Okta, 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 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 October 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 nine months ended October 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 29 companies and industries, we are 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 primarily 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 30 teams, increased 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 and conversion 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 October 31, Nine Months Ended October 31, 2020 2019 2020 2019 (in thousands) Revenue: Subscription $ 206,743 $ 144,517 $ 571,213 $ 394,174 Professional services and other 10,636 8,520 29,471 24,566 Total revenue 217,379 153,037 600,684 418,740 Cost of revenue: Subscription (1) 44,762 30,124 121,420 82,581 Professional services and other (1) 12,146 10,700 35,121 32,118 Total cost of revenue 56,908 40,824 156,541 114,699 Gross profit 160,471 112,213 444,143 304,041 Operating expenses: Research and development (1) 58,150 41,832 160,510 115,909 Sales and marketing (1) 109,812 87,224 312,177 247,721 General and administrative (1) 44,485 28,887 121,019 81,540 Total operating expenses 212,447 157,943 593,706 445,170 Operating loss (51,976) (45,730) (149,563) (141,129) Interest expense (22,368) (7,826) (50,063) (16,371) Interest income and other, net 1,878 4,982 10,737 11,346 Loss on early extinguishment and conversion of debt (89) (14,572) (2,263) (14,572) Interest and other, net (20,579) (17,416) (41,589) (19,597) Loss before provision for (benefit from) income taxes (72,555) (63,146) (191,152) (160,726) Provision for (benefit from) income taxes 209 349 (626) (2,285) Net loss $ (72,764) $ (63,495) $ (190,526) $ (158,441) (1) Includes stock-based compensation expense as follows: Three Months Ended October 31, Nine Months Ended October 31, 2020 2019 2020 2019 (in thousands) Cost of subscription revenue $ 6,090 $ 3,604 $ 15,229 $ 9,137 Cost of professional services and other revenue 2,113 1,900 5,924 5,292 Research and development 17,546 10,894 44,434 26,322 Sales and marketing 14,368 10,937 38,693 26,959 General and administrative 13,535 8,400 35,494 21,984 Total stock-based compensation expense $ 53,652 $ 35,735 $ 139,774 $ 89,694 32 The following table sets forth our results of operations for the periods presented as a percentage of total revenue: Three Months Ended October 31, Nine Months Ended October 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 19 Professional services and other 6 7 6 8 Total cost of revenue 26 27 26 27 Gross profit 74 73 74 73 Operating expenses Research and development 27 27 27 28 Sales and marketing 51 57 52 59 General and administrative 20 19 20 20 Total operating expenses 98 103 99 107 Operating loss (24) (30) (25) (34) Interest expense (10) (5) (8) (4) Interest income and other, net 1 3 1 3 Loss on early extinguishment and conversion of debt — (9) — (4) Interest and other, net (9) (11) (7) (5) Loss before provision for (benefit from) income taxes (33) (41) (32) (39) Provision for (benefit from) income taxes — — — (1) Net loss (33) % (41) % (32) % (38) % Comparison of the Three Months Ended October 31, 2020 and 2019 Revenue Three Months Ended October 31, 2020 2019 $ Change % Change (dollars in thousands) Revenue: Subscription $ 206,743 $ 144,517 $ 62,226 43 % Professional services and other 10,636 8,520 2,116 25 Total revenue $ 217,379 $ 153,037 $ 64,342 42 % Percentage of revenue: Subscription 95 % 94 % Professional services and other 5 6 Total 100 % 100 % Subscription revenue increased by $62.2 million, or 43%, for the three months ended October 31, 2020 compared to the three months ended October 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 $2.1 million, or 25%, for the three months ended October 31, 2020 compared to the three months ended October 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 October 31, 2020 2019 $ Change % Change (dollars in thousands) Cost of revenue: Subscription $ 44,762 $ 30,124 $ 14,638 49 % Professional services and other 12,146 10,700 1,446 14 Total cost of revenue $ 56,908 $ 40,824 $ 16,084 39 % Gross profit $ 160,471 $ 112,213 $ 48,258 43 % Gross margin: Subscription 78 % 79 % Professional services and other (14) (26) Total gross margin 74 73 Cost of subscription revenue increased by $14.6 million, or 49%, for the three months ended October 31, 2020 compared to the three months ended October 31, 2019, primarily due to an increase of $9.3 million in employee compensation costs related to higher headcount to support the growth in our subscription services, an increase of $2.0 million in software license costs and an increase of $1.8 million in third-party hosting costs as we increased capacity to support our growth. Our gross margin for subscription revenue decreased to 78% for the three months ended October 31, 2020 from 79% during the three months ended October 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 improve over the long-term as we achieve additional economies of scale. Cost of professional services and other revenue increased by $1.4 million, or 14%, for the three months ended October 31, 2020, compared to the three months ended October 31, 2019, due to a number of immaterial changes. Our gross margin for professional services and other revenue improved to (14)% during the three months ended October 31, 2020 from (26)% during the three months ended October 31, 2019, primarily due to increases in professional services and other revenue. Operating Expenses Research and Development Expenses Three Months Ended October 31, 2020 2019 $ Change % Change (dollars in thousands) Research and development $ 58,150 $ 41,832 $ 16,318 39 % Percentage of revenue 27 % 27 % Research and development expenses increased $16.3 million, or 39%, for the three months ended October 31, 2020 compared to the three months ended October 31, 2019. The increase was primarily due to an increase of $14.6 million in employee compensation costs due to higher headcount. 34 Sales and Marketing Expenses Three Months Ended October 31, 2020 2019 $ Change % Change (dollars in thousands) Sales and marketing $ 109,812 $ 87,224 $ 22,588 26 % Percentage of revenue 51 % 57 % Sales and marketing expenses increased $22.6 million, or 26%, for the three months ended October 31, 2020 compared to the three months ended October 31, 2019. The increase was primarily due to an increase of $16.3 million in employee compensation costs related to headcount growth, partially offset by a decrease of $5.1 million in employee-related expenses primarily due to reduced travel-related expenditures resulting from our temporary shift of our sales and marketing activities to a primarily online-only format. Marketing and event costs increased by $8.7 million primarily due to increases in demand generation programs, advertising, brand awareness efforts aimed at acquiring new customers and changes in the timing of expenses incurred for a future event. General and Administrative Expenses Three Months Ended October 31, 2020 2019 $ Change % Change (dollars in thousands) General and administrative $ 44,485 $ 28,887 $ 15,598 54 % Percentage of revenue 20 % 19 % General and administrative expenses increased $15.6 million, or 54%, for the three months ended October 31, 2020 compared to the three months ended October 31, 2019. The increase was primarily due to an increase of $10.4 million in employee compensation costs primarily related to higher headcount to support our continued growth. Interest and Other, Net Three Months Ended October 31, 2020 2019 $ Change % Change (dollars in thousands) Interest expense $ (22,368) $ (7,826) (14,542) 186 % Interest income and other, net 1,878 4,982 (3,104) (62) Loss on early extinguishment and conversion of debt (89) (14,572) 14,483 (99) Interest and other, net $ (20,579) $ (17,416) $ (3,163) 18 % Interest expense increased $14.5 million, or 186%, for the three months ended October 31, 2020 compared to the three months ended October 31, 2019, due to an increase of $4.3 million and $12.4 million for the 2025 Notes and 2026 Notes, respectively, partially offset by a decrease of $2.1 million for the 2023 Notes, due to the 2023 Notes Partial Repurchases. Interest income and other, net decreased $3.1 million, or (62)%, for the three months ended October 31, 2020 compared to the three months ended October 31, 2019, primarily due to lower interest rates, resulting in lower interest income earned on higher cash and cash equivalents and short-term investment balances. We expect interest income earned on our investments to continue to decrease in relation to our overall portfolio balance in fiscal 2021. Loss on early extinguishment and conversion of debt decreased $14.5 million, or 99%, for the three months ended October 31, 2020 compared to the three months ended October 31, 2019 primarily due to the First Partial Repurchase of 2023 Notes in the three months ended October 31, 2019, but not in the three months ended October 31, 2020. 35 Comparison of the Nine Months Ended October 31, 2020 and 2019 Revenue Nine Months Ended October 31, 2020 2019 $ Change % Change (dollars in thousands) Revenue: Subscription $ 571,213 $ 394,174 $ 177,039 45 % Professional services and other 29,471 24,566 4,905 20 Total revenue $ 600,684 $ 418,740 $ 181,944 43 % Percentage of revenue: Subscription 95 % 94 % Professional services and other 5 6 Total 100 % 100 % Subscription revenue increased by $177.0 million, or 45%, for the nine months ended October 31, 2020 compared to the nine months ended October 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 $4.9 million, or 20%, for the nine months ended October 31, 2020 compared to the nine months ended October 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 Nine Months Ended October 31, 2020 2019 $ Change % Change (dollars in thousands) Cost of revenue: Subscription $ 121,420 $ 82,581 $ 38,839 47 % Professional services and other 35,121 32,118 3,003 9 Total cost of revenue $ 156,541 $ 114,699 $ 41,842 36 % Gross profit $ 444,143 $ 304,041 $ 140,102 46 % Gross margin: Subscription 79 % 79 % Professional services and other (19) (31) Total gross margin 74 73 Cost of subscription revenue increased by $38.8 million, or 47%, for the nine months ended October 31, 2020 compared to the nine months ended October 31, 2019, primarily due to an increase of $25.1 million in employee compensation costs related to higher headcount to support the growth in our subscription services, an increase of $4.7 million in software license costs and an increase of $4.3 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 nine months ended October 31, 2020 compared to the nine months ended October 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 improve over the long-term as we achieve additional economies of scale. Cost of professional services and other revenue increased by $3.0 million, or 9%, for the nine months ended October 31, 2020, compared to the nine months ended October 31, 2019, primarily due to an increase of $2.3 million in employee compensation costs related to higher headcount. 36 Our gross margin for professional services and other revenue improved to (19)% during the nine months ended October 31, 2020 from (31)% during the nine months ended October 31, 2019 primarily due to increases in professional services and other revenue. Operating Expenses Research and Development Expenses Nine Months Ended October 31, 2020 2019 $ Change % Change (dollars in thousands) Research and development $ 160,510 $ 115,909 $ 44,601 38 % Percentage of revenue 27 % 28 % Research and development expenses increased $44.6 million, or 38%, for the nine months ended October 31, 2020 compared to the nine months ended October 31, 2019. The increase was primarily due to an increase of $41.5 million in employee compensation costs due to higher headcount. Sales and Marketing Expenses Nine Months Ended October 31, 2020 2019 $ Change % Change (dollars in thousands) Sales and marketing $ 312,177 $ 247,721 $ 64,456 26 % Percentage of revenue 52 % 59 % Sales and marketing expenses increased $64.5 million, or 26%, for the nine months ended October 31, 2020, compared to the nine months ended October 31, 2019. The increase was primarily due to an increase of $53.5 million in employee compensation costs related to headcount growth and an increase of $3.5 million in allocated overhead costs, partially offset by a decrease of $13.6 million in employee-related expenses primarily due to reduced travel-related expenditures resulting from our temporary shift of our sales and marketing activities to a primarily online-only format. Marketing and event costs increased by $19.7 million primarily due to increases in demand generation programs, advertising, brand awareness efforts aimed at acquiring new customers, and a change in the timing of expenses incurred for a future event, partially 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 Nine Months Ended October 31, 2020 2019 $ Change % Change (dollars in thousands) General and administrative $ 121,019 $ 81,540 $ 39,479 48 % Percentage of revenue 20 % 20 % General and administrative expenses increased $39.5 million, or 48%, for the nine months ended October 31, 2020 compared to the nine months ended October 31, 2019. The increase was primarily due to an increase of $30.4 million in employee compensation costs related to higher headcount to support our continued growth partially offset by a $3.4 million decrease in acquisition-related costs. 37 Interest and Other, Net Nine Months Ended October 31, 2020 2019 $ Change % Change (dollars in thousands) Interest expense $ (50,063) $ (16,371) $ (33,692) 206 % Interest income and other, net 10,737 11,346 (609) (5) Loss on early extinguishment and conversion of debt (2,263) (14,572) 12,309 (84) Interest and other, net $ (41,589) $ (19,597) $ (21,992) 112 % Interest expense increased $33.7 million, or 206%, for the nine months ended October 31, 2020 compared to the nine months ended October 31, 2019, primarily related to an increase of $22.8 million and $18.9 million for the 2025 Notes and 2026 Notes, respectively, partially offset by a decrease of $8.0 million for the 2023 Notes, due to the 2023 Notes Partial Repurchases. Loss on early extinguishment and conversion of debt decreased $12.3 million or (84)% for the nine months ended October 31, 2020 compared to the nine months ended October 31, 2019 primarily due to differences in the loss on early extinguishment of debt recognized for the First Partial Repurchase of 2023 Notes in the nine months ended October 31, 2019 compared to the Second Partial Repurchase of 2023 Notes in the nine months ended October 31, 2020. 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 October 31, 2020 2019 (dollars in thousands) Customers with annual contract value (ACV) above $100,000 1,780 1,325 Dollar-based net retention rate for the trailing 12 months ended 123 % 117 % Current remaining performance obligations $ 753,238 $ 515,854 Remaining performance obligations $ 1,581,800 $ 1,031,260 Three Months Ended October 31, Nine Months Ended October 31, 2020 2019 2020 2019 (in thousands) Calculated billings $ 252,359 $ 175,576 $ 659,947 $ 478,535 Total Customers and Number of Customers with Annual Contract Value Above $100,000 As of October 31, 2020, we had over 9,400 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 1,780 and 1,325 as of October 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. 38 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. 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 ACV 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 44% in the three months ended October 31, 2020 over the three months ended October 31, 2019, and increased 38% in the nine months ended October 31, 2020, over the nine months ended October 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 39 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. 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 October 31, Nine Months Ended October 31, 2020 2019 2020 2019 (dollars in thousands) Gross profit $ 160,471 $ 112,213 $ 444,143 $ 304,041 Add: Stock-based compensation expense included in cost of revenue 8,203 5,504 21,153 14,429 Amortization of acquired intangibles 1,593 1,347 4,780 3,895 Non-GAAP gross profit $ 170,267 $ 119,064 $ 470,076 $ 322,365 Gross margin 74 % 73 % 74 % 73 % Non-GAAP gross margin 78 % 78 % 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 October 31, Nine Months Ended October 31, 2020 2019 2020 2019 (dollars in thousands) Operating loss $ (51,976) $ (45,730) $ (149,563) $ (141,129) Add: Stock-based compensation expense 53,652 35,735 139,774 89,694 Non-cash charitable contributions 2,245 510 4,662 1,162 Amortization of acquired intangibles 1,593 1,347 4,780 3,895 Acquisition-related expenses (1) — — — 3,449 Non-GAAP operating income (loss) $ 5,514 $ (8,138) $ (347) $ (42,929) Operating margin (24) % (30) % (25) % (34) % Non-GAAP operating margin 3 % (5) % — % (10) % (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 and conversion of debt. 40 Three Months Ended October 31, Nine Months Ended October 31, 2020 2019 (1) 2020 2019 (1) (dollars in thousands) Net loss $ (72,764) $ (63,495) $ (190,526) $ (158,441) Add: Stock-based compensation expense 53,652 35,735 139,774 89,694 Non-cash charitable contributions 2,245 510 4,662 1,162 Amortization of acquired intangibles 1,593 1,347 4,780 3,895 Acquisition-related expenses (2) — — — 3,449 Amortization of debt discount and debt issuance costs (3) 20,931 7,540 47,261 15,653 Loss on early extinguishment and conversion of debt (4) 89 14,572 2,263 14,572 Non-GAAP net income (loss) $ 5,746 $ (3,791) $ 8,214 $ (30,016) Net margin (33) % (41) % (32) % (38) % Non-GAAP net margin 3 % (2) % 1 % (7) % (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 July 31, 2020. Debt issuance costs included are $0.9 million and $2.3 million for the three and nine months ended October 31, 2020, respectively, and $0.5 million and $1.1 million for the three and nine months ended October 31, 2019, respectively. (4) Loss on early extinguishment and conversion of debt is calculated inclusive of write-offs of debt issuance costs, effective July 31, 2020. The amounts of these write-offs are $0.1 million and $1.1 million for the three and nine months ended October 31, 2020, respectively, and $3.8 million for the three and nine months ended October 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 October 31, Nine Months Ended October 31, 2020 2019 (1) 2020 2019 (1) (dollars in thousands) Net loss $ (72,764) $ (63,495) $ (190,526) $ (158,441) Add: Stock-based compensation expense 53,652 35,735 139,774 89,694 Non-cash charitable contributions 2,245 510 4,662 1,162 Amortization of acquired intangibles 1,593 1,347 4,780 3,895 Acquisition-related expenses (2) — — — 3,449 Amortization of debt discount and debt issuance costs (3) 20,931 7,540 47,261 15,653 Loss on early extinguishment and conversion of debt (4) 89 14,572 2,263 14,572 Non-GAAP net income (loss) $ 5,746 $ (3,791) $ 8,214 $ (30,016) Weighted-average shares used to compute net loss per share, basic and diluted 128,813 118,976 126,222 115,598 Non-GAAP weighted-average effect of potentially dilutive securities 14,579 — 15,714 — Non-GAAP weighted-average shares used to compute non-GAAP net income (loss) per share, diluted 143,392 118,976 141,936 115,598 Net loss per share, basic and diluted $ (0.56) $ (0.53) $ (1.51) $ (1.37) Non-GAAP net income (loss) per share, basic (5) $ 0.04 $ (0.03) $ 0.07 $ (0.26) Non-GAAP net income (loss) per share, diluted (5) $ 0.04 $ (0.03) $ 0.06 $ (0.26) (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 July 31, 2020. Debt issuance costs included are $0.9 million and $2.3 million for the three and nine months ended October 31, 2020, respectively, and $0.5 million and $1.1 million for the three and nine months ended October 31, 2019, respectively. (4) Loss on early extinguishment and conversion of debt is calculated inclusive of write-offs of debt issuance costs, effective July 31, 2020. The amounts of these write-offs are $0.1 million and $1.1 million for the three and nine months ended October 31, 2020, respectively, and $3.8 million for the three and nine months ended October 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 $0.04 and $0.04 for the three and nine months ended October 31, 2019, respectively. 42 Free Cash Flow and Free Cash Flow Margin We define Free Cash Flow as net cash provided by 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 October 31, Nine Months Ended October 31, 2020 2019 2020 2019 (dollars in thousands) Net cash provided by operating activities $ 43,426 $ 10,640 $ 93,053 $ 30,768 Less: Purchases of property and equipment (628) (63) (11,297) (9,980) Capitalization of internal-use software costs (1,204) (1,329) (3,530) (2,659) Free cash flow $ 41,594 $ 9,248 $ 78,226 $ 18,129 Net cash used in investing activities $ (595,621) $ 22,888 $ (1,267,882) $ (125,102) Net cash provided by financing activities $ 5,210 $ 798,399 $ 1,066,457 $ 834,731 Free cash flow margin 19 % 6 % 13 % 4 % 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 October 31, Nine Months Ended October 31, 2020 2019 2020 2019 (in thousands) Total revenue $ 217,379 $ 153,037 $ 600,684 $ 418,740 Add: Deferred revenue (end of period) 432,114 313,756 432,114 313,756 Unbilled receivables (beginning of period) 2,113 1,004 1,026 1,457 Less: Unbilled receivables (end of period) (2,427) (1,028) (2,427) (1,028) Deferred revenue (beginning of period) (396,820) (291,193) (371,450) (254,390) Calculated billings $ 252,359 $ 175,576 $ 659,947 $ 478,535 Liquidity and Capital Resources As of October 31, 2020, our principal sources of liquidity were cash, cash equivalents and short-term investments totaling $2,495.1 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 $15.2 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. Through the nine months ended October 31, 2020, we converted certain 2023 Notes (not in connection with the 2023 Notes Partial Repurchases) and exercised corresponding Note Hedges. In connection with these transactions, we made immaterial cash payments and issued approximately 0.2 million shares of Class A common stock to settle approximately $10.4 million principal amount of 2023 Notes. In addition, we exercised a portion of the Note Hedges, corresponding to approximately $10.4 million principal amount of 2023 Notes, which will be net share settled in our fiscal fourth quarter in accordance with their contractual terms. 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 October 31, 2020, we had deferred revenue of $432.1 million, of which $424.8 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. 44 Cash Flows The following table summarizes our cash flows for the periods indicated: Nine Months Ended October 31, 2020 2019 (in thousands) Net cash provided by operating activities $ 93,053 $ 30,768 Net cash used in investing activities (1,267,882) (125,102) Net cash provided by financing activities 1,066,457 834,731 Effects of changes in foreign currency exchange rates on cash, cash equivalents and restricted cash 121 (241) Net increase (decrease) in cash, cash equivalents and restricted cash $ (108,251) $ 740,156 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 nine months ended October 31, 2020, cash provided by operating activities was $93.1 million primarily due to our net loss of $190.5 million, adjusted for non-cash charges of $248.2 million and net cash inflows of $35.4 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 $60.7 million increase in deferred revenue, a $41.7 million increase in accounts payable, accrued compensation and accrued other expenses and a $14.0 million decrease in operating lease right-of-use assets, partially offset by a $51.8 million increase in deferred commissions, an $11.8 million decrease in operating lease liabilities, a $10.5 million increase in accounts receivable, and a $6.8 million increase in prepaid expenses and other assets. During the nine months ended October 31, 2019, cash provided by operating activities was $30.8 million primarily due to our net loss of $158.4 million, adjusted for non-cash charges of $151.0 million and net cash inflows of $38.2 million provided by changes in our operating assets and liabilities. Non-cash charges primarily consisted of stock-based compensation, loss on early extinguishment and conversion of debt, amortization of deferred commissions, amortization of debt discount and issuance costs, depreciation and amortization of property and equipment and intangible assets, and non-cash charitable contributions, offset by non-cash income from deferred income taxes. The primary drivers of the changes in operating assets and liabilities related to a $58.7 million increase in deferred revenue, a $23.3 million increase in accounts payable, accrued compensation, and accrued other expenses and a $7.9 million decrease in operating lease right-of-use assets, partially offset by a $36.6 million increase in deferred commissions, a $9.4 million increase in accounts receivable, a $4.1 million decrease in operating lease liabilities and a $1.5 million increase in prepaid expenses and other assets. Investing Activities Net cash used in investing activities during the nine months ended October 31, 2020 of $1,267.9 million was primarily attributable to purchases of investments of $1,846.0 million partially offset by proceeds from the sales and maturities of investments of $592.9 million, purchases of property and equipment of $11.3 million to support additional office space and headcount and the capitalization of internal-use software costs of $3.5 million associated with the development of additional features and functionality of our platform. Net cash used in investing activities during the nine months ended October 31, 2019 of $125.1 million was primarily attributable to the purchases of investments of $321.5 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 $10.0 million to support additional office space and headcount, and the capitalization of internal-use software costs of $2.7 million associated with the 45 development of additional features and functionality of our platform. These activities were offset by proceeds from the sales and maturities of investments of $261.7 million. Financing Activities Cash provided by financing activities during the nine months ended October 31, 2020 of $1,066.5 million was primarily attributable to the issuance of 2026 Notes for proceeds of $1,134.8 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 $33.6 million and proceeds from employee purchases under our ESPP of $12.8 million. Cash provided by financing activities during the nine months ended October 31, 2019 of $834.7 million was primarily attributable to the issuance of the 2025 Notes for proceeds of $1,040.8 million, net of issuance costs and proceeds from the termination of Note Hedges of $405.9 million, offset by cash payments for the 2023 Notes Partial Repurchase of $224.4 million, payments for the termination of Warrants of $358.6 million, and the purchase of Capped Calls for the 2025 notes of $74.1 million. Other items impacting cash provided by financing activities include proceeds from the exercise of stock options, net of repurchases, of $36.4 million and proceeds from employee purchases under our ESPP of $9.0 million. 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 October 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 nine months ended October 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