VEEVA SYSTEMS INC. You should read the following discussion and analysis of our financial condition and results of operations in conjunction with our condensed consolidated financial statements and notes thereto appearing elsewhere in this report. In addition to historical condensed consolidated financial information, the following discussion and analysis contains forward-looking statements that involve risks, uncertainties, and assumptions. Our actual results could differ materially from those anticipated by these forward-looking statements as a result of many factors. We discuss factors that we believe could cause or contribute to these differences below and elsewhere in this report, including those set forth under "Risk Factors" and "Special Note Regarding Forward-Looking Statements." OverviewVeeva is the leading provider of industry cloud solutions for the global life sciences industry. We were founded in 2007 on the premise that industry-specific cloud solutions could best address the operating challenges and regulatory requirements of life sciences companies. Our solutions are designed to meet the unique needs of our customers and their most strategic business functions-from research and development to commercialization. Our solutions are designed to help life sciences companies develop and bring products to market faster and more efficiently, market and sell more effectively, and maintain compliance with government regulations. In our fiscal year endedJanuary 31, 2019 , we derived approximately 57% and 53% of our subscription services and total revenues, respectively, from ourVeeva Commercial Cloud solutions. In our fiscal year endedJanuary 31, 2019 , we derived approximately 43% and 47% of our subscription services and total revenues, respectively, from our Veeva Vault solutions. For the nine months endedOctober 31, 2019 , we derived approximately 52% and 49% of our subscription services revenues and total revenues, respectively, from our Veeva Commercial Cloud solutions. For the nine months endedOctober 31, 2019 , we derived approximately 48% and 51% of our subscription services revenues and total revenues, respectively, from our Veeva Vault solutions. The contribution of subscription services revenues and total revenues associated with ourVeeva Vault solutions are expected to continue to increase as a percentage of subscription services revenues and total revenues in the future. Please note that revenues attributable to our recently acquired businesses will be classified under Veeva Commercial Cloud, which will, therefore, impact the mix of revenues between Veeva Commercial Cloud and Veeva Vault. We also offer certain of our Veeva Vault solutions to industries outside the life sciences industry, primarily consumer packaged goods, chemicals, and cosmetics and primarily inNorth America andEurope . For our fiscal years endedJanuary 31, 2019 , 2018, and 2017, our total revenues were$862.2 million ,$690.6 million , and$550.5 million , respectively, representing year-over-year growth in total revenues of 25% in fiscal year endedJanuary 31, 2019 and 25% in fiscal year endedJanuary 31, 2018 . For our fiscal years endedJanuary 31, 2019 , 2018, and 2017, our subscription services revenues were$694.5 million ,$559.4 million , and$440.8 million , respectively, representing year-over-year growth in subscription services revenues of 24% in fiscal year endedJanuary 31, 2019 and 27% in fiscal year endedJanuary 31, 2018 . We expect the growth rate of our total revenues and subscription services revenues to decline in the future. We generated net income of$229.8 million ,$151.2 million , and$77.6 million for our fiscal years endedJanuary 31, 2019 , 2018, and 2017, respectively. As ofJanuary 31, 2019 , 2018, and 2017, we served 719, 625, and 517 customers, respectively. As ofJanuary 31, 2019 and 2018, we had 335 and 311Veeva Commercial Cloud customers, respectively, and 574 and 449 Veeva Vault customers, respectively. The combined customer counts for Veeva Commercial Cloud andVeeva Vault exceed the total customer count in each year because some customers subscribe to products in both areas. Veeva Commercial Cloud customers are those customers that have at least one of the following products: Veeva CRM,Veeva CLM, Veeva CRM Approved Email, Veeva CRM Engage, Veeva Align, Veeva CRM Events Management, Veeva OpenData, Veeva Oncology Link, Veeva Network Customer Master or Veeva Network Product Master. Veeva Vault customers are those customers that have at least one Vault product. Many of our Veeva Vault applications are used by smaller, earlier stage pre-commercial companies, some of which may not reach the commercialization stage. Thus, the potential number of Veeva Vault customers is significantly higher than the potential number of Veeva Commercial Cloud customers. For the nine months endedOctober 31, 2019 and 2018, our total revenues were$792.6 million and$629.9 million , respectively, representing period-over-period growth in total revenues of 26%. For the nine months endedOctober 31, 2019 and 2018, our subscription services revenues were$642.2 million and$503.8 million , respectively,
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representing period-over-period growth in subscription services revenues of 27%. We generated net income of$234.9 million and$158.7 million for the nine months endedOctober 31, 2019 and 2018, respectively. Key Factors Affecting Our Performance Investment in Growth. We have invested and intend to continue to invest aggressively in expanding the breadth and depth of our product portfolio, including through acquisitions. We expect to continue to invest in research and development, to expand existing solutions and build new solutions; in sales and marketing, to promote our solutions to new and existing customers and in existing and expanded geographies and industries; in professional services to ensure the success of our customers' implementations of our solutions; and in other operational and administrative functions to support our expected growth. We expect that our headcount will increase as a result of these investments. We also expect our total operating expenses will continue to increase over time, which could have a negative impact on our operating margin. Adoption of Our Solutions by Existing and New Customers. Most of our customers initially deploy our solutions to a limited number of end users within a division or geography and may only initially deploy a limited set of our available solutions. Our future growth is dependent upon our existing customers' continued success and their renewals of subscriptions to our solutions, expanded deployment of our solutions within their organizations, and their purchase of subscriptions to additional solutions. Our growth is also dependent on the adoption of our solutions by new customers. Subscription Services Revenue Retention Rate. A key factor to our success is the renewal and expansion of our existing subscription agreements with our customers. We calculate our annual subscription services revenue retention rate for a particular fiscal year by dividing (i) annualized subscription revenue as of the last day of that fiscal year from those customers that were also customers as of the last day of the prior fiscal year by (ii) the annualized subscription revenue from all customers as of the last day of the prior fiscal year. Annualized subscription revenue is calculated by multiplying the daily subscription revenue recognized on the last day of the fiscal year by 365. This calculation includes the impact on our revenues from customer non-renewals, deployments of additional users or decreases in users, deployments of additional solutions or discontinued use of solutions by our customers, and price changes for our solutions. Historically, the impact of price changes on our subscription services revenue retention rate has been minimal. For our fiscal years endedJanuary 31, 2019 , 2018, and 2017, our subscription services revenue retention rate was 122%, 121%, and 127%, respectively. Components of Results of Operations Revenues We derive our revenues primarily from subscription services fees and professional services fees. Subscription services revenues consist of fees from customers accessing our cloud-based software solutions and subscription or license fees for our data solutions. Professional services and other revenues consist primarily of fees from implementation services, configuration, data services, training, and managed services related to our solutions. For the nine months endedOctober 31, 2019 , subscription services revenues constituted 81% of total revenues and professional services and other revenues constituted 19% of total revenues. We enter into master subscription agreements with our customers and count each distinct master subscription agreement that has not been terminated or expired and that has orders for which we have recognized revenue in the quarter as a distinct customer for purposes of determining our total number of current customers as of the end of that quarter. We generally enter into a single master subscription agreement with each customer, although in some instances, affiliated legal entities within the same corporate family may enter into separate master subscription agreements. Conversely, affiliated legal entities that maintain distinct master service agreements may choose to consolidate their orders under a single master service agreement, and, in that circumstance, our customer count would decrease. Divisions, subsidiaries and operating units of our customers often place distinct orders for our subscription services under the same master subscription agreement, and we do not count such distinct orders as new customers for purposes of determining our total customer count. With respect to data services customers that have not purchased one of our software solutions, we count as a distinct customer each party that has a master subscription agreement and a known and recurring payment obligation. For purposes of determining our total customer count, we count each entity that uses a legacy Zinc Ahead product as a distinct customer if such entity is not otherwise a customer of ours.
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New subscription orders for our core Veeva CRM application generally have a one-year term. If a customer adds end users or additional Veeva Commercial Cloud applications to an existing order for our core Veeva CRM application, such additional orders will generally be coterminus with the anniversary date of the core Veeva CRM order, and as a result, orders for additional end users or additional Veeva Commercial Cloud applications will commonly have an initial term of less than one year. With respect to applications other than our core Veeva CRM application and particularly with respect to our Veeva Vault applications, we have entered into a number of orders that are several years in duration, ranging from two to eight years. The fees associated with such orders are typically not based on the number of end-users and typically escalate over the term of such orders at a pre-agreed rate to account for, among other factors, implementation and adoption timing and planned increased usage by the customer. Pursuant to Topic 606, timing differences between billings and revenue recognition with respect to our multi-year orders with escalating fees will result in fluctuations in deferred revenue and unbilled accounts receivable balances that did not occur prior to our adoption of Topic 606. For instance, when the amounts we are entitled to invoice in any period pursuant to multi-year orders with escalating fees are less than the revenue we are required to recognize pursuant to Topic 606, we will accrue an unbilled accounts receivable balance related to such orders. In the same scenario, the net deferred revenue we would record in connection with such orders will be less than it would have been prior to the adoption of Topic 606 because we will be recognizing more revenue earlier in the term of such multi-year orders. Our subscription orders are generally billed at the beginning of the subscription period in annual or quarterly increments, which means the annualized value of such orders may not be completely reflected in deferred revenue at any single point in time. Also, particularly with respect to our Veeva Commercial Cloud orders, because the term of orders for additional end users or applications is commonly less than one year, the annualized value of such orders may not be completely reflected in deferred revenue at any single point in time. We have also agreed from time to time, and may agree in the future, to allow customers to change the renewal dates of their orders to, for example, align more closely with a customer's annual budget process or to align with the renewal dates of other orders placed by other entities within the same corporate control group, or to change payment terms from annual to quarterly, or vice versa. Such changes typically result in an order of less than one year as necessary to align all orders to the desired renewal date and, thus, may result in a lesser increase to deferred revenue than if the adjustment had not occurred. Additionally, changes in renewal dates may change the fiscal quarter in which deferred revenue associated with a particular order is booked. Accordingly, we do not believe that changes on a quarterly basis in deferred revenue, unbilled accounts receivable, or calculated billings, a metric commonly cited by financial analysts, are accurate indicators of future revenues for any given period of time. Please note that since the adoption of Topic 606, we define the term calculated billings for any period to mean revenue for the period plus the change in deferred revenue from the immediately preceding period minus the change in unbilled accounts receivable from the immediately preceding period. Subscription services revenues are recognized ratably over the respective non-cancelable subscription term because of the continuous transfer of control to the customer. Our subscription services agreements are generally non-cancelable during the term, although customers typically have the right to terminate their agreements for cause in the event of material breach. Our agreements typically provide that orders will automatically renew unless notice of non-renewal is provided in advance. Subscription services revenues are affected primarily by the number of customers, the scope of the subscription purchased by each customer (for example, the number of end users or other subscription usage metric) and the number of solutions subscribed to by each customer. We utilize our own professional services personnel and, in certain cases, third-party subcontractors to perform our professional services engagements with customers. The majority of our professional services arrangements are billed on a time and materials basis and revenues are recognized over time based on time incurred and contractually agreed upon rates. Certain professional services revenues are billed on a fixed fee basis and revenues are typically recognized over time based on the proportion of total services performed. Data services and training revenues are generally recognized as the services are performed. Professional services revenues are affected primarily by our customers' demands for implementation services, configuration, data services, training, and managed services in connection with our solutions. Allocated Overhead and Equity Compensation We accumulate certain costs such as building depreciation, office rent, utilities, and other facilities costs and allocate them across the various departments based on headcount. We refer to these costs as "allocated overhead." Note that beginning in the fiscal quarter endedApril 30, 2019 , we implemented a new equity compensation program
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applicable to the vast majority of our employees, which will increase stock-based compensation expenses allocated to cost of revenues and operating expenses in absolute dollars and as a percentage of revenue during the fiscal year endingJanuary 31, 2020 . For details of equity granted the nine months endedOctober 31, 2019 , refer to note 11 of the notes to our condensed consolidated financial statements. Cost of Revenues Cost of subscription services revenues for all of our solutions consists of expenses related to our computing infrastructure provided by third parties, including salesforce.com andAmazon Web Services , personnel-related costs associated with hosting our subscription services and providing support, including our data stewards, operating lease expenses associated with computer equipment and software, allocated overhead, amortization expense associated with capitalized internal-use software related to our subscription services, and amortization expense associated with purchased intangibles related to our subscription services. Cost of subscription services revenues for Veeva CRM and certain of our multichannel customer relationship management applications includes fees paid to salesforce.com for our use of the Salesforce1 Platform and the associated hosting infrastructure and data center operations that are provided by salesforce.com. We intend to continue to invest additional resources in our subscription services to enhance our product offerings and increase our delivery capacity. We may add or expand computing infrastructure capacity in the future, migrate to new computing infrastructure service providers, and make additional investments in the availability and security of our solutions. Cost of professional services and other revenues consists primarily of employee-related expenses associated with providing these services, including salaries, benefits and stock-based compensation expense, the cost of third-party subcontractors, travel costs and allocated overhead. The cost of providing professional services is significantly higher as a percentage of the related revenues than for our subscription services due to the direct labor costs and costs of third-party subcontractors. Operating Expenses Research and Development. Research and development expenses consist primarily of employee-related expenses, third-party consulting fees, hosted infrastructure costs, and allocated overhead, offset by any internal-use software development costs capitalized during the same period. We continue to focus our research and development efforts on adding new features and applications and increasing the functionality and enhancing the ease of use of our cloud-based applications. Sales and Marketing. Sales and marketing expenses consist primarily of employee-related expenses, amortization expense associated with capitalized sales commissions, sales commissions that do not qualify for capitalization, marketing program costs, amortization expense associated with purchased intangibles related to our customer contracts, customer relationships and brand development, travel-related expenses and allocated overhead. Sales commissions are costs of obtaining customer contracts and are capitalized and then amortized over a period of benefit that we have determined to be three years. Certain program costs are expensed as incurred. General and Administrative. General and administrative expenses consist of employee-related expenses for our executive, finance and accounting, legal, employee success, management information systems personnel, and other administrative employees. In addition, general and administrative expenses include fees related to third-party legal counsel, fees related to third-party accounting, tax and audit services, other corporate expenses, and allocated overhead. Other Income, Net Other income, net consists primarily of transaction gains or losses on foreign currency, net of hedging costs, interest income, and amortization of premiums paid on investments. Provision for Income Taxes Provision for income taxes consists of federal and state income taxes inthe United States and income taxes in certain foreign jurisdictions. See note 8 of the notes to our condensed consolidated financial statements.
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New Accounting Pronouncements Adopted in Fiscal 2019 Refer to note 1 of the notes to our condensed consolidated financial statements for a full description of the recent accounting pronouncements adopted during the fiscal year endingJanuary 31, 2020 . Recent Accounting Pronouncements Cloud Computing Arrangements InAugust 2018 , the FASB issued ASU No. 2018-15, "Intangibles-Goodwill andOther-Internal-Use Software : Customer's Accounting for Implementation Costs Incurred in a Cloud Computing Arrangement That Is a Service Contract" (Topic 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. The standard is effective for interim and annual reporting periods beginning afterDecember 15, 2019 and can be applied either prospectively to implementation costs incurred after the date of adoption or retrospectively to all arrangements. Early adoption is permitted. We will adopt this standard on a prospective basis as ofFebruary 1, 2020 , and the impact of our adoption of this standard on our condensed consolidated financial statements will largely depend on the magnitude of implementation costs incurred in our cloud computing arrangements beginningFebruary 1, 2020 . Credit Losses InJune 2016 , theFinancial Accounting Standards Board , or FASB, issued ASU 2016-13, including subsequent amendments, regarding "Measurement of Credit Losses on Financial Instruments" (Topic 326), which modifies the accounting methodology for most financial instruments. The guidance establishes a new "expected loss model" that requires entities to estimate current expected credit losses on financial instruments by using all practical and relevant information. Additionally, any expected credit losses are to be reflected as allowances rather than reductions in the amortized cost of available-for-sale debt securities. This guidance is effective for annual reporting periods beginning afterDecember 15, 2019 , including interim periods within that reporting period. Early adoption is permitted. We do not expect this standard to have a material impact on our consolidated financial statements and do not plan to early adopt.
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Results of Operations
The following tables set forth selected condensed consolidated statements of
operations data and such data as a percentage of total revenues for each of the
periods indicated:
Three months ended
Nine months ended
October 31,
2019 2018 2019 2018
(in thousands)
Consolidated Statements of Comprehensive
Income Data:
Revenues:
Subscription services $ 226,760 $ 178,214 $ 642,187 $ 503,809
Professional services and other 54,161 46,517 150,386 126,078
Total revenues 280,921 224,731 792,573 629,887
Cost of revenues(1):
Cost of subscription services 31,964 28,335 93,822 87,394
Cost of professional services and other 41,365 33,039 115,228 93,361
Total cost of revenues 73,329 61,374 209,050 180,755
Gross profit 207,592 163,357 583,523 449,132
Operating expenses(1):
Research and development 52,575 40,001 148,694 116,024
Sales and marketing 45,524 37,699 130,962 110,306
General and administrative 28,693 22,563 78,042 62,934
Total operating expenses 126,792 100,263 357,698 289,264
Operating income 80,800 63,094 225,825 159,868
Other income, net 9,141 4,606 22,634 10,087
Income before income taxes 89,941 67,700 248,459 169,955
Provision for income taxes 7,696 3,615 13,523 11,274
Net income 82,245 64,085 234,936 158,681
________________________________________
(1) Includes stock-based compensation as follows:
Cost of revenues: Cost of subscription services$ 560 $ 405 $ 1,528 $ 1,166 Cost of professional services and other 4,825 2,782 12,261 7,767 Research and development 9,899 5,820 25,732 16,282 Sales and marketing 6,882 4,825 19,207 13,743 General and administrative 7,155 6,086 19,719 17,689
Total stock-based compensation
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Three months ended Nine months ended October 31,
October 31,
2019 2018 2019 2018
Consolidated Statements of Comprehensive
Income Data:
Revenues:
Subscription services 80.7 % 79.3 % 81.0 % 80.0 %
Professional services and other 19.3 20.7 19.0 20.0
Total revenues 100.0 100.0 100.0 100.0
Cost of revenues:
Cost of subscription services 11.4 12.6 11.8 13.9
Cost of professional services and other 14.7 14.7 14.5 14.8
Total cost of revenues 26.1 27.3 26.3 28.7
Gross profit 73.9 72.7 73.7 71.3
Operating expenses:
Research and development 18.7 17.8 18.8 18.4
Sales and marketing 16.2 16.8 16.5 17.5
General and administrative 10.2 10.0 9.8 10.0
Total operating expenses 45.1 44.6 45.1 45.9
Operating income 28.8 28.1 28.6 25.4
Other income, net 3.3 2.0 2.9 1.6
Income before income taxes 32.1 30.1 31.5 27.0
Provision for income taxes 2.7 1.6 1.7 1.8
Net income 29.4 % 28.5 % 29.8 % 25.2 %
Revenues
Three months ended October 31, Nine months ended October 31,
2019 2018 % Change 2019 2018 % Change
(dollars in thousands)
Revenues:
Subscription services $ 226,760 $ 178,214 27%
46,517 16 150,386 126,078 19
Total revenues $ 280,921 $ 224,731 25 $ 792,573 $ 629,887 26
Percentage of revenues:
Subscription services 81 % 79 % 81 % 80 %
Professional services and other 19 21 19 20
Total revenues 100 % 100 % 100 % 100 %
Total revenues for the three months ended October 31, 2019 increased $56.2
million , of which $48.5 million was from growth in subscription services
revenues. The increase in subscription services revenues consisted of
$33.2 million of subscription services revenue attributable to Veeva Vault
solutions and $15.3 million of subscription services revenue attributable to
Veeva Commercial Cloud solutions. The geographic mix of subscription services
revenues was 53% from North America and 28% from Europe for the three months
ended October 31, 2019 as compared to subscription services revenues of 54% from
North America and 26% from Europe for the three months ended October 31, 2018 .
Subscription services revenues were 81% of total revenues for the three months
ended October 31, 2019 , compared to 79% of total revenues for the three months
ended October 31, 2018 .
Professional services and other revenues for the three months ended October 31,
2019 increased $7.6 million . The increase in professional services revenues was
due primarily to new customers requesting implementation and deployment related
professional services and existing customers requesting professional services
related to expanding deployments or the deployment of newly purchased solutions.
The increased demand for professional services and the resulting increase in
professional services revenues was weighted heavily towards implementation and
deployments of our Veeva Vault solutions. The geographic mix of professional
services and other revenues was 59% from North America and 32% from Europe for
the three months ended October 31, 2019 as compared to 64% from North America
and 27% from Europe for the three months ended October 31, 2018 .
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Total revenues for the nine months endedOctober 31, 2019 increased$162.7 million , of which$138.4 million was from growth in subscription services revenues. The increase in subscription services revenues consisted of$95.7 million of subscription services revenue attributable to Veeva Vault solutions and$42.7 million of subscription services revenue attributable to Veeva Commercial Cloud solutions. The geographic mix of subscription services revenues was 53% fromNorth America and 28% fromEurope for the nine months endedOctober 31, 2019 as compared to subscription services revenues of 54% fromNorth America and 26% fromEurope for the nine months endedOctober 31, 2018 . Subscription services revenues were 81% of total revenues for the nine months endedOctober 31, 2019 , compared to 80% of total revenues for the nine months endedOctober 31, 2018 . Professional services and other revenues for the nine months endedOctober 31, 2019 increased$24.3 million . The increase in professional services revenues was due primarily to new customers requesting implementation and deployment related professional services and existing customers requesting professional services related to expanding deployments or the deployment of newly purchased solutions. The increased demand for professional services and the resulting increase in professional services revenues was weighted heavily towards implementation and deployments of our Veeva Vault solutions. The geographic mix of professional services and other revenues was 59% fromNorth America and 32% fromEurope for theOctober 31, 2019 as compared to 63% fromNorth America and 27% fromEurope for the nine months endedOctober 31, 2018 . Over time, we expect the proportion of our total revenues from professional services to continue to decrease. Cost of Revenues and Gross Profit Three months endedOctober 31 ,
Nine months ended
2019 2018 % Change 2019 2018 % Change
(dollars in thousands)
Cost of revenues:
Cost of subscription
services $ 31,964 $ 28,335 13% $ 93,822 $ 87,394 7%
Cost of professional
services and other 41,365 33,039 25 115,228 93,361 23
Total cost of revenues $ 73,329 $ 61,374 19 $ 209,050 $ 180,755 16
Gross margin percentage:
Subscription services 86 % 84 % 85 % 83 %
Professional services and
other 24 29 23 26
Total gross margin
percentage 74 % 73 % 74 % 71 %
Gross profit $ 207,592 $ 163,357 27% $ 583,523 $ 449,132 30%
Cost of revenues for the three months ended October 31, 2019 increased $12.0
million , of which $3.6 million was related to cost of subscription services. The
increase in cost of subscription services was primarily due to an increase in
the number of end users of our subscription services, which drove an increase of
$1.9 million in fees paid to salesforce.com. There was an additional increase of
$0.6 million in computing infrastructure costs not related to salesforce.com,
and an additional increase of $0.5 million in employee compensation-related
costs (includes an increase of $0.2 million in stock-based compensation).
Cost of professional services and other for the three months ended October 31,
2019 increased $8.3 million , primarily due to a $7.4 million increase in
employee compensation-related costs (includes an increase of $2.0 million in
stock-based compensation). The increase in employee compensation-related costs
is primarily driven by the increase in headcount during the period.
Gross margin for the three months ended October 31, 2019 and 2018 was 74% and
73%, respectively. The increase compared to the prior period is largely due to
the continued growth of Veeva Vault and our newer multichannel CRM applications
that complement Veeva CRM, all of which have higher subscription services gross
margins than our core Veeva CRM application.
Cost of revenues for the nine months ended October 31, 2019 increased $28.3
million , of which $6.4 million was related to cost of subscription services. The
increase in cost of subscription services was primarily due to an increase in
the number of end users of our subscription services, which drove an increase of
$5.3 million in fees paid to salesforce.com. There was an additional increase of
$1.3 million in employee compensation-related costs (includes an increase of
$0.4 million in stock-based compensation). This was offset by a decrease in
computing infrastructure costs of $1.4 million due to the elimination of
duplicate server costs during the period. We expect cost of subscription
services to increase in absolute dollars in the near term due to increased usage
of our subscription services.
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Cost of professional services and other for the nine months endedOctober 31, 2019 increased$21.9 million , primarily due to a$18.9 million increase in employee compensation-related costs (includes an increase of$4.5 million in stock-based compensation). The increase in employee compensation-related costs is primarily driven by the increase in headcount during the period. We expect cost of professional services and other to increase in absolute dollars and as a percentage of revenue in the near term as we add personnel to our global professional services organization and due to the impact of our new equity compensation program described above. Gross margin for the nine months endedOctober 31, 2019 and 2018 was 74% and 71%, respectively. The increase compared to the prior period is largely due to the continued growth of Veeva Vault and our newer multichannel CRM applications that complement Veeva CRM, all of which have higher subscription services gross margins than our core Veeva CRM application. We expect gross margin to slightly decrease in the fiscal quarter endingJanuary 31, 2020 , primarily due to lower professional services utilization as there are fewer billable days in the quarter due to holidays and our annual field kickoff event and due to the impact from our recently acquired businesses. In the future, we expect the recently acquired businesses to have a slightly dilutive impact to our gross margin. Operating Expenses and Operating Margin Operating expenses include research and development, sales and marketing, and general and administrative expenses. As we continue to invest in our growth through hiring, we expect operating expenses to increase in absolute dollars and may slightly increase as a percentage of revenue in the near term. We also expect stock-based compensation expense to increase in absolute dollars and as a percentage of revenue through the fiscal year endingJanuary 31, 2020 due, in part, to our new equity compensation program described above as well as retention equity awards granted to certain employees associated with the acquisitions inNovember 2019 . Research and Development Three months ended October 31, Nine months ended October 31, 2019 2018 % Change 2019 2018 % Change (dollars in thousands) Research and development$ 52,575 $ 40,001 31%$ 148,694 $ 116,024 28% Percentage of total revenues 19 % 18 % 19 % 18 % Research and development expenses for the three months endedOctober 31, 2019 increased$12.6 million , primarily due to an increase of$9.7 million in employee compensation-related costs (includes an increase of$4.1 million in stock-based compensation) resulting from increased headcount during the period. The expansion of our headcount in research and development is to support development work for the increased number of products that we offer or may offer in the future. Additionally, there was an increase of$1.1 million in costs for increased computing infrastructure requirements in our research and development organization. Research and development expenses for the nine months endedOctober 31, 2019 increased$32.7 million , primarily due to an increase of$24.5 million in employee compensation-related costs (includes an increase of$9.5 million in stock-based compensation) resulting from increased headcount during the period. The expansion of our headcount in this area is to support the increased number of products that we offer or may offer in the future. Additionally, there was an increase of$3.3 million in costs for increased computing infrastructure requirements in our research and development organization. We expect research and development expenses to increase in absolute dollars and may increase as a percentage of revenue in the near term, primarily due to higher headcount, including increased headcount associated with our recently acquired businesses, as we continue to invest in our solutions and develop new technologies.
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Sales and Marketing
Three months ended October 31, Nine months ended October 31,
2019 2018 % Change 2019 2018 % Change
(dollars in thousands)
Sales and marketing $ 45,524 $ 37,699 21% $ 130,962 $ 110,306 19%
Percentage of total revenues 16 % 17 % 17 % 18 %
Sales and marketing expenses for the three months ended October 31, 2019
increased $7.8 million , primarily due to an increase of $5.5 million in employee
compensation-related costs (includes an increase of $2.1 million in stock-based
compensation) and an increase of $1.5 million in marketing program costs. The
overall increase in employee compensation-related costs was primarily driven by
increase in headcount during the period.
Sales and marketing expenses for the nine months ended October 31, 2019
increased $20.7 million , primarily due to an increase of $15.2 million in
employee compensation-related costs (includes an increase of $5.5 million in
stock-based compensation) and an increase of $2.6 million in marketing program
costs. The overall increase in employee compensation-related costs was primarily
driven by an increase in headcount during the period.
We expect sales and marketing expenses to continue to grow in absolute dollars
in the near term, primarily due to employee-related expenses as we increase our
headcount, including increased headcount associated with our recent
acquisitions, to support our sales and marketing efforts associated with our
newer solutions and our continued expansion of our sales capacity across all our
solutions.
General and Administrative
Three months ended October 31,
Nine months ended
2019 2018 % Change 2019 2018 % Change
(dollars in thousands)
General and administrative $ 28,693 $ 22,563 27% $ 78,042 $ 62,934 24%
Percentage of total revenues 10 % 10 % 10 % 10 %
General and administrative expenses for the three months ended October 31, 2019
increased $6.1 million , primarily due to an increase of $2.3 million in employee
compensation-related costs (includes an increase of $1.1 million in stock-based
compensation) and an increase of $2.2 million in legal fees related to
litigation activity during the period. The overall increase in employee
compensation-related costs was primarily driven by increase in headcount during
the period. There was an additional increase of $0.5 million in program costs
related to recruiting activities.
General and administrative expenses for the nine months ended October 31, 2019
increased $15.1 million , primarily due to an increase of $6.6 million in legal
fees related to litigation activity during the period and an increase of
$5.3 million in employee compensation-related costs (includes an increase of
$2.0 million in stock-based compensation). The overall increase in employee
compensation-related costs was primarily driven by increase in headcount during
the period. There was an additional increase of $0.7 million in program costs
related to recruiting activities.
We expect general and administrative expenses to continue to grow in absolute
dollars in the near term as we continue to invest in our business and
infrastructure and in connection with our recently acquired businesses. Such
business and infrastructure costs include increases in third-party fees,
particularly in relation to the matters described in note 13 of the notes to our
condensed consolidated financial statements, and headcount in our finance,
legal, and employee success functions.
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Other Income, Net
Three months ended Nine months ended
October 31, October 31,
2019 2018 % Change 2019 2018 % Change
(dollars in thousands)
Other income, net $ 9,141 $ 4,606 98% $ 22,634 $ 10,087 124%
Other income, net for the three months ended October 31, 2019 increased $4.5
million , primarily due to an increase in interest and other income of $2.9
million driven by higher cash and cash equivalent balances. In addition, there
was a net foreign currency gain of $1.9 million from the prior period, which
includes gains and losses from foreign currency exposures partially offset by
hedge positions.
Other income, net for the nine months ended October 31, 2019 increased $12.5
million , primarily due to an increase in interest and other income of $9.1
million driven by higher cash and cash equivalent balances. In addition, there
was a net foreign currency gain of $1.9 million from the prior period, which
includes gains and losses from foreign currency exposures partially offset by
hedge positions. There was also an increase of $1.5 million in accretion of
investments.
We continue to experience foreign currency fluctuations primarily due to the
impact resulting from the periodic re-measurement of our foreign currency
balances that are denominated in currencies other than the functional currency
of the entities in which they are recorded. Our results of operations are
subject to fluctuations due to changes in foreign currency exchange rates,
particularly changes in the Euro, British Pound Sterling, Japanese Yen and
Chinese Yuan. We may continue to experience favorable or adverse foreign
currency impacts due to volatility in these currencies.
Provision for Income Taxes
Three months ended October 31, Nine months ended October 31,
2019 2018 % Change 2019 2018 % Change
(dollars in thousands)
Income before income taxes $ 89,941 $ 67,700 33% $ 248,459 $ 169,955 46%
Provision for income taxes 7,696 3,615 113% 13,523 11,274 20%
Effective tax rate 8.6 % 5.3 % 5.4 % 6.6 %
The provision for income taxes differs from the tax computed at the U.S. federal
statutory income tax rate due primarily to state taxes, tax credits, equity
compensation, and foreign income subject to taxation in the United States .
Future tax rates could be affected by changes in tax laws and regulations or by
rulings in tax related litigation, as may be applicable.
For the three months ended October 31, 2019 and 2018, our effective tax rates
were 8.6% and 5.3%, respectively. During the three months ended October 31, 2019
as compared to the prior year period, our effective tax rate increased primarily
due to a reduction in excess tax benefits related to equity compensation. We
recognized such excess tax benefits in our provision for income taxes of $8.9
million and $12.0 million for the three months ended October 31, 2019 and 2018,
respectively.
For the nine months ended October 31, 2019 and 2018, our effective tax rates
were 5.4% and 6.6%, respectively. During the nine months ended October 31, 2019
as compared to the prior year period, our effective tax rate decreased primarily
due to an increase in excess tax benefits related to equity compensation. We
recognized such excess tax benefits in our provision for income taxes of $39.5
million and $31.0 million for the nine months ended October 31, 2019 and 2018,
respectively.
Non-GAAP Financial Measures
In our public disclosures, we have provided non-GAAP measures, which we define
as financial information that has not been prepared in accordance with generally
accepted accounting principles in the United States , or GAAP. In addition to our
GAAP measures, we use these non-GAAP measures internally for budgeting and
resource allocation purposes and in analyzing our financial results.
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For the reasons set forth below, we believe that excluding the following items
from our non-GAAP financial measures provides information that is helpful in
understanding our operating results, evaluating our future prospects, comparing
our financial results across accounting periods, and comparing our financial
results to our peers, many of which provide similar non-GAAP financial measures.
• Stock-based compensation expenses. We exclude stock-based compensation
expenses primarily because they are non-cash expenses that we exclude
from our internal management reporting processes. We also find it
useful to exclude these expenses when we assess the appropriate levelof various operating expenses and resource allocations when budgeting,
planning, and forecasting future periods. Moreover, because of varying
available valuation methodologies, subjective assumptions and the
variety of award types that companies can use under FASB ASC Topic 718,
we believe excluding stock-based compensation expenses allows investors
to make meaningful comparisons between our recurring core business
operating results and those of other companies.
• Amortization of purchased intangibles. We incur amortization expense
for purchased intangible assets in connection with acquisitions of
certain businesses and technologies. Amortization of intangible assets
is a non-cash expense and is inconsistent in amount and frequency
because it is significantly affected by the timing, size of
acquisitions, and the inherent subjective nature of purchase price
allocations. Because these costs have already been incurred and cannot
be recovered, and are non-cash expenses, we exclude these expenses for
internal management reporting processes. We also find it useful to
exclude these charges when assessing the appropriate level of various
operating expenses and resource allocations when budgeting, planning,
and forecasting future periods. Investors should note that the use of
intangible assets contributed to our revenues earned during the periods
presented and will contribute to our future period revenues as well.
• Deferred compensation associated with the Zinc Ahead acquisition. The
Zinc Ahead share purchase agreement, as revised, called for share
purchase consideration to be deferred and paid at a rate of one-third
of the deferred consideration amount per year to certain former Zinc
Ahead employee shareholders and option holders who remain employed with
us on each deferred consideration payment date. In accordance with
GAAP, these payments are being accounted for as deferred compensation
and the expense is recognized over the requisite service period. We
view this deferred compensation expense as an unusual acquisition cost
associated with the Zinc Ahead acquisition and find it useful to
exclude it in order to assess the appropriate level of variousoperating expenses to assist in budgeting, planning and forecasting
future periods. We believe excluding this deferred compensation expense
may allow investors to make more meaningful comparisons between our
recurring operating results and those of other companies.
• Income tax effects on the difference between GAAP and non-GAAP costs
and expenses. The income tax effects that are excluded relate to the
imputed tax impact on the difference between GAAP and non-GAAP costsand expenses due to stock-based compensation, purchased intangibles,
and deferred compensation associated with the Zinc Ahead acquisition
for GAAP and non-GAAP measures.
Limitations on the use of Non-GAAP financial measures There are limitations to using non-GAAP financial measures because non-GAAP financial measures are not prepared in accordance with GAAP and may be different from non-GAAP financial measures provided by other companies. The non-GAAP financial measures are limited in value because they exclude certain items that may have a material impact upon our reported financial results. In addition, they are subject to inherent limitations as they reflect the exercise of judgments by management about which items are adjusted to calculate our non-GAAP financial measures. We compensate for these limitations by analyzing current and future results on a GAAP basis as well as a non-GAAP basis and also by providing GAAP measures in our public disclosures. Non-GAAP financial measures should not be considered in isolation from, or as a substitute for, financial information prepared in accordance with GAAP. We encourage investors and others to review our financial information in its entirety, not to rely on any single financial measure to evaluate our business, and to view our non-GAAP financial measures in conjunction with the most directly comparable GAAP financial measures.
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Beginning with the fiscal quarter endedApril 30, 2019 , we no longer exclude the effects of capitalization of internal-use software development expenses and the subsequent amortization of the capitalized expenses in its non-GAAP financial measures. Prior periods have been adjusted to reflect this change, and the effect of this change is not material for any period previously presented. The following table reconciles the specific items excluded from GAAP metrics in the calculation of non-GAAP metrics for the periods shown below: Three months ended October 31, Nine months ended October 31, 2019 2018 2019 2018
Operating income on a GAAP basis
225,825$ 159,868 Stock-based compensation expense 29,321 19,918 78,447 56,647
Amortization of purchased intangibles 1,490 1,667
4,573 5,298
Deferred compensation associated with
Zinc Ahead acquisition - 85 - 343
Operating income on a non-GAAP basis
308,845$ 222,156 Net income on a GAAP basis$ 82,245 $ 64,085 $ 234,936 $ 158,681 Stock-based compensation expense 29,321 19,918 78,447 56,647
Amortization of purchased intangibles 1,490 1,667
4,573 5,298
Deferred compensation associated with
Zinc Ahead acquisition - 85 - 343
Income tax effect on non-GAAP
adjustments(1) (17,662 ) (15,153 ) (56,088 ) (37,497 )
Net income on a non-GAAP basis $ 95,394 $ 70,602 $ 261,868 $ 183,472
Diluted net income per share on a GAAP
basis $ 0.52 $ 0.41 $ 1.49 $ 1.02
Stock-based compensation expense 0.18 0.13 0.50 0.36
Amortization of purchased intangibles 0.01 0.01
0.02 0.03
Deferred compensation associated with
Zinc Ahead acquisition - - - -
Income tax effect on non-GAAP
adjustments(1) (0.11 ) (0.10 ) (0.35 ) (0.23 )
Diluted net income per share on a
non-GAAP basis $ 0.60 $ 0.45 $ 1.66 $ 1.18
_________________________________________________________
(1) For the three and nine months ended
estimated annual effective non-GAAP tax rate of 21.0%.
Liquidity and Capital Resources
Three months ended
October 31 ,
Nine months ended
2019 2018 2019 2018
(in thousands)
Net cash provided by operating activities
398,266$ 278,954 Net cash provided by (used in) investing activities 2,729 (89,360 ) (61,614 ) (147,690 )
Net cash provided by financing activities 1,366 4,867
7,889 19,728
Effect of exchange rate changes on cash
and cash equivalents (487 ) (1,154 ) (2,931 ) (3,530 )
Net change in cash and cash equivalents
341,610
Our principal sources of liquidity continue to be comprised of our cash, cash equivalents, and short-term investments, as well as cash flows generated from our operations. As ofOctober 31, 2019 , our cash, cash equivalents, and short-term investments totaled$1.5 billion , of which$30.8 million represented cash and cash equivalents held outside ofthe United States . OnNovember 1, 2019 , we completed our acquisition ofCrossix Solutions Inc. in exchange for total cash consideration of$431.8 million , which includes the impact of adjustments to purchase price associated with the cash and net working capital of the acquired entity at close, and onNovember 7, 2019 , we completed our acquisition ofPhysicians World LLC in exchange for total cash consideration of$41.4 million , which includes the impact of adjustments to purchase price associated with the cash and net working capital of the acquired entity at close. Except for certain foreign jurisdictions, our remaining non-U.S. cash and cash equivalents have been earmarked for indefinite reinvestment in our operations outsidethe United States , thus noU.S. current or deferred taxes have been accrued. We believe ourU.S. sources of cash and liquidity are sufficient to meet our business needs inthe United States and do not expect that we will need to repatriate additional funds we have designated as indefinitely reinvested outsidethe United States . Under currently enacted tax laws, should our plans change and we were to choose to
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repatriate some or all of the funds we have designated as indefinitely reinvested outsidethe United States , such amounts may be subject to certain jurisdictional taxes. We have financed our operations primarily through cash generated from operations. We believe our existing cash, cash equivalents, and short-term investments generated from operations will be sufficient to meet our working capital and capital expenditure needs over at least the next 12 months. Our future capital requirements will depend on many factors including our growth rate, subscription renewal activity, the timing and extent of spending to support product development efforts, the expansion of sales and marketing activities, the ongoing investments in technology infrastructure, the introduction of new and enhanced solutions, and the continuing market acceptance of our solutions. We may in the future enter into arrangements to acquire or invest in complementary businesses, services and 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 from Operating Activities Our largest source of operating cash inflows is cash collections from our customers for subscription services. We also generate significant cash flows from our professional services arrangements. The first quarter of our fiscal year is seasonally the strongest quarter for cash inflows due to the timing of our annual subscription billings and related collections. Our primary uses of cash from operating activities are for employee-related expenditures, expenses related to our computing infrastructure (including salesforce.com andAmazon Web Services ), third-party professional services costs, employee travel costs, fees for third-party legal counsel and accounting services, and leases for office space. Net cash provided by operating activities was$61.5 million for the three months endedOctober 31, 2019 . Our cash provided by operating activities during the three months endedOctober 31, 2019 primarily reflected our net income of$82.2 million , adjustments for non-cash items of$39.7 million , and a net decrease in our operating assets and liabilities of$60.4 million . Non-cash charges included$29.3 million of stock-based compensation expense and$5.6 million of depreciation and amortization expense. The net changes in operating assets and liabilities included a$78.3 million decrease in deferred revenue due to the timing of renewal billings and a$28.3 million decrease in accounts receivable which was primarily driven by increased collections during the period. Net cash provided by operating activities was$398.3 million for the nine months endedOctober 31, 2019 . Our cash provided by operating activities during the nine months endedOctober 31, 2019 primarily reflected our net income of$234.9 million , adjustments for non-cash items of$108.2 million , and a net increase in our operating assets and liabilities of$55.1 million . Non-cash charges included$78.4 million of stock-based compensation expense and$16.6 million of depreciation and amortization expense. The net changes in operating assets and liabilities included a$105.6 million decrease in deferred revenue due to the timing of renewal billings and a$186.6 million decrease in accounts receivable which was primarily driven by increased collections during the period. The cash flows from operating activities for the nine months endedOctober 31, 2019 represent the vast majority of the cash flows from operating activities that we expect for the remainder of the fiscal year endingJanuary 31, 2020 . As a result, we expect cash flows from operating activities to be substantially less in the fiscal quarter endingJanuary 31, 2020 . Cash Flows from Investing Activities The cash flows from investing activities primarily relate to cash used for the purchase of marketable securities, net of maturities. We also use cash to invest in capital assets to support our growth. Net cash provided by investing activities was$2.7 million for the three months endedOctober 31, 2019 resulting primarily from$4.0 million in net maturities and sales of marketable securities and$0.9 million in purchases of property and equipment to support the growth of our business. Net cash used in investing activities was$61.6 million for the nine months endedOctober 31, 2019 resulting primarily from$57.4 million in net purchases of marketable securities and$3.2 million in purchases of property and equipment to support the growth of our business.
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We expect our cash flows from investing activities for the fiscal quarter endingJanuary 31, 2020 to include cash used for our recent acquisitions of businesses. Cash Flows from Financing Activities The cash flows from financing activities relate to stock option exercises. Net cash provided by financing activities was$1.4 million and$7.9 million for the three and nine months endedOctober 31, 2019 , respectively, primarily related to the proceeds from employee stock option exercises. Commitments Our principal commitments consist of obligations for minimum payment commitments to salesforce.com and leases for office space and data centers. OnMarch 3, 2014 , we amended our agreement with salesforce.com. The agreement, as amended, requires that we meet minimum order commitments of$500 million over the term of the agreement, which ends onSeptember 1, 2025 , including "true-up" payments if the orders we place with salesforce.com have not equaled or exceeded the following aggregate amounts within the timeframes indicated: (i)$250 million for the period fromMarch 1, 2014 toSeptember 1, 2020 and (ii) the full amount of$500 million bySeptember 1, 2025 . We have met our first minimum order commitment of$250 million and have a remaining purchase commitment of$159.8 million , as ofOctober 31, 2019 , that must be made bySeptember 1, 2025 . As ofOctober 31, 2019 , the future non-cancelable minimum payments under these commitments were as follows: Payments due by period 1-3 3-5 More than Total Less than 1 year Years Years 5 years (in thousands) Salesforce.com commitments$ 159,776 $ 6,551 - -$ 153,225 Operating lease obligations 28,766 1,787 13,287 7,327 6,365 Finance lease obligations 1,704 269 1,435 - - Total$ 190,246 $ 8,607$ 14,722 $ 7,327 $ 159,590 The amounts in the table above are associated with agreements that are enforceable and legally binding, which specify significant terms including payment terms, related services, and the approximate timing of the transaction. Obligations under agreements that we can cancel without a significant penalty are not included in the table. We anticipate leasing additional office space in various locations around the world to support our growth. In addition, our existing lease agreements often provide us with an option to renew. We expect our future operating lease obligations will increase as we expand our operations. Off-Balance Sheet Arrangements We do not have any relationships with unconsolidated organizations or financial partnerships, such as structured finance or special purpose entities that would have been established for the purpose of facilitating off-balance sheet arrangements or other contractually narrow or limited purposes. Critical Accounting Policies and Estimates Our condensed consolidated financial statements are prepared in accordance with generally accepted accounting principles inthe United States (GAAP). In the preparation of these condensed consolidated financial statements, we are required to make estimates and assumptions that affect the reported amounts of assets, liabilities, revenues, costs, and expenses and related disclosures. On an ongoing basis, we evaluate our estimates and assumptions. Our actual results may differ from these estimates under different assumptions or conditions. There have been no material changes to our critical accounting policies and estimates during the three months endedOctober 31, 2019 as compared to the those disclosed in our Form 10-K for the fiscal year endedJanuary 31, 2019 .
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Revenue Recognition For a description of our application of GAAP to our revenue recognition, see note 1 of the notes to our condensed consolidated financial statements.
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