Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations.
The following discussion of our financial condition and results of operations should be read together with our condensed financial statements and related notes thereto included elsewhere in this Quarterly Report on Form 10-Q and our audited financial statements and related notes and our Annual Report on Form 10-K filed with the SEC on March 30, 2022. The following discussion contains forward-looking statements that reflect our plans, estimates and beliefs. See the discussion under “Note Regarding Forward-Looking Statements” elsewhere in this Quarterly Report on Form 10-Q for more information. Our actual results could differ materially from those discussed in the forward-looking statements. Factors that could cause or contribute to these differences include those discussed below and particularly in the section titled “Risk Factors” and elsewhere in this Quarterly Report on Form 10-Q, as well as in our other filings with the SEC. Our historical results are not necessarily indicative of the results that may be expected for any period in the future, and our interim results are not necessarily indicative of the results we expect for the full calendar year or any other period. The unaudited condensed consolidated interim financial statements for the quarter and nine months ended September 30, 2021 have been revised to correct prior period errors as discussed in Note 3 “Revision of Prior Periods' Financial Statement” to our unaudited condensed consolidated financial statements included in this Quarterly Report on Form 10-Q. Accordingly, this Management’s Discussion and Analysis of Financial Condition and Results of Operations reflects the effects of the revisions.
Overview
We are a social marketplace that combines the human connection of a physical shopping experience with the scale, reach, ease, and selection benefits of eCommerce. In doing so, we bring the power of community to buying and selling online. We created Poshmark in 2011 to make buying and selling simple, social, and fun. Pairing technology with the inherent human desire to socialize, our marketplace creates passion and personal connections among users. We dynamically curate our marketplace into lifestyle categories that our users love, including apparel, accessories, footwear, home, beauty, and pets. Powered by our proprietary technology, our social marketplace is purpose-built to enable simple transactions, seamless logistics, and an engaging experience at scale. As of September 30, 2022, we had 8.2 million Active Buyers.
We empower people to sell a few items or to become successful entrepreneurs by providing them with end-to-end seller tools. We refer to this as “making selling a superpower.” Our comprehensive infrastructure makes it easy for sellers to build their businesses with seamless listing, merchandising, promotion, pricing, and shipping. Sellers use content, inventory selection, and social interactions to monetize their listings and drive growth. Our transparent fee structure aligns our success with the success of our sellers. Our fee is 20% of the final price for sales $15 and over, or a flat rate of $2.95 for sales under $15. We attract, engage, and retain sellers by offering the community the benefits of social connection with the ability to combine personal passion and economic empowerment. We do not own or manage inventory as products are listed, managed, sold, and shipped by our sellers, utilizing our transaction tool that makes the selling process seamless and easy. This asset-light model creates scalability and favorable working capital dynamics.
Our social features make the discovery and purchase process simple and enticing for buyers, fostering high engagement and retention. The engagement of our community has fueled strong growth in our business, supported by attractive unit economics and efficient user acquisition. We enable buyers to discover, connect, and curate their network and news feed with that of other users who share similar styles and personal preferences, creating a fun shopping experience. Our marketplace is vast, with sellers listing millions of secondhand and new items across multiple categories. We use data-driven personalization to customize each user’s feed to feature the most relevant listings and make it easy to quickly search for and find products of interest. Furthermore, sellers list a variety of items across all price points, with the added benefit of being able to negotiate offers directly with buyers seeking to optimize their budget, allowing sellers to manage their listings to achieve their individual objectives. Because our marketplace features a massive selection of secondhand items, buyers are also able to support their personal style while minimizing their environmental impact.
In the three months ended September 30, 2022 and 2021, we had revenue of $88.4 million and $79.5 million, respectively, representing a 11% growth rate. In the three months ended September 30, 2022, we generated a net loss of $23.5 million compared to a net loss of $6.9 million in the three months ended September 30, 2021.
Potential Merger with Naver
On October 3, 2022, we entered into the Merger Agreement, by and among Poshmark, Naver, Proton Parent and Merger Sub, pursuant to which Merger Sub will merge with and into Poshmark, with Poshmark surviving the Merger as an indirect subsidiary of Naver. As a result of the Merger, each share of Company Common Stock outstanding immediately prior to the effective time of the Merger (subject to certain exceptions set forth in the Merger Agreement) will, at the effective time, automatically be canceled and converted into the right to receive $17.90 in cash, without interest and subject to applicable withholding taxes. If the Merger is consummated, our Class A common stock will be delisted from the Nasdaq Global Select Market and deregistered under the Securities Exchange Act of 1934.
26
The Merger is conditioned upon, among other things, the approval of the Merger Agreement by our stockholders, the expiration of the applicable waiting period (and any extension thereof) under the Hart-Scott-Rodino Antitrust Improvements Act of 1976, as amended and other customary closing condition.
Key Factors Affecting Our Performance
Growth and Retention of Users. We focus on attracting new users and retaining existing users. New users and the social and transactional activities they contribute help keep existing users more active, increasing their lifetime value over time. Users engage in many ways on our social marketplace: they connect, they browse, they buy, and they sell. The positive relationship between new users and existing users illustrates the network effects of our marketplace. As of September 30, 2022, we had 8.2 million Active Buyers.
User Engagement. The engagement of our community has fueled strong growth in our business, supported by attractive unit economics and efficient user acquisition. We believe that cultivating a robust network of users over the longer-term is crucial to bolstering broader community engagement, growing social interactions, and increasing gross merchandise value (GMV). Users can engage on our marketplace in a variety of activities that range from shopping and social interactions to buying and selling. The continuous increase in users, social interactions, and listings has led to steady activations of buyers and sellers across cohorts, resulting in increasing GMV for these cohorts.
Investments in Growing Our User Community. We have invested substantially in marketing to grow our user community and drive further awareness of our brand. These investments have enabled us to grow our base of new users, buyers, and sellers while continuing to retain buyers and sellers, resulting in strong growth of our GMV and revenue. Marketing expenses represented 48% and 46% of revenue in the three months ended September 30, 2022 and 2021, respectively. We intend to manage our marketing spend to balance growth and profitability. While we have seen fluctuations and uncertainty in user acquisition costs, partially due to Apple's policy change that limits the ability of advertisers to collect user data, we will continue to invest in user acquisition and retention while the underlying user unit economics indicate the return on investment is strong.
Investments in Platform Innovation. We invest in both the people and technology behind our platform. We also intend to continue to make significant investments in the technology and infrastructure of our platform to attract and retain buyers and sellers, expand the capabilities and scope of our platform, and enhance the user experience. We expect to continue to make significant investments to attract and retain employees, particularly engineers, data scientists, designers, product management, and operations personnel. All functions are important, and we intend to invest in our people to help us drive additional efficiencies across our marketplace. In addition, we may invest in new and existing businesses that may lower our margins temporarily but may enhance our platform capabilities, deliver revenue growth, and enable us to achieve and maintain long-term profitability.
International Expansion. We began operations in Canada, the first country we expanded to after the United States, in May 2019. In February 2021, we expanded our operations to Australia. In September 2021, we launched operations in India. International expansion may impact our financial performance in the short term. As we continue our global expansion, we believe international demand for our platform will develop and increase. Accordingly, we believe there is a significant opportunity to grow our international business. We have invested, and plan to continue to invest, in the adoption of our platform and solutions internationally, including localization of our platform and the addition of critical capabilities to our platform required to serve those local markets.
Impact of the COVID-19 Pandemic. The COVID-19 pandemic has impacted our business to date and may continue to impact our business in ways that remain unpredictable. In early 2020, the COVID-19 pandemic impacted our business and operations, in which we experienced lower year-over-year GMV growth for the quarter ended March 31, 2020. We have since seen our GMV growth rebound as buyer and seller activity resumed, but such trends may not continue and could be reversed. While COVID-related restrictions have eased throughout 2021 and 2022, there remains substantial uncertainty about the pandemic’s impact on the global economy, e-commerce, and global macroeconomic conditions that impact consumer spending. In particular, as federal and state governmental aid programs initiated in connection with the pandemic are reduced or terminated, and as inflationary pressures rise, consumer discretionary spending would likely decrease, which would have a negative impact on our business.
As of September 30, 2022, we have opened our offices in accordance with local guidelines and regulations, though a remote work model remains largely in place. Future developments, such as new virus variants, actions to contain the pandemic or treat its impact, or a resurgence of offline shopping demand could adversely affect our business, results of operations, liquidity, and financial condition in future periods. The conditions caused by the pandemic are still evolving and we will continue to evaluate the potential impact of the pandemic on our business. See the section titled “Risk Factors” in our Annual Report on Form 10-K filed with the SEC on March 30, 2022 for further discussion of the possible impact of the COVID-19 pandemic on our business, operations and financial condition.
27
Seasonality. Our business is seasonal in nature as it is affected by the cyclicality of the consumer as well as broader market conditions. Historically, we have often seen both stronger growth in the number of Active Users and Active Buyers and in engagement during the first quarter of the year. In addition, we have seen higher GMV in the fourth quarter of the year, followed by the third quarter, which we believe is due in part to the higher price points of seasonal apparel and footwear and the holiday season. We believe the recent growth in our business, as well as the recent effects of sales taxes and the COVID-19 pandemic, have partially masked these trends to date, and we expect the impact of seasonality to be more pronounced in our future quarterly results as our business matures.
Initial Public Offering
Our registration statement on Form S-1 related to our initial public offering (IPO) was declared effective on January 13, 2021, and our Class A common stock began trading on the Nasdaq Global Select Market on January 14, 2021. On January 19, 2021, we closed our IPO, in which we issued and sold 6,600,000 shares plus an additional 990,000 shares subject to the underwriters’ over-allotment option of our Class A common stock at the public offering price of $42.00 per share. We received net proceeds of $292.3 million after deducting underwriting discounts and commissions and offering expenses.
Components of Results of Operations
Net Revenue
We generate revenue from sellers for fees earned when they sell items they have listed on our social marketplace to buyers (20% of the final price for sales $15 and over, or a flat rate of $2.95 for sales under $15). The buyer also pays a shipping label fee as part of their order. On some orders, the shipping label fee exceeds our shipping label cost, which we record as revenue. For the three and nine months ended September 30, 2022, this revenue was 5% and 4% of our total net revenue, respectively. For each of the three and nine months ended September 30, 2021, this revenue was 4% of our total net revenue. Our revenue is recognized when we satisfy our performance obligations. We report both revenue from buyers and revenue from sellers based upon the net amount earned, which is reduced by certain buyer and seller incentives.
Costs and Expenses
Cost of Net Revenue. Cost of net revenue primarily consists of costs associated with credit card processing, transaction fees for order related payments, and hosting expenses associated with operating our platform. Cost of net revenue does not include depreciation and amortization.
We expect cost of net revenue to increase in absolute dollars in future periods and to vary from period to period as a percentage of net revenue for the foreseeable future as we grow our platform by increasing Active Buyers and generating higher GMV.
Operations and Support. Operations and support expense primarily consists of personnel-related compensation costs, including stock-based compensation, incurred in providing support to users of our platform including authentication services that we provide. This expense also includes postage and shipping costs that we incur primarily from order losses and cancellations, and credits and incentives issued to buyers for customer satisfaction purposes in excess of shipping facilitation revenue.
We expect that operations and support expenses will increase in absolute dollars for the foreseeable future as we continue to grow our operations and hire additional employees to support the scaling of our business. To the extent we are successful in becoming more efficient in supporting our users, we would expect operations and support expenses as a percentage of revenue to decrease over the long term.
Research and Development. Research and development expense consist primarily of compensation expenses for engineering, product development, and design employees, including stock-based compensation, expenses associated with ongoing improvements to and maintenance and testing of our platform offerings including website, mobile apps, and other products, and other research and development programs. Research and development expenses are expensed as incurred. We capitalize certain costs associated with website development and software for internal use.
We expect that research and development expenses will increase in absolute dollars and vary from period to period as a percentage of revenue for the foreseeable future as we continue to invest in research and development activities relating to ongoing improvements to and maintenance and testing of our platform offerings including website, mobile apps, and other products, and other research and development programs, including the hiring of engineering, product development, and design employees to support these efforts.
28
Marketing. Marketing expense primarily consists of expenses associated with personnel-related compensation costs, including stock-based compensation, and costs related to user acquisition, public relations, marketing events such as Posh Parties, and business development. User acquisition costs primarily consist of costs associated with acquiring new users by spend on advertising channels such as television, Google, Facebook, Instagram, Snapchat, and TikTok. These marketing expenses also include promotional credits and incentives issued to buyers to encourage buyer activity on our platform in excess of shipping facilitation revenue and cost of referral incentives for new user acquisition. We plan to continue to invest in our marketing efforts, including hiring additional employees, in order to attract new users.
We expect that marketing expenses will increase in absolute dollars and vary from period to period as a percentage of revenue for the foreseeable future as we plan to continue to invest in marketing to grow the number of Active Users and Active Buyers and increase our brand awareness. The trend and timing of our brand marketing expenses will depend in part on the timing of marketing campaigns.
General and Administrative. General and administrative expense consists primarily of employee related costs including stock-based compensation for those employees associated with administrative services such as legal, human resources, information technology, accounting, and finance, and all related costs associated with our facilities, such as rent and office administration. These expenses also include certain third-party consulting services, facilities, IT services, meals and other corporate costs not allocated to other expense categories. As part of the Merger, the Company expects to incur material non-recurring expenses contingent on the deal consummation including banker fees and legal fees.
We expect that general and administrative expenses will increase in absolute dollars and vary from period to period as a percentage of revenue for the foreseeable future as we continue to invest in personnel, corporate infrastructure, and systems required to support our strategic initiatives, the growth of our business, and our compliance and reporting obligations, and controls to enable our internal support functions to scale with the growth of our business. We expect to incur additional expenses as a result of operating as a public company, including expenses to comply with the rules and regulations applicable to companies listed on a national securities exchange, expenses related to compliance and reporting obligations pursuant to the rules and regulations of the SEC, and expenses for general and director and officer insurance, investor relations, and professional services. We also expect rent expense and other facilities related costs to continue to increase in the future.
Depreciation and Amortization. Depreciation and amortization expense primarily consists of depreciation of computer equipment and software, furniture and fixtures, leasehold improvements, website development and software for internal use and amortization of intangible assets.
We expect that depreciation and amortization expense will increase in absolute dollars as we continue to build out our network infrastructure, recognize amortization expense from acquired intangible assets resulting from acquisitions and establish new office locations to support our growth.
Interest Income
Interest income primarily relates to amounts earned on our cash and cash equivalents.
Other Expense, Net
Other expense, net mainly relates to changes in fair value of the convertible notes, redeemable convertible preferred stock warrants and contingent consideration relating to acquisition, and foreign exchange remeasurement gains and losses recorded from consolidating our foreign subsidiaries at each period end.
Provision for Income Taxes
Our provision for income taxes consists primarily of foreign taxes and state minimum taxes in the United States. As we expand the scale of our international business activities, any changes in the U.S. and foreign taxation of such activities may increase our overall provision for income taxes in the future. We have established a valuation allowance for our U.S. deferred tax assets, including federal and state net operating losses.
We expect to maintain this valuation allowance until it becomes more likely than not that the benefit of our federal and state deferred tax assets will be realized by way of expected future taxable income in the United States.
29
Results of Operations
The following tables set forth our condensed consolidated results of operations data and such data as a percentage of net revenue for the periods presented:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended September 30, |
|
|
Nine Months Ended September 30, |
|
|
|
2022 |
|
|
2021 |
|
|
2022 |
|
|
2021 |
|
|
|
(in thousands) |
|
|
|
|
|
|
|
Net revenue |
|
$ |
88,428 |
|
|
$ |
79,463 |
|
|
$ |
268,430 |
|
|
$ |
241,806 |
|
Costs and expenses (1): |
|
|
|
|
|
|
|
|
|
|
|
|
Cost of net revenue, exclusive of depreciation and amortization |
|
|
14,915 |
|
|
|
12,082 |
|
|
|
44,915 |
|
|
|
37,798 |
|
Operations and support |
|
|
15,513 |
|
|
|
13,199 |
|
|
|
46,770 |
|
|
|
41,062 |
|
Research and development |
|
|
18,189 |
|
|
|
12,325 |
|
|
|
52,457 |
|
|
|
43,574 |
|
Marketing |
|
|
42,613 |
|
|
|
36,198 |
|
|
|
129,606 |
|
|
|
104,021 |
|
General and administrative |
|
|
20,473 |
|
|
|
11,729 |
|
|
|
53,281 |
|
|
|
42,317 |
|
Depreciation and amortization |
|
|
1,000 |
|
|
|
827 |
|
|
|
3,033 |
|
|
|
2,463 |
|
Total costs and expenses |
|
|
112,703 |
|
|
|
86,360 |
|
|
|
330,062 |
|
|
|
271,235 |
|
Loss from operations |
|
|
(24,275 |
) |
|
|
(6,897 |
) |
|
|
(61,632 |
) |
|
|
(29,429 |
) |
Interest income |
|
|
1,586 |
|
|
|
77 |
|
|
|
2,145 |
|
|
|
201 |
|
Other expense, net |
|
|
|
|
|
|
|
|
|
|
|
|
Change in fair value of redeemable convertible preferred stock warrant liability |
|
|
— |
|
|
|
— |
|
|
|
— |
|
|
|
(2,816 |
) |
Change in fair value of the convertible notes |
|
|
— |
|
|
|
— |
|
|
|
— |
|
|
|
(49,481 |
) |
Loss on extinguishment of the convertible notes |
|
|
— |
|
|
|
— |
|
|
|
— |
|
|
|
(1,620 |
) |
Change in fair value of contingent consideration |
|
|
(37 |
) |
|
|
— |
|
|
|
396 |
|
|
|
— |
|
Foreign exchange loss, net |
|
|
(694 |
) |
|
|
(36 |
) |
|
|
(969 |
) |
|
|
(220 |
) |
|
|
|
(731 |
) |
|
|
(36 |
) |
|
|
(573 |
) |
|
|
(54,137 |
) |
Loss before provision for income taxes |
|
|
(23,420 |
) |
|
|
(6,856 |
) |
|
|
(60,060 |
) |
|
|
(83,365 |
) |
Provision for income taxes |
|
|
120 |
|
|
|
— |
|
|
|
381 |
|
|
|
180 |
|
Net loss attributable to common stockholders |
|
$ |
(23,540 |
) |
|
$ |
(6,856 |
) |
|
$ |
(60,441 |
) |
|
$ |
(83,545 |
) |
(1)Costs and expenses include stock-based compensation expense as follows:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended September 30, |
|
|
Nine Months Ended September 30, |
|
|
|
2022 |
|
|
2021 |
|
|
2022 |
|
|
2021 |
|
|
|
(in thousands) |
|
|
|
|
|
|
|
Operations and support |
|
$ |
1,558 |
|
|
$ |
758 |
|
|
$ |
3,906 |
|
|
$ |
3,810 |
|
Research and development |
|
|
5,732 |
|
|
|
3,145 |
|
|
|
15,665 |
|
|
|
16,882 |
|
Marketing |
|
|
1,942 |
|
|
|
969 |
|
|
|
4,866 |
|
|
|
5,297 |
|
General and administrative |
|
|
4,242 |
|
|
|
1,796 |
|
|
|
9,848 |
|
|
|
12,923 |
|
Total |
|
$ |
13,474 |
|
|
$ |
6,668 |
|
|
$ |
34,285 |
|
|
$ |
38,912 |
|
Comparison of Three and Nine Months Ended September 30, 2022 and 2021
Net Revenue
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended September 30, |
|
|
Change |
|
|
Nine Months Ended September 30, |
|
|
Change |
|
|
|
2022 |
|
|
2021 |
|
|
$ |
|
|
% |
|
|
2022 |
|
|
2021 |
|
|
$ |
|
|
% |
|
|
|
(dollars in thousands, except percentages) |
|
|
|
|
|
|
|
|
|
|
|
|
|
Net revenue |
|
$ |
88,428 |
|
|
$ |
79,463 |
|
|
$ |
8,965 |
|
|
|
11 |
% |
|
$ |
268,430 |
|
|
$ |
241,806 |
|
|
$ |
26,624 |
|
|
|
11 |
% |
Net revenue increased $9.0 million for the three months ended September 30, 2022 compared to the same period in 2021, and $26.6 million for the nine months ended September 30, 2022 compared to the same period in 2021. This growth was primarily due to an increase in the volume of GMV on our marketplace to a total of $0.5 billion, an increase of 7%. The increase in GMV was substantially driven by the increase in Active Buyers on the platform to 8.2 million for the trailing 12 months ended September 30, 2022, a 13% increase compared to the same period in 2021.
30
Cost of Net Revenue
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended September 30, |
|
|
Change |
|
|
Nine Months Ended September 30, |
|
|
Change |
|
|
|
2022 |
|
|
2021 |
|
|
$ |
|
|
% |
|
|
2022 |
|
|
2021 |
|
|
$ |
|
|
% |
|
|
|
(dollars in thousands, except percentages) |
|
|
|
|
|
|
|
|
|
|
|
|
|
Cost of net revenue |
|
$ |
14,915 |
|
|
$ |
12,082 |
|
|
$ |
2,833 |
|
|
|
23 |
% |
|
$ |
44,915 |
|
|
$ |
37,798 |
|
|
$ |
7,117 |
|
|
|
19 |
% |
Percentage of revenue |
|
|
17 |
% |
|
|
15 |
% |
|
|
|
|
|
|
|
|
17 |
% |
|
|
16 |
% |
|
|
|
|
|
|
Cost of net revenue increased $2.8 million for three months ended September 30, 2022 compared to the same period in 2021. The increase was driven by a $1.7 million increase in costs related to overall volume increases on our marketplace, including increased credit card processing fees and associated expense, and a $1.1 million increase in data hosting costs to support the increased usage of our platform and upgrades we made to our systems which were required to support our growth.
Cost of net revenue increased $7.1 million for the nine months ended September 30, 2022 compared to the same period in 2021. The increase was driven by an increase in data hosting costs of $3.8 million to support the increased usage of our platform and upgrades we made to our systems which were required to support our growth, and a $3.3 million increase in costs related to overall volume increases on our marketplace, including increased credit card processing fees and associated expenses.
Operations and Support
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended September 30, |
|
|
Change |
|
|
Nine Months Ended September 30, |
|
|
Change |
|
|
|
2022 |
|
|
2021 |
|
|
$ |
|
|
% |
|
|
2022 |
|
|
2021 |
|
|
$ |
|
|
% |
|
|
|
(dollars in thousands, except percentages) |
|
|
|
|
|
|
|
|
|
|
|
|
|
Operations and support |
|
$ |
15,513 |
|
|
$ |
13,199 |
|
|
$ |
2,314 |
|
|
|
18 |
% |
|
$ |
46,770 |
|
|
$ |
41,062 |
|
|
$ |
5,708 |
|
|
|
14 |
% |
Percentage of revenue |
|
|
18 |
% |
|
|
17 |
% |
|
|
|
|
|
|
|
|
17 |
% |
|
|
17 |
% |
|
|
|
|
|
|
Operations and support expense increased $2.3 million for the three months ended September 30, 2022 compared to the same period in 2021, primarily driven by an increase in customer service and support personnel costs.
Operations and support expense increased $5.7 million for the nine months ended September 30, 2022 compared to the same period in 2021. The increase was primarily driven by the combined effect from a $3.7 million increase in customer service and support personnel costs, a $0.6 million increase in credits and incentives issued to users for the purposes of dispute resolution, and a $0.4 million increase in net shipping costs as a result of our growth.
Research and Development
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended September 30, |
|
|
Change |
|
|
Nine Months Ended September 30, |
|
|
Change |
|
|
|
2022 |
|
|
2021 |
|
|
$ |
|
|
% |
|
|
2022 |
|
|
2021 |
|
|
$ |
|
|
% |
|
|
|
(dollars in thousands, except percentages) |
|
|
|
|
|
|
|
|
|
|
|
|
|
Research and development |
|
$ |
18,189 |
|
|
$ |
12,325 |
|
|
$ |
5,864 |
|
|
|
48 |
% |
|
$ |
52,457 |
|
|
$ |
43,574 |
|
|
$ |
8,883 |
|
|
|
20 |
% |
Percentage of revenue |
|
|
21 |
% |
|
|
16 |
% |
|
|
|
|
|
|
|
|
20 |
% |
|
|
18 |
% |
|
|
|
|
|
|
Research and development expense increased $5.9 million for the three months ended September 30, 2022 compared to the same period in 2021. The increase was primarily due to a $5.5 million increase in engineering personnel costs to support the growth of our business as we launch new innovations and improve functionality on our platform, and a $0.3 million increase in development-related services.
Research and development expense increased $8.9 million for the nine months ended September 30, 2022 compared to the same period in 2021. The increase was primarily due to a $7.8 million increase in engineering personnel costs required to support the growth of our business as we launch new innovations and improve functionality on our platform, and a $0.8 million increase in development-related services.
31
Marketing
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended September 30, |
|
|
Change |
|
|
Nine Months Ended September 30, |
|
|
Change |
|
|
|
2022 |
|
|
2021 |
|
|
$ |
|
|
% |
|
|
2022 |
|
|
2021 |
|
|
$ |
|
|
% |
|
|
|
(dollars in thousands, except percentages) |
|
|
|
|
|
|
|
|
|
|
|
|
|
Marketing |
|
$ |
42,613 |
|
|
$ |
36,198 |
|
|
$ |
6,415 |
|
|
|
18 |
% |
|
$ |
129,606 |
|
|
$ |
104,021 |
|
|
$ |
25,585 |
|
|
|
25 |
% |
Percentage of revenue |
|
|
48 |
% |
|
|
46 |
% |
|
|
|
|
|
|
|
|
48 |
% |
|
|
43 |
% |
|
|
|
|
|
|
Marketing expense increased $6.4 million for the three months ended September 30, 2022 compared to the same period in 2021. The increase was primarily due to a $3.7 million increase in spending on marketing programs, including increased spending on television ad campaigns and digital marketing, and a $2.7 million increase in marketing personnel costs to support the growth of our business.
Marketing expense increased $25.6 million for the nine months ended September 30, 2022 compared to the same period in 2021. The increase was primarily due to a $21.6 million in spending on marketing programs, including increased spending on television ad campaigns and digital marketing, and a $4.0 million increase in marketing personnel costs to support the growth of our business.
General and Administrative
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended September 30, |
|
|
Change |
|
|
Nine Months Ended September 30, |
|
|
Change |
|
|
|
2022 |
|
|
2021 |
|
|
$ |
|
|
% |
|
|
2022 |
|
|
2021 |
|
|
$ |
|
|
% |
|
|
|
(dollars in thousands, except percentages) |
|
|
|
|
|
|
|
|
|
|
|
|
|
General and administrative |
|
$ |
20,473 |
|
|
$ |
11,729 |
|
|
$ |
8,744 |
|
|
|
75 |
% |
|
$ |
53,281 |
|
|
$ |
42,317 |
|
|
$ |
10,964 |
|
|
|
26 |
% |
Percentage of revenue |
|
|
23 |
% |
|
|
15 |
% |
|
|
|
|
|
|
|
|
20 |
% |
|
|
18 |
% |
|
|
|
|
|
|
General and administrative expense increased $8.7 million for the three months ended September 30, 2022 compared to the same period in 2021. This increase was primarily driven by a $4.2 million increase in personnel costs, a $4.1 million increase in legal and consulting fees required to support our public company transition, and increased IT and facilities services fees of $0.4 million to support the growth of our business.
General and administrative expense increased $11.0 million for the nine months ended September 30, 2022 compared to the same period in 2021. This increase was primarily driven by a $6.4 million increase in legal and consulting fees required to support our public company transition, a $2.8 million increase in personnel costs, increased IT and facilities services fees of $1.1 million to support the growth of our business, and increased insurance costs of $0.2 million required as a result of becoming a public company.
Depreciation and Amortization
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended September 30, |
|
|
Change |
|
|
Nine Months Ended September 30, |
|
|
Change |
|
|
|
2022 |
|
|
2021 |
|
|
$ |
|
|
% |
|
|
2022 |
|
|
2021 |
|
|
$ |
|
|
% |
|
|
|
(dollars in thousands, except percentages) |
|
|
|
|
|
|
|
|
|
|
|
|
|
Depreciation and amortization |
|
$ |
1,000 |
|
|
$ |
827 |
|
|
$ |
173 |
|
|
|
21 |
% |
|
$ |
3,033 |
|
|
$ |
2,463 |
|
|
$ |
570 |
|
|
|
23 |
% |
Percentage of revenue |
|
|
1 |
% |
|
|
1 |
% |
|
|
|
|
|
|
|
|
1 |
% |
|
|
1 |
% |
|
|
|
|
|
|
Depreciation and amortization expense increased for the three and nine months ended September 30, 2022 compared to the same period in 2021. The increase was primarily driven by an increase in amortization of intangible assets, with no comparable activity in the same period in 2021.
32
Interest Income
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended September 30, |
|
|
Change |
|
|
Nine Months Ended September 30, |
|
|
Change |
|
|
|
2022 |
|
|
2021 |
|
|
$ |
|
|
% |
|
|
2022 |
|
|
2021 |
|
|
$ |
|
|
% |
|
|
|
(dollars in thousands, except percentages) |
|
|
|
|
|
|
|
|
|
|
|
|
|
Interest income |
|
$ |
1,586 |
|
|
$ |
77 |
|
|
$ |
1,509 |
|
|
|
1,960 |
% |
|
$ |
2,145 |
|
|
$ |
201 |
|
|
$ |
1,944 |
|
|
|
967 |
% |
Percentage of revenue |
|
|
2 |
% |
|
|
0 |
% |
|
|
|
|
|
|
|
|
1 |
% |
|
|
0 |
% |
|
|
|
|
|
|
Interest income increased for the three and nine months ended September 30, 2022 compared to the same period in 2021, primarily driven by higher interest earned from our cash equivalents.
Other Expense, Net
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended September 30, |
|
|
Change |
|
|
Nine Months Ended September 30, |
|
|
Change |
|
|
|
2022 |
|
|
2021 |
|
|
$ |
|
|
% |
|
|
2022 |
|
|
2021 |
|
|
$ |
|
|
% |
|
|
|
(dollars in thousands, except percentages) |
|
|
|
|
|
|
|
|
|
|
|
|
|
Other expense, net |
|
$ |
(731 |
) |
|
$ |
(36 |
) |
|
$ |
(695 |
) |
|
|
1,931 |
% |
|
$ |
(573 |
) |
|
$ |
(54,137 |
) |
|
$ |
53,564 |
|
|
|
(99 |
)% |
Percentage of revenue |
|
|
(1 |
)% |
|
|
(0 |
)% |
|
|
|
|
|
|
|
|
(0 |
)% |
|
|
(22 |
)% |
|
|
|
|
|
|
Other expense, net increased for the three months ended September 30, 2022 compared to the same period in 2021 primarily due to fluctuation in foreign exchange rates. Other expense, net decreased $53.6 million for the nine months ended September 30, 2022 compared to the same period in 2021. The decrease was primarily due to a change in fair value of the convertible notes, and the change in fair value of the redeemable convertible preferred stock warrant liability, with no comparable activity in the same period in 2022.
Provision for Income Taxes
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended September 30, |
|
|
Change |
|
Nine Months Ended September 30, |
|
|
Change |
|
|
|
2022 |
|
|
2021 |
|
|
$ |
|
|
% |
|
2022 |
|
|
2021 |
|
|
$ |
|
|
% |
|
|
|
(dollars in thousands, except percentages) |
|
|
|
|
|
|
|
|
|
|
|
|
Provision for income taxes |
|
$ |
120 |
|
|
$ |
— |
|
|
$ |
120 |
|
|
NM* |
|
$ |
381 |
|
|
$ |
180 |
|
|
$ |
201 |
|
|
|
112 |
% |
Percentage of revenue |
|
|
0 |
% |
|
|
0 |
% |
|
|
|
|
|
|
|
0 |
% |
|
|
0 |
% |
|
|
|
|
|
|
* NM-not meaningful
The change in our provision for income taxes was primarily attributable to pre-tax foreign earnings.
Key Operating and Non-GAAP Financial Metrics
We collect and analyze operating and financial data to evaluate the health of our community, allocate our resources (such as capital, time, and technology investments), and assess the performance of our business. In addition to revenue, net (loss) income, and other results under GAAP, the key operating and financial metrics we use are GMV, Active Buyers, and Adjusted EBITDA.
33
Gross Merchandise Value. Our gross merchandise value, or GMV, is the total dollar value of transactions on our platform in a given period, prior to returns and cancellations, and excluding shipping and sales taxes. GMV is a measure of the total economic activity generated by our marketplace, and an indicator of the scale and growth of our marketplace and the health of our marketplace ecosystem.
GMV
($ in millions)
Our GMV grew 7% from $442.5 million in the three months ended September 30, 2021 to $475.6 million in the three months ended September 30, 2022. Our quarterly GMV has increased year-over-year for the past nineteen quarters. We have continued to add users and enhance our social marketplace with various initiatives and product updates, including the launch of Posh Shows, our live buying and selling product, the rollout of shipping label QR codes, a printer-less shipping option, addition of Select All, a tool that facilitates the bulk sharing of listings, and release of Scale-to-Fit Photos, a feature that improves the listing experience.
Active Buyers. Active Buyers are unique users who have purchased at least one item on our platform in the trailing 12 months preceding the measurement date, regardless of returns and cancellations. An Active Buyer could have more than one account if they were to use a separate unique email address to set up each account. The number of Active Buyers is a key driver of GMV and revenue, as well as a measure of the scale and growth of our buyer community. We believe it is also an important indicator of our ability to convert user activity on our marketplace into transactions. The number of Active Buyers has increased steadily every quarter as we attract and retain users. Active Buyers can be new users to our marketplace who make a purchase, existing users who convert into buyers for the first time as our marketplace strengthens with more sellers and items, or repeat buyers.
Active Buyers
(in thousands)
5,713 6,032 6,231 5,374 4,952 4,550 4,190 3,734 3,345 2,953 2,657 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 2018 2018 2018 2018 2019 2019 2019 2019 2020 2020 2020 Active Buyers measured as of the last day of the quarter presented
Active Buyers measured as of the last day of the quarter presented
34
Adjusted EBITDA. We define Adjusted EBITDA as net (loss) income attributable to common stockholders, excluding depreciation and amortization, stock-based compensation expense, loss contingency accrual, interest income, other income (expense), net, change in accrued sales tax, provision (benefit) for income taxes, and undistributed earnings attributable to participating securities. Adjusted EBITDA is a key performance measure used by our management and board of directors to assess our operating performance and the operating leverage in our business. We believe that Adjusted EBITDA helps identify underlying trends in our business that could otherwise be masked by the effect of the income and expenses that we exclude in Adjusted EBITDA. Accordingly, we believe that Adjusted EBITDA provides useful information to investors and others in understanding and evaluating our operating results, enhances the overall understanding of our past performance and future prospects, and allows for greater transparency with respect to key financial metrics used by our management in its financial and operational decision-making. See “Reconciliation of Non-GAAP Financial Measures” for more information and for a reconciliation of net (loss) income, the most directly comparable financial measure calculated and presented in accordance with GAAP, to Adjusted EBITDA.
Adjusted EBITDA
($ in millions)
GAAP and Non-GAAP Financial Measures
We also review the following GAAP and non-GAAP financial measures to evaluate our business, measure our performance, identify trends affecting our business, formulate business plans, and make strategic decisions.
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended September 30, |
|
|
Nine Months Ended September 30, |
|
|
|
2022 |
|
|
2021 |
|
|
2022 |
|
|
2021 |
|
|
|
(in thousands) |
|
|
|
|
|
|
|
Net Loss |
|
$ |
(23,540 |
) |
|
$ |
(6,856 |
) |
|
$ |
(60,441 |
) |
|
$ |
(83,545 |
) |
Net Loss Margin(1) |
|
|
(27 |
)% |
|
|
(9 |
)% |
|
|
(23 |
)% |
|
|
(35 |
)% |
Adjusted EBITDA |
|
$ |
(8,001 |
) |
|
$ |
598 |
|
|
$ |
(22,514 |
) |
|
$ |
11,946 |
|
Adjusted EBITDA Margin(2) |
|
|
(9 |
)% |
|
|
1 |
% |
|
|
(8 |
)% |
|
|
5 |
% |
(1)Net Loss Margin is calculated by dividing Net Loss for a period by revenue for the same period.
(2)Adjusted EBITDA Margin is calculated by dividing Adjusted EBITDA for a period by revenue for the same period.
Reconciliation of Non-GAAP Financial Measures
We use Adjusted EBITDA and Adjusted EBITDA Margin in conjunction with GAAP measures as part of our overall assessment of our performance, including the preparation of our annual operating budget and quarterly forecasts, and to evaluate the effectiveness of our business strategies. Our definition may differ from the definitions used by other companies and therefore comparability may be limited. In addition, other companies may not publish similar metrics. Furthermore, this metric has certain limitations in that it does not include the impact of certain expenses that are reflected in our condensed consolidated statements of operations that are necessary to run our business. Thus, our Adjusted EBITDA and Adjusted EBITDA Margin should be considered in addition to, not as a substitute for, or in isolation from, measures prepared in accordance with GAAP.
35
We compensate for these limitations by providing a reconciliation of Adjusted EBITDA and Adjusted EBITDA Margin to the related GAAP financial measure, net loss attributable to common stockholders. We encourage investors and others to review our financial information in its entirety, not to rely on any single financial measure, and to view Adjusted EBITDA and Adjusted EBITDA Margin in conjunction with their respective related GAAP financial measures.
The following table provides a reconciliation of net loss to Adjusted EBITDA:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended September 30, |
|
|
Nine Months Ended September 30, |
|
|
|
2022 |
|
|
2021 |
|
|
2022 |
|
|
2021 |
|
|
|
(in thousands) |
|
|
|
|
|
|
|
Net loss attributable to common stockholders |
|
$ |
(23,540 |
) |
|
$ |
(6,856 |
) |
|
$ |
(60,441 |
) |
|
$ |
(83,545 |
) |
Adjusted to exclude the following: |
|
|
|
|
|
|
|
|
|
|
|
|
Depreciation and amortization |
|
|
1,000 |
|
|
|
827 |
|
|
|
3,033 |
|
|
|
2,463 |
|
Stock-based compensation |
|
|
13,474 |
|
|
|
6,668 |
|
|
|
34,285 |
|
|
|
38,912 |
|
Loss contingency accrual |
|
|
1,800 |
|
|
|
— |
|
|
|
1,800 |
|
|
|
— |
|
Interest income |
|
|
(1,586 |
) |
|
|
(77 |
) |
|
|
(2,145 |
) |
|
|
(201 |
) |
Other expense, net |
|
|
731 |
|
|
|
36 |
|
|
|
573 |
|
|
|
54,137 |
|
Provision for income taxes |
|
|
120 |
|
|
|
— |
|
|
|
381 |
|
|
|
180 |
|
Adjusted EBITDA |
|
$ |
(8,001 |
) |
|
$ |
598 |
|
|
$ |
(22,514 |
) |
|
$ |
11,946 |
|
Liquidity and Capital Resources
On October 3, 2022, we entered into the Merger Agreement with Naver, Proton Parent and Merger Sub, providing for the acquisition of Poshmark by Naver. We have agreed to various covenants and agreements, including, among others, agreements to conduct our business in the ordinary course of business between the execution of the Merger Agreement and the closing of the Merger. Outside of certain limited exceptions, we may not take certain actions without Naver’s consent, including (i) acquiring businesses and disposing of significant assets, (ii) incurring expenditures above specified thresholds, (iii) incurring debt, (iv) issuing additional securities, or (v) repurchasing shares of Company Common Stock. We do not believe these restrictions will prevent us from meeting our ongoing costs of operations, working capital needs or capital expenditure requirements.
As of September 30, 2022, our principal sources of liquidity were cash and cash equivalents of $588.8 million. Cash equivalents consisted of institutional money market funds, and cash in transit from third-party credit card providers that we receive within approximately three to five business days from the date of the underlying transaction.
As of September 30, 2022, our cash and cash equivalents held by our foreign subsidiaries were not material.
Since our inception, we have most often generated negative cash flows from operations and as of September 30, 2022, we had an accumulated deficit of $282.3 million, and we have financed our operations primarily through private sales of equity securities, payments received through our platform, and the issuance of convertible debt. Upon the closing of our IPO in January 2021, we received net proceeds of $292.3 million after deducting underwriting discounts and commissions and offering expenses. We believe our existing cash and cash equivalents will be sufficient to meet our working capital and capital expenditures needs over at least the next 12 months. However, our liquidity assumptions may prove to be incorrect, and we could exhaust our available financial resources sooner than we currently expect. We may seek to raise additional funds at any time through the issuance of debt, equity, and equity-linked arrangements.
Condensed Consolidated Statements of Cash Flows Data
|
|
|
|
|
|
|
|
|
|
|
Nine Months Ended September 30, |
|
|
|
2022 |
|
|
2021 |
|
|
|
(in thousands) |
|
Net cash provided by (used in): |
|
|
|
|
|
|
Operating activities |
|
$ |
4,431 |
|
|
$ |
33,966 |
|
Investing activities |
|
|
(1,311 |
) |
|
|
24,420 |
|
Financing activities |
|
|
3,223 |
|
|
|
295,846 |
|
Effect of foreign exchange rate changes on cash and cash equivalents |
|
|
935 |
|
|
|
95 |
|
Net increase in cash and cash equivalents |
|
$ |
7,278 |
|
|
$ |
354,327 |
|
36
Cash Flows from Operating Activities
For the nine months ended September 30, 2022, net cash provided by operating activities was $4.4 million which consisted of a net loss of $60.4 million, adjusted by non-cash charges of $40.0 million and net cash inflows from the change in net operating assets and liabilities of $24.8 million. The non-cash charges were primarily comprised of stock-based compensation of $34.3 million, and depreciation and amortization of $3.0 million. The net cash inflows from the change in our net operating assets and liabilities was primarily due to a $10.9 million increase in our accounts payable attributable to the timing of payments, a $9.1 million increase in accrued expenses and other liabilities, and a $7.9 million increase in funds payable as a result of our growth, partially offset by a $4.6 million decrease in operating lease liabilities.
For the nine months ended September 30, 2021, net cash provided by operating activities was $34.0 million, which consisted of a net loss of $83.5 million, adjusted by non-cash charges of $95.5 million and net cash inflows from the change in net operating assets and liabilities of $22.0 million. The non-cash charges were primarily comprised of the change in fair value of convertible notes of $51.1 million, stock-based compensation of $38.9 million, change in fair value of redeemable convertible preferred stock warrant liability of $2.8 million, and depreciation and amortization of $2.5 million. The net cash inflows from the change in our net operating assets and liabilities was primarily due to a $19.2 million increase in our funds payable to customers as a result of our growth.
Cash Flows from Investing Activities
For the nine months ended September 30, 2022, net cash used in investing activities of $1.3 million, was attributable to the purchase of property and equipment.
For the nine months ended September 30, 2021, net cash provided by investing activities of $24.4 million, was mainly attributable to the proceeds from the maturities of marketable securities.
Cash Flows from Financing Activities
For the nine months ended September 30, 2022, cash provided by financing activities was $3.2 million, which consisted of proceeds from the exercise of stock options and our employee stock purchase plan.
For the nine months ended September 30, 2021, cash provided by financing activities was $295.8 million, which consisted primarily of net proceeds from our IPO.
Concentration of Credit Risk
We are subject to concentration of credit risk principally from cash and cash equivalents. We reduce credit risk by placing our cash and cash equivalents with major financial institutions with high credit ratings. No customer accounted for 10% or more of our net revenue for the three and nine months ended September 30, 2022 and 2021.
Contractual Obligations and Commitments
As of September 30, 2022, there were no material changes outside the ordinary course of business to the contractual obligations, as disclosed in our Annual Report on Form 10-K for the year ended December 31, 2021.
Critical Accounting Policies and Estimates
Our condensed consolidated financial statements and accompanying notes have been prepared in accordance with GAAP. The preparation of these condensed consolidated financial statements requires us to make estimates and assumptions that affect the amounts reported amounts of assets, liabilities, revenue and expenses, and related disclosures. We base our estimates on historical experience and on various other assumptions that we believe are reasonable under the circumstances. We evaluate our estimates and assumptions on an ongoing basis. Actual results may differ from these estimates. To the extent that there are material differences between these estimates and our actual results, our future financial statements will be affected.
For additional information about our critical accounting policies and estimates, see the disclosure included in our Annual Report on Form 10-K as well as Note 2 – Summary of Significant Accounting Policies in the Notes to Condensed Consolidated Financial Statements (unaudited) included in Part I, Item 1, of this Quarterly Report on Form 10-Q.
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Item 4. Controls and Procedures.
Evaluation of Disclosure Controls and Procedures
Our management, with the participation of our Chief Executive Officer and Chief Financial Officer, evaluated the effectiveness of our disclosure controls and procedures defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934, as amended (“Exchange Act”) as of September 30, 2022. Based on this evaluation, our Chief Executive Officer and Chief Financial Officer concluded that, as of September 30, 2022, our disclosure controls and procedures were not effective due to a material weakness in internal control over financial reporting, as described in Item 9A. “Controls and Procedures–Management’s Annual Report on Internal Control Over Financial Reporting” of our Annual Report on Form 10-K for the year ended December 31, 2021.
Remediation Plan to Address Material Weakness
Our management is taking steps to enhance our internal control over financial reporting and remediate the material weakness identified during the year ended December 31, 2021 related to the completeness and accuracy of third-party data used to calculate and record chargebacks. During the first quarter of 2022, we made progress in our remediation of the material weakness noted above by designing new procedures to obtain completeness and accuracy of third-party data used to calculate and record chargebacks. To assess our remediation progress, during the second quarter of 2022, we initiated testing of the implementation of our redesigned process. During the third quarter of 2022, we continued our remediation progress including testing of the implementation of our redesigned controls. These controls will not be deemed effective until performed effectively for the year ended December 31, 2022.
We believe the measures described above will remediate the material weakness we have identified, however we cannot provide any assurance that our remediation efforts will be successful or that our internal control over financial reporting will be effective as a result of these efforts. We are committed to continuing to improve our internal control processes and will continue to review, optimize, and enhance our financial reporting controls and procedures. As we continue to evaluate and work to improve our internal control over financial reporting, we may take additional measures to address control deficiencies, or we may modify certain of the remediation measures described above. The material weakness will not be considered remediated until the applicable controls operate for a sufficient period of time and management has concluded, through testing, that these controls are operating effectively.
Changes in Internal Control Over Financial Reporting
There have been no changes in our internal control over financial reporting during the quarter ended September 30, 2022 that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.
Inherent Limitations on Effectiveness of Controls
Our management, including our Chief Executive Officer and our Chief Financial Officer, believes that our disclosure controls and procedures and internal control over financial reporting are designed to provide reasonable assurance of achieving their objectives and are effective at the reasonable assurance level. However, our management does not expect that our disclosure controls and procedures or our internal control over financial reporting will prevent all errors and all fraud. A control system, no matter how well conceived and operated, can provide only reasonable, not absolute, assurance that the objectives of the control system are met. Further, the design of a control system must reflect the fact that there are resource constraints, and the benefits of controls must be considered relative to their costs. Because of the inherent limitations in all control systems, no evaluation of controls can provide absolute assurance that all control issues and instances of fraud, if any, have been detected. These inherent limitations include the realities that judgments in decision making can be faulty, and that breakdowns can occur because of a simple error or mistake. Additionally, controls can be circumvented by the individual acts of some persons, by the collusion of two or more people or by management override of controls. The design of any system of controls is also based in part upon certain assumptions about the likelihood of future events, and there can be no assurance that any design will succeed in achieving its stated goals under all potential future conditions; over time, controls may become inadequate because of changes in conditions, or the degree of compliance with policies or procedures may deteriorate. Because of the inherent limitations in a cost-effective control system, misstatements due to error or fraud may occur and not be detected.
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