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 Q2 2016 earnings call. We will 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 and A, we will take questions asked from our sellers' 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.
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 would 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'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 Q2 of $12,500,000,000 up 42% year over year. We also hit a major profitability milestone with positive adjusted EBITDA of $13,000,000 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. 2nd, 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 Q2 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. Today, the convenience of invoices has made it enormously popular with sellers. We have reached $2,300,000,000 cumulative GPV from invoices since the product launched in June of 2014. 3rd, we're continuing to see strong momentum as we move up market.
We grew largest 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 fees 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. And 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 Q2, we extended $189,000,000 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 5 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.
And 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 2nd 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 $439,000,000 and adjusted revenue was $171,000,000 in the 2nd quarter, an increase of 54% year over year. This was comprised of $130,000,000 in transaction profit from the products we monetize through payments, $30,000,000 in direct software and data revenue and $11,000,000 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 $30,000,000 in the 2nd 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 2,000,000 deposits.
GAAP net loss was $27,000,000 in the Q2 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 $13,000,000 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 Q3 guide.
As a reminder, our business is subject to the seasonal trends you see in broader commerce, which historically results in strong sequential growth the Q2 as we experienced and flat sequential growth in the Q3. Hence, we're raising our full year guide based on our strong first half of twenty sixteen and ongoing momentum in our business. For the full year, we expect total GAAP net revenue to be within a range of $1,630,000,000 to $1,670,000,000 adjusted revenue to be in the range of 6 $55,000,000 to $670,000,000 that's up 6% at the midpoint from our previously guided range. We expect adjusted EBITDA to be in the range of $18,000,000 to $24,000,000 up from our previous range of $8,000,000 to $14,000,000 That's a year over year margin improvement of 12 points at the midpoint. So with that, let me turn it back to the operator and we'll start the Q and A portion of the call.
And your first question comes from the line of Jim Snyder 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 are 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 noted on the income statement was?
Is that due to the loans or due to transaction losses?
Thanks, Jim. Appreciate the question. So 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. So and it's very unique in that regard.
So we reach out to you proactively. You're on Square platform and we provide you with an offer. With a click of a button, those funds are in your bank account immediately the today is around $6,000 So 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. So they're still repaying based on every slight step or task that they see.
It helps us 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 We continue to see a really strong recurring element as well in terms of sellers who come back second or 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's just one of the many reasons why we saw so much interest Q1 heading into Q2. And clearly, we ended by adding 5 new investors into the program and continue to see really strong interest around it. So I would say not so much impact on what the seller themselves see. I think the town 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 TPV came in below our kind of 0.1% historical average. There was one prior period adjustment of $6,000,000 that is in that total number. It was really going back to an adjustment since the beginning of Square.
So on a 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're actually incredibly impressed by the results from the risk area this quarter and that we should use that for modeling going forward.
Thanks. And 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. But 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? And just how do
you think about the overall investment levels today?
Sure. Thank you. So we absolutely expect to see leverage as we move forward in terms of margins and so ongoing margin expansion for Square. And 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.
And 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 4 to 5 quarters when a cohort comes on to Square. And then from there, we continue to see a positive retention rate, dollar based positive retention rate.
And what we mean by that is every cohort whether you look at it from a revenue standpoint or a gross profit standpoint continues show growth year after year. And that's true for even our earliest 2010 cohorts. So 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. So I think as you look forward, you should continue to expect ongoing margin improvement, a 12 point increase year over year, certainly a big improvement.
I don't know if we would sign up to keep doing it at that pace. But as you look into 2017 2018, our expectation is you'll continue to see solid margin expansion from Square.
Thank you.
Thank you.
And your next question comes from the line of Tien Tsin Huang with JPMorgan.
Okay, thank you. Congrats on the EBITDA up side here. Just want 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 and things like that?
Yes. Thanks for the question, Simpson. We so we're really we've been really pleased with the momentum of the contactless and ship card reader. So 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. So we definitely see it being purchased from our small sellers who use it in a very mobile environment on the side of a road, for instance, farmer stands 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. 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. So we're going to push as much as possible into tap Apple Pay, Android Pay, tapping with the card and that's also reflective of some of the momentum we're 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 Bottle Rock Festival, 14% tap of overall transaction. So 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 the how the market is transitioning and what customers expect.
So 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. So we're pushing really hard on it.
So 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. So 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 curious what you're thinking as you're in the balance of the year?
Yes. We haven't been experiencing the challenges that our competitors are mentioning. And I think a big part of that is we've really focused on the onboarding experience so that when you square, you don't have to think about anything about making the sale. So 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.
So 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 contact list and the ship 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. So all has been pretty healthy.
Great. I'm all set. Thank you.
And your next question comes from the line of Darrin Peller with Barclays.
Thanks, guys. It's great to see the return to 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. So be sure that just to be sure that you have the capacity to keep growing at that rate given the new investors you've onboarded, number 1. And then 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, Kind of what percentage of merchants now have an attachment to other products?
And I'm assuming that opportunity is still really large. Thanks guys.
Great. Thanks, Darren. So yes, on the capital side, delighted as I mentioned with the new investors that we've added. So we feel like we have a lot of capacity from an actual dollar perspective of what's coming into the program. And then on the other side in terms of seller demand, still a lot of opportunity in our installed base.
I think a couple of things driving that. 1st and foremost, we continue to grow every quarter. As we just showed, our GPV grew 42% year over year. So that's all net new opportunity to us. I think in particular as we move up market towards the larger sellers that also gives us an opportunity with capital to move into a slightly larger loan sizes.
We typically try to extend about 10% to 15% of your GPV. We think that's a good amount to enable you to grow your business without getting overburdened. But clearly as we have 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. So 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 data line, I do want to keep coming back to the fact that we all of our products are software in effect, when we monetize through payments and you see that in the transaction margin portion of adjusted revenue and when we monetize directly. So 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 $2,300,000,000 in GPV on that product alone, and it's only about 2 years old. And 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, 60,000 about 60,000 loans in the first half of this year compared 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 2,000,000 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. So I think overall for our base of 1,000,000, we're starting to see products get up into the 100,000 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, Eric. 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? We'll not have to change at all to keep going at that rate with larger and larger merchants. Just again, it's a great growth rate, especially given the transaction margin being relatively stable.
Maybe more color on that?
Yes. Darren, thanks for the question. This is Jack. Off market has definitely been a key focus for us and we're finally at a place where our tools scale to any size of seller. So 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.
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. Our 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.
So employee management, as we indicated in the letter, through Steve's winery uses this to attract 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 the Scottish Plumber who employees in the field can use invoices to bill their customers online. And 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. 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 and 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 extra 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're seeing that around their neighborhood and they're looking into, well, it actually worked for me and 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, Aaron.
And 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. I thought it was interesting in the shareholder letter you 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 you're having the most success in? I mean, 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. So 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 the speed, the access to capital is also critical and not something that larger sellers are usually used to. But I think 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.
So 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 N to N 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 track. So 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 when small and large.
Okay. And just another question, maybe you have some perspective on. I mean, you're continuing to deliver some really nice upside to your guidance each quarter. So on the net revenue side of that, I mean, 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
Sure
Sure. Thanks, Jason. It's actually our performance across the board. So 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. So 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. And like I 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 promised them that you'll never miss a sale if 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.
So they start at the farmers stall, farmers market stall and then they can become a multi, multi location business that we now support in the U. S. And in Japan, for example. And then I think the 3rd 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 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're able to use it for their entire business.
So no longer just their mobile installation, but instead they're coming back to their restaurants and they can use Square everywhere throughout their business. So I think those are the reasons why I think we continue to see that outperformance just in the payment piece. And then I think there are areas like capital instant deposits, even caviar that have all been nicely ahead of plan. And I think again that speaks to the brand really resonates when we go back into our installed base. And remember with our larger sellers, they're in their dashboard on a daily basis, 78 percent 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. So I feel like right now the growth is being driven across many, 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 3.5 millimeter headphone jack. Do you foresee any conflict with this?
Thanks, Jay, for the question and 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. And we want to make sure that they're always a step ahead of everything that might change or will change in the future. So one of the reasons we're super excited about our contactless and chip card reader is that it 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'll still always be able to make the sale.
And your 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 and having not been through a downturn, what are the kind of things that you continue to see 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 can we are a large U.
S. Reseller. We are largely taking commerce. I think what gets me excited for our business even in a tougher macro downturn is our ability to take share. So 1st and foremost, what I would say is what we do is not discretionary.
So 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. And so, I think you needed to run your business. So 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.
So today it is absolutely a reason why we win. So our 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. So 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 the 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 their acceptance or the ongoing fee to pay out to their merchant acquirer. And they're having to think about just the overlay of having to stitch that altogether and probably pay employees to do that for them.
So 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. And I think our total cost of ownership could actually resonate even stronger frankly in a tougher environment. Those are really the 2 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. 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 kind of 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, in fact 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 you get down the road from bigger sellers?
Sure. So it really shows how different we are that we don't even use a lot of those terms in term life. But 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? We'll start there. So 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. But 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 actually 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're getting that they're paying for via a payments business model. So 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?
Yes, exactly.
So I think there that's 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 5 quarters. But in fact, if you went back over the last 3 or 4 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. And certainly, when you look elsewhere, those margins tend to be a lot lower. And I think it comes back to speaking to the fact that sellers are getting much more a much bigger set of products.
They're getting access to a lot more technology. They're 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. That answer your question?
It does. Thank you.
Great. Thank you.
Next question comes from the line of Scott Debit with Stifel.
Hey, thanks for taking the question. The follow-up on the attach rate question from earlier, but 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. So I think I'll take small versus large first because I think it depends a little bit on the product. So 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 the merchant could be. But we have taken capital all the way up to $100,000 So again, we'll give you a good indication of how big of a merchant that we can go to.
The capital is very broad based versus and 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, not 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. 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, so they remember our merchants come to us.
So there's no kind of random walk down Main Street that happens first. They hit our website 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. And I think when the sales person is involved, often they're 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 3 Steve's 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, every month, every quarter, every year to look at how it's changed. And then with that, we're very, very targeted in how we go back to say, okay, here's a merchant who a year ago didn't make sense to target them with, for example, payroll. But now a year on, clearly, we can see they're utilizing a tool like employee management, so they must have employees. So now we absolutely should target them with a product like payroll.
So 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. And 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 Creation. 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 relatively new business with other startup priorities, I have resisted changing at this time. But to be honest, the only thing keeping me from changing is reliability.
Thanks, Sherry, for the question and also being a Square customer. You're right, reliability is incredibly important to our sellers and to us and it's 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 fail us. And 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.
And that's because we're not just offering 1 processing rate, the whole package is in one app and one system. So we're not breaking up our hardware point of sale and any hidden payment fees. Everything is in one simple rate and that started 7 years ago for us. So this is something we've gotten really, really good at. And it's not just about the payments aspect, but also the entire ecosystem that you need to make really good decisions around your business.
And 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. And also we have fast access to your capital. So 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 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. Good evening. Hey, the question I have is around thinking of Square Capital and the incremental GPV that it provides for you guys. So 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 supercapital customers are using.
If they're purchasing inventory at 50%, they're buying new equipment and marketing. I mean, those are all big drivers, I would think, to GPB, but I haven't really seen a statistic that you guys have produced. So can you just give us any color around that?
Yes. It's a great question and 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. It's really the underlying question is, does the seller grow more once they receive Square Capital? So what does the seller's GPV look like pre and post? And 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, etcetera.
So that is certainly something that I think this is us to get better and better 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. So 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.
So 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 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'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. How
when we think of Square Capital,
I mean, I suspect that's got to be a significant component to that. Would you say it's just one of the major drivers of that total cost
of ownership? Or is it
is there another, I guess, subset of product that really is driving that?
Yes. 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. So for still a large portion of Square sellers, they wouldn't even get on the system to begin with. So they wouldn't even have a conversation about total cost of ownership.
But 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 then have all of the fees that go alongside payments, of CCI fees, chargeback fees, etcetera, etcetera. And so 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 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.
And 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. So I think there it's less about TCO for the seller and more about just 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, right?
Click of a button in your account the next day, you pay back on every swipe as a net. 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 $15,000,000 above your midpoint, would have even been higher if you had backed out some of those transaction loss adjustments. So just help us understand maybe what were the sources of positive surprise outside of the top line? I think you talked to that pretty well.
And then 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 level. So maybe what are some of the major moving parts we should be thinking about there as well?
Sure. Thanks, Josh. So I think in terms of upside, so you're right. A lot of it came from the top line. So we were very pleased with how the top line performed and that clearly filled the whole way down the model in terms of then providing EBITDA upside.
I think if you look at across our operating lines and 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 and then 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've 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. So 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.
So 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, it's not unique to Square, but it's hard for us to forecast at the moment is employer taxes. So 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 and 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 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.
And so we really want you to take that guidance seriously for Q3, the $5,000,000 to $6,000,000 in EBITDA because that does incorporate a fairly hefty employer tax piece. And I think we probably have the better information internally to Square to be able to forecast that. But 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. And 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?
Yes. 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. 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 BigCommerce, Weebly, WooCommerce, Wix and others. So 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 largest sellers have taken to it and how great 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. And as we look out 2017, 2018 longer term, what would you expect that 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 3 components. It has transaction margin, from the piece that is monetized through payments software and data revenue, which I think of it 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, because in some cases like an invoices product, it's a software product. 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. And we want the team to feel like they have degrees of freedom to either pay for it through transaction, have a customer pay for it through transaction profit or have them pay a direct software fee. So that's why I actually don't want to get too focused on what percentage 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?
Yes, that makes sense. But 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. But I think some of those products are so different that it's important to understand for investors to understand which of those software products, call them all software related products. I mean capital is a lot different and I know an invoice and some of these are very different than the others.
But I do think it's important to understand for investors to understand those different products over time.
Yes. So then maybe rather than as a percent, then I would come back to each of those products. So within the software and data line, we're effectively we're getting paid on a more direct basis. The 3 biggest and really the 2 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 1% off every transaction that happens via an 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 is 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 kind of do the multiplication to get down to what you think the addressable market is in the base. And then 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. So I think 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 I think Caviar is still growing at a very hefty rate. We're pleased with the traction that we've seen, predicting in kind of core cities where we believe we're in right out there with the leading products, cities like New York and San Francisco. And so I would kind of base it on a growth rate. And then 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 instance, deposits and then the fee we take of it. I think if you model those 3, 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. And now we have time for one last question.
And your last question comes from the line of Neel Doshi with Mizuho.
Great. Thanks for squeezing me in guys. In terms of PayPal working capital and American Express working capital, how do you view those as competing products? And then would you ever consider opening up Square Capital to non Square hardware customers? And then if we could maybe just get an update on the Square e Commerce solution and Square Marketing Solutions for small businesses, that would be great.
Thanks.
Sure. So let me talk a little, 1st of all, in terms of competitive differentiation, visavis 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 installed base. And 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 core merchants, I think we look at all alternatives here of how can we grow the overall portfolio 1st core capital, it may be using the muscle of what we know in terms of if we have payments data, how we're able to underwrite merchants? Does that need to be our payments data? Not necessarily.
It's certainly an option that we think about. And then 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? And I think there's many more places just even within the Square ecosystem that we can do that. And then in terms of CRM, the Square CRM solution?
Yes, Neal, this is Shaq. In terms of e commerce cycle, we're putting a lot of energy into the API and the build on Square platform. That's where we're seeing a lot of the growth and 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. And 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 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. 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 Q3 earnings call on November 1. Thanks again for participating.
Ladies and gentlemen, thank you for participating in today's program. This does conclude the program. You may all disconnect.