Okta, Inc. 10-K

Item 7. 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 consolidated financial statements and related notes appearing elsewhere in this Annual Report on Form 10-K. In addition to historical financial information, the following discussion contains forward-looking statements that is based upon current plans, expectations and beliefs that involve risks and uncertainties. Our actual results may differ materially from those anticipated in these forward-looking statements as a result of various factors, including those set forth under the section titled “Risk Factors” under Part I, Item 1A in this 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 powered by our category-defining platform that enables our customers to securely connect the right people to the right technologies and services at the right time. Every day, thousands of organizations and millions of people use Okta to securely access a wide range of cloud, mobile and web applications, on-premises servers, application program interfaces (APIs), IT infrastructure providers and services from a multitude of devices. Developers leverage our platform to securely and efficiently embed identity into the software they build, allowing them to focus on their core mission. 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 and secure experiences online and via mobile devices. Given the growth trends in the number of applications and cloud adoption, and the movement to remote workforces, identity is becoming the most critical layer of an organization’s security. Our approach to identity allows our customers to simplify and efficiently scale their security infrastructures across internal IT systems and external customer facing applications. As of January 31, 2021, more than 10,000 customers across nearly every industry used the Okta Identity Cloud to secure and manage identities around the world. Our customers consist of leading global organizations ranging from the largest enterprises, to small and medium-sized businesses, universities, non-profits and government agencies. We also partner with leading application, infrastructure and security vendors through our Okta Integration Network. As of January 31, 2021, we had over 7,000 integrations with these cloud, mobile and web applications and IT infrastructure providers. We employ a Software-as-a-Service (SaaS) business model, and generate revenue primarily by selling multi-year subscriptions to our cloud-based offerings. We focus on acquiring and retaining our customers and increasing their spending with us through expanding the number of users who access the Okta Identity Cloud and up-selling 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. 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 year ended January 31, 2021. 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 53 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 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 security model 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 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, and in the near-term, we have changed our customer, employee and industry events, including Oktane21 Live, to virtual-only format. 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. Proposed Acquisition of Auth0 On March 3, 2021, we entered into a definitive agreement to acquire Auth0, Inc. (Auth0) pursuant to an Agreement and Plan of Merger (the Merger Agreement). Upon consummation of the transaction contemplated by the Merger Agreement, all outstanding shares of Auth0 capital stock, options, warrants, convertible securities, phantom equity and other outstanding equity interests will be cancelled in exchange for aggregate consideration of $6.5 billion in the form of shares of Class A common stock of the Company and assumed awards of corresponding Company equity interests, subject to customary purchase price adjustments and certain customary cash payouts in lieu of shares of Company Class A common stock, as provided by the Merger Agreement. The purchase price payable in shares of Class A common stock will be valued at $276.2147 per share (which price was calculated based on the daily volume-weighted average sales price per share of Company Class A common stock for the 20 trading days ending on February 26, 2021). The per share price of these shares has been fixed as of the Merger Agreement signing date, and the aggregate value of these shares will fluctuate based on changes in our share price between the signing and closing dates. The proposed transaction is expected to close during the Company’s second quarter of fiscal 2022, the quarter ending July 31, 2021. The closing of this transaction is subject to certain customary closing conditions and approvals. If consummated, the acquisition of Auth0 may have a significant impact on our liquidity, financial condition and results of operations. The following discussion and analysis of our results of operations and our liquidity and capital resources focuses on our existing operations exclusive of the impact of the proposed acquisition of Auth0. Any forward-looking statements contained herein do not take into account the impact of the proposed acquisition. Financial Information and Segments We operate our business as one reportable segment. Our revenue has grown significantly. For the years ended January 31, 2021, 2020 and 2019, our revenue was $835.4 million, $586.1 million and $399.3 million, respectively, representing a growth rate of 43% and 47%, respectively. For the years ended January 31, 2021, 2020 and 2019, we generated net losses of $266.3 million, $208.9 million and $125.5 million, respectively. Our accumulated deficit as of January 31, 2021 was $967.5 million. 54 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 January 31, 2021 2020 2019 (dollars in thousands) Customers with annual contract value (ACV) above $100,000 1,950 1,467 1,038 Dollar-based net retention rate for the trailing 12 months ended 121 % 119 % 120 % Current remaining performance obligations $ 841,797 $ 592,309 $ 385,600 Remaining performance obligations $ 1,796,949 $ 1,209,659 $ 728,900 Year Ended January 31, 2021 2020 2019 (in thousands) Calculated billings $ 975,994 $ 703,558 $ 488,217 Total Customers and Number of Customers with Annual Contract Value Above $100,000 As of January 31, 2021, we had over 10,000 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 total revenue, which has contributed to an increase in average revenue per customer. The number of customers who have greater than $100,000 in ACV with us was 1,950, 1,467 and 1,038 as of January 31, 2021, 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 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. 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 (Prior Period ACV). We then calculate the ACV from these same customers as of the current period end (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 Current Period ACV by the 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 (RPO) represent all future, non-cancellable, contracted revenue under our subscription contracts with customers that has not yet been recognized, inclusive of deferred revenue that has 55 been invoiced and non-cancellable 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 reflect 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 39% in the year ended January 31, 2021 over the year ended January 31, 2020. As our Calculated Billings continue to grow in absolute terms, we expect our Calculated Billings growth rate to trend down over time. See the section titled “Non-GAAP Financial Measures” for additional information and a reconciliation of Calculated Billings to total revenue. 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 costs (including rent, utilities and depreciation on assets shared by all departments), certain 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 cost of revenue and operating expense category, sales commissions for sales and marketing and any compensation related taxes. 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 that 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. 56 Gross Margin . Gross margin is gross profit expressed as a percentage of total revenue. Our gross margin may fluctuate from period to period 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 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 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, information technology 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, such as information technology, 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 2023 Notes, convertible notes due in 2025 (2025 Notes) and convertible notes due in 2026 (2026 Notes, together with the 2023 Notes and 2025 Notes, the 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. 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. 57 Results of Operations The following table sets forth our results of operations for the periods presented in dollars: Year Ended January 31, 2021 2020 2019 (in thousands) Revenue Subscription $ 796,613 $ 552,688 $ 370,855 Professional services and other 38,811 33,379 28,399 Total revenue 835,424 586,067 399,254 Cost of revenue Subscription (1) 170,095 116,445 77,354 Professional services and other (1) 47,586 42,937 36,067 Total cost of revenue 217,681 159,382 113,421 Gross profit 617,743 426,685 285,833 Operating expenses Research and development (1) 222,826 159,269 102,385 Sales and marketing (1) 427,350 340,356 227,960 General and administrative (1) 171,726 112,892 75,110 Total operating expenses 821,902 612,517 405,455 Operating loss (204,159) (185,832) (119,622) Interest expense (72,660) (27,017) (15,072) Interest income and other, net 12,891 17,089 9,180 Loss on early extinguishment and conversion of debt (2,263) (14,572) — Interest and other, net (62,032) (24,500) (5,892) Loss before provision for (benefit from) income taxes (266,191) (210,332) (125,514) Provision for (benefit from) income taxes 141 (1,419) (17) Net loss $ (266,332) $ (208,913) $ (125,497) (1) Includes stock-based compensation expense as follows: Year Ended January 31, 2021 2020 2019 (in thousands) Cost of subscription revenue $ 21,895 $ 12,923 $ 7,837 Cost of professional services and other revenue 8,083 7,164 4,983 Research and development 63,270 37,683 22,642 Sales and marketing 53,802 38,077 22,916 General and administrative 49,131 30,777 17,942 Total stock-based compensation expense $ 196,181 $ 126,624 $ 76,320 58 The following table sets forth our results of operations for the periods presented as a percentage of our total revenue: Year Ended January 31, 2021 2020 2019 Revenue Subscription 95 % 94 % 93 % Professional services and other 5 6 7 Total revenue 100 100 100 Cost of revenue Subscription 20 20 19 Professional services and other 6 7 9 Total cost of revenue 26 27 28 Gross profit 74 73 72 Operating expenses: Research and development 27 27 26 Sales and marketing 51 58 57 General and administrative 20 20 19 Total operating expenses 98 105 102 Operating loss (24) (32) (30) Interest expense (9) (5) (3) Interest income and other, net 1 3 2 Loss on early extinguishment and conversion of debt — (2) — Interest and other, net (8) (4) (1) Loss before provision for (benefit from) income taxes (32) (36) (31) Provision for (benefit from) income taxes — — — Net loss (32) % (36) % (31) % 59 A discussion regarding our financial condition and results of operations for the year ended January 31, 2021 compared to the year ended January 31, 2020 is presented below. A discussion regarding our financial condition and results of operations for the year ended January 31, 2020 compared to the year ended January 31, 2019 can be found under Item 7 in our Annual Report on Form 10-K for the fiscal year ended January 31, 2020, filed with the SEC on March 6, 2020, which is available free of charge on the SEC’s website at www.sec.gov and our Investor Relations website at investor.okta.com. Comparison of the Years Ended January 31, 2021 and 2020 Revenue Year Ended January 31, 2021 2020 $ Change % Change (dollars in thousands) Revenue: Subscription $ 796,613 $ 552,688 $ 243,925 44 % Professional services and other 38,811 33,379 5,432 16 Total revenue $ 835,424 $ 586,067 $ 249,357 43 % Percentage of revenue: Subscription 95 % 94 % Professional services and other 5 6 Total 100 % 100 % Subscription revenue increased by $243.9 million, or 44%, for the year ended January 31, 2021 compared to the year ended January 31, 2020. 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 $5.4 million, or 16%, for the year ended January 31, 2021 compared to the year ended January 31, 2020. 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 Year Ended January 31, 2021 2020 $ Change % Change (dollars in thousands) Cost of revenue: Subscription $ 170,095 $ 116,445 $ 53,650 46 % Professional services and other 47,586 42,937 4,649 11 Total cost of revenue $ 217,681 $ 159,382 $ 58,299 37 % Gross profit $ 617,743 $ 426,685 $ 191,058 45 % Gross margin: Subscription 79 % 79 % Professional services and other (23) (29) Total gross margin 74 % 73 % Cost of subscription revenue increased by $53.7 million, or 46%, for the year ended January 31, 2021 compared to the year ended January 31, 2020, primarily due to an increase of $34.7 million in employee compensation costs related to higher headcount to support the growth in our subscription services, an increase of $6.8 million in software license costs and an increase of $6.7 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 year ended January 31, 2021, compared to the year ended January 31, 2020. 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. 60 Cost of professional services and other revenue increased by $4.6 million, or 11%, for the year ended January 31, 2021, compared to the year ended January 31, 2020, primarily due to an increase of $3.7 million in employee compensation costs related to higher headcount. Our gross margin for professional services and other revenue improved to (23)% during the year ended January 31, 2021 from (29)% during the year ended January 31, 2020 primarily due to increases in professional services and other revenue at a faster rate than increases in associated costs. Operating Expenses Research and Development Expenses Year Ended January 31, 2021 2020 $ Change % Change (dollars in thousands) Research and development $ 222,826 $ 159,269 $ 63,557 40 % Percentage of revenue 27 % 27 % Research and development expenses increased $63.6 million, or 40%, for the year ended January 31, 2021 compared to the year ended January 31, 2020. The increase was primarily due to an increase of $57.6 million in employee compensation costs due to higher headcount. Sales and Marketing Expenses Year Ended January 31, 2021 2020 $ Change % Change (dollars in thousands) Sales and marketing $ 427,350 $ 340,356 $ 86,994 26 % Percentage of revenue 51 % 58 % Sales and marketing expenses increased $87.0 million, or 26%, for the year ended January 31, 2021, compared to the year ended January 31, 2020. The increase was primarily due to an increase of $71.0 million in employee compensation costs related to headcount growth, an increase of $5.9 million in allocated overhead costs and an increase of $3.4 million in software license costs, partially offset by a decrease of $18.5 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 $24.5 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 Year Ended January 31, 2021 2020 $ Change % Change (dollars in thousands) General and administrative $ 171,726 $ 112,892 $ 58,834 52 % Percentage of revenue 20 % 20 % General and administrative expenses increased $58.8 million, or 52%, for the year ended January 31, 2021 compared to the year ended January 31, 2020. The increase was primarily due to an increase of $41.3 million in employee compensation costs related to higher headcount to support our continued growth and an increase in non-cash charitable contributions of $7.5 million, partially offset by a decrease of $3.4 million in acquisition costs. 61 Interest and Other, Net Year Ended January 31, 2021 2020 $ Change % Change (dollars in thousands) Interest expense $ (72,660) $ (27,017) $ (45,643) 169 % Interest income and other, net 12,891 17,089 (4,198) (25) Loss on early extinguishment and conversion of debt (2,263) (14,572) 12,309 (84) Interest and other, net $ (62,032) $ (24,500) Interest expense increased $45.6 million or 169% for the year ended January 31, 2021 compared to the year ended January 31, 2020, primarily related to an increase of $23.1 million and $31.5 million for the 2025 Notes and 2026 Notes, respectively, partially offset by a decrease of $9.0 million for the 2023 Notes, due to the partial repurchase of the 2023 Notes in September 2019 (First Partial Repurchase of 2023 Notes) and the partial repurchase of the 2023 Notes in June 2020 (Second Partial Repurchase of 2023 Notes, and together with the First Partial Repurchase of the 2023 Notes, the 2023 Notes Partial Repurchases). Interest income and other, net decreased $4.2 million, or (25)% for the year ended January 31, 2021 compared to the year ended January 31, 2020, primarily due to lower interest rates, resulting in lower interest income earned on higher cash and cash equivalents and short-term investment balances. Loss on early extinguishment and conversion of debt decreased $12.3 million for the year ended January 31, 2021 primarily due to differences in the loss on early extinguishment of debt recognized for the First Partial Repurchase of 2023 Notes in the year ended January 31, 2020 compared to the Second Partial Repurchase of 2023 Notes in the year ended January 31, 2021. 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. 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 included in cost of revenue and amortization of acquired intangibles. 62 Year Ended January 31, 2021 2020 2019 (dollars in thousands) Gross profit $ 617,743 $ 426,685 $ 285,833 Add: Stock-based compensation expense included in cost of revenue 29,978 20,087 12,820 Amortization of acquired intangibles 6,373 5,488 832 Non-GAAP gross profit $ 654,094 $ 452,260 $ 299,485 Gross margin 74 % 73 % 72 % Non-GAAP gross margin 78 % 77 % 75 % 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. Year Ended January 31, 2021 2020 2019 (dollars in thousands) Operating loss $ (204,159) $ (185,832) $ (119,622) Add: Stock-based compensation expense 196,181 126,624 76,320 Non-cash charitable contributions 9,292 1,746 1,008 Amortization of acquired intangibles 6,373 5,488 832 Acquisition-related expenses (1) — 3,449 — Non-GAAP operating income (loss) $ 7,687 $ (48,525) $ (41,462) Operating margin (24) % (32) % (30) % Non-GAAP operating margin 1 % (8) % (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. 63 Year Ended January 31, 2021 2020 (1) 2019 (1) (dollars in thousands) Net loss $ (266,332) $ (208,913) $ (125,497) Add: Stock-based compensation expense 196,181 126,624 76,320 Non-cash charitable contributions 9,292 1,746 1,008 Amortization of acquired intangibles 6,373 5,488 832 Acquisition-related expenses (2) — 3,449 — Amortization of debt discount and debt issuance costs (3) 68,424 25,892 14,387 Loss on early extinguishment and conversion of debt (4) 2,263 14,572 — Non-GAAP net income (loss) $ 16,201 $ (31,142) $ (32,950) Net margin (32) % (36) % (31) % Non-GAAP net margin 2 % (5) % (8) % (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 $3.2 million, $1.8 million and $1.2 million for the years ended January 31, 2021, 2020 and 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 $1.1 million, $3.8 million and nil for the years ended January 31, 2021, 2020 and 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. 64 Year Ended January 31, 2021 2020 (1) 2019 (1) (dollars in thousands) Net loss $ (266,332) $ (208,913) $ (125,497) Add: Stock-based compensation expense 196,181 126,624 76,320 Non-cash charitable contributions 9,292 1,746 1,008 Amortization of acquired intangibles 6,373 5,488 832 Acquisition-related expenses (2) — 3,449 — Amortization of debt discount and debt issuance costs (3) 68,424 25,892 14,387 Loss on early extinguishment and conversion of debt (4) 2,263 14,572 — Non-GAAP net income (loss) $ 16,201 $ (31,142) $ (32,950) Weighted-average shares used to compute net loss per share, basic and diluted 127,212 117,221 107,504 Non-GAAP weighted-average effect of potentially dilutive securities 15,171 — — Non-GAAP weighted-average shares used to compute non-GAAP net income (loss) per share, diluted 142,383 117,221 107,504 Net loss per share, basic and diluted $ (2.09) $ (1.78) $ (1.17) Non-GAAP net income (loss) per share, basic (5) $ 0.13 $ (0.27) $ (0.31) Non-GAAP net income (loss) per share, diluted (5) $ 0.11 $ (0.27) $ (0.31) (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 $3.2 million, $1.8 million and $1.2 million for the years ended January 31, 2021, 2020 and 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 $1.1 million, $3.8 million and nil for the years ended January 31, 2021, 2020 and 2019, respectively. (5) The total impact of the adjustments noted in footnotes (3) and (4) on non-GAAP net income (loss) per share, basic and diluted is $0.04 and $0.01 for the years ended January 31, 2020 and 2019, respectively. 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. Year Ended January 31, 2021 2020 2019 (in thousands) Net cash provided by operating activities $ 127,962 $ 55,603 $ 15,172 Less: Purchases of property and equipment (13,083) (15,442) (19,811) Capitalization of internal-use software costs (4,159) (3,888) (2,851) Proceeds from sales of property and equipment — — 740 Free cash flow $ 110,720 $ 36,273 $ (6,750) Net cash used in investing activities $ (1,305,146) $ (688,041) $ (197,320) Net cash provided by financing activities $ 1,091,598 $ 853,385 $ 357,762 Free cash flow margin 13 % 6 % (2) % 65 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. Year Ended January 31, 2021 2020 2019 (in thousands) Total revenue $ 835,424 $ 586,067 $ 399,254 Add: Deferred revenue (end of period) 513,598 371,450 254,390 Unbilled receivables (beginning of period) 1,026 1,457 809 Less: Unbilled receivables (end of period) (2,604) (1,026) (1,457) Deferred revenue (beginning of period) (371,450) (254,390) (164,779) Calculated billings $ 975,994 $ 703,558 $ 488,217 Liquidity and Capital Resources As of January 31, 2021, our principal sources of liquidity were cash, cash equivalents and short-term investments totaling $2,556.2 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 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 due on February 15, 2023 and received aggregate proceeds of $345.0 million, before deducting costs of issuance of $10.0 million. The interest rate on the 2023 Notes is fixed at 0.25% per annum and is payable semi-annually in arrears on February 15 and August 15 of each year, beginning on August 15, 2018. In connection with the issuance of the 2023 Notes, we entered into convertible note hedges (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 (Warrants) in connection with the issuance of the 2023 Notes. In September 2019, we completed our private offering of the 2025 Notes due on September 1, 2025 and received aggregate proceeds of $1,060.0 million, before deducting issuance costs of approximately $19.3 million. The interest rate on the 2025 Notes is fixed at 0.125% per annum and is payable semi-annually in arrears on March 1 and September 1 of each year, beginning on March 1, 2020. In connection with the 2025 Notes, we entered into capped call transactions (2025 Capped Calls) 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 due on June 15, 2026 and received aggregate proceeds of $1,150.0 million, before deducting issuance costs of approximately $15.2 million. The interest rate on the 2026 Notes is fixed at 0.375% per year and is payable semi-annually in arrears on June 15 and December 15 of each year, beginning on December 15, 2020. In connection with the 2026 Notes, we entered into capped call transactions (2026 Capped Calls) 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. 66 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 year ended January 31, 2021, we converted approximately $10.4 million principal amount of 2023 Notes (not in connection with the Second Partial Repurchase of 2023 Notes) and exercised corresponding Note Hedges. In connection with these transactions, we issued approximately 0.2 million shares of Class A common stock and made immaterial cash payments and received approximately 0.2 million shares of Class A common stock and an immaterial cash payment. During the fourth quarter of fiscal 2021, we received additional conversion requests and settled approximately $4.3 million aggregate principal amount of the 2023 Notes, primarily in shares of Class A common stock, in the first quarter of fiscal 2022. In addition, subsequent to January 31, 2021, the Company has received conversion requests for approximately $3.2 million aggregate principal amount of the 2023 Notes. 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 investments and cash provided by sales of our products and services will be sufficient to meet our short-term and long-term projected working capital and capital expenditure needs for the foreseeable future. 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 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 January 31, 2021, we had deferred revenue of $513.6 million, of which $502.7 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. On March 3, 2021, we and Auth0 entered into the Merger Agreement, pursuant to which we agreed to acquire Auth0, subject to the terms and conditions set forth therein. If consummated, the acquisition of Auth0 may have a significant impact on our liquidity, financial condition and results of operations. Cash Flows The following table summarizes our cash flows for the periods indicated: Year Ended January 31, 2021 2020 2019 (in thousands) Net cash provided by operating activities $ 127,962 $ 55,603 $ 15,172 Net cash used in investing activities (1,305,146) (688,041) (197,320) Net cash provided by financing activities 1,091,598 853,385 357,762 Effects of changes in foreign currency exchange rates on cash, cash equivalents and restricted cash 2,263 (209) (632) Net (decrease) increase in cash, cash equivalents and restricted cash $ (83,323) $ 220,738 $ 174,982 67 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 initial public offering (IPO) in April 2017. During the year ended January 31, 2021, cash provided by operating activities was $128.0 million primarily due to our net loss of $266.3 million, adjusted for non-cash charges of $357.0 million and net cash inflows of $37.3 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, depreciation and amortization of property and equipment and intangible assets, non-cash charitable contributions, loss on early extinguishment and conversion of debt and deferred income taxes. The primary drivers of the changes in operating assets and liabilities related to a $142.1 million increase in deferred revenue, a $53.8 million increase in accounts payable, accrued compensation and accrued other expenses and a $19.1 million decrease in operating lease right-of-use assets, partially offset by a $81.0 million increase in deferred commissions, a $66.4 million increase in accounts receivable, a $17.2 million decrease in operating lease liabilities and a $13.2 million increase in prepaid expenses and other assets. During the year ended January 31, 2020, cash provided by operating activities was $55.6 million primarily due to our net loss of $208.9 million, adjusted for non-cash charges of $213.0 million and net cash inflows of $51.5 million provided by changes in our operating assets and liabilities. Non-cash charges primarily consisted of stock-based compensation, amortization of deferred commissions, amortization of debt discount and issuance costs, depreciation and amortization of property and equipment and intangible assets, deferred income taxes, non-cash charitable contributions and loss on early extinguishment of debt. The primary drivers of the changes in operating assets and liabilities related to a $116.4 million increase in deferred revenue, a $34.7 million increase in accounts payable, accrued compensation, and accrued other expenses and a $13.0 million decrease in operating lease right-of-use assets, partially offset by a $61.2 million increase in deferred commissions, a $37.5 million increase in accounts receivable, a $9.7 million decrease in operating lease liabilities and a $4.1 million increase in prepaid expenses and other assets. Investing Activities Net cash used in investing activities during the year ended January 31, 2021 of $1,305.1 million was primarily attributable to the purchases of investments of $2,029.0 million, purchases of property and equipment of $13.1 million to support additional office space and headcount and the capitalization of internal-use software costs of $4.2 million associated with the development of additional features and functionality for our platform. These activities were offset by proceeds from the sales and maturities of investments of $741.3 million. Net cash used in investing activities during the year ended January 31, 2020 of $688.0 million was primarily attributable to the purchases of investments of $999.4 million, payment of $44.3 million, net of cash acquired, in connection with an acquisition, purchases of property and equipment of $15.4 million to support additional office space and headcount, payment of $8.6 million in connection with the purchase of developed technology intangible assets and the capitalization of internal-use software costs of $3.9 million associated with the development of additional features and functionality for our platform. These activities were offset by proceeds from the sales and maturities of investments of $383.5 million. Financing Activities Cash provided by financing activities during the year ended January 31, 2021 of $1,091.6 million was primarily attributable to the issuance of the 2026 Notes for proceeds of $1,134.8 million, net of issuance costs and proceeds from the termination of Note Hedges of $195.0 million, offset by payments for termination of Warrants of $175.4 million and the purchase of the 2026 Capped Calls of $134.0 million. Other items impacting cash provided by financing activities include proceeds from the exercise of stock options of $45.6 million and proceeds from our employee stock purchase plan (ESPP) of $25.9 million. Cash provided by financing activities during the year ended January 31, 2020 of $853.4 million was primarily attributable to the issuance of the 2025 Notes for proceeds of $1,040.7 million, net of issuance costs, and proceeds from the termination of Note Hedges of $405.9 million, offset by payments for termination of Warrants of $358.6 68 million, payments for the First Partial Repurchase of 2023 Notes of $224.4 million, and the purchase of the 2025 Capped Calls of $74.1 million. Other items impacting cash provided by financing activities include proceeds from the exercise of stock options of $45.4 million and proceeds from our ESPP of $18.8 million. Obligations and Other Commitments Our principal commitments consist of obligations under our convertible senior notes, operating leases for office space, data center hosting facilities, and other sales and marketing obligations. Our obligations under our convertible senior notes are described in the "Liquidity and Capital Resources" section of Item 7 of this Annual Report on Form 10-K and in Note 9 to our consolidated financial statements included elsewhere in this Annual Report on Form 10-K. Information regarding our non-cancellable lease and other purchase commitments as of January 31, 2021 can be found in Notes 10 and 11 to our consolidated financial statements included elsewhere in this Annual Report on Form 10-K. 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 consolidated balance sheets, consolidated statements of operations and comprehensive loss, or consolidated statements of cash flows. Critical Accounting Policies and Estimates We prepare our consolidated financial statements in accordance with GAAP. In the preparation of these 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. Revenue Recognition We derive revenue from subscription fees (which include support fees) and professional services fees. We sell subscriptions to our platform through arrangements that are generally one to five years in length. Our arrangements are generally non-cancellable and non-refundable. Furthermore, if a customer reduces the contracted usage or service level, the customer has no right of refund. Our subscription arrangements do not provide customers with the right to take possession of the software supporting the platform and, as a result, are accounted for as service arrangements. This revenue recognition policy is consistent for sales generated directly with customers and sales generated indirectly through channel partners. 69 We determine revenue recognition through the following steps: • Identification of the contract, or contracts, with a customer; • Identification of the performance obligations in the contract; • Determination of the transaction price; • Allocation of the transaction price to the performance obligations in the contract; and • Recognition of revenue when, or as, we satisfy a performance obligation. Subscription Revenue Subscription revenue, which includes support, is recognized on a straight-line basis over the non-cancellable contractual term of the arrangement, generally beginning on the date that our service is made available to the customer. Professional Services Revenue Our professional services principally consist of customer-specific requests for application integrations, user interface enhancements and other customer specific requests. Revenue for our professional services is recognized as services are performed in proportion with their pattern of transfer. Contracts with Multiple Performance Obligations Some of our contracts with customers contain multiple performance obligations. For these contracts, we account for individual performance obligations separately if they are distinct. The transaction price is allocated to the separate performance obligations on a relative stand-alone selling price (SSP) basis. We determine SSP based on observable prices, if available, for those related services when sold separately. When such observable prices are not available, we determine SSP based on overarching pricing objectives and strategies, taking into consideration market conditions and other factors, including customer size, volume purchased, market and industry conditions, product-specific factors and historical sales of the deliverables. Deferred Commissions Sales commissions earned by our sales force are considered incremental and recoverable costs of obtaining a contract with a customer. Sales commissions for new revenue contracts, including incremental sales to existing customers, are deferred and then amortized on a straight-line basis over a period of benefit, which we have determined to be generally five years. We determined the period of benefit by taking into consideration the terms of our customer contracts, our technology and other factors. Sales commissions for renewal contracts (which are not considered commensurate with sales commissions for new revenue contracts and incremental sales to existing customers) are deferred and then amortized on a straight-line basis over the related period of benefit, which is generally the related contract renewal term. Amortization expense is included in sales and marketing expenses in our consolidated statements of operations. Deferred commissions on our consolidated balance sheets totaled $154.5 million and $111.5 million at January 31, 2021 and 2020, respectively. Business Combinations When we acquire a business, the purchase price is allocated to the net tangible and identifiable intangible assets acquired based on their estimated fair values. Any residual purchase price is recorded as goodwill. The allocation of the purchase price requires management to make significant estimates in determining the fair values of assets acquired and liabilities assumed, especially with respect to intangible assets. These estimates can include, but are not limited to, the cash flows that an asset is expected to generate in the future, the appropriate weighted-average cost of capital and the cost savings expected to be derived from acquiring an asset. These estimates are inherently uncertain and unpredictable. During the measurement period, which may be up to one year from the acquisition date, adjustments to the fair value of these tangible and intangible assets acquired and liabilities assumed may be recorded, with the corresponding offset to goodwill. Upon the conclusion of the measurement period or final determination of the fair value of assets acquired or liabilities assumed, whichever comes first, any subsequent adjustments are recorded to our consolidated statements of operations. 70 Goodwill on our consolidated balance sheets totaled $48.0 million at January 31, 2021 and 2020. Goodwill is tested for impairment annually on November 1 or more frequently if certain indicators are present. Based on the annual assessment, no indicator of impairment was noted and as such no impairment charge was recorded during the years ended January 31, 2021, 2020 and 2019. Convertible Senior Notes We account for the issuance of convertible senior notes in accordance with Financial Accounting Standards Board (FASB) Accounting Standards Codification (ASC) Subtopic 470-20, Debt with Conversion and Other Options. Pursuant to ASC Subtopic 470-20, as our Notes have a net settlement feature and may be settled wholly or partially in cash upon conversion, we are required to separately account for the liability (debt) and equity (conversion option) components of the instrument. The carrying amount of the liability component is computed by estimating the fair value of a similar liability without the conversion option using income and market based approaches. For the income-based approach, we use a convertible bond pricing model that includes several assumptions such as volatility, the risk-free rate, and observable trading activity for the Company's existing Notes. For the market-based approach, we observe the price of derivative instruments purchased in conjunction with our convertible senior note issuances or we evaluate issuances of convertible debt securities by other companies with similar credit risk ratings at the time of issuance. The amount of the equity component is then calculated by deducting the fair value of the liability component from the principal amount of the instrument. This difference represents a debt discount that is amortized to interest expense over the respective terms of the Notes using an effective interest rate method. The equity component is not remeasured as long as it continues to meet the conditions for equity classification. In accounting for the issuance costs related to the Notes, the allocation of issuance costs incurred between the liability and equity components were based on their relative values. Similarly, in accordance with ASC Subtopic 470-20, transactions involving contemporaneous exchanges of cash between the same debtor and creditor in connection with the issuance of a new debt obligation and satisfaction of an existing debt obligation by the debtor should be evaluated as a modification or an exchange transaction depending on whether the exchange is determined to have substantially different terms. When the exchange is deemed to have substantially different terms due to a significant difference between the value of the conversion option immediately prior to and after the exchange, the transaction is accounted for as a debt extinguishment. Pursuant to ASC Subtopic 470-20, total consideration for the satisfaction of an existing debt obligation is separated into liability and equity components by estimating the fair value of a similar liability without a conversion option and assigning the residual value to the equity component. The effective interest rate used to estimate the fair value of the liability component is based on the income and market based approaches used to determine the effective interest rate of the new debt obligation, adjusted for the remaining tenor of the extinguished debt. The difference between the fair value and the amortized carrying value of the extinguished debt, net of the proportionate amounts of unamortized debt discount and remaining unamortized debt issuance costs, is recorded as a gain or loss on extinguishment. Recent Accounting Pronouncements See Note 2 to our consolidated financial statements “Summary of Significant Accounting Policies — Recently Adopted Accounting Pronouncements" and " — Recently Issued Accounting Pronouncements Not Yet Adopted” for more information. 71