are more than 100 million contactless cards.

Square Shareholder letter.pngFor countries such as the UK and Australia, we also needed to enable acceptance of payments that use PINs to authenticate chip card transactions instead of signatures, which are used in the U.S. We built a
new, secure way to enter PINs into the Square app on a mobile device, eliminating the need for expensive hardware PIN pads and making card acceptance more accessible. Also, our solution is quick and easy to update because it is software based, ensuring that our sellers always have access to the latest technology. We are working alongside industry partners to evolve standards for this new mobile PIN acceptance capability, which is the first of its kind for payments.

In addition to payment acceptance, we are now able to bring a broader set of products to new markets right at launch. Sellers in the UK can run their businesses with payments and point of sale, as well as Invoices, Employee and Location Management, Analytics, and Customer Directory, and can integrate Square with their other business solutions through Square App

Marketplace or our Build with Square developer platform of APIs.

Catherine Seay founded Curators Coffee to serve specialty coffee, tea, and freshly prepared food from two central London locations and a pop-up shop. Square’s Employee and Location Management has been invaluable for getting her staff up to speed quickly and easily, and Square Dashboard allows her to easily manage operations in real time.

We’re bringing more of the Square ecosystem to sellers in our other international markets, too. Continuing the momentum of Virtual Terminal’s rollout in the U.S. and Australia, we recently launched the product in Canada and Japan. Virtual Terminal allows sellers to key in payments from a web browser, making it ideal for sellers that typically use a computer instead of a mobile device. In Australia, we formed seven new APISquare Shareholder Letter 2.png partnerships to provide sellers that use alternative point-of-sale and order management platforms with the ability to accept payments with Square.

Integration drives product adoption: Invoices grew significantly after we integrated it into the Square app.

Sellers can now send and manage Invoices directly from the Square app (instead of from Square Dashboard in a web browser), making the product
more accessible from a mobile device. This enhanced functionality—launched in November 2016—resonated with sellers: In March 2017, nearly 50% of all Square invoices were sent from a mobile device, up from 34%
in October 2016. We added more Invoices sellers in this quarter than any other quarter, bringing the total of active Invoices sellers to nearly 225,000, driving approximately $700 million in first-quarter GPV.

Invoices makes it easy for Relevé School of Dance to manage monthly billing for its hundreds of customers in Clermont, Florida. Specifically, owners Colleen and Sean Hensley rely on recurring invoices and mobile
access, both of which are “big time savers.” Combining Invoices with Square Stand and our contactless and chip reader, Relevé is able to provide its customers with the flexibility to pay in person or online.

Integrated, digital invoices enable fast payment, which helps our sellers manage their cash flow. The average payment time of Square Invoices is two to three days, while paper invoices average seven weeks.5 Additionally, we provide sellers with a single platform, and we can uniquely offer invoices that are integrated with other services in the ecosystem, like Square Capital and Instant Deposit. This creates strong product crossover: Instant Deposit adoption is 66% higher among Invoices sellers than other Square sellers.

We continue to expand our industry-specific solutions with features that
help sellers reach more customers and increase sales, like Caviar pickup
for restaurants.

With Caviar, our goal is to help restaurants never miss a sale by expanding
orders beyond table seating, enabling them to Square shareholder letter 3 caviar.pngreach more customers and increase revenue without increasing overhead. With the launch of Caviarpickup in March 2017, Caviar grew from a food delivery service to a more robust food ordering platform for restaurants and their customers. Caviar continues to grow as we enhance the platform, with order volume in the
first quarter of 2017 more than doubling year over year. Caviar also creates meaningful revenue for restaurants: Over half of Caviar’s first-quarter food order volume (FOV) came from restaurants that sell more than $100,000 in FOV with Caviar on an annualized basis.

Square’s expertise in point of sale, order management, and services that help sellers grow differentiates Caviar from food delivery services. We’re also better integrating Caviar into the Square ecosystem. For example, we now complete delivery payouts to all new couriers with the technology underlying Square Cash.

Philz, a national coffee and coffeehouse chain, uses both Square and Caviar, and it has taken advantage of our Customers API, which connects
Square to its other business solutions. Combining customer feedback from Square’s digital receipts with Philz’s CRM system creates a powerful
understanding of customers’ habits and preferences. Caviar delivery has provided Philz with a new channel to reach corporate customers, and with
the addition of pickup Philz is now able to run its food ordering workflow on a single platform, which has simplified its operations.

Financial Discussion

Gross Payment Volume (GPV)

In the first quarter of 2017, we processed $13.6 billion of GPV, which represents an increase of 33% from the first quarter of 2016. This is
comparable to 34% year-over-year growth in the fourth quarter of 2016
and is in line with normal seasonal trends. We continue to see strength
from larger sellers, which are those that generate more than $125,000 in
annualized GPV. In the first quarter of 2017, GPV from larger sellers grew
44% year over year and accounted for 43% of total GPV, up from 39% of
total GPV in the first quarter of 2016.

Revenue

Total net revenue was $462 million in the first quarter of 2017, up 22% compared to the first quarter of 2016. We did not generate any revenue from Starbucks, which transitioned off of our infrastructure during the
fourth quarter of 2016. Excluding Starbucks revenue, total net revenue in the first quarter of 2017 grew 36% year over year. Adjusted Revenue was $204 million in the first quarter of 2017, an increase of 39% from the first quarter of 2016.square shareholder letter total net revenue.png

Transaction-based revenue was $403 million in the first quarter of 2017,
up 34% from the first quarter of 2016. Transaction-based revenue as a
percentage of GPV was 2.96% in the first quarter of 2017, up from 2.92% in
the prior year period. Transaction-based profit as a percentage of GPV was
1.07% in the first quarter of 2017, up from 1.03% in the prior year period.
Excluding the promotional processing credit from the first quarter of 2016,
transaction-based revenue and transaction-based profit as percentages
of GPV are consistent year over year. Our continued ability to grow GPV at
scale, while maintaining our transaction revenue margin, demonstrates that
our sellers recognize the value of our managed payments solution and our
cohesive ecosystem.

Subscription and services-based revenue was $49 million in the first
quarter of 2017, up 106% from the first quarter of 2016 and accelerating
from 81% year-over-year growth in the fourth quarter of 2016. This increase
demonstrates our ability to launch new products and feature improvements
for existing products that resonate with sellers and buyers. Caviar, Square
Capital, and Instant Deposit contributed significantly to subscription and
services-based revenue growth. Specifically, Square Capital facilitated over
40,000 business loans totaling $251 million in the first quarter of 2017, up
64% year over year. Instant Deposit benefited from increased awareness
among both sellers and Square Cash customers.

Hardware revenue in the first quarter of 2017 was $9 million, down 44%
from the first quarter of 2016 and flat on a sequential basis. The year-overyear
decline was driven by the fulfillment of the majority of the backlog of
pre-orders for our contactless and chip reader in the first quarter of 2016.

Operating Expenses/Earnings


Operating expenses were $188 million in the first quarter of 2017,
decreasing 10% year over year and increasing 4% on a sequential basis.
Excluding a litigation expense in the first quarter of 2016 of $50 million,
operating expenses for the first quarter of 2017 would have increased 19%
year over year. Non-GAAP operating expenses were up 24% year over year,
representing 73% of Adjusted Revenue in the first quarter of 2017.

  • Product development expenses were $69 million on a GAAP basis and
$46 million on a non-GAAP basis in the first quarter of 2017, up 6% and
15%, respectively, from the first quarter of 2016. This primarily reflects
increases in engineering, product, and design personnel costs.
  • Sales and marketing expenses were $50 million on a GAAP basis and
$46 million on a non-GAAP basis in the first quarter of 2017, up 30%
and 29%, respectively, from the first quarter of 2016. The increase was
driven primarily by costs related to Square Cash and growth in sales,
account management, and creative personnel costs.
  • General and administrative expenses were $57 million on a GAAP basis
and $45 million on a non-GAAP basis in the first quarter of 2017. Thesesquare shareholder letter transaction loss as a percentage of gpv.png
costs represent a 41% decline and 22% increase, respectively, from the
first quarter of 2016. Excluding the litigation expense in the first quarter
of 2016, expenses would have increased 23% on a GAAP basis. The
year-over-year increase, excluding the litigation expense in 2016, was
due primarily to increased personnel costs for functions including legal,
finance, and business operations for Caviar and Square Capital.
  • Transaction, loan, and advance losses were $12 million in the first
quarter of 2017. Transaction losses as a percentage of GPV for
the first quarter of 2017 are continuing to trend below our 0.1%
historical average, which underscores ongoing improvements in risk
management. We continue to drive a low and declining loss rate as
a result of our ability to use data science and machine learning to
automate risk assessment for over 99.95% of all traSquare Shareholder Letter Net income loss.pngnsactions on our
platform.

Net loss was $15 million in the first quarter of 2017, an improvement of $82
million from the first quarter of 2016. Net loss per share, basic and diluted,
was $0.04 for the first quarter of 2017, compared to a net loss per share
of $0.29 in the first quarter of 2016. We had 367 million weighted-average
shares as of the first quarter of 2017.Adjusted EBITDA was $27 million in the first quarter of 2017, compared
to a loss of $9 million in the first quarter of 2016, an improvement of $36
million on a year-over-year basis. First-quarter Adjusted EBITDA margin
of 13% is an improvement of 19 percentage points year over year. Our
Adjusted EBITDA improvement reflects strong top-line growth coupled
with operating leverage across all segments, as well as improvements in
transaction loss rates.

Adjusted Net Income Per Share (Adjusted EPS) was $0.05 based on 404
million weighted-average diluted shares for the first quarter of 2017. This
represents a $0.10 improvement on a year-over-year basis from the first
quarter of 2016.

Balance Sheet/Cash Flow


We ended the first quarter of 2017 with $990 million in cash, cash
equivalents, restricted cash, and investments in marketable securities,
up from $576 million at the end of the fourth quarter of 2016. Positive
Adjusted EBITDA and proceeds from employee stock option exercises
contributed to the increase in the balance at the end of the quarter. In
addition, we had two transactions in the quarter that affected our cash 
balance.

First, in February 2017, we paid Starbucks approximately $55 million in cash
to cancel a warrant that gave them the right to purchase an aggregate of
approximately 9.5 million shares of Square stock, eliminating the potential
dilutive impact of the warrant.

Second, on March 6, 2017, we completed an offering for $440 million in
convertible senior notes. The convertible senior notes mature in 2022
with a coupon of 0.375%. In connection with the offering, we entered into
multiple hedge and warrant transactions, which increased the effective
conversion premium to 80%, and thus, reduced potential equity dilution.
Total net proceeds from the offering were

Guidance


square shareholder letter guidance.png

Given our strong results for the first quarter, we are increasing our
guidance for the full year. Additionally, our guidance for net income (loss)
per share reflects the effect from our convertible note, which is $(0.04) per
share for the full year and $(0.01) per share for the second quarter.
There are two considerations to point out for the second quarter of 2017:
• Similar to the first quarter, we do not expect Starbucks transactionbased
revenue going forward, which will have a negative impact on
year-over-year growth in total net revenue in 2017.
• Hardware revenue in the second quarter of 2016 also benefited from
the fulfillment of pre-orders for our contactless and chip reader. As
such, year-over-year hardware revenue growth for the second quarter
of 2017 will be more moderate relative to prior year periods, but to a
lesser extent than the effect experienced in the first quarter.

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