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 September 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 October 25, 2016, the number of shares of the registrant’s Class A common stock outstanding was 166,302,906 and the number of shares of the registrant’s Class B common stock outstanding was 185,836,069.

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	33
Item 4. Controls and Procedures	33
PART II—Other Information
Item 1. Legal Proceedings	35
Item 1A. Risk Factors	35
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds	52
Item 3. Defaults Upon Senior Securities	52
Item 4. Mine Safety Disclosures	52
Item 5. Other Information	52
Item 6. Exhibits	52
Signatures	53

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 ability to develop our products and services to operate with changing technology, our anticipated expansion and growth in Gross Payment Volume (GPV) and revenue in international markets, our plans for funding and expanding Square Capital, our expectations regarding litigation, our expectations regarding the effect the Starbucks transition will have on our net revenue, 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)



	September 30, 2016			December 31, 2015
Assets
Current assets:
Cash and cash equivalents	$	437,900		$	470,775
Short-term investments	76,427			—
Restricted cash	13,559			13,537
Settlements receivable	233,812			142,727
Loans held for sale	28,817			604
Merchant cash advance receivable, net	8,268			36,473
Other current assets	44,244			41,447
Total current assets	843,027			705,563
Property and equipment, net	89,957			87,222
Goodwill	56,699			56,699
Acquired intangible assets, net	20,252			26,776
Long-term investments	15,478			—
Restricted cash	23,137			14,686
Other assets	3,658			3,826
Total assets	$	1,052,208		$	894,772
Liabilities and Stockholders’ Equity
Current liabilities:
Accounts payable	$	13,719		$	18,869
Customers payable	364,434			224,811
Accrued transaction losses	21,428			17,176
Accrued expenses	41,943			44,401
Other current liabilities	44,500			28,945
Total current liabilities	486,024			334,202
Other liabilities	55,795			52,522
Total liabilities	541,819			386,724
Commitments and contingencies (Note 17)
Stockholders’ equity:
Preferred stock, $0.0000001 par value: 100,000,000 shares authorized at September 30, 2016 and December 31, 2015. None issued and outstanding at September 30, 2016 and December 31, 2015.	—			—
Common stock, $0.0000001 par value: 1,000,000,000 Class A shares authorized at September 30, 2016 and December 31, 2015; 162,988,864 and 31,717,133 issued and outstanding at September 30, 2016 and December 31, 2015, respectively. 500,000,000 Class B shares authorized at both September 30, 2016 and December 31, 2015; 188,328,922 and 303,232,312 issued and outstanding at September 30, 2016 and December 31, 2015, respectively.	—			—
Additional paid-in capital	1,274,248			1,116,882
Accumulated deficit	(764,072		)	(607,649		)
Accumulated other comprehensive income (loss)	213			(1,185		)
Total stockholders’ equity	510,389			508,048
Total liabilities and stockholders’ equity	$	1,052,208		$	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 September 30,						Nine Months Ended September 30,
	2016			2015			2016			2015
Revenue:
Transaction revenue	$	388,347		$	280,955		$	1,053,664		$	751,929
Starbucks transaction revenue	7,164			32,332			78,869			95,199
Software and data product revenue	35,320			14,694			88,833			35,628
Hardware revenue	8,171			4,207			35,438			10,002
Total net revenue	439,002			332,188			1,256,804			892,758
Cost of revenue:
Transaction costs	254,061			182,007			683,194			479,937
Starbucks transaction costs	4,528			41,410			69,810			118,542
Software and data product costs	12,524			5,593			31,701			13,820
Hardware costs	15,689			5,726			56,444			16,636
Amortization of acquired technology	1,886			1,142			6,142			2,886
Total cost of revenue	288,688			235,878			847,291			631,821
Gross profit	150,314			96,310			409,513			260,937
Operating expenses:
Product development	70,418			55,020			203,648			140,452
Sales and marketing	46,754			39,259			124,470			107,170
General and administrative	52,075			37,820			198,966			97,743
Transaction, loan and advance losses	12,885			16,005			38,201			40,840
Amortization of acquired customer assets	164			423			703			1,373
Total operating expenses	182,296			148,527			565,988			387,578
Operating loss	(31,982		)	(52,217		)	(156,475		)	(126,641		)
Interest (income) and expense, net	(183		)	137			(243		)	995
Other (income) and expense, net	294			644			(690		)	1,390
Loss before income tax	(32,093		)	(52,998		)	(155,542		)	(129,026		)
Provision for income taxes	230			932			881			2,502
Net loss	$	(32,323	)	$	(53,930	)	$	(156,423	)	$	(131,528	)
Net loss per share:
Basic	$	(0.09	)	$	(0.35	)	$	(0.46	)	$	(0.88	)
Diluted	$	(0.09	)	$	(0.35	)	$	(0.46	)	$	(0.88	)
Weighted-average shares used to compute net loss per share
Basic	343,893			152,334			336,593			149,058
Diluted	343,893			152,334			336,593			149,058

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 September 30,						Nine Months Ended September 30,
	2016			2015			2016			2015
Net loss	$	(32,323	)	$	(53,930	)	$	(156,423	)	$	(131,528	)
Net foreign currency translation adjustments	127			(198		)	722			(455		)
Net unrealized gain (loss) on revaluation of intercompany loans	74			80			$	656		$	(15	)
Net unrealized gain (loss) on marketable securities	(60		)	—			20			—
Total comprehensive loss	$	(32,182	)	$	(54,048	)	$	(155,025	)	$	(131,998	)

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)



	Nine Months Ended September 30,
	2016			2015
Cash flows from operating activities:
Net loss	$	(156,423	)	$	(131,528	)
Adjustments to reconcile net loss to net cash provided by operating activities:
Depreciation and amortization	27,817			18,526
Share-based compensation	104,899			49,486
Starbucks share-based instruments	—			1,485
Provision for transaction losses	36,875			32,967
Provision for (reduction in) uncollectible merchant cash advances	509			4,616
Deferred provision for income taxes	(104		)	(207		)
Loss on disposal of property and equipment	(88		)	240
Changes in operating assets and liabilities:
Settlements receivable	(91,390		)	(40,729		)
Purchase of loans held for sale	(421,243		)	—
Proceeds from sales and principal payments of loans held for sale	393,221			—
Merchant cash advance receivable	27,696			(18,725		)
Other current assets	(3,011		)	(4,457		)
Other assets	145			1,102
Accounts payable	(867		)	2,048
Customers payable	139,105			89,446
Charge-offs and recoveries to accrued transaction losses	(32,623		)	(25,415		)
Accrued expenses	86			13,950
Other current liabilities	15,255			1,524
Other noncurrent liabilities	2,376			8,801
Net cash provided by operating activities	42,235			3,130
Cash flows from investing activities:
Purchase of marketable securities	(139,103		)	—
Proceeds from maturities of marketable securities	26,268			—
Proceeds from sale of marketable securities	20,962			—
Purchase of property and equipment	(19,674		)	(30,724		)
Payment for acquisition of intangible assets	(400		)	(110		)
Change in restricted cash	(8,473		)	(252		)
Business acquisitions (net of cash acquired)	—			(4,500		)
Net cash used in investing activities	(120,420		)	(35,586		)
Cash flows from financing activities:
Principal payments on debt	—			(30,000		)
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	48,304			12,209
Net cash provided by (used in) financing activities	42,774			(17,791		)
Effect of foreign exchange rate changes on cash and cash equivalents	2,536			(970		)
Net decrease in cash and cash equivalents	(32,875		)	(51,217		)
Cash and cash equivalents, beginning of period	470,775			225,300
Cash and cash equivalents, end of period	$	437,900		$	174,083

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 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.

Litigation Settlement

On June 8, 2016, a final, definitive settlement agreement (Settlement Agreement) was entered into by Robert E. Morley, REM Holdings 3, LLC, Jack Dorsey, Jim 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. This amount was classified within general and administrative expenses on the condensed consolidated statements of operations for the nine months ended September 30, 2016. On June 17, 2016, the Court entered an Order dismissing the complaints in their entirety, with prejudice.

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 consolidated 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 nine months ended September 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 nine months ended September 30, 2016, the Company had no customer that accounted for greater than 10% of total net revenue. For the three and nine months ended September 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 47%, 39%, and 11% of settlements receivable as of September 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 U.S. 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 nine months ended September 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.

In August 2016, the FASB issues ASU No. 2016-15, Classification of Certain Cash Receipts and Cash Payments. This guidance addresses several specific cash flow issues with the objective of reducing the existing 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.

NOTE 2 - RESTRICTED CASH

As of September 30, 2016 and December 31, 2015, restricted cash of $13.6 million and $13.5 million, respectively, 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 September 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):



	September 30, 2016						December 31, 2015
	Level 1		Level 2		Level 3		Level 1		Level 2		Level 3
Cash and Cash Equivalents:
Money market funds	$	209,364	$	—	$	—	$	337,234	$	—	$	—
Commercial paper	—		1,500		—		—		—		—
Short-term securities:
U.S. agency securities	—		13,088		—		—		—		—
Corporate bonds	—		19,787		—		—		—		—
Commercial paper	—		17,455		—		—		—		—
Municipal securities	—		6,529		—
U.S. government securities	19,568		—		—		—		—		—
Long-term securities:							—		—		—
U.S. agency securities	—		6,519		—		—		—		—
Corporate bonds	—		4,423		—		—		—		—
Municipal securities	—		3,033		—		—		—		—
U.S. government securities	1,503		—		—		—		—		—
Total	$	230,435	$	72,334	$	—	$	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):



	September 30, 2016
	Carrying Value	Fair Value (Level 3)
Loans held for sale	28,817	29,778
Total	28,817	29,778

As of December 31, 2015, the difference between the fair value of loans and the carrying value was 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 nine months ended September 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 September 30, 2016 are as follows (in thousands):



	Amortized Cost		Gross Unrealized Gains		Gross Unrealized Losses			Fair Value
Short-term securities:
U.S. agency securities	$	13,076	$	12	$	—		$	13,088
Corporate bonds	19,795		—		(8		)	19,787
Commercial paper	17,455		—		—			17,455
Municipal securities	6,530		—		(1		)	6,529
U.S. government securities	19,552		16		—			19,568
Total	$	76,408	$	28	$	(9	)	$	76,427

Long-term securities:
U.S. agency securities	$	6,508	$	11	$	—		$	6,519
Corporate bonds	4,419		4		—			4,423
Municipal securities	3,038		—		(5		)	3,033
U.S. government securities	1,500		3		—			1,503
Total	$	15,465	$	18	$	(5	)	$	15,478

For the three and nine months ended September 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 September 30, 2016.

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



	Amortized Cost		Fair Value
Due in one year or less	$	76,408	$	76,427
Due in one to five years	15,465		15,478
Total	$	91,873	$	91,905

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 September 30,						Nine Months Ended September 30,
	2016			2015			2016			2015
Allowance for uncollectible MCA receivables, beginning of the period	$	5,091		$	5,277		$	7,443		$	2,431
Provision for uncollectible MCA receivables	602			1,468			509			4,616
MCA receivables charged off	(855		)	(809		)	(3,114		)	(1,111		)
Allowance for uncollectible MCA receivables, end of the period	$	4,838		$	5,936		$	4,838		$	5,936

As of March 31, 2016, the Company had fully transitioned from offering MCAs to loans. Activity in the table above includes updates to the Company's provision estimates for historical balances and charge offs of 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):



	September 30, 2016			December 31, 2015
Computer equipment	$	50,520		$	43,531
Office furniture and equipment	10,110			9,339
Leasehold improvements	72,308			65,298
Capitalized software	22,761			14,533
Construction in process	670			490
Total	156,369			133,191
Less: Accumulated depreciation and amortization	(66,412		)	(45,969		)
Property and equipment, net	$	89,957		$	87,222

Depreciation and amortization expense on property and equipment was $7.6 million and $20.9 million for the three and nine months ended September 30, 2016, respectively. Depreciation and amortization expense on property and equipment was $5.0 million and $14.2 million for the three and nine months ended September 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 September 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 September 30, 2016
	Cost		Accumulated Amortization			Net
Patent	$	1,285	$	(427	)	$	858
Technology Assets	29,045		(12,786		)	16,259
Customer Assets	6,645		(3,510		)	3,135
Total	$	36,975	$	(16,723	)	$	20,252



	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 $6.9 million for the three and nine months ended September 30, 2016, respectively. Amortization expense associated with other intangible assets was $1.6 million and $4.3 million for the three and nine months ended September 30, 2015, respectively.

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



2016 (remaining 3 months)	$	2,048
2017	7,187
2018	5,687
2019	2,983
2020	1,087
Thereafter	1,260
Total	$	20,252

NOTE 9 - OTHER CONSOLIDATED BALANCE SHEET COMPONENTS (CURRENT)

Other Current Assets

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



	September 30, 2016		December 31, 2015
Accounts receivable	$	7,407	$	4,808
Prepaid expenses	3,734		7,101
Deferred reader costs	3,869		4,018
Inventory	14,695		11,864
Tenant improvement reimbursement receivable	1,189		1,788
Deferred hardware costs	2,839		1,709
Processing costs receivable	4,470		7,847
Other	6,041		2,312
Total	$	44,244	$	41,447

Accrued Expenses

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



	September 30, 2016		December 31, 2015
Accrued hardware costs	$	6,345	$	11,622
Processing costs payable	7,182		11,417
Accrued professional fees	4,247		7,642
Accrued payroll	6,712		2,660
Accrued marketing	7,147		2,443
Other accrued liabilities	10,310		8,617
Total	$	41,943	$	44,401

Other Current Liabilities

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



	September 30, 2016		December 31, 2015
Settlements payable	27,515		$	13,105
Employee early exercised stock options	924		2,141
Accrued redemptions	1,369		1,066
Current portion of deferred rent	2,750		2,393
Deferred revenue	5,303		6,623
Other	6,639		3,617
Total	$	44,500	$	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):



	September 30, 2016		December 31, 2015
Deposits	$	2,104	$	1,993
Deferred tax assets	301		188
Other	1,253		1,645
Total	$	3,658	$	3,826

Other Non-Current Liabilities

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



	September 30, 2016		December 31, 2015
Deferred rent	$	23,790	$	25,543
Employee early exercised stock options	201		1,128
Deferred tax liabilities	285		299
Statutory liabilities	27,554		25,492
Other	3,965		60
Total	$	55,795	$	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 $0.4 million in unused commitment fees during the three and nine months ended September 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 September 30,						Nine Months Ended September 30,
	2016			2015			2016			2015
Accrued transaction losses, beginning of the period	$	16,093		$	15,844		$	17,176		$	8,452
Provision for transaction losses	13,483			11,401			36,875			32,967
Charge-offs and recoveries to accrued transaction losses	(8,148		)	(11,241		)	(32,623		)	(25,415		)
Accrued transaction losses, end of the period	$	21,428		$	16,004		$	21,428		$	16,004

NOTE 13 - INCOME TAXES

The Company recorded an income tax expense of $0.2 million and $0.9 million for the three and nine months ended September 30, 2016, respectively, compared to income tax expense of $0.9 million and $2.5 million for the three and nine months ended September 30, 2015, respectively. The income tax expense recorded for the three and nine months ended September 30, 2016 was primarily due to state and foreign income tax expense.

The Company’s effective tax rate was approximately (0.7)% and (0.6)% for the three and nine months ended September 30, 2016, respectively, compared to an effective tax rate of (1.8)% and (1.9)% for the three and nine months ended September 30, 2015, respectively. The difference between the effective tax rate and the federal statutory tax rate for the three and nine months ended September 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 September 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 nine months ended September 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 September 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 September 30, 2016, there were 162,988,864 shares of Class A common stock and 188,328,922 shares of Class B common stock outstanding. Options and awards granted following the Company's Initial Public Offering are related to underlying Class A common stock. Additionally, Class B shareholders are able to convert their shares into Class A common stock.

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. Beginning November 17, 2015, no additional securities will be issued under 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 September 30, 2016, the total number of shares subject to stock options and RSUs outstanding under the 2015 Plan was 19,037,766, and 35,373,551 shares were available for future issuance. As of September 30, 2016, the total number of shares subject to stock options and RSUs outstanding under the 2009 Plan was 82,934,307.

A summary of stock option activity for the nine months ended September 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	1,767,320		13.49
Exercised	(13,559,723	)	3.02
Forfeited	(9,020,899	)	$	10.99
Balance as of September 30, 2016	86,702,252		7.32		7.40	418,923
Options vested and expected to vest as of
September 30, 2016	81,679,340		7.10		6.81	410,515
Options exercisable as of
September 30, 2016	82,443,845		7.15		7.31	411,791

Restricted Stock Activity

Activity related to RSUs during the nine months ended September 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	14,546,288		12.12
Vested	(1,780,873	)	12.48
Forfeited	(1,128,359	)	13.09
Unvested as of September 30, 2016	15,269,821		$	12.25

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 nine months ended September 30, 2016, share-based compensation expense included $0.6 million and $2.0 million, respectively, related to the vested portion of the impacted options, as a result of the modification. The Company will incur an additional $5.2 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 September 30,				Nine Months Ended September 30,
	2016		2015		2016		2015
Dividend yield	—	%	—	%	—	%	—	%
Risk-free interest rate	1.31	%	1.69	%	1.54	%	1.73	%
Expected volatility	43.51	%	44.56	%	42.74	%	47.91	%
Expected term (years)	6.08		5.86		6.08		6.06

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



	Three Months Ended September 30,				Nine Months Ended September 30,
	2016		2015		2016		2015
Product development	$	23,949	$	13,938	$	70,064	$	33,287
Sales and marketing	3,697		1,750		9,963		4,524
General and administrative	9,133		5,105		24,872		11,675
Total	$	36,779	$	20,793	$	104,899	$	49,486

On November 17, 2015, the Company’s 2015 Employee Stock Purchase Plan (ESPP) became effective. During the three and nine months ended September 30, 2016, the Company recorded $0.8 million and $3.8 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 nine months ended September 30, 2015.

The Company capitalized $1.2 million and $2.0 million of share-based compensation expense related to capitalized software during the three and nine months ended September 30, 2016, respectively. There was no similar activity during the three and nine months ended September 30, 2015.

As of September 30, 2016, there was $272.4 million of total unrecognized compensation cost related to outstanding stock options that is expected to be recognized over a weighted-average period of 2.95 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 September 30,						Nine Months Ended September 30,
	2016			2015			2016			2015
Net loss	$	(32,323	)	$	(53,930	)	$	(156,423	)	$	(131,528	)
Basic shares:
Weighted-average common shares outstanding	346,299			156,206			339,728			153,965
Weighted-average unvested shares	(2,406		)	(3,872		)	(3,135		)	(4,907		)
Weighted-average shares used to compute basic net loss per share	343,893			152,334			336,593			149,058
Diluted shares:
Weighted-average shares used to compute diluted loss per share	343,893			152,334			336,593			149,058
Net loss per share:
Basic	$	(0.09	)	$	(0.35	)	$	(0.46	)	$	(0.88	)
Diluted	$	(0.09	)	$	(0.35	)	$	(0.46	)	$	(0.88	)

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 Nine Months Ended September 30,
	2016	2015
Stock options and restricted stock units	101,972	106,234
Common stock warrants	9,458	9,457
Preferred stock warrants	—	87
Convertible preferred stock	—	135,253
Unvested shares	1,997	3,872
Employee stock purchase plan	637	—
Total anti-dilutive securities	114,064	254,903

NOTE 16 - OTHER INCOME AND EXPENSE, NET

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



	Three Months Ended September 30,				Nine Months Ended September 30,
	2016		2015		2016			2015
Net (gain) loss on foreign exchange	$	217	$	610	$	(789	)	$	1,324
Other	77		34		99			66
Total other (income) and expense, net	$	294	$	644	$	(690	)	$	1,390

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 $2.9 million and $8.4 million for the three and nine months ended September 30, 2016, respectively, compared to $3.1 million and $9.8 million for the three and nine months ended September 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 September 30, 2016 are as follows (in thousands):



	Capital			Operating
Year:
2016 (remaining 3 months)	$	116		$	4,017
2017	449			16,610
2018	406			16,386
2019	299			15,510
2020	—			15,590
Thereafter	—			51,631
Total	$	1,270		$	119,744
Less amount representing interest	(3		)
Present value of capital lease obligations	1,267
Less current portion of capital lease obligation	(458		)
Non-current portion of capital lease obligation	$	809

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.

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 United States District Court for 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 with the United States Court of Appeals for the Ninth Circuit. Mr. Levin filed his opening appellate brief regarding the order compelling arbitration of his individual claims on October 7, 2016. The Company’s answering brief is due November 7, 2016. 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, but this claim may instead be 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 September 30,				Nine Months Ended September 30,
	2016		2015		2016		2015
Revenue
United States	$	421,317	$	320,858	$	1,210,704	$	863,148
International	17,685		11,330		46,100		29,610
Total net revenue	$	439,002	$	332,188	$	1,256,804	$	892,758

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

Long-Lived Assets

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



	September 30, 2016		December 31, 2015
Long-lived assets
United States	$	164,152	$	168,583
International	2,756		2,114
Total long-lived assets	$	166,908	$	170,697

NOTE 19 - SUPPLEMENTAL CASH FLOW INFORMATION

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



	Nine Months Ended September 30,
	2016		2015
Supplemental Cash Flow Data:
Cash paid for interest	$	428	$	888
Cash paid for income taxes	321		1,798
Supplemental disclosures of non-cash investing and financing activities:
Change in purchases of property and equipment in accounts payable and accrued expenses	1,310		4,366
Fair value of shares issued related to acquisitions	—		27,456

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 simple, transparent pricing of 2.75%, or for card not present transactions 3.5% of the total transaction amount plus $0.15 per transaction, that enables sellers to receive all of the following: deposits in 1-2 business days; chargeback protection; payment dispute assistance; and full Payment Card Industry (PCI) compliance. In addition, with our point-of-sale (POS) app, Square Register, sellers can run their business from their mobile device: receive sales reporting and analytics; send digital receipts and receive customer feedback.

We continue to add advanced software services that tailor our POS solution to specific types of sellers, such as food-related, services, and retail businesses. These advanced services are possible because of our strength in payments technology, and we monetize them through transaction or service-specific fees. Build with Square, our developer platform (APIs), allows sellers to process payments with Square through their own fully customized point of sale, as well as on their own self-hosted website.

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 transition from offering merchant cash advances (MCAs) to offering business loans, which offer increased flexibility for sellers, and position the service for continued scalable growth.

For the three and nine months ended September 30, 2016, we processed $13.2 billion and $36.0 billion of GPV, up 39% and 41% from the three and nine months ended September 30, 2015, respectively. For the three and nine months ended September 30, 2016, our total net revenue grew to $439 million and $1,257 million, up 32% and 41% from the three and nine months ended September 30, 2015, respectively. For the three and nine months ended September 30, 2016, our Adjusted Revenue grew to $178 million and $495 million, up 51% and 56% from the three and nine months ended September 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 nine months ended September 30, 2016, we generated a net loss of $32.3 million and $156.4 million, respectively. For the three and nine months ended September 30, 2015, we generated a net loss of $53.9 million and $131.5 million, respectively.

Results of Operations

Revenue (in thousands, except for percentages)



	Three Months Ended September 30,									Nine Months Ended September 30,
	2016		2015		$ Change			% Change		2016		2015		$ Change			% Change
Transaction revenue	$	388,347	$	280,955	$	107,392		38	%	$	1,053,664	$	751,929	$	301,735		40	%
Starbucks transaction revenue	7,164		32,332		$	(25,168	)	(78	)%	$	78,869	$	95,199	$	(16,330	)	(17	)%
Software and data product revenue	35,320		14,694		$	20,626		140	%	$	88,833	$	35,628	$	53,205		149	%
Hardware revenue	8,171		4,207		$	3,964		94	%	$	35,438	$	10,002	$	25,436		254	%
Total net revenue	$	439,002	$	332,188	$	106,814		32	%	$	1,256,804	$	892,758	$	364,046		41	%

Total net revenue for the three and nine months ended September 30, 2016 increased by $106.8 million or 32% and $364.0 million or 41%, respectively, compared to the three and nine months ended September 30, 2015.

Transaction revenue for the three and nine months ended September 30, 2016 increased by $107.4 million or 38% and $301.7 million or 40%, respectively, compared to the three and nine months ended September 30, 2015. This increase was attributable to growth in GPV processed for the three and nine months ended September 30, 2016 of 39% and 41%, respectively, compared to the three and nine months ended September 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 88% and 84% of total net revenue in the three and nine months ended September 30, 2016, respectively, compared to 85% and 84% in the three and nine months ended September 30, 2015, respectively.

Starbucks transaction revenue for the three and nine months ended September 30, 2016 decreased by $25.2 million or 78% and $16.3 million or 17%, respectively, compared to the three and nine months ended September 30, 2015. Under our amended payment processing agreement, Starbucks agreed to pay increased processing rates to us for as long as it continues to process transactions with us. As of September 30, 2016, Starbucks has almost completed its previously announced transition to another payment processor. Starbucks transaction revenue contributed 2% and 6% of total net revenue in the three and nine months ended September 30, 2016, respectively, compared to 10% and 11% in the three and nine months ended September 30, 2015, respectively.

Software and data product revenue for the three and nine months ended September 30, 2016 increased by $20.6 million or 140% and $53.2 million or 149%, respectively, compared to the three and nine months ended September 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 nine months ended September 30, 2016, Square Capital and Caviar remained the largest contributors to software and data product revenue. Software and data product revenue contributed 8% and 7% of total net revenue in the three and nine months ended September 30, 2016, respectively, compared to 4% in both the three and nine months ended September 30, 2015.

Hardware revenue for the three and nine months ended September 30, 2016 increased by $4.0 million or 94% and $25.4 million or 254%, respectively, compared to the three and nine months ended September 30, 2015. During the three and nine months ended September 30, 2016, the increase primarily reflected 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. During the nine months ended September 30, 2016, we generated increased sales across all of our paid hardware products, including Square Stand and third-party peripherals. Hardware revenue contributed 2% and 3% of total net revenue in the three and nine months ended September 30, 2016, respectively, compared to 1% in both the three and nine months ended September 30, 2015.

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



	Three Months Ended September 30,									Nine Months Ended September 30,
	2016		2015		$ Change			% Change		2016		2015		$ Change			% Change
Transaction costs	$	254,061	$	182,007	$	72,054		40	%	$	683,194	$	479,937	$	203,257		42	%
Starbucks transaction costs	4,528		41,410		$	(36,882	)	(89	)%	$	69,810	$	118,542	$	(48,732	)	(41	)%
Software and data product costs	12,524		5,593		$	6,931		124	%	$	31,701	$	13,820	$	17,881		129	%
Hardware costs	15,689		5,726		$	9,963		174	%	$	56,444	$	16,636	$	39,808		239	%
Amortization of acquired technology	1,886		1,142		$	744		65	%	$	6,142	$	2,886	$	3,256		113	%
Total cost of revenue	$	288,688	$	235,878	$	52,810		22	%	$	847,291	$	631,821	$	215,470		34	%

Total cost of revenue for the three and nine months ended September 30, 2016 increased by $52.8 million or 22% and $215.5 million or 34%, respectively, compared to the three and nine months ended September 30, 2015.

Transaction costs for the three and nine months ended September 30, 2016 increased by $72.1 million or 40% and $203.3 million or 42%, respectively, compared to the three and nine months ended September 30, 2015. This increase was attributable to growth in GPV processed for the three and nine months ended September 30, 2016 of 39% and 41%, respectively, compared to the three and nine months ended September 30, 2015.

Starbucks transaction costs for the three and nine months ended September 30, 2016 decreased by $36.9 million or 89% and $48.7 million or 41%, respectively, compared to the three and nine months ended September 30, 2015. Starbucks' previously announced transition to another payment processor resulted in a reduction of Starbucks-related payment volume, offset by Starbucks' agreement to pay us increased processing rates. As a result, for the three and nine months ended September 30, 2016, we experienced a decline in Starbucks transaction costs as a percent of Starbucks transaction revenue, compared to the three and nine months ended September 30, 2015.

Software and data product costs for the three and nine months ended September 30, 2016 increased by $6.9 million or 124% and $17.9 million or 129%, respectively, compared to the three and nine months ended September 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 nine months ended September 30, 2016 increased by $10.0 million or 174% and $39.8 million or 239%, respectively, compared to the three and nine months ended September 30, 2015. For the three and nine months ended, 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. For the nine months ended September 30, 2016, the increase in hardware costs also reflects 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 nine months ended September 30, 2016, the increase in hardware costs outpaced the corresponding increase in hardware revenue primarily due to $1.1 million and $1.7 million in costs, respectively, associated with the write-off of inventory, with no similar activity for the three and nine months ended September 30, 2015. Additionally, for the three and nine months ended September 30, 2016, expenses related to inventory reserves and the revaluation of inventory increased by $0.7 million and $1.0 million compared to the three and nine months ended September 30, 2015, respectively, as a result of changes in standard costs and certain products approaching the end of their useful lives.

Amortization of acquired technology for the three and nine months ended September 30, 2016 increased by $0.7 million or 65% and $3.3 million or 113%, respectively, compared to the three and nine months ended September 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 September 30,											Nine Months Ended September 30,
	2016			2015			$ Change			% Change		2016			2015			$ Change			% Change
Product development	$	70,418		$	55,020		$	15,398		28	%	$	203,648		$	140,452		$	63,196		45	%
% of total net revenue	16		%	17		%						16		%	16		%
Sales and marketing	$	46,754		$	39,259		$	7,495		19	%	$	124,470		$	107,170		$	17,300		16	%
% of total net revenue	11		%	12		%						10		%	12		%
General and administrative	$	52,075		$	37,820		$	14,255		38	%	$	198,966		$	97,743		$	101,223		104	%
% of total net revenue	12		%	11		%						16		%	11		%
Transaction, loan and advance losses	$	12,885		$	16,005		$	(3,120	)	(19	)%	$	38,201		$	40,840		$	(2,639	)	(6	)%
% of total net revenue	3		%	5		%						3		%	5		%
Amortization of acquired customer assets	$	164		$	423		$	(259	)	(61	)%	$	703		$	1,373		$	(670	)	(49	)%
% of total net revenue	—		%	—		%						—		%	—		%
Total operating expenses	$	182,296		$	148,527		$	33,769		23	%	$	565,988		$	387,578		$	178,410		46	%

Product development expenses for the three and nine months ended September 30, 2016 increased by $15.4 million or 28% and $63.2 million or 45%, respectively, compared to the three and nine months ended September 30, 2015, due to the addition of engineering, design, and product personnel in the period from September 30, 2015 to September 30, 2016, combined with increased share-based compensation expense. For the three and nine months ended September 30, 2016, product development expenses included $23.9 million and $70.1 million, respectively, of share-based compensation expense, representing a $10.0 million and $36.8 million increase, respectively, compared to the three and nine months ended September 30, 2015.

Sales and marketing expenses for the three and nine months ended September 30, 2016 increased by $7.5 million or 19% and $17.3 million or 16%, respectively, compared to the three and nine months ended September 30, 2015, primarily due to an increase in sales and marketing personnel in the period from September 30, 2015 to September 30, 2016. Additionally, for the three and nine months ended September 30, 2016, there was an increase in costs associated with our Square Cash peer-to-peer transfer service compared to the three and nine months ended September 30, 2015. For the three and nine months ended September 30, 2016, sales and marketing expenses included $3.7 million and $10.0 million of share-based compensation expense, respectively, representing a $1.9 million and $5.4 million increase compared to the three and nine months ended September 30, 2015, respectively. For the three and nine months ended September 30, 2016, paid marketing expenditures were stable compared to the three and nine months ended September 30, 2015, respectively.

General and administrative expenses for the three and nine months ended September 30, 2016 increased by $14.3 million or 38% and $101.2 million or 104%, compared to the three and nine months ended September 30, 2015. For the nine months ended September 30, 2016, general and administrative expenses included $48.0 million of non-recurring expense related to the settlement of legal proceedings with Robert E. Morley, with no similar activity during the nine months ended September 30, 2015. For the three and nine months ended September 30, 2016, general and administrative expenses included $9.1 million and $24.9 million of share-based compensation expense, respectively, representing a $4.0 million and $13.2 million increase compared to the three and nine months ended September 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. This increase also includes incremental costs associated with our first year adoption efforts with regard to compliance with Sarbanes-Oxley Act of 2002.

Transaction, loan and advance losses for the three and nine months ended September 30, 2016 decreased by $3.1 million and $2.6 million compared to the three and nine months ended September 30, 2015, respectively. During the nine months ended September 30, 2016, we recorded an out of period adjustment 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 nine months ended September 30, 2015. However, during the nine months ended September 30, 2015, we accrued $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. Additionally, during both the three and nine months ended September 30, 2015, we recorded an increase of $4.1 million in our transaction loss provision to reflect updates to our risk model, with no similar activity during the three and nine months ended September 30, 2016. This was offset in part by an increase attributable to growth in GPV processed for the three and nine months ended September 30, 2016.

Amortization of acquired customer assets for the three and nine months ended September 30, 2016 decreased by $0.3 million and $0.7 million compared to the three and nine months ended September 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 September 30,										Nine Months Ended September 30,
	2016			2015		$ Change			% Change		2016			2015		$ Change			% Change
Interest (income) and expense, net	$	(183	)	$	137	$	(320	)	(234	)%	$	(243	)	$	995	$	(1,238	)	(124	)%
Other (income) and expense, net	294			644		$	(350	)	(54	)%	$	(690	)	$	1,390	$	(2,080	)	(150	)%

Interest (income) and expense, net, for the three and nine months ended September 30, 2016 changed by $0.3 million and $1.2 million compared to the three and nine months ended September 30, 2015, respectively, primarily driven by interest income earned on our investment in marketable securities offsetting interest expense.

Other (income) and expense, net, for the three and nine months ended September 30, 2016 changed by $0.4 million and $2.1 million compared to the three and nine months ended September 30, 2015, respectively, driven primarily by fluctuations in foreign exchange rates.

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



	Three Months Ended September 30,											Nine Months Ended September 30,
	2016			2015			$ Change			% Change		2016			2015			$ Change			% Change
Provision for income taxes	$	230		$	932		$	(702	)	(75	)%	$	881		$	2,502		$	(1,621	)	(65	)%
Effective tax rate	(0.7		)%	(1.8		)%						(0.6		)%	(1.9		)%

Provision for income taxes for the three and nine months ended September 30, 2016 decreased by $0.7 million and $1.6 million compared to the three and nine months ended September 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, 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. As of September 30, 2016, Starbucks has almost completed its previously announced transition to another payment processor. 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, 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
September 30,

Nine Months Ended
September 30,

2016

2015

$ Change

% Change

2016

2015

$ Change

% Change

(in thousands, except GPV)