"Our redesign created some headwinds in our revenue this quarter by disrupting user behavior and creating some apprehension among our advertising partners," Snap (NYSE:SNAP) CEO Evan Spiegel said when the company reported first-quarter earnings in May. During that quarter, daily active user (DAU) growth had decelerated to its lowest rate ever -- just 2% on a sequential basis.
The Snapchat parent just reported second-quarter earnings last night, and sequential DAU growth has now dipped into negative territory, as the company disclosed its first decline in users.
Ongoing shift to programmatic
DAUs declined 2% sequentially in the second quarter to 188 million, with Spiegel again blaming the redesign for weighing on user engagement. The drop "was primarily driven by a slightly lower frequency of use among our user base due to the disruption caused by our redesign," Spiegel said on the call.
Spiegel added, "I'm really proud of the progress we're making toward building a sustainable business and generating free cash flow." Free cash flow during the quarter was negative $234 million, despite Snap's capital-light infrastructure model. That figure is comprised of negative $199 million in operating cash flow and $35 million in capital expenditures, which primarily relates to office facilities, as Snap outsources all cloud infrastructure to third-party vendors.
Hosting and infrastructure costs continue to dominate Snap's cost structure. Infrastructure costs were $136 million, or nearly 75% of cost of revenue. That translated into $0.72 per DAU for the quarter. Average revenue per user (ARPU) rose to $1.40. In other words, on a per-DAU basis, infrastructure costs ate up over half of sales. That's an undeniable improvement from the days when infrastructure costs per DAU exceeded ARPU, but variable costs remain the company's biggest hurdle to scaling and exhibiting any semblance of operating leverage.
The ad business continues to show some progress, amid the ongoing shift to a programmatic, self-serve advertising platform that has been taking place for nearly two years. Roughly 75% of ad revenue in the quarter was purchased programmatically, up from 18% a year ago, according to CFO Tim Stone, who came onboard from Amazon.com in May to replace outgoing CFO Drew Vollero. The company is still working on moving its creative tools business to the programmatic platform this year.
Guidance at last
For the first time, Snap is issuing a financial outlook, which is potentially attributable to changing CFOs. "We believe that sharing our thoughts on our near-term financial outputs will be helpful to investors and inform external expectations," Stone said. Yeah, that's what guidance is for.
For the third quarter, Snap expects revenue in the range of $265 million to $290 million, which would represent growth of 27% to 39%. Adjusted EBITDA should be negative $160 million to $185 million. Stone declined to provide an outlook for DAUs, but noted that historically Snap has seen DAU growth be seasonally weak in the third quarters of prior years.
John Mackey, CEO of Whole Foods Market, an Amazon subsidiary, is a member of The Motley Fool's board of directors. Evan Niu, CFA has no position in any of the stocks mentioned. The Motley Fool owns shares of and recommends AMZN. The Motley Fool has a disclosure policy.