DOCUSIGN, INC. 10-Q

ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS The following discussion and analysis of our financial condition and results of operations should be read in conjunction with our condensed consolidated financial statements and related notes included elsewhere in this Quarterly Report on Form 10-Q and with our audited consolidated financial statements included in our 2020 Annual Report on Form 10-K. As discussed in the section titled “Note Regarding Forward-Looking Statements,” the following discussion and analysis contains forward-looking statements that involve risks and uncertainties, as well as assumptions that, if they never materialize or prove incorrect, could cause our results to differ materially from those expressed or implied by such forward-looking statements. Factors that could cause or contribute to these differences include, but are not limited to, those identified below and those discussed in the section titled “Risk Factors” under Part II, Item 1A in this Quarterly Report on Form 10-Q and in our 2020 Annual Report on Form 10-K. Our fiscal year ends January 31. Executive Overview of Third Quarter Results Overview DocuSign accelerates the process of doing business for companies and simplifies life for their customers and employees. We accomplish this by transforming the foundational element of business: the agreement. We offer the world’s #1 e-signature solution as the core part of our broader software suite for automating the agreement process, which we call the DocuSign Agreement Cloud. It is designed to allow companies of all sizes and across all industries to quickly and easily make nearly every agreement, approval process or transaction digital. It provides comprehensive functionality across e-signature and addresses the broader agreement process. As a result, over 820,000 customers and hundreds of millions of users worldwide utilize DocuSign to create, upload and send documents for multiple parties to sign electronically. The DocuSign Agreement Cloud allows users to complete approvals, agreements and transactions faster by 25 building end-to-end processes. DocuSign eSignature integrates with popular business apps, and our functionality can also be embedded using our API. Finally, the DocuSign Agreement Cloud allows our customers to automate and streamline their business-critical workflows to save time and money, while staying secure and legally compliant. We offer access to our platform on a subscription basis with prices based on the functionality our customers require and the quantity of Envelopes provisioned. Similar to the physical envelopes historically used to mail paper documents, an Envelope is a digital container used to send one or more documents for signature or approval to one or more recipients. Our customers have the flexibility to put a large number of documents in an Envelope. For a number of use cases, such as buying a home, multiple Envelopes are used over the course of the process. To drive customer reach and adoption, we also offer for free certain limited-time or feature-constrained versions of our platform. We generate substantially all our revenue from sales of subscriptions, which accounted for 96% and 95% of our revenue in the three months ended October 31, 2020 and 2019. Sales of subscriptions accounted for 95% and 94% of our revenue in the nine months ended October 31, 2020 and 2019. Our subscription fees include the use of our software suite and access to customer support. Subscriptions generally range from one to three years, and substantially all our multi-year customers pay in annual installments, one year in advance. We also generate revenue from professional and other non-subscription services, which consists primarily of fees associated with providing new customers deployment and integration services. Other revenue includes amounts derived from sales of on-premises solutions. Professional services and other revenue accounted for 4% and 5% of our revenue in the three months ended October 31, 2020 and 2019. It accounted for 5% and 6% of our revenue in the nine months ended October 31, 2020 and 2019. We anticipate continuing to invest in customer success through our professional services offerings as we believe it plays an important role in accelerating our customers’ deployment of our software suite, which helps to drive customer retention and expansion of the use of the DocuSign Agreement Cloud. We offer subscriptions to our software suite to enterprise businesses, commercial businesses and very small businesses (“VSBs”), which we define as companies with fewer than 10 employees and includes professionals, sole proprietorships and individuals. We sell to customers through multiple channels. Our go-to-market strategy relies on our direct sales force and partnerships to sell to enterprises and commercial businesses and our web-based self-service channel to sell to VSBs, which we believe is the most cost-effective way to reach our smallest customers. We offer more than 300 off-the-shelf, prebuilt integrations with the applications that many of our customers already use—including those offered by Google, Microsoft, NetSuite, Oracle, Salesforce, SAP, SAP SuccessFactors and Workday—so that they can create, sign, send and manage agreements from directly within these applications. We have a diverse customer base spanning various industries and countries with no significant customer concentration. No single customer accounted for more than 10% of total revenue in any of the periods presented. We focused initially on selling our e-signature solutions to commercial businesses and VSBs, and later expanded our focus to target enterprise customers. To demonstrate this growth over time, the number of our customers with greater than $300,000 in annual contract value (measured in billings) has increased from approximately 30 customers as of January 31, 2013 to 542 customers as of October 31, 2020. Each of our customer types has a different purchasing pattern. VSBs tend to become customers quickly with very little to no direct sales or customer support interaction and generate smaller average contract values, while commercial and enterprise customers typically involve longer sales cycles, larger contract values and greater expansion opportunities for us. COVID-19 Update The COVID-19 pandemic has spread across the world and is particularly prevalent in the U.S., where we are headquartered and the majority of our workforce is located. The pandemic and the public health measures taken in response to it have adversely affected workforces, organizations, customers, economies, and financial markets globally, leading to an economic downturn and increased market volatility. We are continuing to monitor the actual and potential effects of the pandemic across our business. Because these effects are dependent on highly uncertain future developments — including the duration, spread and severity of the outbreak, the actions taken to contain the virus, and how quickly and to what extent normal economic and operating conditions can resume — they are extremely difficult to predict. While our revenue, billings and earnings are relatively predictable as a result of our subscription-based business model, the effects of the COVID-19 pandemic may not be fully reflected in our results of operations until future periods. Since mid-March, we have taken a number of precautionary measures to ensure the health and safety of our employees, partners and customers. DocuSign shifted to a largely remote work environment, providing nearly all employees the opportunity to work from home through at least May 31, 2021. We suspended all business travel other than for essential 26 functions. We have cancelled or replaced planned events, such as our Momentum conferences, with virtual-only experiences. We have incurred expenses to support our employees working from home, including reimbursements for home office equipment and a stipend for other qualifying expenses, as well as expenses associated with planning and risk mitigation for potential reopenings of our offices, and may incur similar expenses in the future. The impact of these and any other operational changes we may implement is uncertain, but as of the date of this filing they have not materially affected our ability to maintain operations. We have experienced a substantial increase in overall demand for our solutions, particularly DocuSign eSignature, as the shift to remote, web-enabled business operations has caused more organizations to adopt or expand their use of digital agreements. This has resulted in a significant increase in customer spending across almost all industries and regions we serve, though we have experienced slower growth or declining spending in certain industries most impacted by the pandemic, such as travel and hospitality. As the pandemic continues, however, we may experience volatility in customer demand; increased customer churn; increases in late payment or non-payment by customers; delayed purchasing decisions; and increased pressure on pricing, discounts and payment terms, any of which could materially harm our business, results of operations and overall financial performance. See the section below titled “Risk Factors” for further discussion of the potential impact of the COVID-19 pandemic on our business, financial condition and results of operations. Financial Results: Three Months Ended October 31, Nine Months Ended October 31, (in thousands) 2020 2019 2020 2019 Total revenue $ 382,923 $ 249,502 $ 1,022,149 $ 699,076 Total costs and expenses 431,393 293,499 1,171,107 850,232 Total stock-based compensation expense 80,920 52,736 203,238 150,799 Loss from operations (48,470) (43,997) (148,958) (151,156) Net loss (58,491) (46,598) (170,855) (160,952) Net cash provided by operating activities 57,443 (1,869) 234,721 70,191 Purchases of property and equipment (19,393) (12,280) (64,144) (42,071) Cash, cash equivalents, restricted cash and investments were $675.6 million as of October 31, 2020 . Key Factors Affecting Our Performance We believe that our future performance will depend on many factors, including the following: Growing Customer Base We are highly focused on continuing to acquire new customers to support our long-term growth. We have invested, and expect to continue to invest, heavily in our sales and marketing efforts to drive customer acquisition. As of October 31, 2020, we had a total of over 820,000 customers, including over 110,000 enterprise and commercial customers, comp ared to over 560,000 customers and over 65,000 enterprise and commercial customers as of October 31, 2019. We define a customer as a separate and distinct buying entity, such as a company, an educational or government institution, or a distinct business unit of a large company that has an active contract to access our software suite. We define enterprise customers as companies generally included in the Global 2000. We define commercial customers to include both mid-market companies, which includes companies outside the Global 2000 that have greater than 250 employees, and small-to-medium-sized businesses, which are companies with between 10 and 249 employees, in each case excluding any enterprise customers. We refer to total customers as all enterprises, commercial businesses and VSBs. We believe that our ability to increase the number of customers using our software suite, particularly the number of enterprise and commercial customers, is an indicator of our market penetration, the growth of our business and our potential future business opportunities. By increasing awareness of our software suite, further developing our sales and marketing expertise and continuing to build features tuned to different industry needs, we have expanded the diversity of our customer base to include organizations of all sizes across nearly every industry. 27 Retaining and Expanding Contracts with Existing Enterprise and Commercial Customers Many of our customers have increased spend with us as they have expanded their use of our offerings in both existing and new use cases across their front or back office operations. Our enterprise and commercial customers may start with just one use case and gradually implement additional use cases across their organization once they see the benefits of our software suite. Several of our largest enterprise customers have deployed our software suite for hundreds of use cases across their organizations. We believe there is significant expansion opportunity with our customers following their initial adoption of our software suite. Increasing International Revenue Our international revenue in the three months ended October 31, 2020 increased by 77% from the three months ended October 31, 2019 and represented 20% and 17% of our total revenue in the three months ended October 31, 2020 and 2019. Our international revenue in the nine months ended October 31, 2020 increased by 61% from the nine months ended October 31, 2019 and represented 19% and 18% of our total revenue in the nine months ended October 31, 2020 and 2019. We started our international selling efforts in English-speaking common law countries, such as Canada, the United Kingdom and Australia, where we were able to leverage our core technologies due to similar approaches to e-signature in these jurisdictions and the United States (“U.S.”). We have since made significant investments to be able to offer our solutions in select civil law countries. For example, in Europe, we have Standards-Based Signature technology tailored for electronic IDentification, Authentication and trust Services (“eIDAS”). Standards-Based Signatures support signatures that involve digital certificates, including those specified in the European Union’s (“EU”) eIDAS regulations for advanced and qualified electronic signatures. In addition, to follow longstanding tradition in Japan, we enable signers to upload and apply their personal eHanko stamp to represent their signatures on an agreement. We plan to increase our international revenue by leveraging and continuing to expand the investments we have already made in our technology, direct sales force and strategic partnerships, as well as helping existing U.S.-based customers manage agreements across their international businesses. Additionally, we expect our strategic partnerships in key international markets to further grow. Investing for Growth We believe that our market opportunity is large, and we plan to invest to continue to support further growth. This includes expanding our sales headcount and increasing our marketing initiatives. We also plan to continue to invest in expanding the functionality of our software suite and underlying infrastructure and technology to meet the needs of our customers across industries. Our recent acquisitions of Seal Software and Liveoak Technologies, intended to bring additional functionality to our DocuSign Agreement Cloud and further expand our eNotary offerings, as well as the continuous development of new features internally, are examples of our commitment to investing for ongoing growth. Components of Results of Operations Revenue We derive revenue primarily from the sale of subscriptions and, to a lesser extent, professional services. Subscription Revenue. Subscription revenue consists of fees for the use of our software suite and our technical infrastructure and access to customer support, which includes phone or email support. We typically invoice customers in advance on an annual basis. We recognize subscription revenue ratably over the term of the contract subscription period beginning on the date access to our software suite is provided. Professional Services and Other Revenue. Professional services revenue includes fees associated with new customers requesting deployment and integration services. We price professional services on a time and materials basis and on a fixed fee basis. We generally have standalone value for our professional services and recognize revenue based on standalone selling price as services are performed or upon completion of services for fixed fee contracts. Other revenue includes amounts derived from sales of on-premises solutions. 28 Overhead Allocation We allocate shared overhead costs, such as facilities (including rent, utilities and depreciation on equipment shared by all departments), information technology, information security and recruiting costs to all departments based on headcount. As such, these allocated overhead costs are reflected in each cost of revenue and operating expense category. Cost of Revenue Cost of Subscription Revenue. Cost of subscription revenue primarily consists of expenses related to hosting our software suite and providing support. These expenses consist of employee-related costs, including salaries, bonuses, benefits, stock-based compensation and other related costs, as well as personnel costs for employees associated with our technical infrastructure, customer success and customer support. These expenses also consist of software and maintenance costs, third-party hosting fees, outside services associated with the delivery of our subscription services, amortization expense associated with capitalized internal-use software and acquired intangible assets, credit card processing fees and allocated overhead costs. Cost of Professional Services and Other Revenue. Cost of professional services and other revenue consists primarily of personnel costs for our professional services delivery team, travel-related costs and allocated overhead costs. We expect our cost of revenue to continue to increase in absolute dollar amounts as we invest in our business. Gross Profit and Gross Margin Gross profit is total revenue less total cost of revenue. Gross margin is gross profit expressed as a percentage of total revenue. We expect that gross profit and gross margin will continue to be affected by various factors including our pricing, timing and amount of investment to maintain or expand our hosting capability, the growth of our software suite support and professional services team, stock-based compensation expenses, amortization of costs associated with capitalized internal use software and acquired intangible assets and allocated overhead costs. Operating Expenses Our operating expenses consist of selling and marketing, research and development and general and administrative expenses. Selling and Marketing Expense. Selling and marketing expense consists primarily of personnel costs, including sales commissions. These expenses also include expenditures related to advertising, marketing, promotional events and brand awareness activities, as well as allocated overhead costs. We expect selling and marketing expense to continue to increase in absolute dollars as we enhance our product offerings and implement marketing strategies. Research and Development Expense. Research and development expense consists primarily of personnel costs. These expenses also include non-personnel costs, such as subcontracting, consulting and professional fees for third-party development resources, as well as allocated overhead costs. Our research and development efforts focus on maintaining and enhancing existing functionality and adding new functionality. We expect research and development expense to increase in absolute dollars as we invest in the enhancement of our software suite. General and Administrative Expense. General and administrative expense consists primarily of employee-related costs for those employees providing administrative services such as legal, human resources, information technology related to internal systems, accounting and finance. These expenses also include certain third-party consulting services, certain facilities costs and allocated overhead costs. We expect general and administrative expense to increase in absolute dollars to support the overall growth of our operations. Interest Expense Interest expense consists primarily of contractual interest expense, amortization of discount and amortization of debt issuance costs on our Convertible Senior Notes (the “ Notes”). 29 Interest Income and Other Income (Expense), Net Interest income and other income (expense), net , consists primarily of interest earned on our cash, cash equivalents and investments, as well as foreign currency transaction gains and losses. Provision for Income Taxes Our provision for income taxes consists primarily of income taxes in certain foreign jurisdictions where we conduct business, and tax benefits arising from deductions for stock options. We have a valuation allowance against our U.S. consolidated group and certain foreign deferred tax assets. We expect to maintain this valuation allowance for the foreseeable future or until it becomes more likely than not that the benefit of these U.S. and foreign deferred tax assets will be realized by way of expected future taxable income. 30 Discussion of Results of Operations The following table summarizes our historical consolidated statements of operations data: Three Months Ended October 31, Nine Months Ended October 31, (in thousands) 2020 2019 2020 2019 Revenue: Subscription $ 366,617 $ 238,072 $ 971,182 $ 660,341 Professional services and other 16,306 11,430 50,967 38,735 Total revenue 382,923 249,502 1,022,149 699,076 Cost of revenue: Subscription 69,905 43,178 186,645 115,769 Professional services and other 27,926 18,786 75,833 59,390 Total cost of revenue 97,831 61,964 262,478 175,159 Gross profit 285,092 187,538 759,671 523,917 Operating expenses: Sales and marketing 209,944 149,231 576,729 430,053 Research and development 73,362 48,758 191,387 133,458 General and administrative 50,256 33,546 140,513 111,562 Total operating expenses 333,562 231,535 908,629 675,073 Loss from operations (48,470) (43,997) (148,958) (151,156) Interest expense (7,769) (7,364) (23,013) (21,793) Interest income and other income (expense), net (311) 5,801 6,032 15,549 Loss before provision for income taxes (56,550) (45,560) (165,939) (157,400) Provision for income taxes 1,941 1,038 4,916 3,552 Net loss $ (58,491) $ (46,598) $ (170,855) $ (160,952) 31 The following table sets forth the components of our consolidated statements of operations data as a percentage of revenue: Three Months Ended October 31, Nine Months Ended October 31, (in thousands) 2020 2019 2020 2019 Revenue: Subscription 96 % 95 % 95 % 94 % Professional services and other 4 5 5 6 Total revenue 100 100 100 100 Cost of revenue: Subscription 18 17 18 17 Professional services and other 8 8 8 8 Total cost of revenue 26 25 26 25 Gross profit 74 75 74 75 Operating expenses: Sales and marketing 55 60 56 62 Research and development 19 20 19 19 General and administrative 13 13 14 16 Total operating expenses 87 93 89 97 Loss from operations (13) (18) (15) (22) Interest expense (2) (3) (2) (3) Interest income and other income (expense), net — 3 1 2 Loss before provision for income taxes (15) (18) (16) (23) Provision for income taxes — 1 1 — Net loss (15) % (19) % (17) % (23) % The following discussion and analysis is for the three and nine months ended October 31, 2020, compared to the same period in 2019. Revenue Three Months Ended October 31, 2020 versus 2019 Nine Months Ended October 31, 2020 versus 2019 (in thousands, except for percentages) 2020 2019 2020 2019 Revenue: Subscription $ 366,617 $ 238,072 54 % $ 971,182 $ 660,341 47 % Professional services and other 16,306 11,430 43 % 50,967 38,735 32 % Total revenue $ 382,923 $ 249,502 53 % $ 1,022,149 $ 699,076 46 % Subscription Revenue Subscription revenue increased by $128.5 million, or 54%, in the three months ended October 31, 2020, and by $310.8 million, or 47%, in the nine months ended October 31, 2020, primarily driven by strong customer growth and the addition of Seal. We continue to invest in a variety of customer programs and initiatives, which, along with expanded customer use cases, have helped increase our subscription revenue over time. We expect subscription revenue to continue to increase as we offer new functionality, attract new customers and fully realize the potential of our acquisitions in our product offerings. 32 Professional Services and Other Revenue Professional services and other revenue increased by $4.9 million, or 43%, in the three months ended October 31, 2020, and by $12.2 million, or 32%, in the nine months ended October 31, 2020, primarily due to the addition of Seal and increased engagement of professional services to support our growing customer base. Cost of Revenue and Gross Margin Three Months Ended October 31, 2020 versus 2019 Nine Months Ended October 31, 2020 versus 2019 (in thousands, except for percentages) 2020 2019 2020 2019 Cost of revenue: Subscription $ 69,905 $ 43,178 62 % $ 186,645 $ 115,769 61 % Professional services and other 27,926 18,786 49 % 75,833 59,390 28 % Total cost of revenue $ 97,831 $ 61,964 58 % $ 262,478 $ 175,159 50 % Gross margin: Subscription 81 % 82 % (1) pts 81 % 82 % (1) pts Professional services and other (71) % (64) % (7) pts (49) % (53) % 4 pts Total gross margin 74 % 75 % (1) pts 74 % 75 % (1) pts Cost of Subscription Revenue Cost of subscription revenue increased $26.7 million, or 62%, in the three months ended October 31, 2020, primarily due to: ▪ An increase of $10.8 million in operating costs to support our platform, including increases of $3.4 million in depreciation and amortization, $2.8 million in third-party partner costs, and $2.2 million in data center costs. The increase in depreciation and amortization reflects the higher existing technology intangible assets from the acquisition of Seal, as well as higher data center equipment and capitalized software assets; and ▪ Increases of $9.1 million in personnel costs and $2.2 million in stock-based compensation expense, primarily due to higher headcount, including the addition of Seal employees to our workforce, annual merit increases, and annual grants issued in the second quarter. Cost of subscription revenue increased $70.9 million, or 61%, in the nine months ended October 31, 2020, primarily due to: ▪ An increase of $32.4 million in operating costs to support our platform, including increases of $10.7 million in subscription reseller fees, $7.2 million in data center costs and $7.2 million in depreciation and amortization, and $2.3 million increase in processing fees. The increase in depreciation and amortization reflects the higher existing technology intangible assets from the acquisition of Seal, as well as higher data center and capitalized software assets; ▪ An increase of $22.8 million in personnel costs and $5.7 million in stock-based compensation expense primarily due to higher headcount, including the addition of Seal employees, and annual merit increases; ▪ An increase of $4.7 million in professional fees mainly in third-party technical support and customer services; and ▪ An increase of $2.4 million in software and technology costs to support higher headcount. Cost of Professional Services and Other Revenue Cost of professional services and other revenue increased $9.1 million, or 49%, in the three months ended October 31, 2020, and $16.4 million, or 28%, in the nine months ended October 31, 2020, primarily due to an increase in personnel costs driven by higher headcount, annual merit increases and the addition of Seal employees to our workforce. Sales and Marketing Three Months Ended October 31, 2020 versus 2019 Nine Months Ended October 31, 2020 versus 2019 (in thousands, except for percentages) 2020 2019 2020 2019 Sales and marketing $ 209,944 $ 149,231 41 % $ 576,729 $ 430,053 34 % Percentage of revenue 55 % 60 % 56 % 62 % 33 Sales and marketing expenses increased $60.7 million, or 41%, in the three months ended October 31, 2020, primarily due to: ▪ An increase of $32.4 million in personnel costs due to higher headcount, annual merit increases, the addition of Seal employees to our workforce and higher commissions in line with higher sales; ▪ An increase of $12.2 million in stock-based compensation expense due to higher headcount and annual merit grants issued in the second quarter; ▪ An increase of $11.4 million in marketing and advertising costs to support higher spend on online advertising platforms to capture the increase in demand; and ▪ An increase of $4.6 million in allocated overhead due to higher technology and facility costs; partially offset by ▪ A decrease of $4.9 million in travel expenses due to travel restrictions resulting from the COVID-19 pandemic. Sales and marketing expenses increased $146.7 million, or 34%, in the nine months ended October 31, 2020, primarily due to: ▪ An increase of $93.2 million in personnel costs due to higher headcount, annual merit increases, the addition of Seal employees to our workforce and higher commissions in line with higher sales; ▪ An increase of $25.2 million in stock-based compensation expense due to higher headcount; ▪ An increase of $20.7 million in marketing and advertising expense, primarily due to higher spend on online advertising platforms to capture the increase in demand; ▪ An increase of $13.1 million in allocated overhead due to higher technology and facility costs; and ▪ An increase of $5.0 million in depreciation and amortization due to the depreciation of additional fixed assets and the amortization of certain intangible assets acquired in the Seal and Liveoak acquisitions; partially offset by ▪ A decrease of $13.9 million in travel expenses due to travel restrictions resulting from the COVID-19 pandemic. Research and Development Three Months Ended October 31, 2020 versus 2019 Nine Months Ended October 31, 2020 versus 2019 (in thousands, except for percentages) 2020 2019 2020 2019 Research and development $ 73,362 $ 48,758 50 % $ 191,387 $ 133,458 43 % Percentage of revenue 19 % 20 % 19 % 19 % Research and development expenses increased $24.6 million, or 50%, in the three months ended October 31, 2020, primarily due to increases of $14.3 million in personnel costs and $7.2 million in stock-based compensation. Research and development expenses increased $57.9 million, or 43%, in the nine months ended October 31, 2020, primarily due to increases of $38.9 million in personnel costs and $14.6 million in stock-based compensation expense. The increases in both periods were primarily driven by higher headcount, annual merit increase and grants, and the addition of Seal and Liveoak employees to our workforce. General and Administrative Three Months Ended October 31, 2020 versus 2019 Nine Months Ended October 31, 2020 versus 2019 (in thousands, except for percentages) 2020 2019 2020 2019 General and administrative $ 50,256 $ 33,546 50 % $ 140,513 $ 111,562 26 % Percentage of revenue 13 % 13 % 14 % 16 % General and administrative expenses increased $16.7 million, or 50%, in the three months ended October 31, 2020, primarily due to: ▪ Increases of $6.6 million in personnel costs and $4.1 million in stock-based compensation due to higher headcount, annual merit increases and grants, and the addition of Seal employees to our workforce; and ▪ An increase of $2.6 million in professional fees due to higher legal and consulting fees. General and administrative expenses increased $29.0 million, or 26%, in the nine months ended October 31, 2020, primarily due to: ▪ Increases of $15.0 million in personnel costs and $3.5 million in stock-based compensation due to higher headcount, annual merit increases and grants, and the addition of Seal employees to our workforce; and ▪ An increase of $3.5 million in bad debt reserve related to the impact of the COVID-19 pandemic. 34 Interest Expense Three Months Ended October 31, 2020 versus 2019 Nine Months Ended October 31, 2020 versus 2019 (in thousands, except for percentages) 2020 2019 2020 2019 Interest expense $ 7,769 7,364 5 % $ 23,013 $ 21,793 6 % Percentage of revenue 2 % 3 % 2 % 3 % Interest expense remained relatively flat in the three and nine months ended October 31, 2020 and primarily consisted of interest expense and amortization of discount and transaction costs on the Notes. Interest Income and Other Income (Expense), Net Three Months Ended October 31, 2020 versus 2019 Nine Months Ended October 31, 2020 versus 2019 (in thousands, except for percentages) 2020 2019 2020 2019 Interest income $ 1,385 $ 4,421 (69) % $ 6,591 $ 12,039 (45) % Foreign currency gain (loss) (1,213) 711 NM (333) (550) (39) % Other (483) 669 NM (226) 4,060 NM Interest income and other income (expense), net $ (311) $ 5,801 NM $ 6,032 $ 15,549 (61) % Percentage of revenue — % 3 % 1 % 2 % Interest income and other income (expense), net, decreased by $6.1 million and $9.5 million, in the three and nine months ended October 31, 2020, primarily due to lower interest income, losses on the revaluation of our foreign currency denominated monetary assets and liabilities, and amortization o n our marketable securities. Provision for Income Taxes Three Months Ended October 31, 2020 versus 2019 Nine Months Ended October 31, 2020 versus 2019 (in thousands, except for percentages) 2020 2019 2020 2019 Provision for income taxes $ 1,941 $ 1,038 87 % $ 4,916 $ 3,552 38 % Percentage of revenue — % 1 % 1 % — % Provision for income taxes increased by $0.9 million in the three months ended October 31, 2020 and increased by $1.4 million in the nine months ended October 31, 2020. The provision consisted primarily of foreign tax expenses resulting from foreign earnings in certain foreign jurisdictions, partially offset by excess benefits from stock option settlements. 35 Liquidity and Capital Resources Our principal sources of liquidity were cash, cash equivalents and investments as well as cash generated from operations. As of October 31, 2020, we had $598.6 million in cash and cash equivalents and short-term investments. We also had $76.8 million in long-term investments that provide additional capital resources. Since inception we have financed our operations primarily through equity financings and payments by our customers for use of our product offerings and related services. In addition, in September 2018 we issued and sold $575.0 million in aggregate principal amount of 0.5% Convertible Senior Notes due 2023, which are further described in Note 9 of our condensed consolidated financial statements. We believe our existing cash, cash equivalents and marketable securities will be sufficient to meet our working capital and capital expenditures needs over at least the next 12 months. While we have generated losses from operations in the past as reflected in our accumulated deficit of $1.3 billion as of October 31, 2020, we generated positive cash flows from operations of $234.7 million in the nine months ended October 31, 2020. We expect to continue to incur operating losses for the foreseeable future due to the investments we intend to make and may require additional capital resources to execute strategic initiatives to grow our business. We typically invoice our customers annually in advance. Therefore, a substantial source of our cash is from such invoices, which are included on our consolidated balance sheets in contract liabilities until revenue is recognized or in accounts receivable until cash is collected. Accordingly, collections from our customers have a material impact on our cash flows from operating activities. Our accounts receivable increased by $11.4 million, excluding the impact from acquisitions, in the nine months ended October 31, 2020, and decreased by $15.1 million in the nine months ended October 31, 2019, which resulted in a $26.5 million decrease in cash provided by operating activities year over year. Contract liabilities consist of the unearned portion of billed fees for our subscriptions, which is subsequently recognized as revenue in accordance with our revenue recognition policy. Our contract liabilities increased by $172.5 million, excluding the impact from acquisitions, in the nine months ended October 31, 2020, compared to an increase of $44.3 million in the nine months ended October 31, 2019. The year over year increase contributed an additional $128.2 million to cash provided by operating activities. Therefore, our growth in billings to existing and new customers has a material net beneficial impact on our cash flows from operating activities. Our future capital requirements will depend on many factors including our growth rate, customer retention and expansion, tax withholding obligations related to settlement of our RSUs, the timing and extent of spending to support our efforts to develop our software suite, the expansion of sales and marketing activities and the continuing market acceptance of our software suite. We may in the future enter into arrangements to acquire or invest in complementary businesses, technologies and intellectual property rights. We may be required to seek additional equity or debt financing. In the event that additional financing is required from outside sources, we may not be able to raise it on terms acceptable to us or at all. If we are unable to raise additional capital when desired, our business, operating results and financial condition would be adversely affected. Cash Flows The following table summarizes our cash flows for the periods indicated: Nine Months Ended October 31, (in thousands) 2020 2019 Change Net cash provided by (used in): Operating activities $ 234,721 $ 70,191 $ 164,530 Investing activities 100,064 (350,795) 450,859 Financing activities (202,435) (39,153) (163,282) Effect of foreign exchange on cash and cash equivalents 1,432 (310) 1,742 Net change in cash, cash equivalents and restricted cash $ 133,782 $ (320,067) $ 453,849 Cash Flows from Operating Activities Net cash provided by operating activities increased by $164.5 million, driven by an increase in the add-back of non-cash expenses of $98.1 million and an increase in the net cash provided by changes in operating assets and liabilities by $76.4 million. The higher add-back was primarily due to increases of $52.4 million in stock-based compensation expense driven by higher headcount and $43.4 million non-cash amortization expense. 36 The increase in the net cash provided by changes in operating assets and liabilit ies was primarily due to: ▪ An increase of $128.2 million in cash provided by changes in contract liabilities; ▪ An increase of $30.2 million in cash provided by changes in accrued compensation; and ▪ An increase of $17.3 million in cash provided by changes in accrued expenses and other liabilities; partially offset by ▪ An increase of $66.8 million in cash used from changes in deferred contract acquisition and fulfillment costs; ▪ An increase of $26.5 million in cash used from changes in accounts receivable; and ▪ An increase of $7.4 million in cash used from changes in other assets. Cash Flows from Investing Activities Net cash provided by investing activities was $100.1 million, as compared to $350.8 million net cash used in investing activity in prior year. This change was primarily due to cash inflows of $353.1 million from net maturities and sales of marketable securities compared to cash outflows of $293.2 million from net purchases of marketable securities in prior year. Additionally, there was a $10.2 million decrease in purchases of strategic investments. The cash inflows were partially offset by cash outflows of $180.4 million paid for acquisitions, net of cash acquired, and a $22.1 million increase in capital expenditures. Cash Flows from Financing Activities Net cash used in financing activities increased by $163.3 million due to a $122.0 million increase in cash used to remit tax withholding obligations on settled RSUs, a $47.3 million decrease in proceeds from exercises of stock options, partially offset by a $6.0 million increase in proceeds from purchases under the ESPP. Contractual Obligations and Commitments Our principal contractual obligations and commitments consist of obligations under the Notes (including principal and coupon interest), operating leases, as well as noncancelable contractual commitments that primarily relate to cloud infrastructure support and sales and marketing activities . Refer to Note 9 for more information on the Notes and Note 10 and Note 11 for our lease and other commitments. As of October 31, 2020, we had unused letters of credit outstanding associated with our various operating leases totaling $8.3 million. Off-Balance Sheet Arrangements We did not have during the periods presented, and we do not currently have, any off-balance sheet financing arrangements or any relationships with unconsolidated entities or financial partnerships, including entities sometimes referred to as structured finance or special purpose entities, that were established for the purpose of facilitating off-balance sheet arrangements or other contractually narrow or limited purposes. Critical Accounting Policies and Estimates W e prepare our financial statements in accordance with U.S. generally accepted accounting principles (“GAAP”). Preparing these financial statements requires us to make estimates and assumptions that affect the reported amounts of assets, liabilities, revenue, expenses and related disclosures. We evaluate our estimates and assumptions on an ongoing basis. Our estimates are based on historical experience and various other assumptions that we believe to be reasonable under the circumstances. The current COVID-19 pandemic has caused uncertainty and disruption in the global economy and financial markets. We are not aware of any specific event or circumstance that would require us to update our estimates, judgments or revise the carrying value of our assets or liabilities. These estimates may change, as new events occur and additional information is obtained. Our actual results could differ from these estimates. The critical accounting estimates, assumptions and judgments that we believe to have the most significant impact on our consolidated financial statements are revenue recognition, deferred contract acquisition costs, stock-based compensation, business combinations and valuation of goodwill and other acquired intangible assets and income taxes. There have been no material changes to our critical accounting policies and estimates as described in our 2020 Annual Report on Form 10-K. 37 Recent Accounting Pronouncements Refer to Note 1 to our consolidated financial statements included elsewhere in this Quarterly Report on Form 10-Q for recently issued accounting pronouncements not yet adopted as of the date of this report. 38 Non-GAAP Financial Measures and Other Key Metrics To supplement our consolidated financial statements, which are prepared and presented in accordance with GAAP, we use certain non-GAAP financial measures, as described below, to understand and evaluate our core operating performance. These non-GAAP financial measures, which may be different than similarly titled measures used by other companies, are presented to enhance investors’ overall understanding of our financial performance and should not be considered a substitute for, or superior to, the financial information prepared and presented in accordance with GAAP. We believe that these non-GAAP financial measures provide useful information about our financial performance, enhance the overall understanding of our past performance and future prospects, and allow for greater transparency with respect to important metrics used by our management for financial and operational decision-making. We present these non-GAAP measures to assist investors in seeing our financial performance using a management view, and because we believe that these measures provide an additional tool for investors to use in comparing our core financial performance over multiple periods with other companies in our industry. Non-GAAP gross profit, non-GAAP gross margin, non-GAAP income from operations, non-GAAP operating margin, non-GAAP net income and non-GAAP net income per share : We define these non-GAAP financial measures as the respective GAAP measures, excluding expenses related to stock-based compensation, employer payroll tax on employee stock transactions, amortization of acquisition-related intangibles, amortization of debt discount and issuance costs from our convertible senior notes issued in September 2018, acquisition-related expenses and, as applicable, other special items. The amount of employer payroll tax-related items on employee stock transactions is dependent on our stock price and other factors that are beyond our control and that do not correlate to the operation of the business. When evaluating the performance of our business and making operating plans, we do not consider these items (for example, when considering the impact of equity award grants, we place a greater emphasis on overall stockholder dilution rather than the accounting charges associated with such grants). We believe it is useful to exclude these expenses in order to better understand the long-term performance of our core business and to facilitate comparison of our results to those of peer companies and over multiple periods. Free cash flows : We define free cash flow as net cash provided by operating activities less purchases of property and equipment. We believe free cash flow is an important liquidity measure of the cash that is available (if any), after purchases of property and equipment, for operational expenses, investment in our business and to make acquisitions. Free cash flow is useful to investors as a liquidity measure because it measures our ability to generate or use cash in excess of our capital investments in property and equipment. Once our business needs and obligations are met, cash can be used to maintain a strong balance sheet and invest in future growth. Billings : We define billings as total revenues plus the change in our contract liabilities and refund liability less contract assets and unbilled accounts receivable in a given period. Billings reflects sales to new customers plus subscription renewals and additional sales to existing customers. Only amounts invoiced to a customer in a given period are included in billings. We believe billings is a key metric to measure our periodic performance. Given that most of our customers pay in annual installments one year in advance, but we typically recognize a majority of the related revenue ratably over time, we use billings to measure and monitor our ability to provide our business with the working capital generated by upfront payments from our customers. 39 Reconciliation of gross profit and gross margin: Three Months Ended October 31, Nine Months Ended October 31, (in thousands) 2020 2019 2020 2019 GAAP gross profit $ 285,092 $ 187,538 $ 759,671 $ 523,917 Add: Stock-based compensation 11,782 7,150 30,010 20,808 Add: Amortization of acquisition-related intangibles 3,376 1,348 7,856 4,356 Add: Employer payroll tax on employee stock transactions 1,676 715 4,450 1,908 Non-GAAP gross profit $ 301,926 $ 196,751 $ 801,987 $ 550,989 GAAP gross margin 74 % 75 % 74 % 75 % Non-GAAP adjustments 5 % 4 % 4 % 4 % Non-GAAP gross margin 79 % 79 % 78 % 79 % GAAP subscription gross profit $ 296,712 $ 194,894 $ 784,537 $ 544,572 Add: Stock-based compensation 5,777 3,534 14,655 8,931 Add: Amortization of acquisition-related intangibles 3,376 1,348 7,856 4,356 Add: Employer payroll tax on employee stock transactions 722 337 2,183 769 Non-GAAP subscription gross profit $ 306,587 $ 200,113 $ 809,231 $ 558,628 GAAP subscription gross margin 81 % 82 % 81 % 82 % Non-GAAP adjustments 3 % 2 % 2 % 3 % Non-GAAP subscription gross margin 84 % 84 % 83 % 85 % GAAP professional services and other gross loss $ (11,620) $ (7,356) $ (24,866) $ (20,655) Add: Stock-based compensation 6,005 3,616 15,355 11,877 Add: Employer payroll tax on employee stock transactions 954 378 2,267 1,139 Non-GAAP professional services and other gross loss $ (4,661) $ (3,362) $ (7,244) $ (7,639) GAAP professional services and other gross margin (71) % (64) % (49) % (53) % Non-GAAP adjustments 42 % 35 % 35 % 33 % Non-GAAP professional services and other gross margin (29) % (29) % (14) % (20) % Reconciliation of income (loss) from operations and operating margin: Three Months Ended October 31, Nine Months Ended October 31, (in thousands) 2020 2019 2020 2019 GAAP loss from operations $ (48,470) $ (43,997) $ (148,958) $ (151,156) Add: Stock-based compensation 80,920 52,736 203,238 150,799 Add: Amortization of acquisition-related intangibles 7,357 4,305 19,032 13,458 Add: Acquisition-related expenses 336 — 7,962 — Add: Employer payroll tax on employee stock transactions $ 8,959 $ 3,844 24,766 13,463 Non-GAAP income from operations $ 49,102 $ 16,888 $ 106,040 $ 26,564 GAAP operating margin (13) % (18) % (15) % (22) % Non-GAAP adjustments 26 % 25 % 25 % 26 % Non-GAAP operating margin 13 % 7 % 10 % 4 % 40 Reconciliation of net income (loss): Three Months Ended October 31, Nine Months Ended October 31, (in thousands, except per share data) 2020 2019 2020 2019 GAAP net loss $ (58,491) $ (46,598) $ (170,855) $ (160,952) Add: Stock-based compensation 80,920 52,736 203,238 150,799 Add: Amortization of acquisition-related intangibles 7,357 4,305 19,032 13,458 Add: Acquisition-related expenses 336 — 7,962 — Add: Employer payroll tax on employee stock transactions 8,959 3,844 24,766 13,463 Add: Amortization of debt discount and issuance costs $ 7,044 $ 6,645 20,828 19,647 Non-GAAP net income $ 46,125 $ 20,932 $ 104,971 $ 36,415 Computation of free cash flow: Three Months Ended October 31, Nine Months Ended October 31, (in thousands) 2020 2019 2020 2019 Net cash provided by operating activities $ 57,443 $ (1,869) $ 234,721 $ 70,191 Less: Purchases of property and equipment (19,393) (12,280) (64,144) (42,071) Non-GAAP free cash flow $ 38,050 $ (14,149) $ 170,577 $ 28,120 Net cash provided by (used in) investing activities $ 9,691 $ (19,067) $ 100,064 $ (350,795) Net cash used in financing activities $ (95,203) $ (6,186) $ (202,435) $ (39,153) Computation of billings: Three Months Ended October 31, Nine Months Ended October 31, (in thousands) 2020 2019 2020 2019 Revenue $ 382,923 $ 249,502 $ 1,022,149 $ 699,076 Add: Contract liabilities and refund liability, end of period 702,691 435,898 702,691 435,898 Less: Contract liabilities and refund liability, beginning of period (638,790) (412,953) (522,201) (390,887) Add: Contract assets and unbilled accounts receivable, beginning of period 20,395 17,757 15,082 13,436 Less: Contract assets and unbilled accounts receivable, end of period (26,808) (20,805) (26,808) (20,805) Add: Contract assets and unbilled accounts receivable by acquisitions — — 6,589 — Less: Contract liabilities and refund liability contributed by acquisitions — — (9,344) — Non-GAAP billings $ 440,411 $ 269,399 $ 1,188,158 $ 736,718 41 ITEM 3. QUALITATIVE AND QUANTITATIVE DISCLOSURES ABOUT MARKET RISK We are exposed to market risks in the ordinary course of our business. Market risk represents the risk of loss that may impact our financial position due to adverse changes in financial market prices and rates. Our market risk exposure is primarily the result of fluctuations in foreign currency exchange and interest rates. Interest Rate Risk As of October 31, 2020, we had cash, cash equivalents and investments totaling $675.4 million, which consisted primarily of bank deposits, money market funds, commercial paper, corporate notes and bonds and U.S. Treasury and government agency securities. Interest-earning instruments carry a degree of interest rate risk. Our investment portfolio is comprised of highly rated securities and limits the amount of credit exposure to any one issuer. A hypothetical 100 basis point increase in interest rates would result in an approximately $1.3 million decrease of the fair value of our investment portfolio as of October 31, 2020 . Such losses would only be realized if we sold the investments prior to maturity. We do not enter into investments for trading or speculative purposes and have not used any derivative financial instruments to manage our interest rate risk exposure. On September 18, 2018, we offered and issued $575.0 million aggregate principal amount of Notes. The Notes have a fixed annual interest rate of 0.5%, and, therefore, we do not have economic interest rate exposure on the Notes. The fair value of the Notes changes when the market price of our stock fluctuates or interest rates change. However, we carry the Notes at face value less unamortized discount on our balance sheet and present the fair value for required disclosure purposes only. Foreign Currency Exchange Risk Our reporting currency is the U.S. dollar, and the functional currency of each of our subsidiaries is either its local currency or the U.S. dollar, depending on the circumstances. The assets and liabilities of each of our subsidiaries are translated into U.S. dollars at exchange rates in effect at each balance sheet date. Operations accounts are translated using the average exchange rate for the relevant period. A strengthening or weakening of the U.S. dollar against the other currencies may negatively or positively affect our operating results as expressed in U.S. dollars. Foreign currency translation adjustments are accounted for as a component of “Accumulated other comprehensive loss” within “Stockholders’ equity.” Gains or losses due to remeasurements of transactions denominated in foreign currencies are included in “Interest and other income, net” in our consolidated statements of operations and comprehensive loss. We have not engaged in the hedging of foreign currency transactions to date, although we may choose to do so in the future. We do not believe that an immediate 10% increase or decrease in the relative value of the U.S. dollar to other currencies would have a material effect on our operating results.