Sprout Social, Inc. 10-Q

Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations You should read the following discussion and analysis of our financial condition and results of operations together with our unaudited condensed consolidated financial statements and related notes included elsewhere in this Quarterly Report. This discussion contains forward-looking statements based upon current plans, expectations and beliefs involving risks and uncertainties, including the potential impact of the COVID-19 pandemic on our business. 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 “Risk Factors” in Part II—Item 1A of this Quarterly Report and Part I—Item 1A of our Annual Report on Form 10-K and in other parts of this Quarterly Report. Overview Sprout Social is a powerful, centralized platform that provides the critical business layer to unlock the massive commercial value of social media. Currently, more than 25,000 customers across 100 countries rely on our platform to reach larger audiences, create stronger relationships with their customers and make better business decisions. Introduced in 2011, our cloud software brings together social messaging, data and workflows in a unified system of record, intelligence and action. Operating across major social media networks, including Twitter, Facebook, Instagram, Pinterest, LinkedIn, Google and YouTube, we provide organizations with a centralized platform to effectively manage their social media efforts across stakeholders and business functions. Virtually every aspect of business has been impacted by social media, from marketing, sales and public relations to customer service, product and strategy, creating a need for an entirely new category of software. We offer our customers a centralized, secure and powerful platform to manage this broad, complex channel effectively across their organization. We generate revenue primarily from subscriptions to our social media management platform under a software-as-a-service model. Our subscriptions can range from monthly to one-year or multi-year arrangements and are generally non-cancellable during the contractual subscription term. Subscription revenue is recognized ratably over the contract terms beginning on the date the product is made available to customers, which typically begins on the commencement date of each contract. We also generate revenue from professional services related to our platform provided to certain customers, which is recognized at the time these services are provided to the customer. This revenue has historically represented less than 1% of our revenue and is expected to be immaterial for the foreseeable future. Our tiered subscription-based model allows our customers to choose among three core plans to meet their needs. Each plan is licensed on a per user per month basis at prices dependent on the level of features offered. Additional product modules, which offer increased functionality depending on a customer’s needs, can be purchased by the customer on a per user per month basis. We generated revenue of $33.7 million and $26.4 million during the three months ended September 30, 2020 and 2019, respectively, representing growth of 27%. Excluding the impact of the 2017 acquisition of Simply Measured, Inc., or Simply Measured, our organic growth rate during the three months ended September 30, 2020 compared to the three months ended September 30, 2019 was 34%. This organic growth rate excludes the impact of revenue generated from legacy Simply Measured products as well as revenue from the transition of legacy customers to our platform up to an amount equal to such customers’ prior spend on legacy Simply Measured products. This organic growth rate includes all incremental revenue generated above such prior spend from the sale of additional or higher-priced products and users and profiles to legacy customers of Simply Measured. We generated revenue of $95.6 million and $74.6 million during the nine months ended September 30, 2020 and 2019, respectively, representing growth of 28%. Our organic growth rate was 37% during the same period. In the three and nine months ended September 30, 2020, software subscriptions contributed 99% of our revenue. 19 We generated net losses of $7.0 million and $5.0 million during the three months ended September 30, 2020 and 2019, respectively, which included stock-based compensation expense of $2.6 million and $0.1 million during the three months ended September 30, 2020 and 2019, respectively. We generated net losses of $25.8 million and $21.0 million during the nine months ended September 30, 2020 and 2019, respectively, which included stock-based compensation expense of $8.6 million and $5.4 million during the nine months ended September 30, 2020 and 2019, respectively. We expect to continue investing in the growth of our business and, as a result, generate net losses for the foreseeable future. COVID-19 In December 2019, a novel coronavirus disease (“COVID-19”) was identified. On March 11, 2020, the World Health Organization characterized COVID-19 as a pandemic. The extent of the impact of COVID-19 on our operational and financial performance and financial position will depend on certain developments, including the duration and spread of the outbreak and the governmental responses to address the pandemic and any re-emergence of COVID-19, impact on our customers and sales cycles and impact on our employees, all of which are uncertain and cannot be predicted. Given the importance of our technology platform and heightened market awareness of social media as a strategic communications channel, our operational and financial performance were not materially impacted by COVID-19 during the nine months ended September 30, 2020. Our recent IPO in December 2019 resulted in $134.3 million net proceeds, as well as an additional $10.0 million of net proceeds received in January 2020 as a result of our sale of over-allotment shares to the underwriters of our IPO, all of which strengthened our liquidity position prior to the pandemic. The $42.1 million in net proceeds from our equity follow-on offering in August 2020 has further strengthened our liquidity position. We believe that over the long-term, we will continue to see strong demand for our technology platform; however, the duration and spread of the pandemic could impact our customers’ marketing or social media budgets or ability to pay for existing subscriptions, particularly in the industries most impacted by COVID-19. We will continue to monitor the potential impact of COVID-19; however, at this time, the extent to which the pandemic may impact our financial condition or results of operations is uncertain. Key Factors Affecting Our Performance Acquiring new customers We are focused on continuing to organically grow our customer base by increasing demand for our platform and penetrating our addressable market. We have invested, and expect to continue to invest, heavily in expanding our sales force and marketing efforts to acquire new customers. Currently, we have more than 25,000 customers. Expanding within our current customer base We believe that there is a substantial and largely untapped opportunity for organic growth within our existing customer base. Customers often begin by purchasing a small number of user subscriptions and then expand over time, increasing the number of users or social profiles, as well as purchasing additional product modules. Customers may then expand use-cases between various departments to drive collaboration across their organizations. Our sales and customer success efforts include encouraging organizations to expand use-cases to more fully realize the value from the broader adoption of our platform throughout an organization. We will continue to invest in enhancing awareness of our brand, creating additional uses for our products and developing more products, features and functionality of existing products, which we believe are vital to achieving increased adoption of our platform. We have a history of attracting new customers and we have recently increased our focus on expanding their use of our platform over time. 20 Sustaining product and technology innovation Our success is dependent on our ability to sustain product and technology innovation and maintain the competitive advantage of our proprietary technology. We continue to invest resources to enhance the capabilities of our platform by introducing new products, features and functionality of existing products. International expansion We see international expansion as a meaningful opportunity to grow our platform. Revenue generated from non-U.S. customers during the nine months ended September 30, 2020 was approximately 28% of our total revenue. We have built local teams in Ireland, Canada, the United Kingdom, Singapore, India and Australia to support our growth internationally. We believe global demand for our platform and offerings will continue to increase as awareness of our platform in international markets grows. We plan to continue adding to our local sales, customer support and customer success teams in select international markets over time. Key Business Metrics We review the following key business metrics to evaluate our business, measure our performance, identify trends, formulate financial projections and make strategic decisions. Number of customers We define a customer as a unique account, multiple accounts containing a common non-personal email domain, or multiple accounts governed by a single agreement. Number of customers excludes customers exclusively using legacy products obtained through the acquisition of Simply Measured. We believe that the number of customers using our platform is an indicator not only of our market penetration, but also of our potential for future growth as our customers often expand their adoption of our platform over time based on an increased awareness of the value of our platform and products. As of September 30, 2020 2019 Number of customers 25,556 23,066 Total ARR Total ARR is ARR from all of our products. We define ARR as the annualized revenue run-rate of subscription agreements from all customers as of the last date of the specified period. Total ARR includes the impact of recurring revenue generated from legacy Simply Measured products, which a small number of legacy Simply Measured customers have continued to access. These customers may continue to do so for a limited period in the future as we continue to transition those customers to other Sprout products. We believe total ARR is an indicator of the scale of our entire platform while mitigating fluctuations due to seasonality and contract term. As of September 30, 2020 2019 (in thousands) Total ARR $ 141,898 $ 109,486 21 Organic ARR Organic ARR is ARR excluding the impact of recurring revenue generated from legacy Simply Measured products. We believe organic ARR is an indicator of the scale and visibility of our core platform while mitigating fluctuations due to seasonality and contract term. As of September 30, 2020 2019 (in thousands) Organic ARR $ 140,615 $ 103,855 Number of customers contributing more than $10,000 in ARR We view the number of customers that contribute more than $10,000 in ARR as a measure of our ability to scale with our customers and attract larger organizations. We believe this represents potential for future growth, including expanding within our current customer base. Over time, larger customers have constituted a greater share of our revenue. We define customers contributing more than $10,000 in ARR as those on a paid subscription plan that had more than $10,000 in ARR as of a period end. As of September 30, 2020 2019 Number of customers contributing more than $10,000 in ARR 2,790 1,965 Components of our Results of Operations Revenue Subscription We generate revenue primarily from subscriptions to our social media management platform under a software-as-a-service model. Our subscriptions can range from monthly to one-year or multi-year arrangements and are generally non-cancellable during the contractual subscription term. Subscription revenue is recognized ratably over the contract terms beginning on the date our product is made available to customers, which typically begins on the commencement date of each contract. Our customers do not have the right to take possession of the online software solution. We also generate a small portion of our subscription revenue from third-party resellers. Professional Services We sell professional services consisting of, but not limited to, implementation fees, specialized training, one-time reporting services and recurring periodic reporting services. Professional services revenue is recognized at the time these services are provided to the customer. This revenue has historically represented less than 1% of our revenue and is expected to be immaterial for the foreseeable future. Cost of Revenue Subscription Cost of revenue primarily consists of expenses related to hosting our platform and providing support to our customers. These expenses are comprised of fees paid to data providers, hosted data center costs and personnel costs directly associated with cloud infrastructure, customer success and 22 customer support, including salaries, benefits, bonuses and allocated overhead. These costs also include depreciation expense and amortization expense related to acquired developed technologies. Overhead associated with facilities and information technology is allocated to cost of revenue and operating expenses based on headcount. Although we expect our cost of revenue to increase in absolute dollars as our business and revenue grows, we expect our cost of revenue to decrease as a percentage of our revenue over time. Professional Services and Other Cost of professional services primarily consists of expenses related to our professional services organization and are comprised of personnel costs, including salaries, benefits, bonuses and allocated overhead. Gross Profit and Gross Margin Gross margin is calculated as gross profit as a percentage of total revenue. Our gross margin may fluctuate from period to period based on revenue earned, the timing and amount of investments made to expand our hosting capacity, our customer support and professional services teams and in hiring additional personnel, and the impact of acquisitions. We expect our gross profit and gross margin to increase as our business grows over time. Operating Expenses Research and Development Research and development expenses primarily consist of personnel costs, including salaries, benefits and allocated overhead. Research and development expenses also include depreciation expense and other expenses associated with product development. We plan to increase the dollar amount of our investment in research and development for the foreseeable future as we focus on developing new features and enhancements to our plan offerings. However, we expect our research and development expenses to decrease as a percentage of our revenue over time. Sales and Marketing Sales and marketing expenses primarily consist of personnel costs directly associated with our sales and marketing department, online advertising expenses, as well as allocated overhead, including depreciation expense and amortization related to acquired developed technologies. Sales force commissions and bonuses are considered incremental costs of obtaining a contract with a customer. Sales commissions are earned and recorded at contract commencement for both new customer contracts and expansion of contracts with existing customers. Sales commissions are deferred and amortized on a straight-line basis over a period of benefit of three years. We plan to increase the dollar amount of our investment in sales and marketing for the foreseeable future, primarily for increased headcount for our sales department. General and Administrative General and administrative expenses primarily consist of personnel expenses associated with our finance, legal, human resources and other administrative employees. Our general and administrative expenses also include professional fees for external legal, accounting and other consulting services, depreciation and amortization expense, as well as allocated overhead. We expect to increase the size of our general and administrative functions to support the growth of our business. We also recognized certain non-recurring professional fees and other expenses as part of our transition to becoming a public company and expect to continue to incur additional expenses as a result of operating as a public company, including costs to comply with rules and regulations applicable to companies listed on a U.S. securities exchange, costs related to compliance and reporting obligations pursuant to the rules and regulations of the SEC, investor relations and professional services. We expect the dollar amount of our 23 general and administrative expenses to increase for the foreseeable future. However, we expect our general and administrative expenses to decrease as a percentage of revenue over time. Interest Income (Expense), Net Interest income (expense), net consists primarily of interest expenses on outstanding line of credit balances and is offset by interest income earned on our cash and investment balances. Other Income Other income consists of sublease rental income from our Seattle, Washington and San Francisco, California offices. Income Tax Provision The income tax provision consists of current and deferred taxes for our U.S. and foreign jurisdictions. We have historically reported a taxable loss in our most significant jurisdiction, the U.S., and have a full valuation allowance against our deferred tax assets. We expect this trend to continue for the foreseeable future. 24 Results of Operations The following tables set forth information comparing the components of our results of operations in dollars and as a percentage of total revenue for the periods presented. Three Months Ended September 30, Nine Months Ended September 30, 2020 2019 2020 2019 (in thousands) Revenue Subscription $ 33,370 $ 26,284 $ 94,889 $ 74,285 Professional services and other 296 137 714 278 Total revenue 33,666 26,421 95,603 74,563 Cost of revenue (1) Subscription 8,588 7,144 24,852 19,113 Professional services and other 186 85 450 175 Total cost of revenue 8,774 7,229 25,302 19,288 Gross profit 24,892 19,192 70,301 55,275 Operating expenses Research and development (1) 7,693 6,361 22,686 19,137 Sales and marketing (1) 14,774 11,894 42,852 34,074 General and administrative (1) 9,346 6,056 30,970 23,417 Total operating expenses 31,813 24,311 96,508 76,628 Loss from operations (6,921) (5,119) (26,207) (21,353) Interest expense (94) (70) (285) (199) Interest income 50 61 563 256 Other income 19 108 222 388 Loss before income taxes (6,946) (5,020) (25,707) (20,908) Income tax expense 51 19 72 49 Net loss and comprehensive loss $ (6,997) $ (5,039) $ (25,779) $ (20,957) _______________ (1) Includes stock-based compensation expense as follows: Three Months Ended September 30, Nine Months Ended September 30, 2020 2019 2020 2019 (in thousands) Cost of revenue $ 153 $ — $ 617 $ — Research and development 509 — 1,443 — Sales and marketing 667 — 1,833 — General and administrative 1,231 65 4,670 5,363 Total stock-based compensation $ 2,560 $ 65 $ 8,563 $ 5,363 25 Three Months Ended September 30, Nine Months Ended September 30, 2020 2019 2020 2019 (as a percentage of total revenue) Revenue Subscription 99 % 99 % 99 % 100 % Professional services and other 1 % 1 % 1 % — % Total revenue 100 % 100 % 100 % 100 % Cost of revenue Subscription 26 % 27 % 26 % 26 % Professional services and other — % — % — % — % Total cost of revenue 26 % 27 % 26 % 26 % Gross profit 74 % 73 % 74 % 74 % Operating expenses Research and development 23 % 24 % 24 % 26 % Sales and marketing 44 % 45 % 45 % 46 % General and administrative 28 % 23 % 32 % 31 % Total operating expenses 95 % 92 % 101 % 103 % Loss from operations (21) % (19) % (27) % (29) % Interest expense — % — % — % — % Interest income — % — % — % — % Other income — % — % — % 1 % Loss before income taxes (21) % (19) % (27) % (28) % Income tax expense — % — % — % — % Net loss and comprehensive loss (21) % (19) % (27) % (28) % Three Months Ended September 30, 2020 Compared to Three Months Ended September 30, 2019 Revenue Three Months Ended September 30, Change 2020 2019 Amount % ( dollars in thousands ) Revenue Subscription $ 33,370 $ 26,284 $ 7,086 27 % Professional services and other 296 137 159 116 % Total revenue $ 33,666 $ 26,421 $ 7,245 27 % Percentage of Total Revenue Subscription 99 % 99 % Professional services and other 1 % 1 % The increase in subscription revenue was primarily driven by revenue from new customers and expansion within existing customers. The total number of customers grew from 23,066 as of 26 September 30, 2019 to 25,556 as of September 30, 2020. The increase in new customers was primarily driven by our growing sales force capacity to meet market demand. Expansion within existing customers was driven by our ability to increase the number of users, social profiles and products purchased by customers. This is in part attributable to the expansion of use-cases across various functions within our existing customers’ organizations. Cost of Revenue and Gross Margin Three Months Ended September 30, Change 2020 2019 Amount % ( dollars in thousands ) Cost of revenue Subscription $ 8,588 $ 7,144 $ 1,444 20 % Professional services and other 186 85 101 119 % Total cost of revenue 8,774 7,229 $ 1,545 21 % Gross profit $ 24,892 $ 19,192 $ 5,700 30 % Gross margin Total gross margin 74 % 73 % The increase in cost of subscription revenue for the three months ended September 30, 2020 compared to the three months ended September 30, 2019 was primarily due to the following: Change ( in thousands ) Data provider fees $ 1,131 Stock-based compensation expense 153 Other 160 Subscription cost of revenue $ 1,444 Fees paid to our data providers increased due to revenue growth. The increase in stock-based compensation was due to the expense related to employee restricted stock units (“RSUs”) vesting since the completion of our IPO on December 17, 2019. Operating Expenses Research and Development Three Months Ended September 30, Change 2020 2019 Amount % ( dollars in thousands ) Research and development $ 7,693 $ 6,361 $ 1,332 21 % Percentage of total revenue 23 % 24 % 27 The increase in research and development expense for the three months ended September 30, 2020 compared to the three months ended September 30, 2019 was primarily due to the following: Change ( in thousands ) Personnel costs $ 863 Stock-based compensation expense 509 Other (40) Research and development $ 1,332 Personnel costs increased primarily as a result of an 8% increase in headcount to grow our research and development teams to drive our technology innovation through the development of new products and features. The increase in stock-based compensation was due to the expense related to employee RSUs vesting since the completion of our IPO on December 17, 2019. Sales and Marketing Three Months Ended September 30, Change 2020 2019 Amount % ( dollars in thousands ) Sales and marketing $ 14,774 $ 11,894 $ 2,880 24 % Percentage of total revenue 44 % 45 % The increase in sales and marketing expense for the three months ended September 30, 2020 compared to the three months ended September 30, 2019 was primarily due to the following: Change ( in thousands ) Personnel costs $ 1,994 Stock-based compensation expense 667 Other 219 Sales and marketing $ 2,880 Personnel costs increased primarily as a result of a 17% increase in headcount as we continue to expand our sales teams to grow our customer base, as well as additional sales commission expense due to the year over year sales growth, which increased the amortization of contract acquisition costs. The increase in stock-based compensation was due to the expense related to employee RSUs vesting since the completion of our IPO on December 17, 2019. General and Administrative Three Months Ended September 30, Change 2020 2019 Amount % ( dollars in thousands ) General and administrative $ 9,346 $ 6,056 $ 3,290 54 % Percentage of total revenue 28 % 23 % 28 The increase in general and administrative expense for the three months ended September 30, 2020 compared to the three months ended September 30, 2019 was primarily due to the following: Change ( in thousands ) Personnel costs $ 1,617 Stock-based compensation expense 1,166 Other 507 General and administrative $ 3,290 Personnel costs increased primarily as a result of a 29% increase in headcount as we continue to grow our business and operate as a publicly traded company. The increase in stock-based compensation was due to the expense related to employee RSUs vesting since the completion of our IPO on December 17, 2019. The increase in other was primarily driven by a $0.2 million increase in legal fees, an increase of $0.1 million in consulting fees, and overhead-related costs. Interest Income (Expense), Net Three Months Ended September 30, Change 2020 2019 Amount % ( dollars in thousands ) Interest income (expense), net $ (44) $ (9) $ (35) n/m (1) Percentage of total revenue — % — % _________________ (1) Calculated metric is not meaningful. The increase in net interest expense was driven by fees associated with our revolving line of credit. Other Income Three Months Ended September 30, Change 2020 2019 Amount % ( dollars in thousands ) Other income $ 19 $ 108 $ (89) (82) % Percentage of total revenue — % — % The decrease in other income is due to sublease rental income declining as the San Francisco office lease expired in June 2019. 29 Income Tax Expense Three Months Ended September 30, Change 2020 2019 Amount % ( dollars in thousands ) Income tax expense $ 51 $ 19 $ 32 n/m (1) Percentage of total revenue — % — % _________________ (1) Calculated metric is not meaningful. The increase in income tax expense is due to the provision related to foreign income taxes. Nine Months Ended September 30, 2020 Compared to Nine Months Ended September 30, 2019 Revenue Nine Months Ended September 30, Change 2020 2019 Amount % ( dollars in thousands ) Revenue Subscription $ 94,889 $ 74,285 $ 20,604 28 % Professional services and other 714 278 436 157 % Total revenue $ 95,603 $ 74,563 $ 21,040 28 % Percentage of Total Revenue Subscription 99 % 100 % Professional services and other 1 % — % The increase in subscription revenue was primarily driven by revenue from new customers and expansion within existing customers. The total number of customers grew from 23,066 as of September 30, 2019 to 25,556 as of September 30, 2020. The increase in new customers was primarily driven by our growing sales force capacity to meet market demand. Expansion within existing customers was driven by our ability to increase the number of users, social profiles and products purchased by customers. This is in part attributable to the expansion of use-cases across various functions within our existing customers’ organizations. 30 Cost of Revenue and Gross Margin Nine Months Ended September 30, Change 2020 2019 Amount % ( dollars in thousands ) Cost of revenue Subscription $ 24,852 $ 19,113 $ 5,739 30 % Professional services and other 450 175 275 157 % Total cost of revenue 25,302 19,288 $ 6,014 31 % Gross profit $ 70,301 $ 55,275 $ 15,026 27 % Gross margin Total gross margin 74 % 74 % The increase in cost of subscription revenue for the nine months ended September 30, 2020 compared to the nine months ended September 30, 2019 was primarily due to the following: Change ( in thousands ) Data provider fees $ 3,351 Personnel costs 1,210 Stock-based compensation expense 617 Other 561 Subscription cost of revenue $ 5,739 Fees paid to our data providers increased due to revenue growth. Personnel costs increased primarily as a result of a 17% increase in headcount as we continue to grow our customer support and customer success teams to support our customer growth. The increase in stock-based compensation was due to the expense related to employee RSUs vesting since the completion of our IPO on December 17, 2019. Operating Expenses Research and Development Nine Months Ended September 30, Change 2020 2019 Amount % ( dollars in thousands ) Research and development $ 22,686 $ 19,137 $ 3,549 19 % Percentage of total revenue 24 % 26 % 31 The increase in research and development expense for the nine months ended September 30, 2020 compared to the nine months ended September 30, 2019 was primarily due to the following: Change ( in thousands ) Personnel costs $ 2,201 Stock-based compensation expense 1,443 Other (95) Research and development $ 3,549 Personnel costs increased primarily as a result of an 8% increase in headcount to grow our research and development teams to drive our technology innovation through the development of new products and features. The increase in stock-based compensation was due to the expense related to employee RSUs vesting since the completion of our IPO on December 17, 2019. Sales and Marketing Nine Months Ended September 30, Change 2020 2019 Amount % ( dollars in thousands ) Sales and marketing $ 42,852 $ 34,074 $ 8,778 26 % Percentage of total revenue 45 % 46 % The increase in sales and marketing expense for the nine months ended September 30, 2020 compared to the nine months ended September 30, 2019 was primarily due to the following: Change ( in thousands ) Personnel costs $ 6,340 Stock-based compensation expense 1,833 Other 605 Sales and marketing $ 8,778 Personnel costs increased primarily as a result of a 17% increase in headcount as we continue to expand our sales teams to grow our customer base, as well as additional sales commission expense due to the year over year sales growth, which increased the amortization of contract acquisition costs. The increase in stock-based compensation was due to the expense related to employee RSUs vesting since the completion of our IPO on December 17, 2019. General and Administrative Nine Months Ended September 30, Change 2020 2019 Amount % ( dollars in thousands ) General and administrative $ 30,970 $ 23,417 $ 7,553 32 % Percentage of total revenue 32 % 31 % 32 The increase in general and administrative expense for the nine months ended September 30, 2020 compared to the nine months ended September 30, 2019 was primarily due to the following: Change ( in thousands ) Personnel costs $ 5,528 Accounting and legal fees 787 Bad debt expense 707 Stock-based compensation expense (693) Other 1,224 General and administrative $ 7,553 Personnel costs increased primarily as a result of a 29% increase in headcount as we continue to grow our business and operate as a publicly traded company. Accounting and legal fees increased due to operating as a publicly traded company and costs incurred with the equity follow-on offering. Bad debt expense increased due to higher accounts receivable balances and our consideration of the potential impact of COVID-19 on our customers’ ability to pay. The decrease in stock-based compensation was due to a restricted stock award to our Chief Executive Officer that immediately vested in June 2019, partially offset by the expense in 2020 related to employee RSUs vesting since the completion of our IPO on December 17, 2019, of which the largest component related to the vesting of a RSU award granted to our President and Chief Executive Officer in connection with achievement of a market capitalization threshold that immediately vested in February 2020. The increase in other was primarily driven by an increase of $0.3 million in consulting fees, an increase of $0.3 million in charitable contributions, and other expenses related to overhead and operating as a publicly traded company. Interest Income (Expense), Net Nine Months Ended September 30, Change 2020 2019 Amount % ( dollars in thousands ) Interest income (expense), net $ 278 $ 57 $ 221 n/m (1) Percentage of total revenue — % — % _________________ (1) Calculated metric is not meaningful. The increase in net interest income was primarily driven by interest earned on cash deposits and marketable securities related to our IPO and equity follow-on proceeds. Other Income Nine Months Ended September 30, Change 2020 2019 Amount % ( dollars in thousands ) Other income $ 222 $ 388 $ (166) (43) % Percentage of total revenue — % 1 % 33 The decrease in other income is due to sublease rental income declining as the San Francisco office lease expired in June 2019. Income Tax Expense Nine Months Ended September 30, Change 2020 2019 Amount % ( dollars in thousands ) Income tax expense $ 72 $ 49 $ 23 47 % Percentage of total revenue — % — % The increase in income tax expense is due to the provision related to foreign income taxes. 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 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, may be helpful to investors because it provides consistency and comparability with past financial performance by excluding certain items that may not be indicative of our business, operating results or future outlook. However, non-GAAP financial information is presented for supplemental informational purposes only, has limitations as an analytical tool and should not be considered in isolation or as a substitute for financial information presented in accordance with GAAP. In addition, other companies, including companies in our industry, may calculate non-GAAP financial measures differently or may use other measures to evaluate their performance, all of which could reduce the usefulness of our non-GAAP financial measures as tools for comparison. 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. Three Months Ended September 30, Nine Months Ended September 30, 2020 2019 2020 2019 ( dollars in thousands, except per share data ) Non-GAAP operating loss $ (4,361) $ (5,054) $ (17,644) $ (15,990) Non-GAAP net loss (4,437) (4,974) (17,216) (15,594) Non-GAAP net loss per share (0.09) (0.30) (0.34) (0.93) Free cash flow $ (4,041) $ (3,441) $ (13,394) $ (10,256) Non-GAAP Operating Loss We define non-GAAP operating loss as GAAP loss from operations, excluding stock-based compensation expense. We believe non-GAAP operating loss provides our management and investors consistency and comparability with our past financial performance and facilitates period-to-period comparisons of operations, as this non-GAAP financial measure eliminates the effect of stock-based compensation, which is often unrelated to overall operating performance, particularly given the impact of 34 stock-based compensation expense recognized in the nine months ended September 30, 2020 after the completion of our December 2019 IPO. Three Months Ended September 30, Nine Months Ended September 30, 2020 2019 2020 2019 Reconciliation of Non-GAAP operating loss ( dollars in thousands ) Loss from operations $ (6,921) $ (5,119) $ (26,207) $ (21,353) Stock-based compensation expense 2,560 65 8,563 5,363 Non-GAAP operating loss $ (4,361) $ (5,054) $ (17,644) $ (15,990) Non-GAAP Net Loss We define non-GAAP net loss as GAAP net loss and comprehensive loss, excluding stock-based compensation expense. We believe non-GAAP net loss provides our management and investors consistency and comparability with our past financial performance and facilitates period-to-period comparisons of operations, as this non-GAAP financial measure eliminates the effect of stock-based compensation, which is often unrelated to overall operating performance, particularly given the impact of stock-based compensation expense recognized in the nine months ended September 30, 2020 after the completion of our December 2019 IPO. Three Months Ended September 30, Nine Months Ended September 30, 2020 2019 2020 2019 Reconciliation of Non-GAAP net loss ( dollars in thousands ) Net loss and comprehensive loss $ (6,997) $ (5,039) $ (25,779) $ (20,957) Stock-based compensation expense 2,560 65 8,563 5,363 Non-GAAP net loss $ (4,437) $ (4,974) $ (17,216) $ (15,594) Non-GAAP Net Loss per Share We define non-GAAP net loss per share as GAAP net loss per share attributable to common shareholders, basic and diluted, excluding stock-based compensation expense. We believe non-GAAP net loss per share provides our management and investors consistency and comparability with our past financial performance and facilitates period-to-period comparisons of operations, as this non-GAAP financial measure eliminates the effect of stock-based compensation, which is often unrelated to overall operating performance, particularly given the impact of stock-based compensation expense recognized in the nine months ended September 30, 2020 after the completion of our December 2019 IPO. Three Months Ended September 30, Nine Months Ended September 30, 2020 2019 2020 2019 Reconciliation of Non-GAAP net loss per share Net loss per share attributable to common shareholders, basic and diluted $ (0.13) $ (0.30) $ (0.51) $ (1.25) Stock-based compensation expense per share (1) 0.04 — 0.17 0.32 Non-GAAP net loss per share $ (0.09) $ (0.30) $ (0.34) $ (0.93) _________________ (1) Value for the three months ended September 30, 2020, has been rounded down for presentation purposes to equal the difference between the calculated GAAP net loss per share and calculated Non-GAAP net loss per share. 35 Free Cash Flow Free cash flow is a non-GAAP financial measure that we define as net cash used in operating activities less purchases of property and equipment. We believe that free cash flow is a useful indicator of liquidity that provides information to management and investors about the amount of cash used in our core operations that, after the purchases of property and equipment, is not available to be used for strategic initiatives. For example, if free cash flow is negative, we may need to access cash reserves or other sources of capital to invest in strategic initiatives. One limitation of free cash flow is that it does not reflect our future contractual obligations. Additionally, free cash flow does not represent the total increase or decrease in our cash balance for a given period. Three Months Ended September 30, Nine Months Ended September 30, 2020 2019 2020 2019 Reconciliation of Free cash flow ( dollars in thousands ) Net cash (used in) operating activities $ (2,633) $ (3,272) $ (11,178) $ (9,712) Purchases of property and equipment (1,408) (169) (2,216) (544) Free cash flow $ (4,041) $ (3,441) $ (13,394) $ (10,256) Liquidity and Capital Resources Our liquidity and capital resources were not materially impacted by the COVID-19 pandemic and the governmental responses to address the pandemic and the related economic impact during the nine months ended September 30, 2020. For further discussion regarding the future potential impacts of COVID-19 and the related economic impacts on our liquidity and capital resources, see “Outlook” and “Part II - Item 1A - Risk Factors”. As of September 30, 2020, our principal sources of liquidity were cash and cash equivalents of $117.8 million, marketable securities of $49.5 million and net accounts receivable of $14.4 million. We have generated losses from operations and negative cash flows from operations, as evidenced by our accumulated deficit and statement of cash flows. We expect to continue to incur operating losses and negative operating cash flows for the foreseeable future due to the investments in our business we intend to make as described above. We may experience greater than anticipated operating losses in the short- and long-term if the COVID-19 pandemic and the governmental responses to address the pandemic and any re-emergence of COVID-19 persist for a prolonged period of time. The impact of the COVID-19 pandemic on our customers and our operations going forward remains uncertain, and we continue to proactively monitor our liquidity position. Prior to our IPO in December 2019, we financed our operations primarily through private issuance of equity securities and line of credit borrowings. In our IPO, we received net proceeds of $134.3 million after deducting underwriting discounts and commissions of $10.5 million and offering expenses of $5.2 million. We subsequently received an additional $10.0 million of net proceeds after deducting underwriting discounts and commissions in January 2020 as a result of the over-allotment option exercise by the underwriters of our IPO. In August 2020, we received $42.1 million of net proceeds from our equity follow-on offering after deducting underwriting discounts and commissions. Our principal uses of cash in recent periods have been to fund operations and invest in capital expenditures. We believe our existing cash and cash equivalents will be sufficient to meet our operating and capital 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 impact of the COVID-19 pandemic on our customers and our operations, the timing and extent of spending to support our research and development efforts, the expansion of sales and marketing activities, the introduction of new and enhanced product offerings, and the continuing market acceptance of our 36 product. In the future, we may enter into arrangements to acquire or invest in complementary businesses, products 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, our business, results of operations and financial condition could be adversely affected. SVB Credit Facility In December 2017, we entered into a Loan and Security Agreement with Silicon Valley Bank, or SVB, which comprised a $15.0 million line of credit, or the Revolver, and a $5.0 million incremental revolving line commitment, or the Incremental Revolver, and, together with the Revolver, the SVB Credit Facility. In November 2019, we amended the SVB Credit Facility to increase the Revolver (including the exercise of the Incremental Revolver, as amended) to $40.0 million and amended, among other terms, levels for the minimum adjusted EBITDA and minimum liquidity covenants, the advance rate and the interest rate. The November 2019 amendment includes a “streamline period”, or Streamline Period, concept, which occurs when we maintain, for every consecutive day in the immediately preceding fiscal quarter, the sum of (i) unrestricted cash at SVB plus (ii) unused availability under the Revolver in an amount equal to or greater than $75.0 million (the Streamline Balance). Any Streamline Period terminates on the earlier of the occurrence of an event of default and failure to maintain the Streamline Balance. The minimum adjusted EBITDA and minimum liquidity covenants do not apply during any Streamline Period. As of September 30, 2020, we did not have any outstanding principal balance under the SVB Credit Facility. In connection with the November 2019 amendment, the Revolver now has a floating interest rate equal to the greater of (i) 4.75% and (ii) (x) at any time when the Streamline Period is not in effect, one and one-half of one percent (1.50%) above the prime rate and (y) at any time when the Streamline Period is in effect, the prime rate, which interest is payable monthly. The SVB Credit Facility matures on January 31, 2022. The SVB Credit Facility contains customary negative covenants that limit our ability to, or require mandatory prepayment in the event that we, among other things, incur additional indebtedness or liens, merge with other companies or consummate certain changes of control, acquire other companies, engage in new lines of business, add new offices or business locations, make certain investments, pay dividends, transfer or dispose of certain assets, liquidate or dissolve and enter into various specified transactions. The SVB Credit Facility also contains affirmative covenants, including certain financial covenants such as minimum adjusted EBITDA and minimum liquidity covenants and financial reporting requirements. With limited exceptions, our obligations under the SVB Credit Facility are secured by all of our property other than intellectual property (which is subject to a negative pledge). As of September 30, 2020, we were in compliance with the covenants in the SVB Credit Facility. The following table summarizes our cash flows for the periods presented: Nine Months Ended September 30, 2020 2019 (in thousands) Net cash (used in) operating activities $ (11,178) $ (9,712) Net cash (used in) investing activities (51,938) (544) Net cash provided by (used in) financing activities 45,584 (3,334) Net (decrease) in cash $ (17,532) $ (13,590) 37 Operating Activities Our largest source of operating cash is cash collections from our customers for subscription services. Our primary uses of cash from operating activities are for personnel costs across the sales and marketing and research and development departments and hosting costs. Historically, we have generated negative cash flows from operating activities. Net cash used in operating activities during the nine months ended September 30, 2020 was $11.2 million, which resulted from a net loss of $25.8 million adjusted for non-cash charges of $20.4 million and net cash outflow of $5.8 million from changes in operating assets and liabilities. Non-cash charges primarily consisted of $8.6 million of stock-based compensation expense, $3.2 million of depreciation and intangible asset amortization expense, $5.4 million for amortization of deferred contract acquisition costs, which were primarily commissions, $1.9 million for bad debt expense and $0.9 million of amortization of right-of-use, or ROU, operating lease assets. The net cash outflow from changes in operating assets and liabilities was primarily the result of a $9.0 million increase in deferred commissions due to the addition of new customers and expansion of the business, a $5.2 million increase in gross accounts receivable, and a $0.4 million decrease in operating lease liabilities. These outflows were primarily offset by a $7.7 million increase in deferred revenue and a $0.7 million increase in accounts payable and other accrued liabilities. Net cash used in operating activities during the nine months ended September 30, 2019 was $9.7 million, which resulted from a net loss of $21.0 million adjusted for non-cash charges of $14.1 million and net cash outflow of $2.8 million from changes in operating assets and liabilities. Non-cash charges primarily consisted of $5.4 million of stock-based compensation expense, $3.2 million of depreciation and intangible asset amortization expense, $3.4 million for amortization of deferred contract acquisition costs, which were primarily commissions, $1.2 million for bad debt expense and $0.8 million of amortization of right-of-use, or ROU, operating lease assets. The net cash outflow from changes in operating assets and liabilities was primarily the result of a $4.9 million increase in deferred commissions due to the addition of new customers and expansion of the business, a $0.9 million increase in gross accounts receivable, a $0.8 million increase in prepaid expenses and a $0.9 million decrease in operating lease liabilities. These outflows were offset by a $5.1 million increase in deferred revenue. Investing Activities Net cash used in investing activities for the nine months ended September 30, 2020 was $51.9 million, which was primarily due to the $49.7 million purchase of marketable securities in June 2020. Purchases of property and equipment of $2.2 million was driven by leasehold improvements of our Seattle office. Net cash used in investing activities for the nine months ended September 30, 2019 was $0.5 million, which was primarily due to purchases of computer equipment and hardware. Financing Activities Net cash provided by financing activities for the nine months ended September 30, 2020 was $45.6 million, which was primarily the result of $42.1 million of net proceeds from our equity follow-on offering, $10.0 million of net proceeds from our sale of over-allotment shares to the underwriters of our IPO, offset by $6.3 million in payments related to the employee withholding taxes as a result of the net settlement of stock-based awards. Net cash used in financing activities for the nine months ended September 30, 2019 was $3.3 million, which was the result of $1.8 million in payments related to the employee taxes due as a result of the net settlement of stock-based awards and $1.6 million in payments of deferred costs associated with our IPO. 38 Contractual Obligations The following table summarizes our non-cancellable contractual obligations as of September 30, 2020. Payments Due by Period Total Less Than One Year 1-3 Years 3-5 Years More Than Five Years ( in thousands ) Operating lease obligations (1) $ 33,058 $ 3,531 $ 7,905 $ 8,271 $ 13,351 Other purchase obligations (2) 66,597 18,758 47,839 — — Total $ 99,655 $ 22,289 $ 55,744 $ 8,271 $ 13,351 _________________ (1) Excludes $0.7 million of lease incentives that will be realized in 2020. (2) Consists of minimum guaranteed purchase commitments for data and services. Off-Balance Sheet Arrangements As of September 30, 2020, we did not have any relationships with any entities 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 purposes. Recent Accounting Pronouncements Refer to section titled “Recently Adopted Accounting Pronouncements” in Note 1 of the notes to our unaudited condensed consolidated financial statements for more information. Critical Accounting Policies and Estimates Our unaudited condensed consolidated financial statements are prepared in accordance with accounting principles generally accepted in the United States. The preparation of these unaudited condensed consolidated financial statements in conformity with GAAP requires management to make estimates, judgments and assumptions that affect the reported amounts of assets and liabilities and the disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenue and expenses during the reporting periods. On an ongoing basis, we evaluate our estimates and assumptions. Our actual results may differ from these estimates. Our significant accounting policies are discussed in Note 1, “Nature of Operations and Summary of Significant Accounting Policies” in the Notes to Consolidated Financial Statements as of and for the year ended December 31, 2019 included in our Annual Report on Form 10-K for the year ended December 31, 2019, filed with the SEC on February 28, 2020. There have been no significant changes to these policies during the nine months ended September 30, 2020, other than those described below and in Note 1. Stock-Based Compensation We recognize compensation expense for equity awards based on the grant‐date fair value on a straight-line basis over the remaining requisite service period for the award. Restricted Stock Units Pursuant to his employment agreement, our President and CEO is eligible to receive awards of fully vested restricted stock units with respect to shares of our Class B common stock under our 2019 Class B Incentive Plan, or the Class B Plan, covering up to 1.0% of our fully diluted common equity determined as of the date of our IPO, or 483,663 shares, following the consummation of our IPO, 39 depending on the valuation of the Company in connection with our IPO and the achievement of market capitalization thresholds thereafter, which we refer to as the Howard IPO Award. The initial grant under the Howard IPO Award was based on the valuation of the Company (calculated based on the closing price of the Company’s Class A common stock on its first trading day on The Nasdaq Capital Market on December 13, 2019) and calculated as follows: (i) a valuation between $750,000,000 and $999,999,999, would result in an initial grant under the Howard IPO Award equal to 0.5% of our outstanding fully diluted common equity; (ii) a valuation at least $1,000,000,000 but less than $2,000,000,000, would result in an initial grant under the Howard IPO Award equal to 0.75% of our fully diluted common equity; and (iii) a valuation at least $2,000,000,000, would result in an initial grant under the Howard IPO Award equal to 1.0% of our outstanding fully diluted common equity. No initial grant under the Howard IPO Award would be made as a result of our IPO if the valuation of the Company calculated as described above was below $750,000,000. The initial Howard IPO Award resulted in a grant equal to 0.5% of our fully diluted common equity, or 241,831 shares on December 17, 2019, which settled in March 2020. If during the twenty-four month period immediately following the effectiveness of our IPO, the Company achieves a “market cap threshold” (calculated based on the 30-day average of the product of the closing price per share of our Class A common stock on a trading day and the number of shares outstanding on such trading day using the treasury stock method) of $1,000,000,000 or greater, Mr. Howard is eligible to receive RSU awards under our Class B Plan equal to: (i) 0.25% of our fully diluted common equity as of the date of our IPO, or 120,916 shares, upon the Company’s achievement of a market capitalization threshold of $1,000,000,000; and (ii) 0.25% of our fully diluted common equity as of the date of our IPO, or 120,916 shares, upon the Company’s achievement of a market capitalization threshold of $2,000,000,000, in each case, to the extent the applicable market capitalization threshold value was not previously achieved in connection with any previous grant made under the Howard IPO Award, and subject to Mr. Howard’s continued service to the Company through each applicable award date. All such RSUs granted pursuant to the Howard IPO Award will be fully vested and the maximum number of Class B common stock issuable upon settlement of such RSUs will not exceed 1.0% of our fully diluted common equity (as described above). In February 2020, Mr. Howard received 120,916 RSUs upon the Company’s achievement of a market capitalization threshold of $1,000,000,000, which settled in June 2020. In connection with RSUs granted to Mr. Howard pursuant to the Howard IPO Award that immediately vested in February 2020, we recognized $1.4 million of stock-based compensation expense in the first quarter of 2020. Because the maximum company valuation was not achieved through September 30, 2020, Mr. Howard remained eligible to receive an additional grant up to the maximum award contemplated by the Howard IPO Award if a certain market capitalization threshold is achieved during the first twenty-four months following the completion of our IPO (as described above). In October 2020, the Company achieved the market capitalization threshold of $2,000,000,000. As a result, in the fourth quarter, Mr. Howard will receive the remaining 120,916 shares and the remaining stock-based compensation expense of $0.2 million will be recognized. JOBS Act Accounting Election We are an “emerging growth company” as defined in the JOBS Act. Under the JOBS Act, emerging growth companies can delay adopting new or revised accounting standards until such time as those standards apply to private companies. We have elected to use this exemption from new or revised accounting standards and, therefore, we will not be subject to the same new or revised accounting standards as other public companies that have not made this election. While we have elected to use this extended transition period, to date we have not delayed the adoption of any applicable accounting standards. 40