Block Inc (SQ) 2016 Q2 法說會逐字稿

Good day, ladies and gentlemen, and welcome to the Square second-quarter 2016 earnings conference call. I would now like to turn the call over to your host, Jason Lee, Head of Investor Relations. Please go ahead.

Hello, everyone. Thank you for joining our second-quarter 2016 earnings call. We have Jack and Sarah with us today.

First, we want to remind everyone on the format of our earnings call. We have published a shareholder letter on our investor relations website which was available shortly after the market close. We will begin this call with some short prepared remarks before opening the call directly to your questions.

During Q&A, we will take questions asked from our seller shareholders in addition to questions asked from conference call participants. We would also like to remind everyone that we will be making forward-looking statements on this call. Actual results could differ materially from those contemplated by our forward-looking statements and reported results should not be considered as an indication of future performance.

Please take a look at our filings with the SEC for discussion of the factors that could cause our results to differ. Also, note that the forward-looking statements on this call are based on information available to us as of today's date. We disclaim any obligation to update any forward looking statements except as required by law.

Also, during this call, we will discuss certain non-GAAP financial measures. Reconciliations to the most directly comparable GAAP financial measures will be provided in the shareholder letter on our investor relations website. These non-GAAP measures are not intended to be a substitute for our GAAP results.

Finally, this call in its entirety is being audio webcast on our investor relations website. An audio replay of this call will be available on our website shortly. With that, I'd like to turn it over to Jack.

Thanks, Jason. And thank you all for joining us. I'm really excited to be here today to talk about our quarter.

Before this call we issued our quarterly shareholder letter with more detail, which I encourage you all to read. I will take a brief moment now to highlight a few items that I think are really important. We are really proud of what we've accomplished this quarter.

First, we continued our strong growth at scale with gross payment volume for the second quarter of $12.5 billion, up 42% year-over-year. We also had a major profitability milestone with positive adjusted EBITDA of $13 million. This improvement reflects our increased scale and operating leverage.

Additionally, we continue to see positive dollar-based retention from existing sellers and momentum in driving new product adoption. Second, we continued to innovate on our core software and services. This enables our sellers to run their business and get paid quickly and easily.

Highlights in the second quarter include the launches of scheduled invoices, recurring invoices, and card on file. These are frequently requested features and they unlock a larger market opportunity us for us in both existing and with our new sellers. To date, the convenience of invoices has made it enormously popular with sellers.

We have reached $2.3 billion cumulative GPV from invoices since the product launched in June 2014. Third, we're continuing to see strong momentum as we move our market. We grew larger seller GPV 61% year-over-year to now account for 42% of GPV, while maintaining overall transaction revenue margin.

Success with larger sellers is due to multiple factors, including our products ease of use and the cohesion of our services on our platform. This cohesion can be attractive for larger sellers who typically do not want to stitch together hardware, software, and payment services from many different vendors. In addition, larger sellers benefit from fast access to capital.

Finally, we're happy with the execution of Square Capital. Our relationship with millions of sellers continues to differentiate us at every step of the loan process. In the second quarter, we extended $189 million in Square Capital, up 123% year-over-year and 23% sequentially.

Square Capital's competitive advantages continue to attract additional investors to purchase our loan products. And we added five new investors this quarter alone. We started Square to enable sellers to always make the sale.

We've grown by focusing on technology and design to create products that are accessible, intuitive, and easy to use. Our results this quarter demonstrate that we are driving strong revenue growth with increased operating efficiency. Now I will turn it over to Sarah for some remarks.

Great, thank you, Jack. We are pleased with our second quarter results and the momentum in our business. This quarter we continued our strong growth trajectory at scale and achieved positive adjusted EBITDA.

In light of this we are increasing our guidance for the full year 2016. Let me dive the little deeper. Total net revenue was $439 million, and adjusted revenue was $171 million in the second quarter, an increase of 64% year-over-year.

This was comprised of $130 million in transaction profits from the products we monetize through payments, $30 million in direct software and data revenue, and $11 million in hardware revenue. We're delighted to see ongoing stability in both our transaction revenue and transaction profit as a percent of GPV at 2.93% and 1.04% respectively this quarter. Excluding the promotional processing credits for our new contactless and chip reader, these would've been 2.94% and 1.05% respectively.

This stability underscores the value that sellers of all sizes see in Square's unique and cohesive offerings of software, hardware and payments combined. In addition to products monetize through payments, we also saw ongoing growth in direct software and data product revenue to $30 million in the second quarter, up 130% year-over-year and 25% on a sequential basis. This is mostly comprised of Square Capital, Caviar, and to a lesser extent, instant deposit revenue.

Jack already touched on capital so let me provide an update on instant deposit. Since launching instant deposit less than a year ago, we've helped over 150,000 sellers complete over 2 million deposits. GAAP net loss was $27 million in the second quarter 2016.

This equates to a net loss per share of $0.08 compared to $0.20 in the prior year. In the second quarter, we reached $13 million in positive adjusted EBITDA, a significant profitability milestone for the Company. This represents 7 points of margin improvement on a year-over-year basis.

With that, let me turn to full year guidance and please see our shareholder letter for specific details on our third-quarter guide. As a reminder, our business is subject to the seasonal trends you see in broader commerce, which historically results in strong sequential growth in the second quarter, as we experienced, and flat sequential growth in the third quarter. Hence, we are raising our full-year guide based on our strong first half of 2016 and ongoing momentum in our business.

For the full year, we expect total GAAP net revenue to be within a range of $1.63 billion to $1.67 billion. Adjusted revenue to be in the range of $655 million to $670 million -- that is up 6% at the midpoint from our previously guided range. We expect adjusted EBITDA to be in the range of $18 million to $24 million, up from our previous range of $8 million to $14 million.

That's a year-over-year margin improvement of 12 points at the midpoint. With that, me turn it back to the operator and we will start the Q&A portion of the call.

(Operator Instructions)

Jim Schneider, Goldman Sachs.

Good afternoon. Thank you for taking my question. One question first, on Square Capital?

Now that we have the traditional loan product and the numbers or starting to come into the numbers, how big of an impact is that on your origination size per loan and your overall origination TAM? And can you maybe talk about what the step up in provisions, you note on the income statement, was? Is that due to the loans or due to the transaction losses?

Thank you, Jim. I appreciate the question. First of all, on the loan product versus our prior product, which is the merchant cash advance, it has not changed from a seller perspective. The product still very much looks as it did before.

It is very unique in that regard. We reached out to you, proactively, you're on the Square platform, and we provide you with an offer. With the click of a button those funds are in your bank account immediately the next day.

In terms of the actual loan size versus NPA size, we really haven't seen much change at all. Our average loan size today is around $6,000. These are still small micro-loans going out into sellers who don't have access to this sort of capital.

From there, nothing else really changes from a seller perspective. There are still repaying based on every swipe or tap that they see. It helps it match to their working capital.

We know that is just one of the many reasons why they love this product. We continue to see a 70-net promoter score and we continue to see a strong recurring element as well in terms of sellers who come back a second or a third time and get an offer. We see about a 90% renewal rate for those.

What loans did bring to us on the investor side was definitely investors who feel more confident in a loan product rather than a merchant cash advance. And I think that is one of the many reasons why we saw so much interest Q1 heading into Q2, and clearly we ended by adding five new investors into the program. And continue to see really strong interest around it.

I would say not so much impact on what the seller themselves see. I think the TAM is still quite big. We have a lot of surface area to go after, where switching to a loan really helped with more on the investor side.

In terms of the step up in provisions due to loans sitting on the income statement, there was nothing incremental there that was different. We continued to see a 4% loss rate in and around that range. No change from Q1.

Overall, transaction losses as a percent of GPV came in below our 0.1% historical average. There was one prior-period adjustment of $6 million that is in that total number. It was really going back to an adjustment since the beginning of Square.

Each year it wasn't material so we chose to take the full adjustment in the quarter rather than going back into every period. But underneath it we are actually incredibly impressed by the results from the risk area this quarter. And you should use that for modeling going forward.

Thanks. As a follow-up, can you talk philosophically, medium to long term about the pace of margin expansion you expect to see for Square? It's a very encouraging to see the 12 points of expansion over the course of 2016 you are projecting now. But can talk about, as we look longer term, should we expect that pace to continue or that pace to moderate as we go forward? And how you think about the overall investment levels today.

Sure. Thank you. We absolutely expect to see leverage as we move forward in terms of margins and so ongoing margin expansion for Square. I think it will come from multiple areas. First and foremost, as we scale, clearly we don't have to scale every function in a linear way. So we just get operating leverage as we grow.

Secondly, we continue to have this really healthy base of sellers, as you know. We were very focused on what the payback period is, so payback period has not changed four to five quarters when a cohort comes onto Square. From there we continue to see a positive retention rate, a dollar-based positive retention rate. What we mean by that is every cohort, whether you're looking at it from a revenue standpoint or gross-profit standpoint, continues to show growth year after year and that's true for even our earliest 2010 cohorts. That clearly continues to drive more profitability into the model as well.

As we are able to leverage that base and sell new products into them, that's another way we can keep adding to the profitability streams of the Company. I think as you look forward, you should continue to expect ongoing margin improvement. A 12 point increase year over year is certainly a big improvement.

I don't know they would sign up to keep doing it at that pace. But as you look into 2017 and 2018, our expectation is you will continue to see solid margin expansion from Square.

Thank you.

Thank you.

Tien-Tsin Huang, JPMorgan

Thank you. Congrats on the EBITDA upside here. Just wanted to get an update on the contactless chip reader and the adoption there? Any stats you can share in terms of units or what percent of your active base now has a contactless reader, things like that?

Yes, thank you for the question, Tien-tsin. We have been really pleased with the momentum of the contactless and chip card reader. One of the things we have been really pleasantly surprised with is its scale in terms of the smaller and also the larger sellers.

So we definitely see it being purchased from our smaller sellers who use it in a very mobile environment, on the side of the road for instance, a farmer stand all the way up to multi-location countertop solution. The thing that we're most excited about, though, is making sure that we continue to educate both the seller and also the buyer on what you can do with this reader. As you know, we are in the middle of a transition to authenticated payments, EMV and NFC Tap.

And as you've seen, the discussion around EMV is rather slow. We have one of the fastest readers in the business. But it really impacts a seller's ability to get through their lines. And it really affects their customers' own happiness as well.

We're going to push as much as possible into Tap, Apple Pay, Android Pay, tapping with the card, and that is also reflective of some of the momentum we are seeing around the world. And we were able, with just simple education, to move an industry average of Tap from 1% to 11% at Coachella and more recently, at the Bottlerock Festival, 14% Tap of overall transactions. We've been really confident in our ability to help educate both sellers and their customers on the benefits and the speed of NFC.

And we're going to continue to push that. This is also the first time the Company has sold a reader. And we're really excited about the momentum here. This is our fastest-growing reader.

And it definitely benefits from the ease of use, but also a number of how the market is transitioning and what customers expect. We continue to see really healthy growth with the reader and we're going to continue to push it. The other thing it allows for us to do, it's a global platform, which enables us to really look more globally around the world in terms of getting sellers and entering into new markets too, so we're pushing really hard on it.

Just as a follow-up to that then, how about promotions? Are more promotions likely? I thought that hardware costs and promotional credits were down?

Should we expect more steady demand from here on the reader? I'm asking because it sounds like some of your legacy competitors have been having issues with EMV certification and whatnot? It seems like a good opportunity here to push it? So I'm curious what your thinking is here in the balance of the year?

We haven't been experiencing the challenges that our competitors are mentioning. I think a big part of that is we've really focused on the onboarding experience so that when you use Square, you don't have to think about anything but making the sale. You don't have to think about certification, you just think about your customer and what it's going to take to make the sale.

And hardware and software should work together. We continue to see a lot of strength in the word of mouth and organic approach to both our software and to our hardware. And we benefit a lot from sellers meeting other sellers and asking what is working for them.

But also our retail presence, being able to walk into an Apple Store and see the NFC and the contact list and the chip card reader right away definitely helps continue to push a lot of people into the Square ecosystem. And we're also seeing the benefits of our focus on reliability and security to retain those sellers as well. All have been pretty healthy.

Great. I'm all set. Thank you.

Darrin Peller, Barclays.

Thank you, guys. It's great to see the returns and meaningful sequential growth on the Square Capital side. I just want to follow-up again I know last quarter there was questions around the number of investors you had, but it seems like you've definitely added some now.

So just to be sure that you have the capacity to keep growing at that rate given the new investors you've onboarded, number one? And as part of the overall software and data segment, if you can give us a little more color on the strength we're seeing in terms of your ability to do attach some of the other products? What percentage of merchants now have an attachment to other products and I'm assuming that opportunity is still really large? Thank you guys.

Thank you, Darrin. Yes, on the capital side, delighted as I mentioned, with the new investors that we've added. We feel like we have a lot of capacity, from an actual dollar perspective, what's coming into the program. And then on the other side in terms of seller demand, still a lot of opportunity in our install base.

I think a couple of things are driving that. First and foremost, we continue to grow every quarter, as we just showed our GPV grew 42% year over year. That is all net new opportunity to us.

I think in particular as we move up market towards those larger sellers, that also gives us an opportunity with capital to move into slightly larger loan sizes. We typically try to extend about 10% to 15% of your GPV. I think that's a good amount to enable to grow your business without getting overburdened. But clearly as we had larger sellers, 10% to 15% is a bigger number.

On top of that, I think there's also an ability to keep utilizing the muscle that we're building to many other elements in and out of Square. Overall I think there's a lot of opportunity in the base.

On your question on strength in software data and another product attach rates, rather than just thinking about it as a software data line, I do want to keep coming back to the fact that all of our products are software, in effect, it's only monetized through payments.

You see that in the transaction margin portion of adjusted revenue and some we monetized directly. If you look at attach rates across the board, invoices are still a terrific example of a new product that we monetized through payments where we are seeing about 140,000 active sellers utilizing the product. In fact we just hit about $2.3 billion in GPV on that product alone. And it's only about two years old. And Jack mentioned some of the newer features and functionality added to invoices, which we think continues to expand the adjustable market there. If you look at capital, about 60,000 loans in the first half of this year, that compares to 70,000 done in 2015.

So already about halfway through the year we're at the same size that we were just a year ago for the full year on capital. Instant deposits, I think I gave you the number. But we're now seeing 2 million deposits done and seeing a very nice number of sellers making use of that product, which I think keeps underscoring the fast access to capital is a core differentiation for our product.

I think overall for our base of millions, we're starting to see products get up into the hundreds and moving towards 200,000 seller attach rate. And that starts to look quite good. Again, a lot of room to run. But still proving that those products have real substance and are actually being utilized by our base.

Thank you, Sarah. Just one follow-up on the larger seller growth rate, again, it continues to impress us at least at 61%. Can you just give us a little more thought process around the strategy and the business model, will that have to change at all to keep going at that rate with larger and larger merchants? Again, its a great growth rate especially given the transaction margin being relatively stable, maybe more color on that?

Yes, Darrin and thank you for the question, it's Jack. Our market has definitely been a key focus for us. We're finally at a place where our tools scale to any size of seller.

Obviously, we started with the smaller base and we are seeing more and more appetite from the larger sellers as well. And specifically multi-location sellers. And we're finding that they actually want the same things that we're seeing from the smaller sellers.

Which is the fast access to capital, being able to swipe the card and get access to that capital, instantly in the instant deposit case, or next business morning is really, really critical. The simplicity is key and also the cohesion. It's one system, it's one download. And it is super simple to set up.

We have been looking at being more horizontally focused, as well. So (inaudible) management, as we indicated in the letter, Three [Cs] Winery uses us to track employees' hours and sales which gives them a much better sense of their business, cohesively. And we also have been looking at going deep with certain industries like retail services and food.

Square invoices is a good example of this where we have a seller named Scottish Plumber who employees in the field can use invoices to bill their customers online. It makes it very easy for them to manage the customer relationship. It also gives the more security to their customers because they are filling out the card details themselves. So it benefits the seller and their customers as well.

On the marketing side, we're growing our sales force and account management team to make sure we're assisting in onboarding. There's more questions as you get larger. So we've been applying a lot of our machine learning and data science towards making sure that we know exactly what type of seller would have those sorts of questions to improve efficiencies.

With the actual people, to talk with them so that we can be very effective and efficient in those conversations. And we're finding that the larger sellers mainly come to us because of the brand. And they are seeing it around the neighborhood and they're looking into, will it actually work for me. And we're finally in a position where, yes it does scale and we can continue to build off them.

That's great, guys. Thanks very much.

Thank you, Darrin.

Jason Kupferberg, Jefferies.

Hello, guys. I want to ask a follow-up on large merchant, because I thought it was interesting, in the shareholder letter you actually carved out a greater-than-$500,000 annualized GPV also which is now up to 14% of volume? I think it was 11% a year ago? What kind of color can you give us there in convertibles that you are having the most success in?

Presumably these are sellers that already were engaged in the electronic payment system in some way, shape or form? You are obviously having some competitive success? Any other color around that slice of your business would be great?

I think there's nothing vertical specific that we're seeing. I think generally, we're winning a lot from the competition because of our core differentiators. The cohesion really matters and being able to download an app and everything that you need to run the business and also scale it across multiple locations has really been important.

I think that the speed and the access to capital is also critical and not something that larger sellers are usually used to. I think that the biggest pain point for folks and why we're seeing people switch to us is that a lot of competitors just offer one thing. A terminal, a point of sale, you have to go and get a different merchant acquisition account. You get analytics from somewhere else.

But we haven't seen anyone else who offers an ecosystem like us. Some have tried to cobble it together. But ours is built to work together from the ground up.

And we continue to build off that [fast] track. There hasn't been anything in particular around a particular vertical. It's really just the cohesive horizontal package that I think is attractive and we continue to see wins, small and large.

Okay. Another question maybe you have some perspective on? You're obviously continuing to deliver some really nice upside to your guidance each quarter? On the net revenue side of that, would you say it's because, more of out performance in terms of the same-store sales growth among your existing sellers?

Is a better cross sell than you had forecasted? Higher-than-expected rate of growth? And the number of new sellers that are joining the platform? Which are the factors do you think are most contributing to the ongoing upside?

Sure. Thank you, Jason. It's actually our performance across the board. When I look at our numbers coming in every month, I think, first of all, there's net new coming to the Square platform.

We continue to see upside to what we were predicting internally, in terms of new activations. I think a huge part of that is the word of mouth that Jack talked about, that people see the brand out there and they see that it can work for a business of their size. We feel very good about net new coming on the platform.

Under the hood, in terms of the base, we're continuing to see that really strong positive retention rate. I think it surprised people when we talked about it originally on our IPO that a business like ours would actually be dollar positive on a year-over-year basis. And that has continued. When you go back to the youngest cohorts on Square coming from 2010 and I look what they did in Q2 of 2016, we're still growing year over year.

Why? Well, we have promised them that you will never miss a sale so your business will grow. I think second, we do see survivorship bias in there, that typically small businesses, when they survive and thrive, they don't just grow at the pace of US retail, they really outperform. So they start as a farmers' market stall, and then they can become a multi-multi-location business that we now support in the US and in Japan, for example.

The third piece that continues to help us as an underlying tailwind in the business, is shifting from a partial-use case, where in the past people may have used Square as the thing you use when you're doing more of a pop-up. Like something that's more ephemeral and now that the product has become much more sophisticated, they are able to use it for their entire business.

No longer just their mobile installation but instead they're coming back to their restaurants and they can use Square everywhere throughout their business. Those are the reasons why we continue to see that out performance in the payment piece. Then I think there are areas like capital instant deposit, even Caviar that have all been nicely ahead of plan.

I think that speaks to the brand really resonates when we go back into our install base, and we go with our larger sellers there in their dashboards on a daily basis. 70% to 80% of them are touching the dashboard daily. They are finding new ways for Square to help them run their business, as Jack talked about, things like payroll for the winery is a great example of an add-on. I feel like right now the growth is being driven across many, many fronts, and that's a good place to be, because there is no one place we're depending on for that growth.

Okay. Makes sense. Thank you.

Thank you.

We will now take our next question from one of our seller/shareholders, Jay Fleming at Casa Blanca Salon. According to the latest Apple [primers], the new iPhone will no longer have 3.5 millimeter headphone jack. Do you foresee any conflict with this?

Thanks, Jay for the question and also for being a Square customer. We believe our main responsibility and role as a Company is to make sure that our sellers always make the sale and help them navigate all the changes that come with the technology industry. We want to make sure that they are always a step ahead of everything that might change or will change in the future.

One of the reasons we're super excited about our contactless chip card reader is that works over Bluetooth. And that means it works with more and more devices and can work with more and more devices in the future. This is an open standard that every Company is behind. It's something that gives our sellers the confidence that no matter how the technology shifts they will still always be able to make the sale.

Andrew Jeffrey, SunTrust.

Hello, good afternoon. Thank you for taking the question. I wonder if you can think a little bit about, or talk a little bit about how you think about your business through the economic cycle?

Especially as it pertains to the nice retention results you've had and the [competitive] trend this quarter in particular loss rates? Is there something about where we are in the cycle that you think provides a tailwind? And having not been through a downturn, what are the kind of things you contingency plan for internally as you think about that?

Sure. Great. Thank you, Andrew. Thank you for that question. It is absolutely something that we think about a lot and plan for internally because clearly, we are a large US reseller.

We are large (inaudible) in commerce. I think what gets me excited for our business, even in a tougher macro downturn, is our ability to take share. First and foremost what I would say is what we do is not discretionary. Unlike, in tougher times where folks may cut back on their marketing expend, for example, payments is something you want to be able to take that electronic payment.

You don't want to miss a sale in fact. If you think that overall the macro environment has gotten worse and so you need it to run your business. That puts us in a stronger position in terms of the product that we offer.

I think the second point is total cost of ownership. Today there's absolutely a reason why we win. Specifically as we look to larger sellers, they are more sophisticated and thinking about the total cost of ownership of a product or of a platform that they are buying into. They are not just thinking about the rate that they will pay on a payment, but they are also thinking about the cost to manage the charge back, something we do for them.

They're thinking about the PCI fee that they get charged somewhere else, or the monthly fee for the piece of hardware for their acceptance, or the ongoing fee to payout to their merchant acquirer, and they're having to think about the overlay and having to stitch that all together and probably pay employees to do that for them. So I think when they looked to Square, they see this incredibly unique cohesive ecosystem.

But you are paying for it in an incredibly simple way. And I think our total cost of ownership could actually resonate even stronger, frankly, in a tougher environment. So those are really the two prongs of attack that we have in our business.

We continue to monitor it. I think the growth in our base is a very strong indicator of the health of the economy. Right now we saw very strong traction in Q2. We feel very good about it. But I think you're right that every Company should always be planning for what a cycle will look like. And we want to make sure that Square meets that cycle on its front foot.

Okay. That's helpful. And as a follow-up, when you talk about larger sellers recognizing that you have good attach rates, improving attach rates and other products to sell through the whole ecosystem, the fact that Jack discussed, if you separate that out and look at [list rate], anything to call out as you go upmarket on the pricing in the door versus the ultimate yield and dollar retention that you get down the road from bigger sellers?

Sure. It really shows how different we are that we don't even use a lot of those terms internally. But I think what you mean is whenever we talk to a bigger seller and the revenue rate that we would get as a percent of GPV, how willing are we to be flexible on that? (inaudible) We have absolutely put in place what we call custom pricing.

Custom pricing doesn't always have to mean less, by the way. What we're making is an economically rational decision about what is the margin that Square will ultimately take home, and making sure that it's fair. We will create a custom price for a larger seller.

And that's a good place for our sales force, as Jack talked about, to engage in a conversation. But I think you quickly can turn that conversation to be much more holistic about that total cost of ownership so it's not just about singular, what's the take rate going to be. They also understand everything else that comes with the technology they are getting that they are paying for via a payment business model.

I think that was kind of your first question. And I think the second was about our ability to therefore maintain our own transaction margin, is that right?

Yes. Exactly.

So I think there, that is something we really are very, very focused on which is why you see that transaction margin be so consistent. In our shareholder letter we showed you the last five quarters. But in fact if you went back over the last three or four years, what you would see is that we have maintained a transaction margin that's been above 100 basis points, 104 basis points for the quarter.

And certainly when you look elsewhere as those margins tend to be a lot lower. And it comes back to speaking to the sell fact that sellers are getting much more, a much bigger set of products. They're getting access to a lot more technology, they are getting access to fast access to funds, they can now utilize other products like invoices and so on.

And I think that's why we've been able to maintain that sort of margin. Does that answer your question?

It does. Thank you.

Great, thank you.

Scott Devitt, Stifel.

Hello, thanks for taking the question. A follow-up on the attach rate question from earlier? Thinking about it in terms of where you're having the most success, if you carve the business up into newer customers coming onto the platform, existing customers, and small versus large, I'm wondering where you are having success on that grid?

When merchants begin adopting the ancillary products, if it's deeper into the cycle of them being a customer? You're getting high attach rates on these new customer accounts now? Thank you.

Sure. I think I will take small versus large first. I think it depends little bit on the product. Something like capital is very, very broad.

We will go all the way down to capital loan sizes that are $1,000. So that will give you a sense of how small a merchant could be. But we have taken capital all the way up to $100,000.

That will give you a good indication of how big of a merchant we can go to. The capital is very broad based versus -- and invoices is a pretty broad-based product too. It's probably more dependent on your merchant category, what vertical you belong to, rather than your particular size.

If you look to a product like payroll, now clearly you're moving into larger merchants before you start to see an attach rate start to happen because you have to have employees to do it. So payroll is much more targeted. In terms of new versus existing, I think with bigger merchants who come in more through the sales channel, remember our merchants come to us so there's no random walk down Main Street that happens first.

They hit our website and they self-declare that they're a bigger merchant. And then we utilize a lot of our data science to say, okay is this going to be a merchant that we should make sure we get back to ASAP with a person that's going to talk to them? When the salesperson is involved, often they are buying several products at once.

There is, though, an evolution that can happen. And I think we even talked about this in the example of Three Cs in our shareholder letter, where they came on as a very small business, so something like payroll didn't make sense for them in the beginning. So our account management team is always going back.

Again, we utilize a lot of data science here to kind of parse through our base every day, month, every quarter, every year to look at how it's changed. Then with that we're very, very targeted to look at how we go back and say here's a merchant that a year ago it didn't make sense to target them with, for example, payroll, but now a year on, clearly we can see that they're utilizing a tool like employee management, so they must have employees. So now we absolutely should be targeting them with a product like payroll.

There's not one size fits all, Scott. It's kind of all those things. I think the net takeaway for us is, there is still a huge amount of running room in the base to attach these products into. And as the products become more sophisticated and have all the table [staker] features, we're finding more and more opportunity both in the base and then with net new customers.

Thank you.

We will take our next question from one of our seller/shareholders, Jimmy Griffin at Real Earth Creations. What are you doing to gain and keep the solid loyalty of your customers? For example, I'm regularly approached by other companies offering lower rates and free equipment and software.

Since we're a relatively new business with other start priorities, I have resisted changing at this time. But to be honest the only thing keeping me from changing is reliability.

Thank you, Jimmy, for the question and also for being a Square customer. You're right, reliability is incredibly important to our sellers and to us and its an ongoing focus for us, and that's through the software, through the payment stack, and everything we do around hardware. And this is definitely a reason why sellers choose Square, and also why they stay on us.

As Sarah mentioned, one of the things we think about and we see a lot of our sellers of different sizes think about is the total cost of ownership. When you actually get into the weeds of what it takes to run a business, Square has the best value here. And that's because we're not just offering one processing rate. The whole package is in one app, in one system.

We're not breaking of (inaudible) hardware point-of-sale and any hidden payment fees. Everything is in one simple rate. And that started seven years ago for us. So this is something we've gotten really, really good at.

And it's not just about the payment aspect but also the entire ecosystem they need to make really good decisions around your business. And that starts with best-in-class hardware that looks great but is also affordable. It's easy to use in terms of the point-of-sale and everything that you need to grow your business.

And we also have fast access to your capital. After you swipe your customers' credit cards, we can get you that money the next business morning, or you can actually get it instantly with our instant deposit service. So we believe all of this adds up to better cost of ownership that we think provides a whole lot more value than you would get anywhere else.

Dan Perlin, RBC Capital Markets.

Thank you, good evening. The question I have is around thinking of Square Capital and the incremental GPV that it provides for you? We've seen pretty significant ramp in both of these numbers?

I'm just wondering, it's not so much of an attachment rate question, so much as I'm looking back over one of your surveys you did about what your Square Capital customers are using, they're purchasing inventory at 50%, they're buying new equipment, they're marketing. Those are a big drivers I would think of GPV, but I haven't really seen a statistic that you've produced? So can you put any color on that?

That's a great question and I don't have a precise answer for you right now. But it is something that we do continue to do a lot of work on. The underlying question is, does the seller grow more once they've received Square Capital?

So what is the sellers GPV look like pre and post. And we absolutely can see in our data that our sellers do grow when they pick Square Capital for all the reasons that you've outlined. They are actually using that capital to do things that should help them grow their business like inventory, equipment, et cetera.

That is certainly something I think behooves us to get better and better at being able to target that number. And I suspect you will hear us begin to talk about it as we feel confident that we have a very clean, repeatable number that we can give you. I think the other thing in there as well that maybe we don't talk about as much is when we do things like capital or add on another product like payroll, it continues to keep the customer very, very sticky.

We had positive retention, so we're not dealing with churn. That said, we want to do everything in our power to make positive retention continue to be a thing. And if we can increase that positive retention, we want that to happen as well.

I think that there is another whole benefit to many of these products that you are talking about, where they do increase the GPV either because the seller grows, or because we now have access to a portion of that seller's business that we didn't have before. Invoices is a great example. Or that we can keep the seller on the Square platform for even longer than perhaps they would have stayed without all of the incremental products they have added on.

Excellent. The other part of that question is when you think about this argument (inaudible) on the total cost of ownership? How, when we think of Square Capital, I suspect that's got to be a significant component to that. Would you say that it's one of the major drivers of that total cost of ownership? Or is there another subset of product that really is driving that?

Yes. I actually wouldn't put capital into that whole discussion on total cost of ownership. When someone is coming on Square, what they are really looking at is, what am I having to pay -- first of all, am I even going to get on the system? What Square really revolutionized is, we thought about risk differently, so for still a large portion of Square sellers, they wouldn't even get on the system to begin with, so we wouldn't even have a conversation about total cost of ownership.

But once they're on the system, they would be paying monthly fees to merchant acquirers, they'd be paying monthly fees to hardware providers, they'd be paying, within that fee, every card that they take would have a different fee associated with it. They would then have all of the fees that go alongside payments so (inaudible) fees, charge back fees, et cetera, et cetera. I think that's more where the total cost of ownership equation plays out.

I think capital in some ways is its own separate animal, if a seller is thinking about TCO, because there's no doubt that mostly they don't just get access to capital. That is the need that we're serving, is that at a $6,000 average capital loan, no bank can do that profitably. And they can't do it profitably because they can't cover the cost of acquisition of the customer, and they can't cover the risk loss that they will take on it.

We've solved for customer acquisitions, this is our base that we've acquired. And we've solved for risk loss by having access to data in real-time and actually tells you about their business. I think there, its less about TCO and more about access and getting it. And then I think it's ease of use thereafter.

Where even if maybe they did have a choice to go elsewhere, we just make it so simple for them. A click of a button, in your account the next day. You pay back on every swipe. Other than that, you don't have to think about having to make ancillary payments outside of what your core business is doing.

Excellent. Thank you guys.

Thank you, Dan.

Josh Beck, Pacific Crest.

Thank you. Want to go to the EBITDA upside in the quarter, it was obviously really strong? I think $15 million above your midpoint? Would have even been higher if you'd backed out some of those transaction loss adjustments?

If you could help us understand, what were the sources of positive surprise outside of the top line, as you talked to that pretty well? And also as we move to the second half of the year, I think guidance implies EBITDA margins will be down a little bit from Q2 levels? What are some of the major moving parts we should be thinking about there as well?

Sure. Thank you, Josh. In terms of upside, you're right. A lot of it came from the top line. We were very pleased with how the top line performed.

And that clearly spilled the whole way down the model in terms of then providing EBITDA upside. I think if you look across our operating line, and it's really a comment about how you think of the first half of the year versus the second half. We did do a lot of recruiting and adding to our headcount in Q1 in particular, and it started to moderate in Q2, and it should continue to moderate through the year.

I think I told you on the last call, we found ourselves kind of a great place where we were able to recruit all the people we wanted to go recruit and to be a tougher environment for other smaller private companies and so forth. I think we've actually had our best win rates as a Company in terms of recruiting in the last couple of quarters and our attrition rates are low. From a people perspective, I feel very strong.

And that was particularly true in the beginning of the year when we wanted to make sure we beefed up in all of our product areas. Because that's when you start building products that will impact not just the back half of this year, but frankly its really what's going to build growth rate for 2017. I think in Q2 that began to slow a little, which helped with some of the EBITDA upside. That's part of why we raised guidance for the full year, too.

The other thing that is unique. It's not unique to Square, but its hard for us to forecast at the moment, is employer taxes. I called it out in the shareholder letter, and it called out when I talked about guidance in my prepared remarks. It's unique in that it's just hard to know exactly what will happen.

We clearly will pay those taxes whenever an employee sells a vested option. And we did our best to forecast it in Q2. We didn't see a lot of selling activity in Q2. We've done that same analysis in Q3, we believe it's our best estimate.

We really want you to take that guidance [seriously] for Q3, the $5 million to $6 million in EBITDA. That does incorporate a fairly hefty employer tax piece. And I think we have better information internally at Square to be able to forecast that.

I think the net of it is we want to continue to show strong profitability improvements as we move through this year and as we look to next year. I think you see that very definitively in the guide that we've given you for 2016 overall.

Thank you, Sarah. And one follow-up for you, Jack? I know Build with Square has been out for little bit of time, I know it is still early, but anything you could share there in early progress and how you'd like to see that product evolve over time?

Yes. Thank you for the question. We're excited that we're finally in a position where we can offer an API in a platform. And we're seeing some really positive momentum. I think the surprising thing that we are seeing is the take from larger sellers.

And how it allows them to really work into their workflow. And build more custom solutions that they need without us having to do bunch of their custom work. So we're seeing a whole lot more optionality to give a solution to a larger seller that they wouldn't have otherwise and would be blocked by us.

And that's really playing out. And we're continuing to add more partners in our marketplace as well. So even our smaller sellers can turn on partners that they want to use like Big Commerce Weebly, [with commerce] Wix, and others.

It's definitely a big part of our fundamental strategy around how to serve sellers of all sizes better. But we're really pleased with how larger stores have taken to it and how creative they've been in the approach that continues to focus back on our strengths around payments.

Great. Thank you.

Bob Napali, William Blair.

Thank you very much. The software and data product revenue was about 18% of net revenue, or adjusted revenue this quarter, up from 12% a year ago? As we look out 2017, 2018, longer term, what would you expect those group of products to represent as a percentage of your total revenue?

Great, thank you, Bob. I appreciate the question because I think it allows us to come back to that both internally and externally, we want to focus on adjusted revenue. And adjusted revenue has the three components. It has transaction margin from the piece that is monetized through payments, data revenue which I think is direct revenue where someone is going to pay a license piece to you, and then hardware revenue.

In the first two, we actually want to stay a little bit more indifferent, because in some cases like in invoices' product, it's a software product. There's a lot of lines of code building a unique product in invoices, and yet it gets paid for through a payment take rate which ultimately transcends to a transaction margin. We want the team to feel like they have degrees of freedom to either have a customer pay for through transaction profit or have them pay a direct software fee.

That's why I actually don't want to get too focused on what percentage will software and data be of total adjusted revenue, I'd rather have you focus on how big can adjusted revenue be? Because I think that will be the true indicator of the success of our products and what our sellers are paying for them. Does that make sense?

Yes. That makes sense, but there's some really unique products within those different lines and maybe they are all software and we can talk about the different lines a little differently? But I think some of those products are so different that I think it's important for investors to understand which of those software products, call them all software related products, capital is a lot different and some of these are very different than the others, but I think it's important to understand for investors to understand those different products over time?

Yes, so maybe rather than as a percent, I would come back to each of those products. Within the software and data lines we're effectively getting paid on a more direct basis. The three biggest, and really the two that are the majority are capital and Caviar.

And then to a lesser extent, instant deposits, which is not a good example of a software product highly correlated to payments. But we get paid as 1% of every transaction that happens, be it instant deposit, or every deposit that's taken. So on the capital side, to model that and to think about its trajectory going forward, I would come back to, what if the GPV at Square that is available to be underwritten?

And then from that, you know we do about 10% to 15% of the GPV. So you can do the multiplication to get down to what you think the addressable market is in the base. And from there, as you know, we take a fee in the mid single digits, off every origination and then a very small servicing fee because we keep the unique relationship to the customer.

So you can actually get -- you can come up with a fairly good estimate of what you think that can grow at over the next couple of years. In Caviar's case, we haven't given you as much to go with there, but Caviar is still growing at a very hefty rate. I'm very pleased with the traction that we've seen, particularly in core cities where we believe we're right out there with a leading product. Cities like New York and San Francisco, and so I would base it on a growth rate.

Then, something like instant deposit, I think again you can back into the number of customers that can utilize the product, what you think the average transaction size is, for instant deposit, and then the fee we take of it. I think if you model those three, you're going to get large way there in terms of software and data for the next couple of years. Does that help?

Yes, appreciate it.

Your last question comes from the line of Neil Doshi with Mizuho.

In terms of PayPal working capital and American Express working capital, how do you view those as competing products? Would you ever consider opening up Square Capital to non-Square hardware customers? Can we get an update on the Square e-commerce solution and eSquare Marketing Solutions for small businesses?

Sure, so let me talk a little first of all in terms of competitive differentiation, vis a vis, some of the others, generally, I would say. And they turned to lending space. I think it comes back to what Square's current advantage is, which is we are really selling Square Capital, or providing Square Capital into our install base.

We know we have deep trust with that base, we know that they engage with us almost every single day, and so our ability to put a product in front of them and have them take it is quite strong. In terms of capital for non-Square merchants, I think we look at all alternatives here, of how can we grow the overall portfolio for Square Capital? And it may be using the muscle of what we know in terms of if we have payment data, how we are able to underwrite merchants, does that need to be our payment data?

Not necessarily, its certainly an option that we think about. I think beyond that, its thinking about, where is Square in the middle of commerce happening between a buyer and a seller? And are there other places where our Square Capital DNA can be put to use?

And I think there's many more places just within the Square ecosystem that we can do that. And then in terms CRM, the Square [CRM] solutions?

This is Jack. In terms of e-commerce [circa], we're putting a lot of energy into the EPI in the build-on Square platform. That's what we're seeing a lot of the growth and also it provides a number of unlocks for us and our sellers so they can build custom solutions for themselves but still benefit from everything that we're doing around the payment stack.

We are also partnering with folks like Big Commerce to make sure that when a seller is already using a solution that they can integrated into the Square dashboard. We have seen merchants do that in a similar way for customer relationship management marketing. We think it's still early, but we definitely played a lot with the receipts that we deliver to customers.

And we have a customer directory that's available to our sellers as well. And we're figuring out exactly where the strengths are in that service and where we can improve. But no update beyond that yet.

Great. Thank you, guys.

Thank you.

I'd now like to turn the call back over to Jason Lee.

Thank you, everyone for joining our call. I'd like to remind everyone that we will be hosting our 2016 third-quarter earnings call on November 1. Thank you again for participating.

Ladies and gentlemen, thank you for participating in today's program. This does conclude the program. You may all disconnect.