DROPBOX, INC. The following discussion and analysis of our financial condition and results of operations should be read in conjunction with the section titled "Selected Consolidated Financial and Other Data" and the consolidated financial statements and related notes thereto included elsewhere in this Annual Report on Form 10-K. This discussion contains forward-looking statements that involve risks and uncertainties. Our actual results could differ materially from those discussed below. Factors that could cause or contribute to such differences include, but are not limited to, those identified below and those discussed in the section titled "Risk Factors" included elsewhere in this Annual Report on Form 10-K.
Overview
Our modern economy runs on knowledge. Today, knowledge lives in the cloud as digital content, and Dropbox is building the world's first smart workspace where businesses and individuals can create, access, and share this content globally. We serve more than 600 million registered users across 180 countries. Since our founding in 2007, our market opportunity has grown as we've expanded from keeping files in sync to keeping teams in sync. Our smart workspace is a digital environment that brings all of a team's content together with the tools they love, helping users cut through the clutter and surfacing what matters most. In a world where using technology at work can be fragmented and distracting, the smart workspace makes it easy to focus on the work that matters. By solving these universal problems, we've become invaluable to our users. The popularity of our platform drives viral growth, which has allowed us to scale rapidly and efficiently. We've built a thriving global business with 14.3 million paying users. Our Subscription Plans We generate revenue from individuals, teams, and organizations by selling subscriptions to our platform, which serve the varying needs of our diverse customer base. Subscribers can purchase individual licenses through our Plus and Professional plans, or purchase multiple licenses through a Standard, Advanced, or Enterprise team plan. Each team represents a separately billed deployment that is managed through a single administrative dashboard. Teams must have a minimum of three users, but can also have more than tens of thousands of users. Customers can choose between an annual or monthly plan, with a small number of large organizations on multi-year plans. A majority of our customers opt for our annual plans. We typically bill our customers at the beginning of their respective terms and recognize revenue ratably over the term of the subscription period. International customers can pay inU.S. dollars or a select number of foreign currencies. Our premium subscription plans, such as Professional and Advanced, provide more functionality than other subscription plans and have higher per user prices. Our Standard and Advanced subscription plans offer robust capabilities for businesses, and the vast majority of Dropbox Business teams purchase our Standard or Advanced subscription plans. While our Enterprise subscription plan offers more opportunities for customization, companies can subscribe to any of these team plans for their business needs. In the first quarter of fiscal 2019, we acquired HelloSign, an e-signature and document workflow platform. The acquisition of HelloSign expands our content collaboration capabilities to include additional business-critical workflows. HelloSign has several product lines, and the pricing and revenue generated from each product line varies, with some product lines priced based on the number of licenses purchased (similar to Dropbox plans), while others are priced based on a customer's transaction volume. Depending on the product purchased, teams must have a minimum of a certain number of licenses, but can also have hundreds of users. Customers can choose between an annual or monthly plan, with a small number of large organizations on multi-year plans. HelloSign also typically bills customers at the beginning of their respective terms and recognizes revenue ratably over the subscription period. HelloSign primarily sells withinthe United States and sells only inU.S. dollars. 41
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Our Customers
Our customer base is highly diversified, and in the period presented, no
customer accounted for more than 1% of our revenue. Our customers include
individuals, teams, and organizations of all sizes, from freelancers and small
businesses to Fortune 100 companies. They work across a wide range of
industries, including professional services, technology, media, education,
industrials, consumer and retail, and financial services. Within companies, our
platform is used by all types of teams and functions, including sales,
marketing, product, design, engineering, finance, legal, and human resources.
Our Business Model
Drive new signups
We acquire users efficiently and at relatively low costs through word-of-mouth
referrals, direct in-product referrals, and sharing of content. Anyone can
create a Dropbox account for free through our website or app and be up and
running in minutes. These users often share and collaborate with other
non-registered users, attracting new signups into our network.
Increase conversion of registered users to our paid subscription plans
We generate over 90% of our revenue from self-serve channels-users who purchase
a subscription through our app or website. To grow our recurring revenue base,
we actively encourage our registered users to convert to one of our paid plans
based on the functionality that best suits their needs. We do this via
in-product prompts and notifications, time-limited free trials of paid
subscription plans, email campaigns, and lifecycle marketing. Together, these
enable us to generate increased recurring revenues from our existing user base.
Upgrade and expand existing customers
We offer a range of paid subscription plans, from Plus and Professional for
individuals to Standard, Advanced, and Enterprise for teams. We analyze usage
patterns within our network and run hundreds of targeted marketing campaigns to
encourage paying users to upgrade their plans. We prompt individual subscribers
who collaborate with others on Dropbox to purchase our Standard or Advanced
plans for a better team experience, and we also encourage existing Dropbox
Business teams to purchase additional licenses or to upgrade to premium
subscription plans.
Key Business Metrics
We review a number of operating and financial metrics, including the following
key metrics to evaluate our business, measure our performance, identify trends
affecting our business, formulate business plans, and make strategic decisions.
Total annual recurring revenue
We primarily focus on total annual recurring revenue ("Total ARR") as the key
indicator of the trajectory of our business performance. Total ARR represents
the amount of revenue that we expect to recur, enables measurement of the
progress of our business initiatives, and serves as an indicator of future
growth. In addition, Total ARR is less subject to variations in trends that may
not appropriately reflect the health of our business. Total ARR is a performance
metric and should be viewed independently of revenue and deferred revenue, and
is not intended to be a substitute for, or combined with, any of these items.
Total ARR consists of contributions from all of our revenue streams, including
subscriptions and add-ons. We calculate Total ARR as the number of users who
have active paid licenses for access to our platform as of the end of the
period, multiplied by their annualized subscription price to our platform. We
adjust the exchange rates used to calculate Total ARR on an annual basis at the
beginning of each fiscal year.
The below tables set forth our Total ARR using the exchange rates set at the
beginning of each year, as well as on a constant currency basis relative to the
exchange rates used in 2019.
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As of March As of June 30, As of September As of December As
of March As of
31, 2018 2018 30, 2018 31, 2018 31, 2019 2019 30, 2019 31, 2019
(in millions)
Total ARR $ 1,307 $ 1,396 $ 1,461 $ 1,530 $ 1,600 $ 1,651 $ 1,766 $ 1,820
Constant As of March As of June 30, As of September As of December As of March As of June 30, As of September As of December
Currency 31, 2018 2018 30, 2018 31, 2018 31, 2019 2019 30, 2019 31, 2019
(in millions)
Total
ARR $ 1,296 $ 1,385 $ 1,449 $ 1,518 $ 1,600 $ 1,651 $ 1,766 $ 1,820
Revaluing our ending Total ARR for fiscal 2019 using exchange rates set at the
beginning of fiscal 2020, Total ARR at the end of fiscal 2019 would be $1,811
million .
We undertook several business initiatives that positively impacted Total ARR in
the periods presented. These initiatives include the renewal of our
grandfathered existing Dropbox Business teams into the Dropbox Business Advanced
plan starting in the second quarter of 2018, and the repricing and repackaging
of our existing Dropbox Plus plans in the second quarter of 2019. In addition to
these business initiatives, we also acquired HelloSign in the first quarter of
2019, resulting in a benefit to Total ARR beginning in that period. We also
undertook several conversion related initiatives and saw benefits in Total ARR
as we expanded opportunities for our users to try Dropbox through trial flows on
more surfaces.
Supplemental Information
Paying users
We define paying users as the number of users who have active paid licenses for
access to our platform as of the end of the period. One person would count as
multiple paying users if the person had more than one active license. For
example, a 50-person Dropbox Business team would count as 50 paying users, and
an individual Dropbox Plus user would count as one paying user. If that
individual Dropbox Plus user was also part of the 50-person Dropbox Business
team, we would count the individual as two paying users.
We have experienced growth in the number of paying users across our products, with the majority of paying users for the periods presented coming from our self-serve channels.
We acquired HelloSign in the first quarter of fiscal 2019. HelloSign has several product lines and the pricing and revenue generated from each product line varies, with some product lines priced based on the number of licenses purchased (similar to Dropbox plans), while others are priced based on a customer's transaction volume. For purposes of HelloSign results, we include as paying users either (i) the number of users who have active paid licenses for access to the HelloSign platform as of the period end for those products that are priced based on the number of licenses purchased (which is the same method we use to evaluate existing Dropbox plans) or (ii) the number of customers for those products that are priced based on transaction volumes.
The below table sets forth the number of paying users as of
As of December 31,
2019 2018 2017
(In millions)
Paying users 14.3 12.7 11.0
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Average revenue per paying user We define average revenue per paying user, or ARPU, as our revenue for the period presented divided by the average paying users during the same period. For interim periods, we use annualized revenue, which is calculated by dividing the revenue for the particular period by the number of days in that period and multiplying this value by 365 days. Average paying users are calculated based on adding the number of paying users as of the beginning of the period to the number of paying users as of the end of the period, and then dividing by two.
We undertook two business initiatives over the last two fiscal years that have positively impacted ARPU in the periods presented.
In the second quarter of 2019, we repackaged our existing Dropbox Plus plans to include additional features and, as a result, increased the price for new and existing users on this plan. For certain existing users, the increase in price will be effective on their next renewal date. As a result of the price increase, and combined with an increased mix of sales towards our higher-priced subscription plans, we experienced an increase in our average revenue per paying user for the year endedDecember 31, 2019 , compared to the year endedDecember 31, 2018 . In 2017, we launched our Dropbox Business Advanced plan. At the time of launch, we grandfathered existing Dropbox Business teams into the Dropbox Business Advanced plan at their legacy price. During 2018 and early 2019, almost all of those grandfathered teams renewed at a higher price. As a result of these renewals, and combined with an increased mix of sales towards our higher-priced subscription plans, we experienced an increase in our average revenue per paying user for the year endedDecember 31, 2019 , compared to the year endedDecember 31, 2018 .
The below table sets forth our ARPU for the years ended
Year ended
2019 2018 2017
ARPU $ 123.07 $ 117.64 $ 111.91
Non-GAAP Financial Measure
In addition to our results determined in accordance with U.S. generally accepted
accounting principles, or GAAP, we believe that free cash flow, or FCF, a
non-GAAP financial measure, is useful in evaluating our liquidity.
Free cash flow
We define FCF as GAAP net cash provided by operating activities less capital
expenditures. We believe that FCF is a liquidity measure and that it provides
useful information regarding cash provided by operating activities and cash used
for investments in property and equipment required to maintain and grow our
business. FCF is presented for supplemental informational purposes only and
should not be considered a substitute for financial information presented in
accordance with GAAP. FCF has limitations as an analytical tool, and it should
not be considered in isolation or as a substitute for analysis of other GAAP
financial measures, such as net cash provided by operating activities. Some of
the limitations of FCF are that FCF does not reflect our future contractual
commitments, excludes investments made to acquire assets under finance leases,
and may be calculated differently by other companies in our industry, limiting
its usefulness as a comparative measure.
Our FCF increased for the year ended December 31, 2019 , compared to the year
ended December 31, 2018 , primarily due to an increase in cash provided by
operating activities, which was driven by increased subscription sales, as a
majority of our paying users are invoiced in advance. These cash inflows were
partially offset by higher capital expenditures related to our new corporate
headquarters and datacenter build-outs.
Our FCF increased for the year ended December 31, 2018 , compared to the year
ended December 31, 2017 , primarily due to higher cash provided by operating
activities, which was driven by increased subscription sales, as a majority of
our paying users are invoiced in advance. These cash inflows were partially
offset by an increase in capital expenditures primarily related to the build-out
of our new corporate headquarters.
We expect our FCF to fluctuate in future periods as we purchase infrastructure
equipment to support our user base and continue to invest in our new and
existing office spaces to support our plans for growth. We expect our capital
expenditures related to our new corporate headquarters to decline as the
majority of the project is now complete.
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The following is a reconciliation of FCF to the most comparable GAAP measure, net cash provided by operating activities:
Year ended December 31,
2019 2018 2017
(In millions)
Net cash provided by operating activities $ 528.5 $ 425.4 $ 330.3
Capital expenditures (136.1 ) (63.0 ) (25.3 )
Free cash flow $ 392.4 $ 362.4 $ 305.0 Components of Our Results of Operations
Revenue
We generate revenue from sales of subscriptions to our platform. Revenue is recognized ratably over the related contractual term generally beginning on the date that our platform is made available to a customer. Our subscription agreements typically have monthly or annual contractual terms, although a small percentage have multi-year contractual terms. Our agreements are generally non-cancelable. We typically bill in advance for monthly contracts and annually in advance for contracts with terms of one year or longer. Amounts that have been billed are initially recorded as deferred revenue until the revenue is recognized. Our revenue is driven primarily by conversions and upsells to our paid plans. We also generate revenue from transaction-based products and fees from the referral of users to our partners. We generate over 90% of our revenue from self-serve channels. No customer represented more than 1% of our revenue in the periods presented. Cost of revenue and gross margin Cost of revenue. Our cost of revenue consists primarily of expenses associated with the storage, delivery, and distribution of our platform for both paying users and free users, also known as Basic users. These costs, which we refer to as infrastructure costs, include depreciation of our servers located in co-location facilities that we lease and operate, rent and facilities expense for those datacenters, network and bandwidth costs, support and maintenance costs for our infrastructure equipment, and payments to third-party datacenter service providers. Cost of revenue also includes costs, such as salaries, bonuses, employer payroll taxes and benefits, travel-related expenses, and stock-based compensation, which we refer to as employee-related costs, for employees whose primary responsibilities relate to supporting our infrastructure and delivering user support. Other non-employee costs included in cost of revenue include credit card fees related to processing customer transactions, and allocated overhead, such as facilities, including rent, utilities, depreciation on leasehold improvements and other equipment shared by all departments, and shared information technology costs. In addition, cost of revenue includes amortization of developed technologies, professional fees related to user support initiatives, and property taxes related to the datacenters. During the first quarter of 2018, based on considerations including our asset replacement cycle and our ongoing infrastructure optimization efforts, we revisited the useful life estimates of certain infrastructure equipment. These optimization efforts included efficiencies that allow us to utilize certain infrastructure equipment for longer periods of time. As a result, we determined that the useful lives of the impacted infrastructure equipment, which are depreciated through cost of revenue, should be increased from three to four years. We accounted for this as a change in estimate that was applied prospectively, effective as ofJanuary 1, 2018 . This change in useful life resulted in a reduction in depreciation expense within cost of revenue of$16.1 million during the year endedDecember 31, 2018 . We plan to continue increasing the capacity and enhancing the capability and reliability of our infrastructure to support user growth and increased use of our platform. We expect that cost of revenue, will increase in absolute dollars in future periods. Gross margin. Gross margin is gross profit expressed as a percentage of revenue. Our gross margin may fluctuate from period to period based on the timing of additional capital expenditures and the related depreciation expense, or other increases in our infrastructure costs, as well as revenue fluctuations. As we continue to increase the utilization of our internal infrastructure, we generally expect our gross margin, to remain relatively constant in the near term and to increase modestly in the long term. 45
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Operating expenses Research and development. Our research and development expenses consist primarily of employee-related costs for our engineering, product, and design teams, compensation expenses related to key personnel from acquisitions and allocated overhead. Additionally, research and development expenses include internal development-related third-party hosting fees. We have expensed almost all of our research and development costs as they were incurred. We plan to continue to hire employees for our engineering, product, and design teams to support our research and development efforts. We expect that research and development costs will increase in absolute dollars in future periods and vary from period to period as a percentage of revenue. Sales and marketing. Our sales and marketing expenses relate to both self-serve and outbound sales activities, and consist primarily of employee-related costs, brand marketing costs, lead generation costs, sponsorships and allocated overhead. Sales commissions earned by our outbound sales team and the related payroll taxes, as well as commissions earned by third-party resellers that we consider to be incremental and recoverable costs of obtaining a contract with a customer, are deferred and are typically amortized over an estimated period of benefit of five years. Additionally, sales and marketing expenses include non-employee costs related to app store fees and fees payable to third-party sales representatives and amortization of acquired customer relationships. We plan to continue to invest in sales and marketing to grow our user base and increase our brand awareness, including marketing efforts to continue to drive our self-serve business model. We expect that sales and marketing expenses will increase in absolute dollars in future periods and vary from period to period as a percentage of revenue. The trend and timing of sales and marketing expenses will depend in part on the timing of marketing campaigns. General and administrative. Our general and administrative expenses consist primarily of employee-related costs for our legal, finance, human resources, and other administrative teams, as well as certain executives. In addition, general and administrative expenses include allocated overhead, outside legal, accounting and other professional fees, and non-income based taxes. We expect to incur additional general and administrative expenses to support the growth of the Company. General and administrative expenses include the recognition of stock-based compensation expense related to grants of restricted stock made to our co-founders. We expect that general and administrative expenses will increase in absolute dollars in future periods and vary from period to period as a percentage of revenue. Interest income (expense), net Interest income (expense), net consists primarily of interest income earned on our money market funds classified as cash and cash equivalents and short-term investments, partially offset by interest expense related to our finance lease obligations for infrastructure and our imputed financing obligation for our liability to the legal owner of our previous corporate headquarters. We no longer incur interest expense for our imputed financing obligation as of the fourth quarter of 2018, due to the termination of our master lease for our previous corporate headquarters in the third quarter of 2018. Other income (expense), net Other income (expense), net consists of other non-operating gains or losses, including those related to equity investments, lease arrangements, which include sublease income, foreign currency transaction gains and losses, and realized gains and losses related to our short-term investments. Benefit from (provision for) income taxes Provision for income taxes consists primarily ofU.S. federal and state income taxes and income taxes in certain foreign jurisdictions in which we conduct business. For the periods presented, the difference between theU.S. statutory rate and our effective tax rate is primarily due to the valuation allowance on deferred tax assets. Our effective tax rate is also impacted by earnings realized in foreign jurisdictions with statutory tax rates lower than the federal statutory tax rate. We maintain a full valuation allowance on our net deferred tax assets for federal, state, and certain foreign jurisdictions as we have concluded that it is not more likely than not that the deferred assets will be realized. 46
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Results of Operations The following tables set forth our results of operations for the periods presented and as a percentage of our total revenue for those periods:
Year ended December 31,
2019 2018 2017
(In millions)
Revenue $ 1,661.3 $ 1,391.7 $ 1,106.8
Cost of revenue(1) 411.0 394.7 368.9
Gross profit 1,250.3 997.0 737.9
Operating expenses:(1)
Research and development 662.1 768.2 380.3
Sales and marketing 423.3 439.6 314.0
General and administrative 245.4 283.2 157.3
Total operating expenses 1,330.8 1,491.0 851.6
Loss from operations (80.5 ) (494.0 ) (113.7 )
Interest income (expense), net 12.5 7.1 (11.0 )
Other income (expense), net 16.0 6.8 13.2
Loss before income taxes (52.0 ) (480.1 ) (111.5 ) Benefit from (provision for) income taxes (0.7 ) (4.8 ) (0.2 ) Net loss$ (52.7 ) $ (484.9 ) $ (111.7 )
(1) Includes stock-based compensation as follows:
Year ended December 31,
2019 2018 2017
(In millions)
Cost of revenue $ 15.8 $ 47.0 $ 12.2
Research and development 147.6 368.2 93.1
Sales and marketing 31.4 94.3 33.7
General and administrative 66.4 140.6 25.6
Total stock-based compensation(2)
(2) Upon the effectiveness of the registration statement for our initial public
offering, which was
vesting condition associated with our two-tier RSUs was satisfied. During
the year ended
stock-based compensation of $418.7 million . See "Significant Impacts of
Stock Based Compensation" for further information regarding our equity
arrangements.
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The following table sets forth our results of operations for each of the periods presented as a percentage of revenue:
Year ended December 31,
2019 2018 2017
As a percentage of revenue
Revenue 100 % 100 % 100 %
Cost of revenue 25 28 33
Gross profit 75 72 67
Operating expenses: -
Research and development 40 55 34
Sales and marketing 25 32 28
General and administrative 15 20 14
Total operating expenses 80 107 77
Loss from operations (5 ) (35 ) (10 )
Interest income (expense), net 1 1 (1 )
Other income (expense), net 1 - 1
Loss before income taxes (3 ) (34 ) (10 )
Benefit from (provision for) income taxes - - -
Net loss (3 )% (35 )% (10 )%
Comparison of the year ended
Year ended
December 31,
2019 2018 $ Change % Change
(In millions)
Revenue
Revenue increased$269.6 million or 19% during the year endedDecember 31, 2019 , as compared to the year endedDecember 31, 2018 . The increase in revenue was driven primarily by the adoption of premium plans by our users, an increase in the price of our Plus plan, and an increase in paying users. Cost of revenue, gross profit, and gross margin Year ended December 31, 2019 2018 $ Change % Change (In millions)
Cost of revenue$ 411.0 $ 394.7 $ 16.3 4 % Gross profit 1,250.3 997.0 253.3 25 % Gross margin 75 % 72 % Cost of revenue increased$16.3 million or 4% during the year endedDecember 31, 2019 , as compared to the year endedDecember 31, 2018 , primarily due to an increase of$13.7 million in infrastructure costs,$13.0 million in employee-related costs, excluding stock-based compensation, due to headcount growth, and$10.4 million in allocated overhead, which includes facilities-related costs for both our current and former corporate headquarters. Additionally, cost of revenue increased due to$5.2 million in credit card transaction fees due to higher sales, and$3.8 million in amortization of acquired intangible assets. These increases were offset by a decrease of$31.1 million in stock-based compensation, which was primarily due to the large 48
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expense recognized in the year endedDecember 31, 2018 due to the achievement of the performance vesting condition of our two-tier RSUs upon the effectiveness of the registration statement related to our IPO. Our gross margin increased from 72% during the year endedDecember 31, 2018 to 75% during the year endedDecember 31, 2019 , primarily due to a 19% increase in our revenue during the period offset by a lesser increase in our cost of revenue described above. Research and development Year ended December 31, 2019 2018 $ Change % Change (In millions)
Research and development
Research and development expenses decreased$106.1 million or 14% during the year endedDecember 31, 2019 , as compared to the year endedDecember 31, 2018 , primarily due to a decrease of$220.6 million in stock-based compensation, which was primarily due to the large expense recognized in the year endedDecember 31, 2018 due to the achievement of the performance vesting condition of our two-tier RSUs upon the effectiveness of the registration statement related to our IPO. This decrease was offset by increases of$62.0 million in employee-related costs, excluding stock-based compensation, due to headcount growth, and$36.9 million in allocated overhead, which includes facilities-related costs for both our current and former corporate headquarters. Sales and marketing Year ended December 31, 2019 2018 $ Change % Change (In millions)
Sales and marketing
Sales and marketing expenses decreased$16.3 million or 4% during the year endedDecember 31, 2019 , as compared to the year endedDecember 31, 2018 , due to decreases of$62.9 million in stock-based compensation, which was primarily due to the large expense recognized in the year endedDecember 31, 2018 due to the achievement of the performance vesting condition of our two-tier RSUs upon the effectiveness of the registration statement related to our IPO, and a decrease of$11.9 million due to brand marketing costs, lead generation costs, third-party sales representative fees, and sponsorships. These decreases were offset by increases of$22.7 million in employee-related costs, excluding stock-based compensation, due to headcount growth, and$16.5 million in allocated overhead, which includes facilities-related costs for both our current and former corporate headquarters. Additionally, the decrease in sales and marketing expenses was further offset by increases of$12.7 million in app store fees due to increased sales and due to$5.0 million in amortization of acquired intangible assets. General and administrative Year ended December 31, 2019 2018 $ Change % Change (In millions)
General and administrative
General and administrative expense decreased$37.8 million or 13% during the year endedDecember 31, 2019 , as compared to the year endedDecember 31, 2018 , primarily due to a decrease of$74.2 million in stock-based compensation, which was primarily due to the large expense recognized in the year endedDecember 31, 2018 due to the achievement of the performance vesting condition of our two-tier RSUs, and the performance-based vesting condition for the Co-Founder Grants 49
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in connection with our IPO. This decrease was offset by increases of$17.2 million in allocated overhead, which includes facilities-related costs for both our current and former corporate headquarters,$10.4 million in non-income based taxes, and$9.2 million in legal-related and acquisition expenses. Interest income (expense), net Interest income (expense), net increased$5.4 million during the year endedDecember 31, 2019 , as compared to the year endedDecember 31, 2018 , due to an increase in interest income from our money market funds and short-term investments. Other income (expense), net Other income (expense), net increased$9.2 million during the year endedDecember 31, 2019 , as compared to the year endedDecember 31, 2018 , primarily due to an increase of$9.0 million in gains related to disposals of infrastructure assets, and$5.0 million in gains related to an equity investment and short-term investments. These increases are partially offset by a decrease of sublease income of$6.0 million . Benefit from (provision for) income taxes Provision for income taxes decreased by$4.1 million during the year endedDecember 31, 2019 as compared to the year endedDecember 31, 2018 , primarily due to a one-time tax benefit related to the acquisition of HelloSign.
Fiscal 2018 Compared to Fiscal 2017
For a comparison of our results of operations for the fiscal years endedDecember 31, 2018 and 2017, see Item 7, Management's Discussion and Analysis of Financial Condition and Results of Operations, of our Annual Report on Form 10-K for the fiscal year endedDecember 31, 2018 , filed with theSEC onFebruary 25, 2019 . Quarterly Results of Operations (Unaudited) The following table sets forth our unaudited quarterly statements of operations data for each of the last eight quarters endedDecember 31, 2019 . The information for each of these quarters has been prepared on the same basis as the audited annual financial statements included elsewhere in this Annual Report on Form 10-K and, in the opinion of management, includes all adjustments, which includes only normal recurring adjustments, necessary for the fair statement of the results of operations for these periods. This data should be read in conjunction with our audited consolidated financial statements and related notes thereto included elsewhere in this Annual Report on Form 10-K. These quarterly results of operations are not necessarily indicative of our future results of operations that may be expected for any future period.
Three months ended
December 31, September 30, June 30, March 31, December 31, September 30, June 30, March 31,
2019 2019 2019 2019 2018 2018 2018 2018
(In millions, except per share amounts)
Revenue $ 446.0 $ 428.2 $ 401.5 $ 385.6 $ 375.9 $ 360.3 $ 339.2 $ 316.3
Cost of revenue(1) 104.9 104.8 102.9 98.4 94.4 90.2 89.5 120.6
Gross profit 341.1 323.4 298.6 287.2 281.5 270.1 249.7 195.7
Operating
expenses:(1)(2)
Research and
development 176.9 172.8 162.4 150.0 136.8 133.2 119.7 378.5
Sales and marketing 106.3 108.2 107.3 101.5 100.2 95.0 87.4 157.0
General and
administrative 64.5 61.0 62.9 57.0 56.5 50.8 49.8 126.1
Total operating
expenses 347.7 342.0 332.6 308.5 293.5 279.0 256.9 661.6
Loss from operations $ (6.6 ) $ (18.6 ) $ (34.0 ) $ (21.3 ) $ (12.0 ) $ (8.9 ) $ (7.2 ) $ (465.9 )
Net loss $ (6.6 ) $ (17.0 ) $ (21.4 ) $ (7.7 ) $ (9.5 ) $ (5.8 ) $ (4.1 ) $ (465.5 )
Net loss per share
attributable to common
stockholders, basic
and diluted $ (0.02 ) $ (0.04 ) $ (0.05 ) $ (0.02 ) $ (0.02 ) $ (0.01 ) $ (0.01 ) $ (2.13 )
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(1) Includes stock-based compensation as follows:
Three months ended
December 31, September 30, June 30, March 31, December 31, September 30, June 30, March 31,
2019 2019 2019 2019 2018 2018 2018 2018
(In millions)
Cost of revenue $ 4.0 $ 4.1 $ 4.7 $ 3.0 $ 3.1 $ 3.2 $ 2.9 $ 37.8
Research and development 40.5 38.9 37.7 30.5 29.2 28.2 27.9 282.9
Sales and marketing 7.8 7.7 8.8 7.1 5.9 8.1 7.9 72.4
General and
administrative 17.0 17.5 16.9 15.0 15.3 15.5 16.4 93.4
Total stock-based
compensation(2)(3) $ 69.3 $ 68.2 $ 68.1 $ 55.6 $ 53.5 $ 55.0 $ 55.1 $ 486.5 (2) During the three months ended
unrecognized stock-based compensation of
two-tier RSUs upon the effectiveness of our registration statement for our
IPO. During the quarter, we also released 26.8 million shares of common
stock underlying the vested two-tier RSUs, and as a result recorded
million in employer related payroll tax expenses associated with these same
awards. Refer to "Significant Impacts of Stock-Based Compensation" included
elsewhere in this Annual Report on Form 10-K for further information.
(3) During the year ended December 31, 2017 , our Board of Directors voted toapprove a modification of vesting schedules for certain unvested one-tier
and two-tier RSUs to align the vesting schedules for all RSUs to vest once
per quarter. As a result, we recognized an incremental
stock-based compensation during the three months ended
to "Significant Impacts of Stock-Based Compensation" included elsewhere in
this Annual Report on Form 10-K for further information.
Three months ended
December 31, September 30, June 30, March 31, December 31, September 30, June 30, March 31,
2019 2019 2019 2019 2018 2018 2018 2018
(As a % of revenue)
Revenue 100 % 100 % 100 % 100 % 100 % 100 % 100 % 100 %
Cost of revenue 24 24 26 26 25 25 26 38
Gross profit 76 76 74 74 75 75 74 62
Operating expenses:
Research and development 40 40 40 39 36 37 35 120
Sales and marketing 24 25 27 26 27 26 26 50
General and administrative 14 14 16 15 15 14 15 40
Total operating expenses 78 80 83 80 78 77 76 209
Loss from operations (1 )% (4 )% (8 )% (6 )% (3 )% (2 )% (2 )% (147 )%
Net Loss (1 )% (4 )% (5 )% (2 )% (3 )% (2 )% (1 )% (147 )%
Quarterly revenue trends
Our revenue increased sequentially in each of the quarters presented primarily
due to increases in Total ARR, paying users, and average revenue per paying
user. Seasonality in our revenue is not material.
Quarterly cost of revenue and gross margin trends
Except for the three months ended March 31, 2018 , our cost of revenue increased
sequentially in the quarters presented primarily due to infrastructure costs and
employee related expenses, excluding stock based compensation, which is offset
by the increases in our revenue causing our gross margins to increase or remain
constant. Our cost of revenue during the three months ended March 31, 2018 , was
higher than the other quarters due to the completion of our initial public
offering, as further described in "-Significant Impacts of Stock-Based
Compensation".
Quarterly operating expense trends
Except for the three months ended March 31, 2018 , our total quarterly operating
expenses increased sequentially in each of the quarters presented primarily due
to headcount growth in connection with the expansion of our business and other
events that are discussed herein. Our quarterly operating expenses during the
three months ended March 31, 2018 , was higher than the other quarters presented
due to the completion of our initial public offering, as further described in
"-Significant Impacts of Stock-Based Compensation".
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Table of Contents Research and development Except for the three months endedMarch 31, 2018 , our research and development expenses increased sequentially in each of the quarters presented primarily due to employee-related expenses due to headcount growth and overhead-related costs, which includes facilities related costs for both our current and former corporate headquarters in certain periods. Our research and development expenses during the three months endedMarch 31, 2018 , were higher than the other quarters presented, primarily due to the completion of our initial public offering, as further described in "-Significant Impacts of Stock-Based Compensation". Sales and marketing Except for the three months endedMarch 31, 2018 , our sales and marketing expenses have generally increased in the quarters presented primarily due to employee-related expenses due to headcount growth and overhead-related costs, which includes facilities related costs for both our current and former corporate headquarters in certain quarters. Additionally, the timing of brand advertising campaigns can impact the trends in sales and marketing expenses. Our sales and marketing expenses during the three months endedMarch 31, 2018 , was higher than the other quarters presented primarily due to the completion of our initial public offering, as further described in "-Significant Impacts of Stock-Based Compensation". General and administrative Except for the three months endedMarch 31, 2018 , our general and administrative expenses have generally increased in the quarters presented, primarily due to increases in employee-related expenses, non-income based taxes, and legal, accounting, and other professional fees. Our general and administrative expenses during the three months endedMarch 31, 2018 , was higher than the other quarters presented primarily due to the completion of our initial public offering. Additionally, as a result of our initial public offering, and in the same quarter, we began recognizing stock-based compensation expense related to market-based awards granted to our co-founders in 2017 ("Co-Founder Grants"), as further described in "-Significant Impacts of Stock-Based Compensation".
Liquidity and Capital Resources
As ofDecember 31, 2019 , we had cash and cash equivalents of$551.3 million and short-term investments of$607.7 million , which were held for working capital purposes. Our cash, cash equivalents, and short-term investments consist primarily of cash, money market funds, corporate notes and obligations,U.S. Treasury securities, certificates of deposit, asset-backed securities, commercial paper,U.S. agency obligations, supranational securities, and municipal securities. As ofDecember 31, 2019 , we had$219.3 million of our cash and cash equivalents held by our foreign subsidiaries. We do not expect to incur material taxes in the event we repatriate any of these amounts. Since our inception, we have financed our operations primarily through equity issuances, cash generated from our operations, and finance leases to finance infrastructure-related assets in co-location facilities that we directly lease and operate. We enter into finance leases in part to better match the timing of payments for infrastructure-related assets with that of cash received from our paying users. In our business model, some of our registered users convert to paying users over time, and consequently there is a lag between initial investment in infrastructure assets and cash received from some of our users. Our principal uses of cash in recent periods have been funding our operations, purchases of short-term investments, the satisfaction of tax withholdings in connection with the settlement of restricted stock units, making principal payments on our finance lease obligations, and capital expenditures. OnFebruary 19, 2020 , our Board of Directors approved a stock repurchase program for the repurchase of up to$600 million of the Company's outstanding shares of Class A common stock. Share repurchases will be subject to a review of the circumstances in place at that time and will be made from time to time in private transactions or open market purchases as permitted by securities laws and other legal requirements. The program does not obligate the Company to repurchase any specific number of shares and may be discontinued at any time. InApril 2017 , we entered into a$600.0 million credit facility with a syndicate of financial institutions. Pursuant to the terms of the revolving credit facility, we may issue letters of credit under the revolving credit facility, which reduce the total amount available for borrowing under such facility. The revolving credit facility terminates onApril 4, 2022 . InFebruary 2018 , we amended our revolving credit facility to, among other things, permit us to make certain investments, enter into an unsecured standby letter of credit facility, and increase our standby letter of credit sublimit to$187.5 million . We also increased our borrowing capacity under the revolving credit facility from$600.0 million to$725.0 million . We may from time to time request increases in the borrowing capacity under our revolving credit facility of up to$275.0 million , provided no event of default has occurred or is continuing or would result from such increase. 52
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Interest on borrowings under the revolving credit facility accrues at a variable rate tied to the prime rate or the LIBOR rate, at our election. Interest is payable quarterly in arrears. Pursuant to the terms of the revolving credit facility, we are required to pay an annual commitment fee that accrues at a rate of 0.20% per annum on the unused portion of the borrowing commitments under the revolving credit facility. In addition, we are required to pay a fee in connection with letters of credit issued under the revolving credit facility that accrues at a rate of 1.5% per annum on the amount of such letters of credit outstanding. There is an additional fronting fee of 0.125% per annum multiplied by the average aggregate daily maximum amount available under all letters of credit. The revolving credit facility contains customary conditions to borrowing, events of default, and covenants, including covenants that restrict our ability to incur indebtedness, grant liens, make distributions to our holders or our subsidiaries' equity interests, make investments, or engage in transactions with our affiliates. In addition, the revolving credit facility contains financial covenants, including a consolidated leverage ratio covenant and a minimum liquidity balance. We were in compliance with all covenants under the revolving credit facility as ofDecember 31, 2019 . As ofDecember 31, 2019 , we had no amounts outstanding under the revolving credit facility and an aggregate of$59.7 million in letters of credit outstanding under the revolving credit facility. Our total available borrowing capacity under the revolving credit facility was$665.3 million as ofDecember 31, 2019 . We believe our existing cash and cash equivalents, together with our short-term investments, cash provided by operations and amounts available under the revolving credit facility, will be sufficient to meet our needs for the foreseeable future. Our future capital requirements will depend on many factors including our revenue growth rate, subscription renewal activity, billing frequency, the timing and extent of spending to support further infrastructure development and research and development efforts, the timing and extent of additional capital expenditures to invest in existing and new office spaces, such as our new corporate headquarters, the satisfaction of tax withholding obligations for the release of restricted stock units, the expansion of sales and marketing and international operation activities, the introduction of new product capabilities and enhancement of our platform, and the continuing market acceptance of our platform. We have and may in the future enter into arrangements to acquire or invest in complementary businesses, services, and technologies, including intellectual property rights. We may be required to seek additional equity or debt financing. In the event that additional financing is required from outside sources, we may not be able to raise it on terms acceptable to us or at all. If we are unable to raise additional capital when desired, our business, results of operations, and financial condition would be materially and adversely affected. Our cash flow activities were as follows for the periods presented: Year ended December 31, 2019 2018 (In millions) Net cash provided by operating activities$ 528.5 $ 425.4 Net cash used in investing activities (320.0 ) (633.8 ) Net cash (used in) provided by financing activities (176.7 ) 300.8 Effect of exchange rate changes on cash and cash equivalents 0.2 (3.1 ) Net increase in cash and cash equivalents$ 32.0
Operating activities Our largest source of operating cash is cash collections from our paying users for subscriptions to our platform. Our primary uses of cash from operating activities are for employee-related expenditures, infrastructure-related costs, and marketing expenses. Net cash provided by operating activities is impacted by our net loss adjusted for certain non-cash items, including depreciation and amortization expenses and stock-based compensation, as well as the effect of changes in operating assets and liabilities. For the year endedDecember 31, 2019 , net cash provided by operating activities was$528.5 million , which mostly consisted of our net loss of$52.7 million , adjusted for stock-based compensation expense of$261.2 million and depreciation and amortization expenses of$173.5 million , and net cash inflow of$145.6 million from operating assets and liabilities. The inflow from operating assets and liabilities was primarily due to an increase of$68.7 million in deferred revenue from increased subscription sales, as a majority of our paying users are invoiced in advance. Additionally, cash provided by operating activities increased due to an increase in other operating assets and liabilities of$76.9 million . Our net cash provided 53
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by operating activities for the year endedDecember 31, 2019 also included cash payments of$55.3 million related to tenant improvement allowance reimbursements. For the year endedDecember 31, 2018 , net cash provided by operating activities was$425.4 million , which mostly consisted of our net loss of$484.9 million , adjusted for stock-based compensation expense of$650.1 million and depreciation and amortization expenses of$166.8 million , and net cash inflow of$83.2 million from operating assets and liabilities. The inflow from operating assets and liabilities was primarily due to an increase of$66.4 million in deferred revenue from increased subscription sales, as a majority of our paying users are invoiced in advance. Additionally, cash provided by operating activities increased due to an increase in other operating assets and liabilities of$16.8 million . Our net cash provided by operating activities for the year endedDecember 31, 2018 also included a payment of$13.8 million of employer payroll taxes related to the release of our two-tier RSUs in connection with our IPO, which was paid in the first quarter of 2018. Investing activities Net cash used in investing activities is primarily impacted by purchases of short-term investments, purchases of property and equipment to make improvements to existing and new office spaces, and for purchasing infrastructure equipment in co-location facilities that we directly lease and operate. For the year endedDecember 31, 2019 , net cash used in investing activities was$320.0 million , which primarily related to purchases of short-term investments of$775.4 million , cash paid for our acquisition of HelloSign, net of cash acquired, of$171.6 million and capital expenditures of$136.1 million related to our office and datacenter build-outs. These outflows were partially offset by inflows of$750.9 million related to proceeds from maturities and sales of short-term investments. For the year endedDecember 31, 2018 , net cash used in investing activities was$633.8 million , which primarily related to purchases of short-term investments of$850.4 million and capital expenditures of$63.0 million related to our office and datacenter build-outs. These outflows were partially offset by inflows of$283.6 million related to proceeds from maturities and sales of short-term investments. Financing activities Net cash (used in) financing activities is primarily impacted by repurchases of common stock to satisfy the tax withholding obligation for the release of restricted stock units ("RSUs") and principal payments on finance lease obligations for our infrastructure equipment. For the year endedDecember 31, 2019 , net cash used in financing activities was$176.7 million , which primarily consisted of$92.9 million in principal payments against finance lease obligations and$85.4 million for the satisfaction of tax withholding obligations for the release of restricted stock units. For the year endedDecember 31, 2018 , net cash provided by financing activities was$300.8 million , which primarily consisted of$746.6 million in net proceeds from the completion of our IPO and concurrent private placement. The proceeds were offset by$351.9 million for the satisfaction of tax withholding obligations for the release of restricted stock units and$109.1 million in principal payments against finance lease obligations. Contractual Obligations Our principal commitments consist of obligations under operating leases for office space and datacenter operations, and finance leases for datacenter equipment. The following table summarizes our commitments to settle contractual obligations in cash as ofDecember 31, 2019 , for the periods presented below: Less than More than Total 1 year 1 - 3 years 3 - 5 years 5 years (In millions)
Operating lease commitments(1)
$ 175.5 $ 636.2 Finance lease commitments(2) 229.0 84.1 123.7 21.2 - Other commitments(3) 73.3 48.8 7.4 0.4 16.7
Total contractual obligations
$ 197.1 $ 652.9 54
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(1) Consists of future non-cancelable minimum rental payments under operating
leases for our offices and datacenters, excluding rent payments from our
sub-tenants and variable operating expenses. As of
are entitled to non-cancelable rent payments from our sub-tenants of
million, which will be collected over the next 3 years.
(2) Consists of future non-cancelable minimum rental payments under finance
leases primarily for our infrastructure.
(3) Consists of commitments to third-party vendors for services related to our
infrastructure, infrastructure warranty contracts, asset retirement
obligations for office modifications, and a note payable related to
financing of our infrastructure.
In addition to the contractual obligations set forth above, as of December 31,
2019 , we had an aggregate of $59.6 million in letters of credit outstanding
under our revolving credit facility.
In 2017, we entered into a new lease agreement for office space in San
Francisco, California , to serve as our new corporate headquarters. We took
initial possession of our new corporate headquarters in June 2018 and began to
recognize rent expense in the same period. Refer to Note 9 "Leases" for further
information.
Off-Balance Sheet Arrangements
As of December 31, 2019 , we did not have any relationships with unconsolidated
entities or financial partnerships, such as entities often referred to as
structured finance or variable interest entities, which would have been
established for the purpose of facilitating off balance sheet arrangements or
other contractually narrow or limited purposes.
Significant Impacts of Stock-Based Compensation
Restricted Stock Units
We have granted restricted stock units, or RSUs, to our employees and members of
our Board of Directors under our 2008 Equity Incentive Plan, or 2008 Plan, our
2017 Equity Incentive Plan, or 2017 Plan and our 2018 Equity Incentive Plan, or
2018 Plan. We have two types of RSUs outstanding as of December 31, 2019 :
• One-tier RSUs, which have a service-based vesting condition over a
four-year period. These awards typically have a cliff vesting period of
one year and continue to vest quarterly thereafter. We recognize
compensation expense associated with one-tier RSUs ratably on a
straight-line basis over the requisite service period.
• Two-tier RSUs, which have both a service-based vesting condition and a
liquidity event-related performance vesting condition. These awards
typically have a service-based vesting period of four years with a
cliff vesting period of one year and continue to vest monthlythereafter. Upon satisfaction of the Performance Vesting Condition,
these awards vest quarterly. The Performance Vesting Condition was
satisfied upon the effectiveness of the registration statement related
to our IPO. Our last grant date for two-tier RSUs was May 2015 . Werecognize compensation expense associated with two-tier RSUs using the
accelerated attribution method over the requisite service period.
Upon the effectiveness of the registration statement related to our IPO, we
recognized stock-based compensation related to our two-tier RSUs using the
accelerated attribution method, with a cumulative catch-up in the amount of
Co-Founder Grants
InDecember 2017 , the Board of Directors approved a grant to the Company's co-founders of non-Plan RSAs with respect to 14.7 million shares of Class A Common Stock in the aggregate (collectively, the "Co-Founder Grants"), of which 10.3 million RSAs were granted toMr. Houston , the Company's co-founder and Chief Executive Officer, and 4.4 million RSAs were granted toMr. Ferdowsi , the Company's co-founder and Director. These Co-Founder Grants have service-based, market-based, and performance-based vesting conditions. The Co-Founder Grants are excluded from Class A common stock issued and outstanding until the satisfaction of these vesting conditions. The Co-Founder Grants also provide the holders with certain stockholder rights, such as the right to vote the shares with the other holders of Class A common stock and a right to cumulative declared dividends. However, the Co-Founder Grants are not considered a participating security for purposes of calculating net loss per share attributable to common stockholders in Note 13, "Net Loss Per Share", as the right to the cumulative declared dividends is forfeitable if the service condition is not met. 55
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The Co-Founder Grants are eligible to vest over the ten-year period following the date the Company's shares of Class A common stock commenced trading on the Nasdaq Global Select Market in connection with the Company's IPO. The Co-Founder Grants comprise nine tranches that are eligible to vest based on the achievement of stock price goals, each of which are referred to as a Stock Price Target, measured over a consecutive thirty-day trading period during the Performance Period. The Performance Period began onJanuary 1, 2019 and the RSUs expire at the earliest date among the following: the date on which all shares vest, the date the Co-Founder(s) cease to meet their service conditions, or the tenth anniversary of the IPO date. Company Stock Price Shares Eligible to Vest for Shares Eligible to Vest Target Mr. Houston for Mr. Ferdowsi$30.00 2,066,667 880,000$37.50 1,033,334 440,000$45.00 1,033,334 440,000$52.50 1,033,333 440,000$60.00 1,033,333 440,000$67.50 1,033,333 440,000$75.00 1,033,333 440,000$82.50 1,033,333 440,000$90.00 1,033,333 440,000 During the first four years of the Performance Period, no more than 20% of the shares subject to each Co-Founder Grant would be eligible to vest in any calendar year. After the first four years, all shares are eligible to vest based on the achievement of the Stock Price Targets. The Company calculated the grant date fair value of the Co-Founder Grants based on multiple stock price paths developed through the use of a Monte Carlo simulation. A Monte Carlo simulation also calculates a derived service period for each of the nine vesting tranches, which is the measure of the expected time to achieve each Stock Price Target. A Monte Carlo simulation requires the use of various assumptions, including the underlying stock price, volatility, and the risk-free interest rate as of the valuation date, corresponding to the length of time remaining in the performance period, and expected dividend yield. The weighted-average grant date fair value of each Co-Founder Grant was estimated to be$10.60 per share. The weighted-average derived service period of each Co-Founder Grant was estimated to be 5.2 years, and ranged from 2.9 - 6.9 years. The Company will recognize aggregate stock-based compensation expense of$156.2 million over the derived service period of each tranche using the accelerated attribution method as long as the co-founders satisfy their service-based vesting conditions. If the Stock Price Targets are met sooner than the derived service period, the Company will adjust its stock-based compensation to reflect the cumulative expense associated with the vested awards. The Company will recognize expense if the requisite service is provided, regardless of whether the market conditions are achieved.
The Performance Vesting Condition for the Co-Founder Grants was satisfied on the
date the Company's shares of Class A common stock commenced trading on the
Nasdaq Global Select Market in connection with the Company's IPO, which was
Award Modification During the year endedDecember 31, 2017 , the Company's Board of Directors voted to approve a modification of vesting schedules for certain unvested one-tier and two-tier RSUs to align the vesting schedules for all RSUs to vest once per quarter. The modification was effectiveFebruary 15, 2018 , which resulted in accelerated vesting of impacted RSUs that had met their service requirement as of that date. As a result, the Company recognized an incremental$10.0 million in stock-based compensation during the first quarter of 2018 related to these modified one-tier and two-tier RSUs.
See Note 1, "Description of the Business and Summary of Significant Accounting Policies" and Note 12, "Stockholders' Equity" to our consolidated financial statements included elsewhere in this Annual Report on Form 10-K for more information regarding our equity awards.
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Critical Accounting Policies and Judgments Our consolidated financial statements and the related notes thereto included elsewhere in this Annual Report on Form 10-K are prepared in accordance with generally accepted accounting principles, or GAAP, inthe United States . The preparation of consolidated financial statements also requires us to make estimates and assumptions that affect the reported amounts of assets, liabilities, revenue, costs and expenses, and related disclosures. We base our estimates on historical experience and on various other assumptions that we believe to be reasonable under the circumstances. Actual results could differ significantly from the estimates made by management. To the extent that there are differences between our estimates and actual results, our future financial statement presentation, financial condition, results of operations, and cash flows will be affected. We believe that the accounting policies described below involve a greater degree of judgment and complexity. Accordingly, these are the policies we believe are the most critical to aid in fully understanding and evaluating our consolidated financial condition and results of operations. Revenue recognition We generate revenue from sales of subscriptions to our platform. Subscription fees exclude sales and other indirect taxes. We determine revenue recognition through the following steps:
• Identification of the contract, or contracts, with a customer
• Identification of the performance obligations in the contract
• Determination of the transaction price
• Allocation of the transaction price to the performance obligations in the
contract
• Recognition of revenue when, or as, we satisfy a performance obligation
Our subscription agreements typically have monthly or annual contractual terms, and a small percentage have multi-year contractual terms. Revenue is recognized ratably over the related contractual term generally beginning on the date that our platform is made available to a customer. Our agreements are generally non-cancelable. We typically bill in advance for monthly contracts and annually in advance for contracts with terms of one year or longer. Business combinations Accounting for business combinations requires us to make significant estimates and assumptions. We allocate the purchase consideration to the tangible and intangible assets acquired and liabilities assumed based on their estimated fair values, with the excess recorded to goodwill. Critical estimates in valuing certain intangible assets include, but are not limited to, future expected cash flows, expected asset lives, and discount rates. The amounts and useful lives assigned to acquisition-related intangible assets impact the amount and timing of future amortization expense.
During the measurement period, which is not to exceed one year from the acquisition date, we may record adjustments to the assets acquired and liabilities assumed, with the corresponding offset to goodwill. Upon the conclusion of the measurement period, any subsequent adjustments are recorded to earnings.
Deferred commissions
Certain sales commissions and the related payroll taxes earned by our outbound
sales team, as well as commissions earned by third-party resellers, are
considered to be incremental and recoverable costs of obtaining a contract with
a customer. These costs are deferred and then amortized over a period of benefit
that we have determined to be five years. We determined the period of benefit by
taking into consideration our historical customer attrition rates, the useful
life of our technology, and the impact of competition in our industry.
Fair value of market condition awards
The Co-Founder Grants contain market-based vesting conditions. The market-based
vesting condition is considered when calculating the grant date fair value of
these awards, which requires the use of various estimates and assumptions. The
grant date fair value of the Co-Founder Grants was estimated using a model based
on multiple stock price paths developed through the use of a Monte Carlo
simulation that incorporates into the valuation the possibility that the market
condition may not be satisfied. A Monte Carlo simulation requires the use of
various assumptions, including our underlying stock price, volatility, and the
risk-free interest rate as of the valuation date, corresponding to the length of
time remaining in the performance period,
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and expected dividend yield. A Monte Carlo simulation also calculates a derived
service period for each of the nine vesting tranches, which is the measure of
the expected time to achieve the market conditions. Expense associated with
market-based awards is recognized over the requisite service period of each
tranche using the accelerated attribution method, regardless of whether the
market conditions are achieved.
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Recent Accounting Pronouncements See Note 1, "Description of the Business and Summary of Significant Accounting Policies" to our consolidated financial statements included elsewhere in this Annual Report on Form 10-K for recently adopted accounting pronouncements and recently issued accounting pronouncements not yet adopted as of the date of this Annual Report on Form 10-K.
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