Item 2. Management’s Discussion and Analysis
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 appearing elsewhere in this Quarterly Report on Form 10-Q and our Annual Report on Form 10-K. As discussed in the section titled “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 Part I, Item 1A in our Annual Report on Form 10-K. Our fiscal year ends January 31.
Overview
Okta is the leading independent identity management platform for the enterprise. The Okta Identity Cloud is our category-defining platform that enables our customers to securely connect the right people to the right technologies at the right time. Every day, millions of people use Okta to securely access a wide range of cloud, mobile and web applications, on premise servers, application program interfaces, or APIs, IT infrastructure providers and services from a multitude of devices. Employees and contractors sign into the Okta Identity Cloud to seamlessly and securely access the applications they need to do their most important work. Organizations use our platform to collaborate with their partners, and to provide their customers with more modern experiences online and via mobile devices. Developers leverage our platform to securely and efficiently embed identity into their software, allowing them to focus on their core mission. Our approach to identity allows our customers to simplify and efficiently scale their security infrastructures across internal IT systems and external customer facing applications.
We have rapidly expanded the breadth and depth of the Okta Integration Network, which provides customers with integrations to cloud, mobile and web applications and IT infrastructure providers that spans the functionality of our products. As of July 31, 2020 , we had over 6,500 integrations with these cloud, mobile and web applications and IT infrastructure providers.
We employ a SaaS business model. We focus on acquiring and retaining our customers and increasing their spending with us through expanding the number of users who access our platform and upselling additional products. We sell our products directly through our field and inside sales teams, as well as indirectly through our network of channel partners, including resellers, system integrators and other distribution partners. Our subscription fees include the use of our service and our technical support and management of our platform. We base subscription fees primarily on the products used and the number of users on our platform. The Okta Identity Cloud is used by our customers to manage and secure their employees, contractors and partners, which we refer to as workforce identity. Our platform is also used to manage and secure the identities of an organization's own customers via the powerful APIs we have developed, which we refer to as customer identity. We typically invoice customers in advance in annual installments for subscriptions to our platform.
Impact of Coronavirus (COVID-19) Pandemic
In December 2019, a novel coronavirus (COVID-19) was reported in China, in January 2020, the World Health Organization (WHO) declared it a Public Health Emergency of International Concern and in March 2020, the WHO declared it a pandemic. This contagious disease outbreak has continued to spread across the globe and is impacting worldwide economic activity and financial markets. The extent of the impact of COVID-19 on our future operational and financial performance will depend on certain developments, including the duration and spread of the outbreak, related public health measures, and their impact on the macroeconomy, our current and prospective customers, employees and vendors. None of these impacts can be predicted with certainty.
Our revenue is relatively predictable as a result of our subscription-based business model, which constituted over 95% of total revenue for the three and six months ended July 31, 2020 . Future growth may be impacted by longer sales cycles, which we have experienced, which in turn, could result in delays in deals closing, creating near-term headwinds for cash flow, remaining performance obligations (RPO) and billings growth as well as potential future impacts on revenue growth and other key metrics on a trailing basis. Our allowance for doubtful accounts and sales reserves have increased primarily due to an increase in overall uncertainty in our forecasts of future economic conditions and concession requests. While we see risks associated with more highly impacted companies and industries, we are
29
also seeing new interest from other organizations, driven by rapidly changing work and business environments. As workforces have transitioned to working from home in a distributed model, Zero Trust has become an increasingly important and identity an increasingly critical service.
We believe we will be able to continue to deliver our cloud-based platform and support to our customers, without compromising our employees’ safety. Since March 2020, we have put in place mandatory work-from-home procedures for all of our global office locations, and our employees have the necessary tools and technology to remain connected and productive. In addition, we shifted our annual user conference, Oktane20 Live, to a virtual-only experience, resulting in cost savings. We have further benefited from cost savings, driven by reduced growth in employee compensation costs due to slower hiring, reductions in employee-related expenses as our sales and marketing activities shift to an online only sales format and a shift to work-from-home procedures.
See Risk Factors for further discussion of the potential impact of COVID-19 and its related public health measures on our business.
Components of Results of Operations
Revenue
Subscription Revenue. Subscription revenue primarily consists of fees for access to and usage of our cloud-based platform and related support. Subscription revenue is driven primarily by the number of customers, the number of users per customer and the products used. We typically invoice customers in advance in annual installments for subscriptions to our platform.
Professional Services and Other . Professional services revenue includes fees from assisting customers in implementing and optimizing the use of our products. These services include application configuration, system integration and training services.
We generally invoice customers as the work is performed for time-and-materials arrangements , and up front for fixed fee arrangements. All professional services revenue is recognized as the services are performed.
Overhead Allocation and Employee Compensation Costs
We allocate shared costs, such as facilities (including rent, utilities and depreciation on assets shared by all departments), information technology costs, and recruiting costs to all departments based on headcount. As such, allocated shared costs are reflected in each cost of revenue and operating expense category. Employee compensation costs include salaries, bonuses, benefits and stock-based compensation for each operating expense category and sales commissions for sales and marketing.
Cost of Revenue and Gross Margin
Cost of Subscription . Cost of subscription primarily consists of expenses related to hosting our services and providing support. These expenses include employee-related costs associated with our cloud-based infrastructure and our customer support organization, third-party hosting fees, software and maintenance costs, outside services associated with the delivery of our subscription services, travel-related costs, amortization expense associated with capitalized internal-use software and acquired technology, and allocated overhead.
We intend to continue to invest additional resources in our platform infrastructure and our platform support organizations. As we continue to invest in technology innovation, we anticipate capitalized internal-use software costs and related amortization may increase. We expect our investment in technology to expand the capability of our platform enabling us to improve our gross margin over time. The level and timing of investment in these areas could affect our cost of subscription revenue in the future.
Cost of Professional Services and Other . Cost of professional services consists primarily of employee-related costs for our professional services delivery team, travel-related costs, and costs of outside services associated with supplementing our professional services delivery team. The cost of providing professional services has historically been higher than the associated revenue we generate.
Gross Margin . Gross margin is gross profit expressed as a percentage of total revenue. Our gross margin may fluctuate from period to period as our revenue fluctuates, and as a result of the timing and amount of investments to expand our hosting capacity, our continued efforts to build platform support and professional services teams, increased
30
stock-based compensation expenses, as well as the amortization of costs associated with capitalized internal-use software and acquired intangible assets.
Operating Expenses
Research and Development. Research and development expenses consist primarily of employee compensation costs and allocated overhead. We believe that continued investment in our platform is important for our growth. We expect our research and development expenses will increase in absolute dollars as our business grows.
Sales and Marketing. Sales and marketing expenses consist primarily of employee compensation costs, costs of general marketing activities and promotional activities, travel-related expenses and allocated overhead. Commissions earned by our sales force that are considered incremental and recoverable costs of obtaining a contract with a customer are deferred and then amortized on a straight-line basis over a period of benefit that we have determined to be generally five years. We expect our sales and marketing expenses will increase in absolute dollars and continue to be our largest operating expense category for the foreseeable future as we expand our sales and marketing efforts. However, we expect our sales and marketing expenses to decrease as a percentage of our total revenue as our total revenue grows.
General and Administrative. General and administrative expenses consist primarily of employee compensation costs for finance, accounting, legal and human resources personnel. In addition, general and administrative expenses include non-personnel costs, such as legal, accounting and other professional fees, charitable contributions, and all other supporting corporate expenses not allocated to other departments. We expect our general and administrative expenses will increase in absolute dollars as our business grows.
Interest and Other, Net
Interest and other, net consists of interest expense, which primarily includes amortization of debt discount and issuance costs and contractual interest expense for our Notes, interest income from our investment holdings and loss on early extinguishment of debt.
Provision for (Benefit from) Income Taxes
Our provision for (benefit from) income taxes consists of federal and state income taxes in the United States and income taxes in certain foreign jurisdictions, and is determined for interim periods using an estimate of our annual effective tax rate, adjusted for discrete items occurring in the quarter. The primary difference between our effective tax rate and the federal statutory rate relates to the net operating losses in jurisdictions with a valuation allowance against related deferred tax assets .
31
Results of Operations
The following table sets forth our results of operations for the periods presented in dollars:
Three Months Ended July 31,
Six Months Ended July 31,
2020
2019
2020
2019
(in thousands)
Revenue:
Subscription
$
190,689
$
132,494
$
364,470
$
249,657
Professional services and other
9,757
7,986
18,835
16,046
Total revenue
200,446
140,480
383,305
265,703
Cost of revenue:
Subscription (1)
39,501
27,917
76,658
52,457
Professional services and other (1)
11,646
10,863
22,975
21,418
Total cost of revenue
51,147
38,780
99,633
73,875
Gross profit
149,299
101,700
283,672
191,828
Operating expenses:
Research and development (1)
53,866
40,045
102,360
74,077
Sales and marketing (1)
98,322
78,385
202,365
160,497
General and administrative (1)
42,499
26,887
76,534
52,653
Total operating expenses
194,687
145,317
381,259
287,227
Operating loss
(45,388
)
(43,617
)
(97,587
)
(95,399
)
Interest expense
(16,931
)
(4,304
)
(27,695
)
(8,545
)
Interest income and other, net
3,960
3,464
8,859
6,364
Loss on early extinguishment of debt
(2,174
)
—
(2,174
)
—
Interest and other, net
(15,145
)
(840
)
(21,010
)
(2,181
)
Loss before benefit from income taxes
(60,533
)
(44,457
)
(118,597
)
(97,580
)
Benefit from income taxes
(433
)
(1,477
)
(835
)
(2,634
)
Net loss
$
(60,100
)
$
(42,980
)
$
(117,762
)
$
(94,946
)
(1)
Includes stock-based compensation expense as follows:
Three Months Ended July 31,
Six Months Ended July 31,
2020
2019
2020
2019
(in thousands)
Cost of subscription revenue
$
5,164
$
3,111
$
9,139
$
5,533
Cost of professional services and other revenue
2,000
1,873
3,811
3,392
Research and development
14,953
9,082
26,888
15,428
Sales and marketing
13,165
9,236
24,325
16,022
General and administrative
13,112
7,972
21,959
13,584
Total stock-based compensation expense
$
48,394
$
31,274
$
86,122
$
53,959
32
The following table sets forth our results of operations for the periods presented as a percentage of total revenue:
Three Months Ended July 31,
Six Months Ended July 31,
2020
2019
2020
2019
Revenue
Subscription
95
%
94
%
95
%
94
%
Professional services and other
5
6
5
6
Total revenue
100
100
100
100
Cost of revenue
Subscription
20
20
20
20
Professional services and other
6
8
6
8
Total cost of revenue
26
28
26
28
Gross profit
74
72
74
72
Operating expenses
Research and development
27
28
27
28
Sales and marketing
49
56
52
60
General and administrative
21
19
20
20
Total operating expenses
97
103
99
108
Operating loss
(23
)
(31
)
(25
)
(36
)
Interest expense
(8
)
(3
)
(7
)
(3
)
Interest income and other, net
2
2
2
2
Loss on early extinguishment of debt
(1
)
—
(1
)
—
Interest and other, net
(7
)
(1
)
(6
)
(1
)
Loss before benefit from income taxes
(30
)
(32
)
(31
)
(37
)
Benefit from income taxes
—
(1
)
—
(1
)
Net loss
(30
)%
(31
)%
(31
)%
(36
)%
Comparison of the Three Months Ended July 31, 2020 and 2019
Revenue
Three Months Ended July 31,
2020
2019
$ Change
% Change
(dollars in thousands)
Revenue:
Subscription
$
190,689
$
132,494
$
58,195
44
%
Professional services and other
9,757
7,986
1,771
22
Total revenue
$
200,446
$
140,480
$
59,966
43
%
Percentage of revenue:
Subscription
95
%
94
%
Professional services and other
5
6
Total
100
%
100
%
Subscription revenue increased by $58.2 million , or 44% , for the three months ended July 31, 2020 compared to the three months ended July 31, 2019 . The increase was primarily due to the addition of new customers as well as an increase in users and sales of additional products to existing customers.
33
Professional services and other revenue increased by $1.8 million , or 22% , for the three months ended July 31, 2020 compared to the three months ended July 31, 2019 . The increase in professional services revenue was primarily related to an increase in implementation and other services associated with an increase in the number of new customers purchasing our subscription services.
Cost of Revenue, Gross Profit and Gross Margin
Three Months Ended July 31,
2020
2019
$ Change
% Change
(dollars in thousands)
Cost of revenue:
Subscription
$
39,501
$
27,917
$
11,584
41
%
Professional services and other
11,646
10,863
783
7
Total cost of revenue
$
51,147
$
38,780
$
12,367
32
%
Gross profit
$
149,299
$
101,700
$
47,599
47
%
Gross margin:
Subscription
79
%
79
%
Professional services and other
(19
)
(36
)
Total gross margin
74
72
Cost of subscription revenue increased by $11.6 million , or 41% , for the three months ended July 31, 2020 compared to the three months ended July 31, 2019 , primarily due to an increase of $8.1 million in employee compensation costs related to higher headcount to support the growth in our subscription services, an increase of $1.5 million in software license costs and an increase of $1.1 million in third-party hosting costs as we increased capacity to support our growth.
Our gross margin for subscription revenue remained consistent at 79% for the three months ended July 31, 2020 compared to the three months ended July 31, 2019 . While our gross margins for subscription revenue may fluctuate in the near-term as we invest in our growth, we expect our subscription revenue gross margin to increase over time as we achieve additional economies of scale.
Cost of professional services and other revenue increased by $0.8 million , or 7 %, for the three months ended July 31, 2020 , compared to the three months ended July 31, 2019 , due to a number of immaterial changes.
Our gross margin for professional services and other revenue improved to (19)% during the three months ended July 31, 2020 from (36)% during the three months ended July 31, 2019 , primarily due to increases in professional services and other revenue.
Operating Expenses
Research and Development Expenses
Three Months Ended July 31,
2020
2019
$ Change
% Change
(dollars in thousands)
Research and development
$
53,866
$
40,045
$
13,821
35
%
Percentage of revenue
27
%
28
%
Research and development expenses increased $13.8 million , or 35% , for the three months ended July 31, 2020 compared to the three months ended July 31, 2019 . The increase was primarily due to an increase of $12.6 million in employee compensation costs due to higher headcount.
34
Sales and Marketing Expenses
Three Months Ended July 31,
2020
2019
$ Change
% Change
(dollars in thousands)
Sales and marketing
$
98,322
$
78,385
$
19,937
25
%
Percentage of revenue
49
%
56
%
Sales and marketing expenses increased $19.9 million , or 25% , for the three months ended July 31, 2020 compared to the three months ended July 31, 2019 . The increase was primarily due to an increase of $17.1 million in employee compensation costs related to headcount growth, offset by a decrease of $5.0 million in employee-related expenses primarily due to reduced travel-related expenditures resulting from our temporary shift to an online only sales format. Marketing and event costs increased by $3.5 million primarily due to increases in demand generation programs, advertising and brand awareness efforts aimed at acquiring new customers.
General and Administrative Expenses
Three Months Ended July 31,
2020
2019
$ Change
% Change
(dollars in thousands)
General and administrative
$
42,499
$
26,887
$
15,612
58
%
Percentage of revenue
21
%
19
%
General and administrative expenses increased $15.6 million , or 58% , for the three months ended July 31, 2020 compared to the three months ended July 31, 2019 . The increase was primarily due to an increase of $11.3 million in employee compensation costs primarily related to higher headcount to support our continued growth.
Interest and Other, Net
Three Months Ended July 31,
2020
2019
$ Change
% Change
(dollars in thousands)
Interest expense
$
(16,931
)
$
(4,304
)
(12,627
)
293
%
Interest income and other, net
3,960
3,464
496
14
Loss on early extinguishment of debt
(2,174
)
—
(2,174
)
—
Interest and other, net
$
(15,145
)
$
(840
)
$
(14,305
)
1,703
%
Interest expense increased $12.6 million , or 293% , for the three months ended July 31, 2020 compared to the three months ended July 31, 2019 , due to an increase of $9.3 million and $6.5 million for the 2025 Notes and 2026 Notes, respectively, offset by a decrease of $3.2 million for the 2023 Notes, due to the 2023 Notes Partial Repurchases.
Loss on early extinguishment of debt increased $2.2 million for the three months ended July 31, 2020 compared to the three months ended July 31, 2019 due to the Second Partial Repurchase of 2023 Notes.
35
Comparison of the Six Months Ended July 31, 2020 and 2019
Revenue
Six Months Ended July 31,
2020
2019
$ Change
% Change
(dollars in thousands)
Revenue:
Subscription
$
364,470
$
249,657
$
114,813
46
%
Professional services and other
18,835
16,046
2,789
17
Total revenue
$
383,305
$
265,703
$
117,602
44
%
Percentage of revenue:
Subscription
95
%
94
%
Professional services and other
5
6
Total
100
%
100
%
Subscription revenue increased by $114.8 million , or 46% , for the six months ended July 31, 2020 compared to the six months ended July 31, 2019 . The increase was primarily due to the addition of new customers as well as an increase in users and sales of additional products to existing customers.
Professional services and other revenue increased by $2.8 million , or 17% , for the six months ended July 31, 2020 compared to the six months ended July 31, 2019 . The increase in professional services revenue was primarily related to an increase in implementation and other services associated with an increase in the number of new customers purchasing our subscription services.
Cost of Revenue, Gross Profit and Gross Margin
Six Months Ended July 31,
2020
2019
$ Change
% Change
(dollars in thousands)
Cost of revenue:
Subscription
$
76,658
$
52,457
$
24,201
46
%
Professional services and other
22,975
21,418
1,557
7
Total cost of revenue
$
99,633
$
73,875
$
25,758
35
%
Gross profit
$
283,672
$
191,828
$
91,844
48
%
Gross margin:
Subscription
79
%
79
%
Professional services and other
(22
)
(33
)
Total gross margin
74
72
Cost of subscription revenue increased by $24.2 million , or 46% , for the six months ended July 31, 2020 compared to the six months ended July 31, 2019 , primarily due to an increase of $15.8 million in employee compensation costs related to higher headcount to support the growth in our subscription services, an increase of $2.7 million in software license costs and an increase of $2.5 million in third-party hosting costs as we increased capacity to support our growth.
Our gross margin for subscription revenue remained consistent at 79% during the six months ended July 31, 2020 compared to the six months ended July 31, 2019 . While our gross margins for subscription revenue may fluctuate in the near-term as we invest in our growth, we expect our subscription revenue gross margin to increase over time as we achieve additional economies of scale.
Cost of professional services and other revenue increased by $1.6 million , or 7% , for the six months ended July 31, 2020 , compared to the six months ended July 31, 2019 , primarily due to an increase of $1.2 million in employee compensation costs related to higher headcount.
Our gross margin for professional services and other revenue improved to (22) % during the six months ended July 31, 2020 from (33)% during the six months ended July 31, 2019 primarily due to increases in professional services and other revenue.
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Operating Expenses
Research and Development Expenses
Six Months Ended July 31,
2020
2019
$ Change
% Change
(dollars in thousands)
Research and development
$
102,360
$
74,077
$
28,283
38
%
Percentage of revenue
27
%
28
%
Research and development expenses increased $28.3 million , or 38% , for the six months ended July 31, 2020 compared to the six months ended July 31, 2019 . The increase was primarily due to an increase of $26.8 million in employee compensation costs due to higher headcount.
Sales and Marketing Expenses
Six Months Ended July 31,
2020
2019
$ Change
% Change
(dollars in thousands)
Sales and marketing
$
202,365
$
160,497
$
41,868
26
%
Percentage of revenue
52
%
60
%
Sales and marketing expenses increased $41.9 million , or 26% , for the six months ended July 31, 2020 , compared to the six months ended July 31, 2019 . The increase was primarily due to an increase of $37.2 million in employee compensation costs related to headcount growth and an increase of $2.4 million in allocated overhead costs, offset by a decrease of $8.4 million in employee-related expenses primarily due to reduced travel-related expenditures resulting from our temporary shift to an online only sales format. Marketing and event costs increased by $11.0 million primarily due to increases in demand generation programs, advertising and brand awareness efforts aimed at acquiring new customers, offset by a decrease of $4.9 million due to a change to a virtual format for our annual customer conference in the first quarter of fiscal 2021 compared to an in-person format in the first quarter of fiscal 2020.
General and Administrative Expenses
Six Months Ended July 31,
2020
2019
$ Change
% Change
(dollars in thousands)
General and administrative
$
76,534
$
52,653
$
23,881
45
%
Percentage of revenue
20
%
20
%
General and administrative expenses increased $23.9 million , or 45% , for the six months ended July 31, 2020 compared to the six months ended July 31, 2019 . The increase was primarily due to an increase of $20.0 million in employee compensation costs related to higher headcount to support our continued growth.
Interest and Other, Net
Six Months Ended July 31,
2020
2019
$ Change
% Change
(dollars in thousands)
Interest expense
$
(27,695
)
$
(8,545
)
$
(19,150
)
224
%
Interest income and other, net
8,859
6,364
2,495
39
Loss on early extinguishment of debt
(2,174
)
—
(2,174
)
—
Interest and other, net
$
(21,010
)
$
(2,181
)
$
(18,829
)
863
%
Interest expense increased $19.2 million , or 224% , for the six months ended July 31, 2020 compared to the six months ended July 31, 2019 , primarily related to an increase of $18.5 million and $6.5 million for the 2025 Notes and
37
2026 Notes, respectively, offset by a decrease of $5.9 million for the 2023 Notes, due to the 2023 Notes Partial Repurchases.
Interest income and other, net increased $2.5 million , or 39% , for the six months ended July 31, 2020 compared to the six months ended July 31, 2019 , primarily due to interest income earned on higher cash and cash equivalents and short-term investment balances. We expect interest income earned on our investments to decrease in relation to our overall portfolio balance in fiscal 2021 due to decreases in interest rates.
Loss on early extinguishment of debt increased $2.2 million for the six months ended July 31, 2020 compared to the six months ended July 31, 2019 due to the Second Partial Repurchase of 2023 Notes.
Key Business Metrics
We review a number of operating and financial metrics, including the following key metrics, to evaluate our business, measure our performance, identify trends affecting our business, formulate business plans, and make strategic decisions.
As of July 31,
2020
2019
(dollars in thousands)
Customers with annual contract value (ACV) above $100,000
1,685
1,222
Dollar-based net retention rate for the trailing 12 months ended
121
%
118
%
Current remaining performance obligations
$
684,515
$
461,147
Remaining performance obligations
$
1,426,722
$
913,573
Three Months Ended July 31,
Six Months Ended July 31,
2020
2019
2020
2019
(in thousands)
Calculated billings
$
198,083
$
155,764
$
407,588
$
302,959
Total Customers and Number of Customers with Annual Contract Value Above $100,000
As of July 31, 2020 , we had over 8,950 customers on our platform. We believe that our ability to increase the number of customers on our platform is an indicator of our market penetration, the growth of our business, and our potential future business opportunities. Increasing awareness of our platform and capabilities, coupled with the mainstream adoption of cloud technology, has expanded the diversity of our customer base to include organizations of all sizes across all industries. Over time, larger customers have constituted a greater share of our revenue, which has contributed to an increase in average revenue per customer. The number of customers who have greater than $100,000 in annual contract value, or ACV, with us was 1,685 and 1,222 as of July 31, 2020 and 2019 , respectively. We expect this trend to continue as larger enterprises recognize the value of our platform and replace their legacy identity access management, or IAM infrastructure. 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 with us or one of our partners to access our platform.
Dollar-Based Net Retention Rate
Our ability to generate revenue is dependent upon our ability to maintain our relationships with our customers and to increase their utilization of our platform. We believe we can achieve these goals by focusing on delivering value and functionality that enables us to both retain our existing customers and expand the number of users and products used within an existing customer. We assess our performance in this area by measuring our Dollar-Based Net Retention Rate. Our Dollar-Based Net Retention Rate measures our ability to increase revenue across our existing customer base through expansion of users and products associated with a customer as offset by churn and contraction in the number of users and/or products associated with a customer.
38
Our Dollar-Based Net Retention Rate is based upon our ACV which is calculated based on the terms of that customer’s contract and represents the total contracted annual subscription amount as of that period end. We calculate our Dollar-Based Net Retention Rate as of a period end by starting with the ACV from all customers as of twelve months prior to such period end, or Prior Period ACV. We then calculate the ACV from these same customers as of the current period end, or Current Period ACV. Current Period ACV includes any upsells and is net of contraction or churn over the trailing twelve months but excludes revenue from new customers in the current period. We then divide the total Current Period ACV by the total Prior Period ACV to arrive at our Dollar-Based Net Retention Rate.
Our strong Dollar-Based Net Retention Rate is primarily attributable to an expansion of users and upselling additional products within our existing customers. Larger enterprises often implement a limited initial deployment of our platform before increasing their deployment on a broader scale.
Remaining Performance Obligations
Remaining performance obligations, or RPO, represent all future, noncancelable, contracted revenue under our subscription contracts with customers that has not yet been recognized, inclusive of deferred revenue that has been invoiced and noncancelable amounts that will be invoiced and recognized as revenue in future periods. Current RPO represents the portion of RPO expected to be recognized during the next 12 months. RPO fluctuates due to a number of factors, including the timing, duration and dollar amount of customer contracts.
Calculated Billings
Calculated Billings represent our total revenue plus the change in deferred revenue and less the change in unbilled receivables in the period. Calculated Billings in any particular period reflects sales to new customers plus subscription renewals and upsells to existing customers, and represent amounts invoiced for subscription, support and professional services. We typically invoice customers in advance in annual installments for subscriptions to our platform.
Calculated Billings increased 27% in the three months ended July 31, 2020 over the three months ended July 31, 2019 , and increased 35% in the six months ended July 31, 2020 , over the six months ended July 31, 2019 . As our Calculated Billings continue to grow in absolute terms, we expect our Calculated Billings growth rate to trend down over time.
Non-GAAP Financial Measures
In addition to our results determined in accordance with U.S. generally accepted accounting principles, or GAAP, we believe the following non-GAAP measures are useful in evaluating our operating performance . We use the below referenced non-GAAP financial information, collectively, to evaluate our ongoing operations and for internal planning and forecasting purposes. We believe that non-GAAP financial information, when taken collectively with GAAP financial measures, may be helpful to investors because it provides consistency and comparability with past financial performance, and assists in comparisons with other companies, some of which use similar non-GAAP financial information to supplement their GAAP results. The non-GAAP financial information is presented for supplemental informational purposes only, and should not be considered a substitute for financial information presented in accordance with GAAP, and may be different from similarly-titled non-GAAP measures used by other companies. The principal limitation of these non-GAAP financial measures is that they exclude significant expenses that are required by GAAP to be recorded in our financial statements. In addition, they are subject to inherent limitations as they reflect the exercise of judgment by our management about which expenses are excluded or included in determining these non-GAAP financial measures. A reconciliation is provided below for each non-GAAP financial measure to the most directly comparable financial measure stated in accordance with GAAP. Investors are encouraged to review the related GAAP financial measures and the reconciliation of these non-GAAP financial measures to their most directly comparable GAAP financial measures, and not to rely on any single financial measure to evaluate our business.
39
Non-GAAP Gross Profit and Non-GAAP Gross Margin
We define non-GAAP gross profit and non-GAAP gross margin as GAAP gross profit and GAAP gross margin, adjusted for stock-based compensation expense and amortization of acquired intangibles.
Three Months Ended July 31,
Six Months Ended July 31,
2020
2019
2020
2019
(dollars in thousands)
Gross profit
$
149,299
$
101,700
$
283,672
$
191,828
Add:
Stock-based compensation expense included in cost of revenue
7,164
4,984
12,950
8,925
Amortization of acquired intangibles
1,594
1,785
3,187
2,548
Non-GAAP gross profit
$
158,057
$
108,469
$
299,809
$
203,301
Gross margin
74
%
72
%
74
%
72
%
Non-GAAP gross margin
79
%
77
%
78
%
77
%
Non-GAAP Operating Income (Loss) and Non-GAAP Operating Margin
We define non-GAAP operating income (loss) and non-GAAP operating margin as GAAP operating loss and GAAP operating margin, adjusted for stock-based compensation expense, non-cash charitable contributions, amortization of acquired intangibles and acquisition-related expenses.
Three Months Ended July 31,
Six Months Ended July 31,
2020
2019
2020
2019
(dollars in thousands)
Operating loss
$
(45,388
)
$
(43,617
)
$
(97,587
)
$
(95,399
)
Add:
Stock-based compensation expense
48,394
31,274
86,122
53,959
Non-cash charitable contributions
1,881
652
2,417
652
Amortization of acquired intangibles
1,594
1,785
3,187
2,548
Acquisition-related expenses (1)
—
—
—
3,449
Non-GAAP operating income (loss)
$
6,481
$
(9,906
)
$
(5,861
)
$
(34,791
)
Operating margin
(23
)%
(31
)%
(25
)%
(36
)%
Non-GAAP operating margin
3
%
(7
)%
(2
)%
(13
)%
(1)
We define acquisition-related expenses as costs associated with acquisitions, including transaction costs and other non-recurring incremental costs incurred.
Non-GAAP Net Income (Loss) and Non-GAAP Net Margin
We define non-GAAP net income (loss) and non-GAAP net margin as GAAP net loss and GAAP net margin, adjusted for stock-based compensation expense, non-cash charitable contributions, amortization of acquired intangibles, acquisition-related expenses, amortization of debt discount and debt issuance costs and loss on early extinguishment of debt.
40
Three Months Ended July 31,
Six Months Ended July 31,
2020
2019 (1)
2020
2019 (1)
(dollars in thousands)
Net loss
$
(60,100
)
$
(42,980
)
$
(117,762
)
$
(94,946
)
Add:
Stock-based compensation expense
48,394
31,274
86,122
53,959
Non-cash charitable contributions
1,881
652
2,417
652
Amortization of acquired intangibles
1,594
1,785
3,187
2,548
Acquisition-related expenses (2)
—
—
—
3,449
Amortization of debt discount and debt issuance costs (3)
15,973
4,088
26,330
8,113
Loss on early extinguishment of debt (4)
2,174
—
2,174
—
Non-GAAP net income (loss)
$
9,916
$
(5,181
)
$
2,468
$
(26,225
)
Net margin
(30
)%
(31
)%
(31
)%
(36
)%
Non-GAAP net margin
5
%
(4
)%
1
%
(10
)%
(1) Prior periods have been adjusted to conform to the current presentation. See footnotes (3) and (4) for additional details.
(2) We define acquisition-related expenses as costs associated with acquisitions, including transaction costs and other non-recurring incremental costs incurred.
(3) Amortization of debt issuance costs is an adjustment to non-GAAP net income (loss), effective the three and six months ended July 31, 2020. Debt issuance costs included are $0.8 million and $1.4 million for the three and six months ended July 31, 2020, respectively, and $0.3 million and $0.6 million for the three and six months ended July 31, 2019, respectively.
(4) Loss on early extinguishment of debt is calculated inclusive of write-offs of debt issuance costs, effective the three and six months ended July 31, 2020. The amounts of these write-offs are $1.0 million for the three and six months ended July 31, 2020, respectively, and nil for the three and six months ended July 31, 2019, respectively.
Non-GAAP Net Income (Loss) per share, basic and diluted
We define non-GAAP net income (loss) per share, basic, as non-GAAP net income (loss) divided by GAAP weighted-average shares used to compute net loss per share, basic and diluted.
We define non-GAAP net income (loss) per share, diluted, as non-GAAP net income (loss) divided by GAAP weighted-average shares used to compute net loss per share, basic and diluted adjusted for the potentially dilutive effect of (i) employee equity incentive plans, excluding the impact of unrecognized stock-based compensation expense, and (ii) convertible senior notes outstanding and related warrants. In addition, non-GAAP net income (loss) per share, diluted, includes the anti-dilutive impact of the Company’s note hedge and capped call agreements on convertible senior notes outstanding, which fully reduced the potential dilutive effect of the convertible senior notes outstanding. Accordingly, the Company did not record any adjustments to non-GAAP net income (loss) for the potential impact of the convertible senior notes outstanding under the if-converted method.
41
Three Months Ended July 31,
Six Months Ended July 31,
2020
2019 (1)
2020
2019 (1)
(dollars in thousands)
Net loss
$
(60,100
)
$
(42,980
)
$
(117,762
)
$
(94,946
)
Add:
Stock-based compensation expense
48,394
31,274
86,122
53,959
Non-cash charitable contributions
1,881
652
2,417
652
Amortization of acquired intangibles
1,594
1,785
3,187
2,548
Acquisition-related expenses (2)
—
—
—
3,449
Amortization of debt discount and debt issuance costs (3)
15,973
4,088
26,330
8,113
Loss on early extinguishment of debt (4)
2,174
—
2,174
—
Non-GAAP net income (loss)
$
9,916
$
(5,181
)
$
2,468
$
(26,225
)
Weighted-average shares used to compute net loss per share, basic and diluted
126,319
115,033
124,922
114,042
Non-GAAP weighted-average effect of potentially dilutive securities
15,936
—
16,281
—
Non-GAAP weighted-average shares used to compute non-GAAP net income (loss) per share, diluted
142,255
115,033
141,203
114,042
Net loss per share, basic and diluted
$
(0.48
)
$
(0.37
)
$
(0.94
)
$
(0.83
)
Non-GAAP net income (loss) per share, basic (5)
$
0.08
$
(0.05
)
$
0.02
$
(0.23
)
Non-GAAP net income (loss) per share, diluted (5)
$
0.07
$
(0.05
)
$
0.02
$
(0.23
)
(1) Prior periods have been adjusted to conform to the current presentation. See footnotes (3), (4) and (5) for additional details.
(2) We define acquisition-related expenses as costs associated with acquisitions, including transaction costs and other non-recurring incremental costs incurred.
(3) Amortization of debt issuance costs is an adjustment to non-GAAP net income (loss), effective the three and six months ended July 31, 2020. Debt issuance costs included are $0.8 million and $1.4 million for the three and six months ended July 31, 2020, respectively, and $0.3 million and $0.6 million for the three and six months ended July 31, 2019, respectively.
(4) Loss on early extinguishment of debt is calculated inclusive of write-offs of debt issuance costs, effective the three and six months ended July 31, 2020. The amounts of these write-offs are $1.0 million for the three and six months ended July 31, 2020, respectively, and nil for the three and six months ended July 31, 2019, respectively.
(5) The total impact of the adjustments noted in footnotes (3) and (4) and for the periods noted in footnote (1) above on non-GAAP net income (loss) per share, basic and diluted is nil and $0.01 for the three and six months ended July 31, 2019, respectively.
42
Free Cash Flow and Free Cash Flow Margin
We define Free Cash Flow as net cash provided by (used in) operating activities, less cash used for purchases of property and equipment, net of sales proceeds, and capitalized internal-use software costs. Free cash flow margin is calculated as free cash flow divided by total revenue.
Three Months Ended July 31,
Six Months Ended July 31,
2020
2019
2020
2019
(dollars in thousands)
Net cash provided by (used in) operating activities
$
10,930
$
(1,134
)
$
49,627
$
20,128
Less:
Purchases of property and equipment
(2,739
)
(2,207
)
(10,669
)
(9,917
)
Capitalization of internal-use software costs
(1,326
)
(961
)
(2,326
)
(1,330
)
Free cash flow
$
6,865
$
(4,302
)
$
36,632
$
8,881
Net cash used in investing activities
$
(722,865
)
$
(22,383
)
$
(672,261
)
$
(147,990
)
Net cash provided by financing activities
$
1,047,080
$
23,070
$
1,061,247
$
36,332
Free cash flow margin
3
%
(3
)%
10
%
3
%
Calculated Billings
We define Calculated Billings as total revenue plus the change in deferred revenue and less the change in unbilled receivables during the period.
Three Months Ended July 31,
Six Months Ended July 31,
2020
2019
2020
2019
(in thousands)
Total revenue
$
200,446
$
140,480
$
383,305
$
265,703
Add:
Deferred revenue (end of period)
396,820
291,193
396,820
291,193
Unbilled receivables (beginning of period)
1,121
799
1,026
1,457
Less:
Unbilled receivables (end of period)
(2,113
)
(1,004
)
(2,113
)
(1,004
)
Deferred revenue (beginning of period)
(398,191
)
(275,704
)
(371,450
)
(254,390
)
Calculated billings
$
198,083
$
155,764
$
407,588
$
302,959
Liquidity and Capital Resources
As of July 31, 2020 , our principal sources of liquidity were cash, cash equivalents and short-term investments totaling $2,514.5 million , which were held for working capital purposes. Our cash equivalents and investments consisted primarily of U.S. treasury securities, money market funds and corporate debt securities. Historically, we have generated significant operating losses and both positive and negative cash flows from operations as reflected in our accumulated deficit and condensed consolidated statements of cash flows. We expect to continue to incur operating losses and cash flows from operations that may fluctuate between positive and negative amounts for the foreseeable future.
In February 2018, we completed our private offering of the 2023 Notes and received aggregate proceeds of $345.0 million , before deducting costs of issuance of $10.0 million . In connection with the issuance of the 2023 Notes, we entered into convertible Note Hedges with respect to our Class A common stock. We used an aggregate amount of $80.0 million of the net proceeds from the sale of the 2023 Notes to purchase the Note Hedges. The cost of the Note Hedges was partially offset by proceeds of $52.4 million from the sale of warrants to purchase shares of our Class A common stock in connection with the issuance of the 2023 Notes.
43
In September 2019, we completed our private offering of the 2025 Notes and received aggregate proceeds of $1,060.0 million , before deducting issuance costs of approximately $19.3 million . In connection with the 2025 Notes, we entered into Capped Call transactions with respect to our Class A common stock. We used an aggregate amount of $74.1 million of the net proceeds from the sale of the 2025 Notes to purchase the 2025 Capped Calls.
Concurrent with the private offering of the 2025 Notes, we repurchased $224.4 million principal amount of the 2023 Notes in privately-negotiated transactions for aggregate consideration of $604.8 million , including approximately $224.4 million in cash and approximately 3.0 million shares of Class A common stock. We also terminated a portion of our existing Note Hedges and Warrants in amounts corresponding to the principal amount of the First Partial Repurchase of 2023 Notes for net proceeds of $47.2 million .
In June 2020, we completed our private offering of the 2026 Notes and received aggregate proceeds of $1,150.0 million , before deducting issuance costs of approximately $15.1 million . In connection with the 2026 Notes, we entered into Capped Call transactions with respect to our Class A common stock. We used an aggregate amount of $134.0 million of the net proceeds from the sale of the 2026 Notes to purchase the 2026 Capped Calls.
Concurrent with the private offering of the 2026 Notes, we repurchased $69.9 million principal amount of the 2023 Notes in privately-negotiated transactions for aggregate consideration of $260.5 million , including approximately 1.4 million shares of Class A common stock and $0.2 million in cash. We also terminated a portion of our existing Note Hedges and Warrants in amounts corresponding to the principal amount of the Second Partial Repurchase of 2023 Notes for net proceeds of $19.6 million .
While the potential impacts of the COVID-19 pandemic may create near-term headwinds for cash flow caused by factors such as delays in customer payments and delays in deals closing, we believe our existing cash and cash equivalents, our short-term investments and cash provided by sales of our products and services will be sufficient to meet our working capital and capital expenditure needs for at least the next 12 months. Our future capital requirements will depend on many factors, including our subscription growth rate, subscription renewal activity, billing frequency, the timing and extent of spending to support development efforts, the expansion of sales and marketing activities, the expansion of our international operations, the introduction of new and enhanced product offerings, and the continuing market adoption of our platform. We continue to assess our capital structure and evaluate the merits of deploying available cash. We may in the future enter into arrangements to acquire or invest in complementary businesses, services and technologies, including 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 or generate cash flows necessary to expand our operations and invest in new technologies this could reduce our ability to compete successfully and harm our results of operations.
A significant majority of our customers pay in advance for annual subscriptions. Therefore, a substantial source of our cash is from our deferred revenue, which is included on our condensed consolidated balance sheet as a liability. Deferred revenue consists of the unearned portion of billed fees for our subscriptions, which is recognized as revenue in accordance with our revenue recognition policy. As of July 31, 2020 , we had deferred revenue of $396.8 million , of which $391.2 million was recorded as a current liability and is expected to be recorded as revenue in the next 12 months, provided all other revenue recognition criteria have been met.
Cash Flows
The following table summarizes our cash flows for the periods indicated:
Six Months Ended July 31,
2020
2019
(in thousands)
Net cash provided by operating activities
$
49,627
$
20,128
Net cash used in investing activities
(672,261
)
(147,990
)
Net cash provided by financing activities
1,061,247
36,332
Effects of changes in foreign currency exchange rates on cash, cash equivalents and restricted cash
578
(1,187
)
Net increase (decrease) in cash, cash equivalents and restricted cash
$
439,191
$
(92,717
)
44
Operating Activities
Our largest source of operating cash is cash collections from our customers for subscription and professional services. Our primary uses of cash from operating activities are for employee-related expenditures, marketing expenses and third-party hosting costs. In recent periods, we have supplemented working capital requirements through net proceeds from the issuance of the 2023, 2025 and 2026 Notes in February 2018, September 2019 and June 2020, respectively, and from our IPO in April 2017.
During the six months ended July 31, 2020 , cash provided by operating activities was $49.6 million primarily due to our net loss of $117.8 million , adjusted for non-cash charges of $147.3 million and net cash inflows of $20.1 million provided by changes in our operating assets and liabilities. Non-cash charges primarily consisted of stock-based compensation, amortization of debt discount and issuance costs, amortization of deferred commissions and depreciation, amortization and accretion of property and equipment, intangible assets and short-term investments. The primary drivers of the changes in operating assets and liabilities related to a $25.4 million increase in deferred revenue, a $18.6 million decrease in accounts receivable, a $15.9 million increase in accounts payable and accrued compensation and a $9.0 million decrease in operating lease right-of-use assets, partially offset by a $30.3 million increase in deferred commissions, a $7.7 million decrease in operating lease liabilities, a $7.6 million increase in prepaid expenses and other assets and a $3.1 million decrease in accrued expenses and other liabilities.
During the six months ended July 31, 2019, cash provided by operating activities was $20.1 million primarily due to our net loss of $94.9 million, adjusted for non-cash charges of $80.9 million and net cash inflows of $34.2 million provided by changes in our operating assets and liabilities. Non-cash charges primarily consisted of stock-based compensation, amortization of debt discount and issuance costs, amortization of deferred commissions and depreciation and amortization of property and equipment and intangible assets, offset by non-cash income from deferred income taxes. The primary drivers of the changes in operating assets and liabilities related to a $36.2 million increase in deferred revenue, a $7.4 million increase in accounts payable, accrued compensation, and accrued other expenses, a $4.5 million decrease in accounts receivable, a $1.5 million decrease in prepaid expenses and other assets and a $6.2 million decrease in operating lease right-of-use assets, partially offset by a $21.4 million increase in deferred commissions.
Investing Activities
Net cash used in investing activities during the six months ended July 31, 2020 of $672.3 million was primarily attributable to purchases of investments of $1,029.3 million partially offset by proceeds from the sales and maturities of investments of $370.0 million , purchases of property and equipment of $10.7 million to support additional office space and headcount and the capitalization of internal-use software costs of $2.3 million associated with the development of additional features and functionality of our platform.
Net cash used in investing activities during the six months ended July 31, 2019 of $148.0 million was primarily attributable to the purchases of investments of $237.7 million, payment of $44.2 million, net of cash acquired, in connection with our Azuqua acquisition, payment of $8.5 million in connection with the purchase of developed technology intangible assets, purchases of property and equipment of $9.9 million to support additional office space and headcount, and the capitalization of internal-use software costs of $1.3 million associated with the development of additional features and functionality of our platform. These activities were offset by proceeds from the sales and maturities of investments of $153.7 million.
Financing Activities
Cash provided by financing activities during the six months ended July 31, 2020 of $1,061.2 million was primarily attributable to the issuance of 2026 Notes for proceeds of $1,135.4 million , net of issuance costs and proceeds from the termination of existing Note Hedges of $195.0 million , offset by payments for the termination of existing Warrants of $175.4 million and the purchase of 2026 Capped Calls of $134.0 million . Other items impacting cash provided by financing activities include proceeds from the exercise of stock options of $27.5 million and proceeds from employee purchases under our ESPP of $12.8 million .
Cash provided by financing activities during the six months ended July 31, 2019 of $36.3 million was primarily attributable to proceeds from the exercise of stock options, net of repurchases, of $27.5 million and proceeds from employee purchases under our ESPP of $9.0 million.
45
Indemnification Agreements
In the ordinary course of business, we enter into agreements of varying scope and terms pursuant to which we agree to indemnify customers, vendors, lessors, business partners and other parties with respect to certain matters, including, but not limited to, losses arising out of the breach of such agreements, services to be provided by us or from intellectual property infringement claims made by third parties. In addition, we have entered into indemnification agreements with our directors and certain officers and employees that will require us, among other things, to indemnify them against certain liabilities that may arise by reason of their status or service as directors, officers or employees. No demands have been made upon us to provide indemnification under such agreements and there are no claims that we are aware of that could have a material effect on our condensed consolidated balance sheets, condensed consolidated statements of operations and comprehensive loss, or condensed consolidated statements of cash flows.
Off-Balance Sheet Arrangements
As of July 31, 2020 , we did not have any relationships with unconsolidated organizations or financial partnerships, such as structured finance or special purpose entities that would have been established for the purpose of facilitating off-balance sheet arrangements or other contractually narrow or limited purposes.
Critical Accounting Policies and Estimates
We prepare our condensed consolidated financial statements in accordance with GAAP. In the preparation of these condensed consolidated financial statements, we are required to make estimates and assumptions that affect the reported amounts of assets, liabilities, revenue, costs and expenses, and related disclosures. To the extent that there are material differences between these estimates and actual results, our financial condition or results of operations would be affected. We base our estimates on past experience and other assumptions that we believe are reasonable under the circumstances, and we evaluate these estimates on an ongoing basis. We refer to accounting estimates of this type as critical accounting policies and estimates, which we discuss below.
Our significant accounting policies are discussed in “Notes to Consolidated Financial Statements - Note 2. Summary of Significant Accounting Policies” in our Form 10-K. There have been no significant changes to these policies for the six months ended July 31, 2020 , except as described in Note 2 to our condensed consolidated financial statements “Accounting Standards and Significant Accounting Policies”.
Recent Accounting Pronouncements
See Note 2 to our condensed consolidated financial statements “Accounting Standards and Significant Accounting Policies” for more information.
46
Text extracted from the filing as submitted to EDGAR. Formatting, tables and exhibits are simplified for reading; the original document is authoritative for anything you rely on.