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.
Hi, everyone. Thanks 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 closed. 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'll 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 a discussion of the factors that could cause our results to differ. 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. 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. 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 would like to turn it over to Jack.
Thanks, Jason. 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'll take a brief moment now to highlight a few items that I think are really important. We're really proud of what we 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 hit 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 continue 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 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 are continuing to see strong momentum as we move up 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 product 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 product, 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'll turn it over to Sarah for some remarks.
Great. Thank you, Jack. We're 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 a little deeper. Total net revenue was $439 million, and adjusted revenue was $171 million in the second quarter, an increase of 54% year-over-year. This was comprised of $130 million in transaction profit 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 have 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 monetized 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 of 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 seven 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're 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-$1.67 billion, adjusted revenue to be in the range of $655 million-$670 million. That's up 6% at the midpoint from our previously guided range. We expect adjusted EBITDA to be in the range of $18 million-$24 million, up from our previous range of $8 million-$14 million. That's a year-over-year margin improvement of 12 points at the midpoint. With that, let me turn it back to the operator, and we'll start the Q&A portion of the call.
Ladies and gentlemen, if you would like to register an audio question, please press the star followed by the one on your telephone keypad. Callers, please limit yourselves to one question. Again, that is star followed by one. Your first question comes from the line of James Schneider with Goldman Sachs.
Good afternoon. Thanks for taking my question. One question first on Square Capital. Now that we have the traditional loan product in 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? Can you maybe talk about what the step-up in provisions you noted on the income statement was? Is that due to the loans or due to transaction losses?
Thanks, Jim. Appreciate the question. First of all, on the loan product versus our prior product, which was a merchant cash advance, it has not changed. From a seller perspective, the product still very much looks as it did before. It's very unique in that regard. We reach out to you proactively, you're on the Square platform, and we provide you with an offer. With a click of a button, those funds are in your bank account immediately the next day. In terms of the actual loan size versus MCA size, we really haven't seen much change at all. Our average loan size today is around $6,000. These are still small microloans going out into sellers who don't have access to this sort of capital. From there, nothing else really changes from a seller perspective.
They're still repaying based on every swipe, dip, or tap that they see. It helps it match to their working capital, and we know that's just one of the many reasons why they've loved this product. We continue to see a 70 Net Promoter Score, and we continue to see a really 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. I think that's just one of the many reasons why we saw so much interest Q1 heading into Q2.
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 sellers themselves see. I think the TAM is still quite big. We still 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 provision due to loans sitting on the income statement, there was nothing incremental there that was different. We continue 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 kind of 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. On each year, it wasn't material, we chose to take the full adjustment in the quarter rather than going back into every period. Underneath it, we're actually incredibly impressed by the results from the risk area this quarter, and you should use that for modeling going forward.
Thanks. Then maybe as a follow-up, can you maybe talk philosophically, medium to long-term, about the pace of margin expansion you expect to see for Square? It's very encouraging to see the 12 points of expansion over the course of 2016 you're projecting now. Can you maybe talk about as we look longer term, should we expect that pace to continue or that pace to moderate as we go forward? Just how do 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, ongoing margin expansion for Square. I think it'll come from multiple areas. First and foremost, as we scale, clearly we don't have to scale every function in a linear way, we just get operating leverage as we grow. Secondly, we continue to have this really healthy base of sellers. As you know, we're very focused on what the payback period is. 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 look at it from a revenue standpoint or a 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're able to leverage that base and sell new products into them, that's another way that 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 if we would sign up to keep doing it at that pace. As you look into 2017 and 2018, our expectation is you'll continue to see solid margin expansion from Square.
Thank you.
Thank you.
Your next question comes from the line of Tien-Tsin Huang with J.P. Morgan.
Great. Thank you. Congrats on the EBITDA upside here. Just wanted to get an update on the contactless and chip reader, and the adoption there. Any stats you can share in terms of units or what % of your active base now has a contactless and chip reader, things like that?
Yeah. Thanks for the question, Tien-Tsin. We've been really pleased with the momentum of the contactless and chip card reader. One of the things that we've been really pleasantly surprised with is its scale in terms of the smaller and also the larger sellers. We definitely see it being purchased from our smaller sellers who use it in a very mobile environment, on the side of a road, for instance, a farmer stand, all the way up to a 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're in the middle of a transition to authenticated payments, EMV and NFC tap. 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 want to push as much as possible into tap, Apple Pay, Android Pay, tapping with a card, and that's also reflective of some of the momentum we're seeing around the world. We were able, with just simple education, to move an industry average of tap from 1%-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 in new markets too. We're pushing really hard on it.
Just as a follow-up to that then, how about promotions? Are more promotions likely? I saw the hardware costs, the 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. Curious what your thinking is here in the balance of the year.
Yeah. 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, 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 the 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's working for them, but also our retail presence.
Being able to walk into an Apple store and see the NFC and the contactless and the chip card reader right away definitely helps continue to push a lot of people into the Square ecosystem. We're also seeing the benefits of our focus on reliability and security to retain those sellers as well. All has been pretty healthy.
Great. I'm all set. Thank you.
Your next question comes from the line of Darrin Peller with Barclays.
Thanks, guys. It's great to see the returns and meaningful sequential growth in the Square Capital side. I just want to follow up again on, I know last quarter there were some questions around the number of investors that you had, but it seems like you definitely added some now. Just to be sure that you have the capacity to keep growing at that rate, given the new investors you've onboarded, number one. I guess just as part of the overall software and data segment, if you can give us a little more color on really the strength we're seeing in terms of your ability to attach some of the other products, what % of merchants now have an attachment to other products, and I'm assuming that opportunity is still really large. Thanks, guys.
Great. Thanks, 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 $ perspective of what's coming into the program. On the other side, in terms of seller demand, still a lot of opportunity in our install base. I think a couple of things driving that. First and foremost, we continue to grow every quarter. As we just showed, our GPV grew 42% year-over-year. That's all net new opportunity to us. I think in particular, as we move upmarket 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%-15% of your GPV. I think that's a good amount to enable you to grow your business without getting overburdened.
Clearly, as we add larger sellers, 10%-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 other product attach rates, rather than just thinking about it as a software and data line, I do want to keep coming back to the fact that all of our products are software, in effect. Some we monetize through payments, and you see that in the transaction margin portion of adjusted revenue, and some we monetize directly.
If you look at attach rates across the board, Invoices is still a terrific example of a new product that we monetize through payments, where we're 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. Jack mentioned some of the newer features and functionality added to Invoices, which we think continues to expand the addressable 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. 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 this 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.
Thanks, Sarah. Just one quick follow-up on the larger seller growth rate, which again, it just continues to impress us, at least at 61%. Can you just give us, I guess, 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, it's a great growth rate, especially given the transaction margin being relatively stable. Maybe more color on that.
Yeah. Darrin, thanks for the question. This is Jack. Upmarket has definitely been a key focus for us, and we're finally at a place where our tools scale to any size of seller. Obviously, we started with the smaller base, and we're seeing more and more appetite from the larger sellers as well, and specifically multi-location sellers. 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's super simple to set up. We have been looking at being more horizontally focused as well.
Employee management, as we indicated in the letter, Three Sticks Winery uses this to track employees' hours and sales, which gives them a much better sense of their business cohesively. 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 The 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, but also gives more security to their customers because they're filling out the card details themselves. 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.
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 With the extra people, to talk with them so that we can be very effective and efficient in those conversations. We're finding that the larger sellers mainly come to us because of the brand. They're seeing it around their neighborhoods, and they're looking into, "Will it actually work for me?" We're finally in a position where, yes, it does scale, and we can continue to build off that.
That's great, guys. All right, thanks very much.
Thanks, Darrin.
Your next question comes from the line of Jason Kupferberg with Jefferies.
Hey, guys. I just wanted to ask sort of a follow-up on large merchants because I thought it was interesting in the shareholder letter, you actually carved out the 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? Which verticals are you having the most success in? Presumably, these are sellers that already were engaged in the electronic payment system in some way, shape, or form, so you're obviously having some competitive success. Just 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 you have everything that you need to run the business and also scale the business 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 point-of-sale, you have to go and get a different merchant acquisition account. You get analytics from somewhere else. We haven't seen anyone else who offers an end-to-end ecosystem like us.
Some have tried to cobble it together, but ours is built to work together from the ground up. We continue to build off that strength. 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 win small and large.
Okay. Just 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 outperformance in terms of the same store sales growth among your existing sellers? Is it better cross-sell than you had forecasted, higher than expected rate of growth in the number of new sellers that are joining the platform? Which of the factors do you think are most contributing to the ongoing upside?
Sure. Thanks, Jason. It's actually outperformance 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 are 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.
Like you said, when you go back to the youngest cohorts on Square coming from 2010, and I look at what they did in Q2 of 2016, they're still growing year-over-year. Why? Well, we've kind of promised them that you'll never miss a sale, 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 kind of grow at the pace of U.S. retail, they really outperform. They start at the farmer's market stall, and then they can become a multi-location business that we now support in the U.S. and in Japan, for example.
I think 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. Now that the product has become much more sophisticated, they're 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. I think those are the reasons why I think we continue to see that outperformance just in the payment piece. I think there are areas like Capital, Instant Deposit, even Caviar, that have all been nicely ahead of plan.
I think, again, that speaks to the brand really resonates when we go back into our install base. We remember with our larger sellers, they're in their dashboard on a daily basis. 70%-80% of them are touching the dashboard daily. They're finding new ways for Square to really 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 fronts, and that's a good place to be because there's 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 Casablanca Salon: According to the latest Apple rumors, the new iPhone will no longer have a three-and-a-half-millimeter headphone jack. Do you foresee any conflict with this?
Thanks, Jay, for the question, also 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're 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 and chip card reader is that it works over Bluetooth. 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, something that gives our sellers the confidence that no matter how the technology shifts, they'll still always be able to make the sale.
Our next question comes from the line of Andrew Jeffrey with SunTrust.
Hi. Good afternoon. Thanks 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 better than trend this quarter in particular loss rates. Is there something about where we are in the cycle that you think provides a tailwind? Having not been through a downturn, what are the kind of things that 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 a lot about and plan for internally, because clearly, we are a large U.S. reseller. We are largely taking commerce. 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 spend, 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. I think you need it to run your business.
I think 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, it is absolutely a reason why we win. Particularly if you look to larger sellers, they are more sophisticated in thinking about the total cost of ownership of a product or of a platform that they're buying into. They're not just thinking about the rate that they will pay on a payment, but they're also thinking about the cost to manage a chargeback, something that 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 to do acceptance, or the ongoing fee to pay out to their merchant acquirer.
They're having to think about just the overlay of having to stitch that all together and probably pay employees to do that for them. I think when they look to Square, they see this incredibly unique, cohesive ecosystem, but you're paying for it in an incredibly simple way. I think our total cost of ownership could actually resonate even stronger, frankly, in a tougher environment. Those are really the two prongs of attack that I think 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, so we feel very good about it.
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 kind of on its front foot.
Okay. That's helpful. 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 effect that Jack discussed, if you separate that out and you just sort of look at list rate, anything to call out as you go up market on just sort of the pricing in the door versus the ultimate yield and dollar retention that you get down the road from bigger sellers?
It really shows how different we are that we don't even use a lot of those terms internally. I think what you mean is whenever we talk to a bigger seller, and there's the revenue rate that we would get as a percent of GPV, how willing are we to be flexible on that? I'll start there. 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 are 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. That's a good place for our sales force, as Jack talked about, to actually engage in a conversation.
I think you quickly can turn that conversation to be much more holistic about that total cost of ownership. It's not just about singular, what's the take rate gonna be. They also understand everything else that comes with the technology they're getting, that they're paying for via a payments business model. I think that was kind of your first question, and then I think the second was about our ability to therefore maintain our own transaction margin. Is that right?
Yeah, exactly.
I think there, that's something we really, you know, 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. 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, or 104 basis points this quarter. Certainly, when you look elsewhere, those margins tend to be a lot lower. I think it comes back to speaking to the fact that sellers are getting a much bigger set of products. They're getting access to a lot more technology. They're getting fast access to funds. They can now utilize other products like Invoices and so on. 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.
Your next question comes from the line of Scott Bibby with Stifel.
Hey, thanks for taking the question. The follow-up on the attach rate question from earlier, thinking about it in terms of where you're having the most success if you kind of carve the business up into newer customers coming onto the platform, existing customers, and small versus large. I'm wondering where you're having success on that grid when merchants begin adopting the ancillary products, if it's deeper into the cycle of them being a customer or you're getting high attach rates on these new customer accounts now. Thank you.
Sure. I think I'll take small versus large first because I think it depends a 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. That'll give you a sense of how small the merchant could be. We have taken Capital all the way up to $100,000. Again, we'll give you a good indication of how big of a merchant that we can go to. Capital is very broad-based. Invoices actually 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 happen because you've got to have employees to do it. 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, there's no kind of random walk down Main Street that happens first. They hit our website and they self-declare that they're a bigger merchant. 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?" I think when the sales person is involved, often they're buying several products at once.
There is, though, an evolution that can happen, I think we even talked about this in the example of 3C's in our shareholder letter, where they came on as a very small business, something like payroll didn't make sense for them in the beginning. 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, every month, every quarter, every year to look at how it's changed. With that, we're very, very targeted in how we go back to say, "Okay, here's a merchant who a year ago it didn't make sense to target them with, for example, payroll. Now a year on, clearly we can see they're utilizing a tool like employee management, they must have employees.
We absolutely should be targeting them with a product like payroll." There's not a one-size-fits-all, Scott. It's kind of all of those things because I think the net takeaway for us is there's still a huge amount of running room in the base to attach these products into. As the products become more sophisticated, and have all the table stakes 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, Jerry 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 are a relatively new business with other startup priorities, I have resisted changing at this time. To be honest, the only thing keeping me from changing is reliability.
Thanks, Jerry, for the question, and also for being a Square customer. You're right, reliability is incredibly important to our sellers and to us, and it's an ongoing focus for us. That's through the software, through the payment stack, and everything we do around hardware. This is definitely a reason why sellers choose Square and also why they stay on us. As Sarah mentioned, one of the things that 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. 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 up our hardware point-of-sale and any hidden payment fees.
Everything is in one simple rate, that started 7 years ago for us. This is something we've gotten really, really, really good at. It's not just about the payments aspect, but also the entire ecosystem that you need to make really good decisions around your business. That starts with really best-in-class hardware that looks great but also is affordable. It's easy to use in terms of the point of sale and everything that you need to grow your business. Also, we have fast access to your capital. After you swipe your customer's credit cards
We can get you that money the next business morning, or you can actually get it instantly with our Instant Deposit service. We believe all this adds up to a better cost of ownership that we think provides a whole lot more value than you would get anywhere else.
Your next question comes from the line of Dan Perlin with RBC Capital Markets.
Thanks. Good evening. The question I have is around thinking of Square Capital and the incremental GPV that it provides for you guys. We've seen pretty significant ramp in both of these numbers. I'm just wondering, it's not so much 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. I mean, those are all big drivers, I would think, to GPV, but I haven't really seen the statistics that you guys have produced. Can you just give us any color around that?
Yeah. It's a great question. I actually 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. Really the underlying question is, does a seller grow more once they receive Square Capital? What does the seller's GPV look like pre- and post? We absolutely can see in our data that our sellers do grow when they take Square Capital for all the reasons that you outlined, because they're actually using that capital to do things that should help them grow their business, right? Inventory, new equipment, et cetera.
That is certainly something that I think behooves us to get better and better at being able to target that number, and I suspect you will hear us again 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 sticky. We have 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're 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. 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've added on.
Excellent. The other part of that question is, when you think about this argument, you talk a lot about total cost of ownership. When we think of Square Capital, I suspect that's got to be a significant component to that. Would you say, is this one of the major drivers of that total cost of ownership? Is there another, I guess, subset of product that really is driving that?
Yeah. I actually wouldn't put capital into that whole discussion on total cost of ownership, because I think when someone is coming on Square, what they're really looking at is what am I having to pay-- First of all, am I even going to get on the system, right? What Square really revolutionized is we thought about risk differently. For still a large portion of Square sellers, they wouldn't even get on the system to begin with. They wouldn't even have a conversation about total cost of ownership. Once they are on the system, they'd 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 have all of the fees that go alongside payments, so PCI fees, chargeback fees, et cetera. I think that's more where the total cost of ownership equation really 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 just don't get access to capital, right? That's the need that we're serving, is that at a $6,000 average capital loan, no bank can do that profitably. They can't do it profitably because they can't cover the cost of acquisition of a customer, and they can't cover the risk loss that they'll take on it.
We've solved for customer acquisition because this is our base that we've already acquired, and we have solved for risk loss by having access to data that's real-time and actually tells you about their business. I think there it's less about TCO for the seller and more about just access and getting it. I think it's the ease of use thereafter. Where even if maybe they did have a choice to go elsewhere, we just make it so simple for them, right? Click of a button, it's in your account the next day. You pay back on every swipe as a net, so you don't have to think about having to make ancillary payments outside of what your core business is doing.
Excellent. Thank you, guys.
Thanks, Dan.
Your next question comes from the line of Josh Beck with Pacific Crest.
Thanks. I wanted to go to the EBITDA upside in the quarter. It was obviously really strong. I think $15 million above your midpoint would've even been higher if you had backed out some of those transaction loss adjustments. Just to help us understand maybe what were the sources of positive surprise outside of the top line. I think you talked through that pretty well. Also maybe 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. Maybe what are some of the major moving parts we should be thinking about there as well?
Sure. Thanks, Josh. I think 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, that clearly spilled the whole way down the model in terms of then providing EBITDA upside. I think if you look at across our operating lines, it's really a comment about how you think about 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, it started to moderate in Q2, it should continue to moderate through the year. I think I told you on the last call, we found ourselves in kind of a great place where we were able to recruit all the people we wanted to go recruit.
Seemed 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, it feels very strong, and that was, again, 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, it's really what's going to build your growth rate for 2017. I think in Q2, that began to slow a little, which helped with some of the EBITDA upside. It's part of why we raised guidance for the full year, too.
The other thing that is unique, well, it's not unique to Square, but is hard for us to forecast at the moment is employer taxes. I called it out in the shareholder letter, and I called it 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. We did our best to forecast it in Q2. We didn't really see a lot of selling activity in Q2. We've done that same kind of 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, because that does incorporate a fairly hefty employer tax piece.
I think we probably have the better information internally to 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, and I think you see that very definitively in the guide that we've given you for 2016 overall.
Thanks, Sarah. One follow-up for you, Jack. I know Build with Square has been out for a little bit of time. I know it's still early, but just anything you can share kind of early progress and how you'd like to see that product evolve over time.
Yeah, thanks for the question. We're excited that we're finally in a position where we can offer an API and a platform, and we're seeing some really positive momentum. I think the surprising thing that we're 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 a bunch of that custom work. 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. We're continuing to add more partners in our marketplace as well. Even our smaller sellers can turn on partners that they want to use, like BigCommerce, Weebly, WooCommerce, 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 our larger sellers have taken to it and how creative they've been in the approach that continues to focus back on our strengths around payments.
Great to hear. Thank you.
Your next question comes from the line of Bob Napoli with 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. Thanks, Bob. I appreciate the question because I think it allows us to come back to that both internally and externally, we really want focus on adjusted revenue, and adjusted revenue has the three components. It has transaction margin from the piece that is monetized through payments, software and data revenue, which I think of as 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.
In some cases, like an Invoices product, it's a software product, right? There's a lot of lines of code building a really 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 it 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 % will software and data be of total adjusted revenue. 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? Yeah, that makes sense.
There's some really unique products within those different lines, and maybe they're all software and we can talk about the different lines a little differently. I think some of those products are so different that it's important for investors to understand which of those software products, call them all software related products. I mean, Capital is a lot different, an Invoice, some of these are very different than the others. I do think it's important for investors to understand those different products over time. Yeah. Then maybe rather than as a %, I would come back to each of those products.
Sure.
Within the software and data line, where effectively we're 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 Deposit, which is another good example of a software product, highly correlated to payments, but we get paid as a 1% off every transaction that happens via an Instant Deposit or every deposit that's taken. On the Capital side, to model out and to think about its trajectory going forward, I would come back to what is the GPV of Square that is available to be underwritten. From that, you know we do about 10%-15% of the GPV. You can kind of do the multiplication to get down to what you think the addressable market is in the base.
From there, as you know, we take a fee. It's in about the mid-single digits of every origination, and then a very small servicing fee because we keep the unique relationship to the customer. I think 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 I think Caviar is still growing at a very hefty rate. Very pleased with the traction that we've seen, particularly in kind of core cities where we believe we're right out there with a leading product, cities like New York and San Francisco. I would kind of base it on a growth rate.
Something like Instant Deposit, again, I think you can back into the number of customers that can utilize the product, what you think the average transaction size is for Instant Deposit, the fee we take of it. I think if you model those three, you're going to get a large way there in terms of software and data for the next couple of years. Does that help?
Yes. Thank you very much. Appreciate it.
Thank you.
We have time for one last question.
Your last question comes from the line of Neil Doshi with Mizuho.
Great. Thanks for squeezing me in, guys.
Not at all.
In terms of PayPal Working Capital and American Express working capital, how do you view those as competing products? Then would you ever consider opening up Square Capital to non-Square hardware customers? Then if we could maybe just get an update on the Square e-commerce solution and Square marketing solutions for small businesses, that'd be great. Thanks.
Sure. Let me talk a little, first of all, in terms of competitive differentiation, vis-a-vis some of the others, just generally, I would say in the alternative 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, 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. It may be using the muscle of what we know in terms of if we have payments data, are we able to underwrite merchants?
Does that need to be our payments data? Not necessarily. It's certainly an option that we think about. I think beyond that, it's just 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? I think there's many more places just even within the Square ecosystem that we can do that. In terms of CRM, the Square CRM solution.
Yeah, Neil, this is Jack. In terms of e-commerce, we're putting a lot of our energy into the API and the build on Square platform. That's where we're seeing a lot of the growth, also it provides a number of unlocks for us and our sellers so that they can really build custom solutions for themselves but still benefit from everything that we're doing around the payment stack. We're also partnering with folks like BigCommerce to make sure that when a seller is already using a solution, that they can integrate it 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've definitely played a lot with the receipts that we deliver to customers, we have a customer directory that's available to our sellers as well.
We're figuring out exactly where the strengths are in that service and where we can improve. No update beyond that yet.
Great. Thanks, guys.
Thank you.
I'd now like to turn the call back over to Jason Lee.
Thank you, everyone, for joining our call. I would like to remind everyone that we'll be hosting our 2016 third quarter earnings call on November 1st. Thanks again for participating.
Ladies and gentlemen, thank you for participating in today's program. This does conclude the program. You may all disconnect.