Snap Inc Q2 FY2022 Earnings Call

Thank you, and good afternoon, everyone. Welcome to Snap's Second Quarter 2022 Earnings Conference Call. With us today are Evan Spiegel, Chief Executive Officer and Co-Founder; Jeremi Gorman, Chief Business Officer; and Derek Andersen, Chief Financial Officer. Today, we published our inaugural investor letter on our Investor Relations website and with the SEC shortly after market close. The investor letter includes full details of our results, and we hope that you had a chance to read it. Please also refer to our Investor Relations website at investor.snap.com to find today's press release, slides and our updated investor presentation. This conference call includes forward-looking statements, which are based on our assumptions as of today. Actual results may differ materially from those expressed in these forward-looking statements, and we make no obligation to update our disclosures. For more information about factors that may cause actual results to differ materially from forward-looking statements, please refer to the press release we issued today as well as the risks described in our most recent Form 10-Q, particularly in the section titled Risk Factors. Today's call will include both GAAP and non-GAAP measures. Reconciliations between the two can be found in today's press release. Please note that when we discuss all of our expense figures, they will exclude stock-based compensation and related payroll taxes as well as depreciation and amortization and nonrecurring charges. Please refer to our filings with the SEC to understand how we calculate any of the metrics discussed on today's call. With that, I'd like to turn the call back over to the operator, who will begin our analyst Q&A session.

Great. Maybe we could start with the macro environment. You stated in the letter that Q3 is roughly flattish thus far. And that's a pretty material slowdown from where you guys were 90 days ago, which, I guess, isn't surprising given what's going on with the macro. So could you parse out for us which categories are slowing the most in your ad business? And you called out in the letter some high-growth sectors cutting back. I'd assume you mean venture-backed, startup-type companies that buy ads on Snap. How big of a revenue bucket is that for you guys? And how does the trajectory there compare to the larger kind of Fortune 500 marketers on your platform?

Ross, it's Derek speaking, and thanks for the question. I think it's probably a good opportunity to step back and discuss how the overall demand environment is materializing. As you noted, we have seen a pretty good deceleration over the last 90 days. And as we noted in the shareholder letter, we've seen that across our direct response and brand businesses as well as a number of sectors. But over a longer trajectory here, we've observed a fairly steady deceleration in demand over the last year. The deceleration began with the platform policy changes implemented in Q3 of last year. Those policy changes upended a decade of advertising industry standards, and in turn, the model is used to drive the direct response to advertising business as well as the tools used to measure the returns from that direct response advertising. And then beginning later in Q4 and certainly through the first half of this year, we've seen macroeconomic challenges build. While there have been lingering supply chain and labor supply issues impacting certain segments that began during the pandemic, more recently, we've seen the impact of persistently high inflation, then rising interest rates, and rising geopolitical risks associated with the war in Ukraine. Those macro headwinds have disrupted many of the industry segments that have been most critical to the growing demand for advertising solutions over prior years. We're seeing these various headwinds put pressure on the earnings of a wide variety of companies, and this is directly impacting the demand for advertising. Specifically, advertising spending, in particular, auction-driven direct response advertising is among the very few line items in a company's cost structure that they can reduce immediately in response to pressure on their top line or their input costs. As a result, as many industries and verticals have come under top line or input cost pressure, advertising spending has been among the first areas impacted. And to put a finer point on that, we've, over time, worked very hard to make it very easy for our clients to turn on advertising and to ramp their advertising. And that's been particularly good for our business as budgets have grown over time. But in a period where we're seeing headwinds, it's also very easy to turn off and very quick to turn off. So we see this dynamic within our business as advertisers have lowered their budgets and their bids per action to reflect their current willingness to pay. So for example, in some industries where top line growth may remain strong but the businesses are experiencing input cost pressure due to inflation, we've observed reduced marketing spending and lower bids per action. And in certain other high-growth sectors where businesses are seeing higher cost of capital, that's further reflected in their campaign budgets and their level of bids per action. So amid these various headwinds, we're also seeing increasing competition because the advertising dollars in aggregate are now growing more slowly, and that intensifies the competition we see. So because of these impacts from the platform policy changes and the macro environment and the competition all compound on one another, it can be difficult to attribute the deceleration to any one factor. But in order to keep growing, we've got to stay focused on the inputs that we control. And that means investing to improve our direct response business including our first and third-party measurement solutions as well as improving ranking and optimization. So hopefully, that gives you a little broader context of how we're seeing the demand environment evolve and how that's translating into our business more recently.

I have two. The first one, I appreciate the color around where we are sort of to start out Q3 being flattish. I know there's a lot of moving pieces on here, Derek, on the months and things. Just remind us how we should think about the monthly comps, July versus August versus September, and some of the platform changes impacting the year-on-year comp structure throughout this quarter. And then the second one, I think the last answer was pretty helpful. But just walk us through philosophically in this type of macro environment, what do you have to execute on to really get the business back to growth? Do you have to add more advertisers? How do you get advertisers to expand ad budgets? Like what are sort of your key strategies you need to execute on to sort of get back to healthy growth in the next 6 months through the platform?

Thanks for the question. I'll take both of those. First, as we enter Q3, a lot of the headwinds that I just talked about in the prior question continue to be as significant as they've been at any point recently. And it's not clear how those headwinds are going to evolve as we go through the quarter, whether they might abate or whether they may intensify. And one of the reasons for that is the point I mentioned near the end there, which is, in particular, how easy it is to ramp up spending on our platform and how flexible we've made it for folks to ramp down their spending. And so the reaction within our business and our top line to a shift in those trends can be fairly rapid, and that makes the visibility forward-looking particularly challenging. So given that, we believe the most prudent approach to giving folks some indication of what to expect going forward is to focus on providing transparency on how our business is performing right now and our plans to better position our business for long-term growth. So that sort of leads into your second question. And essentially, to return to a higher rate of long-term revenue growth, we're focused on three priorities. The first is investing in our products and our platforms to sustain the growth of our community, which has been very healthy. The second is investing heavily in our direct response advertising business, and we've articulated three key priorities there, including around investing in our first and third-party measurement solutions as well as continuing to make improvements in our optimization and ranking and product innovation. And then lastly, as we shared a little bit in the letter, we're focused on cultivating new sources of revenue that will help diversify our top line revenue over time. So we believe that if we can stay committed and focused on these priorities and combine that with our unique reach and rapid product innovation that we've demonstrated over a long period of time here, that provides us a path to regain momentum over time. So hopefully, that gives you a little bit of helpful additional context on your questions. Thank you.

I'm going to struggle to keep it to one. But on Page 1, you called out growing competition for ad dollars on top of the slowing ad market. I'm curious, how much of that is sort of directly tied to TikTok, which has been a monster in terms of its growth, versus sort of the two juggernauts that exist today in terms of Google and Facebook? Any color on sort of where that competition is coming from? And then I guess sort of related to this on time spent. Is any of this people spending less time, and it obviously relates to competition, but is this people spending less time on Snapchat every day, meaning fewer opportunities to monetize the user? Or is this just purely advertisers simply not spending as much as they were before? I'd be curious on both of those points.

We face strong competition from several large and sophisticated players in the monetization space. Currently, the overall advertising market is growing at a slower pace due to various macroeconomic challenges. This intensifying competition, including from platforms like TikTok, makes it difficult to pinpoint the exact causes of the slowing growth in our business. As the market grows more slowly with increasing competition, it becomes a more significant factor in discussions around our performance. Regarding engagement, our community continues to expand healthily, and we're seeing an increase in time spent with content that generates most of our revenue, evidenced by approximately 9% impression growth. The main issue lies in how demand is developing. We have observed a slowdown in demand, influenced first by changes to our platform and subsequently by overarching macroeconomic factors, along with competition. Understanding growth requires focusing on demand, and we must concentrate on what we can control, such as investing in our direct response business and enhancing our measurement solutions, as well as improving optimization and personalization. While the community's growth will contribute positively over the long term, our immediate focus is addressing demand and refining our advertising tools to meet that need for sustained future success. I hope this provides useful context for your questions.

Maybe I'll ask this as a two-parter. As you look back over the last two years from when Apple first announced their policy changes and then implemented them a year ago, maybe talk a little bit about what your key learnings have been that you wish you had maybe done on a more accelerated timetable or how you might have positioned the company differently looking backward over the last two years. And putting a finer point on the three elements of how to build and scale the direct response business from here, can you put some sense around how far along you are on those initiatives and the amount of investment capacity that might be needed to achieve them and/or a timetable in which to achieve them?

Yes. Sure. Thanks for the question. This is Jeremi talking. So I think when you want to talk about the long term, I want to go back to what Derek was mentioning regarding our key priorities and where we're focused on growing the business. So in particular, focusing on our measurement strategies as well as integrating with both third-party and first-party measurement solutions to get everything back on track. When you think of our advertising set more broadly, there are a litany of ways that they measure their advertising, including their own proprietary tools and then, of course, our first-party, privacy-centric tools but then the third-party tools that they prefer. So continuing to optimize there and then continuing to drive demand in categories where we have headwinds, I think, are particularly important in that regard.

If I can ask two. I guess the first one would just be as we think about the divergence in tone between the major ad agency holding companies that continue to sound relatively upbeat versus what you guys are seeing, do you think that that's just a function of them being a lagging indicator? Is it a different customer base? Is digital brand just easier to cut faster? Like what do you think are some of the divergences you're seeing there? And are there customers still spending at healthy rates with you guys or maybe just moving budget? And then the second one would just be as we think about moving through whatever form of downturn this is coming out on the other side, do you think that the 50% top line growth ambition is still attainable in this kind of environment of increased competition and diluted ad performance post-ATT? Is it just going to be a tougher road structurally? Or do you think 50% is still on the table on the other side of this trough here?

This is Jeremi again. I will take the first part and then hand it over to Derek. We saw a lot of enthusiasm at Cannes, along with great reactions to our incredible augmented reality exhibit there. In general, I'm echoing what Derek mentioned earlier in the call about how we have spent considerable time over the past few years reducing obstacles in buying and selling on our platform. You pointed out that it is easier to turn things on and definitely easier to turn them off. As companies rethink their priorities and cost structures, they are examining areas like digital ad spending, which is easy to pause and reconsider. The same tools and services that facilitate increases also make it simple to decrease spending. We recognize that our advertising partners are dealing with considerable uncertainty, which we've discussed several times. I will focus on the other points. You mentioned a significant selection bias regarding the team members and clients at Cannes. We often discuss the balance between our direct response and brand businesses. Large agencies and brands are well-represented at Cannes, while companies like direct-to-consumer, e-commerce, or app install businesses have less representation. This difference contributes to the divergence you're observing, as the attendees represent a different mix. Many of the brands affected by the macro issues we've previously addressed are not well represented at Cannes. That's part of what you are seeing. However, one exciting aspect for me during the event was the enthusiasm surrounding the future of augmented reality advertising. We showcased our capabilities alongside numerous impressive brands, and I believe this will positively impact our AR business long-term, reinforcing our commitment alongside our robust performance business.

And it's Derek. I can take the second part of that, which is with the long-term growth prospects. I think first, it's important to step back, and I think it's probably clear for all. But in order to achieve really elevated growth rates, we're going to need an operating environment that is more cooperative than the one that we're experiencing right now. Having stable platform policies that we can build and optimize against are really important, but having a macro environment where clients are able to invest and grow their marketing budgets is essential, too. It's definitely easier to grow our top line in an environment where there are incremental budgets being deployed and we can capture incremental share versus simply having to take share of the existing pie in order to grow. The key here is being focused on the inputs that we control and the things that are critical to long-term growth. We've articulated some of those in our letter. So to be super clear, one is continuing the growth of our global community at a rapid pace. We already reached a very deep penetration in many of the world's most attractive advertising markets, but continuing to deepen our engagement and our penetration of those advertising markets and the overall global community is input one. And the second is, as we've discussed earlier here today, is continuing to invest in our direct response business and improving that consistently over time. Number one, we're improving our first and third-party measurement solutions; and two, through better ranking and optimization that delivers better optimization for our advertising partners and therefore return on ad spend over time; and then three is really about continuing to cultivate new sources of revenue across our business, and there's lots of opportunity for that. Obviously, we have a number of screens in our application that are currently undermonetized that present a lot of opportunity to grow over time, whether that's Spotlight or the Camera that's very early in its monetization, or over the longer term, the Map and, of course, the future of AR and many other formats. And of course, we've got other endeavors that are earlier and are going that could provide growth, including the recently launched Snapchat+. So continuing to invest in diversifying our top line growth to drive resiliency into our business and being well positioned for the long term is the key. And if we stay focused on those priorities, we believe we'll be well positioned over time.

Great. You've talked a lot about measurement in both the letter and on the comments here. I guess the first question is, did measurement deteriorate in the quarter? Any changes from Apple or Google, either in the quarter or looking forward to the second half? And then second, when you look at the measurement opportunity, how would you say you do versus peers today? And what is the timing for starting to see real improvement there?

Yes, no problem. This is Jeremi. We'll discuss the measurement tools, particularly in relation to our peers. Thank you for your question. It's important to remember that measurement, targeting, optimization, and engagement all play a crucial role in driving performance. We've always focused on measurable performance specifically. We see significant potential to enhance our optimization and engagement, which we've identified as one of our core priorities. I can specifically address measurement, which we have highlighted for some time. Our main focus is on two key priorities. Over the past year, as platform changes have occurred, driving adoption, utilization, and trust in our first-party privacy-preserving measurement solutions, such as estimated conversions, has been central to this process. In the near term, we are concentrating on increasing the adoption of these privacy-focused integration technologies, which are instrumental for both measurement and optimization, like the conversions API we've had for a while. From there, we must build trust in those estimated conversions. As I noted earlier, advertisers are exploring new measurement options, combining first-party, third-party, and proprietary solutions. These statistically modeled conversions can complement some of the third-party tools when we establish trust. An example would be Scan, which allows for privacy-preserving methods and provides advertisers with more timely information. Overall, we believe that estimated conversions will become increasingly vital in a privacy-centric advertising landscape, which ties into our second measurement priority: ensuring our advertising performance is well represented in advertisers' preferred third-party measurement solutions. This alignment is essential for building trust. Regardless of the effectiveness of our advertising, if our first-party measurement tools do not align with the advertisers' preferred trusted third-party tools, we face challenges. Third-party tools across both web and app have been affected by platform policy changes, particularly impacting web-based advertisers and leading to greater reliance on same session, last click-based advertising, where we must demonstrate our effectiveness. We are still in the early stages of this journey. The platform policy changes are constantly evolving, but we feel confident in our solutions and the opportunities ahead. We will address this challenge holistically, believing that we can enhance performance alongside how we are represented in third-party tools, which will help us receive recognition for the conversions we drive. This, in turn, will foster trust in our first-party solutions, enabling us to focus on optimizing for these privacy-based observable actions, driving our advertising growth.

Derek, can you talk to the trade-off to profitability? And what are the steps you're taking, as you highlight in the letter, to emerge as a more focused company?

Brent, thanks for the question. First, I think it's clear, our rate of revenue growth has slowed considerably, and we are acknowledging we must adapt our investment strategy accordingly. So first, we intend to substantially slow our rate of hiring to effectively pause growth in our headcount, which is a significant portion of our operating expenses. In addition, we'll be looking at the rate of operating expense growth that is non-personnel-related in order to stem the rate of growth in our overall operating expenses, the objective there being to get to a place where we can carve out a path to free cash flow breakeven or better even at reduced rates of top line growth. As we implement these changes, we'll be reprioritizing our investments and driving renewed focus on productivity in particular. And in addition, we'll focus our go-forward investments around sustaining the investments we believe are most critical to capitalizing on the future of augmented reality and executing on the priorities we articulated in the letter and that I've shared here today. We may incur some transition costs along the way as we execute on these changes, but we expect to emerge from all of that with a more focused cost structure as a result. So hopefully, that gives you a sense of how we're thinking about it in terms of both a priority perspective and how to bring the growth both in our operating expenses and overall cost structure under control. Thanks for the question. I hope that provides some additional insight.

When you talk about diversifying your revenue streams, I think, Derek, you mentioned a couple of different areas, Maps, Spotlight, etc. Could you triage those a little bit? Of those different areas, which do you think has got the greatest potential to the least potential in terms of diversification? And then I want to get back to one macro question. In the script here, you talked about macroeconomic challenges that have disrupted many of the industries that have been most critical to your advertising solutions. Is there a particular reason why the macro pressures would have impacted your advertiser base more than what would happen with other companies? Is there something about your advertiser base that may be more economically sensitive than what we would see in the general economy?

Thanks for the questions. I'll address them starting with your second question about our advertising composition and the challenges we face. It's hard to know how others' businesses are structured, but we have less exposure to small- and medium-sized brick-and-mortar businesses. This affects our situation. The shift from rapid growth to nearly flat growth poses challenges. Gaining market share is easier when budgets and investments are increasing. As the overall advertising market grows at a slower pace, competition for available budgets intensifies. Regarding our revenue mix, most of our income comes from direct response advertising. We’ve worked hard to make it easy for our partners to adjust their direct response advertising quickly. When partners increase their marketing budgets, they can scale their advertising effectively with us, resulting in a high return on investment. Conversely, it's simple for them to cut back when they need to reduce budgets, which may affect our growth rates relative to others. Looking at long-term opportunities, we see significant potential in our application. We have room to grow in our content business and are testing monetization for Spotlight, which we're optimistic about expanding later in the year. The most exciting long-term opportunity is augmented reality, where we are heavily investing to create monetization and enterprise solutions for our partners. Additionally, we're encouraged by the engagement we're seeing with the Map, which presents more avenues for monetization in our advertising business. We're also exploring diversification opportunities, such as the launch of Snapchat+. Focusing on our core priorities will be crucial for executing our plans. Overall, we are optimistic about long-term growth.

Derek, I know you mentioned a few times, I think, the ability for Snap to grow as ad budgets grow. And I guess what I'm wondering is in conversations with some of your core advertisers, how much of the impact that they're seeing to their ad budgets would you say are transitory versus a real permanent rebasing in how they think about performance marketing and digital advertising spend?

Thanks for the question. This is Jeremi. I can take this one. I think we're looking at macro pressures from a litany of different angles. We're hearing supply chain pressure, inflationary costs, of course, that are impacting unit economics as it pertains to moving product. They're getting pressure from the cost of capital, as we've talked about before, capital being more expensive as well as drying up in different areas. So insofar as any of those are transitory, I think that's yet to play out in the overall macro. But what we're hearing from advertisers, I think, more specifically as it pertains to advertising budgets is what we said before, which is that they are taking this time, given all of those other macro pressures, to reevaluate their priorities to ensure that they're making the right investments in the right places. And when we talk about digital advertising, it is the easiest thing to turn off. I know we said that a couple of different times, but I think it's important to reiterate here, is that it is the most important thing to turn off. But it is also one of the most performant tools in their tool chest. So as things start to rebound for some of these advertisers in the areas where the macro pressures are a little bit more transitory, it's also the first thing to get turned back on. So we remain optimistic that as things hopefully start to improve in the macro that we can capture that opportunity by remaining focused on the three key priorities that we've articulated in the call earlier.

Just when you think about the new sources of revenue, you talked about some of the new surfaces, including Spotlight and Camera and perhaps Map further out. How do you think about balancing opening up more inventory there with what's essentially more of a demand problem near term? And then on a related question, can you just talk about Spotlight engagement and the extent to which you think it's incremental versus a shift for users within the platform?

Derek here. I’ll address the first question. From a short-term perspective, the key issue is demand generation. In the near term, our focus is on generating demand. Opening new sources of inventory and supply is crucial for our long-term growth and health, which is why we are committed to investing in community growth, content, Maps, and our AR capabilities to create more effective inventory over time. As we prepare to ramp up tests for monetizing Spotlight, we also consider when demand generation peaks throughout the year. In the very short term, you’re correct that this is primarily about demand. The impact of additional supply will be more significant in the medium to long term. The positive growth and engagement in our community greatly support these long-term opportunities. Regarding Spotlight, we are focused on fostering content engagement, especially through Stories from friends and family, which draws users into Discover and encourages them to explore more entertaining content. We’re pleased to see global content viewing times increase year-over-year, with Spotlight also performing well—showing a 59% year-over-year growth in watch time and a 46% year-over-year increase in monthly active users, now exceeding 270 million. This growth in content engagement alongside Spotlight’s accelerated growth is promising for overall user engagement. Simultaneously, Discover continues to thrive, especially with a significant increase in viewership among users over 25, which is exciting as we evolve with our community. Overall, we are very enthusiastic about community growth, which is essential for driving users toward our products. The 18% year-over-year increase in daily active users, amounting to 54 million, is a strong indicator of the community's health, and effectively engaging users with our products is crucial. I hope that provides additional context, and thank you for the question.

This concludes our question-and-answer session as well as Snap Inc.'s Second Quarter 2022 Earnings Conference Call. Thank you for attending today's session. You may now disconnect.