XYZ Did the Loss Really Double, or Is $50 Million of Litigation Hiding the Real Story?

Two Very Different Stories, One Headline Number

This Form 10-Q, covering the quarter ended March 31, 2016 and filed with the SEC on May 6, 2016, is Square's first quarterly report as a public company, following the FY2015 annual report covered here previously. On the surface, the quarter looks worse: GAAP operating loss widened from $(46.4) million to $(97.1) million, and net loss nearly doubled from $(48.0) million to $(96.8) million.

That headline number is almost entirely one thing: a $50.0 million litigation accrual recorded in general and administrative expenses, tied to Square's long-running ownership dispute with early collaborator Robert Morley and REM Holdings 3, LLC - the same dispute flagged here last quarter as an "unresolved, if likely long-shot, claim on the company's own ownership structure." It isn't a long shot anymore (see Beyond the Usual below). Back out that single accrual, and operating loss would have widened by less than $1 million on 51% revenue growth - which is closer to what actually happened to the business this quarter than the reported number suggests.

Underneath that one distorting line, the ordinary parts of the business kept doing what they'd been doing: GPV^» grew 45% to $10.3 billion, Adjusted Revenue^» grew 64% to $146.2 million, and Adjusted EBITDA^» loss narrowed by more than half, from $(20.1) million to $(9.1) million. The recurring-revenue diversification thesis from last quarter's post - software and data products growing faster than the core payments business - kept compounding: software and data product revenue grew 197% to $23.8 million, now 6% of total net revenue versus 3% a year earlier. Square also began serving sellers in Australia during the quarter, a fourth country alongside the U.S., Canada, and Japan, though international revenue is still just 3.2% of the total - early enough that it doesn't move the consolidated numbers yet, same as it wasn't last quarter.

The one place hardware tells a genuinely mixed story: hardware revenue jumped 634% to $16.2 million on the launch of Square's EMV (Europay, Mastercard, and Visa chip-card standard) and NFC reader in late 2015, but hardware costs grew even faster (537%, to $26.7 million) - Square is still selling reader hardware for less than it costs to make, a deliberate loss-leader bet to get EMV-compliant readers into sellers' hands ahead of the October 2015 U.S. liability-shift deadline, not a margin problem to be alarmed about on its own.

The Prescription

Square should keep leaning into the same mix shift the FY2015 numbers first showed: software and data products (Square Capital, Caviar, instant deposits) are growing at multiples of the core payments business and are the actual path to a profitable business model, not incremental GPV growth on an already-thin transaction margin. This quarter reinforces that read - software and data product revenue nearly tripled year-over-year while transaction revenue grew 42% - and it's the mix the market should be pricing, not the noisy GAAP operating-loss line this quarter's litigation accrual distorted.

What it should stop doing: let founder and IP disputes fester for years and then resolve them all at once with a nine-figure-adjacent charge landing in a single quarter's income statement. The six-year-old Morley/REM dispute (see Beyond the Usual below) is exactly that pattern - a public company carrying an open-ended dispute this long should be settling it well before a public trial date forces its hand, not after.

Key Financial Metrics

Q1 2016 vs. Q1 2015 - consolidated, reported in USD (Square reports natively in USD, no FX conversion needed)

Metric	Q1 2016	Q1 2015	YoY
Total Net Revenue	$379.3M	$250.6M	✅ +51%
Adjusted EBITDA	$(9.1)M	$(20.1)M	✅ loss narrowed 55%
Operating Loss	$(97.1)M	$(46.4)M	⚠️ loss widened 110% (almost entirely the $50M litigation accrual - see above)
Net Loss	$(96.8)M	$(48.0)M	⚠️ loss widened 102%
Free Cash Flow»	$(23.0)M	$(21.4)M	⚠️ loss widened slightly
Cash and Cash Equivalents (period-end)	$370.6M	n/a - not disclosed for Mar 2015 in this filing	—

Balance sheet metric	Mar 2016	Dec 2015	Change
Total Assets	$945.1M	$894.8M	✅ +5.6%
Total Liabilities	$500.2M	$386.7M	⚠️ +29.4%
Total Stockholders' Equity	$444.9M	$508.0M	⚠️ -12.4%

Free Cash Flow here is operating cash flow of $(15.5) million less $7.5 million of capital expenditures, versus $(11.0) million operating cash flow less $10.4 million of capex a year earlier - a slightly wider cash burn, driven mainly by the same net-loss increase discussed above rather than a change in the underlying cash-conversion cycle (settlements receivable and customers payable, which move with GPV, actually swung to a larger net cash inflow than a year ago). Total stockholders' equity fell 12.4% sequentially purely because the quarter's $96.8 million net loss exceeded the $32.8 million added to additional paid-in capital from share-based compensation and option exercises - a mechanical consequence of the accrual above, not a capital-structure concern.

Operating loss "doubling" and net loss "doubling" are both mostly optical this quarter - a single $50 million litigation accrual accounts for essentially all of the operating-loss deterioration, while the metrics management actually uses to run the business (Adjusted EBITDA, Adjusted Revenue, GPV) all moved in the right direction, several of them substantially.

Key Operational Metrics

Q1 2016 vs. Q1 2015

Metric	Q1 2016	Q1 2015	YoY
GPV	$10,290M	$7,117M	✅ +45%
Adjusted Revenue	$146.2M	$89.2M	✅ +64%
Software & Data Product Revenue (% of total net revenue)	6%	3%	✅ +3pp
Hardware Revenue	$16.2M	$2.2M	✅ +634% (still sold below cost - see above)
International Revenue (% of total net revenue)	3.2%	3.0%	➡️ roughly flat
Countries served	4 (US, Canada, Japan, Australia added this quarter)	3	✅ +1

Square still does not disclose a total active-seller count, merchant retention metric, or average-revenue-per-seller figure anywhere in this filing - the same gap flagged in the FY2015 post, still open a quarter later. Square continues to operate as a single operating segment with no reportable segment breakdown, leaving no segment comparison to run, same as last quarter.

Stock Price: A Round Trip Inside One Quarter

Square's Class A stock closed 2015 at $13.09, then closed January 2016 at $8.77 - a 33% drop over its first full additional month of public trading - before recovering to close the quarter at $15.28 on March 31, 2016, a 74% rebound from that January month-end level and 17% above where it started the year. (These are month-end closing levels, not necessarily the exact intra-quarter high and low.) Square has not split its stock since its November 2015 IPO - confirmed against public split-history records, none show a forward split for the company at any point since - so these are the actual nominal prices quoted at the time, not split-adjusted figures. A formal two-year price-history comparison still isn't meaningful here - the stock has only traded publicly since November 19, 2015, so this quarter adds roughly three more months to a six-week trading history, not a multi-year window. The January dip and rebound track the broader early-2016 selloff in newly public, still-unprofitable tech names generally, rather than anything specific disclosed in this filing.

Beyond the Usual

The Ownership Dispute Called "Unable to Estimate" Turned Out to Cost $50 Million

Square's FY2015 annual report disclosed the Morley/REM ownership dispute (see the prior post) as a claim the company "is unable to estimate a possible loss or range of possible loss from" because "key aspects of the litigation may be resolved by summary judgment." That summary judgment motion was denied by the District Court on April 22, 2016. The same quarter, Square signed a binding term sheet stipulating the material terms of a settlement with Mr. Morley and REM, and recorded a $50.0 million charge in general and administrative expenses for the three months ended March 31, 2016 - a charge equal to more than half of the quarter's entire net loss. The final definitive settlement agreement had not yet been signed as of this filing, so Square states it can make no assurances about the specific monetary and nonmonetary terms beyond the accrued amount. A dispute the company told investors for years it couldn't size turned out to be sizable enough to swing the quarter's entire GAAP results on its own.

The $375 Million Credit Line Nobody's Touched

Square entered a new $375.0 million revolving secured credit facility in November 2015, maturing in November 2020 and secured by certain of the company's tangible and intangible assets. As of March 31, 2016, not a single dollar had been drawn against it - Square paid only the $0.1 million unused-commitment fee for the quarter. A newly public, still loss-making company carrying a fully undrawn $375 million facility on top of $443.8 million of cash, cash equivalents, and marketable securities is a considerably larger liquidity cushion than the balance sheet's cash line alone suggests.

The Food-Delivery Misclassification Suit Flagged Last Quarter Is Over

The Caviar worker-misclassification class action flagged here last quarter - Jeffry Levin's suit alleging Caviar couriers were misclassified as independent contractors - was dismissed in its entirety by the Northern District of California on May 2, 2016, after the court entered a notice of intent to dismiss on March 29, 2016. The parties stipulated that certain dismissed claims could still be pursued by a different courier, so the underlying legal theory isn't fully closed off industry-wide, but Square's own named exposure to this particular suit is gone.

A Retention Sweetener for Employees Sitting on Options Through the IPO Lockup

Effective August 31, 2015, Square modified all of its nonstatutory stock option grants to extend the post-termination exercise window for employees who had completed two years of service, to the earlier of three years from termination or one year following the IPO. The modification added $0.7 million of share-based compensation expense this quarter, with another $7.4 million still to be recognized over the remaining vesting periods of the affected grants - a real, multi-year cost of giving departing long-tenured employees more time to exercise their options around the IPO, rather than forcing an immediate decision.

An Unexplained "Statutory Liabilities" Line Growing Alongside the International Footprint

Square's "other non-current liabilities" line - $50.3 million at quarter-end - splits out $25.1 million of deferred rent and $24.2 million of "statutory liabilities," a category not broken down further in this filing. As Square's footprint expands into more jurisdictions (Canada, Japan, and now Australia), a growing statutory-liabilities line is worth watching in future filings for what it's actually composed of - it's plausibly payroll or VAT-related obligations tied to that international footprint, but the filing doesn't say so explicitly.

Target Valuation Range

~3.35x EV/TTM Revenue. Too early to call a fair-value range with real confidence - but on the metric Square itself wants investors to focus on (Adjusted Revenue), this quarter's multiple is barely different from the FY2015 year-end multiple, meaning the market hasn't meaningfully re-rated the stock despite a very different quarter's growth mix.

Market cap → enterprise value	Q1 2016 (period-end)
Share price (period-end)	$15.28
Shares outstanding (Class A + B)	335,270,441
Market capitalization	~$5.12 billion
Less: cash, cash equivalents, and short/long-term marketable securities	$443.8 million
Drawn debt	none (see Beyond the Usual above)
Enterprise value	~$4.68 billion

Using trailing-twelve-month figures reconstructed from the FY2015 annual report and this quarter (FY2015 total, less Q1 2015, plus Q1 2016):

Peer-multiple sanity check (TTM basis)	FY2015	Q1 2016 (TTM)	Change
Market capitalization	~$4.38 billion	~$5.12 billion	⚠️ up
Enterprise value	~$3.91 billion	~$4.68 billion	⚠️ up
TTM Revenue	-	~$1.40 billion	-
EV/TTM Revenue	~3.1x	~3.35x	⚠️ up modestly
TTM Adjusted Revenue	-	~$509 million	-
EV/TTM Adjusted Revenue	~8.7x	~9.2x	⚠️ up slightly
TTM GPV	-	~$38.8 billion	-
EV/TTM GPV	~0.11x	~0.12x	➖ essentially unchanged

The EV/TTM Adjusted Revenue multiple barely moved despite Adjusted Revenue growing 64% year-over-year this quarter alone - a multiple that barely moves while the growth rate it's supposedly pricing accelerates is itself a data point: the market was already pricing in fast Adjusted Revenue growth a quarter ago.

A full DCF still isn't attempted here, for the same reasons as last quarter plus one new one: Square remains GAAP loss-making, has barely five months of public trading history, and this quarter's own reported operating loss is distorted by a one-time $50 million litigation accrual that a discounted cash flow model would need to explicitly normalize out rather than extrapolate forward - exactly the kind of precision-dressed-as-speculation the peer- and self-referential multiples above are meant to avoid.

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