Snap Inc. — Q3 2017 Form 10-Q
Reporting period: Quarter and nine months ended September 30, 2017; unaudited. Comparisons are with the corresponding 2016 periods unless noted. Dollar amounts below are in millions except per-share data and user metrics.
Business context and operating performance
Snap operates Snapchat, a camera and communications application, and monetizes primarily through advertising. It also sells Spectacles hardware. In Q3, average daily active users (DAUs) were 178 million, up 17% year over year, and users created more than 3.5 billion Snaps daily. Average revenue per user (ARPU) was $1.17, versus $0.84 a year earlier and $1.05 in Q2 2017.
Key financial metrics
| Metric | Q3 2017 | Q3 2016 | Nine months 2017 | Nine months 2016 |
|---|---|---|---|---|
| Revenue | $207.9 | $128.2 | $539.3 | $238.8 |
| Cost of revenue | $210.7 | $127.8 | $526.2 | $298.3 |
| Operating loss | $(461.8) | $(131.0) | $(3,124.6) | $(350.6) |
| Net loss | $(443.2) | $(124.2) | $(3,095.1) | $(344.7) |
| Diluted loss per share | $(0.36) | $(0.15) | $(2.71) | $(0.43) |
| Adjusted EBITDA loss | $(178.9) | $(108.6) | $(561.1) | $(307.0) |
| Free cash flow | $(220.0) | $(234.1) | $(621.9) | $(489.6) |
Q3 gross loss was approximately $2.8 million, a gross margin of about -1.3%; net loss was about 213% of revenue. Adjusted EBITDA and free cash flow are non-GAAP measures; the company cautions they should not be considered substitutes for GAAP results.
- Cash flow: Q3 operating cash used was $194.0 million and capital expenditures were $25.9 million. For the nine months, operating cash used was $558.6 million and capital expenditures were $63.3 million.
- Liquidity: At September 30, cash and cash equivalents were $317.6 million and marketable securities were $1,980.5 million, totaling approximately $2.30 billion. The company said it believed available cash would fund working capital, investing, and financing needs for at least 12 months.
- Debt and commitments: No borrowings were outstanding under the $1.2 billion revolving credit facility. Contractual commitments totaled $3.21 billion, including $2.71 billion of hosting commitments and $470.3 million of operating and financing lease payments. Financing lease obligations included in other liabilities were $15.9 million.
Material changes versus prior periods
- Q3 revenue rose 62% year over year; nine-month revenue rose 126%. Management attributed growth mainly to more ads delivered, advertiser demand, increased sales capacity, higher DAUs, and the advertising API. API inventory generally sells at lower prices.
- Q3 costs and expenses increased to $669.8 million from $259.2 million. Cost of revenue exceeded revenue in Q3, including $39.9 million of Spectacles-related charges: excess inventory reserves, purchase-commitment cancellation charges, and asset impairments.
- Nine-month GAAP losses were substantially affected by $2.46 billion of stock-based compensation, including recognition of IPO-triggered RSU expense and a $636.6 million CEO award expense. Q3 stock-based compensation was $221.7 million.
- Cash and marketable securities increased from $987.4 million at December 31, 2016, primarily reflecting IPO proceeds. Snap received approximately $2.6 billion net of underwriting commissions in its March 2017 IPO.
- Snap acquired Zenly and Placed, among other businesses, for total cash paid for acquisitions of $352.4 million during the nine months. Acquisition-related goodwill increased to $612.8 million at quarter end.
Outlook, commentary, risks, and unusual items
- The filing provides no quarterly or annual financial guidance. Management said user growth rates are expected to decline over time and that future results depend increasingly on engagement and monetization. The company expects operating expenses to increase and states it may not achieve or sustain profitability.
- Snap’s principal risks include competition for users and advertising, reliance on advertising for substantially all revenue, user growth and engagement uncertainty, and dependence on Google Cloud for most computing, storage, and bandwidth. Hosting costs and long-term minimum cloud-purchase commitments could pressure margins and liquidity.
- Product and execution risks include Spectacles demand and inventory estimates, high operating costs, and the need to scale infrastructure and personnel. User metrics involve estimation and measurement limitations disclosed in the filing.
- Legal matters include securities class actions relating to the IPO; management says it intends to defend them, but the outcome and reasonably possible loss range could not be estimated. A separate speed-filter injury claim was dismissed in 2017 and is on appeal. Other patent, privacy, and ordinary-course matters are also disclosed.
- Class A shares have no voting rights; the founders hold substantial voting control through Class C shares. This governance structure, along with stock-price volatility and potential share sales, is a notable investor consideration.
- Subsequent disclosures note the planned departure of the Senior Vice President of Engineering, appointment of a principal accounting officer, and Tencent’s reported purchase of 145.8 million non-voting Class A shares. Snap notes that changes in Tencent’s ownership may not be publicly reported.
- Management concluded disclosure controls were effective as of September 30, 2017; no material changes to internal control over financial reporting were identified during the quarter.
Important facts for investors to verify
- Whether DAU growth, ARPU, and advertising demand continue to support revenue growth, and how lower-priced API inventory affects monetization.
- Whether operating costs, hosting commitments, and continued losses can be managed without materially weakening liquidity; assess the scale and timing of the $3.21 billion contractual commitments.
- How much of reported losses reflects recurring operating economics versus IPO-related stock compensation, and the expected ongoing stock-based compensation burden.
- Potential further Spectacles inventory charges, acquisition integration and valuation outcomes, and the final purchase-price allocations.
- Developments in IPO-related litigation, privacy and regulatory matters, and the implications of founder voting control and non-voting public shares.