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, 2017



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, a smaller reporting company, or an emerging growth company. See definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company,” and “emerging growth company” in Rule 12b-2 of the Exchange Act.

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

If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. 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 28, 2017, the number of shares of the registrant’s Class A common stock outstanding was 251,876,547 and the number of shares of the registrant’s Class B common stock outstanding was 131,821,806.

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	26
Item 3. Quantitative and Qualitative Disclosures About Market Risk	38
Item 4. Controls and Procedures	38
PART II—Other Information
Item 1. Legal Proceedings	40
Item 1A. Risk Factors	40
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds	60
Item 3. Defaults Upon Senior Securities	60
Item 4. Mine Safety Disclosures	60
Item 5. Other Information	60
Item 6. Exhibits	61
Signatures	62

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 invest in and develop our products and services to operate with changing technology, our anticipated expansion and growth in Gross Payment Volume (GPV) and revenue, our plans for international expansion, our plans with respect to patents and other intellectual property, our expectations regarding litigation, our expectation regarding future revenue from Starbucks, 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, 2017			December 31, 2016
Assets
Current assets:
Cash and cash equivalents	$	716,989		$	452,030
Short-term investments	203,287			59,901
Restricted cash	22,147			22,131
Settlements receivable	309,021			321,102
Customer funds	73,596			43,574
Loans held for sale	50,079			42,144
Other current assets	62,798			60,543
Total current assets	1,437,917			1,001,425
Property and equipment, net	87,442			88,328
Goodwill	57,961			57,173
Acquired intangible assets, net	16,452			19,292
Long-term investments	124,099			27,366
Restricted cash	14,565			14,584
Other assets	3,278			3,194
Total assets	$	1,741,714		$	1,211,362
Liabilities and Stockholders’ Equity
Current liabilities:
Accounts payable	$	11,375		$	12,602
Customers payable	465,926			431,632
Settlements payable	41,834			51,151
Accrued transaction losses	22,455			20,064
Accrued expenses	56,699			39,543
Other current liabilities	26,639			22,472
Total current liabilities	624,928			577,464
Long-term debt (Note 10)	349,960			—
Other liabilities	63,082			57,745
Total liabilities	1,037,970			635,209
Commitments and contingencies (Note 15)
Stockholders’ equity:
Preferred stock, $0.0000001 par value: 100,000,000 shares authorized at June 30, 2017 and December 31, 2016. None issued and outstanding at June 30, 2017 and December 31, 2016.	—			—
Class A common stock, $0.0000001 par value: 1,000,000,000 shares authorized at June 30, 2017 and December 31, 2016; 250,974,736 and 198,746,620 issued and outstanding at June 30, 2017 and December 31, 2016, respectively.	—			—
Class B common stock, $0.0000001 par value: 500,000,000 shares authorized at June 30, 2017 and December 31, 2016; 131,645,329 and 165,800,756 issued and outstanding at June 30, 2017 and December 31, 2016, respectively.	—			—
Additional paid-in capital	1,515,237			1,357,381
Accumulated deficit	(810,974		)	(779,239		)
Accumulated other comprehensive loss	(519		)	(1,989		)
Total stockholders’ equity	703,744			576,153
Total liabilities and stockholders’ equity	$	1,741,714		$	1,211,362

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,
	2017			2016			2017			2016
Revenue:
Transaction-based revenue	$	482,065		$	364,864		$	885,543		$	665,317
Starbucks transaction-based revenue	—			32,867			—			71,705
Subscription and services-based revenue	59,151			29,717			108,211			53,513
Hardware revenue	10,289			11,085			19,305			27,267
Total net revenue	551,505			438,533			1,013,059			817,802
Cost of revenue:
Transaction-based costs	311,092			234,857			568,870			429,133
Starbucks transaction-based costs	—			28,672			—			65,282
Subscription and services-based costs	17,116			10,144			32,992			19,177
Hardware costs	14,173			14,015			26,835			40,755
Amortization of acquired technology	1,695			1,886			3,502			4,256
Total cost of revenue	344,076			289,574			632,199			558,603
Gross profit	207,429			148,959			380,860			259,199
Operating expenses:
Product development	78,126			68,638			146,708			133,230
Sales and marketing	59,916			39,220			109,816			77,716
General and administrative	62,988			50,784			119,923			146,891
Transaction, loan and advance losses	18,401			17,455			30,292			25,316
Amortization of acquired customer assets	222			222			427			539
Total operating expenses	219,653			176,319			407,166			383,692
Operating loss	(12,224		)	(27,360		)	(26,306		)	(124,493		)
Interest and other (income) expense, net	3,266			(327		)	3,765			(1,044		)
Loss before income tax	(15,490		)	(27,033		)	(30,071		)	(123,449		)
Provision for income taxes	472			312			981			651
Net loss	$	(15,962	)	$	(27,345	)	$	(31,052	)	$	(124,100	)
Net loss per share:
Basic	$	(0.04	)	$	(0.08	)	$	(0.08	)	$	(0.37	)
Diluted	$	(0.04	)	$	(0.08	)	$	(0.08	)	$	(0.37	)
Weighted-average shares used to compute net loss per share
Basic	376,357			334,488			371,573			332,906
Diluted	376,357			334,488			371,573			332,906

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,
	2017			2016			2017			2016
Net loss	$	(15,962	)	$	(27,345	)	$	(31,052	)	$	(124,100	)
Net foreign currency translation adjustments	430			85			1,187			595
Net unrealized gain (loss) on revaluation of intercompany loans	432			329			$	403		$	582
Net unrealized gain (loss) on marketable securities	(139		)	4			(120		)	80
Total comprehensive loss	$	(15,239	)	$	(26,927	)	$	(29,582	)	$	(122,843	)

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,
	2017			2016
Cash flows from operating activities:
Net loss	$	(31,052	)	$	(124,100	)
Adjustments to reconcile net loss to net cash provided by (used in) operating activities:
Depreciation and amortization	18,562			18,136
Non-cash interest and other expense	5,680			131
Share-based compensation	71,263			68,120
Transaction, loan and advance losses	30,292			25,316
Deferred provision for income taxes	99			63
Changes in operating assets and liabilities:
Settlements receivable	8,934			(64,186		)
Customer funds	(30,022		)	3,233
Purchase of loans held for sale	(570,819		)	(212,727		)
Sales and principal payments of loans held for sale	560,209			183,748
Other current assets	(2,201		)	7,985
Other assets	(110		)	(377		)
Accounts payable	143			2,538
Customers payable	34,149			84,826
Settlements payable	(9,317		)	(10,579		)
Charge-offs to accrued transaction losses	(22,243		)	(24,475		)
Accrued expenses	17,000			(13,784		)
Other current liabilities	4,327			24,025
Other noncurrent liabilities	5,696			(431		)
Net cash provided by (used in) operating activities	90,590			(32,538		)
Cash flows from investing activities:
Purchase of marketable securities	(314,055		)	(102,245		)
Proceeds from maturities of marketable securities	52,064			16,768
Proceeds from sale of marketable securities	21,730			4,964
Purchase of property and equipment	(13,883		)	(15,840		)
Payment for acquisition of intangible assets	—			(400		)
Business acquisitions	(1,600		)	—
Net cash used in investing activities	(255,744		)	(96,753		)
Cash flows from financing activities:
Proceeds from issuance of convertible senior notes, net	428,250			—
Purchase of convertible senior note hedges	(92,136		)	—
Proceeds from issuance of warrants	57,244			—
Payment for termination of Starbucks warrant	(54,808		)	—
Principal payments on capital lease obligation	(634		)	—
Payments of offering costs related to initial public offering	—			(5,530		)
Proceeds from the exercise of stock options and purchases under the employee stock purchase plan, net	89,863			15,496
Net cash provided by financing activities	427,779			9,966
Effect of foreign exchange rate changes on cash and cash equivalents	2,331			2,672
Net increase (decrease) in cash, cash equivalents and restricted cash	264,956			(116,653		)
Cash, cash equivalents and restricted cash, beginning of period	488,745			489,552
Cash, cash equivalents and restricted cash, end of period	$	753,701		$	372,899

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 start, run, and grow their businesses. Square enables sellers to accept card payments and also provides reporting and analytics, next-day settlement, and chargeback protection. Square’s point-of-sale software and other business services help sellers manage inventory, locations, and employees; access financing; engage customers; and grow sales. Square Cash is an easy way for businesses and individuals to send and receive money, and Caviar is a food ordering service for restaurants. Square was founded in 2009 and is headquartered in San Francisco, with offices in the United States, Canada, Japan, Australia, Ireland, and the United Kingdom.

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, 2016 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 six months ended June 30, 2017 are not necessarily indicative of the results that may be expected for the year ending December 31, 2017, 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, 2016.

Reclassifications and other adjustments

As a result of the Company’s adoption of Accounting Standards Update (ASU) No. 2016-18, Restricted Cash, on January 1, 2017, the Company reclassified changes in restricted cash balances from investing activities in the statement of cash flows to changes in cash, cash equivalents and restricted cash. For the six months ended June 30, 2016, $8.5 million was reclassified from cash outflows from investing activities to changes in cash, cash equivalents and restricted cash.

The presentation of changes in customer funds in the statement of cash flows for the six months ended June 30, 2016 has also been revised for the correction of an immaterial error that was identified during the fourth quarter of 2016 whereby the Company had previously misclassified and reported certain customer funds as cash and cash equivalents rather than classifying these customer funds as a component of current assets impacting operating activities. The effect of the revision was to decrease the amount of net cash used in operating activities for the six months ended June 30, 2016 by $3.2 million and increase cash and cash equivalents as of June 30, 2016 by that same amount. Net cash provided by operating activities for the year ended December 31, 2016 and cash and cash equivalents as of December 31, 2016 were not misstated.

The Company has reclassified certain prior period balances to conform to the current period presentation. In particular the Company has combined the Customer funds obligation and Customers payable into a single caption called Customer payable on the consolidated balance sheet. This classification change was made because both accounts reflect customer amounts that are held by Square that are obligations to the customer.

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, valuation of the debt component of convertible senior notes, valuation of loans held for sale, goodwill and intangible assets, income and other taxes, and share-based compensation.

Concentration of Credit Risk

For the three and six months ended June 30, 2017, the Company had no customer that accounted for greater than 10% of total net revenue. For the three and six months ended June 30, 2016, the Company had no customer other than Starbucks that accounted for greater than 10% of total net revenue. During the fourth quarter of 2016, Starbucks completed its previously announced transition to another payments solution provider. Accordingly, the Company does not expect transaction-based revenue from Starbucks in the future.

The Company had three third-party processors that represented approximately 44%, 42%, and 10% of settlements receivable as of June 30, 2017. The same three parties represented approximately 52%, 35%, and 10% of settlements receivable as of December 31, 2016.

Financial instruments that potentially subject the Company to concentrations of credit risk consist primarily of cash and cash equivalents, restricted cash, marketable securities, settlements receivables, customer funds, and loans held for sale. The associated risk of concentration for cash and cash equivalents and restricted cash is mitigated by banking with creditworthy institutions. At certain times, amounts on deposit exceed federal deposit insurance limits. The associated risk of concentration for marketable securities is mitigated by holding a diversified portfolio of highly rated investments. Settlements receivable are amounts due from well-established payment processing companies and normally take one or two business days to settle which mitigates the associated risk of concentration. The associated risk of concentration for loans held for sale is partially mitigated by credit evaluations that are performed prior to facilitating the offering of loans and ongoing performance monitoring of the Company’s loan customers.

Significant Accounting Policies

Except for the adoption of ASU 2016-18, Restricted Cash, described above, there have been no material changes to the Company’s significant accounting policies during the six months ended June 30, 2017, as compared to the significant accounting policies described in the Company’s Annual Report on Form 10-K for the year ended December 31, 2016.

Recent Accounting Pronouncements

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, ASU 2016-12, and ASU 2016-20. 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 Company does not plan to early adopt the guidance. The guidance can be adopted either through the full retrospective approach which requires restatement of all periods presented or through a modified retrospective approach which requires a cumulative effect adjustment as of the date of adoption. The modified retrospective approach also requires additional disclosures, during the year of adoption, of the impact of the new guidance to each of the financial statements line items and qualitative explanation of the significant changes between the reported results under the new revenue guidance and the previous revenue guidance. The Company plans to apply the modified retrospective approach in the year of adoption of this guidance and is currently assessing the impact that the adoption of the guidance will have on the consolidated financial statements and

related disclosures. The Company is also assessing any financial reporting system changes that would be necessary to implement the new guidance.

In July 2015, the FASB issued ASU No. 2015-11, Simplifying the Measurement of Inventory, as part of its simplification initiative. The current guidance requires an entity to measure inventory at the lower of cost or market. Market could be replacement cost, net realizable value, or net realizable value less a normal profit margin. Under the new guidance, inventory is measured at the lower of cost and net realizable value, which would eliminate the other two options that currently exist for market replacement cost and net realizable value less a normal profit margin. The amendment 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 adopted this new guidance on January 1, 2017, and it did not have any effect on the consolidated financial statements and related disclosures.

In January 2016, the FASB issued ASU No. 2016-01, Recognition and Measurement of Financial Assets and Financial Liabilities. This guidance is intended to improve the recognition, measurement, presentation, and disclosure of financial instruments. 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 with certain restrictions. The Company is currently evaluating the impact this new guidance may have on the consolidated financial statements and related disclosures.

In February 2016, the FASB issued ASU No. 2016-02, Leases, which will require, among other items, lessees to recognize most leases as assets and liabilities on the balance sheet. Qualitative and quantitative disclosures will be enhanced to better understand the amount, timing and uncertainty of cash flows arising from leases. This guidance is effective for financial statements issued for fiscal years beginning after December 15, 2018, and interim periods within those fiscal years, with early adoption permitted. The Company does not plan to early adopt this guidance. The Company’s operating leases primarily comprise of office spaces, with the most significant leases relating to corporate headquarters in San Francisco and an office in New York. Based on the Company's initial assessment of its current leases and potential, the Company does not anticipate the adoption of this guidance to have a material impact on its operating results. The Company will continue to evaluate the impact of recording right to use assets and related liabilities on its consolidated balance sheets.

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 adopted this new guidance on January 1, 2017. As part of the adoption, the Company elected to account for forfeitures as they occur. As this guidance requires a modified retrospective approach when eliminating the forfeiture rate, the Company recorded an adjustment of $0.7 million to increase accumulated deficit and additional paid-in capital as of January 1, 2017. With respect to classification of excess tax benefits on the Statement of Cash Flows, the Company has elected to apply this guidance on a prospective basis. Thus, the prior periods have not been adjusted. The remaining areas of simplification in this guidance did not have an impact 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 and related disclosures.

In August 2016, the FASB issued ASU No. 2016-15, Classification of Certain Cash Receipts and Cash Payments. This guidance addresses several cash flow issues with the objective of reducing the existing diversity in practice. Specific issues addressed in this guidance include, but are not limited to, debt prepayment or extinguishment costs, contingent consideration payments made after a business combination and application of the predominance principle. 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 amendments should be applied retrospectively. The Company does not expect the adoption of this new guidance to have a material impact on the consolidated financial statements and related disclosures.

In October 2016, the FASB issued ASU No. 2016-16, Intra-Entity Transfers of Assets Other Than Inventory, which amends existing guidance on the recognition of current and deferred income tax impacts for intra-entity asset transfers other than inventory. The current guidance requires companies to defer the income tax effects of intercompany transfers of all assets, until the asset has been sold to an outside party whereas the new guidance will not allow the deferral of income tax effects of

intercompany transfers of assets except for inventory. This standard is effective for annual periods beginning after December 15, 2017, and interim periods within those fiscal years, with early adoption permitted. The amendments in this guidance should be applied on a modified retrospective basis through a cumulative-effect adjustment directly to retained earnings as of the beginning of the period of adoption. The Company is currently evaluating the impact this new guidance may have on the consolidated financial statements and related disclosures.

In November 2016, the FASB issued ASU No. 2016-18, Restricted Cash, which provides guidance on the classification of restricted cash to be included with cash and cash equivalents when reconciling the beginning of period and end of period total amounts on the statement of cash flows. This standard is effective for annual periods beginning after December 15, 2017, and interim periods within those fiscal years, with early adoption permitted. The Company early adopted this guidance on January 1, 2017, and adjusted its condensed consolidated statements of cash flow for each of the periods presented.

In January 2017, the FASB issued ASU No. 2017-01, Clarifying the Definition of a Business. The amendment seeks to clarify the definition of a business with the objective of adding guidance to assist entities with evaluating whether transactions should be accounted for as acquisitions (or disposals) of assets or businesses. The definition of a business affects many areas of accounting including acquisitions, disposals, goodwill, intangible assets and consolidation. This standard is effective for annual periods beginning after December 15, 2017, and interim periods within those fiscal years, with early adoption permitted. The amendments should be applied prospectively on or after the effective dates. The Company is currently evaluating the impact this new guidance may have on the consolidated financial statements and related disclosures.

In January 2017, the FASB issued ASU No. 2017-04, Simplifying the Test for Goodwill Impairment. This guidance modified the concept of impairment assessment from the condition that exists when the carrying amount of goodwill exceeds its implied fair value to the condition that exists when the carrying amount of a reporting unit exceeds its fair value. This standard should be adopted when the Company performs its annual or any interim goodwill impairment tests in fiscal years beginning after December 15, 2019, with early adoption permitted. The amendments should be applied on a prospective basis. The Company does not expect the adoption of this guidance to have a material the impact on the consolidated financial statements and related disclosures.

In March 2017, the FASB issued ASU No. 2017-08, Premium Amortization on Purchased Callable Debt Securities, which amends the amortization period for certain purchased callable debt securities held at a premium, shortening such period to the earliest call date. This standard is effective for annual periods beginning after December 15, 2018, and interim periods within those fiscal years, with early adoption permitted. The amendments in this guidance should be applied on a modified retrospective basis through a cumulative-effect adjustment directly to retained earnings as of the beginning of the period of adoption. The Company is currently evaluating the impact this new guidance may have on the consolidated financial statements and related disclosures.

In May 2017, the FASB issued ASU No. 2017-09, Scope of Modification Accounting, which clarifies when to account for a change to the terms or conditions of a share-based payment award as a modification. This standard is effective for annual periods beginning after December 15, 2017, and interim periods within those fiscal years, with early adoption permitted. The amendments should be applied on a prospective basis. The Company is currently evaluating the impact this new guidance may have on the consolidated financial statements and related disclosures.

NOTE 2 - RESTRICTED CASH

As of both June 30, 2017 and December 31, 2016, restricted cash of $22.1 million is related to pledged cash deposited into savings accounts at the financial institutions that process the Company's sellers' payment transactions and as collateral pursuant to an agreement with the originating bank for the Company's loan product. The Company uses the restricted cash to secure letters of credit with the financial institution to provide collateral for cash flow timing differences in the processing of these payments and loans. 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 both June 30, 2017 and December 31, 2016, the remaining restricted cash of $14.6 million 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 15). The Company has recorded this amount as a non-current asset on the condensed consolidated balance sheets as the terms of the related leases 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, 2017						December 31, 2016
	Level 1		Level 2		Level 3		Level 1		Level 2		Level 3
Cash and Cash Equivalents:
Money market funds	$	333,693	$	—	$	—	$	207,168	$	—	$	—
U.S. agency securities	—		7,498		—		—		—		—
Commercial paper	—		15,740		—		—		7,496		—
U.S. government securities	—		—		—		—		—		—
Corporate bonds	—		—		—		—		—		—
Municipal securities	—		—		—		—		1,000		—
Short-term securities:
U.S. agency securities	—		15,584		—		—		9,055		—
Corporate bonds	—		48,404		—		—		6,980		—
Commercial paper	—		54,285		—		—		17,298		—
Municipal securities	—		17,655		—		—		8,028		—
U.S. government securities	67,359		—		—		18,540		—		—
Long-term securities:
U.S. agency securities	—		15,023		—		—		3,502		—
Corporate bonds	—		53,253		—		—		12,914		—
Municipal securities	—		18,961		—		—		2,492		—
U.S. government securities	36,862		—		—		8,458		—		—
Total	$	437,914	$	246,403	$	—	$	234,166	$	68,765	$	—

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

The Company estimates the fair value of its convertible senior notes based on their last actively traded prices (Level 1) or market observable inputs (Level 2). The estimated fair value and carrying value of the convertible senior notes were as follows (in thousands):



	June 30, 2017
	Carrying Value		Fair Value (Level 2)
Convertible senior notes	$	349,960	$	539,062
Total	$	349,960	$	539,062

Loans held for sale 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, applied to the loans held for sale, 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, 2017				December 31, 2016
	Carrying Value		Fair Value (Level 3)		Carrying Value		Fair Value (Level 3)
Loans held for sale	$	50,079	$	52,266	$	42,144	$	42,633
Total	$	50,079	$	52,266	$	42,144	$	42,633

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, 2017 and 2016, 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, 2017 are as follows (in thousands):



	Amortized Cost		Gross Unrealized Gains		Gross Unrealized Losses			Fair Value
Short-term securities:
U.S. agency securities	$	15,593	$	1	$	(10	)	$	15,584
Corporate bonds	48,397		29		(22		)	48,404
Commercial paper	54,285		—		—			54,285
Municipal securities	17,668		8		(21		)	17,655
U.S. government securities	67,388		2		(31		)	67,359
Total	$	203,331	$	40	$	(84	)	$	203,287

Long-term securities:
U.S. agency securities	$	15,028	$	3	$	(8	)	$	15,023
Corporate bonds	53,282		20		(49		)	53,253
Municipal securities	18,973		6		(18		)	18,961
U.S. government securities	36,911		6		(55		)	36,862
Total	$	124,194	$	35	$	(130	)	$	124,099

The Company's short-term and long-term investments as of December 31, 2016 are as follows (in thousands):



	Amortized Cost		Gross Unrealized Gains		Gross Unrealized Losses			Fair Value
Short-term securities:
U.S. agency securities	$	9,048	$	7	$	—		$	9,055
Corporate bonds	17,318		—		(20		)	17,298
Commercial paper	6,980		—		—			6,980
Municipal securities	8,037		—		(9		)	8,028
U.S. government securities	18,537		3		—			18,540
Total	$	59,920	$	10	$	(29	)	$	59,901

Long-term securities:
U.S. agency securities	$	3,502	$	—	$	—		$	3,502
Corporate bonds	12,939		—		(25		)	12,914
Municipal securities	2,505		—		(13		)	2,492
U.S. government securities	8,478		—		(20		)	8,458
Total	$	27,424	$	—	$	(58	)	$	27,366

For the periods presented, gains or losses realized on the sale of investments were not material. 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 for any of the periods presented.

The contractual maturities of the Company's short-term and long-term investments as of June 30, 2017 are as follows (in thousands):



	Amortized Cost		Fair Value
Due in one year or less	$	203,331	$	203,287
Due in one to five years	124,194		124,099
Total	$	327,525	$	327,386

NOTE 5 - 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, 2017			December 31, 2016
Leasehold improvements	$	74,138		$	73,366
Computer equipment	60,041			52,915
Capitalized software	28,475			24,642
Office furniture and equipment	12,509			10,737
Total	175,163			161,660
Less: Accumulated depreciation and amortization	(87,721		)	(73,332		)
Property and equipment, net	$	87,442		$	88,328

Depreciation and amortization expense on property and equipment was $7.2 million and $14.5 million for the three and six months ended June 30, 2017, respectively. 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.

NOTE 6 - 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 June 30, 2017 and December 31, 2016, goodwill was $58.0 million and $57.2 million, respectively.

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 7 - ACQUIRED INTANGIBLE ASSETS

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



	Balance at June 30, 2017
	Cost		Accumulated Amortization			Net
Patents	$	1,285	$	(506	)	$	779
Technology Assets	29,158		(18,287		)	10,871
Customer Assets	8,886		(4,084		)	4,802
Total	$	39,329	$	(22,877	)	$	16,452



	Balance at December 31, 2016
	Cost		Accumulated Amortization			Net
Patents	$	1,285	$	(454	)	$	831
Technology Assets	29,075		(14,702		)	14,373
Customer Assets	7,745		(3,657		)	4,088
Total	$	38,105	$	(18,813	)	$	19,292

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

Amortization expense associated with other intangible assets was $1.9 million and $4.1 million for the three and six months ended June 30, 2017, 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.

The total estimated annual future amortization expense of these intangible assets as of June 30, 2017 is as follows (in thousands):



2017 (remaining 6 months)	$	3,538
2018	6,037
2019	3,253
2020	1,296
2021	759
Thereafter	1,569
Total	$	16,452

NOTE 8 - OTHER CONSOLIDATED BALANCE SHEET COMPONENTS (CURRENT)

Other Current Assets

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



	June 30, 2017		December 31, 2016
Inventory, net	$	18,457	$	13,724
Prepaid expenses	10,216		7,365
Accounts receivable, net	8,104		6,191
Processing costs receivable	7,514		8,593
Deferred hardware costs	5,458		4,546
Deferred magstripe reader costs	2,681		3,911
Merchant cash advance receivable, net	885		4,212
Tenant improvement reimbursement receivable	213		1,189
Other	9,270		10,812
Total	$	62,798	$	60,543

Accrued Expenses

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



	June 30, 2017		December 31, 2016
Accrued marketing	$	9,406	$	3,972
Accrued payroll	8,469		5,799
Processing costs payable	7,170		9,655
Accrued professional fees	7,151		5,788
Accrued hardware costs	5,873		3,148
Other accrued liabilities	18,630		11,181
Total	$	56,699	$	39,543

Other Current Liabilities

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



	June 30, 2017		December 31, 2016
Square Payroll payable	$	9,158	$	4,769
Deferred revenue	4,523		5,407
Current portion of deferred rent	2,944		2,862
Accrued redemptions	1,794		1,628
Other	8,220		7,806
Total	$	26,639	$	22,472

NOTE 9 - OTHER CONSOLIDATED BALANCE SHEET COMPONENTS (NON-CURRENT)

Other Non-Current Liabilities

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



	June 30, 2017		December 31, 2016
Statutory liabilities	$	34,736	$	29,497
Deferred rent	21,770		23,119
Deferred tax liabilities	476		476
Other	6,100		4,653
Total	$	63,082	$	57,745

NOTE 10 - INDEBTEDNESS

Revolving Credit Facility

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, 2017 and 2016, respectively. As of June 30, 2017, the Company was in compliance with all financial covenants associated with this credit facility.

Convertible Senior Notes

On March 6, 2017, the Company issued an aggregate principal amount of $400.0 million of convertible senior notes (Notes) and an additional 10% or $40.0 million pursuant to the exercise in full of the option to the initial purchasers to cover over-allotments. The Notes mature on March 1, 2022, unless earlier converted or repurchased, and bear interest at a rate of 0.375% payable semi-annually on March 1 and September 1 of each year. The Notes are convertible at an initial conversion rate of 43.5749 shares of the Company's Class A common stock per $1,000 principal amount of Notes, which is equivalent to an initial conversion price of approximately $22.95 per share of Class A common stock. Holders may convert their Notes at any time prior to the close of business on the business day immediately preceding December 1, 2021 only under the following circumstances: (1) during any calendar quarter commencing after the calendar quarter ending on June 30, 2017 (and only during such calendar quarter), if the last reported sale price of the Company’s Class A common stock for at least 20 trading days (whether or not consecutive) during a period of 30 consecutive trading days ending on the last trading day of the immediately preceding calendar quarter is greater than or equal to 130% of the conversion price on each applicable trading day; (2) during the five business day period after any five consecutive trading day period (the measurement period) in which the trading price (as defined in the indenture governing the Notes) per $1,000 principal amount of Notes for each trading day of the measurement period was less than 98% of the product of the last reported sale price of the Company’s Class A common stock and the conversion rate on each such trading day; or (3) upon the occurrence of specified corporate events, including certain distributions, the occurrence of a fundamental change (as defined in the Indenture governing the Notes) or a transaction resulting in the Company’s Class A common stock converting into other securities or property or assets. On or after December 1, 2021, up until the close of business on the second scheduled trading day immediately preceding the maturity date, a holder may convert all or any portion of its Notes regardless of the foregoing circumstances. Upon conversion, the Company will pay or deliver, as the case may be, cash, shares of its Class A common stock, or a combination of cash and shares of its Class A common stock, at the Company’s election. It is the Company’s current intent and policy to settle conversions through combination settlement with a specified dollar amount of $1,000 per $1,000 principal amount of notes.

In accounting for the issuance of the Notes, the Company separated the Notes into liability and equity components. The carrying amount of the liability component was calculated by measuring the fair value of a similar debt instrument that does not have an associated convertible feature. The carrying amount of the equity component representing the conversion option was $86.2 million and was determined by deducting the fair value of the liability component from the par value of the Notes. The equity component is not remeasured as long as it continues to meet the conditions for equity classification. The excess of the principal amount of the liability component over its carrying amount ("debt discount") is amortized to interest expense over the term of the Notes at an effective interest rate of 5.34% over the contractual terms of the Notes.

Debt issuance costs related to the Notes comprised of discounts and commissions payable to the initial purchasers of $11.0 million and third party offering costs of $0.8 million. The Company allocated the total amount incurred to the liability and equity components of the Notes based on their relative values. Issuance costs attributable to the liability component were $9.4 million and will be amortized to interest expense using the effective interest method over the contractual term. Issuance costs attributable to the equity component were netted with the equity component in stockholders’ equity.

The Notes consisted of the following (in thousands):



	June 30, 2017
Principal	$	440,000
Less: unamortized debt discount	(81,146		)
Less: unamortized debt issuance costs	(8,894		)
Net carrying amount	$	349,960

The net carrying amount of the equity component of the Notes was as follows (in thousands):



	June 30, 2017
Debt discount related to value of conversion option	$	86,203
Less: allocated debt issuance costs	(2,302		)
Equity component, net	$	83,901

The Company recognized interest expense on the Notes as follows (in thousands, except for percentages):



	Three Months Ended			Six Months Ended
	June 30,			June 30,
	2017			2017
Contractual interest expense based on 0.375% per annum	$	413		$	526
Amortization of debt discount and issuance costs	4,221			5,611
Total	$	4,634		$	6,137
Effective interest rate of the liability component	5.34		%	5.34		%

Convertible Note Hedge and Warrant Transactions

In connection with the offering of the Notes, the Company entered into convertible note hedge transactions with certain financial institutions (Counterparties) whereby the Company has the option to purchase a total of approximately 19.2 million shares of its Class A common stock at a price of approximately $22.95 per share. The total cost of the convertible note hedge transactions was $92.1 million. In addition, the Company sold warrants to the Counterparties whereby the Counterparties have the option to purchase a total of approximately 19.2 million shares of the Company’s Class A common stock at a price of

approximately $31.18 per share. The Company received $57.2 million in cash proceeds from the sale of these warrants. Taken together, the purchase of the convertible note hedges and sale of the warrants are intended to offset any actual dilution from the conversion of the Notes and to effectively increase the overall conversion price from approximately $22.95 per share to approximately $31.18 per share. As these instruments are considered indexed to the Company's own stock and are considered equity classified, the convertible note hedges and warrants are recorded in stockholders’ equity, are not accounted for as derivatives and are not remeasured each reporting period. The net costs incurred in connection with the convertible note hedge and warrant transactions were recorded as a reduction to additional paid-in capital on the condensed consolidated balance sheets.

NOTE 11 - ACCRUED TRANSACTION LOSSES

The Company is exposed to transaction losses due to chargebacks as a result of fraud or uncollectibility.

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,
	2017			2016			2017			2016
Accrued transaction losses, beginning of the period	$	20,444		$	15,419		$	20,064		$	17,176
Provision for transaction losses	13,076			16,210			24,634			23,392
Charge-offs to accrued transaction losses	(11,065		)	(15,536		)	(22,243		)	(24,475		)
Accrued transaction losses, end of the period	$	22,455		$	16,093		$	22,455		$	16,093

NOTE 12 - INCOME TAXES

The Company recorded an income tax expense of $0.5 million and $1.0 million for the three and six months ended June 30, 2017, respectively, compared to income tax expense of $0.3 million and $0.7 million for the three and six months ended June 30, 2016, respectively. The income tax expense recorded for the three and six months ended June 30, 2017 and June 30, 2016 was primarily due to state and foreign income tax expense.

The Company’s effective tax rate was (3.0)% and (3.3)% for the three and six months ended June 30, 2017, respectively, compared to an effective tax rate of (1.2)% and (0.5)% for the three and six months ended June 30, 2016, respectively. The difference between the effective tax rate and the federal statutory tax rate for the three and six months ended June 30, 2017 and 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, 2017, 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, 2017 and 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 13 - STOCKHOLDERS’ EQUITY

The changes in total stockholders’ equity were as follows (in thousands):



	Total stockholders’ equity
Balance at December 31, 2016	$	576,153
Net loss	(31,052		)
Exercise of stock options	82,225
Purchases under the employee stock purchase plan	7,767
Vesting of early exercised stock options and other	488
Conversion feature of convertible senior notes, due 2022, net of allocated debt issuance costs	83,901
Purchase of bond hedges in conjunction with issuance of convertible senior notes, due 2022	(92,136		)
Sale of warrants in conjunction with issuance of convertible senior notes, due 2022	57,244
Payment for termination of Starbucks warrant	(54,808		)
Change in other comprehensive loss	1,470
Share-based compensation	72,492
Balance at June 30, 2017	$	703,744

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, 2017, 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, 2017, there were 250,974,736 shares of Class A common stock and 131,645,329 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, holders of Class B common stock are able to convert such shares into Class A common stock.

Warrants

On February 24, 2017, the Company and Starbucks entered into a Warrant Cancellation and Payment Agreement pursuant to which the Company paid Starbucks cash consideration of approximately $54.8 million in return for the termination of the Warrant to Purchase Stock dated August 7, 2012, as amended, that provided Starbucks with the right to purchase an aggregate of 9,456,955 shares of the Company’s common stock.

In conjunction with the Notes offering, the Company sold warrants whereby the Counterparties have the option to purchase a total of approximately 19.2 million shares of the Company’s Class A common stock at a price of $31.18 per share. The Company received $57.2 million in cash proceeds from the sale of these warrants. See Note 10, Indebtedness, for more details on this transaction.

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. Since November 17, 2015, no additional securities have been nor will be in the future issued under the 2009 Plan.

Under the 2015 Plan, shares of the Company's Class A 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, 2017, the total number of shares subject to stock options and RSUs outstanding under the 2015 Plan was 25,989,237, and 47,378,192 shares were available for future issuance. As of June 30, 2017, the total number of shares subject to stock options and RSUs outstanding under the 2009 Plan was 52,709,658.

A summary of stock option activity for the six months ended June 30, 2017 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 at December 31, 2016	73,261,562		$	7.70	7.28	$	443,711
Granted	1,216,959		17.20
Exercised	(14,912,966	)	5.51
Forfeited	(2,144,552	)	11.38
Balance at June 30, 2017	57,421,003		$	8.33	6.80	$	868,556
Options exercisable as of
June 30, 2017	53,717,383		$	8.03	6.65	$	829,122

Restricted Stock Activity

Activity related to RSUs during the six months ended June 30, 2017 is set forth below:



	Number of RSUs		Weighted Average Grant Date Fair Value
Unvested as of December 31, 2016	15,443,391		$	12.09
Granted	9,656,680		16.78
Vested	(2,383,941	)	11.91
Forfeited	(1,438,238	)	12.66
Unvested as of June 30, 2017	21,277,892		$	14.20

Share-Based Compensation

The fair value of stock options and employee stock purchase plan rights are estimated on the date of grant using the Black-Scholes-Merton option valuation model.

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



	Three and Six Months Ended June 30,
	2017		2016
Dividend yield	—	%	—	%
Risk-free interest rate	1.88	%	1.55	%
Expected volatility	32.22	%	42.71	%
Expected term (years)	6.02		6.08

As a result of the Company’s adoption of ASU No. 2016-09, Improvements to Employee Share-Based Payment Accounting, the Company elected to account for forfeitures as they occur. As this guidance requires a modified retrospective approach when eliminating the forfeiture rate, the Company recorded an adjustment of $0.7 million to increase accumulated deficit and additional paid-in capital as of January 1, 2017.

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,
	2017		2016		2017		2016
Cost of revenue	$	18	$	—	$	18	$	—
Product development	25,136		24,168		44,492		46,115
Sales and marketing	4,355		3,363		8,290		6,266
General and administrative	10,084		9,391		18,463		15,739
Total	$	39,593	$	36,922	$	71,263	$	68,120

The Company recorded $1.2 million and $3.0 million of share-based compensation expense related to the Company's 2015 Employee Stock Purchase Plan during the three and six months ended June 30, 2017, respectively, compared to $1.5 million and $3.0 million for the three and six months ended June 30, 2016, respectively, which are included in the table above.

The Company capitalized $0.7 million and $1.2 million of share-based compensation expense related to capitalized software costs during the three and six months ended June 30, 2017, respectively, compared to $0.9 million for both the three and six months ended June 30, 2016.

As of June 30, 2017, there was $386.0 million of total unrecognized compensation cost related to outstanding stock options that is expected to be recognized over a weighted-average period of 2.93 years.

NOTE 14 - 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,
	2017			2016			2017			2016
Net loss	$	(15,962	)	$	(27,345	)	$	(31,052	)	$	(124,100	)
Basic shares:
Weighted-average common shares outstanding	377,959			337,635			373,291			336,406
Weighted-average unvested shares	(1,602		)	(3,147		)	(1,718		)	(3,500		)
Weighted-average shares used to compute basic net loss per share	376,357			334,488			371,573			332,906
Diluted shares:
Weighted-average shares used to compute diluted loss per share	376,357			334,488			371,573			332,906
Net loss per share:
Basic	$	(0.04	)	$	(0.08	)	$	(0.08	)	$	(0.37	)
Diluted	$	(0.04	)	$	(0.08	)	$	(0.08	)	$	(0.37	)

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,
	2017	2016
Stock options and restricted stock units	78,699	113,981
Common stock warrants	19,173	9,458
Unvested shares	1,469	2,878
Employee stock purchase plan	262	127
Total anti-dilutive securities	99,603	126,444

Additionally, since the Company expects to settle the principal amount of its outstanding Notes in cash, the Company uses the treasury stock method for calculating any potential dilutive effect of the conversion spread on diluted net income per share, if applicable. The conversion spread will have a dilutive impact on diluted net income per share of common stock when the average market price of the Company’s common stock for a given period exceeds the conversion price of $22.95 per share for the Notes, which has not occurred as of June 30, 2017.

NOTE 15 - 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 2017 and 2025. The Company recognized total rental expenses under operating leases of $3.1 million and $5.9 million for the three and six months ended June 30, 2017, respectively, compared to $2.7 million and $5.5 million for the three and six months ended June 30, 2016, 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, 2017 are as follows (in thousands):



	Capital			Operating
Year:
2017 (remaining 6 months)	$	762		$	8,599
2018	1,495			17,065
2019	1,380			16,165
2020	142			16,223
2021	—			16,614
Thereafter	—			36,084
Total	$	3,779		$	110,750
Less amount representing interest	(2		)
Present value of capital lease obligations	3,777
Less current portion of capital lease obligation	(1,511		)
Non-current portion of capital lease obligation	$	2,266

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 filed its answering brief on December 7, 2016, and Mr. Levin filed his reply on December 21, 2016. No hearing date has been set. 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 that it may instead be pursued by a different courier. Subsequently, couriers Nadezhda Rosen and La’Dell Brewster filed a new PAGA-only claim in the Superior Court of the State of California for the County of San Francisco on November 7, 2016. Plaintiffs claim that Caviar misclassified its couriers as independent contractors resulting in numerous violations of the California Labor Code, pursuant to which plaintiffs seek statutory penalties for those violations. In February 2017, the Company participated in a mediation with the parties in these Caviar misclassification suits to explore resolution of the matters at hand. After continued negotiation, the parties reached a preliminary global settlement of these suits, which is subject to final approval by the arbitrator. The Company has made appropriate accruals in the financial statements for the immaterial amounts expected to be paid as settlement.

In addition, from time to time, the Company is involved in various other litigation matters and disputes arising in the ordinary course of business. The Company cannot at this time fairly estimate a reasonable range of exposure, if any, of the potential liability with respect to these other matters. While the Company does not believe, at this time, that any ultimate liability resulting from any of these other matters will have a material adverse effect on the Company's results of operations, financial position, or liquidity, the Company cannot give any assurance regarding the ultimate outcome of these other matters, and their

resolution could be material to the Company's operating results for any particular period, depending on the level of income for the period.

NOTE 16 - 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 is the chief executive officer who 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,
	2017		2016		2017		2016
Revenue
United States	$	530,008	$	421,808	$	974,907	$	789,387
International	21,497		16,725		38,152		28,415
Total net revenue	$	551,505	$	438,533	$	1,013,059	$	817,802

No individual country from the international markets contributed in excess of 10% of total revenue for the three and six months ended June 30, 2017 and 2016.

Long-Lived Assets

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



	June 30, 2017		December 31, 2016
Long-lived assets
United States	$	158,721	$	162,118
International	3,134		2,675
Total long-lived assets	$	161,855	$	164,793

NOTE 17 - SUPPLEMENTAL CASH FLOW INFORMATION

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



	Six Months Ended June 30,
	2017		2016
Supplemental Cash Flow Data:
Cash paid for interest	$	284	$	284
Cash paid for income taxes	850		168
Supplemental disclosures of non-cash investing and financing activities:
Change in purchases of property and equipment in accounts payable and accrued expenses	1,454		4,192
Unpaid business acquisition purchase price	644		—

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 businesses (sellers) to accept card payments, an important capability that was previously inaccessible to many businesses. However, sellers also need innovative solutions to thrive, and we have since expanded to provide additional products and services to provide these businesses with access to the same tools as large businesses. Square is a cohesive commerce ecosystem that combines sophisticated software with affordable hardware that turns mobile and computing devices into powerful payments and point-of-sale solutions enabling sellers to start, run, and grow their businesses. We focus on technology and design to create products and services that are cohesive, fast, self-serve, and dependable.

The foundation of our ecosystem is a full service, managed payments offering. With our offering, a seller can accept payments in person via magnetic stripe (a swipe), EMV (Europay, MasterCard, and Visa) (a dip), or NFC (Near Field Communication) (a tap); or online via Square Invoices, Square Virtual Terminal, or the seller’s website. Once in our ecosystem, sellers gain access to technology and features such as reporting and analytics, next-day settlements, digital receipts, payment dispute management and chargeback protection, and Payment Card Industry (PCI) compliance. On the consumer (buyer) side, Square Cash is our payments app that allows individuals to send and track both P2P (peer-to-peer) and Cash Card payments, store money, and deposit money to their bank account. We monetize these features through a per transaction fee which we record as revenue upon authorization of a transaction by the seller's customer's bank. We recognize revenue net of refunds, which arise from reversals of transactions initiated by sellers.

Our commerce ecosystem also includes powerful point-of-sale software and services that help sellers make informed business decisions through the use of analytics and reporting. As a result, sellers can manage orders, inventory, locations, employees, and payroll; engage and grow their sales with customers; and gain access to business loans. Some of these advanced point-of-sale features are broadly applicable to our seller base and include Employee Management and Customer Engagement. We have also extended our ecosystem to serve sellers with more specific needs. For example, our Build with Square developer platform allows businesses with individualized needs to customize their business solutions while processing payments on Square and taking advantage of all the services in our ecosystem, including integration with third-party applications. In addition, certain verticals, such as service and retail sellers, benefit from specific features such as Invoices, Appointments, and Square Inventory. We monetize these features through either a per transaction fee, a subscription fee, or a service fee.

With Square Capital, we facilitate the offering of loans to sellers based on their payment processing history, and the product is broadly applicable across our seller base. We currently fund a majority of these loans from arrangements with institutional third-party investors who purchase these loans. We recognize revenue upon the sale of the loans to third-party investors or over time as the sellers pay down the outstanding amounts for the loans that we hold as available for sale. We also earn a servicing fee from third-party investors that we record as revenue as we provide the services.

We also serve sellers through Caviar, a food ordering service that helps restaurants reach new customers and increase sales without additional overhead. Caviar revenue consists of seller fees charged to restaurants, delivery fees, and service fees from consumers. All fees are recognized upon delivery of the food, net of refunds.

We also provide our sellers with contactless and chip readers, chip card readers, Square Stand, and third-party peripherals. We recognize revenue from the sale of this hardware net of returns upon delivery of the hardware to the end user.

We have grown rapidly to serve millions of sellers that represent a diverse set of industries, including retail, services, and food-related businesses, and sizes, ranging from a single vendor at a farmers’ market to multi-location businesses. These sellers also span geographies including the United States, Canada, Japan, Australia, and the United Kingdom.

Results of Operations

Revenue (in thousands, except for percentages)



	Three Months Ended June 30,									Six Months Ended June 30,
	2017		2016		$ Change			% Change		2017		2016		$ Change			% Change
Transaction-based revenue	$	482,065	$	364,864	$	117,201		32	%	$	885,543	$	665,317	$	220,226		33	%
Starbucks transaction-based revenue	—		32,867		(32,867		)	(100	)%	$	—	$	71,705	$	(71,705	)	(100	)%
Subscription and services-based revenue	59,151		29,717		29,434			99	%	$	108,211	$	53,513	$	54,698		102	%
Hardware revenue	10,289		11,085		(796		)	(7	)%	$	19,305	$	27,267	$	(7,962	)	(29	)%
Total net revenue	$	551,505	$	438,533	$	112,972		26	%	$	1,013,059	$	817,802	$	195,257		24	%

Total net revenue for the three and six months ended June 30, 2017 increased by $113.0 million or 26% and $195.3 million or 24%, respectively, compared to the three and six months ended June 30, 2016.

Transaction-based revenue for the three and six months ended June 30, 2017 increased by $117.2 million or 32% and $220.2 million or 33%, respectively, compared to the three and six months ended June 30, 2016. This increase was attributable to growth in Gross Payment Volume (GPV) processed for the three and six months ended June 30, 2017 of 32% for each period, compared to the three and six months ended June 30, 2016. We continue to benefit from growth in processed volumes from our existing sellers, in addition to meaningful contributions from new sellers.

During the fourth quarter of 2016, Starbucks completed its previously announced transition to another payments solution provider. Accordingly, we did not record any Starbucks transaction-based revenue in the three and six months ended June 30, 2017 and we do not expect transaction-based revenue from Starbucks in the future.

Subscription and services-based revenue for the three and six months ended June 30, 2017 increased by $29.4 million or 99% and $54.7 million or 102%, respectively, compared to the three and six months ended June 30, 2016. The increase was primarily driven by continued growth and expansion of Instant Deposit, Caviar, and Square Capital, which were also the largest contributors to subscription and services-based revenue. Subscription and services-based revenue contributed 11% of total net revenue in both the three and six months ended June 30, 2017, compared to 7% in both the three and six months ended June 30, 2016.

Hardware revenue for the three and six months ended June 30, 2017 decreased by $0.8 million or 7% and $8.0 million or 29%, respectively, compared to the three and six months ended June 30, 2016. During the three and six months ended June 30,

2016, we experienced elevated growth in shipments of our contactless and chip reader driven by the fulfillment of the majority of the backlog of pre-orders in the first quarter of 2016, and to a lesser extent in the second quarter of 2016, following its launch in the fourth quarter of 2015, with no similar activity during the three and six months ended June 30, 2017.

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



	Three Months Ended June 30,									Six Months Ended June 30,
	2017		2016		$ Change			% Change		2017		2016		$ Change			% Change
Transaction-based costs	$	311,092	$	234,857	$	76,235		32	%	$	568,870	$	429,133	$	139,737		33	%
Starbucks transaction-based costs	—		28,672		(28,672		)	(100	)%	$	—	$	65,282	$	(65,282	)	(100	)%
Subscription and services-based costs	17,116		10,144		6,972			69	%	$	32,992	$	19,177	$	13,815		72	%
Hardware costs	14,173		14,015		158			1	%	$	26,835	$	40,755	$	(13,920	)	(34	)%
Amortization of acquired technology	1,695		1,886		(191		)	(10	)%	$	3,502	$	4,256	$	(754	)	(18	)%
Total cost of revenue	$	344,076	$	289,574	$	54,502		19	%	$	632,199	$	558,603	$	73,596		13	%

Total cost of revenue for the three and six months ended June 30, 2017 increased by $54.5 million or 19% and $73.6 million or 13%, respectively, compared to the three and six months ended June 30, 2016.

Transaction-based costs for the three and six months ended June 30, 2017 increased by $76.2 million or 32% and $139.7 million or 33%, respectively, compared to the three and six months ended June 30, 2016. This increase was attributable to growth in GPV processed for the three and six months ended June 30, 2017 of 32% for each period, compared to the three and six months ended June 30, 2016.

As noted above, Starbucks completed its previously announced transition to another payments solution provider. Accordingly, we did not record any Starbucks transaction-based costs in the three and six months ended June 30, 2017 and we do not expect Starbucks transaction-based costs in the future.

Subscription and services-based costs for the three and six months ended June 30, 2017 increased by $7.0 million or 69% and $13.8 million or 72%, respectively, compared to the three and six months ended June 30, 2016, primarily reflecting increased costs associated with the growth of Caviar.

Hardware costs for the three and six months ended June 30, 2017 increased by $0.2 million or 1% and decreased by $13.9 million or 34%, respectively, compared to the three and six months ended June 30, 2016. During the three and six months ended June 30, 2016, we experienced elevated growth in shipments of our contactless and chip reader driven by the fulfillment of the majority of the backlog of pre-orders, in the first quarter of 2016, and to a lesser extent in the second quarter of 2016, following its launch in the fourth quarter of 2015, with no similar activity during the three and six months ended June 30, 2017.

Amortization of acquired technology for the three and six months ended June 30, 2017 decreased by $0.2 million or 10% and $0.8 million or 18%, respectively, compared to the three and six months ended June 30, 2016, as a result of certain technology assets reaching end of life.

Operating Expenses (in thousands, except for percentages)



	Three Months Ended June 30,										Six Months Ended June 30,
	2017			2016			$ Change		% Change		2017			2016			$ Change			% Change
Product development	$	78,126		$	68,638		$	9,488	14	%	$	146,708		$	133,230		$	13,478		10	%
% of total net revenue	14		%	16		%					14		%	16		%
Sales and marketing	$	59,916		$	39,220		$	20,696	53	%	$	109,816		$	77,716		$	32,100		41	%
% of total net revenue	11		%	9		%					11		%	10		%
General and administrative	$	62,988		$	50,784		$	12,204	24	%	$	119,923		$	146,891		$	(26,968	)	(18	)%
% of total net revenue	11		%	12		%					12		%	18		%
Transaction, loan and advance losses	$	18,401		$	17,455		$	946	5	%	$	30,292		$	25,316		$	4,976		20	%
% of total net revenue	3		%	4		%					3		%	3		%
Amortization of acquired customer assets	$	222		$	222		$	—	—	%	$	427		$	539		$	(112	)	(21	)%
% of total net revenue	—		%	—		%					—		%	—		%
Total operating expenses	$	219,653		$	176,319		$	43,334	25	%	$	407,166		$	383,692		$	23,474		6	%

Product development expenses for the three and six months ended June 30, 2017 increased by $9.5 million or 14% and $13.5 million or 10%, respectively, compared to the three and six months ended June 30, 2016, primarily due to the following:


•	an increase in headcount of 14% in product development personnel mainly in our engineering, product, and design teams; and


•	share-based compensation expense increased by $1.0 million and decreased by $1.6 million compared to the three and six months ended June 30, 2016, respectively.

Sales and marketing expenses for the three and six months ended June 30, 2017 increased by $20.7 million or 53% and $32.1 million or 41%, respectively, compared to the three and six months ended June 30, 2016, primarily due to the following:


•	an increase of $6.1 million and $6.4 million in advertising costs compared to the three and six months ended June 30, 2016