Edgar Filing: Square, Inc.

Document

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

______________________

FORM 10-Q

______________________

(Mark One)



ý	QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended June 30, 2016



o	TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the transition period from ________ to ________

Commission File Number: 001-37622

______________________

Square, Inc.

(Exact name of registrant as specified in its charter)

______________________



Delaware		80-0429876
(State or other jurisdiction of incorporation or organization)		(IRS Employer Identification No.)

1455 Market Street, Suite 600

San Francisco, CA 94103

(Address of principal executive offices, including zip code)

(415) 375-3176

(Registrant’s telephone number, including area code)

______________________

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes ý No o

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes ý No o

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.

Large accelerated filer o Accelerated filer o Non-accelerated filer ý (Do not check if smaller reporting company) Smaller reporting company o

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes o No ý

As of July 26, 2016, the number of shares of the registrant’s Class A common stock outstanding was 123,747,963 and the number of shares of the registrant’s Class B common stock outstanding was 218,016,908.

TABLE OF CONTENTS



Page No.
PART I—Financial Information
Item 1. Financial Statements
Condensed Consolidated Balance Sheets (unaudited)	4
Condensed Consolidated Statements of Operations (unaudited)	5
Condensed Consolidated Statements of Comprehensive Loss (unaudited)	6
Condensed Consolidated Statements of Cash Flows (unaudited)	7
Notes to the Condensed Consolidated Financial Statements (unaudited)	8
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations	23
Item 3. Quantitative and Qualitative Disclosures About Market Risk	34
Item 4. Controls and Procedures	34
PART II—Other Information
Item 1. Legal Proceedings	36
Item 1A. Risk Factors	36
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds	54
Item 3. Defaults Upon Senior Securities	54
Item 4. Mine Safety Disclosures	54
Item 5. Other Information	54
Item 6. Exhibits	54
Signatures	55

SPECIAL NOTE REGARDING FORWARD-LOOKING STATEMENTS

This Quarterly Report on Form 10-Q contains forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended, that involve substantial risks and uncertainties. Forward-looking statements generally relate to future events or our future financial or operating performance. In some cases, you can identify forward-looking statements because they contain words such as “may,” “will,” “appears,” “should,” “expects,” “plans,” “anticipates,” “could,” “intends,” “target,” “projects,” “contemplates,” “believes,” “estimates,” “predicts,” “potential,” or “continue,” or the negative of these words or other similar terms or expressions that concern our expectations, strategy, plans, or intentions. Forward-looking statements contained in this Quarterly Report on Form 10-Q include, but are not limited to, statements about our future financial performance, our anticipated growth and growth strategies and our ability to effectively manage that growth, our anticipated expansion in international markets, our plans for funding and expanding Square Capital, our expectations regarding litigation, and the sufficiency of our cash and cash equivalents and cash generated from operations to meet our working capital and capital expenditure requirements.

The outcome of the events described in these forward-looking statements is subject to risks, uncertainties, and other factors described in the section titled “Risk Factors” and elsewhere in this Quarterly Report on Form 10-Q.

We undertake no obligation to update any forward-looking statements made in this Quarterly Report on Form 10-Q to reflect events or circumstances after the date of this Quarterly Report on Form 10-Q or to reflect new information or the occurrence of unanticipated events, except as required by law.

Part I—Financial Information

Item 1. Financial Statements

SQUARE, INC.

CONDENSED CONSOLIDATED BALANCE SHEETS

(Unaudited)

(In thousands, except share and per share data)



	June 30, 2016			December 31, 2015
Assets
Current assets:
Cash and cash equivalents	$	342,436		$	470,775
Short-term investments	60,991			—
Restricted cash	13,545			13,537
Settlements receivable	204,541			142,727
Loans held for sale	29,774			604
Merchant cash advance receivable, net	21,268			36,473
Other current assets	48,473			41,447
Total current assets	721,028			705,563
Property and equipment, net	86,325			87,222
Goodwill	56,699			56,699
Acquired intangible assets, net	22,329			26,776
Long-term investments	19,602			—
Restricted cash	23,131			14,686
Other assets	4,178			3,826
Total assets	$	933,292		$	894,772
Liabilities and Stockholders’ Equity
Current liabilities:
Accounts payable	$	16,211		$	18,869
Customers payable	310,242			224,811
Accrued transaction losses	16,093			17,176
Accrued expenses	26,133			44,401
Other current liabilities	42,790			28,945
Total current liabilities	411,469			334,202
Other liabilities	50,364			52,522
Total liabilities	461,833			386,724
Commitments and contingencies (Note 17)
Stockholders’ equity:
Preferred stock, $0.0000001 par value: 100,000,000 shares authorized at June 30, 2016, and December 31, 2015. None issued and outstanding at June 30, 2016, and December 31, 2015.	—			—
Common stock, $0.0000001 par value: 1,000,000,000 Class A shares authorized at both June 30, 2016, and December 31, 2015; 118,365,688 and 31,717,133 issued and outstanding at June 30, 2016, and December 31, 2015, respectively. 500,000,000 Class B shares authorized at both June 30, 2016, and December 31, 2015; 222,597,682 and 303,232,312 issued and outstanding at June 30, 2016, and December 31, 2015, respectively.	—			—
Additional paid-in capital	1,203,136			1,116,882
Accumulated deficit	(731,749		)	(607,649		)
Accumulated other comprehensive income (loss)	72			(1,185		)
Total stockholders’ equity	471,459			508,048
Total liabilities and stockholders’ equity	$	933,292		$	894,772

The accompanying notes are an integral part of these unaudited condensed consolidated financial statements.

SQUARE, INC.

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS

(Unaudited)

(In thousands, except per share data)



	Three Months Ended June 30,						Six Months Ended June 30,
	2016			2015			2016			2015
Revenue:
Transaction revenue	$	364,864		$	259,864		$	665,317		$	470,974
Starbucks transaction revenue	32,867			33,630			71,705			62,867
Software and data product revenue	29,717			12,928			53,513			20,934
Hardware revenue	11,085			3,591			27,267			5,795
Total net revenue	438,533			310,013			817,802			560,570
Cost of revenue:
Transaction costs	234,857			165,823			429,133			297,930
Starbucks transaction costs	28,672			40,921			65,282			77,132
Software and data product costs	10,144			5,072			19,177			8,227
Hardware costs	14,015			6,713			40,755			10,910
Amortization of acquired technology	1,886			1,142			4,256			1,744
Total cost of revenue	289,574			219,671			558,603			395,943
Gross profit	148,959			90,342			259,199			164,627
Operating expenses:
Product development	68,638			45,887			133,230			85,432
Sales and marketing	39,220			31,730			77,716			67,911
General and administrative	50,784			31,804			146,891			59,923
Transaction, loan and advance losses	17,455			8,513			25,316			24,835
Amortization of acquired customer assets	222			482			539			950
Total operating expenses	176,319			118,416			383,692			239,051
Operating loss	(27,360		)	(28,074		)	(124,493		)	(74,424		)
Interest (income) and expense, net	(129		)	444			(60		)	858
Other (income) and expense, net	(198		)	(50		)	(984		)	746
Loss before income tax	(27,033		)	(28,468		)	(123,449		)	(76,028		)
Provision for income taxes	312			1,152			651			1,570
Net loss	$	(27,345	)	$	(29,620	)	$	(124,100	)	$	(77,598	)
Net loss per share:
Basic	$	(0.08	)	$	(0.20	)	$	(0.37	)	$	(0.53	)
Diluted	$	(0.08	)	$	(0.20	)	$	(0.37	)	$	(0.53	)
Weighted-average shares used to compute net loss per share
Basic	334,488			149,253			332,906			147,288
Diluted	334,488			149,253			332,906			147,288

The accompanying notes are an integral part of these unaudited condensed consolidated financial statements.

SQUARE, INC.

CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE LOSS

(Unaudited)

(In thousands)



	Three Months Ended June 30,						Six Months Ended June 30,
	2016			2015			2016			2015
Net loss	$	(27,345	)	$	(29,620	)	$	(124,100	)	$	(77,598	)
Net foreign currency translation adjustments	85			(30		)	595			(257		)
Net unrealized gain (loss) on revaluation of intercompany loans	329			(95		)	$	582		$	(95	)
Net unrealized gain (loss) on marketable securities	4			—			$	80		$	—
Total comprehensive loss	$	(26,927	)	$	(29,745	)	$	(122,843	)	$	(77,950	)

The accompanying notes are an integral part of these unaudited condensed consolidated financial statements.

SQUARE, INC.

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(Unaudited)

(In thousands)



	Six Months Ended June 30,
	2016			2015
Cash flows from operating activities:
Net loss	$	(124,100	)	$	(77,598	)
Adjustments to reconcile net loss to net cash used in operating activities:
Depreciation and amortization	18,136			11,956
Share-based compensation	68,120			28,693
Provision for transaction losses	23,392			21,566
Provision for (reduction in) uncollectible merchant cash advances	(93		)	3,148
Deferred provision for income taxes	63			(207		)
Loss on disposal of property and equipment	131			240
Changes in operating assets and liabilities:
Settlements receivable	(62,169		)	(56,326		)
Purchase of loans held for sale	(212,727		)	—
Proceeds from sales and principal payments of loans held for sale	183,748			—
Merchant cash advance receivable	15,298			(6,145		)
Other current assets	(7,313		)	(4,735		)
Other assets	(377		)	1,177
Accounts payable	2,538			3,408
Customers payable	84,826			67,286
Charge-offs and recoveries to accrued transaction losses	(24,475		)	(14,174		)
Accrued expenses	(13,784		)	3,834
Other current liabilities	13,446			(10		)
Other noncurrent liabilities	(431		)	7,388
Net cash used in operating activities	(35,771		)	(10,499		)
Cash flows from investing activities:
Purchase of marketable securities	(102,245		)	—
Proceeds from maturities of marketable securities	16,768			—
Proceeds from sale of marketable securities	4,964			—
Purchase of property and equipment	(15,840		)	(20,760		)
Payment for acquisition of intangible assets	(400		)	(110		)
Change in restricted cash	(8,453		)	—
Business acquisitions (net of cash acquired)	—			(3,750		)
Net cash used in investing activities	(105,206		)	(24,620		)
Cash flows from financing activities:
Payments of offering costs related to initial public offering	(5,530		)	—
Proceeds from issuances of common stock from the exercise of options and employee stock purchase plan	15,496			8,633
Net cash provided by financing activities	9,966			8,633
Effect of foreign exchange rate changes on cash and cash equivalents	2,672			(874		)
Net decrease in cash and cash equivalents	(128,339		)	(27,360		)
Cash and cash equivalents, beginning of period	470,775			225,300
Cash and cash equivalents, end of period	$	342,436		$	197,940

The accompanying notes are an integral part of these unaudited condensed consolidated financial statements.

SQUARE, INC.

NOTES TO THE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

NOTE 1 - DESCRIPTION OF BUSINESS AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

Business

Square, Inc. (together with its subsidiaries, Square or the Company) creates tools that help sellers of all sizes start, run, and grow their businesses – from payment processing to point of sale, hardware to software, business loans to payroll and more. Businesses and individuals can also use Square Cash, an easy way to send and receive money, as well as Caviar, a food delivery service for popular restaurants. Square was founded in 2009 and is headquartered in San Francisco, with offices in the United States, Canada, Japan, and Australia.

Initial Public Offering

In November 2015, the Company completed its Initial Public Offering (IPO) in which it issued and sold 29,700,000 shares of Class A common stock at a public offering price of $9.00 per share and a selling stockholder sold 1,350,000 shares of Class A common stock. The Company did not receive any proceeds from the sale of shares by the selling stockholder. The total net proceeds received by the Company from the IPO were $245.7 million after deducting underwriting discounts and commissions of $14.7 million and other offering expenses of approximately $6.9 million.

Out of Period Adjustments

During the three months ended June 30, 2016, the Company recorded an out of period adjustment for the amount of $6.0 million to transaction, loan and advance losses as a result of a correction to the calculation of its reserve for transaction losses. The adjustment was recorded to correct an understatement of transaction losses in prior periods. Of the total amount of this adjustment, $0.5 million is related to the three months ended March 31, 2016, and $2.6 million, $1.6 million and $1.0 million is related to the years ended December 31, 2015, 2014, and 2013, respectively. The remaining $0.3 million is related to historical periods. The Company does not believe that such amounts are material with respect to the estimated operating loss or estimated net loss for the current fiscal year or any previously reported consolidated financial statements.

Basis of Presentation

The accompanying interim condensed consolidated financial statements of the Company are unaudited. These interim condensed consolidated financial statements have been prepared in accordance with generally accepted accounting principles in the United States of America (U.S. GAAP) and the applicable rules and regulations of the Securities and Exchange Commission (SEC) for interim financial information. Accordingly, they do not include all of the information and footnotes required by U.S. GAAP for complete financial statements. The December 31, 2015 condensed consolidated balance sheet was derived from the audited financial statements as of that date, but does not include all of the information and footnotes required by U.S. GAAP for complete financial statements.

The accompanying unaudited interim condensed consolidated financial statements have been prepared on the same basis as the audited consolidated financial statements and, in the opinion of management, reflect all adjustments of a normal recurring nature considered necessary to state fairly the Company's financial position, results of operations, comprehensive loss, and cash flows for the interim periods. All intercompany transactions and balances have been eliminated in consolidation. The interim results for the three and six months ended June 30, 2016 are not necessarily indicative of the results that may be expected for the year ending December 31, 2016, or for any other future annual or interim period.

The information included in this Quarterly Report on Form 10-Q should be read in conjunction with “Management’s Discussion and Analysis of Financial Condition and Results of Operations,” “Quantitative and Qualitative Disclosures About Market Risk,” and the Consolidated Financial Statements and notes thereto included in Items 7, 7A, and 8, respectively, in the Company's Annual Report on Form 10-K for the year ended December 31, 2015.

Use of Estimates

The preparation of the Company’s consolidated financial statements in conformity with U.S. GAAP requires management to make estimates and assumptions that affect the reported amounts of assets, liabilities, revenue, and expenses, as well as related disclosure of contingent assets and liabilities. Actual results could differ from the Company’s estimates. To the extent that there are material differences between these estimates and actual results, the Company’s financial condition or operating results will be materially affected. The Company bases its estimates on past experience and other assumptions that the Company believes are reasonable under the circumstances, and the Company evaluates these estimates on an ongoing basis.

Significant estimates, judgments, and assumptions in these consolidated financial statements include, but are not limited to, those related to revenue recognition, accrued transaction losses, provision for uncollectible receivables related to merchant cash advances (MCAs), valuation of loans held for sale, business combinations, goodwill and intangible assets, income taxes, and share-based compensation.

Concentration of Credit Risk

For the three and six months ended June 30, 2016, the Company had no customer that accounted for greater than 10% of total net revenue. For the three and six months ended June 30, 2015, the Company had no customer other than Starbucks that accounted for greater than 10% of total net revenue. The Company had three third-party processors that represented approximately 50%, 34%, and 12% of settlements receivable as of June 30, 2016. The same three parties represented approximately 56%, 23%, and 16% of settlements receivable as of December 31, 2015.

The Company places its cash and cash equivalents and investments in marketable securities with large, creditworthy financial institutions. Balances in these accounts may exceed federally insured limits at times.

Significant Accounting Policies

Except as described below, there have been no material changes to the Company’s significant accounting policies during the six months ended June 30, 2016, as compared to the significant accounting policies described in the Company’s Annual Report on Form 10-K for the year ended December 31, 2015.

Loans Held for Sale

The Company provides loans to sellers prequalified through an analysis of the aggregated data of the seller’s business which includes, but is not limited to, the seller’s historical processing volumes, transaction count, chargebacks, growth, and length of time as a Square customer. The loans are originated by a bank, from whom the Company purchases the loans obtaining all rights, title, and interest.

The loans are classified as held for sale upon purchase, as it is the Company’s intent to sell all of its rights, title, and interest in these loans to third-party investors for an up-front origination fee when the loans are sold. The Company also earns a servicing fee by continuing to service the loans by remitting monies to the third-party investors. Revenue from origination fees are recognized upon transfer of title to investors and servicing revenue is recognized as servicing is delivered.

A loan that is initially designated as held for sale may be reclassified to held for investment if and when the Company's intent for that loan changes. There have been no reclassifications made to date. Loans are recorded at the lower of cost or fair value. To determine the fair value of loans, the Company utilizes industry standard modeling, such as discounted cash flow models, to arrive at an estimate of fair value.

Recently Issued Accounting Standards

In May 2014, the Financial Accounting Standards Board (FASB) issued Accounting Standards Update (ASU) No. 2014-09, Revenue from Contracts with Customers, and issued subsequent amendments to the initial guidance within ASU 2015-04, ASU 2016-08, ASU 2016-10, and ASU 2016-12. The new guidance will replace all current U.S. GAAP guidance on this topic and eliminate all industry specific guidance. The core principal of this new guidance is that revenue is recognized when promised goods or services are transferred to customers in an amount that reflects the consideration for which the Company expects to be entitled in exchange for those goods or services. This guidance is effective for financial statements issued for fiscal years beginning after December 15, 2017, and interim periods within those fiscal years, with early adoption permitted. The guidance can be applied either retrospectively to each period presented or as a cumulative effect adjustment as of the date of

adoption. The Company has not yet selected a transition method and is evaluating the impact of adopting this new accounting standard update on the consolidated financial statements and related disclosures.

In March 2016, the FASB issued ASU No. 2016-04, Recognition of Breakage for Certain Prepaid Stored-Value Products. This guidance specifies how prepaid stored-value product liabilities should be derecognized, thereby eliminating the current and potential future diversity in practice. This guidance is effective for financial statements issued for fiscal years beginning after December 15, 2017, and interim periods within those fiscal years, with early adoption permitted. The Company is currently evaluating the impact this new guidance may have on the consolidated financial statements.

In March 2016, the FASB issued ASU No. 2016-09, Improvements to Employee Share-Based Payment Accounting,

which is intended to simplify several aspects of the accounting for share-based payment transactions, including the income tax consequences, classification of awards as either equity or liabilities, and classification on the statement of cash flows. This guidance is effective for financial statements issued for fiscal years beginning after December 15, 2016, and interim periods within those fiscal years, with early adoption permitted. The Company is currently evaluating the impact this new guidance may have on the consolidated financial statements.

In June 2016, the FASB issued ASU No. 2016-13, Measurement of Credit Losses on Financial Instruments, which requires measurement and recognition of expected credit losses for financial assets held. This guidance is effective for financial statements issued for fiscal years beginning after December 15, 2019, and interim periods within those fiscal years, with early adoption permitted. The Company is currently evaluating the impact this new guidance may have on the consolidated financial statements.

NOTE 2 - RESTRICTED CASH

As of both June 30, 2016 and December 31, 2015, restricted cash of $13.5 million is related to pledged cash deposited into savings accounts at the financial institutions that process the Company's sellers' payment transactions. The Company uses the restricted cash to secure letters of credit with the financial institutions to provide collateral for cash flow timing differences in the processing of these payments. The Company has recorded this amount as a current asset on the condensed consolidated balance sheets due to the short-term nature of these cash flow timing differences and that there is no minimum time frame during which the cash must remain restricted.

As of June 30, 2016 and December 31, 2015, the remaining restricted cash of $23.1 million and $14.7 million, respectively, is primarily related to cash deposited into money market funds that is used as collateral pursuant to multi-year lease agreements entered into in 2012 and 2014 (see note 17) and as collateral pursuant to an agreement with the originating bank for the Company's loan product. The Company has recorded this amount as a non-current asset on the condensed consolidated balance sheets as the terms extend beyond one year.

NOTE 3 - FAIR VALUE OF FINANCIAL INSTRUMENTS

The Company measures its cash equivalents and short-term and long-term investments at fair value. The Company classifies its cash equivalents and short-term and long-term investments within Level 1 or Level 2 of the fair value hierarchy because the Company values these investments using quoted market prices or alternative pricing sources and models utilizing market observable inputs.

The Company’s financial assets and liabilities that are measured at fair value on a recurring basis are classified as follows (in thousands):



	June 30, 2016						December 31, 2015
	Level 1		Level 2		Level 3		Level 1		Level 2		Level 3
Cash and Cash Equivalents:
Money market funds	$	156,001	$	—	$	—	$	337,234	$	—	$	—
Commercial paper	—		10,745		—		—		—		—
Municipal securities	—		250		—		—		—		—
Short-term securities:
U.S. agency securities	—		11,617		—		—		—		—
Corporate bonds	—		8,805		—		—		—		—
Commercial paper	—		22,465		—		—		—		—
Municipal securities	—		3,005		—
U.S. government securities	15,099		—		—		—		—		—
Long-term securities:							—		—		—
U.S. agency securities	—		7,024		—		—		—		—
Corporate bonds	—		7,056		—		—		—		—
Municipal securities	—		1,502		—		—		—		—
U.S. government securities	4,020		—		—		—		—		—
Total	$	175,120	$	72,469	$	—	$	337,234	$	—	$	—

Loans are recorded at the lower of cost or fair value. To determine the fair value of loans, the Company utilizes industry-standard valuation modeling, such as discounted cash flow models, to arrive at an estimate of fair value.

A summary of loans disclosed at fair value on a recurring basis is as follows (in thousands):



	June 30, 2016
	Carrying Value	Fair Value (Level 3)
Loans held for sale	29,774	32,167
Total	29,774	32,167

As of December 31, 2015, the difference between the fair value of loans and the carrying value is insignificant.

The carrying amounts of certain financial instruments, including cash equivalents, settlements receivable, merchant cash advance receivable, accounts payable, customers payable, and settlements payable, approximate their fair values due to their short-term nature.

If applicable, the Company will recognize transfers into and out of levels within the fair value hierarchy at the end of the reporting period in which the actual event or change in circumstance occurs. During the three and six months ended June 30, 2016 and 2015, the Company did not have any transfers in or out of Level 1, Level 2, or Level 3 assets or liabilities.

NOTE 4 - INVESTMENTS

The Company determines the appropriate classification of its investments in marketable securities at the time of purchase and reevaluates such designation at each balance sheet date. The Company has classified and accounted for its marketable securities as available-for-sale.

The Company's short-term and long-term investments as of June 30, 2016 are as follows (in thousands):



	Amortized Cost		Gross Unrealized Gains		Gross Unrealized Losses			Fair Value
Short-term securities:
U.S. agency securities	$	11,605	$	12	$	—		$	11,617
Corporate bonds	8,801		4		—			8,805
Commercial paper	22,465		—		—			22,465
Municipal securities	3,006		—		(1		)	3,005
U.S. government securities	15,080		19		—			15,099
Total	$	60,957	$	35	$	(1	)	$	60,991

Long-term securities:
U.S. agency securities	$	7,005	$	19	$	—		$	7,024
Corporate bonds	7,047		9		—			7,056
Municipal securities	1,501		1		—			1,502
U.S. government securities	4,003		17		—			4,020
Total	$	19,556	$	46	$	—		$	19,602

For the three and six months ended June 30, 2016, gains or losses realized on the sale of investments were insignificant. Investments are reviewed periodically to identify possible other-than-temporary impairments. As the Company has the ability and intent to hold these investments with unrealized losses until a recovery of fair value, or for a reasonable period of time sufficient for the recovery of fair value, which may be maturity, the Company does not consider these investments to be other-than-temporarily impaired as of June 30, 2016.

The contractual maturities of the Company's short-term and long-term investments as of June 30, 2016 are as follows (in thousands):



	Amortized Cost		Fair Value
Due in one year or less	$	60,957	$	60,991
Due in one to five years	19,556		19,602
Total	$	80,513	$	80,593

NOTE 5 - ALLOWANCE FOR MERCHANT CASH ADVANCE LOSSES

The following table summarizes the activities of the Company’s allowance for uncollectible merchant cash advance receivables (in thousands):



	Three Months Ended June 30,						Six Months Ended June 30,
	2016			2015			2016			2015
Allowance for uncollectible MCA receivables, beginning of the period	$	7,458		$	4,935		$	7,443		$	2,431
Provision for (reduction in) uncollectible MCA receivables	(166		)	644			(93		)	3,148
MCA receivables charged off	(2,201		)	(302		)	(2,259		)	(302		)
Allowance for uncollectible MCA receivables, end of the period	$	5,091		$	5,277		$	5,091		$	5,277

As of June 30, 2016, the Company has fully transitioned from offering MCAs to loans. The table above includes a reduction in uncollectible receivables for the three and six months ended June 30, 2016, primarily as a result of updates to the Company's provision estimates for historical balances. Additionally, the Company charged off certain MCA receivables based on payment inactivity.

NOTE 6 - PROPERTY AND EQUIPMENT, NET

The following is a summary of property, equipment, and internally-developed software at cost, less accumulated depreciation and amortization (in thousands):



	June 30, 2016			December 31, 2015
Computer equipment	$	47,685		$	43,531
Office furniture and equipment	9,604			9,339
Leasehold improvements	67,823			65,298
Capitalized software	19,974			14,533
Construction in process	256			490
Total	145,342			133,191
Less: Accumulated depreciation and amortization	(59,017		)	(45,969		)
Property and equipment, net	$	86,325		$	87,222

Depreciation and amortization expense on property and equipment was $6.9 million and $13.3 million for the three and six months ended June 30, 2016, respectively. Depreciation and amortization expense on property and equipment was $4.8 million and $9.2 million for the three and six months ended June 30, 2015, respectively.

NOTE 7 - GOODWILL

Goodwill is recorded when the consideration paid for an acquisition of a business exceeds the fair value of identifiable net tangible and intangible assets acquired. As of both June 30, 2016 and December 31, 2015, goodwill was $56.7 million.

The Company performs a goodwill impairment test annually on December 31 and more frequently if events and circumstances indicate that the asset might be impaired. For the periods presented, the Company had recorded no impairment charges.

NOTE 8 - ACQUIRED INTANGIBLE ASSETS

The following table presents the detail of acquired intangible assets as of the periods presented (in thousands):



	Balance as of June 30, 2016
	Cost		Accumulated Amortization			Net
Patent	$	1,285	$	(400	)	$	885
Technology Assets	29,045		(10,900		)	18,145
Customer Assets	6,645		(3,346		)	3,299
Total	$	36,975	$	(14,646	)	$	22,329



	Balance as of December 31, 2015
	Cost		Accumulated Amortization			Net
Patent	$	1,285	$	(348	)	$	937
Technology Assets	28,645		(6,644		)	22,001
Customer Assets	6,645		(2,807		)	3,838
Total	$	36,575	$	(9,799	)	$	26,776

The weighted average amortization periods for acquired patents, acquired technology, and customer intangible assets are approximately 13 years, three years, and six years, respectively.

Amortization expense associated with other intangible assets was $2.1 million and $4.8 million for the three and six months ended June 30, 2016, respectively. Amortization expense associated with other intangible assets was $1.7 million and $2.7 million for the three and six months ended June 30, 2015, respectively.

The total estimated annual future amortization expense of these intangible assets as of June 30, 2016 is as follows (in thousands):



2016 (remaining 6 months)	$	4,125
2017	7,187
2018	5,687
2019	2,983
2020	1,087
Thereafter	1,260
Total	$	22,329

NOTE 9 - OTHER CONSOLIDATED BALANCE SHEET COMPONENTS (CURRENT)

Other Current Assets

The following table presents the detail of other current assets (in thousands):



	June 30, 2016		December 31, 2015
Accounts receivable	$	4,563	$	4,808
Prepaid expenses	8,730		7,101
Deferred reader costs	3,310		4,018
Inventory	17,199		11,864
Tenant improvement reimbursement receivable	1,350		1,788
Deferred hardware costs	3,363		1,709
Processing costs receivable	4,670		7,847
Other	5,288		2,312
Total	$	48,473	$	41,447

Accrued Expenses

The following table presents the detail of accrued expenses (in thousands):



	June 30, 2016		December 31, 2015
Accrued hardware costs	$	1,660	$	11,622
Processing costs payable	2,865		11,417
Accrued professional fees	5,434		7,642
Accrued payroll	3,347		2,660
Other accrued liabilities	12,827		11,060
Total	$	26,133	$	44,401

Other Current Liabilities

The following table presents the detail of other current liabilities (in thousands):



	June 30, 2016		December 31, 2015
Settlements payable	23,684		$	13,105
Employee early exercised stock options	1,140		2,141
Accrued redemptions	1,036		1,066
Current portion of deferred rent	2,657		2,393
Deferred revenue	5,119		6,623
Other	9,154		3,617
Total	$	42,790	$	28,945

NOTE 10 - OTHER CONSOLIDATED BALANCE SHEET COMPONENTS (NON-CURRENT)

Other Non-Current Assets

The following table presents the detail of other non-current assets (in thousands):



	June 30, 2016		December 31, 2015
Deposits	$	2,587	$	1,993
Deferred tax assets	130		188
Other	1,461		1,645
Total	$	4,178	$	3,826

Other Non-Current Liabilities

The following table presents the detail of other non-current liabilities (in thousands):



	June 30, 2016		December 31, 2015
Deferred rent	$	24,427	$	25,543
Employee early exercised stock options	365		1,128
Deferred tax liabilities	285		299
Statutory liabilities	25,255		25,492
Other	32		60
Total	$	50,364	$	52,522

NOTE 11 - DEBT

In November 2015, the Company entered into a revolving credit agreement with certain lenders, which extinguished the prior revolving credit agreement and provided for a $375.0 million revolving secured credit facility maturing in November 2020. This revolving credit agreement is secured by certain tangible and intangible assets.

Loans under the credit facility bear interest at the Company’s option of (i) a base rate based on the highest of the prime rate, the federal funds rate plus 0.50%, and an adjusted LIBOR rate for a one-month interest period, in each case plus a margin ranging from 0.00% to 1.00%, or (ii) an adjusted LIBOR rate plus a margin ranging from 1.00% to 2.00%. This margin is determined based on the Company’s total leverage ratio for the preceding four fiscal quarters. The Company is obligated to pay other customary fees for a credit facility of this size and type including an annual administrative agent fee of $0.1 million and an unused commitment fee of 0.15%. To date no funds have been drawn under the credit facility, with $375.0 million remaining available. The Company paid $0.1 million and $0.3 million in unused commitment fees during the three and six months ended June 30, 2016, respectively.

NOTE 12 - ACCRUED TRANSACTION LOSSES

The Company is exposed to transaction losses due to chargebacks as a result of fraud or uncollectibility. Recoveries are reflected as a reduction in the reserve for transaction losses when the recovery occurs.

The following table summarizes the activities of the Company’s reserve for transaction losses (in thousands):



	Three Months Ended June 30,						Six Months Ended June 30,
	2016			2015			2016			2015
Accrued transaction losses, beginning of the period	$	15,419		$	16,811		$	17,176		$	8,452
Provision for transaction losses	16,210			7,809			23,392			21,566
Charge-offs and recoveries to accrued transaction losses	(15,536		)	(8,776		)	(24,475		)	(14,174		)
Accrued transaction losses, end of the period	$	16,093		$	15,844		$	16,093		$	15,844

NOTE 13 - INCOME TAXES

The Company recorded an income tax expense of $0.3 million and $0.7 million for the three and six months ended June 30, 2016, respectively, compared to income tax expense of $1.2 million and $1.6 million for the three and six months ended June 30, 2015, respectively. The income tax expense recorded for the three and six months ended June 30, 2016 was primarily due to state and foreign income tax expense.

The Company’s effective tax rate was approximately (1.2)% and (0.5)% for the three and six months ended June 30, 2016, respectively, compared to an effective tax rate of (4.0)% and (2.1)% for the three and six months ended June 30, 2015, respectively. The difference between the effective tax rate and the federal statutory tax rate for the three and six months ended June 30, 2016 primarily relates to the valuation allowance on the Company’s deferred tax assets.

The Company’s effective tax rate may be subject to fluctuation during the year as new information is obtained, which may affect the assumptions used to estimate the annual effective tax rate, including factors such as the mix of forecasted pre-tax earnings in the various jurisdictions in which the Company operates, valuation allowances against deferred tax assets, the recognition and de-recognition of tax benefits related to uncertain tax positions, and changes in or the interpretation of tax laws in jurisdictions where the Company conducts business.

As of June 30, 2016, the Company retains a full valuation allowance on its deferred tax assets in the U.S. and certain foreign jurisdictions. The realization of the Company’s deferred tax assets depends primarily on its ability to generate taxable income in future periods. The amount of deferred tax assets considered realizable in future periods may change as management continues to reassess the underlying factors it uses in estimating future taxable income.

The tax provision for the three and six months ended June 30, 2016 was calculated on a jurisdiction basis. The Company estimated the foreign income tax provision using the effective income tax rate expected to be applicable for the full year.

NOTE 14 - STOCKHOLDERS’ EQUITY

Common Stock

The Company has authorized the issuance of Class A common stock and Class B common stock. Class A common stock and Class B common stock are referred to as "common stock" throughout these Notes to the Condensed Consolidated Financial Statements, unless otherwise noted. As of June 30, 2016, the Company was authorized to issue 1,000,000,000 shares of Class A common stock and 500,000,000 shares of Class B common stock, each with a par value of $0.0000001 per share. As of June 30, 2016, there were 118,365,688 shares of Class A common stock and 222,597,682 shares of Class B common stock outstanding.

Stock Plans

The Company maintains two share-based employee compensation plans: the 2009 Stock Plan (2009 Plan) and the 2015 Equity Incentive Plan (2015 Plan). The 2015 Plan serves as the successor to the 2009 Plan. The 2015 Plan became effective as of November 17, 2015. Outstanding awards under the 2009 Plan continue to be subject to the terms and conditions of the 2009 Plan.

Under the 2015 Plan, shares of common stock are reserved for the issuance of incentive and nonstatutory stock options, restricted stock awards, restricted stock units (RSUs), performance shares, and stock bonuses to qualified employees, directors, and consultants. The shares may be granted at a price per share not less than the fair market value at the date of grant. Initially, 30,000,000 shares were reserved under the 2015 Plan, and any shares subject to options or other similar awards granted under the 2009 Plan that expire, are forfeited, are repurchased by the Company, or otherwise terminate unexercised will become available under the 2015 Plan. The number of shares available for issuance under the 2015 Plan will be increased on the first day of each fiscal year, in an amount equal to the least of (i) 40,000,000 shares, (ii) 5% of the outstanding shares on the last day of the immediately preceding fiscal year, or (iii) such number of shares determined by the Company’s board of directors. As of June 30, 2016, the total number of shares subject to stock options and RSUs outstanding under the 2015 Plan was 18,678,552, and 33,719,245 shares were available for future issuance. As of June 30, 2016, the total number of shares subject to stock options and RSUs outstanding under the 2009 Plan was 95,302,472. As of November 17, 2015, no additional securities will be issued under 2009 Plan.

A summary of stock option activity for the six months ended June 30, 2016 is as follows (in thousands, except share and per share data):



	Number of Stock Options Outstanding		Weighted Average Exercise Price		Weighted Average Remaining Contractual Term (in years)	Aggregate Intrinsic Value
Balance as of December 31, 2015	107,515,554		$	6.99	7.87	$	656,194
Granted	1,707,320		13.54
Exercised	(4,225,876	)	1.91
Forfeited	(5,993,756	)	$	11.26
Balance as of June 30, 2016	99,003,242		7.06		7.57	307,645
Options vested and expected to vest as of
June 30, 2016	92,406,077		6.79		6.88	303,773
Options exercisable as of
June 30, 2016	94,552,296		6.89		7.47	307,645

Restricted Stock Activity

The Company issued RSUs to certain employees in fiscal year 2015. These RSUs typically vest over a term of four years.

Activity related to RSUs during the six months ended June 30, 2016 is set forth below:



	Number of RSUs		Weighted Average Grant Date Fair Value
Unvested as of December 31, 2015	3,632,765		$	13.14
Granted	12,649,921		12.43
Vested	(754,643	)	12.38
Forfeited	(550,261	)	13.53
Unvested as of June 30, 2016	14,977,782		$	12.56

Share-Based Compensation

The fair value of stock options and employee stock purchase plan shares granted to employees is estimated on the date of grant using the Black-Scholes-Merton option valuation model.

Effective August 31, 2015, the Company modified all of its nonstatutory stock option grants to extend the exercise term for terminated employees who have completed two years of service. In the event of a termination, the modified expiration date will be the earlier of (i) three years from termination or (ii) one year following an initial public offering, if in each case, the date of termination occurs between August 31, 2015 and the nine-month anniversary of the initial public offering. In all cases, the grants remain subject to earlier expiration in accordance with their original terms. During the three and six months ended June 30, 2016, share-based compensation expense included $0.7 million and $1.4 million, respectively, related to the vested portion of the impacted options, as a result of the modification. The Company will incur an additional $6.3 million of share-based compensation expense over the remaining vesting periods of the impacted options.

The fair value of stock options granted was estimated using the following weighted-average assumptions:



	Three Months Ended June 30,				Six Months Ended June 30,
	2016		2015		2016		2015
Dividend yield	—	%	—	%	—	%	—	%
Risk-free interest rate	1.55	%	1.80	%	1.55	%	1.74	%
Expected volatility	42.71	%	46.27	%	42.71	%	48.63	%
Expected term (years)	6.08		6.08		6.08		6.10

The following table summarizes the effects of share-based compensation on the Company's condensed consolidated statements of operations (in thousands):



	Three Months Ended June 30,				Six Months Ended June 30,
	2016		2015		2016		2015
Product development	$	24,168	$	10,391	$	46,115	$	19,349
Sales and marketing	3,363		1,345		6,266		2,774
General and administrative	9,391		3,496		15,739		6,570
Total	$	36,922	$	15,232	$	68,120	$	28,693

On November 17, 2015, the Company’s 2015 Employee Stock Purchase Plan (ESPP) became effective. During the three and six months ended June 30, 2016, the Company recorded $1.5 million and $3.0 million, respectively, of share-based compensation expense related to the ESPP, which is included in the table above. There was no similar activity during the three and six months ended June 30, 2015.

As of June 30, 2016, there was $303.3 million of total unrecognized compensation cost related to outstanding stock options that is expected to be recognized over a weighted-average period of 3.07 years.

NOTE 15 - LOSS PER SHARE

Basic net loss per share is computed by dividing the net loss by the weighted-average number of shares of common stock outstanding during the period. Diluted loss per share is the same as basic loss per share for all years presented because the effects of potentially dilutive items were anti-dilutive given the Company’s net loss.

The following table presents the calculation of basic and diluted net loss per share (in thousands, except per share data):



	Three Months Ended June 30,						Six Months Ended June 30,
	2016			2015			2016			2015
Net loss	$	(27,345	)	$	(29,620	)	$	(124,100	)	$	(77,598	)
Basic shares:
Weighted-average common shares outstanding	337,635			154,464			336,406			152,827
Weighted-average unvested shares	(3,147		)	(5,211		)	(3,500		)	(5,539		)
Weighted-average shares used to compute basic net loss per share	334,488			149,253			332,906			147,288
Diluted shares:
Weighted-average shares used to compute diluted loss per share	334,488			149,253			332,906			147,288
Net loss per share:
Basic	$	(0.08	)	$	(0.20	)	$	(0.37	)	$	(0.53	)
Diluted	$	(0.08	)	$	(0.20	)	$	(0.37	)	$	(0.53	)

The following potential common shares were excluded from the calculation of diluted net loss per share because their effect would have been anti-dilutive for the periods presented (in thousands):



	Three and Six Months Ended June 30,
	2016	2015
Stock options and restricted stock units	113,981	103,628
Common stock warrants	9,458	15,762
Preferred stock warrants	—	87
Convertible preferred stock	—	135,253
Unvested shares	2,878	5,211
Employee stock purchase plan	127	—
Total anti-dilutive securities	126,444	259,941

NOTE 16 - OTHER INCOME AND EXPENSE, NET

Other income and expense, net, is comprised of the following (in thousands):



	Three Months Ended June 30,						Six Months Ended June 30,
	2016			2015			2016			2015
Net (gain) loss on foreign exchange	$	(108	)	$	(57	)	$	(1,005	)	$	714
Other	(90		)	7			21			32
Total other (income) and expense, net	$	(198	)	$	(50	)	$	(984	)	$	746

NOTE 17 - COMMITMENTS AND CONTINGENCIES

Operating and Capital Leases

The Company has entered into various non-cancelable operating leases for certain offices with contractual lease periods expiring between 2016 and 2025. The Company recognized total rental expenses under operating leases of $2.7 million and $5.5 million for the three and six months ended June 30, 2016, respectively, compared to $3.3 million and $6.8 million for the three and six months ended June 30, 2015, respectively.

Future minimum lease payments under non-cancelable operating leases (with initial or remaining lease terms in excess of one year) and future minimum capital lease payments as of June 30, 2016 are as follows (in thousands):



	Capital			Operating
Year:
2016 (remaining 6 months)	$	33		$	7,842
2017	50			15,858
2018	7			15,622
2019	—			15,511
2020	—			15,590
Thereafter	—			51,629
Total	$	90		$	122,052
Less amount representing interest	(4		)
Present value of capital lease obligations	86
Less current portion of capital lease obligation	(62		)
Non-current portion of capital lease obligation	$	24

Litigation

The Company is currently a party to, and may in the future be involved in, various litigation matters (including intellectual property litigation), legal claims, and government investigations.

Notably, the Company was involved in legal proceedings with Robert E. Morley and REM Holdings 3, LLC (REM), which included disputes over certain patents and over Mr. Morley’s early involvement in the business enterprise that became Square. On December 1, 2010, the Company, along with its co-founder Jim McKelvey, filed a complaint (2010 Complaint) in the United States District Court for the Eastern District of Missouri to, among other things, add Mr. McKelvey as a named inventor of certain patents of which Mr. Morley was named the sole inventor. REM counterclaimed, alleging infringement by the Company of the patents. On January 30, 2014, Mr. Morley and REM filed a complaint against the Company, Jack Dorsey, and Mr. McKelvey, in the same Court, alleging that the formation of Square and the development of the Company's card reader and decoding technologies constituted, among other things, breach of an alleged joint venture, fraud, negligent misrepresentation, civil conspiracy, unjust enrichment, and misappropriation of trade secrets, as well as other related claims (2014 Complaint), and sought a judgment and order that the Company, Mr. Dorsey, and Mr. McKelvey held ownership of Square in constructive trust for Mr. Morley, as well as a variety of additional damages, injunctive relief, royalties, and correction of inventorship of certain of the Company’s patents. The Court consolidated the 2014 Complaint with the 2010 Complaint (collectively, the Complaints) on July 16, 2014.

On June 8, 2016, a final, definitive settlement agreement (Settlement Agreement) resolving the Complaints was entered into by Mr. Morley, REM, Mr. Dorsey, Mr. McKelvey, and the Company. The Settlement Agreement required an aggregate total payment of $50 million to plaintiffs, including meaningful contributions by Mr. Dorsey and Mr. McKelvey. The Company made a payment of $48 million to plaintiffs and met its obligations under the Settlement Agreement. On June 17, 2016, the Court entered an Order dismissing the Complaints in their entirety, with prejudice.

Additionally, the Company is involved in a class action lawsuit concerning independent contractors in connection with the Company’s Caviar business. On March 19, 2015, Jeffry Levin, on behalf of a putative nationwide class, filed a lawsuit in the Northern District of California against the Company’s wholly owned subsidiary, Caviar, Inc., which, as amended, alleges that Caviar misclassified Mr. Levin and other similarly situated couriers as independent contractors and, in doing so, violated various provisions of the California Labor Code and California Business and Professions Code by requiring them to pay various business expenses that should have been borne by Caviar. The Court compelled arbitration of Mr. Levin’s individual claims on November 16, 2015 and dismissed the lawsuit in its entirety with prejudice on May 2, 2016. On June 1, 2016, Mr. Levin filed a Notice of Appeal of the Court’s order compelling arbitration. Mr. Levin also sought an award of penalties pursuant to the Labor Code Private Attorneys General Act of 2004 (PAGA). The parties stipulated that Mr. Levin would no longer pursue this PAGA claim, and this claim is instead being pursued by a different courier.

In addition, from time to time, the Company is involved in various other litigation matters and disputes arising in the ordinary course of business. While it is not feasible to predict or determine the ultimate outcome of these matters, the Company believes that none of the Company's current legal proceedings will have a material adverse effect on the Company's business.

NOTE 18 - SEGMENT AND GEOGRAPHICAL INFORMATION

Operating segments are defined as components of an enterprise for which discrete financial information is available that is evaluated regularly by the chief operating decision maker (CODM) for purposes of allocating resources and evaluating financial performance. The Company’s CODM reviews financial information presented on a consolidated basis for purposes of allocating resources and evaluating financial performance. As such, the Company’s operations constitute a single operating segment and one reportable segment.

Revenue

Revenue by geography is based on the billing addresses of the merchants. The following table sets forth revenue by geographic area (in thousands):



	Three Months Ended June 30,				Six Months Ended June 30,
	2016		2015		2016		2015
Revenue
United States	$	421,808	$	299,326	$	789,387	$	542,282
International	16,725		10,687		28,415		18,288
Total net revenue	$	438,533	$	310,013	$	817,802	$	560,570

No individual country from the international markets contributed in excess of 10% of total revenue for three and six months ended June 30, 2016 and 2015.

Long-Lived Assets

The following table sets forth long-lived assets by geographic area (in thousands):



	June 30, 2016		December 31, 2015
Long-lived assets
United States	$	162,469	$	168,583
International	2,884		2,114
Total long-lived assets	$	165,353	$	170,697

NOTE 19 - SUPPLEMENTAL CASH FLOW INFORMATION

The supplemental disclosures of cash flow information consist of the following (in thousands):



	Six Months Ended June 30,
	2016		2015
Supplemental Cash Flow Data:
Cash paid for interest	$	284	$	744
Cash paid for income taxes	168		791
Supplemental disclosures of non-cash investing and financing activities:
Change in purchases of property and equipment in accounts payable and accrued expenses	4,192		5,394
Fair value of shares issued related to acquisitions	—		22,887

Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations

You should read the following discussion and analysis in conjunction with the information set forth within the condensed consolidated financial statements and the notes thereto included elsewhere in this Quarterly Report on Form 10-Q. The statements in this discussion regarding our expectations of our future performance, liquidity and capital resources, our plans, estimates, beliefs and expectations that involve risks and uncertainties, and other non-historical statements in this discussion, are forward-looking statements. These forward-looking statements are subject to numerous risks and uncertainties, including, but not limited to, the risks and uncertainties described under “Risk Factors” and elsewhere in this Quarterly Report on Form 10-Q. Our actual results may differ materially from those contained in or implied by any forward-looking statements.

Overview

We started Square in February 2009 to enable anyone with a mobile device to accept card payments, anywhere, anytime. While we found early success providing easy access to card payments, commerce extends beyond payments. In every transaction, we see opportunity for our sellers: to learn more about which products are selling best, to reinvest in their businesses, or to create and engage loyal buyers. Although we currently generate approximately 90% of our total net revenue from payment processing services, which include revenue generated from Starbucks, we have extended our product and service offerings to include additional software and data products, all to help sellers start, run, and grow their businesses.

We work to democratize commerce—leveling the playing field for sellers of all sizes. Our focus on technology and design allows us to create products and services that are accessible, intuitive, and easy-to-use. We set attractive and transparent pricing that is easy for our sellers to understand. We provide a free software app with our affordable (often free) hardware to turn mobile devices into powerful point-of-sale (POS) solutions in minutes. Our insights into our sellers’ businesses have allowed us to develop services that are applicable to businesses of all types and sizes, from Square Analytics to digital receipts. We continue to add advanced software features that tailor our POS solution to specific types of sellers, such as food-related, services, and retail businesses. We also bring further capabilities to our sellers through Build with Square, a suite of developer tools that allows sellers to process online payments on their own self-hosted website, customize any iOS point-of-sale to process payments with Square, and track, manage, and grow both their online and offline businesses in a single dashboard.

Because of our approach, we have grown rapidly. Millions of sellers accept payments with Square. They span all types of businesses: from cabs to coffee shops, lawyers to landscapers, retail stores to restaurants. Although substantially all of our revenue is currently generated in the United States, we also serve sellers throughout Canada, Japan and, as of the first quarter of 2016, Australia. As this international base of sellers grows, we expect our Gross Payment Volume (GPV) and revenue in these regions to grow as well. We serve sellers of all sizes, ranging from a single vendor at a farmers’ market to multinational businesses. Our products and services are built to scale, so sellers can stay with us over the life of their businesses.

The addition of new products and services is also a key part of our strategy. Our scale, growth, and unique insights enable us to serve sellers of all sizes with additional services, further strengthening our business. For example, we expect sellers who grow sales as a result of deploying funds from Square Capital into their business will likely also process increased payment volume with us. We are also focused on evolving each of our services to best serve our sellers, as evidenced by Square Capital's recent expansion from offering merchant cash advances (MCAs) to offering business loans, which offer increased flexibility for sellers, and position the service for continued scalable growth. As of June 30, 2016, we have fully transitioned from offering MCAs to loans.

For the three and six months ended June 30, 2016, we processed $12.5 billion and $22.7 billion of GPV, up 42% and 43% from the three and six months ended June 30, 2015, respectively. For the three and six months ended June 30, 2016, our total net revenue grew to $439 million and $818 million, up 41% and 46% from the three and six months ended June 30, 2015, respectively. For the three and six months ended June 30, 2016, our Adjusted Revenue grew to $171 million and $317 million, up 54% and 59% from the three and six months ended June 30, 2015, respectively. We intend to continue to make investments that will serve sellers and buyers over the long term even if a return on these investments is not realized in the short term. For the three and six months ended June 30, 2016, we generated a net loss of $27.3 million and $124.1 million, respectively. For the three and six months ended June 30, 2015, we generated a net loss of $29.6 million and $77.6 million, respectively.

Results of Operations

Revenue (in thousands, except for percentages)



	Three Months Ended June 30,									Six Months Ended June 30,
	2016		2015		$ Change			% Change		2016		2015		$ Change		% Change
Transaction revenue	$	364,864	$	259,864	$	105,000		40	%	$	665,317	$	470,974	$	194,343	41	%
Starbucks transaction revenue	32,867		33,630		$	(763	)	(2	)%	$	71,705	$	62,867	$	8,838	14	%
Software and data product revenue	29,717		12,928		$	16,789		130	%	$	53,513	$	20,934	$	32,579	156	%
Hardware revenue	11,085		3,591		$	7,494		209	%	$	27,267	$	5,795	$	21,472	371	%
Total net revenue	$	438,533	$	310,013	$	128,520		41	%	$	817,802	$	560,570	$	257,232	46	%

Total net revenue for the three and six months ended June 30, 2016 increased by $128.5 million or 41% and $257.2 million or 46%, respectively, compared to the three and six months ended June 30, 2015.

Transaction revenue for the three and six months ended June 30, 2016 increased by $105.0 million or 40% and $194.3 million or 41%, respectively, compared to the three and six months ended June 30, 2015. This increase was attributable to growth in GPV processed for the three and six months ended June 30, 2016 of 42% and 43%, respectively, compared to the three and six months ended June 30, 2015. New-seller growth made up the majority of our GPV increase, while positive dollar-based retention from existing sellers also had a meaningful impact. Transaction revenue contributed 83% and 81% of total net revenue in the three and six months ended June 30, 2016, respectively, compared to 84% in both the three and six months ended June 30, 2015.

Starbucks transaction revenue for the three and six months ended June 30, 2016 decreased by $0.8 million or 2% and increased $8.8 million or 14%, respectively, compared to the three and six months ended June 30, 2015. Starbucks transaction revenue contributed 7% and 9% of total net revenue in the three and six months ended June 30, 2016, respectively, compared to 11% in both the three and six months ended June 30, 2015. Under our amended payment processing agreement, effective October 1, 2015, Starbucks agreed to pay increased processing rates to us for as long as it continues to process transactions with us. While Starbucks announced that it would transition to another payment processor prior to the expiration of the payment processing agreement in the third quarter of 2016, we are continuing to process a portion of Starbucks payments, generating transaction revenue at the newly increased rates. We are now negotiating an amendment that may extend the agreement beyond the third quarter of 2016 to allow Starbucks additional time to complete their transition, which has been taking longer than anticipated.

Software and data product revenue for the three and six months ended June 30, 2016 increased by $16.8 million or 130% and $32.6 million or 156%, respectively, compared to the three and six months ended June 30, 2015. The increase was primarily driven by continued growth and expansion of Square Capital and Caviar, and to a lessor extent, the launch and expansion of new products and services, including Instant Deposit. During the three and six months ended June 30, 2016, Square Capital and Caviar remained the largest contributors to software and data product revenue. Software and data product revenue contributed 7% of total net revenue in both the three and six months ended June 30, 2016, respectively, compared to 4% in both the three and six months ended June 30, 2015.

Hardware revenue for the three and six months ended June 30, 2016, increased by $7.5 million or 209% and $21.5 million or 371%, respectively, compared to the three and six months ended June 30, 2015. The increase primarily reflects growth in shipments of our Square Reader for Europay, MasterCard, and Visa (EMV) chip cards and near field communication (NFC) following its launch in the fourth quarter of 2015. We also continued to generate increased sales across all of our paid hardware products, including Square Stand and third-party peripherals. Hardware revenue contributed 3% of total net revenue in both the three and six months ended June 30, 2016, respectively, compared to 1% in both the three and six months ended June 30, 2015, respectively.

Total Cost of Revenue (in thousands, except for percentages)



	Three Months Ended June 30,									Six Months Ended June 30,
	2016		2015		$ Change			% Change		2016		2015		$ Change			% Change
Transaction costs	$	234,857	$	165,823	$	69,034		42	%	$	429,133	$	297,930	$	131,203		44	%
Starbucks transaction costs	28,672		40,921		$	(12,249	)	(30	)%	$	65,282	$	77,132	$	(11,850	)	(15	)%
Software and data product costs	10,144		5,072		$	5,072		100	%	$	19,177	$	8,227	$	10,950		133	%
Hardware costs	14,015		6,713		$	7,302		109	%	$	40,755	$	10,910	$	29,845		274	%
Amortization of acquired technology	1,886		1,142		$	744		65	%	$	4,256	$	1,744	$	2,512		144	%
Total cost of revenue	$	289,574	$	219,671	$	69,903		32	%	$	558,603	$	395,943	$	162,660		41	%

Total cost of revenue for the three and six months ended June 30, 2016 increased by $69.9 million or 32% and $162.7 million or 41%, respectively, compared to the three and six months ended June 30, 2015.

Transaction costs for the three and six months ended June 30, 2016 increased by $69.0 million or 42% and $131.2 million or 44%, respectively, compared to the three and six months ended June 30, 2015. This increase was attributable to growth in GPV processed for the three and six months ended June 30, 2016 of 42% and 43%, respectively, compared to the three and six months ended June 30, 2015.

Starbucks transaction costs for the three and six months ended June 30, 2016 decreased by $12.2 million or 30% and $11.9 million or 15%, respectively, compared to the three and six months ended June 30, 2015. Starbucks' previously announced transition to another payment processor drove a reduction in Starbucks-related payment volumes, offset by Starbucks' agreement to pay us increased processing rates effective October 1, 2015. As a result, for the three and six months ended June 30, 2016, we experienced a decline in Starbucks transaction costs as a percent of Starbucks transaction revenue, compared to the three and six months ended June 30, 2015.

Software and data product costs for the three and six months ended June 30, 2016 increased by $5.1 million or 100% and $11.0 million or 133%, respectively, compared to the three and six months ended June 30, 2015, primarily reflecting increased costs associated with the growth of Caviar. To a lesser extent we also incurred increased amortization costs related to the development of certain software and data products.

Hardware costs for the three and six months ended June 30, 2016 increased by $7.3 million or 109% and $29.8 million or 274%, respectively, compared to the three and six months ended June 30, 2015. The increase primarily reflects growth in shipments of our Square Reader for EMV chip cards and NFC following its launch in the fourth quarter of 2015, and to a lesser extent, increased sales of Square Stand, third-party peripherals, and other paid hardware products. Hardware costs associated

with the production of Square Stand exceed the revenue we derive from sales of Square Stand. For the three and six months ended June 30, 2016, hardware costs grew more slowly than hardware revenue as a result of increased sales of third-party peripherals, the introduction of our Square Reader for EMV chip cards and NFC, and growth in other paid hardware products outside of Square Stand.

Amortization of acquired technology for the three and six months ended June 30, 2016 increased by $0.7 million or 65% and $2.5 million or 144%, respectively, compared to the three and six months ended June 30, 2015. The increase was primarily related to new technology assets obtained through acquisitions that occurred in 2015.

Operating Expenses (in thousands, except for percentages)



	Three Months Ended June 30,											Six Months Ended June 30,
	2016			2015			$ Change			% Change		2016			2015			$ Change			% Change
Product development	$	68,638		$	45,887		$	22,751		50	%	$	133,230		$	85,432		$	47,798		56	%
% of total net revenue	16		%	15		%						16		%	15		%
Sales and marketing	$	39,220		$	31,730		$	7,490		24	%	$	77,716		$	67,911		$	9,805		14	%
% of total net revenue	9		%	10		%						10		%	12		%
General and administrative	$	50,784		$	31,804		$	18,980		60	%	$	146,891		$	59,923		$	86,968		145	%
% of total net revenue	12		%	10		%						18		%	11		%
Transaction, loan and advance losses	$	17,455		$	8,513		$	8,942		105	%	$	25,316		$	24,835		$	481		2	%
% of total net revenue	4		%	3		%						3		%	4		%
Amortization of acquired customer assets	$	222		$	482		$	(260	)	(54	)%	$	539		$	950		$	(411	)	(43	)%
% of total net revenue	—		%	—		%						—		%	—		%
Total operating expenses	$	176,319		$	118,416		$	57,903		49	%	$	383,692		$	239,051		$	144,641		61	%

Product development expenses for the three and six months ended June 30, 2016 increased by $22.8 million or 50% and $47.8 million or 56%, respectively, compared to the three and six months ended June 30, 2015, due to the addition of engineering, design, and product personnel in the period from June 30, 2015 to June 30, 2016, combined with increased share-based compensation expense. For the three and six months ended June 30, 2016, product development expenses included $24.2 million and $46.1 million, respectively, of share-based compensation expense, representing a $13.8 million and $26.8 million increase, respectively, compared to the three and six months ended June 30, 2015. For the six months ended June 30, 2016, we also incurred increased costs associated with the development of our next generation hardware products compared to the six months ended June 30, 2015.

Sales and marketing expenses for the three and six months ended June 30, 2016 increased by $7.5 million or 24% and $9.8 million or 14%, respectively, compared to the three and six months ended June 30, 2015, primarily due to an increase in sales and marketing personnel in the period from June 30, 2015 to June 30, 2016. Additionally, for the six months ended June 30, 2016, there was an increase in costs associated with our Square Cash peer-to-peer transfer service compared to the six months ended June 30, 2015. For the three and six months ended June 30, 2016, sales and marketing expenses included $3.4 million and $6.3 million of share-based compensation expense, respectively, representing a $2.0 million and $3.5 million increase compared to the three and six months ended June 30, 2015, respectively. For the three months ended June 30, 2016, paid marketing expenditures increased by $1.9 million, compared to the three months ended June 30, 2015, primarily due to elevated TV advertising costs. For the six months ended June 30, 2016, paid marketing expenditures were stable compared to the six months ended June 30, 2015.

General and administrative expenses for the three and six months ended June 30, 2016 increased by $19.0 million or 60% and $87.0 million or 145%, compared to the three and six months ended June 30, 2015. For the six months ended June 30, 2016, general and administrative expenses included $48.0 million of expense related to the settlement of legal proceedings with Robert E. Morley, with no similar activity during the six months ended June 30, 2015. For the three and six months ended June 30, 2016, general and administrative expenses included $9.4 million and $15.7 million of share-based compensation expense, respectively, representing a $5.9 million and $9.2 million increase compared to the three and six months ended June 30,

2015, respectively. The balance of the increased expenses was primarily due to increases in customer support, legal, compliance, risk, finance, and Square Capital operations personnel that together will drive long-term operating efficiencies as our business scales. We also experienced increased third-party legal, finance, consulting, and certain software license expenses.

Transaction, loan and advance losses for the three and six months ended June 30, 2016 increased by $8.9 million and $0.5 million compared to the three and six months ended June 30, 2015, respectively. During the three months ended June 30, 2016, we recorded an out of period adjustment for the amount of $6.0 million as a result of a correction to the calculation of our reserve for transaction losses with no similar activity during the three months ended June 30, 2015. However, during the six months ended June 30, 2015, the Company accrued an amount of $5.7 million related to a fraud loss from a single seller, which offsets the year over year impact of the 2016 out of period adjustment discussed above. The remaining increase was attributable to growth in GPV processed for the three and six months ended June 30, 2016.

Amortization of acquired customer assets for the three and six months ended June 30, 2016 decreased by $0.3 million and $0.4 million compared to the three and six months ended June 30, 2015, respectively, as a result of certain customer assets reaching end of life.

Interest and Other Income and Expense, Net (in thousands, except for percentages)



	Three Months Ended June 30,											Six Months Ended June 30,
	2016			2015			$ Change			% Change		2016			2015		$ Change			% Change
Interest (income) and expense, net	$	(129	)	$	444		$	(573	)	(129	)%	$	(60	)	$	858	$	(918	)	(107	)%
Other (income) and expense, net	(198		)	(50		)	$	(148	)	NM		$	(984	)	$	746	$	(1,730	)	(232	)%

Interest (income) and expense, net, for the three and six months ended June 30, 2016 changed by $0.6 million and $0.9 million compared to the three and six months ended June 30, 2015, respectively, primarily driven by interest income earned on our recent investment in marketable securities offsetting interest expense.

Other (income) and expense, net, for the three and six months ended June 30, 2016 changed by $0.1 million and $1.7 million compared to the three and six months ended June 30, 2015, respectively, driven primarily by favorable fluctuations in foreign exchange rates.

Provision for Income Taxes (in thousands, except for percentages)



	Three Months Ended June 30,											Six Months Ended June 30,
	2016			2015			$ Change			% Change		2016			2015			$ Change			% Change
Provision for income taxes	$	312		$	1,152		$	(840	)	(73	)%	$	651		$	1,570		$	(919	)	(59	)%
Effective tax rate	(1.2		)%	(4.0		)%						(0.5		)%	(2.1		)%

Provision for income taxes for the three and six months ended June 30, 2016, decreased by $0.8 million and $0.9 million compared to the three and six months ended June 30, 2015, respectively. The decrease for both periods primarily relates to the reduction in federal income tax expense.

Key Operating Metrics and Non-GAAP Financial Measures

We collect and analyze operating and financial data to evaluate the health of our business, allocate our resources, and assess our performance. In addition to revenue, net (loss) income, and other results under generally accepted accounting principles in the United States (GAAP), the following table sets forth key operating metrics and non-GAAP financial measures we use to evaluate our business. Each of these metrics and measures excludes the effect of our payment processing agreement with Starbucks. We amended our payment processing agreement with Starbucks to eliminate the exclusivity provision in order to permit Starbucks to begin transitioning to another payment processor starting October 1, 2015. Under the amendment, Starbucks also agreed to pay increased processing rates to us for as long as it continues to process transactions with us. While Starbucks announced that it would transition to another payment processor prior to the expiration of the payment processing agreement in the third quarter of 2016, we are continuing to process a portion of Starbucks payments, generating transaction revenue at the newly increased rates. We are now negotiating an amendment that may extend the agreement beyond the third quarter of 2016 to allow Starbucks additional time to complete their transition, which has been taking longer than anticipated. We do not intend to renew this agreement with Starbucks upon its expiration. As a result, we believe it is useful to exclude Starbucks activity to clearly show the impact Starbucks has had on our financial results historically, to provide insight into the impact of the expected termination of the Starbucks agreement on our revenues going forward, to facilitate period-to-period comparisons of our business, and to facilitate comparisons of our performance to that of other payment processors. Our agreements with other sellers, including Starbucks following the amendment described above, generally provide both those sellers and us the unilateral right to terminate such agreements at any time, without fine or penalty. Furthermore, we generally do not enter into long-term contractual agreements with sellers.



	Three Months Ended June 30,								Six Months Ended June 30,
	2016		2015		$ Change		% Change		2016		2015	$ Change	% Change
	(in thousands, except GPV)								(in thousands, except GPV)
Gross Payment Volume (GPV) (in millions)	$	12,451	$	8,793	$	3,658	42	%	$	22,741<