Square’s status? It’s complicated

May 14, 2014, 5:42 PM UTC

FORTUNE — Even in an industry where things happen at Internet speed, the purported reversal of fortune at Square was remarkably fast. In seemingly no time, the mobile payments startup led by Twitter co-founder Jack Dorsey went from darling to impending disaster. Square is a fast-growing but money-losing enterprise, reports proclaimed, with a high burn rate, shrinking balance sheet, and narrowing set of options.

But several interviews with Square executives, board members, and people close to the company — as well as a series of internal company e-mails obtained by Fortune — suggest a far more subtle narrative.

Square is certainly a company in transition. It has built a sizable and fast-growing payments business, which it is now trying to use as a springboard to expand into new and potentially more profitable areas. This week, the company introduced two new products intended to do just that. Success is hardly guaranteed, and the release comes in the wake of the failure of one of the company’s high-profile products — Square Wallet.

The company has yet to turn a profit, but its losses are largely the result of the heavy investment it is making in new products. In the last year alone, Square added 300 employees. Its current headcount is nearing 900.

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Some earlier reports suggest Square loses money on every transaction in its core payments business. But internal e-mails show that gross margins on transactions — the amount of profit left after paying card processors, payment networks and other intermediaries — are a relatively healthy 34%. On a $100 transaction, the company takes a cut of about $3, which it records as revenue and from which it earns about $1 in gross profit. According to the internal e-mails, company is processing about $30 billion in transactions annually, which would put its gross profit at an annual rate of about $300 million. (These figures exclude the transactions Square handles on behalf of Starbucks; more on that below.)

“The gross profits we earn on transactions already pay for the non-growth expenses of the company,” said Roelof Botha, a partner at Sequoia Capital and a board member of Square. “We could be profitable tomorrow morning if we said, ‘Lets not spend money to keep growing.’ ”

Botha declined to comment on any specific financial figures. Aaron Zamost, a company spokesman, also declined to comment on specific financial information.

Internal projections show that the company expects to start turning a profit about a year from now, according to the documents reviewed by Fortune. (An alternate plan that contemplates more aggressive investments in new products shows profitability would be delayed by a couple of months but would increase at a faster rate afterwards.) Though the company expects its cash reserves to decline between now and then, its projections show that a turnaround will happen before Square would run out of cash. Further, the company recently secured a $225 million line of credit — a total higher than what has been previously reported — that will give it additional breathing room. People familiar with the company’s finances say that its projections are relatively conservative, and do not include revenue from Square’s new (and as yet unproven) products, which could conceivably help the company reach profitability sooner.

Though the company recorded am overall loss of roughly $100 million in 2013, its EBITDA loss, a commonly used accounting measure, was $67 million, according to the internal e-mails. The loss, which excludes Starbucks transactions, was $12 million lower than the company had projected and slightly smaller than the year before, the e-mails show.

Botha declined to comment on any of the internal forecasts, but said that Square’s business has been “incredibly predictable,” meaning that revenue has grown in line with previous predictions.

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Square executives were stung by a recent story that ran in the front page of the Wall Street Journal that suggested the company was at risk of running out of cash. The story also said that Square had discussed selling itself to deep-pocketed giants, most notably Google (GOOG). Square vehemently denied that it held acquisition talks with anyone.

People familiar with the matter say that Square and Google had talks, but that they were centered around a possible investment in Square by Google Ventures, the company’s venture capital arm. Square and Google Ventures declined to comment.

It is not clear whether Square — which has already raised a total of $367 million from investors — is actively trying to raise additional funds. The company had about $155 million left on its balance sheet at the end of 2013, according to the internal emails. In the past, the company has been opportunistic about financing, raising money when it was possible to do so on favorable terms. Square executives seem to be confident that investors still find its shares attractive. When the company recently allowed employees to sell a limited number of their shares in a secondary offering, demand for the shares exceeded supply by about $40 million, according to internal e-mails. The company chose not to sell any of its own shares, even though it could have done so to close the gap and to raise additional funds in the process.

The man charged with leading Square’s transition into new product categories is Gokul Rajaram, a 39-year-old product engineering whiz who led the development of some of the most important ad technologies at Google and Facebook (FB) before joining Square nearly a year ago.

The past week has been a busy one for Rajaram and his team. On Monday, the company launched Order, a new app that allows people to preorder and prepay for food from restaurants and coffee shops. The app replaces the once-ballyhooed mobile payment service Wallet after it failed to get wide consumer adoption. Square takes 2.75% of most transactions, but with Orders it will charge 8%. The app faces competition from PayPal, among others.

On Tuesday, Square launched Feedback, its first subscription product. Feedback allows merchants to use receipts as a channel for communicating with customers. With the service, which costs $10 per month, merchants will be able to ask consumers to rate their experience. Merchants could then follow up with customers, offering discounts to those who were unhappy or sending coupons to fans. “It’s an opportunity to start a conversation around a transaction,” Rajaram said during an interview at Square headquarters.

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Rajaram said that the millions of transactions that Square processes through its credit card readers give it valuable data that it can turn into other money-making ventures. He said that Square Capital, a program to offer cash advances to merchants that it began testing in March, has had a high uptake rate among merchants in part because the company knows how to target the offers.

Square has said little about the performance of its all-in-one cash register or Square Cash, its person-to-person payment service. But Wallet is not Square’s only disappointment: Its high-profile deal with Starbucks has also failed to meet expectations.

When asked about it, Botha took a long pause before saying: “It’s dangerous to look at things with the benefit of hindsight.” Based on what the company knew at the time, he said, it made sense to do the deal, which made Square the payment processor at 7,000 Starbucks locations. The company had hoped that the deal would boost adoption of Square Wallet, but that didn’t pan out. Internal e-mails show the deal cost Square an additional $25 million in losses last year.

Botha insists that plenty of good came from the deal, including the intangible boost to the Square brand and the benefit of having Starbucks founder Howard Schultz on Square’s board of directors for a year. “Howard provided wonderful value to Jack and the team,” Botha said.

A big question is whether Square will grow into its $5 billion valuation. In a recent widely-read post, venture capitalist Fred Wilson of Union Square Ventures warned about what we called the “valuation trap.” “The combination of sky high valuations, equally high burn rates, and a disappearing IPO market is not a pleasant one,” Wilson wrote. He said that Square and Box, which recently delayed its initial public offering, were both potentially facing that situation. Wilson wrote that he expected both companies to “navigate the valuation trap” but not without having to make “some hard choices.”

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Botha dismissed those concerns, saying he had seen companies whose valuations had gotten ahead of their business prospects and suffered painful recapitalizations and financing rounds at decreasing valuations. “Do I worry with regards to Square?” he asked. “No.”

With no plans to go public this year, it’s no surprise that the cooling of the I.P.O. market and the recent downturn in tech stocks is not a major concern for Square executives. A more immediate concern may be any sign that the company’s core business stops growing at projected rates, whether from competition, a slowing economy, or the changing habits of consumers or merchants. If that happens, Square’s well-laid plans may not amount to much.