Square Drops Its "Adjusted" Revenue Metric to Appease Regulators

Square (SQ 5.04%) recently stated that it will stop reporting "adjusted" revenue figures after receiving a comment letter from the U.S. Securities and Exchange Commission. The digital payments company has used that non-GAAP metric since its IPO four years ago, so should investors be concerned about the abrupt shift?

What is Square's "adjusted" revenue?

Square's "adjusted" revenue subtracts transaction-based costs and bitcoin costs from its total revenue, then adds back certain deferred revenue from previous acquisitions. At the time of its IPO, Square stated that its adjusted revenue measured the "performance and growth" of its "ongoing recurring business" and enabled easier comparisons to "other businesses in the payment processing sector."

Image source: Getty Images.

Square initially introduced the metric to give investors a clearer picture of its growth after its contract with Starbucks expired in late 2016. Starbucks once accounted for a large percentage of Square's transactions, so it needed to show investors that it could continue growing without the coffee giant.

However, Square continued to use the adjusted revenue figure after it lapped the end of the Starbucks partnership, and it gradually evolved from its "revenue without Starbucks" into its current, more convoluted definition.

Why are regulators concerned?

The SEC allows companies to make non-GAAP adjustments to their revenue and earnings, so long as they are clearly reconciled with the GAAP numbers. But the agency also scrutinizes non-GAAP revenue figures much more closely than non-GAAP earnings metrics.

During a speech at Baruch College in May 2016, SEC Deputy Chief Accountant Wesley Bricker stated that companies that reported "adjusted revenue" should expect his agency "to look closely, and skeptically, at the explanation as to why the revenue adjustment is appropriate."

The SEC generally isn't as concerned about non-GAAP earnings, since they usually exclude easy-to-spot charges like stock-based compensation expenses, acquisition costs, and one-time tax or litigation charges. Non-GAAP revenue is much tougher to justify.

Should investors be worried?

Square's use of adjusted revenue after its divorce from Starbucks was highly unusual. Its rival PayPal only reports one set of revenue, even as it faces the gradual loss of its longtime customer eBay to its European rival Adyen.

Image source: Square.

However, Square's adjusted revenue figure still gives investors a clearer look into its core business without the fog of transaction costs and bitcoin transactions. The metric is also arguably easier to compare to an adjusted version of its gross profits than its total revenue since it excludes most of its cost of revenue.

Square's total and adjusted revenues both grew at a robust pace over the past year, but its adjusted revenue growth notably decelerated at a faster rate than that of its total revenue:

YOY = Year-over-year. Source: Square quarterly reports.

Square expects that deceleration to continue in the fourth quarter, with its adjusted revenue (excluding the divestment of its food delivery platform Caviar) growing 37% annually. That slowdown might continue into 2020, but the elimination of the adjusted revenue metric could make it tougher to gauge Square's long-term growth.

The key takeaways

Many analysts modeled their forecasts based on Square's adjusted revenue, so those estimates will likely need to be revised. However, the change also makes the stock cheaper at just six times this year's revenue, compared to 12 times its adjusted revenue.

Investors shouldn't fret too much over this change since Square wasn't deliberately masking any crucial information. But moving forward, they'll need to pay closer attention to Square's gross profits (and the impact of new businesses like bitcoin and stock trading) to gauge the growth of its core business.