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DOCUSIGN, INC. - Quarter Report: 2019 October (Form 10-Q)

UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
______________________________________
FORM 10-Q
______________________________________

(Mark One)
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended October 31, 2019
or
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from                 to                
Commission File Number: 001-38465
______________________________________
DOCUSIGN, INC.
(Exact name of registrant as specified in its charter)
______________________________________
Delaware
 
91-2183967
(State or Other Jurisdiction of Incorporation)
 
(I.R.S. Employer Identification Number)
 
 
 
 
 
221 Main St.
Suite 1550
San Francisco
California
94105
(Address of Principal Executive Offices)
(Zip Code)
(415) 489-4940
(Registrant’s Telephone Number, Including Area Code)

Securities registered pursuant to Section 12(b) of the Act:
Title of each class
Trading Symbol
Name of each exchange on which registered
Common Stock, par value $0.0001 per share
DOCU
The Nasdaq Stock Market LLC

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 (Exchange Act) during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes     No 
Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit such files). Yes     No 
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company, or an emerging growth company. See definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company,” and “emerging growth company” in Rule 12b-2 of the Exchange Act.
Large accelerated filer
Accelerated filer
 
 
 
 
Non-accelerated filer
Smaller reporting company
 
 
 
 
Emerging growth company
 
 
If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. 
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).    Yes     No 
The registrant has 179,455,116 shares of common stock, par value $0.0001, outstanding at November 30, 2019.



DOCUSIGN, INC.
TABLE OF CONTENTS

 
 
 
 
 
 
 
 
 
 
 
 


2


NOTE REGARDING FORWARD-LOOKING STATEMENTS

This Quarterly Report on Form 10-Q contains forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended, which statements involve substantial risk and uncertainties. All statements contained in this Quarterly Report on Form 10-Q other than statements of historical fact, including statements regarding our future operating results and financial position, our business strategy and plans, market growth and trends, and our objectives for future operations, are forward-looking statements. Forward-looking statements generally relate to future events or our future financial or operating performance. In some cases, you can identify forward-looking statements because they contain words such as “may,” “will,” “should,” “expects,” “plans,” “anticipates,” “could,” “intends,” “target,” “projects,” “contemplates,” “believes,” “estimates,” “predicts,” “potential,” or “continue” or the negative of these words or other similar terms or expressions that concern our expectations, strategy, plans or intentions. Forward-looking statements contained in this Quarterly Report on Form 10-Q include, but are not limited to, statements about:
our ability to effectively sustain and manage our growth and future expenses, and our ability to achieve and maintain future profitability;
our ability to attract new customers and to maintain and expand our existing customer base;
our ability to scale and update our software suite to respond to customers’ needs and rapid technological change;
the effects of increased competition on our market and our ability to compete effectively;
our ability to expand use cases within existing customers and vertical solutions;
our ability to expand our operations and increase adoption of our software suite internationally;
our ability to strengthen and foster our relationship with developers;
our ability to expand our direct sales force, customer success team and strategic partnerships around the world;
our ability to identify targets for and execute potential acquisitions;
our ability to successfully integrate the operations of businesses we may acquire, or to realize the anticipated benefits of such acquisitions;
our ability to maintain, protect and enhance our brand;
the sufficiency of our cash and cash equivalents to satisfy our liquidity needs;
our failure or the failure of our software suite of services to comply with applicable industry standards, laws and regulations;
our ability to maintain, protect and enhance our intellectual property;
our ability to successfully defend litigation against us;
our ability to attract large organizations as users;
our ability to maintain our corporate culture;
our ability to offer high-quality customer support;
our ability to hire, retain and motivate qualified personnel;
our ability to estimate the size and potential growth of our target market; and
our ability to maintain proper and effective internal controls.

In addition, statements that “we believe” and similar statements reflect our beliefs and opinions on the relevant subject. These statements are based upon information available to us as of the date of this Quarterly Report on Form 10-Q, and while we believe such information forms a reasonable basis for such statements, such information may be limited or incomplete, and our statements should not be read to indicate that we have conducted an exhaustive inquiry into, or review of, all potentially available relevant information. These statements are inherently uncertain, and investors are cautioned not to unduly rely upon these statements.

You should not rely upon forward-looking statements as predictions of future events. We have based the forward-looking statements contained in this Quarterly Report on Form 10-Q primarily on our current expectations and projections about future events and trends that we believe may affect our business, financial condition, results of operations, and prospects. The outcome of the events described in these forward-looking statements is subject to risks, uncertainties, and other factors described in the section titled “Risk Factors” and elsewhere in this Quarterly Report on Form 10-Q. Moreover, we operate in a very competitive and rapidly changing environment. New risks and uncertainties emerge from time to time, and it is not possible for us to predict all risks and uncertainties that could have an impact on the forward-looking statements contained in this Quarterly Report on Form 10-Q. We cannot assure you that the results, events, and circumstances reflected in the forward-looking statements will be achieved or occur, and actual results, events, or circumstances could differ materially from those described in the forward-looking statements.

The forward-looking statements made in this Quarterly Report on Form 10-Q relate only to events as of the date on which such statements are made. We undertake no obligation to update any forward-looking statements after the date of this

3


Quarterly Report on Form 10-Q or to conform such statements to actual results or revised expectations, except as required by law.

4


PART I - FINANCIAL INFORMATION
ITEM 1. CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
DOCUSIGN, INC.
CONDENSED CONSOLIDATED BALANCE SHEETS (Unaudited)
(in thousands, except per share data)
October 31, 2019
 
January 31, 2019
Assets
 
 
 
Current assets
 
 
 
Cash and cash equivalents
$
197,697

 
$
517,811

Investments—current
456,080

 
251,203

Restricted cash
414

 
367

Accounts receivable
159,464

 
174,548

Contract assets—current
17,921

 
10,616

Prepaid expense and other current assets
37,814

 
29,976

Total current assets
869,390

 
984,521

Investments—noncurrent
257,783

 
164,220

Property and equipment, net
105,917

 
75,832

Operating lease right-of-use assets
136,627

 

Goodwill
195,024

 
195,225

Intangible assets, net
60,759

 
74,203

Deferred contract acquisition costs—noncurrent
136,248

 
112,583

Other assets—noncurrent
24,617

 
8,833

Total assets
$
1,786,365

 
$
1,615,417

Liabilities and Stockholders' Equity
 
 
 
Current liabilities
 
 
 
Accounts payable
$
29,099

 
$
19,590

Accrued expenses
33,094

 
21,755

Accrued compensation
70,860

 
77,553

Contract liabilities—current
423,742

 
381,060

Operating lease liabilities—current
18,743

 

Deferred rent—current

 
2,452

Other liabilities—current
12,956

 
13,903

Total current liabilities
588,494

 
516,313

Convertible senior notes, net
458,578

 
438,932

Contract liabilities—noncurrent
9,339

 
7,712

Operating lease liabilities—noncurrent
150,362

 

Deferred rent—noncurrent

 
24,195

Deferred tax liability—noncurrent
4,275

 
4,207

Other liabilities—noncurrent
5,955

 
9,696

Total liabilities
1,217,003

 
1,001,055

Commitments and contingencies (Note 11)

 

Stockholders' equity
 
 
 
Preferred stock, $0.0001 par value; 10,000 shares authorized, 0 shares issued and outstanding as of October 31, 2019 and January 31, 2019

 

Common stock, $0.0001 par value; 500,000 shares authorized, 179,252 shares outstanding as of October 31, 2019; 500,000 shares authorized, 169,303 shares outstanding as of January 31, 2019
18

 
17

Additional paid-in capital
1,660,313

 
1,545,088

Accumulated other comprehensive loss
(1,191
)
 
(1,965
)
Accumulated deficit
(1,089,778
)
 
(928,778
)
Total stockholders' equity
569,362

 
614,362

Total liabilities and stockholders' equity
$
1,786,365

 
$
1,615,417

The accompanying notes are an integral part of these unaudited condensed consolidated financial statements.

5


DOCUSIGN, INC.
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS AND COMPREHENSIVE LOSS (Unaudited)
 
Three Months Ended October 31,
 
Nine Months Ended October 31,
(in thousands, except per share data)
2019
 
2018
 
2019
 
2018
Revenue:
 
 
 
 
 
 
 
Subscription
$
238,072

 
$
169,426

 
$
660,341

 
$
476,085

Professional services and other
11,430

 
8,959

 
38,735

 
25,152

Total revenue
249,502

 
178,385

 
699,076

 
501,237

Cost of revenue:
 
 
 
 
 
 
 
Subscription
43,178

 
28,709

 
115,769

 
84,204

Professional services and other
18,786

 
16,364

 
59,390

 
55,524

Total cost of revenue
61,964

 
45,073

 
175,159

 
139,728

Gross profit
187,538

 
133,312

 
523,917

 
361,509

Operating expenses:
 
 
 
 
 
 
 
Sales and marketing
149,231

 
117,051

 
430,053

 
411,915

Research and development
48,758

 
38,404

 
133,458

 
143,047

General and administrative
33,546

 
36,274

 
111,562

 
170,242

Total operating expenses
231,535

 
191,729

 
675,073

 
725,204

Loss from operations
(43,997
)
 
(58,417
)
 
(151,156
)
 
(363,695
)
Interest expense
(7,364
)
 
(3,503
)
 
(21,793
)
 
(3,743
)
Interest income and other income, net
5,801

 
3,395

 
15,549

 
4,165

Loss before provision for (benefit from) income taxes
(45,560
)
 
(58,525
)
 
(157,400
)
 
(363,273
)
Provision for (benefit from) income taxes
1,038

 
(5,712
)
 
3,552

 
(3,059
)
Net loss
$
(46,598
)
 
$
(52,813
)
 
$
(160,952
)
 
$
(360,214
)
Net loss per share attributable to common stockholders, basic and diluted
$
(0.26
)
 
$
(0.31
)
 
$
(0.92
)
 
$
(2.90
)
Weighted-average number of shares used in computing net loss per share attributable to common stockholders, basic and diluted
178,314

 
167,736

 
175,303

 
124,343

 
 
 
 
 
 
 
 
Other comprehensive income (loss):
 
 
 
 
 
 
 
Foreign currency translation gain (loss), net of tax
$
1,336

 
$
(1,483
)
 
$
(340
)
 
$
(6,896
)
Unrealized gains on investments, net of tax
418

 

 
1,114

 

Other comprehensive income (loss)
1,754

 
(1,483
)
 
774

 
(6,896
)
Comprehensive loss
$
(44,844
)
 
$
(54,296
)
 
$
(160,178
)
 
$
(367,110
)
 
 
 
 
 
 
 
 
Stock-based compensation expense included in costs and expenses:
 
 
 
 
 
 
 
Cost of revenue—subscription
$
3,534

 
$
2,398

 
$
8,931

 
$
13,941

Cost of revenue—professional services
3,616

 
3,578

 
11,877

 
22,445

Sales and marketing
24,649

 
22,338

 
68,693

 
151,610

Research and development
11,679

 
9,919

 
30,959

 
64,546

General and administrative
9,258

 
13,515

 
30,339

 
109,165


The accompanying notes are an integral part of these unaudited condensed consolidated financial statements.

6


DOCUSIGN, INC.
CONDENSED CONSOLIDATED STATEMENTS OF REDEEMABLE CONVERTIBLE PREFERRED STOCK AND STOCKHOLDERS’ EQUITY (Unaudited)
 
Common Stock
 
Additional Paid-In Capital
 
Accumulated Other Comprehensive Income (Loss)
 
Accumulated Deficit
 
Total Stockholders’ Equity
(in thousands)
Shares
 
Amount
 
 
 
 
Balances at July 31, 2019
175,953

 
$
18

 
$
1,612,786

 
$
(2,945
)
 
$
(1,043,180
)
 
$
566,679

Exercise of stock options
1,877

 

 
19,815

 

 

 
19,815

Settlement of RSUs
1,777

 

 

 

 

 

Tax withholding on RSU settlement
(632
)
 

 
(39,310
)
 

 

 
(39,310
)
Employee stock purchase plans
277

 

 
13,309

 

 

 
13,309

Employee stock-based compensation expense

 

 
53,677

 

 

 
53,677

Non-employee stock-based compensation expense

 

 
36

 

 

 
36

Net loss

 

 

 

 
(46,598
)
 
(46,598
)
Other comprehensive income, net

 

 

 
1,754

 

 
1,754

Balances at October 31, 2019
179,252

 
$
18

 
$
1,660,313

 
$
(1,191
)
 
$
(1,089,778
)
 
$
569,362


 
Common Stock
 
Additional Paid-In Capital
 
Accumulated Other Comprehensive Loss
 
Accumulated Deficit
 
Total Stockholders’ Equity
(in thousands)
Shares
 
Amount
 
 
 
 
Balances at July 31, 2018
156,786

 
$
16

 
$
1,555,185

 
$
(2,010
)
 
$
(809,721
)
 
$
743,470

Exercise of stock options
469

 

 
5,048

 

 

 
5,048

Employee stock-based compensation expense

 

 
52,126

 

 

 
52,126

Non-employee stock-based compensation expense

 

 
53

 

 

 
53

Equity component of Convertible Senior Notes

 

 
131,331

 
 
 
 
 
131,331

Purchase of capped calls related to issuance of Convertible Senior Notes

 

 
(67,563
)
 
 
 
 
 
(67,563
)
Net loss

 

 

 

 
(52,813
)
 
(52,813
)
Other comprehensive loss, net

 

 

 
(1,483
)
 

 
(1,483
)
Balances at October 31, 2018
157,255

 
$
16

 
$
1,676,180

 
$
(3,493
)
 
$
(862,534
)
 
$
810,169


The accompanying notes are an integral part of these unaudited condensed consolidated financial statements.

7


DOCUSIGN, INC.
CONDENSED CONSOLIDATED STATEMENTS OF REDEEMABLE CONVERTIBLE PREFERRED STOCK AND STOCKHOLDERS’ EQUITY (Continued) (Unaudited)
 
Common Stock
 
Additional Paid-In Capital
 
Accumulated Other Comprehensive Income (Loss)
 
Accumulated Deficit
 
Total Stockholders’ Equity
(in thousands)
Shares
 
Amount
 
 
 
 
Balances at January 31, 2019
169,303

 
$
17

 
$
1,545,088

 
$
(1,965
)
 
$
(928,778
)
 
$
614,362

Exercise of stock options
5,746

 

 
62,263

 

 

 
62,263

Settlement of RSUs
5,921

 
1

 
(1
)
 

 

 

Tax withholding on RSU settlement
(2,226
)
 

 
(125,288
)
 

 

 
(125,288
)
Employee stock purchase plan
508

 

 
23,872

 

 

 
23,872

Employee stock-based compensation expense

 

 
154,274

 

 

 
154,274

Non-employee stock-based compensation expense

 

 
105

 

 

 
105

Net loss

 

 

 

 
(160,952
)
 
(160,952
)
Cumulative impact of Topic 842 adoption

 

 

 

 
(48
)
 
(48
)
Other comprehensive income, net

 

 

 
774

 

 
774

Balances at October 31, 2019
179,252

 
$
18

 
$
1,660,313

 
$
(1,191
)
 
$
(1,089,778
)
 
$
569,362


 
Redeemable Convertible Preferred Stock
 
 
Common Stock
 
Additional Paid-In Capital
 
Accumulated Other Comprehensive Income (Loss)
 
Accumulated Deficit
 
Total Stockholders’ Equity (Deficit)
(in thousands)
Shares
 
Amount
 
 
Shares
 
Amount
 
 
 
 
Balances at January 31, 2018
100,226

 
$
547,501

 
 
35,700

 
$
4

 
$
160,265

 
$
3,403

 
$
(502,320
)
 
$
(338,648
)
Exercise of stock options

 

 
 
1,869

 

 
15,365

 

 

 
15,365

Employee stock-based compensation expense

 

 
 

 

 
362,260

 

 

 
362,260

Non-employee stock-based compensation expense

 

 
 

 

 
886

 

 

 
886

Accretion of preferred stock

 
353

 
 

 

 
(353
)
 

 

 
(353
)
Issuance of common stock in connection with initial public offering, net of offering costs

 

 
 
19,314

 
2

 
525,297

 

 

 
525,299

Conversion of redeemable convertible preferred stock to common stock in connection with initial public offering
(100,226
)
 
(547,854
)
 
 
100,350

 
10

 
547,844

 

 

 
547,854

Conversion of preferred stock warrant to common stock warrant in connection with initial public offering

 

 
 

 

 
848

 

 

 
848

Equity component of Convertible Senior Notes

 

 
 

 

 
131,331

 

 

 
131,331

Purchase of capped calls related to issuance of Convertible Senior Notes

 

 
 

 

 
(67,563
)
 

 

 
(67,563
)
Exercise of warrants

 

 
 
22

 

 

 

 

 

Net loss

 

 
 

 

 

 

 
(360,214
)
 
(360,214
)
Other comprehensive loss, net

 

 
 

 

 

 
(6,896
)
 

 
(6,896
)
Balances at October 31, 2018

 
$

 
 
157,255

 
$
16

 
$
1,676,180

 
$
(3,493
)
 
$
(862,534
)
 
$
810,169

The accompanying notes are an integral part of these unaudited condensed consolidated financial statements.


8


DOCUSIGN, INC.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (Unaudited)
 
Nine Months Ended October 31,
(in thousands)
2019
 
2018
Cash flows from operating activities:
 
 
 
Net loss
$
(160,952
)
 
$
(360,214
)
Adjustments to reconcile net loss to net cash used in operating activities
 
 
 
Depreciation and amortization
36,916

 
26,024

Amortization of deferred contract acquisition and fulfillment costs
49,360

 
29,889

Amortization of debt discount and transaction costs
19,647

 
3,147

Non-cash operating lease costs
13,843

 

Stock-based compensation expense
150,799

 
361,707

Deferred income taxes
42

 
(7,347
)
Other
(2,142
)
 
(2,079
)
Changes in operating assets and liabilities
 
 
 
Accounts receivable
15,084

 
1,366

Contract assets
(7,223
)
 
2,774

Prepaid expenses and other current assets
(2,036
)
 
(2,383
)
Deferred contract acquisition and fulfillment costs
(77,800
)
 
(52,545
)
Other assets
926

 
2,002

Accounts payable
2,306

 
(5,990
)
Accrued expenses
7,236

 
3,610

Accrued compensation
(6,693
)
 
2,171

Contract liabilities
44,309

 
35,856

Operating lease liabilities
(10,886
)
 

Other liabilities
(2,545
)
 
3,961

Net cash provided by operating activities
70,191

 
41,949

Cash flows from investing activities:
 
 
 
Purchases of marketable securities
(753,934
)
 

Maturities of marketable securities
460,710

 

Purchases of strategic investments
(15,500
)
 

Cash paid for acquisition, net of acquired cash

 
(218,779
)
Purchases of property and equipment
(42,071
)
 
(19,096
)
Net cash used in investing activities
(350,795
)
 
(237,875
)
Cash flows from financing activities:
 
 
 
Proceeds from issuance of convertible senior notes, net of initial purchasers' discounts and transaction costs

 
560,756

Purchase of capped calls related to issuance of convertible senior notes

 
(67,563
)
Proceeds from issuance of common stock in initial public offering, net of underwriting commissions

 
529,305

Payment of tax withholding obligation on RSU settlement
(125,288
)
 

Proceeds from exercise of stock options
62,263

 
15,365

Proceeds from employee stock purchase plan
23,872

 

Payment of deferred offering costs

 
(3,692
)
Net cash provided by (used in) financing activities
(39,153
)
 
1,034,171

Effect of foreign exchange on cash, cash equivalents and restricted cash
(310
)
 
(1,181
)
Net increase (decrease) in cash, cash equivalents and restricted cash
(320,067
)
 
837,064

Cash, cash equivalents and restricted cash at beginning of period
518,178

 
257,436

Cash, cash equivalents and restricted cash at end of period
$
198,111

 
$
1,094,500

The accompanying notes are an integral part of these unaudited condensed consolidated financial statements.


9


DOCUSIGN, INC.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (Continued) (Unaudited)
 
Nine Months Ended October 31,
(in thousands)
2019
 
2018
Supplemental disclosure:
 
 
 
Cash paid for interest
$
2,852

 
$
204

Cash paid for operating lease liabilities
16,313

 

Cash paid for taxes
1,745

 
2,718

Non-cash investing and financing activities:
 
 
 
Property and equipment in accounts payable and other accrued liabilities
$
13,162

 
$
4,889

Conversion of redeemable convertible preferred stock to common stock in connection with initial public offering

 
547,854

Conversion of preferred stock warrant to common stock warrant in connection with initial public offering

 
848

Preferred stock accretion

 
353

Recognition of build-to-suit lease

 
2,479

Operating lease right-of-use assets exchanged for lease obligations
58,694

 

Derecognition of build-to-suit lease
2,479

 


The accompanying notes are an integral part of these unaudited condensed consolidated financial statements.

10


DOCUSIGN, INC.
Index for Notes to the Condensed Consolidated Financial Statements



11



DOCUSIGN, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)

Note 1. Summary of Significant Accounting Policies

Organization and Description of Business

DocuSign, Inc. (“we,” “our” or “us”) was incorporated in the State of Washington in April 2003. We merged with and into DocuSign, Inc., a Delaware corporation, in March 2015.

We provide a platform that enables businesses of all sizes to digitally prepare, execute and act on agreements, thereby simplifying and accelerating the process of doing business.

Basis of Presentation and Principles of Consolidation

Our condensed consolidated financial statements include the accounts of DocuSign, Inc. and our subsidiaries. All intercompany transactions and balances have been eliminated in consolidation.
    
Our condensed consolidated financial statements have been prepared in accordance with United States (“U.S.”) generally accepted accounting principles (“GAAP”) for interim financial information. Certain information and note disclosures normally included in the financial statements prepared in accordance with GAAP have been condensed or omitted pursuant to the applicable rules and regulations of the Securities and Exchange Commission (“SEC”). Therefore, these unaudited interim consolidated financial statements should be read in conjunction with the consolidated financial statements and related notes included in our 2019 Annual Report on Form 10-K.

Our condensed consolidated financial statements are unaudited and have been prepared on a basis consistent with that used to prepare the audited annual consolidated financial statements and, in our opinion, include all adjustments of a normal recurring nature necessary for the fair statement of our financial position, results of operations and cash flows. Our condensed consolidated balance sheet as of January 31, 2019 was derived from audited financial statements but does not include all disclosures required by GAAP. The results of operations for the nine months ended October 31, 2019 are not necessarily indicative of the results to be expected for the year ending January 31, 2020.

Our fiscal year ends on January 31. References to fiscal 2020, for example, are to the fiscal year ending January 31, 2020.

Use of Estimates

The preparation of financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates.

Items subject to such estimates and assumptions include those related to the allocation of revenue between recognized and deferred amounts, allowance for bad debts, goodwill, intangible assets, deferred contract acquisition costs, customer benefit period, fair value of financial instruments, valuation of stock-based compensation, valuation of common stock, fair value of the liability and equity components of the convertible notes, whether an arrangement is or contains a lease, the discount rate used for operating leases, and the valuation allowance for deferred income taxes.

Significant Accounting Policies

Other than described below, there have been no changes to our significant accounting policies described in our 2019 Annual Report on Form 10-K that have had a material impact on our consolidated financial statements and related notes.

Leases

Leases arise from contractual obligations that convey the right to control the use of identified property, plant or equipment for a period of time in exchange for consideration. We determine whether an arrangement is or contains a lease at inception, based on whether there is an identified asset and whether we control the use of the identified asset throughout the period of use. At lease commencement date, we determine lease classification between finance and operating, allocate the

12



consideration to the lease and nonlease components and recognize a right-of-use asset and corresponding lease liability for each lease component. A right-of-use asset represents our right to use an underlying asset and a lease liability represents our obligation to make payments during the lease term.

The lease liability is initially measured as the present value of the remaining lease payments over the lease term. The discount rate used to determine the present value is our incremental borrowing rate unless the interest rate implicit in the lease is readily determinable. We estimate our incremental borrowing rate based on the information available at lease commencement date for borrowings with a similar term. The right-of-use asset is initially measured as the present value of the lease payments, adjusted for initial direct costs, prepaid lease payments to lessors and lease incentives. Our operating lease right-of-use assets and liabilities recognized at February 1, 2019, the adoption date, were based on the present value of lease payments over the remaining lease term as of that date, using the incremental borrowing rate as of that date.

We do not recognize right-of-use assets and liabilities for leases with a term of twelve months or less. Additionally, we do not separate nonlease components from the associated lease components for our office leases and certain other asset classes. The total consideration includes fixed payments and contractual escalation provisions. We are responsible for maintenance, insurance, property taxes and other variable payments, which are expensed as incurred. Our leases include options to renew or terminate. We include the option to renew or terminate in our determination of the lease term when the option is deemed to be reasonably assured to be exercised. 

Operating leases are classified in “Operating lease right-of-use assets”, “Operating lease liabilities—current”, and “Operating lease liabilities—noncurrent” on our condensed consolidated balance sheets. Operating lease expense is recognized on a straight-line basis over the expected lease term and included in “Loss from operations” in our condensed consolidated statements of operations and comprehensive loss.

Strategic Investments

Our strategic investments consist of non-marketable equity investments in privately-held companies in which we do not have a controlling interest or significant influence. We have elected to apply the measurement alternative for equity investments that do not have readily determinable fair values, measuring them at cost, less any impairment, plus or minus adjustments resulting from observable price changes in orderly transactions for the identical or a similar investment of the same issuer. An impairment loss is recorded when an event or circumstance indicates a decline in value has occurred.

In March 2019, we purchased equity investments in privately-held companies totaling $15.5 million that were classified in “Other assets—noncurrent” on our condensed consolidated balance sheets. As there have been no material observable price changes, we have not recorded any adjustments resulting from observable price changes for identical or similar investments or impairment charges for any of our equity investments in privately-held companies in the nine months ended October 31, 2019. We had no such investments as of January 31, 2019.

Recently Adopted Accounting Pronouncements

On February 1, 2019, we adopted Accounting Standards Update (“ASU”) No. 2016-02, Leases (Topic 842). We elected the optional transition approach to not apply Topic 842 in the comparative periods presented. We elected the practical expedient to use hindsight when determining the lease term and the package of practical expedients to not reassess whether existing contracts contain leases, the lease classification for existing leases and whether existing initial direct costs meet the new definition. The adoption of Topic 842 resulted in the derecognition of $26.6 million in deferred rent and the recognition of total right-of-use assets of $93.9 million and total lease liabilities of $121.8 million as of the adoption date, with the most significant impact related to our office space leases, with cumulative effect adjustment being recorded in our accumulated deficit. Additionally, we derecognized $2.5 million related to the build-to-suit asset and corresponding liability upon adoption of this standard pursuant to the transition guidance provided for build-to-suit leases. The adoption of Topic 842 did not have a material impact to the consolidated statements of operations or statements of cash flows.

Other Recent Accounting Pronouncements

In June 2016, the Financial Accounting Standards Board (“FASB”) issued ASU No. 2016-13, Financial InstrumentsCredit Losses (Topic 326). The FASB subsequently issued ASU No. 2019-04, Codification Improvements to Topic 326, Financial Instruments - Credit Losses, Topic 815, Derivatives and Hedging, and Topic 825, Financial Instruments, to eliminate inconsistencies and provide clarifications to the transition requirements of ASU No. 2016-13. These ASUs change the impairment model for most financial assets and will require the use of an expected loss model in place of the currently used incurred loss method. Under this model, entities will be required to estimate the lifetime expected credit loss on such

13



instruments and record an allowance to offset the amortized cost basis of the financial asset, resulting in a net presentation of the amount expected to be collected on the financial asset. The ASUs are effective for interim and annual periods beginning after December 15, 2019. We are evaluating the impact of the adoption of the ASUs on our consolidated financial statements.

In August 2018, the FASB issued ASU No. 2018-15, Intangibles—Goodwill and Other—Internal-Use Software (Subtopic 350-40), which aligns the requirements for capitalizing implementation costs incurred in a hosting arrangement that is a service contract with the requirements for capitalizing implementation costs incurred to develop or obtain internal-use software (and hosting arrangements that include an internal use software license). The accounting for the service element of a hosting arrangement that is a service contract is not affected by the amendments in this ASU. The ASU is effective for public business entities for interim and annual periods beginning after December 15, 2019. Early adoption is permitted. We are evaluating the impact of the adoption of the ASU on our consolidated financial statements.

Note 2. Revenue and Performance Obligations

Subscription revenue is recognized over time and accounted for approximately 95% of our revenue for both the three months ended October 31, 2019 and 2018. It accounted for approximately 94% and 95% of our revenue for the nine months ended October 31, 2019 and 2018.
    
The typical subscription term is one to three years. Most of our subscription contracts are noncancelable over the contractual term. Customers typically have the right to terminate their contracts for cause, if we fail to perform. As of October 31, 2019, the aggregate amount of the transaction price allocated to remaining performance obligations was $673.3 million, which consists of both billed and unbilled consideration that we expect to recognize as subscription revenue. We expect to recognize 54% of the transaction price in the 12 months following October 31, 2019, in our consolidated statement of operations and comprehensive loss with the remainder recognized thereafter.

We do not disclose the transaction price allocated to remaining performance obligations for contracts with a contract term of one year or less. In addition, we do not disclose the transaction price related to revenue from professional services, training services and web revenue as revenue from these sources is recognized within one year.

Note 3. Fair Value Measurements
We carry certain assets at fair value. Fair value is defined as an exit price, representing the amount that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. The three-tier hierarchy for inputs used in measuring fair value, which prioritizes the inputs based on the observability as of the measurement date, is as follows:
Level 1
Quoted prices in active markets for identical assets or liabilities;
Level 2
Observable inputs other than the quoted prices in active markets for identical assets and liabilities; and
Level 3
Unobservable inputs for which there is little or no market data, which require us to develop assumptions of what market participants would use in pricing the asset or liability.


14



The following table summarizes our financial assets that are measured at fair value on a recurring basis during the period:
 
October 31, 2019
(in thousands)
Amortized Cost
 
Gross Unrealized Gains
 
Gross Unrealized Losses
 
Estimated Fair Value
Level 1:
 
 
 
 
 
 
 
Cash equivalents
 
 
 
 
 
 
 
Money market funds
$
82,438

 
$

 
$

 
$
82,438

Level 2:
 
 
 
 
 
 
 
Available-for-sale securities
 
 
 
 
 
 
 
Commercial paper
31,415

 
26

 

 
31,441

Corporate notes and bonds
368,440

 
982

 
(67
)
 
369,355

U.S. Treasury securities
135,550

 
313

 
(3
)
 
135,860

U.S. government agency securities
177,083

 
181

 
(57
)
 
177,207

Level 2 total
712,488

 
1,502

 
(127
)
 
713,863

Total
$
794,926

 
$
1,502

 
$
(127
)
 
$
796,301

 
 
 
 
 
 
 
 
 
January 31, 2019
(in thousands)
Amortized Cost
 
Gross Unrealized Gains
 
Gross Unrealized Losses
 
Estimated Fair Value
Level 1:
 
 
 
 
 
 
 
Cash equivalents
 
 
 
 
 
 
 
Money market funds
$
350,063

 
$

 
$

 
$
350,063

Level 2:
 
 
 
 
 
 
 
Cash equivalents
 
 
 
 
 
 
 
Commercial paper
76,828

 

 
(11
)
 
76,817

Corporate notes and bonds
2,998

 

 

 
2,998

U.S. government agency securities
6,491

 

 

 
6,491

Available-for-sale securities
 
 
 
 
 
 
 
Commercial paper
86,655

 
4

 
(21
)
 
86,638

Corporate notes and bonds
287,496

 
389

 
(105
)
 
287,780

U.S. Treasury securities
4,982

 

 
(1
)
 
4,981

U.S. government agency securities
36,021

 
7

 
(4
)
 
36,024

Level 2 total
501,471

 
400

 
(142
)
 
501,729

Total
$
851,534

 
$
400

 
$
(142
)
 
$
851,792



Money market funds consist of cash equivalents with original maturities of three months or less at the date of purchase. We use quoted prices in active markets for identical assets to determine the fair value of our Level 1 investments in money market funds. The fair value of our Level 2 investments is determined using pricing based on quoted market prices or alternative market observable inputs.

The fair value of our available-for-sale marketable securities as of October 31, 2019, by remaining contractual maturities, were as follows (in thousands):
Due in one year or less
$
456,080

Due in one to two years
257,783

 
$
713,863


As of October 31, 2019, we had a total of 181 available-for-sale securities, none of which were considered to be other-than-temporarily impaired.

15




Convertible Senior Notes

As of October 31, 2019, the estimated fair value of our 0.5% Convertible Senior Notes (the “Notes”) with aggregate principal amount of $575.0 million was $673.5 million. We estimated the fair value based on the quoted market prices in an inactive market on the last trading day of the reporting period (Level 2). The Notes are recorded at face value less unamortized debt discount and transaction costs as “Convertible senior notes, net” on our consolidated balance sheets. Refer to Note 9 for further information.

Note 4. Property and Equipment, Net

Property and equipment consisted of the following:
(in thousands)
October 31, 2019
 
January 31, 2019
Computer and network equipment
$
64,204

 
$
55,233

Software, including capitalized software development costs
34,371

 
27,959

Furniture and office equipment
12,343

 
9,511

Leasehold improvements
48,916

 
41,464

 
159,834

 
134,167

Less: Accumulated depreciation
(77,094
)
 
(66,479
)
 
82,740

 
67,688

Work in progress
23,177

 
8,144

 
$
105,917

 
$
75,832



Depreciation expense associated with property and equipment was $8.4 million and $6.5 million for the three months ended October 31, 2019 and 2018, and $23.5 million and $17.9 million for the nine months ended October 31, 2019 and 2018.

As of January 31, 2019, leasehold improvements include $2.5 million related to the fair value of the Israel leased space that was recorded under the build-to-suit lease guidance. Upon adoption of Topic 842 on February 1, 2019, we derecognized the build-to-suit asset and recognized an operating right-of-use asset for the related lease within the condensed consolidated balance sheet as of October 31, 2019. Refer to Note 1 for additional information.

Note 5. Acquisition of SpringCM Inc.

On September 4, 2018, we completed the acquisition of SpringCM Inc. (“SpringCM”), a cloud-based document generation and contract lifecycle management software company based in Chicago, Illinois. With the addition of SpringCM's capabilities in document generation, redlining, advanced document management and end-to-end agreement workflow, the acquisition further accelerates the broadening of our solution beyond e-signature to the rest of the agreement process—from preparing to signing, acting-on and managing agreements. Under the terms of the merger agreement, we acquired SpringCM for approximately $218.8 million in cash, excluding cash acquired, working capital and transaction cost adjustments. Of the cash paid at closing, $8.2 million is held in escrow until 18 months after closing to partially secure our indemnification rights under the merger agreement.

Additionally, we granted certain continuing employees of SpringCM restricted stock units (“RSUs”) with service and performance conditions covering up to 0.5 million shares of our common stock with an aggregate grant date fair value of $26.5 million that will be accounted for as a post-acquisition compensation expense over the vesting period. The performance-based condition will be satisfied upon SpringCM meeting certain revenue targets during the year ending January 31, 2020, and will impact the quantity of shares that will vest. As of October 31, 2019, the performance-based condition was considered probable of being met.

We accounted for the transaction as a business combination using the acquisition method of accounting. We allocated the purchase price to the tangible and identifiable intangible assets acquired and liabilities assumed based on their respective estimated fair values on the acquisition date. Fair values were determined using the valuation performed by management. Excess purchase price consideration was recorded as goodwill and is primarily attributable to the assembled workforce and expanded market opportunities when integrating SpringCM’s capabilities in document generation, redlining, advanced document management and end-to-end agreement workflow with our other offerings. 

16





The fair values of the assets acquired and liabilities assumed were determined using the market, income and cost approaches. The following table summarizes the acquisition date fair values of assets acquired and liabilities assumed at the date of acquisition:
(in thousands)
September 4, 2018
Cash and cash equivalents
$
6,950

Accounts receivable and other assets
10,542

Property and equipment
6,108

Goodwill
159,097

Intangible assets
73,000

Contract liabilities
(9,973
)
Other liabilities
(12,948
)
Deferred tax liability
(7,047
)
 
$
225,729



None of the goodwill recognized upon acquisition is deductible for U.S. federal income tax purposes.

The estimated useful lives, primarily based on the expected period of benefit to us, and fair values of the identifiable intangible assets at acquisition date were as follows:
(in thousands, except years)
Estimated Fair Value
 
Expected Useful Life
Existing technology
$
11,900

 
3 years
Customer relationships—subscription
54,200

 
9 years
Backlog—subscription
6,400

 
2 years
Tradenames / trademarks
500

 
1 year
Total intangible assets
$
73,000

 
 


In the year ended January 31, 2019, we incurred acquisition costs of $1.8 million. These costs included legal, accounting fees and other costs directly related to the acquisition and are recognized within operating expenses in our condensed consolidated statements of operations.

The following unaudited pro forma information has been prepared for illustrative purposes only and assumes the acquisition occurred on February 1, 2017. It includes pro forma adjustments related to the amortization of acquired intangible assets, stock-based compensation expense, professional services revenue and contract acquisitions costs adjustments under the new revenue recognition standard, and contract liabilities fair value adjustment. The unaudited pro forma results have been prepared based on estimates and assumptions, which we believe are reasonable, however, they are not necessarily indicative of the consolidated results of operations had the acquisition occurred on February 1, 2017, or of future results of operations:
(in thousands, except per share data)
Three Months Ended
October 31, 2018
 
Nine Months Ended
October 31, 2018
Revenue
$
181,490

 
$
517,507

Net loss
(57,433
)
 
(384,917
)
Net loss per share attributable to common stockholders, basic and diluted
(0.34
)
 
(3.10
)



17



Note 6. Goodwill and Intangible Assets, Net

The changes in the carrying amount of goodwill for the nine months ended October 31, 2019, were as follows (in thousands):
Balance at January 31, 2019
$
195,225

Cumulative translation adjustment
(201
)
Balance at October 31, 2019
$
195,024



Intangible assets consisted of the following:
 
 
 
As of October 31, 2019
 
As of January 31, 2019
(in thousands, except years)
Weighted-average Remaining Useful Life (Years)
 
Estimated Fair Value
 
Accumulated Amortization
 
Acquisition-related Intangibles, Net
 
Estimated Fair Value
 
Accumulated Amortization
 
Acquisition-related Intangibles, Net
Existing technology
1.9
 
$
31,594

 
$
(24,138
)
 
$
7,456

 
$
31,594

 
$
(20,747
)
 
$
10,847

Tradenames / trademarks
0.5
 
2,419

 
(2,319
)
 
100

 
2,419

 
(1,858
)
 
561

Customer contracts & related relationships
7.7
 
65,782

 
(17,110
)
 
48,672

 
65,782

 
(11,168
)
 
54,614

Certifications
0.8
 
6,917

 
(5,884
)
 
1,033

 
6,917

 
(4,846
)
 
2,071

Maintenance contracts & related relationships
0.6
 
1,498

 
(1,328
)
 
170

 
1,498

 
(1,104
)
 
394

Backlog—Subscription
0.9
 
6,400

 
(3,705
)
 
2,695

 
6,400

 
(1,304
)
 
5,096

 
6.5
 
$
114,610

 
$
(54,484
)
 
60,126

 
$
114,610

 
$
(41,027
)
 
73,583

Cumulative translation adjustment
 
 
 
 
 
 
633

 
 
 
 
 
620

Total
 
 
 
 
 
 
$
60,759

 
 
 
 
 
$
74,203



Amortization of finite-lived intangible assets for the three and nine months ended October 31, 2019 and 2018, was as follows:
 
Three Months Ended October 31,
 
Nine Months Ended October 31,
(in thousands)
2019
 
2018
 
2019
 
2018
Cost of subscription revenue
$
1,348

 
$
1,632

 
$
4,356

 
$
4,303

Sales and marketing
2,957

 
2,257

 
9,102

 
3,787

Total
$
4,305

 
$
3,889

 
$
13,458

 
$
8,090



As of October 31, 2019, future amortization of finite-lived intangibles that will be recorded in cost of revenue and operating expenses is estimated as follows, excluding cumulative translation adjustment:
Fiscal Period:
(in thousands)

2020, remainder
$
4,260

2021
13,818

2022
8,370

2023
6,023

2024
6,023

Thereafter
21,632

Total
$
60,126




18



Note 7. Contract Balances

Contract assets represent amounts for which we have recognized revenue, pursuant to our revenue recognition policy, for contracts that have not yet been invoiced to our customers where there is a remaining performance obligation, typically for multi-year arrangements. Total contract assets were $19.2 million and $11.9 million as of October 31, 2019 and January 31, 2019, of which $1.2 million and $1.3 million were noncurrent and included within Other assets—noncurrent on our consolidated balance sheets. The change in contract assets reflects the difference in timing between our satisfaction of remaining performance obligations and our contractual right to bill our customers.

Contract liabilities consist of deferred revenue and include payments received in advance of performance under the contract. Such amounts are generally recognized as revenue over the contractual period. For the nine months ended October 31, 2019 and 2018, we recognized revenue of $342.6 million and $238.1 million that was included in the corresponding contract liability balance at the beginning of the periods presented.

We receive payments from customers based upon contractual billing schedules. We record accounts receivable when the right to consideration becomes unconditional. Payment terms on invoiced amounts are typically 30 days.

Note 8. Deferred Contract Acquisition and Fulfillment Costs

The following table represents a rollforward of our deferred contract acquisition costs:
 
Nine Months Ended October 31,
(in thousands)
2019
 
2018
Beginning balance
$
115,985

 
$
77,344

Additions to deferred contract acquisition costs
66,416

 
51,038

Amortization of deferred contract acquisition costs
(42,099
)
 
(28,561
)
Cumulative translation adjustment
(1,188
)
 

Ending balance
$
139,114

 
$
99,821


 
October 31,
(in thousands)
2019
 
2018
Deferred contract acquisition costs, current
$
2,866

 
$
2,730

Deferred contract acquisitions costs, noncurrent
136,248

 
97,091

Total
$
139,114

 
$
99,821


The following table represents our contract fulfillment costs, which include third-party service fees:
 
Nine Months Ended October 31,
(in thousands)
2019
 
2018
Beginning balance
$
3,432

 
$
3,316

Additions to deferred contract fulfillment costs
11,384

 
1,507

Amortization of deferred contract fulfillment costs
(7,261
)
 
(1,328
)
Ending balance
$
7,555

 
$
3,495



 
October 31,
(in thousands)
2019
 
2018
Deferred contract fulfillment costs, current
$
4,052

 
$
1,042

Deferred contract fulfillment costs, noncurrent
3,503

 
2,453

Total
$
7,555

 
$
3,495




19



Current deferred contract acquisition and fulfillment costs are included in "Prepaid expense and other current assets" and noncurrent deferred contract fulfillment costs are included in "Other assets—noncurrent" on our consolidated balance sheets.

Note 9. Convertible Senior Notes

In September 2018, we issued $575.0 million in aggregate principal amount of the Notes due in 2023, which included the initial purchasers’ exercise in full of their option to purchase an additional $75.0 million principal amount of the Notes, in a private placement to qualified institutional buyers in an offering exempt from registration under the Securities Act of 1933, as amended. The net proceeds from the issuance of the Notes were $560.8 million after deducting the initial purchasers’ discounts and transaction costs.

The Notes are governed by an indenture (the “Indenture”) between us, as the issuer, and U.S. Bank National Association, as trustee. The Notes are senior unsecured obligations and rank senior in right of payment to any of our indebtedness that is expressly subordinated in right of payment to the Notes; equal in right of payment to any of our unsecured indebtedness then existing and future liabilities that are not so subordinated; effectively junior in right of payment to any of our secured indebtedness, to the extent of the value of the assets securing such indebtedness; and structurally junior to all indebtedness and other liabilities (including trade payables) of our subsidiaries. The Indenture does not contain any financial covenants or restrictions on the payments of dividends, the incurrence of indebtedness, or the issuance or repurchase of securities by us or any of our subsidiaries. The Notes mature on September 15, 2023, unless earlier repurchased or redeemed by us or earlier converted in accordance with their terms prior to the maturity date. Interest is payable semi-annually in arrears on March 15 and September 15 of each year, beginning on March 15, 2019.

The Notes have an initial conversion rate of 13.9860 shares of our common stock per $1,000 principal amount of Notes, which is equal to an initial conversion price of approximately $71.50 per share of our common stock and is subject to adjustment in some events. Following certain corporate events that occur prior to the maturity date or following our issuance of a notice of redemption, we will increase the conversion rate for a holder who elects to convert its Notes in connection with such corporate event or during the related redemption period in certain circumstances. Additionally, upon the occurrence of a corporate event that constitutes a “fundamental change” under the Indenture, holders of the Notes may require us to repurchase for cash all or a portion of their Notes at a purchase price equal to 100% of the principal amount of the Notes plus accrued and unpaid interest.

On or after June 15, 2023, until the close of business on September 13, 2023, holders may convert all or any portion of their Notes at any time regardless of whether the conditions set forth below have been met. Upon conversion, holders will receive cash, shares of our common stock or a combination of cash and shares of our common stock, at our election.

Holders of the Notes may convert all or any portion of their Notes at any time prior to the close of business on June 14, 2023, in integral multiples of $1,000 principal amount, only under the following circumstances:
During any fiscal quarter commencing after the fiscal quarter ending on January 31, 2019 (and only during such fiscal quarter), if the last reported sale price of our common stock for at least 20 trading days (whether or not consecutive) during a period of 30 consecutive trading days ending on, and including, the last trading day of the immediately preceding fiscal quarter is greater than or equal to 130% of the conversion price on each applicable trading day;
During the 5-business day period after any 10 consecutive trading day period (the “measurement period”) in which the trading price as defined in the Indenture per $1,000 principal amount of notes for each trading day of the measurement period was less than 98% of the product of the last reported sale price of our common stock and the conversion rate on each such trading day;
If we call any or all of the notes for redemption, at any time prior to the close of business on the scheduled trading day immediately preceding the redemption date; or
Upon the occurrence of specified corporate events described in the Indenture.

We may redeem for cash or shares all or any portion of the Notes, at our option, at a redemption price equal to 100% of the principal amount of the notes to be redeemed, plus accrued and unpaid interest, beginning on or after September 20, 2021 if the last reported sale price of our common stock for at least 20 trading days (whether or not consecutive) during a period of 30 consecutive trading days ending on, and including, the last trading day of the immediately preceding fiscal quarter is greater than or equal to 130% of the conversion price on each applicable trading day.

As of October 31, 2019, the conditions allowing holders of the Notes to convert have not been met and therefore the Notes are not yet convertible.


20



We account for the Notes as separate liability and equity components. We determined the carrying amount of the liability component as the present value of its cash flows using a discount rate of 6% based on comparable convertible transactions for similar companies. The carrying amount of the equity component representing the conversion option was $134.7 million and was calculated by deducting the carrying value of the liability component from the principal amount of the Notes as a whole. This difference represents a debt discount that is amortized to interest expense over the term of the Notes using the effective interest rate method. The equity component is not remeasured as long as it continues to meet the conditions for equity classification.

We allocate transaction costs related to the issuance of the Notes to the liability and equity components using the same proportions as the initial carrying value of the Notes. Transaction costs attributable to the liability component were $10.9 million and are being amortized to interest expense using the effective interest method over the term of the Notes. Transaction costs attributable to the equity component were $3.3 million and are netted with the equity component of the Notes in stockholders’ equity.

The net carrying value of the liability component of the Notes was as follows:
(in thousands)
October 31, 2019
Principal
$
575,000

Less: unamortized debt discount
(107,698
)
Less: unamortized transaction costs
(8,724
)
Net carrying amount
$
458,578


The net carrying amount of the equity component of the Notes was as follows:
(in thousands)
October 31, 2019
Proceeds allocated to the conversion option (debt discount)
$
134,667

Less: transaction costs
(3,336
)
Net carrying amount
$
131,331


The interest expense recognized related to the Notes was as follows:
(in thousands)
Three Months Ended October 31, 2019
 
Nine Months Ended October 31, 2019
Contractual interest expense
$
719

 
$
2,157

Amortization of debt discount
6,147

 
18,175

Amortization of transaction costs
498

 
1,472

Total
$
7,364

 
$
21,804



Capped Calls

In connection with the offering of the Notes, we entered into privately-negotiated capped call transactions (“Capped Calls”) with certain counterparties. The Capped Calls each have an initial strike price of approximately $71.50 per share, subject to certain adjustments, which corresponds to the initial conversion price of the Notes. The Capped Calls have initial cap prices of $110.00 per share, subject to certain adjustments. The Capped Calls cover, subject to anti-dilution adjustments, approximately 8.0 million shares of common stock. The Capped Calls are generally intended to reduce or offset the potential dilution to our common stock upon any conversion of the Notes with such reduction or offset, as the case may be, subject to a cap based on the cap price. As the Capped Call transactions are considered indexed to our own stock and are considered equity classified, they are recorded in stockholders’ equity and are not accounted for as derivatives. The cost of $67.6 million incurred in connection with the Capped Calls was recorded as a reduction to additional paid-in capital.


21



Impact on Earnings Per Share

The Notes will not have an impact on our diluted earnings per share until the average market price of our common stock exceeds the cap price of $110.00 per share, as we intend and have the ability to settle the principal amount of the Notes in cash upon conversion. We are required under the treasury stock method to compute the potentially dilutive shares of common stock related to the Notes for periods we report net income. However, upon conversion, there will be no economic dilution from the Notes until the average market price of our common stock exceeds the cap price of $110.00 per share, as exercise of the Capped Calls offsets any dilution from the Notes from the conversion price up to the cap price. Capped Calls are excluded from the calculation of diluted earnings per share, as they would be antidilutive under the treasury stock method.

Note 10. Leases

We lease office space and equipment under non-cancelable operating lease agreements that expire at various dates through February 2032. As of October 31, 2019, we have no finance leases.
    
The following table is a summary of our operating lease costs:
(in thousands)
Three Months Ended
October 31, 2019
 
Nine Months Ended
October 31, 2019
Operating lease cost
$
6,762

 
$
19,055

Short-term lease cost
60

 
474

Variable lease cost and other, net
(25
)
 
162

Total lease cost
$
6,797

 
$
19,691



Future lease payments as of October 31, 2019, were as follows:
Fiscal Period:
(in thousands, except years and percentages)

2020, remainder
$
5,872

2021
27,502

2022
28,534

2023
28,978

2024
29,103

Thereafter
80,154

Total undiscounted cash flows
$
200,143

Less: imputed interest
(31,038
)
Present value of lease liabilities
$
169,105

Weighted average remaining term (years)
7.9

Weighted average discount rate
4.4
%


The future minimum annual lease payments as of January 31, 2019, related to the outstanding lease agreements were as follows:
Fiscal period:
(in thousands)

2020
$
22,198

2021
22,617

2022
22,556

2023
23,173

2024
23,373

Thereafter
34,634

Total minimum lease payments
$
148,551



22




As of October 31, 2019, we had commitments of $26.2 million for operating leases with commencement dates subsequent to quarter end. These leases have terms of 8 years.

Note 11. Commitments and Contingencies

As of October 31, 2019, we had unused letters of credit outstanding associated with our various operating leases totaling $9.9 million.

We have entered into certain noncancelable contractual arrangements that require future purchases of goods and services. These arrangements primarily relate to cloud infrastructure support and sales and marketing activities. As of October 31, 2019, our noncancelable contractual obligations with a remaining term of more than one year were as follows:
Fiscal period:
(in thousands)

2020, remainder
$
4,097

2021
15,238

2022
12,522

2023
898

2024
943

Thereafter
4,555

Total
$
38,253



Indemnification

We enter into indemnification provisions under our agreements with customers and other companies in the ordinary course of business, including business partners, contractors and parties performing our research and development. Pursuant to these arrangements, we agree to indemnify and defend the indemnified party for certain claims and related losses suffered or incurred by the indemnified party from actual or threatened third-party claim because of our activities. The duration of these indemnification agreements is generally perpetual. The maximum potential amount of future payments we could be required to make under these indemnifications is not determinable. Historically, we have not incurred material costs to defend lawsuits or settle claims related to these indemnification agreements. As a result, we believe the fair value of these indemnification agreements is not material as of October 31, 2019, and January 31, 2019. We maintain commercial general liability insurance and product liability insurance to offset certain of our potential liabilities under these indemnification agreements.

We have entered into indemnification agreements with each of our directors, executive officers and certain other officers. These agreements require us to indemnify such individuals, to the fullest extent permitted by Delaware law, for certain liabilities to which they may become subject as a result of their affiliation with us.

Claims and Litigation

From time to time, we may be subject to legal proceedings, claims and litigations made against us in the ordinary course of business. We believe the final outcome of these matters will not have a material adverse effect on our business, consolidated financial position, results of operations or cash flows.

Note 12. Stockholders' Equity

Equity Incentive Plans

We maintain three stock-based compensation plans: the 2018 Equity Incentive Plan (the “2018 Plan”), the Amended and Restated 2011 Equity Incentive Plan (the “2011 Plan”) and the Amended and Restated 2003 Stock Plan (the “2003 Plan”).

Our board of directors adopted, and our stockholders approved, the 2018 Plan during the year ended January 31, 2019. The 2018 Plan went into effect in April 2018 upon the effectiveness of our initial public offering (“IPO”) Registration Statement. The 2018 Plan serves as a successor to the 2011 Plan and 2003 Plan and provides for the grant of stock-based awards to our employees, directors and consultants. No additional awards under the 2011 Plan or 2003 Plan have been made since the

23



effective date of the 2018 Plan. Outstanding awards under these two plans continue to be subject to the terms and conditions of the respective plans.

The 2018 Plan permits the granting of incentive stock options, nonstatutory stock options, stock appreciation rights, restricted stock awards, restricted stock unit awards, performance stock awards, performance cash awards and other stock awards. RSUs granted under the 2018 Plan generally vest over a four-year period, either quarterly or with 25% vesting at the end of one year and the remainder quarterly thereafter. Additionally, the Company grants performance-based RSUs to its executives on an annual basis.

Shares available for grant under the 2011 Plan that were reserved but not issued as of the effective date of the 2018 Plan were added to the reserves of the 2018 Plan. Any shares subject to outstanding awards originally granted under the 2011 Plan that: (i) expire or terminate for any reason prior to exercise or settlement; (ii) are forfeited because of the failure to meet a contingency or condition required to vest such shares or otherwise returned to DocuSign, Inc.; or (iii) are reacquired, withheld (or not issued) to satisfy a tax withholding obligation in connection with an award or to satisfy the purchase price or exercise price of a stock award will be added to the reserves of the 2018 Plan. As of October 31, 2019, 24.5 million shares were available for future issuance under the 2018 Plan.

The 2018 Plan provides that the number of shares reserved will automatically increase on the first day of each fiscal year, beginning on February 1, 2019, and ending on February 1, 2028, by 5% of the total number of shares of our capital stock outstanding on the immediately preceding January 31st  (or such lesser number of shares as our board of directors or a committee of our board of directors may approve). The most recent automatic increase of 8.5 million shares occurred on February 1, 2019.

Stock Options
    
Option activity for the nine months ended October 31, 2019, was as follows:
(in thousands, except years and per share data)
Number of Options Outstanding
 
Weighted-Average Exercise Price Per Share
 
Weighted-Average Remaining Contractual Term (Years)
 
Aggregate Intrinsic Value
Outstanding at January 31, 2019
13,648

 
$
12.27

 
5.38
 
$
507,371

Exercised
(5,746
)
 
10.09

 
 
 
 
Canceled/expired
(30
)
 
17.67

 
 
 
 
Outstanding at October 31, 2019
7,872

 
$
13.85

 
5.40
 
$
412,060

Vested and expected to vest at October 31, 2019
7,803

 
$
13.81

 
5.40
 
$
408,684

Exercisable at October 31, 2019
6,883

 
$
13.30

 
5.10
 
$
364,048



As of October 31, 2019, our total unrecognized compensation cost related to stock option grants was $7.2 million. We expect to recognize this expense over the remaining weighted-average period of approximately 1.2 years.

RSUs

Substantially all the RSUs that we have issued on or before January 31, 2018, vest upon the satisfaction of both service-based and performance-based vesting conditions. The service-based condition is typically satisfied over a four-year service period. The performance-based condition related to these awards was satisfied upon the effectiveness of our IPO Registration Statement on April 26, 2018. On that date we recorded a cumulative stock-based compensation expense of $262.8 million using the accelerated attribution method for all the RSUs whose service conditions were fully satisfied. The majority of RSUs granted after January 31, 2018, vest upon the satisfaction of a service-based vesting condition. From time to time, we also grant RSUs that are subject to performance-based or market-based vesting conditions. The performance-based conditions will be satisfied upon satisfaction of certain financial performance targets. The market-based conditions will be satisfied if certain milestones based on our common stock price or relative total shareholder return are met. As of October 31, 2019, we had 0.3 million unvested RSUs subject to performance-based conditions for which the performance condition was deemed probable as of period end and 0.2 million unvested RSUs subject to market-based conditions.


24



RSU activity for the nine months ended October 31, 2019, was as follows:
(in thousands, except per share data)
Number of Units
 
Weighted-Average Grant Date Fair Value
Unvested at January 31, 2019
17,142

 
$
34.56

Granted
5,747

 
54.03

Vested
(5,907
)
 
28.66

Canceled
(1,853
)
 
38.66

Unvested at October 31, 2019
15,129

 
$
43.76



As of October 31, 2019, our total unrecognized compensation cost related to RSUs was $482.8 million. We expect to recognize this expense over the remaining weighted-average period of approximately 2.4 years.

2018 Employee Stock Purchase Plan

Our 2018 Employee Stock Purchase Plan (“ESPP”) allows eligible employees to purchase shares of our common stock at a discounted price by accumulating funds, normally through payroll deductions, of up to 15% of their earnings. The purchase price for common stock under the ESPP is equal to 85% of the fair market value of our common stock on the first or last day of the offering period, whichever is lower. The ESPP provides for separate six-month offering periods that begin on September 15 and March 15 of each year. In the nine months ended October 31, 2019, 0.5 million shares of our common stock were purchased under the ESPP. Compensation expense related to the ESPP was $2.4 million and $6.4 million for the three and nine months ended October 31, 2019.

The number of shares reserved under the ESPP will automatically increase on the first day of each fiscal year, starting on February 1, 2019 and continuing through February 1, 2028, in an amount equal to the lesser of (i) 1% of the total number of shares of our common stock outstanding on January 31 of the preceding fiscal year, (ii) 3.8 million shares, or (iii) a lesser number of shares determined by our board of directors. As of October 31, 2019, 5.0 million shares were reserved for future issuance under the ESPP.

Note 13. Net Loss per Share Attributable to Common Stockholders

The following table presents the calculation of basic and diluted net loss per share attributable to common stockholders for periods presented:
 
Three Months Ended October 31,
 
Nine Months Ended October 31,
(in thousands, except per share data)
2019
 
2018
 
2019
 
2018
Numerator:
 
 
 
 
 
 
 
Net loss
$
(46,598
)
 
$
(52,813
)
 
$
(160,952
)
 
$
(360,214
)
Less: preferred stock accretion

 

 

 
(353
)
Net loss attributable to common stockholders
$
(46,598
)
 
$
(52,813
)
 
$
(160,952
)
 
$
(360,567
)
Denominator:
 
 
 
 
 
 
 
Weighted-average common shares outstanding
178,314

 
167,736

 
175,303

 
124,343

Net loss per share attributable to common stockholders:
 
 
 
 
 
 
 
Basic and diluted
$
(0.26
)
 
$
(0.31
)
 
$
(0.92
)
 
$
(2.90
)


25



Outstanding potentially dilutive securities that were excluded from the diluted per share calculations because they would have been antidilutive are as follows:
 
October 31,
(in thousands)
2019
 
2018
Stock options
7,872

 
17,629

RSUs
14,600

 
18,598

ESPP
273

 

Total antidilutive securities
22,745

 
36,227



The table above does not include 0.5 million and 0.7 million RSUs outstanding as of October 31, 2019 and 2018, as these RSUs are subject to performance-based vesting conditions that were not considered to be met as of the end of the reporting period.

Note 14. Income Taxes

Our provision for or benefit from income taxes for interim periods is determined using an estimate of our annual effective tax rate, adjusted for discrete items, if any, that are taken into account in the relevant period. Each quarter, we update our estimate of the annual effective tax rate, and if our estimated tax rate changes, we make a cumulative adjustment.

Our income tax provision was $1.0 million and income tax benefit was $5.7 million for the three months ended October 31, 2019 and 2018. Our income tax provision was $3.6 million and income tax benefit was $3.1 million for the nine months ended October 31, 2019 and 2018. The provision was primarily due to foreign tax expenses, resulting foreign earnings in certain foreign jurisdictions, partially offset by excess benefits from stock option settlements.

We review the likelihood that we will realize the benefit of our deferred tax assets and, therefore, the need for valuation allowances, on a quarterly basis. There is no corresponding income tax benefit recognized with respect to losses incurred and no corresponding income tax expense recognized with respect to earnings generated in jurisdictions with a valuation allowance. This causes variability in our effective tax rate. We maintain a valuation allowance against certain deferred tax assets, including all federal, state, and certain foreign deferred tax assets as a result of uncertainties regarding the realization of the asset balance due to historical losses, the variability of operating results, and uncertainty regarding near term projected results. In the event that we determine the deferred tax assets are realizable based on its assessment of relevant factors, an adjustment to the valuation allowance may increase income in the period such determination is made.

As of October 31, 2019, our gross unrecognized tax benefits totaled $11.4 million, excluding related accrued interest and penalties, all of which would impact the effective tax rate if recognized. Our policy is to account for interest and penalties related to uncertain tax positions as a component of income tax provision. We do not expect to have any significant changes to unrecognized tax benefits during the next twelve months.

We are subject to taxation in the U.S. and various state and foreign jurisdictions. Earnings from international activities are subject to local country income tax. The material jurisdictions where we are subject to potential examination by taxing authorities include the U.S., California and Israel. We are currently under an income tax examination by the Israel Tax Authority for tax years 2013 through 2016. We are not currently under audit by the Internal Revenue Service or any similar taxing authority in any other material jurisdiction. We believe that adequate amounts have been reserved in all jurisdictions.

Note 15. Geographic Information

We operate in one operating and one reportable segment as we only report financial information on an aggregate and consolidated basis to the Chief Executive Officer, who is our chief operating decision maker.


26



Revenue by geography is generally based on the address of the customer as specified in our master subscription agreement. Revenue by geographic area was as follows:
 
Three Months Ended October 31,
 
Nine Months Ended October 31,
(in thousands)
2019
 
2018
 
2019
 
2018
U.S.
$
206,439

 
$
147,677

 
$
576,441

 
$
416,034

International
43,063

 
30,708

 
122,635

 
85,203

Total revenue
$
249,502

 
$
178,385

 
$
699,076

 
$
501,237



No single country other than the U.S. had revenue greater than 10% of total revenue for the three and nine months ended October 31, 2019 and 2018.

Our long-lived assets by geographic area, which consist of property and equipment, net and operating lease right-of-use assets, net were as follows:
(in thousands)
October 31, 2019
 
January 31, 2019
U.S.
$
155,561

 
$
60,625

International
86,983

 
15,207

Total long-lived assets
$
242,544

 
$
75,832



ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

The following discussion and analysis of our financial condition and results of operations should be read in conjunction with our consolidated financial statements and related notes included elsewhere in this Quarterly Report on Form 10-Q and with our audited consolidated financial statements included in our 2019 Annual Report on Form 10-K.  As discussed in the section titled “Note Regarding Forward-Looking Statements,” the following discussion and analysis contains forward-looking statements that involve risks and uncertainties, as well as assumptions that, if they never materialize or prove incorrect, could cause our results to differ materially from those expressed or implied by such forward-looking statements. Factors that could cause or contribute to these differences include, but are not limited to, those identified below and those discussed in the section titled “Risk Factors” under Part II, Item 1A in this Quarterly Report on Form 10-Q and in our 2019 Annual Report on Form 10-K. Our fiscal year ends January 31.

Executive Overview of Third Quarter Results

Overview

DocuSign accelerates the process of doing business for companies and simplifies life for their customers and employees. We accomplish this by transforming the foundational element of business: the agreement.

We offer the world’s #1 e-signature solution as the core part of our broader software suite for automating the agreement process, which we call the DocuSign Agreement Cloud. It is designed to allow companies of all sizes and across all industries to quickly and easily make nearly every agreement, approval process or transaction digital. It provides comprehensive functionality across e-signature and addresses the broader agreement process. As a result, over 560,000 customers and hundreds of millions of users worldwide utilize DocuSign to create, upload and send documents for multiple parties to sign electronically. The DocuSign Agreement Cloud allows users to complete approvals, agreements and transactions faster by building end-to-end processes. DocuSign eSignature integrates with popular business apps, and our functionality can also be embedded using our API. Finally, the DocuSign Agreement Cloud allows our customers to automate and streamline their business-critical workflows to save time and money, while staying secure and legally compliant.

We offer access to our platform on a subscription basis with prices based on the functionality our customers require and the quantity of Envelopes provisioned. Similar to the physical envelopes historically used to mail paper documents, an Envelope is a digital container used to send one or more documents for signature or approval to one or more recipients. Our customers have the flexibility to put a large number of documents in an Envelope. For a number of use cases, such as buying a home, multiple Envelopes are used over the course of the process. To drive customer reach and adoption, we also offer for free certain limited-time or feature-constrained versions of our platform.

27



We generate substantially all our revenue from sales of subscriptions, which accounted for 95% of our revenue for both the three months ended October 31, 2019 and 2018. Sales of subscriptions accounted for 94% and 95% of our revenue for the nine months ended October 31, 2019 and 2018. Our subscription fees include the use of our software suite and access to customer support. Subscriptions generally range from one to three years, and substantially all our multi-year customers pay in annual installments, one year in advance.

We also generate revenue from professional and other non-subscription services, which consists primarily of fees associated with providing new customers deployment and integration services. Other revenue includes amounts derived from sales of on-premises solutions. Professional services and other revenue accounted for 5% of our revenue for both the three months ended October 31, 2019 and 2018. It accounted for 6% and 5% of our revenue for the nine months ended October 31, 2019 and 2018. We anticipate continuing to invest in customer success through our professional services offerings as we believe it plays an important role in accelerating our customers’ deployment of our software suite, which helps to drive customer retention and expansion of the use of the DocuSign Agreement Cloud.

We offer subscriptions to our software suite to enterprise businesses, commercial businesses and very small businesses (“VSBs”), which we define as companies with fewer than 10 employees and includes professionals, sole proprietorships and individuals. We sell to customers through multiple channels. Our go-to-market strategy relies on our direct sales force and partnerships to sell to enterprises and commercial businesses and our web-based self-service channel to sell to VSBs, which we believe is the most cost-effective way to reach our smallest customers. We offer more than 300 off-the-shelf, prebuilt integrations with the applications that many of our customers already use—including those offered by Google, Microsoft, NetSuite, Oracle, Salesforce, SAP, SAP SuccessFactors and Workday—so that they can create, sign, send and manage agreements from directly within these applications. We have a diverse customer base spanning various industries and countries with no significant customer concentration. No single customer accounted for more than 10% of total revenue for each of the three and nine months ended October 31, 2019 and 2018.

We focused initially on selling our e-signature solutions to commercial businesses and VSBs, and later expanded our focus to target enterprise customers. To demonstrate this growth over time, the number of our customers with greater than $300,000 in annual contract value (measured in billings) has increased from approximately 30 as of January 31, 2013 to 401 as of October 31, 2019. Each of our customer types has a different purchasing pattern. VSBs tend to become customers quickly with very little to no direct sales or customer support interaction and generate smaller average contract values, while commercial and enterprise customers typically involve longer sales cycles, larger contract values and greater expansion opportunities for us.

Financial Results for the Three and Nine Months Ended October 31, 2019:
 
Three Months Ended October 31,
 
Nine Months Ended October 31,
(in thousands)
2019
 
2018
 
2019
 
2018
Total revenue
$
249,502

 
$
178,385

 
$
699,076

 
$
501,237

Total costs and expenses
293,499

 
236,802

 
850,232

 
864,932

Total stock-based compensation expense
52,736

 
51,748

 
150,799

 
361,707

Loss from operations
(43,997
)
 
(58,417
)
 
(151,156
)
 
(363,695
)
Net loss
(46,598
)
 
(52,813
)
 
(160,952
)
 
(360,214
)
Cash provided by (used in) operating activities
(1,869
)
 
4,261

 
70,191

 
41,949

Capital expenditures
(12,280
)
 
(227,355
)
 
(42,071
)
 
(237,875
)

Cash, cash equivalents and investments were $911.6 million as of October 31, 2019.


28


Key Factors Affecting Our Performance

We believe that our future performance will depend on many factors, including the following:

Growing Customer Base
    
We are highly focused on continuing to acquire new customers to support our long-term growth. We have invested, and expect to continue to invest, heavily in our sales and marketing efforts to drive customer acquisition. As of October 31, 2019, we had a total of over 560,000 customers, including over 65,000 enterprise and commercial customers, compared to over 450,000 customers and over 50,000 enterprise and commercial customers as of October 31, 2018. We define a customer as a separate and distinct buying entity, such as a company, an educational or government institution, or a distinct business unit of a large company that has an active contract to access our software suite. We define enterprise customers as companies generally included in the Global 2000. We generally define commercial customers to include both mid-market companies, which includes companies outside the Global 2000 that have greater than 250 employees, and small-to-medium-sized businesses (“SMBs”), which are companies with between 10 and 249 employees, in each case excluding any enterprise customers. VSBs include companies with fewer than 10 employees. We refer to total customers as all enterprises, commercial businesses and VSBs.

We believe that our ability to increase the number of customers using our software suite, particularly the number of enterprise and commercial customers, is an indicator of our market penetration, the growth of our business and our potential future business opportunities. By increasing awareness of our software suite, further developing our sales and marketing expertise and continuing to build features tuned to different industry needs, we have expanded the diversity of our customer base to include organizations of all sizes across nearly every industry.

Retaining and Expanding Contracts with Existing Enterprise and Commercial Customers
    
Many of our customers have increased spend with us as they have expanded their use of our offerings in both existing and new use cases across their front or back office operations. Our enterprise and commercial customers may start with just one use case and gradually implement additional use cases across their organization once they see the benefits of our software suite. Several of our largest enterprise customers have deployed our platform for hundreds of use cases across their organizations. We believe there is significant expansion opportunity with our customers following their initial adoption of our platform.

Increasing International Revenue
    
Our international revenue represented 17% of our total revenue for the three months ended October 31, 2019 and 2018, and 18% and 17% of our total revenue for the nine months ended October 31, 2019 and 2018. We started our international selling efforts in English-speaking common law countries, such as Canada, the United Kingdom and Australia, where we were able to leverage our core technologies due to similar approaches to e-signature in these jurisdictions and the United States (“U.S.”). We have since made significant investments to be able to offer our solutions in select civil law countries. For example, in Europe, we offer Standards-Based Signature technology tailored for electronic IDentification, Authentication and trust Services (“eIDAS”). In addition, to follow longstanding tradition in Japan, we enable signers to upload and apply their personal eHanko stamp to represent their signatures on an agreement.
    
We plan to increase our international revenue by leveraging and continuing to expand the investments we have already made in our technology, direct sales force and strategic partnerships, as well as helping existing U.S.-based customers manage agreements across their international businesses. Additionally, we expect our strategic partnerships in key international markets, including our current relationships with SAP in Europe, to further grow.

Investing for Growth

We believe that our market opportunity is large, and we plan to invest to continue to support further growth. This includes expanding our sales headcount and increasing our marketing initiatives. We also plan to continue to invest in expanding the functionality of our software suite and underlying infrastructure and technology to meet the needs of our customers across industries.


29


Components of Results of Operations

Revenue

We derive revenue primarily from the sale of subscriptions and, to a lesser extent, professional services.

Subscription Revenue. Subscription revenue consists of fees for the use of our software suite and technical infrastructure and access to customer support, which includes phone or email support. We typically invoice customers in advance on an annual basis. We recognize subscription revenue ratably over the term of the contract subscription period beginning on the date access to our software suite is provided, as long as all other revenue recognition criteria have been met.

Professional Services and Other Revenue. Professional services revenue includes fees associated with new customers requesting deployment and integration services. We price professional services on a time and materials basis and on a fixed fee basis. We generally have standalone value for our professional services and recognize revenue based on standalone selling price as services are performed or upon completion of services for fixed fee contracts. Other revenue includes amounts derived from sales of on-premises solutions.

Overhead Allocation

We allocate shared overhead costs, such as facilities (including rent, utilities and depreciation on equipment shared by all departments), information technology, information security costs and recruiting to all departments based on headcount. As such, allocated shared costs are reflected in each cost of revenue and operating expense category.

Cost of Revenue

Cost of Subscription Revenue. Cost of subscription revenue primarily consists of expenses related to hosting our software suite and providing support. These expenses consist of employee-related costs, including salaries, bonuses, benefits, stock-based compensation and other related costs, as well as personnel costs for employees associated with our technical infrastructure and customer support. These expenses also consist of software and maintenance costs, third-party hosting fees, outside services associated with the delivery of our subscription services, amortization expense associated with capitalized internal-use software and acquired intangible assets, credit card processing fees and allocated overhead. We expect our cost of revenue to continue to increase in absolute dollar amounts as we invest in our business.

Cost of Professional Services and Other Revenue. Cost of professional services and other revenue consists primarily of personnel costs for our professional services delivery team, travel-related costs and allocated overhead.

Gross Profit and Gross Margin

Gross profit is total revenue less total cost of revenue. Gross margin is gross profit expressed as a percentage of total revenue. We expect that gross profit and gross margin will continue to be affected by various factors including our pricing, timing and amount of investment to maintain or expand our hosting capability, the growth of our software suite support and professional services team, stock-based compensation expenses, amortization of costs associated with capitalized internal use software and acquired intangible assets and allocated overhead.

Operating Expenses

Our operating expenses consist of selling and marketing, research and development and general and administrative expenses.

Selling and Marketing Expense. Selling and marketing expense consists primarily of personnel costs, including sales commissions. These expenses also include expenditures related to advertising, marketing, promotional events and brand awareness activities, as well as allocated overhead. We expect selling and marketing expense to continue to increase in absolute dollars as we enhance our product offerings and implement marketing strategies.

Research and Development Expense. Research and development expense consists primarily of personnel costs. These expenses also include non-personnel costs, such as subcontracting, consulting and professional fees for third-party development resources and depreciation costs, as well as allocated overhead. Our research and development efforts focus on

30


maintaining and enhancing existing functionality and adding new functionality. We expect research and development expense to increase in absolute dollars as we invest in the enhancement of our software suite.

General and Administrative Expense. General and administrative expense consists primarily of personnel costs associated with administrative services such as legal, human resources, information technology related to internal systems, accounting and finance. These expenses also include certain third-party consulting services, certain facilities costs and allocated overhead. We expect general and administrative expense to increase in absolute dollars to support the overall growth of our operations.

Interest Expense

After our issuance of the Notes in September 2018, interest expense consists primarily of contractual interest expense, amortization of discount and amortization of debt issuance costs on our Notes. Prior to the issuance of the Notes, interest expense consisted primarily of commitment fees and amortization of costs related to a loan facility, which was terminated in May 2018.

Interest Income and Other Income, Net

Interest income and other income, net, consists primarily of interest earned on our cash, cash equivalents and investments, as well as foreign currency transaction gains and losses.

Provision For (Benefit From) Income Taxes

Our provision for (benefit from) income taxes consists primarily of income taxes in certain foreign jurisdictions where we conduct business, state minimum taxes in the U.S., and certain tax benefits arising from acquisitions. We have a valuation allowance against our U.S. deferred tax assets, including U.S. net operating loss carryforwards. We expect to maintain this valuation allowance for the foreseeable future or until it becomes more likely than not that the benefit of our U.S. deferred tax assets will be realized by way of expected future taxable income in the U.S.


31


Discussion of Results of Operations

The following table summarizes our historical consolidated statements of operations data:
 
Three Months Ended October 31,
 
Nine Months Ended October 31,
(in thousands)
2019
 
2018
 
2019
 
2018
Revenue:
 
 
 
 
 
 
 
Subscription
$
238,072

 
$
169,426

 
$
660,341

 
$
476,085

Professional services and other
11,430

 
8,959

 
38,735

 
25,152

Total revenue
249,502

 
178,385

 
699,076

 
501,237

Cost of revenue:
 
 
 
 
 
 
 
Subscription
43,178

 
28,709

 
115,769

 
84,204

Professional services and other
18,786

 
16,364

 
59,390

 
55,524

Total cost of revenue
61,964

 
45,073

 
175,159

 
139,728

Gross profit
187,538

 
133,312

 
523,917

 
361,509

Operating expenses:
 
 
 
 
 
 
 
Sales and marketing
149,231

 
117,051

 
430,053

 
411,915

Research and development
48,758

 
38,404

 
133,458

 
143,047

General and administrative
33,546

 
36,274

 
111,562

 
170,242

Total operating expenses
231,535

 
191,729

 
675,073

 
725,204

Loss from operations
(43,997
)
 
(58,417
)
 
(151,156
)
 
(363,695
)
Interest expense
(7,364
)
 
(3,503
)
 
(21,793
)
 
(3,743
)
Interest income and other income, net
5,801

 
3,395

 
15,549

 
4,165

Loss before provision for (benefit from) income taxes
(45,560
)
 
(58,525
)
 
(157,400
)
 
(363,273
)
Provision for (benefit from) income taxes
1,038

 
(5,712
)
 
3,552

 
(3,059
)
Net loss
$
(46,598
)
 
$
(52,813
)
 
$
(160,952
)
 
$
(360,214
)


32


The following table sets forth the components of our consolidated statements of operations data as a percentage of revenue:
 
Three Months Ended October 31,
 
Nine Months Ended October 31,
 
2019
 
2018
 
2019
 
2018
Revenue:
 
 
 
 
 
 
 
Subscription
95
 %
 
95
 %
 
94
 %
 
95
 %
Professional services and other
5

 
5

 
6

 
5

Total revenue
100

 
100

 
100

 
100

Cost of revenue:
 
 
 
 
 
 
 
Subscription
17

 
16

 
17

 
17

Professional services and other
8

 
9

 
8

 
11

Total cost of revenue
25

 
25

 
25

 
28

Gross profit
75

 
75

 
75

 
72

Operating expenses:
 
 
 
 
 
 
 
Sales and marketing
60

 
66

 
62

 
82

Research and development
20

 
22

 
19

 
29

General and administrative
13

 
20

 
16

 
34

Total operating expenses
93

 
108

 
97

 
145

Loss from operations
(18
)
 
(33
)
 
(22
)
 
(73
)
Interest expense
(3
)
 
(2
)
 
(3
)
 
(1
)
Interest income and other income, net
3

 
2

 
2

 
2

Loss before provision for (benefit from) income taxes
(18
)
 
(33
)
 
(23
)
 
(72
)
Provision for (benefit from) income taxes
1

 
(3
)
 

 

Net loss
(19
)%
 
(30
)%
 
(23
)%
 
(72
)%

The following discussion and analysis are for the three and nine months ended October 31, 2019, compared to the same periods in 2018, unless otherwise stated.

Revenue
 
Three Months Ended October 31,
 
 
 
Nine Months Ended October 31,
 
 
(in thousands, except for percentages)
2019
 
2018
 
% Change
 
2019
 
2018
 
% Change
Revenue:
 
 
 
 
 
 
 
 
 
 
 
Subscription
$
238,072

 
$
169,426

 
41
%
 
$
660,341

 
$
476,085

 
39
%
Professional services and other
11,430

 
8,959

 
28
%
 
38,735

 
25,152

 
54
%
Total revenue
$
249,502

 
$
178,385

 
40
%
 
$
699,076

 
$
501,237

 
39
%

Subscription Revenue

Subscription revenue increased $68.6 million, or 41%, in the three months ended October 31, 2019, and $184.3 million, or 39%, in the nine months ended October 31, 2019. These increases were primarily attributable to higher subscription sales to new and existing customers and the addition of offerings related to SpringCM.

We continue to invest in a variety of customer programs and initiatives, which, along with expanded customer use cases, have helped increase our subscription revenue over time. We expect subscription revenue to continue to increase as we offer new functionality and attract new customers.


33


Professional Services and Other Revenue

Professional services and other revenue increased by $2.5 million, or 28%, in the three months ended October 31, 2019, and $13.6 million, or 54%, in the nine months ended October 31, 2019, primarily due to increased engagement of professional services to support our growing customer base and the addition of services from SpringCM and our strategic partnerships. We expect professional services revenue to continue to increase as we offer new functionality and serve new customers.

Cost of Revenue and Gross Margin
 
Three Months Ended October 31,
 
 
 
Nine Months Ended October 31,
 
 
(in thousands, except for percentages)
2019
 
2018
 
% Change
 
2019
 
2018
 
% Change
Cost of revenue:
 
 
 
 
 
 
 
 
 
 
 
Subscription
$
43,178

 
$
28,709

 
50
 %
 
$
115,769

 
$
84,204

 
37
%
Professional services and other
18,786

 
16,364

 
15
 %
 
59,390

 
55,524

 
7
%
Total cost of revenue
$
61,964

 
$
45,073

 
37
 %
 
$
175,159

 
$
139,728

 
25
%
Gross margin:
 
 
 
 
 
 
 
 
 
 
 
Subscription
82
 %
 
83
 %
 
(1
)pts
 
82
 %
 
82
 %
 

Professional services and other
(64
)%
 
(83
)%
 
19
 pts
 
(53
)%
 
(121
)%
 
68
pts
Total gross margin
75
 %
 
75
 %
 

 
75
 %
 
72
 %
 
3
pts

Cost of Subscription Revenue

Cost of subscription revenue increased $14.5 million, or 50%, in the three months ended October 31, 2019, primarily due to:
An increase of $7.8 million in operating costs to support our platform, primarily related to higher data center costs; and
Increases of $4.1 million in personnel costs and $1.1 million in stock-based compensation, primarily due to higher headcount and the addition of SpringCM employees.

Cost of subscription revenue increased $31.6 million, or 37%, in the nine months ended October 31, 2019, primarily due to:
An increase of $20.1 million in operating costs, primarily related to an increase in reseller partnership fees, higher data center costs and the addition of SpringCM;
An increase of $11.5 million in personnel costs primarily due to higher headcount; and
An increase of $2.3 million in allocated technology and facilities costs.
These increases were partially offset by a decrease of $5.0 million in stock-based compensation expense as the nine months ended October 31, 2018 included the cumulative catch‑up of stock‑based compensation expense on the effective date of our IPO.

Cost of Professional Services and Other Revenue

Cost of professional services and other revenue increased $2.4 million, or 15%, in the three months ended October 31, 2019, primarily due an increase of $1.6 million in personnel costs primarily related to the increased headcount in our professional services organization and the addition of SpringCM employees.

Cost of professional services and other revenue increased $3.9 million, or 7%, in the nine months ended October 31, 2019, primarily due to:
An increase of $8.4 million in personnel costs primarily due to higher headcount in our professional services organization and the addition of SpringCM employees; and
An increase of $3.4 million in operating costs, primarily related to the addition of SpringCM contractors providing professional services.
These increases in cost of professional services and other revenue were partially offset by a decrease of $10.6 million in stock-based compensation expense as the nine months ended October 31, 2018 included the cumulative catch‑up of stock‑based compensation expense on the effective date of our IPO.



34


Sales and Marketing
 
Three Months Ended October 31,
 
 
 
Nine Months Ended October 31,
 
 
(in thousands, except for percentages)
2019
 
2018
 
% Change
 
2019
 
2018
 
% Change
Sales and marketing
$
149,231

 
$
117,051

 
27
%
 
430,053

 
411,915

 
4
%
Percentage of revenue
60
%
 
66
%
 
 
 
62
%
 
82
%
 
 

Sales and marketing expenses increased $32.2 million, or 27%, in the three months ended October 31, 2019, primarily due to:
An increase of $22.5 million in personnel costs due to higher headcount, the addition of SpringCM employees and higher commissions from higher sales and headcount;
An increase of $4.4 million in allocated overhead due to higher technology and facility costs;
An increase of $2.3 million in stock-based compensation expense due to higher headcount; and
An increase of $1.5 million in depreciation and amortization due to the amortization of certain intangible assets acquired in the SpringCM acquisition on September 4, 2018.

Sales and marketing expenses increased $18.1 million, or 4%, in the nine months ended October 31, 2019, primarily due to:
An increase of $62.9 million in personnel costs due to higher headcount, the addition of SpringCM employees, higher commissions in line with higher sales and headcount, as well as the employer portion of payroll taxes related to restricted stock unit (“RSU”) settlements with no such expense in the prior year;
An increase of $14.4 million in allocated overhead due to higher technology and facility costs;
An increase of $7.4 million in marketing and advertising expense, primarily due to higher spend for online advertising campaigns;
An increase of $7.3 million in depreciation and amortization due to the amortization of the intangible assets acquired in the SpringCM acquisition on September 4, 2018; and
An increase of $4.3 million in other expenses primarily due to higher spend on employee-related costs and partner commissions.
These increases in sales and marketing expense were offset by a decrease of $82.9 million in stock-based compensation expense as the nine months ended October 31, 2018 included the cumulative catch‑up of stock‑based compensation expense on the effective date of our IPO.

Research and Development
 
Three Months Ended October 31,
 
 
 
Nine Months Ended October 31,
 
 
(in thousands, except for percentages)
2019
 
2018
 
% Change
 
2019
 
2018
 
% Change
Research and development
$
48,758

 
$
38,404

 
27
%
 
133,458

 
143,047

 
(7
)%
Percentage of revenue
20
%
 
22
%
 
 
 
19
%
 
29
%
 
 

Research and development expenses increased $10.4 million, or 27%, in the three months ended October 31, 2019, primarily due to increases of $6.7 million in personnel costs and $1.8 million in stock-based compensation, due to higher headcount and the addition of SpringCM employees.

Research and development expenses decreased $9.6 million, or 7%, in the nine months ended October 31, 2019, primarily due to a decrease of $33.6 million in stock-based compensation expense as the nine months ended October 31, 2018 included the cumulative catch‑up of stock‑based compensation expense on the effective date of our IPO. This decrease in stock-based compensation was partially offset by:
An increase of $16.4 million in personnel costs due to higher headcount and the addition of SpringCM employees; and
An increase of $3.0 million in allocated overhead due to increased technology and facility costs.

General and Administrative
 
Three Months Ended October 31,
 
 
 
Nine Months Ended October 31,
 
 
(in thousands, except for percentages)
2019
 
2018
 
% Change
 
2019
 
2018
 
% Change
General and administrative
$
33,546

 
$
36,274

 
(8
)%
 
111,562

 
170,242

 
(34
)%
Percentage of revenue
13
%
 
20
%
 
 
 
16
%
 
34
%
 
 

35


    
General and administrative expenses decreased $2.7 million, or 8%, in the three months ended October 31, 2019, primarily due to:
A decrease of $4.3 million in stock-based compensation primarily due to fewer grants after our IPO; and
A decrease of $3.0 million in professional fees, primarily related to advisory and consulting services incurred for our convertible debt and secondary offerings, and the acquisition of SpringCM in September 2018.
These decreases in general and administrative expenses were partially offset by an increase of $2.7 million in personnel costs due to higher headcount.

General and administrative expenses decreased $58.7 million, or 34%, in the nine months ended October 31, 2019, primarily due to a decrease of $78.8 million in stock-based compensation expense as the nine months ended October 31, 2018 included the cumulative catch‑up of stock‑based compensation expense on the effective date of our IPO. This decrease in stock-based compensation was partially offset by:
An increase of $10.3 million in personnel costs due to higher headcount and the employer portion of payroll taxes related to RSU settlements compared to no such expense in the prior year;
An increase of $4.7 million in allocated overhead due to technology and facility costs; and
An increase of $2.5 million in professional fees due to higher litigation costs partially offset by lower legal and consulting fees.

Interest expense
 
Three Months Ended October 31,
 
 
 
Nine Months Ended October 31,
 
 
(in thousands, except for percentages)
2019
 
2018
 
% Change
 
2019
 
2018
 
% Change
Interest expense
$
(7,364
)
 
$
(3,503
)
 
110
%
 
(21,793
)
 
(3,743
)
 
482
%
Percentage of revenue
(3
)%
 
(2
)%
 
 
 
(3
)%
 
(1
)%
 
 

Interest expense increased by $3.9 million and $18.1 million in the three and nine months ended October 31, 2019, due to interest expense and amortization of discount and transaction costs on the Notes.

Interest Income and Other Income, Net
 
Three Months Ended October 31,
 
 
 
Nine Months Ended October 31,
 
 
(in thousands, except for percentages)
2019
 
2018
 
% Change
 
2019
 
2018
 
% Change
Interest income
$
4,421

 
$
3,942

 
12
%
 
12,039

 
7,326

 
64
%
Foreign currency gain (loss)
711

 
(680
)
 
NM

 
(550
)
 
2,947

 
NM

Other
669

 
133

 
403
%
 
4,060

 
(6,108
)
 
NM

Interest income and other income, net
$
5,801

 
$
3,395

 
71
%
 
$
15,549

 
$
4,165

 
273
%
Percentage of revenue
3
%
 
2
%
 
 
 
2
%
 
2
%
 
 

Interest income and other income, net, increased by $2.4 million and $11.4 million, in the three and the nine months ended October 31, 2019, primarily due to accretion on our debt securities investments as well as higher interest income on our cash and cash equivalents and investments.

Provision for (Benefit from) Income Taxes
 
Three Months Ended October 31,
 
 
 
Nine Months Ended October 31,
 
 
(in thousands, except for percentages)
2019
 
2018
 
% Change
 
2019
 
2018
 
% Change
Provision for (benefit from) income taxes
$
1,038

 
$
(5,712
)
 
NM
 
3,552

 
(3,059
)
 
NM
Percentage of revenue
1
%
 
(3
)%
 
 
 
%
 
%
 
 


36


Provision for income taxes was $1.0 million and $3.6 million in the three and nine months ended October 31, 2019 as compared to benefit from income taxes of $5.7 million and $3.1 million in the three and nine months ended October 31, 2018. The provision in the three and nine months ended October 31, 2019 primarily consisted of foreign tax expenses, resulting from foreign earnings in certain foreign jurisdictions, partially offset by excess benefits from stock option settlements while the tax benefit in the three and nine months ended October 31, 2018 resulted from the release of a portion of our deferred tax valuation allowance in connection with the SpringCM acquisition.

Liquidity and Capital Resources

Our principal sources of liquidity were cash and cash equivalents, investments and cash generated from operations. As of October 31, 2019, we had $653.8 million in cash and cash equivalents and short-term investments. We also had $257.8 million in long-term investments that provide additional capital resources. Since inception we have financed our operations primarily through equity financings and payments by our customers for use of our product offerings and related services. In addition, in September 2018 we issued and sold $575 million in aggregate principal amount of 0.5% Convertible Senior Notes due 2023, which are further described in Note 9.

We believe our existing cash and cash equivalents will be sufficient to meet our working capital and capital expenditures needs over at least the next 12 months. While we generated positive cash flows from operations of $70.2 million in the nine months ended October 31, 2019, we have generated losses from operations in the past as reflected in our accumulated deficit of $1.1 billion as of October 31, 2019. We expect to continue to incur operating losses for the foreseeable future due to the investments we intend to make and may require additional capital resources to execute strategic initiatives to grow our business.

We typically invoice our customers annually in advance. Therefore, a substantial source of our cash is from such invoices, which are included on our consolidated balance sheets as accounts receivable until collection and contract liabilities. Our accounts receivable decreased by $15.1 million in the nine months ended October 31, 2019, compared to a decrease of $1.4 million in the nine months ended October 31, 2018, which resulted in a $13.7 million increase in cash provided by operating activities year over year. Accordingly, collections from our customers have a material impact on our cash flows from operating activities. Contract liabilities consists of the unearned portion of billed fees for our subscriptions, which is subsequently recognized as revenue in accordance with our revenue recognition policy. As of October 31, 2019, we had contract liabilities of $433.1 million, compared to $388.8 million as of January 31, 2019. The increase in contract liabilities resulted in net cash provided by operating activities of $44.3 million. Therefore, our growth in billings to existing and new customers has a net beneficial impact on our cash flows from operating activities, after consideration of the impact on our accounts receivable.

Our future capital requirements will depend on many factors including our growth rate, customer retention and expansion, the timing and extent of spending to support our efforts to develop our software suite, the expansion of sales and marketing activities and the continuing market acceptance of our software suite. We may in the future enter into arrangements to acquire or invest in complementary businesses, technologies and intellectual property rights. We may be required to seek additional equity or debt financing. In the event that additional financing is required from outside sources, we may not be able to raise it on terms acceptable to us or at all. If we are unable to raise additional capital when desired, our business, operating results and financial condition would be adversely affected.

Cash Flows

The following table summarizes our cash flows for the periods indicated:
 
Nine Months Ended October 31,
 
 
(in thousands)
2019
 
2018
 
$ Change
Net cash provided by (used in):
 
 
 
 
 
Operating activities
$
70,191

 
$
41,949

 
$
28,242

Investing activities
(350,795
)
 
(237,875
)
 
(112,920
)
Financing activities
(39,153
)
 
1,034,171

 
(1,073,324
)
Effect of foreign exchange on cash and cash equivalents
(310
)
 
(1,181
)
 
871

Net change in cash, cash equivalents and restricted cash
$
(320,067
)
 
$
837,064

 
$
(1,157,131
)

37



Cash Flows from Operating Activities

Cash provided by operating activities increased by $28.2 million. This change was primarily due to a decrease of $199.3 million in net loss, partially offset by a decrease of $142.9 million in non-cash expenses. The decrease in non-cash expenses was primarily due to a $210.9 million decrease in in stock-based compensation expense as the nine months ended October 31, 2018 included the cumulative catch‑up of stock‑based compensation expense on the effective date of our IPO. This decrease was partially offset by higher non-cash amortization expenses in the nine months ended October 31, 2019.

Net cash used in operating assets and liabilities increased by $28.1 million primarily due to an increase of $25.3 million in cash used in deferred contract acquisition and fulfillment costs and $10.9 million in payments of operating lease liabilities. These were partially offset by an increase of $13.7 million in cash provided from changes in accounts receivable and $11.9 million in cash provided from changes in accounts payable and accrued expenses due to the timing of cash receipts and payments.

Cash Flows from Investing Activities

Net cash used in investing activities increased by $112.9 million. This change was primarily due to $308.7 million net purchases of marketable securities and other investments and a $23.0 million higher spending on purchases of property and equipment. The increase was partially offset by the net cash paid to acquire SpringCM of $218.8 million in the nine months ended October 31, 2018.

Cash Flows from Financing Activities

Net cash used in financing activities in the nine months ended October 31, 2019 primarily consisted of $125.3 million used to remit tax withholding obligations on RSUs settled in the period, partially offset by proceeds from exercises of stock options and purchases under the ESPP. Net cash provided by financing activities in the nine months ended October 31, 2018, primarily consisted of net proceeds of $529.3 million from the issuance of common stock in our IPO and $560.8 million from the issuance of the Notes.

Contractual Obligations and Commitments
Our principal contractual obligations and commitments consist of obligations under the Notes (including principal and coupon interest), operating leases, as well as noncancelable contractual commitments that primarily relate to cloud infrastructure support and sales and marketing activities. Refer to Note 9 for more information on the Notes and Note 10 and Note 11 for all other commitments.

As of October 31, 2019, we had unused letters of credit outstanding associated with our various operating leases totaling $9.9 million.

Off-Balance Sheet Arrangements
We did not have during the periods presented, and we do not currently have, any off-balance sheet financing arrangements or any relationships with unconsolidated entities or financial partnerships, including entities sometimes referred to as structured finance or special purpose entities, that were established for the purpose of facilitating off-balance sheet arrangements or other contractually narrow or limited purposes.

38


Critical Accounting Policies and Estimates
    
We prepare our financial statements in accordance with U.S. generally accepted accounting principles (“GAAP”). Preparing these financial statements requires us to make estimates and assumptions that affect the reported amounts of assets, liabilities, revenue, expenses and related disclosures. We evaluate our estimates and assumptions on an ongoing basis. Our estimates are based on historical experience and various other assumptions that we believe to be reasonable under the circumstances. Our actual results could differ from these estimates.

The critical accounting estimates, assumptions and judgments that we believe to have the most significant impact on our consolidated financial statements are revenue recognition, deferred contract acquisition costs, stock-based compensation, business combinations and valuation of goodwill and other acquired intangible assets and income taxes.
    
There have been no material changes to our critical accounting policies and estimates as described in our 2019 Annual Report on Form 10-K.

Recent Accounting Pronouncements

Refer to Note 1 to our consolidated financial statements included elsewhere in this Quarterly Report on Form 10-Q for recently issued accounting pronouncements not yet adopted as of the date of this report.


39


Non-GAAP Financial Measures and Other Key Metrics

To supplement our consolidated financial statements, which are prepared and presented in accordance with GAAP, we use certain non-GAAP financial measures, as described below, to understand and evaluate our core operating performance. These non-GAAP financial measures, which may be different than similarly titled measures used by other companies, are presented to enhance investors’ overall understanding of our financial performance and should not be considered a substitute for, or superior to, the financial information prepared and presented in accordance with GAAP.

We believe that these non-GAAP financial measures provide useful information about our financial performance, enhance overall understanding of our past performance and future prospects, and allow for greater transparency with respect to important metrics used by our management for financial and operational decision-making. We present these non-GAAP measures to assist investors in seeing our financial performance using a management view, and because we believe that these measures provide an additional tool for investors to use in comparing our core financial performance over multiple periods with other companies in our industry.

Non-GAAP gross profit, non-GAAP subscription gross profit, non-GAAP professional services and other gross profit, non-GAAP gross margin, non-GAAP income (loss) from operations, non-GAAP operating margin and non-GAAP net income (loss): We define these non-GAAP financial measures as the respective GAAP measures, excluding expenses related to stock-based compensation, employer payroll tax on employee stock transactions, amortization of acquisition-related intangibles, amortization of debt discount and issuance costs from our convertible senior notes issued in September 2018, and, as applicable, other special items. The amount of employer payroll tax-related items on employee stock transactions depend on our stock price and other factors that are beyond our control and that do not correlate to the operation of the business. We believe it is useful to exclude these expenses in order to better understand the long-term performance of our core business and to facilitate comparison of our results to those of peer companies and over multiple periods.

Free cash flows: We define free cash flow as net cash provided by (used in) operating activities less purchases of property and equipment. We believe free cash flow is an important liquidity measure of the cash (if any) that is available, after purchases of property and equipment, for operational expenses, investment in our business and to make acquisitions. Free cash flow is useful to investors as a liquidity measure because it measures our ability to generate or use cash in excess of our capital investments in property and equipment. Once our business needs and obligations are met, cash can be used to maintain a strong balance sheet and invest in future growth.

Billings: We define billings as total revenue plus the change in our contract liabilities and refund liability less contract assets and unbilled accounts receivable in a given period. Billings reflects sales to new customers plus subscription renewals and additional sales to existing customers. Only amounts invoiced to a customer in a given period are included in billings. We believe billings is a key metric to measure our periodic performance. Given that most of our customers pay in annual installments one year in advance, but we typically recognize a majority of the related revenue ratably over time, we use billings to measure and monitor our ability to provide our business with the working capital generated by upfront payments from our customers.


40


Reconciliation of gross profit and gross margin:
 
Three Months Ended October 31,
 
Nine Months Ended October 31,
(in thousands)
2019
 
2018
 
2019
 
2018
GAAP gross profit
$
187,538

 
$
133,312

 
$
523,917

 
$
361,509

Add: Stock-based compensation
7,150

 
5,976

 
20,808

 
36,386

Add: Amortization of acquisition-related intangibles
1,348

 
1,632

 
4,356

 
4,303

Add: Acquisition-related expenses

 
108

 

 
108

Add: Employer payroll tax on employee stock transactions
715

 

 
1,908

 

Non-GAAP gross profit
$
196,751

 
$
141,028