Snap Inc. — Q2 2017 Form 10-Q
Reporting period: Quarter and six months ended June 30, 2017; unaudited consolidated results. Snap operates Snapchat and earns substantially all revenue from advertising. Unless otherwise noted, financial amounts below are in millions of U.S. dollars.
Business context and performance
Snap reported average daily active users (DAUs) of 173 million, up 21% from 143 million a year earlier. Management said user growth was primarily driven by North America and Europe. Average revenue per user (ARPU) was $1.05, versus $0.50 a year earlier and $0.90 in Q1 2017; North American ARPU was $1.97. Advertising revenue growth reflected more ads delivered, advertiser demand, a growing sales team, and increased use of the advertising API. API inventory generally sells at lower prices.
Key financial metrics
| Metric | Q2 2017 | Q2 2016 | Six months 2017 | Six months 2016 |
|---|---|---|---|---|
| Revenue | $181.7 | $71.8 | $331.3 | $110.6 |
| Gross profit (loss) | $29.5 | $(23.0) | $15.8 | $(59.9) |
| Gross margin | 16.3% | (32.0%) | 4.8% | (54.2%) |
| Operating loss | $(449.0) | $(115.9) | $(2,662.8) | $(219.7) |
| Net loss | $(443.1) | $(115.9) | $(2,651.9) | $(220.5) |
| Adjusted EBITDA loss | $(194.0) | $(105.1) | $(382.2) | $(198.4) |
| Diluted loss per share | $(0.36) | $(0.14) | $(2.43) | $(0.28) |
Q2 operating costs and expenses were $630.7 million, including $152.1 million of cost of revenue, $255.7 million of research and development, $90.9 million of sales and marketing, and $131.9 million of general and administrative expense. Cost of revenue was 84% of revenue in Q2, compared with 132% a year earlier.
For the six months, net cash used in operating activities was $364.6 million and free cash flow was $(401.9) million; Q2 figures were $(209.6) million and $(228.9) million, respectively. Capital expenditures were $37.4 million for the six months and $19.4 million in Q2.
At June 30, cash and cash equivalents were $501.7 million and marketable securities were $2.296 billion, or approximately $2.8 billion combined. Total assets were $3.875 billion, total liabilities $334.6 million, and stockholders’ equity $3.541 billion. No debt was outstanding under the $1.2 billion revolving credit facility. The filing states existing cash is sufficient for at least the next 12 months.
Material changes versus the prior comparable period
- Q2 revenue rose 153% year over year; first-half revenue rose 200%. Q2 revenue increased from $149.6 million in Q1, primarily due to more ads delivered.
- Q2 gross margin improved to 16.3% from negative 32.0%, but the company remained substantially loss-making as expenses grew faster than revenue.
- First-half net loss increased by $2.431 billion year over year, largely because of $2.237 billion of stock-based compensation expense, versus $10.3 million in the prior-year period. This included a $636.6 million CEO award and substantial expense recognition for pre-2017 RSUs when the IPO registration statement became effective.
- First-half operating cash use increased by $137.9 million year over year. IPO proceeds supported financing cash flow of $2.441 billion and contributed to the higher cash and marketable securities balance.
- Acquisitions used $224.2 million of cash in the first half. The May acquisition of Zenly had $196.1 million of purchase consideration, with purchase accounting still preliminary.
Outlook, commentary, risks and unusual items
- Guidance: The filing provides no quarterly or annual financial guidance. Management expects operating expenses to increase and says future capital needs depend on growth, hiring, marketing, product development, engagement, and acquisitions.
- Commitments: Contractual commitments totaled $3.355 billion, including $2.826 billion for hosting, $410.4 million for operating leases, and $47.9 million for financing leases. Google Cloud requires at least $400 million of purchases annually under a five-year agreement; AWS commitments total $1.0 billion for 2017–2021. Failure to meet annual minimums may require payment of the shortfall.
- Cash needs: RSU tax withholding required $208.4 million of cash in the first half; a further approximately $105 million was remitted through July 31. A $135.2 million acquisition closed in July, after quarter-end.
- Legal matters: Securities class actions filed beginning in May 2017 relate to the IPO; management says it intends to defend them, but the outcome and reasonably possible loss could not be estimated. A separate speed-filter injury claim against Snap was dismissed and is on appeal. The filing also identifies patent, privacy, and other ordinary-course claims.
- Key business risks: User growth and engagement, intense competition, dependence on advertising, rapid cost growth and ongoing losses, reliance on Google Cloud, privacy and security, and the ability to monetize users. Snap cautions that its user metrics are estimates, may undercount or miscount activity, and may not be comparable across periods.
- Governance and market risks: Class A shares have no voting rights; founders hold concentrated voting control through Class C shares. Management also disclosed potential stock-price and index-eligibility effects related to this structure. Class A shares traded between $17.00 and $29.44 through June 30, 2017.
- Unusual item: The IPO triggered substantial one-time stock-based compensation recognition, materially distorting reported GAAP losses. Adjusted EBITDA excludes stock compensation and other items and should not be treated as a substitute for GAAP results or cash flow.
Important facts for investors to verify
- Whether DAU growth, engagement, and ARPU can continue to improve, and how Snap’s metric definitions and known measurement limitations affect comparisons.
- Whether advertising revenue and pricing can outpace hosting, content, and personnel costs, especially as lower-priced API inventory expands.
- The scale and timing of remaining stock-based compensation, including unrecognized compensation costs, and the resulting effect on GAAP losses and share dilution.
- How the large minimum cloud-service commitments compare with actual usage, revenue growth, and available liquidity.
- Developments in IPO-related securities litigation and other legal matters, for which the filing did not provide a clear loss estimate.
- The implications of the non-voting Class A structure, founder voting control, and future RSU-related share issuance or tax-withholding cash requirements.