Snap Inc 10-Q

Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations The following discussion and analysis of our financial condition and results of operations should be read in conjunction with our consolidated financial statements and related notes included elsewhere in this Quarterly Report on Form 10-Q and with our audited consolidated financial statements included in our Annual Report. In addition to historical consolidated financial information, the following discussion contains forward-looking statements that reflect our plans, estimates, and beliefs that involve significant risks and uncertainties. Our actual results could differ materially from those discussed in the forward-looking statements. Factors that could cause or contribute to those differences include those discussed below and elsewhere in this Quarterly Report on Form 10-Q, particularly in “Risk Factors,” “Note Regarding Forward-Looking Statements,” and “Note Regarding User Metrics and Other Data.” Overview of Third Quarter 2020 Results Our key user metrics and financial results for the third quarter of 2020 were as follows: User Metrics • Daily Active Users, or DAUs, increased to 249 million in Q3 2020, compared to 210 million in Q3 2019. • Average revenue per user, or ARPU, increased to $2.73 in Q3 2020, compared to $2.12 in Q3 2019. Financial Results • Cash used in operating activities was $(54.8) million in Q3 2020, compared to $(76.1) million in Q3 2019. • Free Cash Flow was $(69.6) million in Q3 2020, compared to $(84.1) million in Q3 2019. • Common shares outstanding plus shares underlying stock-based awards, including restricted stock units, restricted stock awards, and outstanding stock options, totaled 1,624 million at September 30, 2020, compared with 1,565 million one year ago. • Capital expenditures were $14.7 million in Q3 2020, compared to $7.9 million in Q3 2019. • Cash, cash equivalents, and marketable securities were $2.7 billion as of September 30, 2020. • Revenue increased 52% to $678.7 million in Q3 2020, compared to $446.2 million in Q3 2019. • Total costs and expenses, excluding stock-based compensation and related payroll tax expense, increased 26% to $644.1 million in Q3 2020, compared to $509.2 million in Q3 2019. • Net loss decreased 12% to $(199.9) million in Q3 2020, compared to $(227.4) million in Q3 2019. • Diluted net loss per share decreased 16% to $(0.14) in Q3 2020, compared to $(0.16) in Q3 2019. • Adjusted EBITDA increased 233% to $56.4 million in Q3 2020, compared to $(42.4) million in Q3 2019. Overview Snap Inc. is a camera company. We believe that reinventing the camera represents our greatest opportunity to improve the way that people live and communicate. We contribute to human progress by empowering people to express themselves, live in the moment, learn about the world, and have fun together. Our flagship product, Snapchat, is a camera application that helps people communicate visually with friends and family through short videos and images called Snaps. 24 Trends in User Metrics We define a DAU as a registered Snapchat user who opens the Snapchat application at least once during a defined 24-hour period. We define ARPU as quarterly revenue divided by the average DAUs. We assess the health of our business by measuring DAUs and ARPU because we believe that these metrics are important ways for both management and investors to understand engagement and monitor our platform. User Engagement We calculate average DAUs for a particular quarter by adding the number of DAUs on each day of that quarter and dividing that sum by the number of days in that quarter. DAUs are broken out by geography because markets have different characteristics . We had 249 million DAUs on average in the third quarter of 2020, an increase of 39 million, or 18%, from the third quarter of 2019. Quarterly Average Daily Active Users (in millions) (1) North America includes Mexico, the Caribbean, and Central America. (2) Europe includes Russia and Turkey. 25 Monetization We recorded revenue of $678.7 million for the three months ended September 30, 2020, compared to revenue of $446.2 million for the same period in 2019, an increase of 52% year-over-year. In the nine months ended September 30, 2020, we recorded revenue of $1.6 billion compared to revenue of $1.2 billion for the same period in 2019, an increase of 38% year-over-year. We monetize our business primarily through advertising. Our advertising products include Snap Ads and Sponsored Creative Tools. We measure our business using ARPU because it helps us understand the rate at which we’re monetizing our daily user base. ARPU was $2.73 in the third quarter of 2020, up from $2.12 in the third quarter of 2019 and $1.91 in the second quarter of 2020. For purposes of calculating ARPU, revenue by user geography is apportioned to each region based on a determination of the geographic location in which advertising impressions are delivered, as this approximates revenue based on user activity. This differs from the presentation of our revenue by geography in the notes to our consolidated financial statements, where revenue is based on the billing address of the advertising customer. Quarterly Average Revenue per User (1) North America includes Mexico, the Caribbean, and Central America. (2) Europe includes Russia and Turkey. 26 Results of Operations The following table summarizes certain selected historical financial results: Three Months Ended September 30, Nine Months Ended September 30, 2020 2019 2020 2019 (dollars in thousands) Revenue $ 678,668 $ 446,199 $ 1,595,304 $ 1,154,646 Operating loss (167,864 ) (228,853 ) (764,836 ) (849,732 ) Net loss (199,853 ) (227,375 ) (831,740 ) (792,956 ) Adjusted EBITDA (1) 56,361 (42,375 ) (120,446 ) (244,537 ) (1) For information on how we define and calculate Adjusted EBITDA, and a reconciliation of net loss to Adjusted EBITDA, see “Non-GAAP Financial Measures.” Components of Results of Operations Revenue We generate substantially all of our revenue through the sale of our advertising products, which include Snap Ads and Sponsored Creative Tools, and measurement services, referred to as advertising revenue. Snap Ads may be subject to revenue sharing arrangements between us and the media partner. We also generate revenue from sales of our hardware product, Spectacles. This revenue is reported net of allowances for returns. Cost of Revenue Cost of revenue consists primarily of payments to third-party infrastructure partners for hosting our products, which include expenses related to storage, computing, and bandwidth costs. Cost of revenue also includes payments for content and third party selling costs, referred to as revenue share. In addition, cost of revenue includes advertising measurement services and personnel-related costs, including salaries, benefits, and stock-based compensation expenses. In addition, cost of revenue includes facilities and other supporting overhead costs, including depreciation and amortization, and inventory costs for Spectacles. Research and Development Expenses Research and development expenses consist primarily of personnel-related costs, including salaries, benefits, and stock-based compensation expense for our engineers, designers, and other employees engaged in the research and development of our products. In addition, research and development expenses include facilities and other supporting overhead costs, including depreciation and amortization. Research and development costs are expensed as incurred. Sales and Marketing Expenses Sales and marketing expenses consist primarily of personnel-related costs, including salaries, benefits, commissions, and stock-based compensation expense for our employees engaged in sales and sales support, business development, media, marketing, corporate partnerships, and customer service functions. Sales and marketing expenses also include costs incurred for advertising, market research, tradeshows, branding, marketing, promotional expense, and public relations, as well as facilities and other supporting overhead costs, including depreciation and amortization. General and Administrative Expenses General and administrative expenses consist primarily of personnel-related costs, including salaries, benefits, and stock-based compensation expense for our finance, legal, information technology, human resources, and other administrative teams. General and administrative expenses also include facilities and supporting overhead costs, including depreciation and amortization, and external professional services. Interest Income Interest income consists primarily of interest earned on our cash, cash equivalents, and marketable securities. 27 Interest Expense Interest expense consists primarily of interest expense associated with the Convertible Notes and commitment fees and amortization of financing costs related to our revolving credit facility. Other Income (Expense), Net Other income (expense), net consists of realized gains and losses on sales of marketable securities, our portion of non-marketable investment income and losses, foreign currency transaction gains and losses, and impairment on non-marketable investments. Other income (expense), net also includes any gains or losses on divestitures of businesses. Income Tax Benefit (Expense) We are subject to income taxes in the United States and numerous foreign jurisdictions. These foreign jurisdictions have different statutory tax rates than the United States. Additionally, certain of our foreign earnings may also be taxable in the United States. Accordingly, our effective tax rates will vary depending on the relative proportion of foreign to domestic income, use of tax credits, changes in the valuation of our deferred tax assets and liabilities, and changes in tax laws. Adjusted EBITDA We define Adjusted EBITDA as net income (loss), excluding interest income; interest expense; other income (expense), net; income tax benefit (expense); depreciation and amortization; stock-based compensation expense and related payroll tax expense; and certain other non-cash or non-recurring items impacting net income (loss) from time to time. We consider the exclusion of certain non-cash and non-recurring expenses in calculating Adjusted EBITDA to provide a useful measure for period-to-period comparisons of our business and for investors and others to evaluate our operating results in the same manner as does our management. Additionally, we believe that Adjusted EBITDA is an important measure since we use third-party infrastructure partners to host our services and therefore we do not incur significant capital expenditures to support revenue-generating activities. See “Non-GAAP Financial Measures” for additional information and a reconciliation of net loss to Adjusted EBITDA. 28 Discussion of Results of Operations Impact of COVID-19 Pandemic The broader impact of the recent COVID-19 pandemic on our results of operations and overall financial performance continues to remain uncertain. The COVID-19 pandemic has impacted our year to date revenue growth, and will likely continue to adversely impact many aspects of our business and our partners. See “Risk Factors” for further discussion of the potential adverse impacts of the COVID-19 pandemic and related events on our business and partners. The following table sets forth our consolidated statements of operations data: Three Months Ended September 30, Nine Months Ended September 30, 2020 2019 2020 2019 (dollars in thousands) Consolidated Statements of Operations Data: Revenue $ 678,668 $ 446,199 $ 1,595,304 $ 1,154,646 Costs and expenses (1) (2) : Cost of revenue 293,095 223,140 796,959 642,399 Research and development 283,639 211,599 783,115 663,983 Sales and marketing 143,511 123,240 397,834 332,626 General and administrative 126,287 117,073 382,232 365,370 Total costs and expenses 846,532 675,052 2,360,140 2,004,378 Operating loss (167,864 ) (228,853 ) (764,836 ) (849,732 ) Interest income 2,801 10,317 16,158 25,579 Interest expense (28,212 ) (8,654 ) (68,052 ) (10,219 ) Other income (expense), net (5,669 ) (1,481 ) (14,483 ) 41,477 Loss before income taxes (198,944 ) (228,671 ) (831,213 ) (792,895 ) Income tax benefit (expense) (909 ) 1,296 (527 ) (61 ) Net loss $ (199,853 ) $ (227,375 ) $ (831,740 ) $ (792,956 ) Adjusted EBITDA (3) $ 56,361 $ (42,375 ) $ (120,446 ) $ (244,537 ) (1) Stock-based compensation expense included in the above line items: Three Months Ended September 30, Nine Months Ended September 30, 2020 2019 2020 2019 (dollars in thousands) Stock-based compensation expense: Cost of revenue $ 2,623 $ 1,332 $ 6,471 $ 4,967 Research and development 132,003 108,176 377,836 353,028 Sales and marketing 27,393 23,333 79,306 67,567 General and administrative 30,061 28,387 86,687 93,796 Total $ 192,080 $ 161,228 $ 550,300 $ 519,358 (2) Depreciation and amortization expense included in the above line items: Three Months Ended September 30, Nine Months Ended September 30, 2020 2019 2020 2019 (dollars in thousands) Depreciation and amortization expense: Cost of revenue $ 5,615 $ 4,580 $ 16,672 $ 16,368 Research and development 9,526 8,632 26,904 24,470 Sales and marketing 3,233 3,109 9,780 10,169 General and administrative 3,430 4,325 10,577 15,618 Total $ 21,804 $ 20,646 $ 63,933 $ 66,625 29 (3) See “Non-GAAP Financial Measures” for more information and for a reconciliation of Adjusted EBITDA to net loss, the most directly comparable financial measure calculated and presented in accordance with GAAP. The following table sets forth the components of our consolidated statements of operations data for each of the periods presented as a percentage of revenue: Three Months Ended September 30, Nine Months Ended September 30, 2020 2019 2020 2019 Consolidated Statements of Operations Data: Revenue 100 % 100 % 100 % 100 % Costs and expenses: Cost of revenue 43 50 50 56 Research and development 42 47 49 58 Sales and marketing 21 28 25 29 General and administrative 19 26 24 32 Total costs and expenses 125 151 148 174 Operating loss 25 51 48 74 Interest income 0 2 1 2 Interest expense 4 2 4 1 Other income (expense), net 1 — 1 4 Loss before income taxes 29 51 52 69 Income tax benefit (expense) — — — — Net loss 29 % 51 % 52 % 69 % Three and Nine Months Ended September 30, 2020 and 2019 Revenue Three Months Ended September 30, Nine Months Ended September 30, 2020 2019 2020 2019 (dollars in thousands) Revenue $ 678,668 $ 446,199 $ 1,595,304 $ 1,154,646 Revenue as a dollar change $ 232,469 $ 440,658 Revenue as a percentage change 52 % 38 % Revenue for the three months ended September 30, 2020 increased $232.5 million, or 52%, compared to the same period in 2019. Revenue was $1.6 billion for the nine months ended September 30, 2020, compared to $1.2 billion for the same period in 2019, an increase of $440.7 million, or 38%. Revenue increased due to overall growth in advertiser demand. Cost of Revenue Three Months Ended September 30, Nine Months Ended September 30, 2020 2019 2020 2019 (dollars in thousands) Cost of Revenue $ 293,095 $ 223,140 $ 796,959 $ 642,399 Cost of Revenue as a dollar change $ 69,955 $ 154,560 Cost of Revenue as a percentage change 31 % 24 % 30 Cost of revenue for the three and nine months ended September 30, 2020 increased $70.0 million and $154.6 million, respectively, compared to the same periods in 2019. The increase in cost of revenue primarily consisted of increased infrastructure costs of $27.6 million and $71.3 million for the three and nine months ended September 30, 2020, respectively, attributable to DAU growth and increased user activity between the periods, net of infrastructure cost efficiencies. Additionally, the increases were driven by increased revenue share costs due to the overall increase in revenue and a higher mix of revenue subject to revenue share. Research and Development Expenses Three Months Ended September 30, Nine Months Ended September 30, 2020 2019 2020 2019 (dollars in thousands) Research and Development Expenses $ 283,639 $ 211,599 $ 783,115 $ 663,983 Research and Development Expenses as a dollar change $ 72,040 $ 119,132 Research and Development Expenses as a percentage change 34 % 18 % Research and development expenses for the three and nine months ended September 30, 2020 increased $72.0 million and $119.1 million, respectively, compared to the same periods in 2019. The increase primarily consisted of an increase in personnel costs, driven by growth in research and development headcount that contributed to higher total stock-based compensation expense, and changes to our cash compensation programs . Sales and Marketing Expenses Three Months Ended September 30, Nine Months Ended September 30, 2020 2019 2020 2019 (dollars in thousands) Sales and Marketing Expenses $ 143,511 $ 123,240 $ 397,834 $ 332,626 Sales and Marketing Expenses as a dollar change $ 20,271 $ 65,208 Sales and Marketing Expenses as a percentage change 16 % 20 % Sales and marketing expenses for the three and nine months ended September 30, 2020 increased $20.3 million and $65.2 million compared to the same periods in 2019. T he increase was primarily driven by an increase in personnel expenses due to the growth in sales and marketing headcount as well as increased marketing initiatives. The increase was partially offset by the impact of lower travel and event-related spending given COVID-19 related restrictions on these activities. General and Administrative Expenses Three Months Ended September 30, Nine Months Ended September 30, 2020 2019 2020 2019 (dollars in thousands) General and Administrative Expenses $ 126,287 $ 117,073 $ 382,232 $ 365,370 General and Administrative Expenses as a dollar change $ 9,214 $ 16,862 General and Administrative Expenses as a percentage change 8 % 5 % General and administrative expenses for the three months ended September 30, 2020 increased $9.2 million, or 8%, compared to the same period in 2019. The increase primarily consisted of higher personnel expenses, driven by an increase in headcount. The increase was partially offset by the impact of lower travel and event-related spending given COVID-19 related restrictions on these activities. 31 General and administrative expenses for the nine months ended September 30, 2020 increased $16.9 million , or 5% , compa red to the same period in 2019. The increase consisted of a n increase in legal settlement expenses primarily related to the preliminary settlement of the Vaporstream matter in the first quarter of 2020 , as well as an increase in personnel expenses driven by an increase in headcount. This increase was partially offset by a lower cost per head driven by a decrease in stock - based compensation expense and the impact of lower travel and event-related spending given COVID-19 related restrictions on these activities . Interest Income Three Months Ended September 30, Nine Months Ended September 30, 2020 2019 2020 2019 (dollars in thousands) Interest Income $ 2,801 $ 10,317 $ 16,158 $ 25,579 Interest Income as a dollar change $ (7,516 ) $ (9,421 ) Interest Income as a percentage change (73 )% (37 )% Interest income for the three and nine months ended September 30, 2020 decreased $7.5 million and $9.4 million, respectively, compared to the same periods in 2019. The decrease was primarily a result of lower interest rates on U.S. government-backed securities, partially offset by a higher overall invested cash balance. Interest Expense Three Months Ended September 30, Nine Months Ended September 30, 2020 2019 2020 2019 (dollars in thousands) (NM = Not Meaningful) Interest Expense $ (28,212 ) $ (8,654 ) $ (68,052 ) $ (10,219 ) Interest Expense as a dollar change $ (19,558 ) $ (57,833 ) Interest Expense as a percentage change NM NM Interest expense for the three and nine months ended September 30, 2020 increased $19.6 million and $57.8 million, respectively, compared to the same periods in 2019. The increase in interest expense is related to the Convertible Notes. Other Income (Expense), Net Three Months Ended September 30, Nine Months Ended September 30, 2020 2019 2020 2019 (dollars in thousands) Other Income (Expense), Net $ (5,669 ) $ (1,481 ) $ (14,483 ) $ 41,477 Other Income (Expense), Net as a dollar change $ (4,188 ) $ (55,960 ) Other Income (Expense), Net as a percentage change 283 % (135 )% Other expense, net for the three months ended September 30, 2020 was $(5.7) million compared to $(1.5) million in the same period in 2019. Other expense, net for the three months ended September 30, 2020 was primarily a result of a $5.0 million impairment of a non-marketable investment. Other expense, net in the comparable period in 2019 was primarily a result of losses on non-marketable investments. Other expense, net for the nine months ended September 30, 2020 was $(14.5) million, compared to other income, net of $41.5 million in the same period in 2019. Other expense, net for the nine months ended September 30, 2020 was primarily a result of a $15.5 million in impairment of non-marketable investments. Other income, net in the comparable period in 2019 was primarily a result of a gain of $39.9 million on the divestiture of Placed, as well as gains on non-marketable investments. 32 Income Tax Benefit (Expense) Three Months Ended September 30, Nine Months Ended September 30, 2020 2019 2020 2019 (dollars in thousands) Income Tax Benefit (Expense) $ (909 ) $ 1,296 $ (527 ) $ (61 ) Income Tax Benefit (Expense) as a dollar change $ (2,205 ) $ (466 ) Income Tax Benefit (Expense) as a percentage change (170 )% 764 % Effective Tax Rate (0.5 )% 0.6 % (0.1 )% (0.0 )% Income tax expense for the three and nine months ended September 30, 2020 was $(0.9) million and $(0.5) million, respectively, compared to an income tax benefit of $1.3 million and a tax expense of $(0.1) million, respectively, for the same periods in 2019. Our effective tax rate differs from the U.S. statutory tax rate primarily due to valuation allowances on our deferred tax assets as it is more likely than not that some or all of our deferred tax assets will not be realized. Net Loss and Adjusted EBITDA Three Months Ended September 30, Nine Months Ended September 30, 2020 2019 2020 2019 (dollars in thousands) Net Loss $ (199,853 ) $ (227,375 ) $ (831,740 ) $ (792,956 ) Net Loss as a dollar change $ 27,522 $ (38,784 ) Net Loss as a percentage change (12 )% 5 % Adjusted EBITDA $ 56,361 $ (42,375 ) $ (120,446 ) $ (244,537 ) Adjusted EBITDA as a dollar change $ 98,736 $ 124,091 Adjusted EBITDA as a percentage change (233 )% (51 )% Net loss for the three and nine months ended September 30, 2020 was $(199.9) million and $(831.7) million, respectively, compared to $(227.4) million and $(793.0) million, respectively, for the same periods in 2019. Adjusted EBITDA for the three and nine months ended September 30, 2020 was $56.4 million and $(120.4) million, respectively, compared to $(42.4) million and $(244.5) million, respectively, for the same periods in 2019. Adjusted EBITDA for the three and nine months ended September 30, 2020 increased $98.7 million and $124.1 million, respectively, compared to the same periods in 2019 due to an increase in revenue partially offset by an increase in cost of revenue attributable to DAU growth and an increase in personnel expenses. The increase in net loss for the nine months ended September 30, 2020 was primarily due to the $39.9 million gain from the Placed divestiture recognized in the prior periods. For a discussion of the limitations associated with using Adjusted EBITDA rather than GAAP measures and a reconciliation of this measure to net loss, see “Non-GAAP Financial Measures.” Non-GAAP Financial Measures To supplement our consolidated financial statements, which are prepared and presented in accordance with GAAP, we use certain non-GAAP financial measures, as described below, to understand and evaluate our core operating performance. These non-GAAP financial measures, which may be different than similarly titled measures used by other companies, are presented to enhance investors’ overall understanding of our financial performance and should not be considered a substitute for, or superior to, the financial information prepared and presented in accordance with GAAP. We use the non-GAAP financial measure of Free Cash Flow, which is defined as net cash provided by (used in) operating activities, reduced by purchases of property and equipment. We believe Free Cash Flow is an important liquidity measure of the cash that is available, after capital expenditures, for operational expenses and investment in our business and is a key financial indicator used by management. Additionally, we believe that Free Cash Flow is an important measure since we use third-party infrastructure partners to host our services and therefore we do not incur significant capital expenditures to support revenue generating activities. Free Cash Flow is useful to investors as a liquidity measure because it measures our ability to generate or use cash. Once our business needs and obligations are met, cash can be used to maintain a strong balance sheet and invest in future growth. 33 We use the non-GAAP financial measure of Adjusted EBITDA, which is defined as net income (loss); excluding interest income; interest expense; other income (expense), net; income tax benefit (expense); depreciation and amortization; stock-based compensation expense and related payroll tax expense; and certain other non-cash or non-recurring items impacting net income (loss) from time to time. We believe that Adjusted EBITDA helps identify underlying trends in our business that could otherwise be masked by the effect of the expenses that we exclude in Adjusted EBITDA. We believe that both Free Cash Flow and Adjusted EBITDA provide useful information about our financial performance, enhance the overall understanding of our past performance and future prospects, and allow for greater transparency with respect to key metrics used by our management for financial and operational decision-making. We are presenting the non-GAAP measures of Free Cash Flow and Adjusted EBITDA to assist investors in seeing our financial performance through the eyes of management, and because we believe that these measures provide an additional tool for investors to use in comparing our core financial performance over multiple periods with other companies in our industry. These non-GAAP financial measures should not be considered in isolation from, or as substitutes for, financial information prepared in accordance with GAAP. There are a number of limitations related to the use of these non-GAAP financial measures compared to the closest comparable GAAP measure. Some of these limitations are that: • Free Cash Flow does not reflect our future contractual commitments. • Adjusted EBITDA excludes certain recurring, non-cash charges such as depreciation of fixed assets and amortization of acquired intangible assets and, although these are non-cash charges, the assets being depreciated and amortized may have to be replaced in the future; • Adjusted EBITDA excludes stock-based compensation expense and related payroll tax expense, which have been, and will continue to be for the foreseeable future, significant recurring expenses in our business and an important part of our compensation strategy; and • Adjusted EBITDA does not reflect tax payments that reduce cash available to us. The following table presents a reconciliation of Free Cash Flow to net cash provided by operating activities, the most comparable GAAP financial measure, for each of the periods presented: Three Months Ended September 30, Nine Months Ended September 30, 2020 2019 2020 2019 (dollars in thousands) Free Cash Flow reconciliation: Net cash used in operating activities $ (54,828 ) $ (76,149 ) $ (115,099 ) $ (238,116 ) Less: Purchases of property and equipment (14,727 ) (7,938 ) (41,385 ) (27,385 ) Free Cash Flow $ (69,555 ) $ (84,087 ) $ (156,484 ) $ (265,501 ) The following table presents a reconciliation of Adjusted EBITDA to net loss, the most comparable GAAP financial measure, for each of the periods presented: Three Months Ended September 30, Nine Months Ended September 30, 2020 2019 2020 2019 (dollars in thousands) Adjusted EBITDA reconciliation: Net loss $ (199,853 ) $ (227,375 ) $ (831,740 ) $ (792,956 ) Add (deduct): Interest income (2,801 ) (10,317 ) (16,158 ) (25,579 ) Interest expense 28,212 8,654 68,052 10,219 Other (income) expense, net 5,669 1,481 14,483 (41,477 ) Income tax (benefit) expense 909 (1,296 ) 527 61 Depreciation and amortization 21,804 20,646 63,933 66,625 Stock-based compensation expense 192,080 161,228 550,300 519,358 Payroll tax expense related to stock-based compensation 10,341 4,604 30,157 19,212 Adjusted EBITDA $ 56,361 $ (42,375 ) $ (120,446 ) $ (244,537 ) 34 Liquidity and Capital Resources Cash, cash equivalents, and marketable securities were $2.7 billion as of September 30, 2020, primarily consisting of cash on deposit with banks and highly liquid investments in U.S. government and agency securities, corporate debt securities, certificates of deposit, and commercial paper. Our primary source of liquidity is cash generated through financing activities. Our primary uses of cash include operating costs such as personnel-related costs and the infrastructure costs of the Snapchat application, facility-related capital spending, and acquisitions and investments. There are no known material subsequent events that could have a material impact on our cash or liquidity. We may contemplate and engage in merger and acquisition activity that could materially impact our liquidity and capital resource position. In April 2020, we issued the 2025 Notes with an aggregate principal amount of $1.0 billion. The net proceeds from the issuance of the 2025 Notes were $888.6 million, net of debt issuance costs and cash used to pay the costs of the 2025 Capped Call Transactions. The 2025 Notes mature on May 1, 2025 unless repurchased, redeemed, or converted in accordance with their terms prior to such date. The 2025 Notes were not convertible as of September 30, 2020. In August 2019, we issued the 2026 Notes with an aggregate principal amount of $1.265 billion. The net proceeds from the issuance of the 2026 Notes were $1.15 billion, net of debt issuance costs and cash used to pay the costs of the 2026 Capped Call Transactions. The 2026 Notes mature on August 1, 2026 unless repurchased, redeemed, or converted in accordance with their terms prior to such date. The 2026 Notes were not convertible as of September 30, 2020. In July 2016, we entered into a five-year senior unsecured revolving credit facility, or the Credit Facility, with lenders some of which are affiliated with certain members of the underwriting syndicate for our Convertible Notes offering, that allows us to borrow up to $1.1 billion to fund working capital and general corporate-purpose expenditures. The loan bears interest at LIBO plus 0.75%, as well as an annual commitment fee of 0.10% on the daily undrawn balance of the facility. No origination fees were incurred at the closing of the Credit Facility. In December 2016, the amount we are permitted to borrow under the Credit Facility was increased to $1.2 billion. In February 2018, the amount we are permitted to borrow under the Credit Facility was increased to $1.25 billion. In August 2018, we amended the Credit Facility to extend the term to August 2023 with respect to an aggregate of $1.05 billion of the $1.25 billion that we may borrow under the Credit Facility. In August 2019, we amended the Credit Facility to revise the covenants that restrict the repurchase of equity securities and the incurrence of indebtedness to permit the 2026 Capped Call Transactions and issuance of the 2026 Notes. In April 2020, we amended the Credit Facility to revise the covenants that restrict the incurrence of indebtedness to permit the 2025 Capped Call Transactions and issuance of the 2025 Notes. As of September 30, 2020, no amounts were outstanding under the Credit Facility. As of September 30, 2020, we had $25.4 million in the form of outstanding standby letters of credit. We believe our existing cash balance is sufficient to fund our ongoing working capital, investing, and financing requirements for at least the next 12 months. Our future capital requirements will depend on many factors including our growth rate, headcount, sales and marketing activities, research and development efforts, the introduction of new features, products, and acquisitions, and continued user engagement. We continually evaluate opportunities to issue or repurchase equity or debt securities, obtain, retire, or restructure credit facilities or financing arrangements, or declare dividends for strategic reasons or to further strengthen our financial position. As of September 30, 2020, approximately 5% of our cash, cash equivalents, and marketable securities was held outside the United States. These amounts were primarily held in the United Kingdom and are utilized to fund our foreign operations. Cash held outside the United States may be repatriated, subject to certain limitations, and would be available to be used to fund our domestic operations. However, repatriation of funds may result in additional tax liabilities. We believe our existing cash balance in the United States is sufficient to fund our working capital needs. The following table sets forth the major components of our consolidated statements of cash flows for the periods presented: Three Months Ended September 30, Nine Months Ended September 30, 2020 2019 2020 2019 (dollars in thousands) Net cash used in operating activities $ (54,828 ) $ (76,149 ) $ (115,099 ) $ (238,116 ) Net cash used in investing activities (375,250 ) (688,319 ) (495,797 ) (584,532 ) Net cash provided by financing activities 2,434 1,157,550 914,623 1,164,488 Change in cash, cash equivalents, and restricted cash $ (427,644 ) $ 393,082 $ 303,727 $ 341,840 Free Cash Flow (1) $ (69,555 ) $ (84,087 ) $ (156,484 ) $ (265,501 ) 35 (1) For information on how we define and calculate Free Cash Flow and a reconciliation to net cash provided by (used in) operating activities to Free Cash Flow, see “Non-GAAP Financial Measures.” Three and Nine Months Ended September 30, 2020 and 2019 Net Cash Used in Operating Activities Net cash used in operating activities decreased $21.3 million in the three months ended September 30, 2020, compared to the same period in 2019. Net cash used in operating activities was $(54.8) million for three months ended September 30, 2020, resulting primarily from net loss, adjusted for non-cash items, primarily stock-based compensation expense of $192.1 million and depreciation and amortization expense of $21.8 million. Net cash used in operating activities for the three months ended September 30, 2020 was also driven by an increase in the accounts receivable balance of $151.9 million due to an increase in revenue, partially offset by a $61.6 million increase in accrued expenses and other current liabilities primarily due to the timing of payments. Net cash used in operating activities decreased $123.0 million in the nine months ended September 30, 2020, compared to the same period in 2019. Net cash used in operating activities was $(115.1) million for the nine months ended September 30, 2020, resulting primarily from net loss, adjusted for non-cash items, primarily stock-based compensation expense of $550.3 million and depreciation and amortization expense of $63.9 million. Net cash used in operating activities for the nine months ended September 30, 2020 was also driven by an increase in the accounts receivable balance of $43.3 million due to an increase in revenue, partially offset by a $94.4 million increase in accrued expenses and other current liabilities primarily due to the timing of payments. Net Cash Used in Investing Activities Net cash used in investing activities was $(375.3) million for the three months ended September 30, 2020, compared to net cash used in investing activities of $(688.3) million for the same period in 2019. Our investing activities in the three months ended September 30, 2020 consisted of cash used in the purchase of marketable securities of $1.1 billion, partially offset by the maturities of marketable securities of $668.9 million and sales of marketable securities of $155.9 million. Net cash used in investing activities in the prior period consisted of t he purchase of marketable securities of $1.1 billion, partially offset by the maturities of marketable securities of $411.0 million. Net cash used in investing activities was $(495.8) million for the nine months ended September 30, 2020, compared to net cash provided by investing activities of $584.5 million for the same period in 2019. Our investing activities in the nine months ended September 30, 2020 consisted of cash used in the purchase of marketable securities of $2.6 billion and non-marketable investments of $95.3 million, partially offset by the maturities of marketable securities of $1.9 billion and sales of marketable securities of $373.9 million. Net cash used in investing activities in the prior period c onsisted of the purchase of marketable securities of $1.9 billion, partially offset by maturities of marketable securities of $1.2 billion and sales of marketable securities of $102.4 million. Net Cash Provided by Financing Activities Net cash provided by financing activities was $2.4 million and $914.6 million for the three months and nine months ended September 30, 2020, respectively, compared to net cash provided by financing activities of $1.2 billion for the same periods in 2019. Our financing activities for the nine months ended September 30, 2020 consisted primarily of net proceeds of $888.6 million from the issuance of the 2025 Notes and the purchase of the 2025 Capped Call Transactions. Net cash provided by financing activities in the prior period consisted primarily of net proceeds of $1.15 billion from the issuance of the 2026 Notes and the purchase of the 2026 Capped Call Transactions. Net cash provided by financing activities in all periods presented includes proceeds from the exercise of stock options. Free Cash Flow Free Cash Flow was $(69.6) million and $(84.1) million in the three months ended September 30, 2020 and 2019, respectively, and was composed of net cash used in operating activities, resulting primarily from net loss, adjusted for non-cash items as well as changes in working capital and other operating assets and liabilities. Free Cash Flow also included purchases of property and equipment of $14.7 million and $7.9 million for the three months ended September 30, 2020 and 2019, respectively. 36 Free Cash Flow was $(156.5) million and $(265.5) million in the nine months ended September 30, 2020 and 2019, respectively, and was composed of net cash used in operating activities, resulting primarily from net loss, adjusted for non-cash items as well as changes in working capital and other operating assets and liabilities. Free Cash Flow also included purchases of property and equipment of $(41.4) million and $(27.4) million for the three months ended September 30, 2020 and 2019, respectively. Off-Balance Sheet Arrangements We do not have any off-balance sheet arrangements for any of the periods presented. Contingencies We are involved in claims, lawsuits, tax matters, government investigations, and proceedings arising in the ordinary course of our business. We record a provision for a liability when we believe that it is both probable that a liability has been incurred and the amount can be reasonably estimated. We also disclose material contingencies when we believe that a loss is not probable but reasonably possible. Significant judgment is required to determine both probability and the estimated amount. Such claims, suits, and proceedings are inherently unpredictable and subject to significant uncertainties, some of which are beyond our control. Many of these legal and tax contingencies can take years to resolve. Should any of these estimates and assumptions change or prove to be incorrect, it could have a material impact on our results of operations, financial position, and cash flows. Commitments The following table summarizes our contractual obligations as of September 30, 2020: Total Less than 1 Year (Remainder of 2020) 1-3 Years (2021 and 2022) 3-5 Years (2023 and 2024) After 5 Years (Thereafter) (in thousands) Hosting commitments $ 1,194,169 $ 139,098 1,055,071 $ — $ — Lease commitments 422,381 7,631 134,612 125,192 154,946 Other commitments 59,263 37,648 20,619 780 216 Total contractual commitments $ 1,675,813 $ 184,377 $ 1,210,302 $ 125,972 $ 155,162 For additional discussion on our data hosting and other purchase commitments, see Note 8 to our consolidated financial statements included elsewhere in this Quarterly Report on Form 10-Q. In January 2017, we entered into the Google Cloud Platform License Agreement. Under the agreement, we were granted a license to access and use certain cloud services. The agreement has an initial term of five years and we are required to purchase at least $400.0 million of cloud services in each year of the agreement. For each of the first four years, up to 15% of this amount may be moved to a subsequent year. If we fail to meet the minimum purchase commitment during any year, we are required to pay the difference. In March 2016, we entered into the AWS Enterprise Agreement for the use of cloud services from Amazon Web Services, Inc. We are committed to spend an aggregate of $1.1 billion between January 2017 and December 2022 on AWS services ($90.0 million in 2018, $150.0 million in 2019, $215.0 million in 2020, $280.0 million in 2021, and $349.0 million in 2022). If we fail to meet the minimum purchase commitment during any year, we are required to pay the difference. Any such payment may be applied to future use of AWS services during the term, although it will not count towards meeting the future minimum purchase commitments. 37 Critical Accounting Policies and Estimates We prepare our financial statements in accordance with GAAP. Preparing these financial statements requires us to make estimates and assumptions that affect the reported amounts of assets, liabilities, revenue, expenses, and related disclosures. We evaluate our estimates and assumptions on an ongoing basis. Our estimates are based on historical experience and various other assumptions that we believe to be reasonable under the circumstances. Our actual results could differ from these estimates. The critical accounting estimates, assumptions, and judgments that we believe to have the most significant impact on our consolidated financial statements are revenue recognition, stock-based compensation, business combinations and valuation of goodwill and other acquired intangible assets, Convertible Notes, loss contingencies, and income taxes. There have been no material changes to our critical accounting policies and estimates as described in our Annual Report, other than described below. Recent Accounting Pronouncements See Note 1 to our consolidated financial statements included elsewhere in this Quarterly Report on Form 10-Q for recently adopted accounting pronouncements and recently issued accounting pronouncements not yet adopted as of the date of this Quarterly Report on Form 10-Q. Item 3. Qualitative and Quantitative Factors about Market Risk We are exposed to market risks in the ordinary course of our business. These risks primarily include interest rate risk and foreign currency risk as follows: Interest Rate Risk We had cash and cash equivalents totaling $824.1 million and $520.3 million at September 30, 2020 and December 31, 2019, respectively. We had marketable securities totaling $1.9 billion and $1.6 billion at September 30, 2020 and December 31, 2019, respectively. Our cash and cash equivalents consist of cash in bank accounts and marketable securities consisting of U.S. government debt and agency securities, corporate debt securities, certificates of deposit, and commercial paper. The primary objectives of our investment activities are to preserve principal and provide liquidity without significantly increasing risk. We do not enter into investments for trading or speculative purposes. Due to the relatively short-term nature of our investment portfolio, a hypothetical 100 basis point change in interest rates would not have a material effect on the fair value of our portfolio for the periods presented. In August 2019, we issued 2026 Notes with an aggregate principal amount of $1.265 billion. We carry the 2026 Notes at face value less the unamortized debt discount and issuance costs on our consolidated balance sheets. The 2026 Notes have a fixed interest rate; therefore, we have no financial statement risk associated with changes in interest rates with respect to the 2026 Notes. The fair value of the 2026 Notes changes when the market price of our stock fluctuates or market interest rates change. In April 2020, we issued 2025 Notes with an aggregate principal amount of $1.0 billion. We carry the 2025 Notes at face value less the unamortized debt discount and issuance costs on our consolidated balance sheets. The 2025 Notes have a fixed interest rate; therefore, we have no financial statement risk associated with changes in interest rates with respect to the 2025 Notes. The fair value of the 2025 Notes changes when the market price of our stock fluctuates or market interest rates change. 38 Foreign Currency Risk For all periods presented, the majority of our sales and operating expenses were denominated in U.S. dollars. We therefore have not had material foreign currency risk associated with sales and cost-based activities. The functional currency of our material operating entities is the U.S. dollar. For the periods presented, our operations outside of the United States are not considered material and incur a majority of their operating expenses in foreign currencies. Therefore, our results of operations and cash flows are minimally subject to fluctuations from changes in foreign currency rates. We believe the exposure to foreign currency fluctuation from operating expenses is immaterial at this time as the related costs do not constitute a significant portion of our total expenses. As we grow operations, our exposure to foreign currency risk will likely become more significant. For the periods presented, we did not enter into any foreign currency exchange contracts. We may, however, enter into foreign currency exchange contracts for purposes of hedging foreign exchange rate fluctuations on our business operations in future operating periods as our exposures are deemed to be material. For additional discussion on foreign currency risk, see “Risk Factors” elsewhere in this Quarterly Report on Form 10-Q.