0001512673-18-000014.txt : 20181107 0001512673-18-000014.hdr.sgml : 20181107 20181107161930 ACCESSION NUMBER: 0001512673-18-000014 CONFORMED SUBMISSION TYPE: 10-Q PUBLIC DOCUMENT COUNT: 110 CONFORMED PERIOD OF REPORT: 20180930 FILED AS OF DATE: 20181107 DATE AS OF CHANGE: 20181107 FILER: COMPANY DATA: COMPANY CONFORMED NAME: Square, Inc. CENTRAL INDEX KEY: 0001512673 STANDARD INDUSTRIAL CLASSIFICATION: SERVICES-PREPACKAGED SOFTWARE [7372] IRS NUMBER: 800429876 STATE OF INCORPORATION: DE FISCAL YEAR END: 1231 FILING VALUES: FORM TYPE: 10-Q SEC ACT: 1934 Act SEC FILE NUMBER: 001-37622 FILM NUMBER: 181166607 BUSINESS ADDRESS: STREET 1: 1455 MARKET STREET STREET 2: SUITE 600 CITY: SAN FRANCISCO STATE: CA ZIP: 94103 BUSINESS PHONE: 415-375-3176 MAIL ADDRESS: STREET 1: 1455 MARKET STREET STREET 2: SUITE 600 CITY: SAN FRANCISCO STATE: CA ZIP: 94103 10-Q 1 q3fy18squareinc10-q.htm 10-Q Document
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
______________________
FORM 10-Q
______________________
(Mark One)
ý
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended September 30, 2018
OR
o
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from  ________ to ________
Commission File Number: 001-37622
______________________
Square, Inc.
(Exact name of registrant as specified in its charter)
______________________
Delaware
 
80-0429876
(State or other jurisdiction of
incorporation or organization)
 
(IRS Employer
Identification No.)

1455 Market Street, Suite 600
San Francisco, CA 94103
(Address of principal executive offices, including zip code)
(415) 375-3176
(Registrant’s telephone number, including area code)
______________________
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.    Yes  ý    No  o
Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit such files).    Yes  ý    No  o
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company, or an emerging growth company. See definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company,” and “emerging growth company” in Rule 12b-2 of the Exchange Act.
Large accelerated filer  ý   Accelerated filer  o   Non-accelerated filer  o Smaller reporting company  o Emerging growth company o

If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. o

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).    Yes  o    No  ý
As of November 2, 2018, the number of shares of the registrant’s Class A common stock outstanding was 308,397,662 and the number of shares of the registrant’s Class B common stock outstanding was 105,099,942.




TABLE OF CONTENTS
 


Page No.
PART I—Financial Information
 
 
PART II—Other Information
 




SPECIAL NOTE REGARDING FORWARD-LOOKING STATEMENTS

This Quarterly Report on Form 10-Q contains forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended, that involve substantial risks and uncertainties. Forward-looking statements generally relate to future events or our future financial or operating performance. In some cases, you can identify forward-looking statements because they contain words such as “may,” “will,” “appears,” “should,” “expects,” “plans,” “anticipates,” “could,” “intends,” “target,” “projects,” “contemplates,” “believes,” “estimates,” “predicts,” “potential,” or “continue,” or the negative of these words or other similar terms or expressions that concern our expectations, strategy, plans, or intentions. Forward-looking statements contained in this Quarterly Report on Form 10-Q include, but are not limited to, statements about our future financial performance, our anticipated growth and growth strategies and our ability to effectively manage that growth, our ability to invest in and develop our products and services to operate with changing technology, our anticipated expansion and growth in Gross Payment Volume (GPV) and revenue, including our expectations regarding larger sellers, our plans for international expansion, the expected impact of our recent acquisitions, our plans with respect to patents and other intellectual property, our expectations regarding litigation, our expectations regarding share-based compensation, our expectations regarding the impacts of accounting guidance, our expectations regarding restricted cash, the sufficiency of our cash and cash equivalents and cash generated from operations to meet our working capital and capital expenditure requirements, and our expected uses of proceeds from our convertible senior notes.
We have based the forward-looking statements on our current expectations and projections about future events and trends that we believe may affect our business, financial condition, results of operations, prospects, business strategy, and financial needs. The outcome of the events described in these forward-looking statements is subject to known and unknown risks, uncertainties, and other factors described in the section titled “Risk Factors” and elsewhere in this Quarterly Report on Form 10-Q. We operate in a very competitive and rapidly changing environment. New risks and uncertainties emerge from time to time and it is not possible for us to predict all risks and uncertainties that could have an impact on the forward-looking statements contained in this Quarterly Report on Form 10-Q. We cannot assure you that the results, events, and circumstances reflected in the forward-looking statements will be achieved or occur, and actual results, events, or circumstances could differ materially from those described in the forward-looking statements.
All forward-looking statements are based on information and estimates available to the Company at the time of this Quarterly Report on Form 10-Q and are not guarantees of future performance. We undertake no obligation to update any forward-looking statements made in this Quarterly Report on Form 10-Q to reflect events or circumstances after the date of this Quarterly Report on Form 10-Q or to reflect new information or the occurrence of unanticipated events, except as required by law.




Part I—Financial Information
Item 1. Financial Statements
SQUARE, INC.
CONDENSED CONSOLIDATED BALANCE SHEETS
(Unaudited)
(In thousands, except share and per share data)
 
September 30,
2018
 
December 31,
2017
Assets
 
 
 
Current assets:
 
 
 
Cash and cash equivalents
$
721,738

 
$
696,474

Short-term investments
448,986

 
169,576

Restricted cash
33,230

 
28,805

Settlements receivable
1,194,701

 
620,523

Customer funds
269,094

 
103,042

Loans held for sale
73,219

 
73,420

Other current assets
136,400

 
86,454

Total current assets
2,877,368

 
1,778,294

Property and equipment, net
130,145

 
91,496

Goodwill
259,964

 
58,327

Acquired intangible assets, net
81,130

 
14,334

Long-term investments
537,663

 
203,667

Restricted cash
10,102

 
9,802

Other non-current assets
76,996

 
31,350

Total assets
$
3,973,368

 
$
2,187,270

Liabilities and Stockholders’ Equity
 
 
 
Current liabilities:
 
 
 
Accounts payable
$
12,448

 
$
16,763

Customers payable
1,315,108

 
733,736

Settlements payable
203,274

 
114,788

Accrued transaction losses
35,332

 
26,893

Accrued expenses
101,066

 
52,280

Current portion of long-term debt
125,971

 

Other current liabilities
70,338

 
28,367

Total current liabilities
1,863,537

 
972,827

Long-term debt, net of current portion (Note 13)
897,976

 
358,572

Other non-current liabilities
89,711

 
69,538

Total liabilities
2,851,224

 
1,400,937

Commitments and contingencies (Note 18)

 

Stockholders’ equity:
 
 
 
Preferred stock, $0.0000001 par value: 100,000,000 shares authorized at September 30, 2018 and December 31, 2017. None issued and outstanding at September 30, 2018 and December 31, 2017.

 

Class A common stock, $0.0000001 par value: 1,000,000,000 shares authorized at September 30, 2018 and December 31, 2017; 306,228,873 and 280,400,813 issued and outstanding at September 30, 2018 and December 31, 2017, respectively.

 

Class B common stock, $0.0000001 par value: 500,000,000 shares authorized at September 30, 2018 and December 31, 2017; 106,143,959 and 114,793,262 issued and outstanding at September 30, 2018 and December 31, 2017, respectively.

 

Additional paid-in capital
1,986,059

 
1,630,386

Accumulated other comprehensive loss
(6,345
)
 
(1,318
)
Accumulated deficit
(857,570
)
 
(842,735
)
Total stockholders’ equity
1,122,144

 
786,333

Total liabilities and stockholders’ equity
$
3,973,368

 
$
2,187,270

The accompanying notes are an integral part of these unaudited condensed consolidated financial statements.

4


SQUARE, INC.
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(Unaudited)
(In thousands, except per share data)

 
Three Months Ended September 30,
 
Nine Months Ended September 30,
 
2018
 
2017
 
2018
 
2017
Revenue:
 
 
 
 
 
 
 
Transaction-based revenue
$
655,384

 
$
510,019

 
$
1,803,649

 
$
1,395,562

Subscription and services-based revenue
166,203

 
65,051

 
397,589

 
173,262

Hardware revenue
17,558

 
10,089

 
50,337

 
29,394

Bitcoin revenue
42,963

 

 
114,074

 

Total net revenue
882,108

 
585,159

 
2,365,649

 
1,598,218

Cost of revenue:
 
 
 
 
 
 
 
Transaction-based costs
414,456

 
328,043

 
1,137,716

 
896,913

Subscription and services-based costs
47,078

 
18,169

 
117,230

 
51,161

Hardware costs
23,229

 
18,775

 
68,467

 
45,610

Bitcoin costs
42,408

 

 
112,876

 

Amortization of acquired technology
2,277

 
1,556

 
5,714

 
5,058

Total cost of revenue
529,448

 
366,543

 
1,442,003

 
998,742

Gross profit
352,660

 
218,616

 
923,646

 
599,476

Operating expenses:
 
 
 
 
 
 
 
Product development
135,773

 
82,547

 
355,668

 
229,255

Sales and marketing
116,337

 
66,533

 
291,846

 
176,349

General and administrative
85,527

 
64,312

 
243,800

 
184,235

Transaction, loan and advance losses
23,596

 
19,893

 
63,603

 
50,185

Amortization of acquired customer assets
1,294

 
222

 
2,235

 
649

Total operating expenses
362,527

 
233,507

 
957,152

 
640,673

Operating loss
(9,867
)
 
(14,891
)
 
(33,506
)
 
(41,197
)
Interest expense, net
7,224

 
3,080

 
12,806

 
7,570

Other income, net
(37,800
)
 
(1,226
)
 
(37,908
)
 
(1,951
)
Income (loss) before income tax
20,709

 
(16,745
)
 
(8,404
)
 
(46,816
)
Provision (benefit) for income taxes
1,066

 
(647
)
 
1,845

 
334

Net income (loss)
$
19,643

 
$
(16,098
)
 
$
(10,249
)
 
$
(47,150
)
Net income (loss) per share:
 
 
 
 
 
 
 
Basic
$
0.05

 
$
(0.04
)
 
$
(0.03
)
 
$
(0.13
)
Diluted
$
0.04

 
$
(0.04
)
 
$
(0.03
)
 
$
(0.13
)
Weighted-average shares used to compute net income (loss) per share
 
 
 
 
 
 
 
Basic
409,690

 
383,951

 
402,980

 
375,743

Diluted
474,915

 
383,951

 
402,980

 
375,743

The accompanying notes are an integral part of these unaudited condensed consolidated financial statements.

5


SQUARE, INC.
CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (LOSS)
(Unaudited)
(In thousands)

 
Three Months Ended September 30,
 
Nine Months Ended September 30,
 
2018
 
2017
 
2018
 
2017
Net income (loss)
$
19,643

 
$
(16,098
)
 
$
(10,249
)
 
$
(47,150
)
Net foreign currency translation adjustments
(946
)
 
367

 
(3,341
)
 
1,554

Net unrealized gain (loss) on revaluation of intercompany loans
(296
)
 
(41
)
 
$
(89
)
 
$
362

Net unrealized gain (loss) on marketable debt securities
(647
)
 
(200
)
 
(1,597
)
 
(320
)
Total comprehensive income (loss)
$
17,754

 
$
(15,972
)
 
$
(15,276
)
 
$
(45,554
)

The accompanying notes are an integral part of these unaudited condensed consolidated financial statements.

6


SQUARE, INC.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)
(In thousands)
 
Nine Months Ended September 30,
 
2018
 
2017
Cash flows from operating activities:
 
 
 
Net loss
$
(10,249
)
 
$
(47,150
)
Adjustments to reconcile net loss to net cash provided by operating activities:
 
 
 
Depreciation and amortization
38,323

 
27,647

Non-cash interest and other expense
23,554

 
9,969

Loss on extinguishment of long-term debt
1,625

 

Share-based compensation
157,856

 
111,311

Replacement stock awards issued in connection with acquisition
899

 

Gain on revaluation of equity investment
(36,908
)
 

Recovery of common stock in connection with indemnification settlement agreement
(2,745
)
 

Transaction, loan and advance losses
63,603

 
50,185

Change in deferred income taxes
(563
)
 
133

Changes in operating assets and liabilities:
 
 
 
Settlements receivable
(579,769
)
 
(271,235
)
Customer funds
(156,162
)
 
(41,899
)
Purchase of loans held for sale
(1,139,142
)
 
(874,498
)
Sales and principal payments of loans held for sale
1,130,378

 
852,187

Other current assets
(50,060
)
 
(6,262
)
Other non-current assets
(8,875
)
 
(1,699
)
Accounts payable
(6,470
)
 
1,223

Customers payable
581,530

 
295,406

Settlements payable
88,486

 
30,263

Charge-offs to accrued transaction losses
(40,354
)
 
(33,081
)
Accrued expenses
31,015

 
20,328

Other current liabilities
27,230

 
(1,125
)
Other non-current liabilities
5,458

 
8,614

Net cash provided by operating activities
118,660

 
130,317

Cash flows from investing activities:
 
 
 
Purchase of marketable debt securities
(859,060
)
 
(485,484
)
Proceeds from maturities of marketable debt securities
128,603

 
106,079

Proceeds from sale of marketable debt securities
106,358

 
65,121

Purchase of property and equipment
(37,173
)
 
(19,625
)
Purchase of equity investment

 
(25,000
)
Purchase of intangible assets
(1,584
)
 

Business combinations, net of cash acquired
(112,399
)
 
(1,600
)
Net cash used in investing activities
(775,255
)
 
(360,509
)
Cash flows from financing activities:
 
 
 
Proceeds from issuance of convertible senior notes, net
855,663

 
428,250

Purchase of convertible senior note hedges
(172,586
)
 
(92,136
)
Proceeds from issuance of warrants
112,125

 
57,244

Principal payment on conversion of senior notes
(70,047
)
 

Payment of deferred purchase consideration
(640
)
 

Payment for termination of Starbucks warrant

 
(54,808
)
Principal payments on capital lease obligation
(2,658
)
 
(1,020
)
Proceeds from the exercise of stock options and purchases under the employee stock purchase plan, net
94,780

 
111,889

Payments for tax withholding related to vesting of restricted stock units
(125,899
)
 
(18,298
)
Net cash provided by financing activities
690,738

 
431,121

Effect of foreign exchange rate on cash and cash equivalents
(4,154
)
 
3,836

Net increase in cash, cash equivalents and restricted cash
29,989

 
204,765

Cash, cash equivalents and restricted cash, beginning of period
735,081

 
488,745

Cash, cash equivalents and restricted cash, end of period
$
765,070

 
$
693,510

The accompanying notes are an integral part of these unaudited condensed consolidated financial statements.

7

SQUARE, INC.
NOTES TO THE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)


NOTE 1 - DESCRIPTION OF BUSINESS AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Business
    
Square, Inc. (together with its subsidiaries, Square or the Company) creates tools that help sellers start, run, and grow their businesses. Square enables sellers to accept card payments and also provides reporting and analytics, next-day settlement, and chargeback protection. Square’s point-of-sale software and other business services help sellers manage inventory, locations, and employees; access financing; engage buyers; build a website or online store; and grow sales. The Cash App is an easy way to send, spend, and receive money, and Caviar is a food-ordering platform. Square was founded in 2009 and is headquartered in San Francisco, with offices in the United States, Canada, Japan, Australia, Ireland, and the UK.

Reclassifications and Other Adjustments

During the third quarter of 2018, the Company has reclassified prior period balances within interest and other (income) expense, net, to disaggregate the amounts and separately present interest (income) expense, net and other (income) expense, net on its consolidated statements of operations to conform to the current period presentation. This classification change was made to provide clarity of the balances as the activity continues to grow, particularly as a result of the impact of revaluation of an equity investment in the current period. During both the three and nine months ended September 30, 2018, the Company recorded a gain of $36.9 million to other income on the consolidated statements of operations arising from revaluation of this investment (Note 12). There was no impact to the net income (loss) on its consolidated statements of operations to any of the periods presented as result of this change.

Basis of Presentation
    
The accompanying interim condensed consolidated financial statements of the Company are unaudited. These interim condensed consolidated financial statements have been prepared in accordance with generally accepted accounting principles in the United States of America (U.S. GAAP) and the applicable rules and regulations of the Securities and Exchange Commission (SEC) for interim financial information. Accordingly, they do not include all of the information and footnotes required by U.S. GAAP for complete financial statements. The December 31, 2017 condensed consolidated balance sheet was derived from the audited financial statements as of that date, but does not include all of the information and footnotes required by U.S. GAAP for complete financial statements.

The accompanying unaudited interim condensed consolidated financial statements have been prepared on the same basis as the audited consolidated financial statements and, in the opinion of management, reflect all adjustments of a normal recurring nature considered necessary to state fairly the Company's consolidated financial position, results of operations, comprehensive income (loss), and cash flows for the interim periods. All intercompany transactions and balances have been eliminated in consolidation. The interim results for the three and nine months ended September 30, 2018 are not necessarily indicative of the results that may be expected for the year ending December 31, 2018, or for any other future annual or interim period.

The information included in this Quarterly Report on Form 10-Q should be read in conjunction with “Management’s Discussion and Analysis of Financial Condition and Results of Operations,” “Quantitative and Qualitative Disclosures About Market Risk,” and the Consolidated Financial Statements and notes thereto included in Items 7, 7A, and 8, respectively, in the Company's Annual Report on Form 10-K for the year ended December 31, 2017.

Use of Estimates
The preparation of the Company’s consolidated financial statements in conformity with U.S. GAAP requires management to make estimates and assumptions that affect the reported amounts of assets, liabilities, revenue and expenses, as well as related disclosure of contingent assets and liabilities. Actual results could differ from the Company’s estimates. To the extent that there are material differences between these estimates and actual results, the Company’s financial condition or operating results will be materially affected. The Company bases its estimates on past experience and other assumptions that the Company believes are reasonable under the circumstances, and the Company evaluates these estimates on an ongoing basis.

Estimates, judgments, and assumptions in these consolidated financial statements include, but are not limited to, those related to revenue recognition, accrued transaction losses, valuation of the debt component of convertible senior notes, valuation

8


of loans held for sale, goodwill, acquired intangible assets and deferred revenue, income and other taxes, and share-based compensation.

Concentration of Credit Risk
    
For the three and nine months ended September 30, 2018 and 2017, the Company had no customer that accounted for greater than 10% of total net revenue.

The Company had three third-party payment processors that represented approximately 50%, 37%, and 9% of settlements receivable as of September 30, 2018. The same three parties represented approximately 46%, 42%, and 8% of settlements receivable as of December 31, 2017. All other third-party processors were insignificant.

Financial instruments that potentially subject the Company to concentrations of credit risk consist primarily of cash and cash equivalents, restricted cash, marketable debt securities, settlements receivables, customer funds, and loans held for sale. The associated risk of concentration for cash and cash equivalents and restricted cash is mitigated by banking with creditworthy institutions. At certain times, amounts on deposit exceed federal deposit insurance limits. The associated risk of concentration for marketable debt securities is mitigated by holding a diversified portfolio of highly rated investments. Settlements receivable are amounts due from well-established payment processing companies and normally take one or two business days to settle which mitigates the associated risk of concentration. The associated risk of concentration for loans held for sale is partially mitigated by credit evaluations that are performed prior to facilitating the offering of loans and ongoing performance monitoring of the Company’s loan customers.

Accounting Policies
Except for the adoption of ASC 606, Revenue from Contracts with Customers (ASC 606), described in Note 2, and the accounting policy on cryptocurrency transactions and customer funds, both described below, there have been no material changes to the Company’s accounting policies during the nine months ended September 30, 2018, as compared to the accounting policies described in the Company’s Annual Report on Form 10-K for the year ended December 31, 2017.

Cryptocurrency transactions

During the fourth quarter of 2017, the Company started offering its Cash App customers the ability to purchase bitcoin, a cryptocurrency denominated asset, from the Company. The Company purchases bitcoin from private broker dealers or from Cash App customers. Upon purchase, the Company records the cost of bitcoin within other current assets in its consolidated balance sheets. Upon sale, the Company records the total sale amount received from customers as bitcoin revenue and the associated cost as cost of revenue. The carrying value of bitcoin held by the Company was $0.2 million and $0.3 million as of September 30, 2018 and December 31, 2017, respectively. The Company assesses the carrying value of bitcoin held by the Company at each reporting date and records an impairment charge if the cost exceeds the fair value. Losses on bitcoin for the three and nine months ended September 30, 2018, were insignificant.

Customer funds

Customer funds represent Cash App customers' stored balances that customers can later use to send money or make payments, or customers with cash in transit. As of December 31, 2017, the Company held these stored balances as short term bank deposits. During the third quarter of 2018, the Company started investing a portion of these stored balances in short-term marketable debt securities (Note 5).

Recent Accounting Pronouncements

Recently issued accounting pronouncements not yet adopted

In February 2016, the Financial Accounting Standards Board (FASB) issued Accounting Standards Update (ASU) No. 2016-02, Leases, which will require, among other items, lessees to recognize a right of use asset and a related lease liability for most leases on the balance sheet. Qualitative and quantitative disclosures will be enhanced to better understand the amount, timing and uncertainty of cash flows arising from leases. This guidance is effective for financial statements issued for fiscal years beginning after December 15, 2018, and interim periods within those fiscal years, with early adoption permitted. The new standard should be applied on a modified retrospective basis. The Company does not plan to early adopt this guidance. The

9


Company’s operating leases primarily comprise of office facilities, with the most significant leases relating to corporate headquarters in San Francisco and an office in New York. While the Company continues to evaluate the impact of adopting this guidance on its consolidated financial statements, it does expect to record material right to use assets and related lease liabilities on its consolidated balance sheets upon adoption, which will increase total assets and liabilities.
    
In June 2016, the FASB issued ASU No. 2016-13, Measurement of Credit Losses on Financial Instruments, which requires measurement and recognition of expected credit losses for financial assets held. This guidance is effective for financial statements issued for fiscal years beginning after December 15, 2019, and interim periods within those fiscal years. Early adoption is permitted for fiscal years beginning after December 15, 2018, and interim periods within those fiscal years. The Company is currently evaluating the impact this guidance may have on the consolidated financial statements and related disclosures.

In January 2017, the FASB issued ASU No. 2017-04, Simplifying the Test for Goodwill Impairment. The new guidance eliminates the requirement to calculate the implied fair value of goodwill assuming a hypothetical purchase price allocation (i.e., Step 2 of the goodwill impairment test) to measure a goodwill impairment charge. Instead, entities will record an impairment charge based on the excess of a reporting unit’s carrying amount over its fair value, not to exceed the carrying amount of goodwill. This standard should be adopted when the Company performs its annual or any interim goodwill impairment tests in fiscal years beginning after December 15, 2019, with early adoption permitted. The amendments should be applied on a prospective basis. The Company does not expect the adoption of this guidance to have a material impact on the consolidated financial statements and related disclosures.

In March 2017, the FASB issued ASU No. 2017-08, Premium Amortization on Purchased Callable Debt Securities, which amends the amortization period for certain purchased callable debt securities held at a premium, shortening such period to the earliest call date. This standard is effective for annual periods beginning after December 15, 2018, and interim periods within those fiscal years, with early adoption permitted. The amendments in this guidance should be applied on a modified retrospective basis through a cumulative-effect adjustment directly to retained earnings as of the beginning of the period of adoption. The Company is currently evaluating the impact this guidance may have on the consolidated financial statements and related disclosures.

In February 2018, the FASB issued ASU 2018-02, Reclassification of Certain Tax Effects from Accumulated Other Comprehensive Income. When the Tax Cuts and Jobs Act of 2017 was enacted in December 2017, there was a valuation allowance on the deferred tax assets included within the Company's accumulated other comprehensive income; therefore no tax expense resulted from the change in the federal income tax rate. This guidance allows companies to reclassify such tax effects from accumulated other comprehensive income to retained earnings. This guidance is effective for financial statements issued for fiscal years beginning after December 15, 2018, and interim periods within those fiscal years, with early adoption permitted. The Company does not expect the adoption of this guidance to have a material impact on the consolidated financial statements and related disclosures.

In July 2018, the FASB issued ASU 2018-13, Changes to the Disclosure Requirements for Fair Value Measurement, which will remove, modify and add disclosure requirements for fair value measurements to improve the overall usefulness of such disclosures. This guidance is effective for financial statements issued for fiscal years beginning after December 15, 2019, and interim periods within those fiscal years, with early adoption permitted for any removed or modified disclosure requirements. Transition is on a prospective basis for the new and modified disclosures, and on a retrospective basis for disclosures that have been eliminated. The Company is currently evaluating the impact this guidance may have on the consolidated financial statements and related disclosures.

In August 2018, the FASB issued ASU 2018-15, Customer’s Accounting for Implementation Costs Incurred in a Cloud Computing Arrangement That Is a Service Contract, which is intended to align the requirements for capitalization of implementation costs incurred in a cloud computing arrangement that is a service contract with the existing guidance for internal-use software. This guidance is effective for financial statements issued for fiscal years beginning after December 15, 2019, and interim periods within those fiscal years, with early adoption permitted. The guidance provides flexibility in adoption, allowing for either retrospective adjustment or prospective adjustment for all implementation costs incurred after the date of adoption. The Company is currently evaluating the impact this guidance may have on the consolidated financial statements and related disclosures.


10


NOTE 2 - REVENUE

Adoption of ASC 606, Revenue from Contracts with Customers

On January 1, 2018, the Company adopted ASC 606 using the modified retrospective method applied to those contracts which were not completed as of January 1, 2018. Results for reporting periods beginning after January 1, 2018 are presented under ASC 606, while prior period amounts are not adjusted and continue to be reported in accordance with the Company's historic revenue recognition methodology under ASC 605, Revenue Recognition.

The Company recorded a net reduction to retained earnings of $4.6 million as of January 1, 2018, due to the cumulative impact of adopting ASC 606, primarily related to the effect on revenue and associated cost of revenue from hardware sold through the retail distribution channels and hardware installment sales. The impact to revenue for the three and nine months ended September 30, 2018 was an increase of $1.6 million and $5.3 million, respectively, as a result of applying ASC 606.

For the three months ended September 30, 2018, the revenue recognized from contracts with customers was $857.7 million and revenue from other sources was $24.5 million. For the nine months ended September 30, 2018, the revenue recognized from contracts with customers was $2,298.7 million and revenue from other sources was $67.0 million. Impairment losses arising from contracts with customers were $0.9 million and $2.7 million for the three and nine months ended September 30, 2018, respectively.

The impact of adoption of ASC 606 on the Company's condensed consolidated statement of operations was as follows (in thousands):

 
Three Months Ended September 30, 2018
 
Nine Months Ended September 30, 2018
 
As reported
 
Balances without adoption
of ASC 606
 
Effect of change
 
As reported
 
Balances without adoption
of ASC 606
 
Effect of change
Impact on the Condensed Consolidated Statement of Operations:
 
 
 
 
 
 
 
 
 
 
 
Subscription and services-based revenue
$
166,203

 
$
166,037

 
$
166

 
$
397,589

 
$
397,272

 
$
317

Hardware revenue
17,558

 
16,145

 
1,413

 
50,337

 
45,378

 
4,959

Subscription and services-based costs
47,078

 
47,078

 

 
117,230

 
117,230

 

Hardware costs
$
23,229

 
$
21,969

 
$
1,260

 
$
68,467

 
$
63,665

 
$
4,802


The impact of adoption of ASC 606 on the Company's condensed consolidated balance sheets was as follows (in thousands):

 
September 30, 2018
 
As reported
 
Balances without adoption
of ASC 606
 
Effect of change
Impact on the Condensed Consolidated Balance Sheets:
 
 
 
 
 
Other current assets
$
136,400

 
$
148,491

 
$
(12,091
)
Other current liabilities
70,338

 
78,260

 
(7,922
)
Other non-current assets
76,996

 
78,584

 
(1,588
)
Other non-current liabilities
$
89,711

 
$
91,311

 
$
(1,600
)


11


Revenue Recognition

Revenue is recognized when control of the promised goods or services is transferred to customers, in an amount that reflects the consideration the Company expects to be entitled to in exchange for those goods or services. The Company's contracts with customers generally do not include multiple performance obligations with differing patterns of revenue recognition, except for domain name registration offered with website hosting services sold after May 31, 2018 following the acquisition of Weebly (Note 8).

The following table presents the Company's revenue from contracts with customers disaggregated by revenue source (in thousands):

 
Three Months Ended September 30,
 
Nine Months Ended September 30,
 
2018
 
2017
 
2018
 
2017
Revenue from Contracts with Customers:
 
 
 
 
 
 
 
Transaction-based revenue
$
655,384

 
$
510,019

 
$
1,803,649

 
$
1,395,562

Subscription and services-based revenue
141,752

 
65,051

 
330,637

 
173,262

Hardware revenue
17,558

 
10,089

 
50,337

 
29,394

Bitcoin revenue
$
42,963

 
$

 
$
114,074

 
$

         
Transaction-based revenue

The Company charges its sellers a transaction fee for managed payments solutions that is generally calculated as a percentage of the total transaction amount processed. The Company selectively offers custom pricing for certain sellers. The Company collects the transaction amount from the seller's customer's bank, net of acquiring interchange and assessment fees, processing fees, and bank settlement fees paid to third-party payment processors and financial institutions. The Company retains its fees and remits the net amount to the sellers.

The Company acts as the merchant of record for its sellers and works directly with payment card networks and banks so that its sellers do not need to manage the complex systems, rules, and requirements of the payments industry. The Company satisfies its performance obligations and therefore recognizes the transaction fees as revenue upon authorization of a transaction by the seller's customer's bank.

Revenue is recognized net of refunds, which arise from reversals of transactions initiated by sellers.

The transaction fees collected from sellers are recognized as revenue on a gross basis as the Company is the principal in the delivery of the managed payments solutions to the sellers. The Company has concluded it is the principal because as the merchant of record, it controls the services before delivery to the seller, it is primarily responsible for the delivery of the services to its sellers, and it has discretion in setting prices charged to sellers. The Company also has the unilateral ability to accept or reject a transaction based on criteria established by the Company. As the merchant of record, Square is liable for the costs of processing the transactions for its sellers, and records such costs within cost of revenue.

Subscription and services-based revenue

Subscription and services-based revenue is primarily comprised of revenue the Company generates from Instant Deposit and Cash Card, Caviar, website hosting and domain name registration services, and various other software as a service (SaaS) products.

Instant Deposit is a functionality within the Cash App and the Company's managed payments solution that enables customers, including individuals and sellers, to instantly deposit funds into their bank accounts. The Company charges a per transaction fee which is recognized as revenue when customers instantly deposit funds to their bank account. The Company also offers Cash App customers the ability to use funds stored in the Cash App via a Visa debit card, for which the Company charges a per transaction fee that is recorded as revenue.


12


Caviar is a food ordering platform that facilitates food delivery services. The Company's performance obligations are the delivery of food orders from restaurants to customers and the provision of catered meals to corporate customers. For delivery of food orders, the Company charges fees to restaurants, as sellers, and also charges delivery and service fees to individuals. For provision of catered meals the Company charges corporate customers a fee. All fees are billed upon delivery of food orders or catered meals, when the Company considers that it has satisfied its performance obligations. Revenue is recognized upon delivery of the food orders or catered meals, net of refunds. Refunds are estimated based on historical experience.

Following the acquisition of Weebly, the Company offers customers website hosting services for a fee that is generally billed at inception. The Company also acts as a reseller of domain names registration services for a registrar for a fee, which is also generally billed at inception. The Company considers that it satisfies its performance obligations over time and as such recognizes revenue ratably over the term of the relevant arrangements, which vary from one month to twenty four months for website hosting, and one year to ten years for domain name registration.

SaaS represents software products and solutions that provide customers with access to various technologies for a fee which is recognized as revenue ratably as the service is provided. The Company's contracts with customers are generally for a term of one month and renew automatically each month. The Company invoices its customers monthly. The Company considers that it satisfies its performance obligations over time each month as it provides the SaaS services to customers and hence recognizes revenue ratably over the month.

Hardware revenue

The Company generates revenue through the sale of hardware through e-commerce and through its retail distribution channels. The Company satisfies its performance obligation upon delivery of hardware to its customers who include end user customers, distributors, and retailers. The Company may at times offer concessions to customers and also allow for customer returns, which are accounted for as variable consideration. The Company estimates these amounts based on historical experience and reduces revenue recognized. The Company invoices end user customers upon delivery of the products to customers, and payments from such customers are due upon invoicing. Distributors and retailers have payment terms that range from 30 to 90 days after delivery.

The Company offers hardware installment sales to customers with terms ranging from three to twenty four months. The Company allocates a portion of the consideration received from these arrangements to a financing component when it determines that a significant financing component exists. The financing component is subsequently recognized as financing revenue separate from hardware revenue, within subscription and services-based revenue, over the terms of the arrangement with the customer.

Bitcoin revenue

During the fourth quarter of 2017, the Company started offering its Cash App customers the ability to purchase bitcoin, a cryptocurrency denominated asset, from the Company. The Company satisfies its performance obligation and records revenue when bitcoin is transferred to the customer's account.

Arrangements with Multiple Performance Obligations

The Company also offers its customers the option to buy website hosting bundled with domain name registration, and infrequently the Company has offered its hardware customers free managed payments solutions with the purchase of its hardware as part of a marketing promotion. For such arrangements, the Company allocates revenue to each performance obligation based on its relative standalone selling price. We generally determine standalone selling prices based on the prices charged to customers since the Company's products and services are normally sold on a stand alone basis.

Deferred Revenue

Deferred revenue is primarily comprised of payments for website hosting and domain name registration received from customers at inception of the arrangements prior to the services being rendered. Deferred revenue also includes unearned revenue related to managed payments services offered in conjunction with hardware sales for which the cash payments from customers are received and due upon the sale of the hardware.


13


The deferred revenue balances were as follows (in thousands):
 
Three Months Ended September 30,
 
Nine Months Ended September 30,
 
2018
 
2017
 
2018
 
2017
Deferred revenue, beginning of the period
$
27,155

 
$
4,523

 
$
5,893

 
$
5,407

Less: accumulative adjustment for adoption of ASC 606

 

 
(4,303
)
 

Deferred revenue, beginning of the period, as adjusted
27,155

 
4,523

 
1,590

 
5,407

Deferred revenue, end of the period
33,614

 
3,424

 
33,614

 
3,424

Deferred revenue arising from business combination
22,800

 

 
22,800

 

Revenue recognized in the period from amounts included in deferred revenue at the beginning of the period
$
10,165

 
$
2,060

 
$
1,539

 
$
5,312


Practical Expedients

The Company does not recognize a financing component for hardware installment sales that have a term of one year or less.

NOTE 3 - RESTRICTED CASH
    
As of September 30, 2018 and December 31, 2017, restricted cash of $33.2 million and $28.8 million, respectively, is related to pledged cash deposited into savings accounts at the financial institutions that process the Company's sellers' payment transactions and as collateral pursuant to an agreement with the originating bank for the Company's loan product. The Company uses the restricted cash to secure letters of credit with the financial institution to provide collateral for cash flow timing differences in the processing of these payments. The Company has recorded this amount as a current asset on the consolidated balance sheets due to the short-term nature of these cash flow timing differences and that there is no minimum time frame during which the cash must remain restricted. Additionally, this balance includes certain amounts held as collateral pursuant to multi-year lease agreements, discussed in the paragraph below, which we expect to become unrestricted within the next year.
    
As of September 30, 2018 and December 31, 2017, the remaining restricted cash of $10.1 million and $9.8 million, respectively, is primarily related to cash deposited into money market funds that is used as collateral pursuant to multi-year lease agreements (Note 18). The Company has recorded this amount as a non-current asset on the consolidated balance sheets as the terms of the related leases extend beyond one year.

NOTE 4 - INVESTMENTS

The Company determines the appropriate classification of its investments in marketable debt securities at the time of purchase and reevaluates such designation at each balance sheet date. The Company has classified and accounted for its marketable debt securities as available-for-sale.


14


The Company's short-term and long-term investments as of September 30, 2018 are as follows (in thousands):

 
Amortized Cost
 
Gross Unrealized Gains
 
Gross Unrealized Losses
 
Fair Value
Short-term debt securities:
 
 
 
 
 
 
 
U.S. agency securities
$
48,206

 
$
11

 
$
(27
)
 
$
48,190

Corporate bonds
83,647

 
135

 
(64
)
 
83,718

Municipal securities
28,904

 
37

 
(49
)
 
28,892

U.S. government securities
270,094

 
70

 
(372
)
 
269,792

Non-U.S. government securities
18,433

 

 
(39
)
 
18,394

Total
$
449,284

 
$
253

 
$
(551
)
 
$
448,986

 
 
 
 
 
 
 
 
Long-term debt securities:
 
 
 
 
 
 
 
U.S. agency securities
$
132,013

 
$
1

 
$
(244
)
 
$
131,770

Corporate bonds
160,777

 
178

 
(75
)
 
160,880

Municipal securities
20,203

 
82

 
(45
)
 
20,240

U.S. government securities
221,751

 
202

 
(419
)
 
221,534

Non-U.S. government securities
3,251

 

 
(12
)
 
3,239

Total
$
537,995

 
$
463

 
$
(795
)
 
$
537,663


The Company's short-term and long-term investments as of December 31, 2017 are as follows (in thousands):

 
Amortized Cost
 
Gross Unrealized Gains
 
Gross Unrealized Losses
 
Fair Value
Short-term debt securities:
 
 
 
 
 
 
 
U.S. agency securities
$
15,122

 
$

 
$
(39
)
 
$
15,083

Corporate bonds
57,855

 
22

 
(79
)
 
57,798

Commercial paper
17,428

 

 

 
17,428

Municipal securities
23,743

 
8

 
(51
)
 
23,700

U.S. government securities
55,729

 
1

 
(163
)
 
55,567

Total
$
169,877

 
$
31

 
$
(332
)
 
$
169,576

 
 
 
 
 
 
 
 
Long-term debt securities:
 
 
 
 
 
 
 
U.S. agency securities
$
20,288

 
$
2

 
$
(121
)
 
$
20,169

Corporate bonds
91,959

 
25

 
(571
)
 
91,413

Municipal securities
26,371

 
13

 
(160
)
 
26,224

U.S. government securities
66,362

 
19

 
(520
)
 
65,861

Total
$
204,980

 
$
59

 
$
(1,372
)
 
$
203,667


For the periods presented, gains or losses realized on the sale of investments were not material. Investments are reviewed periodically to identify possible other-than-temporary impairments. As the Company has the ability and intent to hold these investments with unrealized losses for a reasonable period of time sufficient for the recovery of fair value, which may be maturity, the Company does not consider these investments to be other-than-temporarily impaired for any of the periods presented.

The amortized cost of investments classified as cash equivalents approximated the fair value due to the short term nature of the investments.

15



The contractual maturities of the Company's short-term and long-term investments as of September 30, 2018 are as follows (in thousands):

 
Amortized Cost
 
Fair Value
Due in one year or less
$
449,284

 
$
448,986

Due in one to five years
537,995

 
537,663

Total
$
987,279

 
$
986,649



NOTE 5 - CUSTOMER FUNDS

The following table presents the assets underlying customer funds (in thousands):

 
September 30,
2018
 
December 31,
2017
Cash
$
219,087

 
$
103,042

Cash Equivalents:
 
 
 
Money market funds
1,884

 

U.S. agency securities
8,335

 

U.S. government securities
29,898

 

Short-term debt securities:
 
 
 
U.S. government securities
$
9,890

 
$

Total
$
269,094

 
$
103,042


The Company determines the appropriate classification of the investments in marketable debt securities within customer funds at the time of purchase and reevaluates such designation at each balance sheet date. The Company has classified and accounted for its marketable debt securities within customer funds as available-for-sale.

The Company's investments within customer funds as of September 30, 2018 are as follows (in thousands):

 
Amortized Cost
 
Gross Unrealized Gains
 
Gross Unrealized Losses
 
Fair Value
Short-term debt securities:
 
 
 
 
 
 
 
U.S. government securities
9,891

 

 
(1
)
 
9,890

Total
$
9,891

 
$

 
$
(1
)
 
$
9,890

    
For the periods presented, gains or losses realized on the sale of investments were not material. Investments are reviewed periodically to identify possible other-than-temporary impairments. As the Company has the ability and intent to hold these investments with unrealized losses for a reasonable period of time sufficient for the recovery of fair value, which may be maturity, the Company does not consider these investments to be other-than-temporarily impaired for any of the periods presented.

The amortized cost of investments classified as cash equivalents approximated the fair value due to the short term nature of the investments.


16


The contractual maturities of the Company's investments within customer funds as of September 30, 2018 are as follows (in thousands):

 
Amortized Cost
 
Fair Value
Due in one year or less
$
9,891

 
$
9,890

Due in one to five years

 

Total
$
9,891

 
$
9,890



NOTE 6 - FAIR VALUE OF FINANCIAL INSTRUMENTS

The Company measures its cash equivalents, customer funds, short-term and long-term marketable debt securities, and equity investments at fair value. The Company classifies these investments within Level 1 or Level 2 of the fair value hierarchy because the Company values these investments using quoted market prices or alternative pricing sources and models utilizing market observable inputs.
The Company’s financial assets and liabilities that are measured at fair value on a recurring basis are classified as follows (in thousands):
 
September 30, 2018
 
December 31, 2017
 
Level 1
 
Level 2
 
Level 3
 
Level 1
 
Level 2
 
Level 3
Cash Equivalents:
 
 
 
 
 
 
 
 
 
 
 
Money market funds
$
311,158

 
$

 
$

 
$
387,698

 
$

 
$

U.S. agency securities

 
123,202

 

 

 

 

Commercial paper

 

 

 

 
24,695

 

U.S. government securities
20,065

 

 

 

 

 

Customer funds:
 
 
 
 
 
 
 
 
 
 
 
Money market funds
1,884

 

 

 

 

 

U.S. agency securities

 
8,335

 

 

 

 

U.S. government securities
39,788

 

 

 

 

 

Short-term debt securities:
 
 
 
 
 
 
 
 
 
 
 
U.S. agency securities

 
48,190

 

 

 
15,083

 

Corporate bonds

 
83,718

 

 

 
57,798

 

Commercial paper

 

 

 

 
17,428

 

Municipal securities

 
28,892

 

 

 
23,700

 

U.S. government securities
269,792

 

 

 
55,567

 

 

Non-U.S. government securities

 
18,394

 

 

 

 

Long-term debt securities:
 
 
 
 
 
 
 
 
 
 
 
U.S. agency securities

 
131,770

 

 

 
20,169

 

Corporate bonds

 
160,880

 

 

 
91,413

 

Municipal securities

 
20,240

 

 

 
26,224

 

U.S. government securities
221,534

 

 

 
65,861

 

 

Non-U.S. government securities

 
3,239

 

 

 

 

Other:
 
 
 
 
 
 
 
 
 
 
 
Equity investment
61,908

 

 

 

 

 

Total
$
926,129

 
$
626,860

 
$

 
$
509,126

 
$
276,510

 
$



17


The carrying amounts of certain financial instruments, including settlements receivable, accounts payable, customers payable, and settlements payable, approximate their fair values due to their short-term nature.

The Company estimates the fair value of its convertible senior notes based on their last actively traded prices (Level 1) or market observable inputs (Level 2). The estimated fair value and carrying value of the convertible senior notes were as follows (in thousands):
 
September 30, 2018
 
December 31, 2017
 
Carrying Value
 
Fair Value (Level 2)
 
Carrying Value
 
Fair Value (Level 2)
2023 Notes
$
711,229

 
$
1,234,496

 
$

 
$

2022 Notes
312,718

 
1,599,954

 
358,572

 
719,356

Total
$
1,023,947

 
$
2,834,450

 
$
358,572

 
$
719,356


Loans held for sale are recorded at the lower of amortized cost or fair value determined on an individual loan basis. To determine the fair value the Company utilizes industry-standard valuation modeling, such as discounted cash flow models, taking into account the estimated timing and amounts of periodic repayments.
  
The estimated fair value and carrying value of loans held for sale is as follows (in thousands):

 
September 30, 2018
 
December 31, 2017
 
Carrying Value
 
Fair Value (Level 3)
 
Carrying Value
 
Fair Value (Level 3)
Loans held for sale
$
73,219

 
$
76,302

 
$
73,420

 
$
76,070

Total
$
73,219

 
$
76,302

 
$
73,420

 
$
76,070


The Company recognizes a charge within transaction, loan and advance losses on the consolidated statement of operations whenever the amortized cost of a loan exceeds its fair value, with such charges being reversed for subsequent increases in fair value, but only to the extent that such reversals do not result in the amortized cost of a loan exceeding its fair value. For the three and nine months ended September 30, 2018, the Company recorded a charge for the excess of amortized cost over fair value of the loans of $3.3 million and $9.0 million, respectively. For the three and nine months ended September 30, 2017, the Company recorded a charge for the excess of amortized cost over fair value of the loans of $3.4 million and $6.1 million, respectively.
If applicable, the Company will recognize transfers into and out of levels within the fair value hierarchy at the end of the reporting period in which the actual event or change in circumstance occurs. During the three and nine months ended September 30, 2018 and 2017, the Company did not have any transfers in or out of Level 1, Level 2, or Level 3 assets or liabilities.

NOTE 7 - PROPERTY AND EQUIPMENT, NET
The following is a summary of property and equipment, less accumulated depreciation and amortization (in thousands):    

September 30,
2018

December 31,
2017
Leasehold improvements
$
99,722

 
$
77,073

Computer equipment
90,218


66,186

Capitalized software
51,177

 
35,063

Office furniture and equipment
18,773


14,490

 
259,890

 
192,812

Less: Accumulated depreciation and amortization
(129,745
)

(101,316
)
Property and equipment, net
$
130,145

 
$
91,496


18


Depreciation and amortization expense on property and equipment was $11.7 million and $29.2 million for the three and nine months ended September 30, 2018, respectively. Depreciation and amortization expense on property and equipment was $7.3 million and $21.8 million for the three and nine months ended September 30, 2017, respectively.

NOTE 8 - ACQUISITIONS
Weebly, Inc.
On May 31, 2018, the Company acquired 100% of the outstanding shares of Weebly, a technology company that offers customers website hosting and domain name registration solutions. The acquisition of Weebly enables the Company to combine Weebly’s web presence tools with the Company's in-person and online offerings to create a cohesive solution for sellers to start or grow an omnichannel business. The acquisition will also expand the Company’s customer base globally and add a new recurring revenue stream.

The purchase consideration was comprised of $132.4 million in cash and 2,418,271 shares of the Company’s Class A common stock with an aggregate fair value of $140.1 million based on the closing price of the Company’s Class A common stock on the acquisition date. As part of the acquisition, the Company paid an aggregate of $17.7 million in cash and shares to settle outstanding vested and unvested employee options, of which $2.6 million was accounted for as post-combination compensation expense and is excluded from the purchase consideration. Third-party acquisition-related costs were insignificant. The results of Weebly's operations have been included in the consolidated financial statements since the closing date.
The acquisition was accounted for as a business combination. This method requires, among other things, that assets acquired and liabilities assumed be recognized at their fair values as of the acquisition date and that the difference between the fair value of the consideration paid for the acquired entity and the fair value of the net assets acquired be recorded as goodwill, which is not amortized but is tested at least annually for impairment.
The table below summarizes the consideration paid for Weebly and the preliminary assessment of the fair value of the assets acquired and liabilities assumed at the closing date (in thousands, except share data).
Consideration:
 
Cash
$
132,432

Stock (2,418,271 shares of Class A common stock)
140,107

 
$
272,539

Recognized amounts of identifiable assets acquired and liabilities assumed:
 
Current assets (inclusive of cash acquired of $25,758)
$
44,685

Intangible customer assets
42,700

Intangible technology assets
14,900

Intangible trade name
11,300

Intangible other assets
961

Total liabilities assumed (including deferred revenue of $22,800)
(35,849
)
Total identifiable net assets acquired
78,697

Goodwill
193,842

Total
$
272,539

The Company prepared an initial determination of the fair value of the assets acquired and liabilities assumed as of the acquisition date using preliminary information. During the third quarter of 2018, the Company has recognized measurement period adjustments to the purchase consideration and the fair value of certain liabilities assumed as a result of further refinements in the Company’s estimates. These adjustments were prospectively applied. The effect of these adjustments on the preliminary purchase price allocation was an increase in goodwill and tax liabilities assumed of $4.3 million and $3.0 million, respectively. There was no impact to the consolidated statements of operations as result of these adjustments. The Company continues the process of completing the valuation of the acquired intangible assets and deferred revenue and evaluating contingencies and tax effects related to the acquisition. Accordingly, the preliminary values reflected in the table above are subject to change.

19


As of September 30, 2018, $19.9 million of cash and 372,578 shares of the total consideration were withheld as security for indemnification obligations related to general representations and warranties, in addition to certain potential tax exposures.
Goodwill from the Weebly acquisition is primarily attributable to the value of expected synergies created by incorporating Weebly solutions into the Company's technology platform and the value of the assembled workforce. None of the goodwill generated from the Weebly acquisition or the acquired intangible assets are expected to be deductible for tax purposes. Additionally the acquisition would have resulted in recognition of deferred tax assets arising mainly from the net of deferred tax assets from acquired net operating losses (NOLs) and research and development credits, and deferred tax liabilities associated with intangible assets and deferred revenue. However, the realization of such deferred tax assets depends primarily on the Company's post-acquisition ability to generate taxable income in future periods. Accordingly, a valuation allowance was recorded against the net acquired deferred tax asset in accounting for the acquisition.

The acquisition of Weebly did not have a material impact on the Company's reported revenue or net loss amounts for any period presented. Accordingly, pro forma financial information has not been presented.
Other acquisitions

The Company also spent an aggregate of $9.9 million, net of cash acquired, in connection with other immaterial acquisitions during the nine months ended September 30, 2018, which resulted in the recognition of additional intangible assets and goodwill. Pro forma financial information has not been presented for any of our acquisitions as the impact to our consolidated financial statements was not material.

NOTE 9 - GOODWILL

Goodwill is recorded when the consideration paid for an acquisition of a business exceeds the fair value of identifiable net tangible and intangible assets acquired.

The change in carrying value of goodwill in the period was as follows (in thousands):
Balance at December 31, 2017
$
58,327

Acquisitions completed during the nine months ended September 30, 2018
201,637

Balance at September 30, 2018
$
259,964


The Company performs a goodwill impairment test annually on December 31 and more frequently if events and circumstances indicate that the asset might be impaired. For the periods presented, the Company had recorded no impairment charges.


20


NOTE 10 - ACQUIRED INTANGIBLE ASSETS    

The Company entered into two transactions accounted for as business combinations during the quarter ended June 30, 2018, that involved the acquisition of intangible assets. Refer to Note 8 for further details.

The following table presents the detail of acquired intangible assets as of the periods presented (in thousands):
 
Balance at September 30, 2018
Cost
 
Accumulated Amortization
 
Net
Patents
$
1,285

 
$
(638
)
 
$
647

Technology assets
45,978

 
(27,043
)
 
18,935

Customer assets
57,109

 
(6,775
)
 
50,334

Trade name
11,300

 
(942
)
 
10,358

Other
961

 
(105
)
 
856

Total
$
116,633

 
$
(35,503
)
 
$
81,130


 
Balance at December 31, 2017
Cost
 
Accumulated Amortization
 
Net
Patents
$
1,285

 
$
(559
)

$
726

Technology assets
29,158

 
(21,329
)
 
7,829

Customer assets
10,319

 
(4,540
)
 
5,779

Total
$
40,762

 
$
(26,428
)
 
$
14,334


The weighted average amortization periods for acquired patents, acquired technology, customer intangible assets, and acquired trade name are approximately 13 years, 5 years, 11 years and 4 years, respectively.

All intangible assets are amortized over their estimated useful lives. The changes to the carrying value of intangible assets were as follows (in thousands):

 
Three Months Ended September 30,
 
Nine Months Ended September 30,
 
2018
 
2017
 
2018
 
2017
Acquired intangible assets, net, beginning of the period
$
85,514

 
$
16,452

 
$
14,334

 
$
19,292

Acquisitions

 

 
75,871

 
1,224

Amortization expense
4,384

 
1,804

 
9,075

 
5,868

Acquired intangible assets, net, end of the period
$
81,130

 
$
14,648

 
$
81,130

 
$
14,648



21


The total estimated future amortization expense of these intangible assets as of September 30, 2018 is as follows (in thousands):
2018 (remaining 3 months)
$
4,069

2019
13,702

2020
11,496

2021
10,299

2022
8,369

Thereafter
33,195

Total
$
81,130


NOTE 11 - OTHER CONSOLIDATED BALANCE SHEET COMPONENTS (CURRENT)
Other Current Assets
The following table presents the detail of other current assets (in thousands):
    
 
September 30,
2018
 
December 31,
2017
Inventory, net
$
25,294

 
$
16,777

Processing costs receivable
36,747

 
21,083

Prepaid expenses
12,666

 
14,473

Accounts receivable, net
18,980

 
8,606

Deferred hardware costs (i)

 
7,931

Deferred magstripe reader costs (ii)
6,996

 
2,469

Prepaid compensation, current (iii)
5,487

 

Other
30,230

 
15,115

Total
$
136,400

 
$
86,454


(i) The deferred hardware costs represented costs associated with hardware sold through the retail distribution channels. The adoption of ASC 606 on January 1, 2018, has resulted in the recognition of such costs upon delivery of the hardware to the distribution channel.

(ii) The Company capitalizes the cost of its magstripe readers, including packaging and shipping costs, held on-hand by the Company as of each consolidated balance sheet date. Once the readers are shipped to a third-party distributor or an end-customer, they are recorded as marketing expense on the consolidated statements of operations.

(iii) Prepaid compensation relates to cash transferred by the Company to an escrow agent in connection with a business combination that will be paid to officers of the acquiree over time as they provide services to the Company.


22


Accrued Expenses
The following table presents the detail of accrued expenses (in thousands):    
 
September 30,
2018
 
December 31,
2017
Accrued payroll
$
17,691

 
$
9,103

Accrued professional fees
6,903

 
5,638

Accrued advertising and other marketing
16,391

 
6,723

Processing costs payable
11,150

 
10,145

Accrued non income tax liabilities
6,390

 
6,155

Accrued hardware costs
10,232

 
2,496

Other accrued liabilities
32,309

 
12,020

Total
$
101,066

 
$
52,280


Other Current Liabilities
The following table presents the detail of other current liabilities (in thousands):    
    
 
September 30,
2018
 
December 31,
2017
Deferred revenue, current
$
29,285

 
$
5,893

Square Capital payable (iv)
12,762

 
7,671

Square Payroll payable (v)
6,707

 
2,850

Deferred rent, current
3,844

 
3,311

Accrued redemptions
1,052

 
1,036

Other
16,688

 
7,606

Total
$
70,338

 
$
28,367


(iv) Square Capital payable represents unpaid amounts arising from the purchase of loans or loan repayments collected on behalf of third parties.

(v) Square Payroll payable represents amounts received from Square Payroll product customers that will be utilized to settle the customers employee payroll and related obligations.


23


NOTE 12 - OTHER CONSOLIDATED BALANCE SHEET COMPONENTS (NON-CURRENT)

Other Non-Current Assets

The following table presents the detail of other non-current assets (in thousands):

 
September 30,
2018
 
December 31,
2017
Equity investment (i)
$
61,908

 
$
25,000

Prepaid compensation, non-current (ii)
6,959

 

Deposits
2,544

 
2,738

Debt issuance costs
580

 
788

Deferred tax assets
540

 
519

Other
4,465

 
2,305

Total
$
76,996

 
$
31,350


(i) In August, 2017, the Company invested $25.0 million for preferred shares of Eventbrite, Inc. (Eventbrite) which was carried at cost. In September, 2018, upon Eventbrite's initial public offering, the preferred shares held by the Company converted into Class B common shares of Eventbrite. The Company revalued this investment and will subsequently carry it at fair value, with changes in fair value being recorded within other income or expense on the consolidated statement of operations. During the three and nine months ended September 30, 2018, the Company recorded a gain of $36.9 million to other income on the consolidated statements of operations arising from revaluation of this investment.
    
(ii) Prepaid compensation relates to cash transferred by the Company to an escrow agent in connection with a business combination that will be paid to officers of the acquiree over time as they provide services to the Company.
Other Non-Current Liabilities
The following table presents the detail of other non-current liabilities (in thousands):
 
September 30,
2018
 
December 31,
2017
Statutory liabilities (iii)
$
51,134

 
$
40,768

Deferred rent, non-current
22,243

 
20,349

Deferred purchase consideration
3,900

 

Deferred revenue, non-current
4,329

 
432

Deferred tax liabilities
147

 
644

Other
7,958

 
7,345

Total
$
89,711

 
$
69,538


(iii) Statutory liabilities represent loss contingencies that may arise from the Company's interpretation and application of certain guidelines and rules issued by various federal, state, local, and foreign regulatory authorities.


24


NOTE 13 - INDEBTEDNESS

Revolving Credit Facility

In November 2015, the Company entered into a revolving credit agreement with certain lenders, which extinguished the prior revolving credit agreement and provided for a $375.0 million revolving secured credit facility maturing in November 2020. This revolving credit agreement is secured by certain tangible and intangible assets.

Loans under the credit facility bear interest at the Company’s option of (i) a base rate based on the highest of the prime rate, the federal funds rate plus 0.50%, and an adjusted LIBOR rate for a one-month interest period, in each case plus a margin ranging from 0.00% to 1.00%, or (ii) an adjusted LIBOR rate plus a margin ranging from 1.00% to 2.00%. This margin is determined based on the Company’s total leverage ratio for the preceding four fiscal quarters. The Company is obligated to pay other customary fees for a credit facility of this size and type including an annual administrative agent fee of $0.1 million and an unused commitment fee of 0.15%. To date no funds have been drawn under the credit facility, with $375.0 million remaining available. The Company paid $0.1 million and $0.4 million in unused commitment fees during both the three and nine months ended September 30, 2018 and 2017, respectively. As of September 30, 2018, the Company was in compliance with all financial covenants associated with this credit facility.

Convertible Senior Notes due in 2023

On May 25, 2018, the Company issued an aggregate principal amount of $750.0 million of convertible senior notes and an additional 15% or $112.5 million pursuant to the exercise in full of the option to the initial purchaser to cover over-allotments (2023 Notes). The 2023 Notes mature on May 15, 2023, unless earlier converted or repurchased, and bear interest at a rate of 0.50% payable semi-annually on May 15 and November 15 of each year. The 2023 Notes are convertible at an initial conversion rate of 12.8456 shares of the Company's Class A common stock per $1,000 principal amount of 2023 Notes, which is equivalent to an initial conversion price of approximately $77.85 per share of Class A common stock. Holders may convert their 2023 Notes at any time prior to the close of business on the business day immediately preceding February 15, 2023 only under the following circumstances: (1) during any calendar quarter commencing after September 30, 2018 (and only during such calendar quarter), if the last reported sale price of the Company’s Class A common stock for at least 20 trading days (whether or not consecutive) during a period of 30 consecutive trading days ending on the last trading day of the immediately preceding calendar quarter is greater than or equal to 130% of the conversion price on each applicable trading day; (2) during the five business day period after any five consecutive trading day period (the measurement period) in which the trading price (as defined in the indenture governing the 2023 Notes) per $1,000 principal amount of 2023 Notes for each trading day of the measurement period was less than 98% of the product of the last reported sale price of the Company’s Class A common stock and the conversion rate on each such trading day; or (3) upon the occurrence of specified corporate events, including certain distributions, the occurrence of a fundamental change (as defined in the indenture governing the 2023 Notes) or a transaction resulting in the Company’s Class A common stock converting into other securities or property or assets. On or after February 15, 2023, up until the close of business on the second scheduled trading day immediately preceding the maturity date, a holder may convert all or any portion of its 2023 Notes regardless of the foregoing circumstances. Upon conversion, the Company will pay or deliver, as the case may be, cash, shares of its Class A common stock, or a combination of cash and shares of its Class A common stock, at the Company’s election. Effective October 2018, the Company revised its prior stated policy of settling conversions through combination settlement with a specified dollar amount of $1,000 per $1,000 principal amount of 2023 Notes, and currently expects to settle future conversions entirely in shares of the Company's Class A common stock. The Company will reevaluate this policy from time to time as conversion notices are received from holders of the 2023 Notes.

In accounting for the issuance of the 2023 Notes, the Company separated the 2023 Notes into liability and equity components. The carrying amount of the liability component was calculated by measuring the fair value of a similar debt instrument that does not have an associated convertible feature. The carrying amount of the equity component representing the conversion option was $155.3 million and was determined by deducting the fair value of the liability component from the par value of the 2023 Notes. The equity component is not remeasured as long as it continues to meet the conditions for equity classification. The excess of the principal amount of the liability component over its carrying amount ("debt discount") is amortized to interest expense over the term of the 2023 Notes at an effective interest rate of 4.69% over the contractual terms of the Notes.

Debt issuance costs related to the 2023 Notes comprised of discounts and commissions payable to the initial purchasers of $6.0 million and third party offering costs of $0.8 million. The Company allocated the total amount incurred to the liability and equity components of the 2023 Notes based on their relative values. Issuance costs attributable to the liability component

25


were $5.6 million and will be amortized to interest expense using the effective interest method over the contractual term. Issuance costs attributable to the equity component were netted with the equity component in stockholders’ equity.

Convertible Senior Notes due in 2022

On March 6, 2017, the Company issued an aggregate principal amount of $400.0 million of convertible senior notes and an additional 10% or $40.0 million pursuant to the exercise in full of the option to the initial purchasers to cover over-allotments (2022 Notes). The 2022 Notes mature on March 1, 2022, unless earlier converted or repurchased, and bear interest at a rate of 0.375% payable semi-annually on March 1 and September 1 of each year. The 2022 Notes are convertible at an initial conversion rate of 43.5749 shares of the Company's Class A common stock per $1,000 principal amount of 2022 Notes, which is equivalent to an initial conversion price of approximately $22.95 per share of Class A common stock. Holders may convert their 2022 Notes at any time prior to the close of business on the business day immediately preceding December 1, 2021 only under the following circumstances: (1) during any calendar quarter (and only during such calendar quarter), if the last reported sale price of the Company’s Class A common stock for at least 20 trading days (whether or not consecutive) during a period of 30 consecutive trading days ending on the last trading day of the immediately preceding calendar quarter is greater than or equal to 130% of the conversion price on each applicable trading day; (2) during the five business day period after any five consecutive trading day period (the measurement period) in which the trading price (as defined in the indenture governing the 2022 Notes) per $1,000 principal amount of 2022 Notes for each trading day of the measurement period was less than 98% of the product of the last reported sale price of the Company’s Class A common stock and the conversion rate on each such trading day; or (3) upon the occurrence of specified corporate events, including certain distributions, the occurrence of a fundamental change (as defined in the indenture governing the 2022 Notes) or a transaction resulting in the Company’s Class A common stock converting into other securities or property or assets. On or after December 1, 2021, up until the close of business on the second scheduled trading day immediately preceding the maturity date, a holder may convert all or any portion of its 2022 Notes regardless of the foregoing circumstances. Upon conversion, the Company will pay or deliver, as the case may be, cash, shares of its Class A common stock, or a combination of cash and shares of its Class A common stock, at the Company’s election. The circumstances required to allow the holders to convert their 2022 Notes were met starting January 1, 2018. During the third quarter of 2018, certain holders of the 2022 Notes converted an aggregate principal amount of $70.0 million of their Notes. The Company settled the principal amount in cash and the balance by issuing 2.2 million shares of the Company's Class A common stock. Additionally, as of September 30, 2018, the Company had received notification from certain holders of the 2022 Notes of their intention to convert an aggregate principal amount of $149.0 million of 2022 Notes, that are expected to be settled in the fourth quarter of 2018 through a combination of cash and shares of the Company's Class A common stock. Effective October 2018, the Company revised its prior stated policy of settling conversions through combination settlement with a specified dollar amount of $1,000 per $1,000 principal amount of 2022 Notes. The Company currently expects to settle future conversions in shares of the Company's Class A common stock. The Company will reevaluate this policy from time to time as conversion notices are received from holders of the 2022 Notes.

In accounting for the issuance of the 2022 Notes, the Company separated the 2022 Notes into liability and equity components. The carrying amount of the liability component was calculated by measuring the fair value of a similar debt instrument that does not have an associated convertible feature. The carrying amount of the equity component representing the conversion option was $86.2 million and was determined by deducting the fair value of the liability component from the par value of the 2022 Notes. The equity component is not remeasured as long as it continues to meet the conditions for equity classification. The debt discount is amortized to interest expense over the term of the 2022 Notes at an effective interest rate of 5.34% over the contractual terms of the Notes.

Debt issuance costs related to the 2022 Notes comprised of discounts and commissions payable to the initial purchasers of $11.0 million and third party offering costs of $0.8 million. The Company allocated the total amount incurred to the liability and equity components of the 2022 Notes based on their relative values. Issuance costs attributable to the liability component were $9.4 million and will be amortized to interest expense using the effective interest method over the contractual term.  Issuance costs attributable to the equity component were netted with the equity component in stockholders’ equity.

The debt component associated with the 2022 Notes that were converted was accounted for as an extinguishment of debt, with the Company recording loss on extinguishment of $1.6 million, as the difference between the estimated fair value and the carrying value of such 2022 Notes. The equity component associated with the 2022 Notes that were converted was accounted for as a reacquisition of equity upon the conversion of such 2022 Notes. Accordingly, the excess of the fair value of the consideration issued to settle the conversion over the fair value of the debt component of $9.3 million was accounted for as a reduction to the additional paid in capital.


26



The net carrying amount of the Notes were as follows (in thousands):

 
Principal outstanding
 
Unamortized debt discount
 
Unamortized debt issuance costs
 
Net carrying value
September 30, 2018
 
 
 
 
 
 
 
2023 Notes
$
862,500

 
$
(145,998
)
 
$
(5,273
)
 
$
711,229

2022 Notes
369,953

 
(51,581
)
 
(5,654
)
 
312,718

Total
1,232,453

 
(197,579
)
 
(10,927
)
 
1,023,947

 
 
 
 
 
 
 
 
December 31, 2017
 
 
 
 
 
 
 
2022 Notes
$
440,000

 
$
(73,384
)
 
$
(8,044
)
 
$
358,572



The net carrying amount of the equity component of the Notes were as follows (in thousands):

 
Amount allocated to conversion option
 
Less: allocated issuance costs
 
Equity component, net
September 30, 2018
 
 
 
 
 
2023 Notes
$
155,250

 
$
(1,231
)
 
$
154,019

2022 Notes
72,480

 
(1,936
)
 
70,544

Total
227,730

 
(3,167
)
 
224,563

 
 
 
 
 
 
December 31, 2017
 
 
 
 
 
2022 Notes
$
86,203

 
$
(2,302
)
 
$
83,901



The Company recognized interest expense on the Notes as follows (in thousands, except for percentages):

 
Three Months Ended September 30,
 
Nine Months Ended September 30,
 
2018
 
2017
 
2018
 
2017
Contractual interest expense
$
1,469

 
$
413

 
$
2,732

 
$
938

Amortization of debt discount and issuance costs
11,627

 
4,277

 
22,850

 
9,889

Total
$
13,096

 
$
4,690

 
$
25,582

 
$
10,827


The effective interest rate of the liability component is 4.69% and 5.34% for the 2023 Notes and 2022 Notes, respectively.

Convertible Note Hedge and Warrant Transactions

In connection with the offering of the 2023 Notes, the Company entered into convertible note hedge transactions (2023 convertible note hedges) with certain financial institution counterparties whereby the Company has the option to purchase a total of approximately 11.1 million shares of its Class A common stock at a price of approximately $77.85 per share. The total cost of the 2023 convertible note hedge transactions was $172.6 million. In addition, the Company sold warrants (2023 warrants) to the counterparties whereby the counterparties have the option to purchase a total of 11.1 million shares of the Company’s Class A common stock at a price of approximately $109.26 per share. The Company received $112.1 million in cash proceeds from the sale of the 2023 warrants. Taken together, the purchase of the 2023 convertible note hedges and sale of the 2023 warrants

27


are intended to reduce dilution from the conversion of the 2023 Notes and/or offset any cash payments the Company is required to make in excess of the principal amount of the converted 2023 Notes, as the case may be, and to effectively increase the overall conversion price from approximately $77.85 per share to approximately $109.26 per share. As these instruments are considered indexed to the Company's own stock and are considered equity classified, the 2023 convertible note hedges and 2023 warrants are recorded in stockholders’ equity, are not accounted for as derivatives and are not remeasured each reporting period. The net costs incurred in connection with the 2023 convertible note hedge and 2023 warrant transactions were recorded as a reduction to additional paid-in capital on the condensed consolidated balance sheets.

In connection with the offering of the 2022 Notes, the Company entered into convertible note hedge transactions (2022 convertible note hedges) with certain financial institution counterparties whereby the Company has the option to purchase a total of approximately 19.2 million shares of its Class A common stock at a price of approximately $22.95 per share. The total cost of the 2022 convertible note hedge transactions was $92.1 million. In addition, the Company sold warrants (2022 warrants) to the counterparties whereby the counterparties have the option to purchase a total of 19.2 million shares of the Company’s Class A common stock at a price of approximately $31.18 per share. The Company received $57.2 million in cash proceeds from the sale of the 2022 warrants. Taken together, the purchase of the 2022 convertible note hedges and sale of the 2022 warrants are intended to reduce dilution from the conversion of the 2022 Notes and/or offset any cash payments the Company is required to make in excess of the principal amount of the converted 2022 Notes, as the case may be, and to effectively increase the overall conversion price from approximately $22.95 per share to approximately $31.18 per share. As these instruments are considered indexed to the Company's own stock and are considered equity classified, the 2022 convertible note hedges and 2022 warrants are recorded in stockholders’ equity, are not accounted for as derivatives and are not remeasured each reporting period. The net costs incurred in connection with the 2022 convertible note hedge and 2022 warrant transactions were recorded as a reduction to additional paid-in capital on the condensed consolidated balance sheets. During the third quarter of 2018, the Company exercised a pro-rata portion of the 2022 convertible note hedges to offset the shares of the Company's Class A common stock issued to settle the conversion of the 2022 Notes discussed above. The 2022 convertible note hedges were net share settled, and the Company received 2.2 million shares of the Company's Class A common stock from the counterparties.

NOTE 14 - ACCRUED TRANSACTION LOSSES
The Company is exposed to transaction losses due to chargebacks as a result of fraud or uncollectibility.
The following table summarizes the activities of the Company’s reserve for transaction losses (in thousands):
    
 
Three Months Ended September 30,
 
Nine Months Ended September 30,
 
2018
 
2017
 
2018
 
2017
Accrued transaction losses, beginning of the period
$
29,207

 
$
22,455

 
$
26,893

 
$
20,064

Provision for transaction losses
20,449

 
15,102

 
48,794

 
39,737

Charge-offs to accrued transaction losses
(14,324
)
 
(10,837
)
 
(40,355
)
 
(33,081
)
Accrued transaction losses, end of the period
$
35,332

 
$
26,720

 
$
35,332

 
$
26,720


NOTE 15 - INCOME TAXES
The Company recorded an income tax expense of $1.1 million and $1.8 million for the three and nine months ended September 30, 2018, respectively, compared to income tax (benefit) expense of $(0.6) million and $0.3 million for the three and nine months ended September 30, 2017, respectively. The income tax expense recorded for the three and nine months ended September 30, 2018 was primarily due to state and foreign income tax expense offset by a release in the U.S. valuation allowance.

The Company’s effective tax rate was 5.1% and (22.0)% for the three and nine months ended September 30, 2018, respectively, compared to an effective tax rate of 3.9% and (0.7)% for the three and nine months ended September 30, 2017, respectively. The difference between the effective tax rate and the federal statutory tax rate for the three and nine months ended September 30, 2018 and September 30, 2017 primarily relates to the valuation allowance on the Company’s deferred tax assets and the income tax benefit of the monetization of its alternative minimum tax (AMT) credit in 2017.


28


The Company’s effective tax rate may be subject to fluctuation during the year as new information is obtained, which may affect the assumptions used to estimate the annual effective tax rate, including factors such as the mix of forecasted pre-tax earnings in the various jurisdictions in which the Company operates, valuation allowances against deferred tax assets, the recognition and de-recognition of tax benefits related to uncertain tax positions, and changes in or the interpretation of tax laws in jurisdictions where the Company conducts business.

As of September 30, 2018, the Company retains a full valuation allowance on its deferred tax assets in the U.S. and certain foreign jurisdictions. The realization of the Company’s deferred tax assets depends primarily on its ability to generate taxable income in future periods. The amount of deferred tax assets considered realizable in future periods may change as management continues to reassess the underlying factors it uses in estimating future taxable income.
The tax provision for the three and nine months ended September 30, 2018 and September 30, 2017, was calculated on a jurisdictional basis. The Company estimated the foreign income tax provision using the effective income tax rate expected to be applicable for the full year.

On December 22, 2017, the SEC issued Staff Accounting Bulletin No. 118 (SAB 118) to address the application of U.S. GAAP in situations when a registrant does not have the necessary information available, prepared, or analyzed (including computations) in reasonable detail to complete the accounting for certain income tax effects of the Tax Cuts and Jobs Act of 2017 (Tax Act).  During the third quarter of 2018, the Company finalized its federal and state income tax returns, making no material adjustments to provisional amounts previously recorded. If additional guidance clarifying aspects of the Tax Act is released, any subsequent adjustment to these amounts will be recorded to current tax expense as a change in tax law.



NOTE 16 - STOCKHOLDERS’ EQUITY
The changes in total stockholders’ equity were as follows (in thousands):

 
Total stockholders’ equity
Balance at December 31, 2017
$
786,333

Net loss
(10,249
)
Exercise of stock options
82,202

Purchases under the employee stock purchase plan
12,578

Vesting of early exercised stock options and other
136

Issuance of common stock in connection with business combination
140,107

Replacement stock awards issued in connection with acquisition
899

Conversion feature of convertible senior notes, due 2023, net of allocated costs
154,019

Purchase of bond hedges in conjunction with issuance of convertible senior notes, due 2023
(172,586
)
Sale of warrants in conjunction with issuance of convertible senior notes, due 2023
112,125

Issuance of common stock in conjunction with the conversion of senior notes, due 2022
(9,305
)
Exercise of bond hedges in conjunction with the conversion of senior notes, due 2022

Share-based compensation
164,142

Tax withholding related to vesting of restricted stock units
(125,899
)
Cumulative adjustment for adoption of ASC 606
(4,586
)
Recovery of common stock in connection with indemnification settlement agreement
(2,745
)
Change in other comprehensive loss
(5,027
)
Balance at September 30, 2018
$
1,122,144



29


Common Stock

The Company has authorized the issuance of Class A common stock and Class B common stock. Class A common stock and Class B common stock are referred to as "common stock" throughout these Notes to the Condensed Consolidated Financial Statements, unless otherwise noted. As of September 30, 2018, the Company was authorized to issue 1,000,000,000 shares of Class A common stock and 500,000,000 shares of Class B common stock, each with a par value of $0.0000001 per share. As of September 30, 2018, there were 306,228,873 shares of Class A common stock and 106,143,959 shares of Class B common stock outstanding. Options and awards granted following the Company's initial public offering are related to underlying Class A common stock. Additionally, holders of Class B common stock are able to convert such shares into Class A common stock.

Warrants

In conjunction with the 2023 Notes offering, the Company sold the 2023 warrants whereby the counterparties have the option to purchase a total of approximately 11.1 million shares of the Company’s Class A common stock at a price of $109.26 per share. The Company received $112.1 million in cash proceeds from the sale of the 2023 warrants. See Note 13, Indebtedness, for more details on this transaction.

Release of Caviar Shares Held Back

In 2014, in conjunction with the Company's acquisition of Caviar, Inc. (Caviar), 1,291,979 shares of the purchase consideration issuable were withheld for indemnification purposes. In April 2018, the Company reached an agreement with the former owners of Caviar whereby 822,085 of the shares held back were released to the former owners and 469,894 shares were forfeited back to the Company as indemnification against liabilities related to Caviar preacquisition matters. Upon reaching the agreement, the Company recorded an indemnification asset of $2.8 million and a corresponding credit to expense to compensate for the costs previously incurred in connection with Caviar preacquisition claims. The remaining value of the forfeited shares was treated as an equity repurchase.

Conversion of 2022 Notes and Exercise of the 2022 Convertible Note Hedges

In connection with the conversion of certain of the 2022 Notes, the Company issued 2.2 million shares of Class A common stock. The Company also exercised a pro-rata portion of the 2022 convertible note hedges and received 2.2 million shares of Class A common stock from the counterparties to offset the shares issued.

Stock Plans

The Company maintains two share-based employee compensation plans: the 2009 Stock Plan (2009 Plan) and the 2015 Equity Incentive Plan (2015 Plan). The 2015 Plan serves as the successor to the 2009 Plan. The 2015 Plan became effective as of November 17, 2015. Outstanding awards under the 2009 Plan continue to be subject to the terms and conditions of the 2009 Plan. Since November 17, 2015, no additional awards have been nor will be in the future granted under the 2009 Plan.

Under the 2015 Plan, shares of the Company's Class A common stock are reserved for the issuance of incentive and nonstatutory stock options, restricted stock awards (RSAs), restricted stock units (RSUs), performance shares, and stock bonuses to qualified employees, directors, and consultants. The awards must be granted at a price per share not less than the fair market value at the date of grant. Initially, 30,000,000 shares were reserved under the 2015 Plan, and any shares subject to options or other similar awards granted under the 2009 Plan that expire, are forfeited, are repurchased by the Company, or otherwise terminate unexercised, will become available under the 2015 Plan. The number of shares available for issuance under the 2015 Plan will be increased on the first day of each fiscal year, in an amount equal to the least of (i) 40,000,000 shares, (ii) 5% of the outstanding shares on the last day of the immediately preceding fiscal year, or (iii) such number of shares determined by the Company’s board of directors or a committee thereof. As of September 30, 2018, the total number of shares subject to stock options, RSAs and RSUs outstanding under the 2015 Plan was 25,272,110, and 63,264,588 shares were available for future issuance. As of September 30, 2018, the total number of shares subject to stock options, RSAs and RSUs outstanding under the 2009 Plan was 31,343,565.


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A summary of stock option activity for the nine months ended September 30, 2018 is as follows (in thousands, except share and per share data):
 
Number of Stock Options Outstanding
 
Weighted
Average
Exercise
Price
 
Weighted
Average
Remaining
Contractual
Term
(in years)
 
Aggregate
Intrinsic
Value
Balance at December 31, 2017
47,270,091

 
$
8.67

 
6.52
 
$
1,229,103

Granted
783,625

 
44.75

 
 
 
 
Exercised
(10,661,450
)
 
7.71

 
 
 
 
Forfeited
(674,525
)
 
12.97

 
 
 
 
Balance at September 30, 2018
36,717,741

 
$
9.64

 
5.94
 
$
3,281,558

Options exercisable as of
 
 
 
 
 
 
 
September 30, 2018
33,952,212

 
$
8.64

 
5.75
 
$
3,068,274


Restricted Stock Activity
Activity related to RSAs and RSUs during the nine months ended September 30, 2018 is set forth below:
 
Number of
shares
 
Weighted
Average Grant
Date Fair Value
Unvested as of December 31, 2017
21,317,525

 
$
17.84

Granted
6,408,650

 
52.93

Vested
(5,796,657
)
 
18.30

Forfeited
(2,031,584
)
 
18.56

Unvested as of September 30, 2018
19,897,934

 
$
28.94


Share-Based Compensation
The fair value of stock options and employee stock purchase plan rights are estimated on the date of grant using the Black-Scholes-Merton option valuation model. The fair value of RSAs and RSUs is determined by the closing price of the Company’s common stock on each grant date. 
The fair value of stock options granted was estimated using the following weighted-average assumptions:
    
 
Nine Months Ended September 30,
 
2018
 
2017
Dividend yield
%
 
%
Risk-free interest rate
2.92
%
 
1.88
%
Expected volatility
30.87
%
 
32.22
%
Expected term (years)
6.19

 
6.02




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The following table summarizes the effects of share-based compensation on the Company's condensed consolidated statements of operations (in thousands):
 
Three Months Ended September 30,
Nine Months Ended September 30,
 
2018
 
2017
2018
 
2017
Cost of revenue
$
18

 
$
29

$
79

 
$
47

Product development
39,525

 
25,254

103,813

 
69,746

Sales and marketing
6,108