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What to Expect When Square Reports Fourth-Quarter Earnings Tomorrow

By Evan Niu, CFA – Mar 8, 2016 at 5:30PM

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Jack Dorsey's mobile payments processor reports its first public earnings release after market close tomorrow.

Image source: Square.

Tomorrow will mark payment processor Square's (SQ -0.84%) first earnings release as a public company, following its IPO last November. The release will detail how Square fared in the fourth quarter, and the pressure is on considering the fact that Square's shares briefly fell below the $9 IPO price earlier this year.

What to expect when you're expecting fourth-quarter earnings
For starters, analysts are expecting the company to put up $343.2 million in revenue, which would represent 37% growth compared to the $250.9 million in sales that Square generated in Q4 2014, according to its prospectus. The consensus estimates also call for an adjusted net loss of $0.13 per share, slightly wider than the adjusted net loss of $0.11 per share a year prior.

The disastrous deal with Starbucks will continue to weigh on results until it expires in the third quarter of this year. The two companies agreed last August that Starbucks would transition to a different payment processor starting in October 2015.

It will also be important to see if Square can rein in costs in order to increase its spread. On average, Square keeps approximately 1% of its gross payment volume, which is significantly worse than larger rivals like PayPal (PYPL -0.83%). Both companies charge comparable fees, but Square's cost structure isn't as scalable as PayPal's. PayPal processed $81.5 billion in total payment volumes in the fourth quarter.

Square Capital is key
Much of Square's future growth is also predicated on its ability to cross-sell additional value-added services to its large base of small and local merchants. Management has invested very heavily in growing Square Capital, for instance, which provides cash advances to merchants based upon their processing volume and history. Square Capital is mostly funded by third-party financing partners, minimizing the risk and capital requirements. Square even offers payroll services now as well.

This software and services business is extremely important to Square, though, since it's a high-margin business, and Square Capital is the largest product in the segment. For the first three quarters of 2015, software and services gross margin was 61%, more than double Square's corporate average gross margin of 29%. Software and services revenue was $14.7 million in the third quarter. These services also serve a critical strategic purpose in boosting seller engagement and retention.

While the hardware business operates at a loss typically, it's imperative that Square continues to grow its hardware install base, and the low costs of its devices helps in that department.

Where does Square go from here?
The results and the market's reaction will be an important test, since Square was one of many private companies that saw its valuation drop precipitously last year. After earning a $6 billion private valuation, the company went public at a $2.9 billion valuation, and public investors are still trying to figure out if the IPO was an exit for early VCs or if Square has a bright future. Investors won't have to wait long for the first glimpse.

Evan Niu, CFA owns shares of Starbucks. The Motley Fool owns shares of and recommends PayPal Holdings and Starbucks. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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