Back to your questions…
You then referenced some letters between Square and the SEC, but didn’t really explain what the
content was or why it was relevant to the specific discrepancy under discussion. I would greatly
appreciate a summary of those letters and a little more explanation of how they might explain a
41% decline in YOY revenue decline.
Saul was absolutely on the mark with his explanation to Frank that the supposed 41% decline had
to do with Schwab and Yahoo mistakenly comparing two different kinds of revenue – revenue that
included transaction fees with revenue that didn’t. I didn’t have a problem with that.
What I thought was funny was when Saul said that GAAP forced Square to report revenue that
included transaction fees but that Square was honest and reported it’s “true revenue” as adjusted
revenue. And that just didn’t square with the facts. Quite the opposite! So if you look back at the
exchange of letters between the SEC and Square you can see that Square had a choice about how it
wanted to report top line revenue – it could report revenue with transaction fees or without. And
Square chose to report top line with fees, using GAAP standards as a guide.
Below is what they said in one of their letters to the SEC. (When they say “gross basis” they mean
with fees, and when they say “net basis” they mean without fees.)
The Company considered whether to recognize revenue on a gross or net basis using the following
indicators from ASC 605-45:
a. The Company is the primary obligor in the arrangement. The Company acts as the merchant of
record for its sellers, and works directly with payment card networks and banks so that
sellers do not need to manage the complex systems, rules, and requirements of the payments
industry. As the merchant of record, Square is liable for the settlement of the underlying
transactions. The use of any third parties to process the transactions is not transparent to
sellers who view Square as the ultimate party responsible, as the Company is responsible for
remitting payments to the seller.
b. The Company has latitude in establishing price. The Company has complete latitude in
establishing the price charged to its customers for the service. The fee charged by the
Company is not contractually dependent upon the fee charged by suppliers, which primarily
consists of fees charged by payment card processors and payment card verification services.
As a result, the Company bears the margin risk and reward of the transaction.
c. The Company changes the product or performs part of the service. The Company provides the
interface between the seller and end consumer to enable the transaction to take place and the
Company is responsible for the service being provided. The Company also provides customer
service and issue resolution to its customers, including seller payment protection in certain
cases of fraud and unresolved disputes.
d. The Company has discretion in supplier selection. The Company has complete discretion in
selecting the suppliers with whom it contracts in providing payment processing services.
e. The Company is involved in the determination of product and service specifications. The
Company has complete discretion in determining the service specifications. For example,
the Company offers sellers a variety of settlement options, including instant settlement,
standard settlement terms, as well as the ability to hold seller funds if required.
f. The Company has credit risk. As noted above, the Company bears the risk of fraudulent
transactions as well as certain risks of return transactions and chargebacks. The Company
bears the risk as there is no refund of vendor fees when a fraudulent transaction occurs.
Based on the factors above, the Company determined that recognizing revenue on a gross basis is appropriate.
Now the reason they made that choice and why it’s significant is that Square has a different business model from its
competitors. Square sits between the merchant and the processors, and banks, and networks. Square is the merchant of
record for its sellers. “SQ” appears as the seller on the buyer’s credit card statement. Square assumes all the risk,
including fraud, defaults, and chargebacks. Square is not dependent on fees charged by suppliers but can establish its
own prices. Square can choose which intermediaries it wants to work with.
It’s competitors can’t do any of these things! That’s why that top line revenue is not phony or
trivial. There’s a relationship between gross payment volume, transaction-based revenue, and
adjusted revenue. That relationship is important to track, and that transaction-based revenue may
take on more meaning going forward because Square has control of it and its competitors don’t.
In any case, it wasn’t Square being forced…Square chose how to report.
Now, as to why they report adjusted revenue…it has nothing to do with honesty. It’s because right
now that’s how they manage the business, and more important it’s because their competitors all have a
business model where they pass through the transaction fees to their merchants. So Square would look
square reporting with fees when their competitors report without fees.
Here is what they say in their letter to the SEC:
The Company respectfully advises the Staff that it has revised the disclosure on page 58 to clarify that
Adjusted Revenue, with its exclusion of transaction costs, is a primary metric used by management to measure
the Company’s business performance, and as such, the Company believes that it would be useful for the investor
community in evaluating the Company’s business. In addition, the Company supplementally advises the Staff that
because other payment processors, including Heartland Payments, Global Payments, Vantiv, Evertec, and Fleetcor
exclude these costs in their net revenue calculation, the Company’s inclusion of the Adjusted Revenue non-GAAP
performance metric allows investors to more easily compare revenue metrics across these companies. These payment
processors exclude such transaction costs from their GAAP revenue because they pass these costs directly through
to their customers and do not bear the risk of these costs. However, the Company does bear the risk of these costs
as it does not merely pass through these costs to its customers. This increased comparability is afforded regardless
of whether or not a company passes these costs through to its customers.
As an aside, do you actually labor through all this sort of documentation and form a deep
understanding from what you’ve read before making any investment decision?
Hope this helps.