SPLUNK INC. The following discussion and analysis of our financial condition and results of operations should be read in conjunction with our condensed consolidated financial statements and related notes appearing elsewhere in this Quarterly Report on Form 10-Q. This discussion contains forward-looking statements based upon current expectations that involve risks and uncertainties. Our actual results may differ materially from those anticipated in these forward-looking statements. Statements that are not purely historical are forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended. Forward-looking statements are often identified by the use of words such as, but not limited to, "anticipate," "believe," "can," "continue," "could," "estimate," "expect," "predict," "intend," "may," "might," "plan," "project," "potential," "seek," "should," "target," "will," "would" and similar expressions or variations intended to identify forward-looking statements. Such statements include, but are not limited to, statements concerning our business and our market opportunity, our future financial and operating results; our planned investments, particularly in our product development efforts; our planned expansion of our sales and marketing organization; our expectations regarding our acquisitions; our expectation that we will continue to use acquisitions to contribute to our growth objectives; our growth and product integration strategies; our continued efforts to market and sell both domestically and internationally; our expectations about seasonal trends; our ability to achieve our goals; our expectations regarding our revenues mix; our expectations regarding our cost of revenues and gross margin; use of non-GAAP (as defined below) financial measures; our expectations regarding new accounting standards; our expectations regarding our operating expenses, including increases in research and development, sales and marketing, and general and administrative expenses; our expectations regarding our capital expenditures; sufficiency of cash to meet cash needs for at least the next 12 months; exposure to interest rate changes; inflation; anticipated income tax rates and liabilities; our expectations regarding our leases; exposure to exchange rate fluctuations and our ability to manage such exposure; and our expected cash flows and liquidity. These statements are based on the beliefs and assumptions of our management based on information currently available to us. Such forward-looking statements are subject to risks, uncertainties and other important factors that could cause actual results and the timing of certain events to differ materially from future results expressed or implied by such forward-looking statements. 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 under Part II, Item 1A below. Furthermore, such forward-looking statements speak only as of the date of this report. Except as required by law, we undertake no obligation to update any forward-looking statements to reflect events or circumstances that occur after the date of this report. Amounts reported in millions are rounded based on the amounts in thousands. As a result, the sum of the components reported in millions may not equal the total amount reported in millions due to rounding. In addition, percentages presented are calculated from the underlying numbers in thousands and may not add to their respective totals due to rounding.
Overview
Splunk provides innovative software solutions that enable organizations to gain
real-time operational intelligence by harnessing the value of their data. Our
offerings enable users to investigate, monitor, analyze and act on data
regardless of format or source. Our offerings address large and diverse data
sets commonly referred to as big data. Data is produced by
23--------------------------------------------------------------------------------
Table of Contents
nearly every software application and electronic device across an organization
and contains a real-time record of various activities, such as transactions,
customer and user behavior, and security threats. Beyond an organization's
traditional information technology ("IT") and security infrastructure, data from
the Industrial Internet, including industrial control systems, sensors,
supervisory control and data acquisition ("SCADA") systems, networks,
manufacturing systems, smart meters and the Internet of Things ("IoT"), which
includes consumer-oriented systems, such as electronic wearables, mobile
devices, automobiles and medical devices are also continuously generating data.
Our offerings help organizations gain the value contained in data by delivering
real-time information to enable operational decision making.
We believe the market for products that provide operational intelligence
presents a substantial opportunity as data grows in volume and diversity,
creating new risks, opportunities and challenges for organizations. Since our
inception, we have invested a substantial amount of resources developing our
offerings to address this market.
Our offerings are designed to deliver rapid return-on-investment for our
customers. They generally do not require customization, long deployment cycles
or extensive professional services commonly associated with traditional
enterprise software applications. Prospective users can get started with our
free online sandboxes that enable our customers to immediately try and
experience Splunk offerings. Users that prefer to deploy the software
on-premises can take advantage of our free 60-day trial of Splunk Enterprise,
which converts into a limited free perpetual license of up to 500 megabytes of
data per day. A 15-day free trial is available to users that prefer the core
functionalities of Splunk Enterprise delivered as a cloud service. These users
can sign up for Splunk Cloud and avoid the need to provision, deploy and manage
internal infrastructure. Alternatively, they can simply download and install the
software, typically in a matter of hours, to connect to their relevant data
sources. Customers can also provision a compute instance on Amazon Web Services
("AWS") via a pre-built Amazon Machine Image, which delivers a pre-configured
virtual machine instance with our Splunk Enterprise software. We offer free
development-test licenses for certain commercial customers, allowing users to
explore new data and use cases in a non-production environment without incurring
additional fees. We also offer support, training and professional services to
our customers to assist in the deployment of our software.
For Splunk Enterprise, we typically base our license fees on either the
estimated daily data indexing capacity or compute power our customers require. A
substantial portion of our license revenues consist of revenues from term
licenses, and to a much lesser extent, perpetual licenses, whereby we generally
recognize the license fee portion of these arrangements upfront. As a result,
the timing of when we enter into large term and perpetual licenses may lead to
fluctuations in our revenues and operating results because our expenses are
largely fixed in the short-term.
Splunk Cloud delivers the core capabilities of Splunk Enterprise as a scalable,
reliable cloud service. We typically base our Splunk Cloud annual subscription
fees on either the volume of data indexed per day including a fixed amount of
data storage, or purchased infrastructure and data storage our customers
require. We recognize the revenues associated with our cloud services ratably
over the associated subscription term. Splunk Enterprise Security ("ES")
addresses emerging security threats and security information and event
management ("SIEM") use cases through monitoring, alerts and analytics. Splunk
IT Service Intelligence ("ITSI") is a machine learning powered monitoring and
analytics solution that correlates nearly any kind of data across IT and the
business to provide monitoring and troubleshooting support and predict problems
before they have an impact. Splunk Phantom automates and orchestrates incident
response workflows to take immediate action the moment an incident is detected.
Splunk User Behavior Analytics ("UBA") detects cyber-attacks and insider threats
using data science, machine learning and advanced correlation. VictorOps is
cloud-based Collaborative Incident Response system that delivers context-rich
alerts, reducing the time required to react to and address incidents. SignalFx
is a cloud-based service that provides real-time monitoring and metrics for
cloud infrastructure, microservices and applications observability, as well as
application performance management ("APM") for organizations.
We continue to rapidly shift our revenue mix from sales of perpetual licenses to
sales of term licenses and cloud subscriptions, as we transition to a renewable
model, and anticipate this transition will be substantially complete by the end
of fiscal year 2020. As part of this transition, we discontinued selling new
perpetual licenses effective November 1, 2019 . We have also shifted from
generally invoicing our multi-year term license contracts upfront to invoicing
on an annual basis. Accordingly, we expect that the timing of our cash
collections will be over a longer period of time than it has been historically,
which will negatively impact operating cash flows through at least fiscal 2022.
We use total annual recurring revenue ("Total ARR") and subscription annual
recurring revenue ("Subscription ARR") to identify the annual recurring value of
customer contracts at the end of a reporting period. Total ARR represents the
annualized revenue run-rate of active term license, maintenance, and
subscription contracts at the end of a reporting period. Subscription ARR
represents the annualized revenue run-rate of active subscription contracts at
the end of a reporting period. Total ARR was $1.44 billion and subscription ARR
was $368.4 million as of October 31, 2019 .
24--------------------------------------------------------------------------------
Table of Contents
We intend to continue investing for long-term growth. We have invested and
intend to continue to invest heavily in product development to deliver
additional features and performance enhancements, deployment models and
solutions that can address new end markets. For example, during fiscal 2020, we
released new versions of existing offerings such as Splunk ITSI and Splunk ES
and introduced Splunk Data Fabric Search ("DFS") and Splunk Data Stream
Processor ("DSP"). We also introduced Splunk Business Flow, a process mining
solution that enables process improvement and business operations professionals
to discover, investigate, and check conformance of any business process. We
expect to continue to aggressively expand our sales and marketing organizations
to market and sell our software both in the United States and internationally.
We have utilized and expect to continue to utilize acquisitions to contribute to
our long-term growth objectives. During the third quarter of fiscal 2020, we
completed the acquisitions of SignalFx, Inc. ("SignalFx"), a developer of
real-time monitoring and metrics for cloud infrastructure, microservices and
applications, and Cloud Native Labs, Inc. ("Omnition"), which develops a
platform for distributed tracing and application monitoring. We also announced
our acquisition of Streamlio, Inc. , which specializes in designing and operating
streaming data solutions. Refer to Notes 6 and 12 of our accompanying Notes to
Condensed Consolidated Financial Statements included elsewhere in this Quarterly
Report on Form 10-Q for further information.
Our goal is to make our software the platform for delivering operational intelligence and real-time business insights from data. The key elements of our growth strategy are to:
• Extend our technological capabilities.
• Continue to expand our direct and indirect sales organization, including
our channel relationships, to increase our sales capacity and enable
greater market presence.
• Further penetrate our existing customer base and drive enterprise-wide
adoption.
• Enhance our value proposition through a focus on solutions which address
core and expanded use cases.
• Grow our user communities and partner ecosystem to increase awareness of
our brand, target new use cases, drive operational leverage and deliver
more targeted, higher value solutions.
• Continue to deliver a rich developer environment to enable rapiddevelopment of enterprise applications that leverage data and the Splunk
platform.
We believe the factors that will influence our ability to achieve our goals
include, among other things, our ability to deliver new offerings as well as
additional product functionality; acquire new customers across geographies and
industries; cultivate incremental sales from our existing customers by driving
increased use of our software within organizations; provide additional solutions
that leverage our core data platform to help organizations understand and
realize the value of their data in specific end markets and use cases; add
additional original equipment manufacturer ("OEM") and strategic relationships
to enable new sales channels for our software as well as extend our integration
with third-party products; help software developers leverage the functionality
of our data platform through software development kits ("SDKs") and application
programming interfaces ("APIs"); and successfully integrate acquired businesses
and technologies.
25--------------------------------------------------------------------------------
Table of Contents Financial Summary (Dollars in millions) Three Months EndedOctober 31, 2019 and 2018 [[Image Removed: chart-2054ba4b6d1b543aa23.jpg]] [[Image Removed: chart-5b8aec7514b95a03bafa03.jpg]] [[Image Removed: chart-34bc9a9812ad5fd6833a03.jpg]] [[Image Removed: chart-fcb37cc8b6375bc384da03.jpg]] [[Image Removed: chart-456c6e781bc656baa64.jpg]] [[Image Removed: chart-12abe6653828587fa10.jpg]] Nine Months EndedOctober 31, 2019 and 2018 [[Image Removed: chart-27a825c0aad4535ebfda03.jpg]] [[Image Removed: chart-a66c1870372658ac84ca03.jpg]] [[Image Removed: chart-2dd06e703e8d512ebf4a03.jpg]] [[Image Removed: chart-b607ad96d3cb504f92ea03.jpg]] [[Image Removed: chart-7ab3064fdf215421b4ba03.jpg]] [[Image Removed: chart-fcc0cf6bc8e459b4947a03.jpg]] 26
--------------------------------------------------------------------------------
Table of Contents
_________________________
* Refer to Non-GAAP Financial Results below for further information regarding
our GAAP to non-GAAP Financial Measures and related reconciliations.
Our customers and end-users represent the public sector and a wide variety of industries, including financial services, manufacturing, retail and technology, among others. As ofOctober 31, 2019 , we had 19,000 customers, including over 90 of the Fortune 100 companies. Our quarterly results reflect seasonality in the sale of our offerings. Historically, a pattern of increased sales in the fourth fiscal quarter as a result of industry buying patterns has positively impacted sales activity in that period, which can result in lower sequential revenues in the following first fiscal quarter. Our gross margins and operating losses have been affected by these historical trends because the majority of our expenses are relatively fixed in the short-term. The majority of our expenses are personnel-related and include salaries, stock-based compensation, benefits and incentive-based compensation plan expenses. As a result, we have not experienced significant seasonal fluctuations in the timing of expenses from period to period.
Non-GAAP Financial Results
To supplement our condensed consolidated financial statements, which are prepared and presented in accordance with GAAP, we provide investors with the following non-GAAP financial measures: cost of revenues, gross margin, research and development expense, sales and marketing expense, general and administrative expense, operating income (loss), operating margin, income tax provision (benefit), net income (loss), net income (loss) per share and free cash flow (collectively the "non-GAAP financial measures"). These non-GAAP financial measures exclude all or a combination of the following (as reflected in the following reconciliation tables): expenses related to stock-based compensation and related employer payroll tax, amortization of acquired intangible assets, adjustments related to a financing lease obligation, acquisition-related adjustments, including the partial release of the valuation allowance due to acquisitions, and non-cash interest expense related to our convertible senior notes that were issued in the fiscal third quarter of 2019. The adjustments for the financing lease obligation are to reflect the expense we would have recorded if our build-to-suit lease arrangement had been deemed an operating lease instead of a financing lease and is calculated as the net of actual ground lease expense, depreciation and interest expense over estimated straight-line rent expense. The non-GAAP financial measures are also adjusted for our estimated tax rate on non-GAAP income (loss). To determine the annual non-GAAP tax rate, we evaluate a financial projection based on our non-GAAP results. The annual non-GAAP tax rate takes into account other factors including our current operating structure, our existing tax positions in various jurisdictions and key legislation in major jurisdictions where we operate. The non-GAAP tax rate applied to the three and nine months endedOctober 31, 2019 was 20%. We expect to utilize this annual non-GAAP tax rate for all of fiscal 2020 and will provide updates to this rate on an annual basis, or more frequently if material changes occur. The applicable fiscal 2019 tax rates are noted in the reconciliations. In addition, our non-GAAP financial measures include free cash flow, which represents operating cash flow less purchases of property and equipment. The presentation of the non-GAAP financial measures is not intended to be considered in isolation or as a substitute for, or superior to, the financial information prepared and presented in accordance with GAAP. We use these non-GAAP financial measures for financial and operational decision-making purposes and as a means to evaluate period-to-period comparisons. We believe that these non-GAAP financial measures provide useful information about our operating results, enhance the overall understanding of past financial performance and future prospects and allow for greater transparency with respect to key metrics used by management in our financial and operational decision making. In addition, these non-GAAP financial measures facilitate comparisons to competitors' operating results. We exclude stock-based compensation expense because it is non-cash in nature and excluding this expense provides meaningful supplemental information regarding our operational performance and allows investors the ability to make more meaningful comparisons between our operating results and those of other companies. We exclude employer payroll tax expense related to employee stock plans in order for investors to see the full effect that excluding that stock-based compensation expense had on our operating results. These expenses are tied to the exercise or vesting of underlying equity awards and the price of our common stock at the time of vesting or exercise, which may vary from period to period independent of the operating performance of our business. We also exclude amortization of acquired intangible assets, adjustments related to a financing lease obligation, acquisition-related adjustments, including the partial release of the valuation allowance due to our acquisitions, and non-cash interest expense related to our convertible senior notes from our non-GAAP financial measures because these expenses are considered by management to be outside of our core operating results. Accordingly, we believe that excluding these expenses provides investors and management with greater visibility to the underlying performance of our business operations, facilitates comparison of our results with other periods and may also facilitate comparison with the results of other companies in our industry. We consider free cash flow to be a liquidity measure that provides useful information to management and investors about the amount of cash generated or used by the business. There are limitations in using non-GAAP financial measures because the non-GAAP financial measures are not prepared in accordance with GAAP, may be different from non-GAAP financial measures used by our competitors and exclude expenses that may have a material impact upon our reported financial results. Further, stock-based compensation expense has been and will continue to be for the foreseeable future a significant recurring expense in our business and an important part of the compensation provided to our employees. The non-GAAP financial measures are meant to supplement and be viewed in conjunction with GAAP financial measures. 27
--------------------------------------------------------------------------------
Table of Contents
The following table reconciles our net cash provided by (used in) operating activities to free cash flow:
Three Months Ended October 31, Nine Months Ended October 31,
(In thousands) 2019 2018 2019 2018
Net cash provided by (used in)
operating activities $ (134,863 ) $ 59,075 $ (228,805 ) $ 169,086
Less purchases of property and
equipment (27,090 ) (7,319 ) (53,524 ) (15,177 )
Free cash flow (non-GAAP) $ (161,953 ) $ 51,756 $ (282,329 ) $ 153,909
Net cash used in investing activities $ (617,472 ) $ (441,746 ) $ (643,284 ) $ (700,344 )
Net cash provided by (used in)
financing activities $ (46,399 ) $
1,831,647
The following table reconciles our GAAP to non-GAAP Financial Measures for the
three months ended
Non-cash
interest
Stock-based expense
compensation and Amortization of related to Income tax effects
(In thousands, except related employer acquired intangible Acquisition-related convertible related to non-GAAP
per share amounts) GAAP payroll tax assets adjustments senior notes adjustments (3) Non-GAAP
Cost of revenues $ 107,819 $ (10,729 ) $ (7,865 ) $ - $ - $ - $ 89,225
Gross margin 82.8 % 1.7 % 1.3 % - % - % - % 85.8 %
Research and development 158,887 (45,701 ) (174 ) (12 ) - - 113,000
Sales and marketing 319,023 (51,795 ) (2,081 ) (172 ) - - 264,975
General and
administrative 88,092 (27,082 ) - (7,408 ) - - 53,602
Operating income (loss) (47,485 ) 135,307 10,120 7,592 - - 105,534
Operating margin (7.6 )% 21.6 % 1.6 % 1.2 % - % - % 16.8 %
Income tax provision
(benefit) (1,855 ) - - 6,006 (2) - 18,630 22,781
Net income (loss) $ (57,639 ) $ 135,307 $ 10,120 $ 1,586 $ 20,382 $ (18,630 ) $ 91,126
Net income (loss) per
share (1) $ (0.38 ) $ 0.58 _________________________
(1) GAAP net loss per share calculated based on 152,404 weighted-average shares
of common stock. Non-GAAP net income per share calculated based on 156,526
diluted weighted-average shares of common stock, which includes 4,122
potentially dilutive shares related to employee stock awards. GAAP to
non-GAAP net income (loss) per share is not reconciled due to the difference
in the number of shares used to calculate basic and diluted weighted-average
shares of common stock.
(2) Represents the partial release of the valuation allowance.
(3) Represents the tax effect of the non-GAAP adjustments based on the estimated
annual effective tax rate of 20%.
The following table reconciles our GAAP to non-GAAP Financial Measures for the
three months ended
28--------------------------------------------------------------------------------
Table of Contents
Non-cash
interest
Stock-based expense
compensation and Amortization of Adjustments related related to Income tax effects (In thousands, except
related employer acquired intangible to financing lease convertible related to non-GAAP per share amounts)
GAAP payroll tax assets obligation senior notes adjustments (3) Non-GAAP
Cost of revenues $ 89,225 $ (9,203 ) $ (5,923 ) $ 300 $ - $ - $ 74,399
Gross margin 81.4 % 2.0 % 1.2 % (0.1 )% - % - % 84.5 %
Research and
development 117,722 (35,892 ) (249 ) 514 - - 82,095
Sales and marketing 264,223 (46,527 ) (955 ) 1,134 - - 217,875
General and
administrative 59,819 (18,875 ) - 259 - - 41,203
Operating income
(loss) (50,006 ) 110,497 7,127 (2,207 ) - - 65,411
Operating margin (10.4 )% 23.0 % 1.5 % (0.5 )% - % - % 13.6 %
Income tax provision 1,814 - - - - 12,597 14,411
Net income (loss) $ (55,705 ) $ 110,497 $ 7,127 $ (169 ) (2) $ 8,491 $ (12,597 ) $ 57,644
Net income (loss) per
share (1) $ (0.38 ) $ 0.38 _________________________
(1) GAAP net loss per share calculated based on 146,391 weighted-average shares
of common stock. Non-GAAP net income per share calculated based on 152,691
diluted weighted-average shares of common stock, which includes 6,300
potentially dilutive shares related to employee stock awards. GAAP to
non-GAAP net income (loss) per share is not reconciled due to the difference
in the number of shares used to calculate basic and diluted weighted-average
shares of common stock.
(2) Includes
obligation.
(3) Represents the tax effect of the non-GAAP adjustments based on the estimated
annual effective tax rate of 20%.
The following table reconciles our GAAP to non-GAAP Financial Measures for the
nine months ended
Non-cash
interest
Stock-based expense
compensation and Amortization of related to Income tax effects
(In thousands, except per related employer acquired intangible Acquisition-related convertible related to non-GAAP share amounts) GAAP payroll tax assets adjustments senior notes adjustments (3) Non-GAAP Cost of revenues$ 301,950 $ (33,342 ) $ (19,662 ) $ - $ - $ -$ 248,946 Gross margin 80.7 % 2.1 % 1.3 % - % - % - % 84.1 % Research and development 422,287 (130,539 ) (672 ) (12 ) - - 291,064 Sales and marketing 896,757 (155,657 ) (3,991 ) (172 ) - - 736,937 General and administrative 226,118 (72,206 ) - (7,408 ) - - 146,504 Operating income (loss) (279,368 ) 391,744 24,325 7,592 - - 144,293 Operating margin (17.8 )% 24.9 % 1.6 % 0.5 % - % - % 9.2 % Income tax provision 7,010 - - 6,006 (2) - 22,226 35,242 Net income (loss)$ (313,940 ) $ 391,744 $ 24,325 $ 1,586$ 59,478 $ (22,226 ) $ 140,967 Net income (loss) per share (1)$ (2.08 ) $ 0.90
_________________________
(1) GAAP net loss per share calculated based on 150,659 weighted-average shares
of common stock. Non-GAAP net income per share calculated based on 155,960
diluted weighted-average shares of common stock, which includes 5,301
potentially dilutive shares related to employee stock awards. GAAP to
non-GAAP net income (loss) per share is not reconciled due to the difference
in the number of shares used to calculate basic and diluted weighted-average
shares of common stock.
(2) Represents the partial release of the valuation allowance.
29--------------------------------------------------------------------------------
Table of Contents
(3) Represents the tax effect of the non-GAAP adjustments based on the estimated
annual effective tax rate of 20%.
The following table reconciles our GAAP to non-GAAP Financial Measures for the
nine months ended
Non-cash
interest
Stock-based expense
compensation and Amortization of Adjustments related related to Income tax effects
(In thousands, except related employer acquired intangible to financing lease Acquisition-related convertible related to non-GAAP
per share amounts) GAAP payroll tax assets obligation adjustments senior notes adjustments (4) Non-GAAP
Cost of revenues $ 250,943 $ (28,190 ) $ (15,526 ) $ 916 $ - $ - $ - $ 208,143
Gross margin 78.8 % 2.4 % 1.3 % (0.1 )% - % - % - % 82.4 %
Research and
development 310,818 (98,648 ) (795 ) 1,510 - - - 212,885
Sales and marketing 726,089 (139,387 ) (1,785 ) 3,451 - - - 588,368
General and
administrative 168,405 (53,602 ) - 741 (6,034 ) - - 109,510
Operating income (loss) (275,330 ) 319,827 18,106 (6,618 ) 6,034 - - 62,019
Operating margin (23.3 )% 27.2 % 1.5 % (0.6 )% 0.5 % - % - % 5.3 %
Income tax provision 637 - - - 3,313 (3) - 11,037 14,987
Net income (loss) $ (277,703 ) $ 319,827 $ 18,106 $ (456 ) (2) $ 2,721 $ 8,491 $ (11,037 ) $ 59,949
Net income (loss) per
share (1) $ (1.91 ) $ 0.40 _________________________
(1) GAAP net loss per share calculated based on 145,015 weighted-average shares
of common stock. Non-GAAP net income per share calculated based on 151,451
diluted weighted-average shares of common stock, which includes 6,436
potentially dilutive shares related to employee stock awards. GAAP to
non-GAAP net income (loss) per share is not reconciled due to the difference
in the number of shares used to calculate basic and diluted weighted-average
shares of common stock.
(2) Includes
obligation.
(3) Represents the partial release of the valuation allowance.
(4) Represents the tax effect of the non-GAAP adjustments based on the estimated
annual effective tax rate of 20%.
30--------------------------------------------------------------------------------
Table of Contents
Components of Operating Results
Revenues
License revenues. License revenues reflect the revenues recognized from sales of licenses to new customers and additional licenses to existing customers, including sales from the renewal of term licenses. We are focused on acquiring new customers and increasing revenues from our existing customers as they realize the value of our software by indexing higher volumes of data and expanding the use of our software through additional use cases and broader deployment within their organizations. Our license revenues consist of revenues from term licenses and perpetual licenses, under which we generally recognize the license fee portion of the arrangement upfront, assuming all revenue recognition criteria are satisfied. In addition, seasonal trends that contribute to increased sales activity in the fourth fiscal quarter often result in lower sequential revenues in the first fiscal quarter, and we expect this trend to continue. We continue to rapidly shift our revenue mix from sales of perpetual licenses to sales of term licenses and cloud subscriptions, as we transition to a renewable model, and anticipate this transition will be substantially complete by the end of fiscal year 2020. As part of this transition, we discontinued selling new perpetual licenses effectiveNovember 1, 2019 . Maintenance and services revenues. Maintenance and services revenues consist of revenues from maintenance agreements, cloud services and professional services and training.
• Maintenance revenues. When a term license is purchased, maintenance is
bundled with the license for the term of the license period. Typically,
when purchasing a perpetual license, a customer also purchases one year of
maintenance for which we charge a percentage of the license fee. Customers
with maintenance agreements are entitled to receive support and
unspecified upgrades and enhancements when and if they become available
during the maintenance period. We recognize the revenues associated with
maintenance agreements ratably, on a straight-line basis, over the
associated maintenance period.
• Cloud services revenues. Cloud services allow customers to use hosted
software over the contract period without taking possession of the
software. We recognize the revenues associated with our cloud services
ratably over the associated subscription term. We expect revenues from
cloud services to continue to increase as a percentage of total revenue as
we continue our transition to a renewable model.
• Professional services and training revenues. We have a professional
services organization focused on helping our customers deploy our software
in highly complex operational environments and train their personnel.
Training and professional services have stated billing rates per service
hour or are provided on a subscription basis, accordingly, revenues are
recognized as services are delivered or ratably over the subscription
period. Professional services and training revenues as a percentage of
total revenues, were 8% for both the three months ended October 31, 2019
and 2018. We have experienced continued growth in our professional
services revenues primarily due to the deployment of our software with
some customers that have large, highly complex IT environments.
Cost of Revenues
Cost of license revenues. Cost of license revenues includes all direct costs to deliver our products, including salaries, benefits, stock-based compensation and related expenses such as employer taxes, allocated overhead for facilities and IT and amortization of acquired intangible assets. We recognize these expenses as they are incurred. Cost of maintenance and services revenues. Cost of maintenance and services revenues includes salaries, benefits, stock-based compensation and related expenses such as employer taxes for our maintenance and services organizations, third-party consulting services, allocated overhead for depreciation of equipment, facilities and IT, amortization of acquired intangible assets and third-party hosting fees related to our cloud services. We recognize expenses related to our maintenance and services organizations as they are incurred.
Operating Expenses
Our operating expenses are classified into three categories: research and
development, sales and marketing, and general and administrative. For each
category, the largest component is personnel costs, which include salaries,
employee benefit costs, bonuses, commissions as applicable, stock-based
compensation and related expenses such as employer taxes. Operating expenses
also include allocated overhead costs for depreciation of equipment, facilities
and IT. Allocated costs for facilities include costs for compensation of our
facilities personnel, leasehold improvements and rent. Our allocated costs for
IT
31--------------------------------------------------------------------------------
Table of Contents
include costs for compensation of our IT personnel, costs associated with our IT infrastructure and software subscriptions. Operating expenses are generally recognized as incurred.
Research and development. Research and development expenses primarily consist of personnel and facility-related costs attributable to our research and development personnel. We have devoted our product development efforts primarily to enhancing the functionality and expanding the capabilities of our software and services. We expect that our research and development expenses will continue to increase, in absolute dollars, as we increase our research and development headcount to further strengthen and enhance our software and services and invest in the development of our solutions and apps. Sales and marketing. Sales and marketing expenses primarily consist of personnel and facility-related costs for our sales, marketing and business development personnel, commissions earned by our sales personnel, and the cost of marketing and business development programs, including advertising programs to promote our brand and awareness, demand generating activities, and customer events. We expect that sales and marketing expenses will continue to increase, in absolute dollars, as we continue to hire additional personnel and invest in marketing programs. General and administrative. General and administrative expenses primarily consist of personnel and facility-related costs for our executive, finance, legal, human resources and administrative personnel; our legal, accounting and other professional services fees; and other corporate expenses. We anticipate continuing to incur additional expenses due to growing our operations, including higher legal, corporate insurance and accounting expenses.
Interest and Other Income (Expense), Net
Interest and other income (expense), net consists primarily of interest expense related to our convertible senior notes, foreign exchange gains and losses, interest income on our investments and cash and cash equivalents balances, and changes in the fair value of forward exchange contracts.
Income Tax Provision (Benefit)
The income tax provision (benefit) consists of federal, state and foreign income taxes. We recognize deferred tax assets and liabilities for the expected tax consequences of temporary differences between the tax basis of assets and liabilities and their reported amounts using enacted tax rates in effect for the year in which we expect the differences to reverse. We record a valuation allowance to reduce the deferred tax assets to the amount that we are more-likely-than-not to realize. Because of our history ofU.S. net operating losses, we have established, in prior years, a full valuation allowance against potential future benefits forU.S. deferred tax assets including loss carryforwards and research and development and other tax credits. We regularly assess the likelihood that our deferred income tax assets will be realized based on the realization guidance available. To the extent that we believe any amounts are not more-likely-than-not to be realized, we record a valuation allowance to reduce the deferred income tax assets. We regularly assess the need for the valuation allowance on our deferred tax assets, and to the extent that we determine that an adjustment is needed, such adjustment will be recorded in the period that the determination is made. 32
--------------------------------------------------------------------------------
Table of Contents
Results of Operations
The following table sets forth our results of operations for the periods presented and as a percentage of our total revenues for those periods. The period-to-period comparison of financial results is not necessarily indicative of financial results to be achieved in future periods.
© Edgar Online, source
