From Snowflake’s (SNOW) annual report for 2022:
Free Cash Flow We define free cash flow, a non-GAAP financial measure, as GAAP net cash provided by (used in) operating activities reduced by purchases of property and equipment and capitalized internal-use software development costs. We believe information regarding free cash flow provides useful supplemental information to investors because it is an indicator of the strength and performance of our core business operations. The following table presents a reconciliation of free cash flow to net cash provided by (used in) operating activities, the most directly comparable financial measure calculated in accordance with GAAP, for the periods presented (in millions): Fiscal Year Ended January 31, 2022 2021 2020 ----- ----- ------ Net cash provided by (used in) operating activities 110.2 -45.4 -176.6 Less: purchases of property and equipment -16.2 -35.0 -18.6 Less: capitalized internal-use software development costs -12.8 -5.3 -4.3 ----- ----- ------ Free cash flow (non-GAAP) 81.2 -85.7 -199.4
Management at SNOW considers free cash flow a key indicator. They claim it illustrates the
power of their core business operations. Free cash flow, as defined by SNOW, has not only
turned positive in 2022, but has been rapidly rising the last three years. SNOW’s free cash
flow paints a rosy picture of performance!
But what happens if we drill down into the quality of the operating cash flows that contribute
to free cash flow? To judge quality, I look at least two things: are there any claims on the cash
flow and is the cash flow sustainable? Let’s break out SNOW’s cash flows in the operating section
of the Cash Flow Statement in a bit more detail.
Fiscal Year Ended January 31, 2022 2021 2020 ----- ----- ------ Net Loss -679.9 -539.1 -348.5 Plus: Stock Based Compensation 605.1 301.4 78.4 Plus: Deferred Revenue 526.2 312.9 223.0 Less: Other Adjustments -341.2 -120.6 -129.4 ----- ----- ------ Net cash provided by (used in) operating activities 110.2 -45.4 -176.6 Less: purchases of property and equipment -16.2 -35.0 -18.6 Less: capitalized internal-use software development costs -12.8 -5.3 -4.3 ----- ----- ------ Free cash flow (non-GAAP) 81.2 -85.7 -199.4
Clearly the elephant in this free cash flow room is the explosive growth of Stock Based
Compensation (SBC). In fiscal year 2022, SNOW’s SBC was roughly 50% of revenues. To put
that in perspective, a survey in 2020 of the 1,000 largest US companies found that SBC
ranged from 1-15% of revenues. A 2020 survey of strictly SaaS companies found that SBC
ranged from 8-20%. SNOW is an overachiever when it comes to SBC.
SBC can be thought of as one number that combines two activities: an operating activity
where an employee provides a service to the company and a financing activity where the
employee buys shares or is given shares of the company in return for that service. SBC
is an estimate of the value of these transactions. It’s a promise to pay. An IOU. Which
means this cash flow is not really “free”.
It’s also not sustainable. To significantly increase free cash flow in future years,
SNOW would have to issue even greater amounts of SBC as a percent of revenue. SBC also
depends on the price of the stock. In a down market or if the multiple deflates, SBC
becomes a less attractive incentive for employees, and may decline as a percent of
For a groundbreaking analysis of SBC, cash flows, and inflated valuations, see
I’ve argued here that SNOW’s free cash flow is of poor quality because of the issues
with SBC. I didn’t even touch on the other elephant – Deferred Revenue – which has
problems of its own. Which means SNOW’s free cash flow number is suspect and multiples
based on its free cash flow may mean it’s overinflated. That’s enough to keep me out.
Even if I were right, however, so what? It may take the rest of the world a REALLY long
time to agree! Thus, SNOW may make a very lucrative investment for some.