Gross Margins in Software and What Drives Them

RBC Capital Markets, LLC
EQUITY RESEARCH
Rishi Jaluria (Analyst)
(415) 633-8798,
rishi.jaluria@rbccm.com
Matthew Hedberg (Analyst)
(612) 313-1293,
matthew.hedberg@rbccm.com
Philip Rigby (Senior
October 27, 2021 Associate)
(971) 400-3331,
Gross Margins in Software and What Drives Them philip.rigby@rbccm.com
Richard Poland (Senior
Associate)
Our view: In our third software white paper, we focus on gross margins, which are a key driver in the (347) 920-6958,
path to profitability. Based on our analysis, we call out DOCU, ZI, and HUBS as high gross margins names; richard.poland@rbccm.com
VEEV, TWLO, and COUR as names with the most upside to gross margins, and are incrementally cautious
on BOX and FSLY.
• In our third software whitepaper, we continue to focus on key themes in software. Previously, we
have written about sales efficiency and software in a post-pandemic world. This quarter, we focus
on gross margins.
• We also highlight ongoing key themes, including performance, valuations, the “Rule of 40”, IPOs, and
M&A; highlight our top picks; recap corporate access events; summarize our data points; and discuss
our outlook. The RBC Software Index was up 12% in 3Q (vs. NASDAQ up 11%).
• Gross margins are critical for software companies and we believe one of four key drivers in a
company’s path to profitability (the others being net retention rates, sales efficiency, and TAM).
• Gross margins are a key reason why software companies command high valuation multiples. High
gross margins effectively “free” up money for investment in other areas (sales, product, etc.), while
also enabling companies to absorb higher costs – critical in an inflationary environment. In addition,
gross margins help us differentiate true software companies versus "SaaS pretenders."
• Based on our analysis of gross margins for 82 companies, we have three key findings:
1. The average gross margin in the RBC Software Index is 77% (vs. 48% gross margin for S&P 500);
2. The most important drivers of gross margins are revenue mix, product mix, deployment (cloud
vs. on-premise), capital intensity, infrastructure efficiency, pricing power, and accounting;
3. Improving gross margins signal a favorable mix-shift and pricing power, while deteriorating
gross margins can signal pricing pressure or other issues in the business. That said, temporary
pressure on gross margins isn’t always bad, if it’s a result of product mix-shift/international
expansion (e.g. TWLO) or a cloud transition (e.g. MDB).
• DOCU, ZM, HUBS, ZI, DBX, PD, DT, and NOW have the highest gross margins among SaaS companies,
while we have concerns around BOX and FSLY’s long-term gross margins. We also see VEEV, TWLO,
COUR, CRWD, NTNX, and XMTR as the names with the most upside to gross margins.
• We offer company-specific commentary on gross margins for 82 companies in the extended
software sector.
• Our top picks are ZM, TWLO, VEEV, COUR, MSFT, CRWD, DT, ESTC, NOW, and PANW.
Exhibit 1 - Software Gross Margins, Most Recent FY
.
Source: RBC Capital Markets, company reports
Priced as of prior trading day's market close, EST (unless otherwise noted). All values in USD unless otherwise noted
Disseminated: Oct 27, 2021 00:15EDT; Produced: Oct 27, 2021 00:03EDT
For Required Conflicts Disclosures, see page 171
Gross Margins in Software and What Drives Them
Table of contents
Gross Margins..................................................................................................................................... 3
Why gross margins matter..........................................................................................................................3
Case Studies................................................................................................................................................ 7
Caveats and Considerations........................................................................................................................ 9
Company Specific Analysis........................................................................................................................ 10
The Winner Effect........................................................................................................................... 150
Returns by Style.............................................................................................................................. 151
Valuation......................................................................................................................................... 152
Rule of 40....................................................................................................................................... 155
IPOs.................................................................................................................................................158
SPACs...............................................................................................................................................161
M&A................................................................................................................................................162
Corporate Access Recap.................................................................................................................. 164
Top Picks......................................................................................................................................... 165
LinkedIn/Glassdoor Trackers............................................................................................................168
October 27, 2021 2

Gross Margins
Why gross margins matter
High gross margins are one of the key reasons investors assign high valuation multiples to
software companies. In fact, we believe software is one of the highest (if not the highest) gross
margin sector. As noted, the average gross margin in the RBC Software Index is 77%, significantly
higher than 48% for the S&P 500. Gross margins, combined with growth, recurring revenue
models, secular tailwinds, and economic resilience, justify the high valuation multiples, in our
view.
Gross margins remain one of the four key drivers in a company’s path to profitability: 1) gross
margins; 2) sales efficiency; 3) net expansion/retention rates; and 4) TAM.
From a model perspective, the reason high gross margins are so important is they effectively
“free” up money for investment in other areas. Most newly-minted software IPOs seem to have
a long-term target model of 20%+ operating margins, no matter how deeply unprofitable they
are today. But the glide path is certainly a lot easier to see if the gross margins are there. As
an illustrative example, a software company with 80% gross margins can spend 50% of revenue
combined on R&D and S&M (assuming a consistent 10% of revenue on G&A) and still reach 20%
operating margins. A software company with 60% gross margins, however, would only be able to
spend 30% of revenue combined on R&D and S&M to reach that 20% operating margin target.
We would add another key point, which is that gross margins help us differentiate which
companies are truly software companies, versus companies that market themselves as SaaS
companies, yet only have 20% gross margins. This is not to say that every low gross margin
company is a SaaS pretender, but it serves as a useful check and can be an immediate warning
sign when looking at new IPOs or SPACs.
In this note, we analyze factors that drive gross margins, outline two case studies, and discuss
caveats and considerations. We also analyzed gross margin trends for 82 companies in the
extended software sector.
The detailed company-by-company analysis for these companies begins on page 10. Names
analyzed include ADBE, ADSK, AKAM, ALTR, ANSS, ASAN, AYX, BASE, BLKB, BOX, BSY, CHKP,
CLDR, COUP, COUR, CRM, CRWD, CSOD, CTXS, CVLT, CWAN, DBX, DCT, DDOG, DOCU, DT, DV,
ESTC, EVCM, FFIV, FSLY, FTNT, GWRE, JAMF, LLNW, MCFE, MDB, MIME, MSFT, MSP, NABL, NET,
NEWR, NICE, NLOK, NOW, NTCT, NTNX, OKTA, OLO, PANW, PATH, PD, PEGA, PING, PLTR, PTC,
PWSC, QLYS, RPD, SAIL, SCWX, SMAR, SPLK, SUMO, SWI, TDC, TEAM, TWLO, TWOU, VEEV,
VMW, VRNS, VRNT, WDAY, XMTR, ZD, ZEN, ZI, ZM, and ZS.
Exhibit 2 - Software Gross Margins, Most Recent FY
.
October 27, 2021 3

Exhibit 3 - Software Gross Margins, 5YR Average
.
Exhibit 4 shows the impact of gross margins on valuation multiples. As expected, investors
tend to reward higher gross margin businesses with higher valuation multiples. We note the
relationship isn't exactly linear, as many high gross margin companies also tend to be on-premise
and we find on-premise software companies garner lower multiples than SaaS companies.
Exhibit 4 - Average EV/CY22E Revenue Multiple by Gross Margin
.
Source: RBC Capital Markets, Factset consensus, company reports
October 27, 2021 4

Factors that drive gross margins
As we conducted this analysis, we found a number of factors that matter when discussing gross
margins.
• Revenue mix. We generally see SaaS companies divide revenue between subscription (which
itself is a mix of license and support) and professional services. Given that professional
services (customization, implementation, training) is more people-intensive, it tends to be
significantly lower gross margin than subscription revenue, which is the actual software
piece. We would also add that services mix generally declined in software partly due to
the pandemic, when there was effectively no travel, meaning less was billed to the clients.
Generally, higher subscription mixes result in higher overall gross margins. The caveat is not
every company discloses the breakdown and some companies (e.g. BOX, CSOD) treat some
services (“premium” or “recurring” services) as subscription. Companies with the highest
subscription mix include DOCU, ZM, MDB, OKTA, PD, and HUBS.
• Professional services practices. Following up on the prior point, software companies have
different approaches to professional services, with some treating it as a cost center and almost
a “necessary evil”, while others aim to generate some level of profit on services (even if it
comes with a lower margin). This shows up with some companies having deeply negative
professional services gross margins (e.g. DOCU, OKTA), while others have 30%+ professional
services gross margins (e.g. SMAR, DCT).
• Product mix. Sometimes, different products have different gross margins and mix-shift can
meaningfully drive overall gross margins. For example, as AKAM’s security mix grows, overall
gross margins should improve. Similarly, as VEEV’s Vault business grows, overall subscription
gross margins should improve (as we illustrate in our case study). On the other hand, TWLO
has seen pressure on overall gross margins as messaging (the lowest gross margin product)
has accelerated during the pandemic.
• Pricing. This is one key reason we look at trends in gross margins. Falling subscription gross
margins can signal pricing pressure (since costs associated with software revenue are generally
fixed to deployment and per seat), while rising gross margins can indicate a favorable pricing
environment or even a mix-shift towards premium subscription plans (which should be higher
gross margin). We look at DOCU’s stable-to-improving subscription gross margins as evidence
that it has maintained pricing (in spite of competition from ADBE), while BOX’s declining gross
margins lead us to believe the company has faced pricing pressure (especially from MSFT).
• Cloud vs. on-premise. On-premise tends to have higher gross margins, since there is no
infrastructure cost associated with the software, while SaaS companies have lower gross
margins overall. For companies with hybrid deployment models, a growing cloud mix (e.g.
MDB with Atlas) would pressure overall gross margins. The important point, however, is that
SaaS should generally have higher gross profit dollars than the equivalent on-premise solution
(a revenue uplift of 2x-3x is typical).
• Cloud transitions. Related to the prior point, companies that undergo a cloud transition will
see gross margins pressured, especially if the cloud product is sub-scale and has lower gross
margins as it gains traction (e.g., PEGA).
• Capital intensity. Capital intensive businesses (e.g., AKAM, FSLY) will generally have lower gross
margins, especially as most of the D&A related to CapEx flows through the cost of revenue
line item.
• Support mix and people cost. As mentioned earlier, subscription revenue truly includes the
cost of the software itself (inclusive of upgrades), as well as support (whether done through
phone, chat, or online forums). Generally, the more “hand holding” required to use software
and the more people-related support required, the lower the subscription gross margins will
be.
• Infrastructure efficiency. Some SaaS companies generally leverage the public cloud
infrastructure in a more efficient manner, which leads to overall gross margin uplift. DBX is
October 27, 2021 5

one company that actually manages its own infrastructure (having mostly moved off AWS) and
sees high gross margins as a result.
• Duplicative costs. Some companies make the decision to move from co-located infrastructure
to public cloud vendors (e.g., NEWR), while others do the opposite (e.g. DBX). During
this migration, a company will typically pay duplicative costs to ensure minimal disruption,
which meaningfully weighs down gross margins (NEWR has seen its gross margins decline
meaningfully during this process).
• Free users and free trials. Companies with a high mix of free users (which can help boost
sales efficiency) also see pressure on gross margins… with the giant caveat that companies
account for the cost to support free users differently. DBX and ZM categorize this cost as a
cost of revenue line item (a stance we agree with), while companies like BOX and NET define
it as sales and marketing. With ZM, we note the surge in free users (and free K-12 adoption)
meaningfully pressured gross margins last year. Free trials are an item we also believe should
be in cost of revenue, but this impact will likely be less significant than free users (we also note
that it is unclear with many companies where they categorize free trials, but we believe most
account for it under sales and marketing).
• Accounting. Changes in revenue recognition or D&A schedules can impact gross margins. For
example, with AYX’s on-premise model, the mix of license vs. maintenance (a function of
duration and product mix) meaningfully impacts gross margins.
• Non-GAAP adjustments. Our view that generally non-GAAP gross margins should only subtract
stock-based compensation and amortization of acquired intangibles, but we see situations
where companies make other adjustments (such as adding back in deferred revenue write-
downs), which impacts the comparability of the metric between companies. We also note
some companies use alternative non-GAAP metrics to analyze gross margins (such as AKAM
with “cash gross margins”, which we do not rely on).
• Pricing tiers. Many SaaS companies offer tiered pricing, with entry level and premium SKUs. A
higher mix towards higher priced tiers is likely a tailwind to gross margins.
• Geography. Generally, international should carry the same gross margins as US (unless the
company is meaningfully discounting internationally), but there are situations like TWLO where
international carries meaningfully lower gross margins (crucial to the debate on the stock).
• Pass-through revenue. In some cases, we see revenue that is effectively 0% gross margins and
weighs on overall gross margin, even if it has no impact on overall gross profit dollars. For
example, the carrier fee associated with TWLO’s messaging business is generally pass-through
(as are Verizon A2P fees). BLKB is another example as a company with a meaningful payments
business, since BLKB recognizes payments revenue on a gross basis, not a net basis.
• Royalties. Some software companies have royalties they must pay as a percentage of revenue,
either through use of third-party data sources (e.g. CWAN, AYX) or by building a solution on top
of a third-party platform (e.g. VEEV, NCNO, which are both built on the Salesforce Platform).
• Architecture. Most SaaS companies leverage multi-tenancy, but some leverage single-tenant
architecture (e.g. PEGA, NOW, DCT, GWRE), which is lower gross margin than multi-tenant. In
addition, the use of Kubernetes (K8S) can help lift overall gross margins.
• M&A. Accretion/dilution aside (buying high gross margin companies boosts overall gross
margins, buying low gross margin companies weighs on gross margins overall), M&A can
temporarily depress gross margins due to a mismatch in costs and recognized revenue. This is
the case we’re seeing with COUP following the LLamasoft acquisition.
• Capitalized Software. Some companies capitalize some level of software R&D (versus
expensing all of it) and these companies have differing treatment of the amortization of this
line. Those that include the amortization in COGS will see a drag on gross margins, while those
who amortize it under R&D won’t see any impact.
October 27, 2021 6

Case Studies
Veeva Case Study
Given all the moving parts and financial transparency, we view VEEV as a great case study to
analyze multiple gross margin drivers (Exhibit 5).
Exhibit 5 - Veeva Gross Margin Components Overview
.
Source: RBC Capital Markets, Company reports
Takeaways from our analysis of Veeva's Gross Margins:
1. Subscription revenue is ~81% of revenue, which is up from 77% in FY16. The increase in
services mix in FY21 was largely the result of M&A (Physicians World and Crossix). We expect
the subscription mix to continue growing over time, especially as the Vault services attach
rate declines.
2. VEEV’s subscription gross margins are rather healthy at 85%+, which is up meaningfully over
the past several years. We believe this subscription gross margin expansion has primarily
been driven by revenue mix-shift away from CRM (particularly Vault). We also note that VEEV
has relatively high professional services gross margins, which makes the high services mix
less of a drag on overall gross margins.
October 27, 2021 7

3. VEEV discloses revenue mix between Commercial Cloud (primarily CRM and add-ons, but
also products like Network Nitro, CRM Engage, etc.) and Vault (which includes all applications
built on Vault, VEEV’s content management platform). Vault has grown from 21% of total
subscription revenue in FY16 to nearly 50% in FY21.
4. VEEV no longer discloses the mix between CRM and non-CRM, but we estimate CRM
represents ~46% of total revenue today, down from 74% in FY16 (and 93% in FY14).
5. To estimate the gross margin difference between CRM and non-CRM, we look at total
subscription COGS (on a non-GAAP basis) by year. We then take the total annual royalty
payments to Salesforce.com (which is included in the COGS line and disclosed in the 10-Qs
and 10-Ks) to get the remaining non-GAAP cost of subscription revenue.
6. We then take the remaining non-GAAP cost of subscription revenue and allocate these costs
proportionally between CRM and non-CRM subscription revenue (based on our estimates),
then add back in the royalty payments to Salesforce.com to the CRM revenue line item.
This implies that subscription gross margins for CRM are ~77% (up from 73% in FY16), while
subscription gross margins in the non-CRM business are in the low-to-mid 90s (which we
view as best-in-class).
7. VEEV discloses revenue mix within Commercial cloud, with subscription representing 84% of
the business and services representing 16%. We note this is a benefit of maturity and scale
– in FY13, when VEEV was 97% CRM, professional services represented 43% of revenue.
8. Vault, on the other hand, is more services heavy, with professional services representing 23%
of total Vault revenue, which is down substantially from 38% in FY16. We do believe Vault
has a higher services attach rate profile than Commercial Cloud, but still expect the services
mix to decline.
9. Interestingly, in spite of Vault’s higher services mix, it has a higher overall gross margin profile
than Commercial Cloud. As a result, we expect a growing Vault mix-shift to be a tailwind to
overall gross margins.
DocuSign Case Study

Exhibit 6 shows our DOCU case study, which is a much simpler case study than VEEV.
Exhibit 6 - DOCU Gross Margin Components Overview, FY16-FY21
.
Takeaways from our analysis of DOCU's gross margins:
1. Subscription has been growing consistently as a percentage of revenue to over 95%.

Subscription revenue has grown at a CAGR of 43%, eclipsing the 23% CAGR for professional
services.
2. Professional services has declined from 8.5% of revenue to under 5% last year, one of the
lowest mixes in software. We attribute this to DOCU’s ease of use and 400+ pre-existing
integrations.
3. Subscription gross margins have improved from 79% to ~84% in the past year. This does
suggest that DOCU has not been hit by pricing pressure, in spite of ADBE offering a
significantly cheaper offering (and potential pricing pressure from DBX with HelloSign). We
October 27, 2021 8
also believe all the costs for free users (people signing on DOCU, but not paying for the
software) shows up in COGS. We do note that subscription gross margins have declined off
the highs in FY19, which we believe to be due to the acquisition of SpringCM (which closed
late in FY19). This does suggest CLM is lower gross margin than e-signature.
4. Professional services gross margins have generally run at a loss for DOCU, which suggests the
company treats it as a cost center, versus trying to make profit off it (FY17 was an anomaly).
Given the low services attach rate for DOCU, this doesn’t have a huge impact on overall gross
margins (if professional services were breakeven in FY21, it would have added ~60 bps to
overall gross margins).
5. Overall gross margins have improved significantly to 79%, which we view as very healthy,
even if slightly down, which we attribute to CLM being a lower gross margin product, as
discussed earlier.
Caveats and Considerations

• Not always comparable. As we pointed out under observations, we try to use non-GAAP gross
margins to compare gross margins between companies, but every company defines the metric
differently, accounting treatments vary, and sometimes, important costs are excluded. It is
important to consider these factors when comparing gross margins.
• Gross margin pressure isn’t always bad. While generally, a trend of declining gross margins
is seen as worrisome and the result of pricing pressure, declining gross margins aren’t always
bad. For example, cloud transitions will generally see gross margin pressure, while a multi-
modal company will see margins pressured if its cloud products do well (e.g. MDB, NICE). In
addition, some companies will see temporary gross margin pressure when migrating from its
own infrastructure to the public cloud (and vice versa), often due to duplicative costs.
• Gross profit dollar growth is more important. If a company is growing gross profit dollars
at a healthy clip, this ultimately matters more than the specific margin profile. We’d rather
see a company grow gross profit dollars by 30% while seeing gross margins decline, versus a
company maintaining gross margins, but only growing gross profit dollars by 10%.
• Only one part of the equation! As with any KPI analysis we do, gross margins are only one part
of the story. As mentioned, it is one of the four key drivers of a company’s path to profitability
(the others being net retention rates, sales efficiency, and TAM) and sometimes, those other
factors can more than offset lower gross margins (e.g. TWLO), while other teams, those metrics
being softer hurt a solid gross margin profile (e.g. BOX).
October 27, 2021 9

Company Specific Analysis

Adobe Inc. (ADBE)
Non-GAAP Gross Margin: 88.6% in FY20.
Definition (from 10-K):
“Cost of subscription revenue consists of third-party hosting services and data center costs,
royalty fees and other expenses related to operating our network infrastructure, including
depreciation expense and operating lease payments associated with computer equipment,
salaries and related expenses of network operations, implementation, account management and
technical support personnel, amortization of certain intangible assets and allocated overhead.
Cost of product revenue is primarily comprised of third-party royalties, amortization related

to purchased intangibles and acquired rights to use technology, excess and obsolete inventory,
localization costs and the costs associated with the manufacturing of our products.
Cost of services and other revenue is primarily comprised of employee-related and other
associated costs incurred to provide consulting services, training and product support. Cost of
services and other also includes media costs related to impressions purchased from third-party ad
inventory sources for our transaction-based Adobe Advertising Cloud offerings, which we began
to discontinue in the second quarter of fiscal 2020.”
What drives gross margins:
• Mix-shift between subscription, product and services.

• Gross margins have trended higher as subscription has become a larger percentage of revenue.
• Change in hosting services and data center costs have driven much of the dollar increase in
cost of revenue over the last several years.
• Product revenue includes third party royalties, which has declined as product has become a
lower percentage of revenue.
• Cost of services is largely comprised of employee related expenses, with declines in media
costs and compensation related to headcount driving improvements.
October 27, 2021 10

Exhibit 7 - ADBE Non-GAAP Gross Margin, 2015-2020

Exhibit 7 shows ADBE’s non-
GAAP gross margins since
FY15.
.
Exhibit 8 - ADBE Revenue Breakdown, 2015-2020

Exhibit 8 shows ADBE’s mix
between subscription, product
and services since FY15.
.
October 27, 2021 11

Autodesk, Inc. (ADSK)

“Cost of subscription and maintenance revenue includes the labor costs of providing product
support to our subscription and maintenance customers, including SaaS vendor costs and
allocated IT costs, facilities costs, professional services fees related to operating our network and
cloud infrastructure, royalties, depreciation expense and operating lease payments associated
with computer equipment, data center costs, salaries, related expenses of network operations,
stock-based compensation expense, and gains and losses on our operating expense cash flow
hedges.
Cost of other revenue includes labor costs associated with product setup, costs of consulting and
training services contracts, and collaborative project management services contracts. Cost of
other revenue also includes stock-based compensation expense, overhead charges, allocated IT
and facilities costs, professional services fees, and gains and losses on our operating expense
cash flow hedges.”
• Mix-shift between maintenance, subscription, license and other has driven an increase in gross
margins.
• Labor costs and hosting costs for cloud offerings are the largest drivers beyond mix.
• Consulting costs, amortization of developed technology, new customer support offerings,
license royalties, stock-based compensation and operating expense cash flow hedges gains
and losses also impact gross margin dollars.
October 27, 2021 12

Exhibit 9 - ADSK Non-GAAP Gross Margin by Segment, 2016-2021

Exhibit 9 shows ADSK’s non-
GAAP total and by segment
gross margins since FY16.
.
Exhibit 10 - ADSK Revenue Breakdown, 2016-2021

Exhibit 10 shows ADSK’s mix
between maintenance and
subscription and license and
other revenue since FY16.
.
October 27, 2021 13

Akamai Technologies, Inc. (AKAM)

Non-GAAP Gross Margin: 65.4% in 2020
Definition (from 10-K): Below we provide AKAM's cost of revenue definition as stated in the
company's 10-K. AKAM provides a detailed breakdown of all components of cost of revenue
(exhibit 11), a rare disclosure among companies in our extended universe. Our calculation of
Akamai's Non-GAAP Gross Margins excludes only SBC although we note that the company's
published reconciliation to Non-GAAP "Cash cost of revenue" also excludes related Depreciation
and amortization.
"Cost of revenue consists primarily of fees paid to network providers for bandwidth and to third-
party network data centers for housing servers, also known as co-location costs. Cost of revenue
also includes employee costs for services delivery and network operation, build-out and support
of the Company's network; network storage costs; cost of software licenses; depreciation of
network equipment used to deliver the Company’s services; amortization of network-related
internal-use software; and costs for the production of live events streamed by the Company for
customers. The Company enters into contracts for bandwidth with third-party network providers
with terms typically ranging from several months to five years. These contracts generally commit
the Company to pay minimum monthly fees plus additional fees for bandwidth usage above
the committed level. In some circumstances, internet service providers (“ISPs”) make rack space
available for the Company to locate its servers and provide access to their bandwidth at a
discount or no cost. Although the Company does not provide any goods or services to the ISPs
or the ISPs’ customers under these arrangements, the ISPs and their customers indirectly benefit
by accessing content through a local Company server, resulting in better content delivery. The
Company records the cost of these vendor relationships at their negotiated transaction price,
which is either at a discount or no cost."
Exhibit 11 - AKAM Cost of Revenue Breakdown, 2016-2020

Exhibit 11 shows a breakdown
of the components of AKAM's
cost of revenue from 2016 to
2020.
.
Source: Company reports
October 27, 2021 14

What's included: Bandwidth, co-location, network, employees, network depreciation, and

amortization of software.
What's not included: Amortization of acquired intangibles is not included in GAAP cost of
revenue. That said, amortization of acquired intangibles is typically excluded from Non-GAAP
cost of revenues.
Drivers of gross margins:
• Network efficiencies.
• Pricing. Generally, we expect pricing compression of 15%-20% per year.
• Capital expenditures. Gross margins tend to be lower following years of more aggressive CapEx
investments due to greater depreciation of network equipment.
• Revenue mix. AKAM's security business has substantially higher gross margins relative to its
CDN business, roughly 20 points higher (on a cash gross margin basis) as disclosed at the
company's recent investor summit. We also believe performance is actually the highest gross
margin segment (well above media delivery). Additionally, we believe that the company's
faster growing Edge Applications (a sub-segment of the CDN business) have higher gross
margins as well.
• Traffic mix. Some types of traffic (e.g. live video vs. static video) have higher gross margin.
• Customer mix-shift. Web division customers have higher gross margins than Media and Carrier
Division customers.
Exhibit 12 - AKAM Non-GAAP Gross Margins 2016-2020

Exhibit 12 shows AKAM's non-
2016. As seen, gross margins
reached a high in 2019 and
declined in 2020, likely due to
the acceleration in the media
delivery business.
.
October 27, 2021 15

Exhibit 13 - AKAM Cash Gross Margins by Customer Division, 2017

Exhibit 13 compares cash
gross margins for the
company's Media and Web
divisions as disclosed in 2017.
We note that cash gross
margins excludes network-
related depreciation. While
we do not use cash gross
margins when analyzing
AKAM, we believe the
directional color is useful.
.
Exhibit 14 - AKAM Revenue Breakdown, 2016-2020

of the Media and Web
divisions as a percentage of
revenue. We expect Web
to return to growth as a
percent of total revenue as
COVID tailwinds fade which
should favorably benefit gross
margins.
.
October 27, 2021 16

Altair Engineering Inc. (ALTR)

“Cost of software revenue consists of expenses related to software licensing, hardware sales and
customer support. Significant expenses include employee compensation and related costs for
support team members, including salaries, benefits, bonuses and stock-based compensation, as
well as hardware costs, travel costs, certain data center and facility costs and royalties for third-
party software products available to customers through our products or as part of our APA.
Cost of software related services revenue consists of personnel and related costs, such as salaries,
benefits, bonuses and stock-based compensation, as well as travel expenses and certain data
center and facility costs.
Cost of engineering services revenue consists primarily of employee compensation and related
costs. We employ and pay them only for the duration of the placement at a customer site.
Cost of other revenue includes the cost of LED lighting products and freight related to products
sold to retail and commercial sales channels.”
• Mix-shift between software, software related services, CES and innovation.

• Software increasing as a percentage of revenue with software at 83.4% of revenue in FY20 vs.
69.9% in FY15, which has driven gross margin to 74.7% from 66.3% over the same period.
• Software gross margin has benefited recently from a reduction in travel expense and a
decrease in hardware costs related to service revenue, offset by increases in employee
compensation and stock-based compensation expense.
• Software related services gross margin has recently benefited from a reduction in travel related
expense.
• CES gross margin has recently benefited from employee related expense.
October 27, 2021 17

Exhibit 15 - ALTR Non-GAAP Gross Margin, 2015-2020

Exhibit 15 shows ALTR’s non-
FY15.
.
Exhibit 16 - ALTR Gross Margin by Segment, 2015-2020

Exhibit 16 shows ALTR’s total
and by segment gross margin
since FY15.
.
October 27, 2021 18

Exhibit 17 - ALTR Revenue by Segment, 2015-2020

Exhibit 17 shows ALTR’s mix
between software, software
and related services, CES
and innovation revenue
since FY15maintenance and
subscription and license and
other revenue since FY15.
.
ANSYS, Inc. (ANSS)

“Cost of sales consists of software licenses, amortization as well as maintenance and services.”
• Mix-shift between software licenses and maintenance and services.

• Software license has recently been impacted by increased third-party royalties.
• Gross margin has recently been impacted by an increase in amortization due to newly acquired
intangible assets.
• Maintenance and services have recently been impacted by increased employee-related
expenses, third-party technical support and increased stock-based compensation offset by
decreased employee travel.
October 27, 2021 19

Exhibit 18 - ANSS Non-GAAP Gross Margin, 2016-2020

Exhibit 18 shows ANSS’ non-
FY16.
.
Exhibit 19 - ANSS Gross Margin by Segment, 2016-2020

Exhibit 19 shows ANSS’ total
since FY16.
.
October 27, 2021 20

Exhibit 20 - ANSS Revenue by Segment, 2016-2020

Exhibit 20 shows ANSS’ mix
between software licenses
and maintenance and services
revenue since FY16.
.
Asana, Inc. (ASAN)

Non-GAAP Gross Margin: 87.5% in FY21
"Cost of revenues consists primarily of the cost of providing our platform to free users and
paying customers and is comprised of third-party hosting fees, personnel-related expenses for
our operations and support personnel, credit card processing fees, and amortization of our
capitalized internal-use software costs.
As we acquire new customers and existing customers increase their use of our cloud-based
platform, we expect that our cost of revenues will continue to increase in dollar amount."
What's included: Hosting costs (for both free and paid users), personnel, credit card processing
fees, amortization.
What's not included: N/A
• Revenue mix. ASAN has an "immaterial" professional services mix, which serves as a natural
tailwind to gross margins.
• Free users. The greater the free users, the higher the drag on gross margins, since there is
effectively zero revenue associated with free users.
• Network efficiency.
October 27, 2021 21

Exhibit 21 - ASAN Non-GAAP Gross Margins, FY19A-FY21A

Exhibit 21 shows ASAN's non-
GAAP gross margins FY19A.
Gross margins have continued
to improve off an already
high base, likely as a result of
success upmarket.
.
Alteryx Inc. (AYX) — Non-Covered

"Cost of revenue consists primarily of employee-related costs, including salaries and bonuses,
stock-based compensation expense, and employee benefit costs associated with our customer
support and professional services organizations. It also includes expenses related to hosting and
operating our cloud infrastructure in a third-party data center, licenses of third-party syndicated
data, amortization and impairment of intangible assets, and related overhead expenses. The
majority of our cost of revenue does not fluctuate directly with increases in revenue.
We allocate shared overhead costs such as information technology infrastructure, rent, and
occupancy charges in each expense category based on headcount in that category. As such,
certain general overhead expenses are reflected in cost of revenue.
We intend to continue to invest additional resources in our cloud infrastructure. We expect that
the cost of third-party data center hosting fees will increase over time as we continue to expand
our cloud-based offering."
What's included: Employees, SBC, hosting and cloud infrastructure, overhead expenses.
What's not included: AYX does not explicitly state whether costs related to free trials are included
in cost of revenue or sales and marketing.
• Revenue mix of license vs. PCS/services. Because AYX is on-premise, a portion of TCV
is allocated to either subscription-based software license (recognized upfront), PCS (post-
contract support, which is ratable and similar to maintenance), or services (which is <5% of
revenue and recognized when delivered). As noted, the software license mix grew significantly
October 27, 2021 22

in 2019, before reverting in 2020 (which we believe is largely due to duration headwinds during
the pandemic).
• PCS vs. services mix. As the services mix decreases, the PCS/services gross margin profile will
improve, which is what we believe happened in 2020.
• Deployment. A vast majority of AYX is on-premise today, but if it began to offer a fully-managed
cloud offering, that could be a headwind to gross margins.
Exhibit 22 - AYX Non-GAAP Gross Margins, 2015-2020

Exhibit 22 shows AYX's non-
2016. AYX has high gross
margins owing to the low
services mix and the on-
premise deployment. We
also note that numbers for
2015-2017 are under ASC
605 and not comparable to
2018-2020, which are under
ASC 606 and have more
upfront revenue recognition.
.
October 27, 2021 23

Exhibit 23 - AYX Non-GAAP Gross Margin by Segment, 2018-2020

Exhibit 23 shows AYX's
gross margins within its two
segments: subscription-
based software and PCS and
services.
.
Exhibit 24 - AYX Revenue Mix by Segment, 2018-2020

Exhibit 24 shows the revenue
mix-shift between software
and services.
.
October 27, 2021 24

Couchbase, Inc. (BASE)

Definition (from Prospectus):
“Cost of subscription revenue primarily consists of personnel-related costs associated with

our customer support organization, including salaries, bonuses, benefits and stock-based
compensation, expenses associated with software and subscription services dedicated for use
by our customer support organization, third-party cloud infrastructure expenses, amortization of
costs associated with capitalized internal-use software related to Couchbase Cloud and allocated
overhead. There is no cost of revenue associated with our license revenue. We expect our cost of
subscription revenue to increase in absolute dollars as our subscription revenue increases and as
we continue to amortize capitalized internal-use software costs related to Couchbase Cloud.
Cost of services revenue primarily consists of personnel-related costs associated with our
professional services and training organization, including salaries, bonuses, benefits and stock-
based compensation, costs of contracted third-party partners for professional services, expenses
associated with software and subscription services dedicated for use by our professional services
and training organization, travel-related expenses and allocated overhead. We expect our cost
of services revenue to increase in absolute dollars as our services revenue increases.”
• Mix-shift between subscription and services as new cloud offerings could drive gross margins
a bit lower.
• Gross margin is expected to decline modestly as new platform capabilities are introduced and
as geographic expansion continues.
Exhibit 25 - BASE Non-GAAP Gross Margin, 2019-2021

Exhibit 25 shows BASE’s non-
FY19.
.
October 27, 2021 25

Exhibit 26 - BASE Gross Margin by Segment, 2019-2021

Exhibit 26 shows BASE’s total
since FY19.
.
Exhibit 27 - BASE Revenue by Segment, 2019-2021

Exhibit 27 shows BASE’s mix
between subscription and
services revenue since FY19.
.
October 27, 2021 26

Blackbaud, Inc. (BLKB) — Not-Covered

"Cost of recurring revenue is primarily comprised of compensation costs for customer support
and production IT personnel, hosting and data center costs, third-party contractor expenses,
third-party royalty and data expenses, allocated depreciation, facilities and IT support costs,
amortization of intangible assets from business combinations, amortization of software
development costs, transaction-based costs related to payments services including remittances
of amounts due to third-parties and other costs incurred in providing support and recurring
services to our customers.
Cost of one-time services and other is primarily comprised of compensation costs for professional
services and onsite training personnel, other costs incurred in providing onsite customer training,
third-party contractor expenses, data expense incurred to perform one-time analytic services,
third-party software royalties, costs of user conferences, allocated depreciation, facilities and IT
support costs and amortization of intangible assets from business combinations."
What's included: Headcount, hosting, services, third-party contractor/royalty,data expenses,

transaction costs related to payments, costs of user conferences, depreciation and amortization.
• Revenue mix. Recurring is generally higher gross margin than services (although there are a
number of different items in recurring revenue), while services itself is lower gross margin,
although the services/other bucket includes perpetual license revenue (which is very small)
and is likely higher gross margin.
• Recurring revenue mix. Within the recurring revenue line, there are generally six different
buckets (we note "contractual recurring" revenue is 65% of total revenue and likely consists
of SaaS, maintenance, term licenses, and recurring services, payments is 25% of revenue, and
"other transactional" is 4% of revenue).
○ SaaS, which is high gross margin (although lower than on-premise deployments)
○ Transactional, which we believe is close to SaaS gross margins.
○ Payments, which is meaningfully lower gross margin, as BLKB recognizes payments revenue
on a gross basis, not a net basis.
○ On-premise maintenance revenue, which is high gross margin (we estimate mid-80s).
○ On-premise term licenses, likely a higher gross margin item.
○ Recurring services, likely lower gross margin.
• User conferences. BLKB curiously lists user conferences (which are now virtual) as a cost of
services line item, versus a sales and marketing expense, as is traditionally the case.
• Network efficiency. BLKB is migrating most of its hosting to Azure, while we believe it is still
paying some duplicative costs with its own co-located infrastructure.
October 27, 2021 27

Exhibit 28 - BLKB Non-GAAP Gross Margin by Segment, 2016-2020

Exhibit 28 shows BLKB's
gross margins by recurring
and services segments.
Subscription gross margins
have continued declining,
likely due to great payments
mix and the migration to
Azure.
.
Exhibit 29 - BLKB Revenue Mix by Segment, 2016-2020

Exhibit 29 shows BLKB's
revenue mix between its
recurring and services
segments.
.
October 27, 2021 28

Box, Inc. (BOX)

"Our cost of revenue consists primarily of costs related to providing our subscription services
to our paying customers, including employee compensation and related expenses for data
center operations, customer support and professional services personnel, payments to outside
technology service providers, depreciation of servers and equipment, security services and other
tools, as well as amortization expense associated with acquired technology and capitalized
internally developed software. We allocate overhead such as rent, information technology costs
and employee benefit costs to all departments based on headcount. As such, general overhead
expenses are reflected in cost of revenue and each of the operating expense categories set forth
below."
What's included: headcount, data center operations, support, payments to third-party

technology service providers, depreciation, depreciation and amortization, security services and
other tools, and general overhead expenses.
What's not included: The cost to support free users (including data center and customer
support). We believe this should be included in cost of revenues rather than sales and marketing.
• Network efficiency. BOX is increasingly relying on AWS instead of its own infrastructure and
had a time period of duplicative costs.
• Pricing. We believe BOX has faced pricing pressure over the past several years, which has
served as a headwind on gross margins.
• Product mix. We believe add-ons should be higher gross margin than core Box.
• Revenue mix. BOX has stated that its revenue is almost entirely subscription and professional
services represents ~4% of revenue (with 10%-20% gross margins), which creates a ~3% drag
on overall gross margins. The one caveat is BOX offers "premier services", which it considers
subscription and recognizes ratably.
October 27, 2021 29

Exhibit 30 - BOX Non-GAAP Gross Margins, FY16A-FY21A

Exhibit 30 shows Box's Non-
GAAP gross margins from
FY16A-FY21A.
.
Bentley Systems, Inc. (BSY)

Definition (from 10K):
“Cost of subscriptions and licenses includes salaries and other related costs, including the
depreciation of property and equipment and the amortization of capitalized software costs
associated with servicing software subscriptions, the amortization of intangible assets associated
with acquired software and technology, channel partner compensation for providing sales
coverage to subscribers, as well as cloud#related costs incurred for servicing our customers using
cloud deployed hosted solutions and those using our SELECT subscription offering.
Cost of services includes salaries for internal and third#party personnel and related overhead
costs, including depreciation of property and equipment, for providing training, implementation,
configuration, and customization services to customers, amortization of capitalized software
costs, and related out#of#pocket expenses incurred.”
• Mix-shift between subscription and licenses and services.

• Hosting and associated costs as cloud and SELECT subscriptions scale could drive margins
slightly lower.
October 27, 2021 30

Exhibit 31 - BSY Non-GAAP Gross Margin, 2018-2020

Exhibit 31 shows BSY’s non-
FY18.
.
Exhibit 32 - BSY Gross Margin by Segment, 2018-2020

Exhibit 32 shows BSY’s total
since FY18.
.
October 27, 2021 31

Exhibit 33 - BSY Revenue by Segment, 2018-2020

Exhibit 33 shows BSY’s mix
.
Check Point Software Technologies Ltd. (CHKP)

Definition (from 20-F):
“Cost of revenues includes cost of product and licenses, cost of security subscriptions and cost
of software updates and maintenance and amortization of technology. Our cost of products and
licenses includes mainly cost of software and hardware production, packaging and shipping. Our
cost of security subscriptions is comprised of costs paid to third parties, hosting and infrastructure
costs and cost of customer support related to these services. Our cost of software updates and
maintenance include mainly the cost of post-sale customer support.”
• Mix-shift between products and licenses, security subscriptions and software updates and
maintenance.
• Headcount related to customer support and professional services.
• Despite an evolving model, gross margins have remained stable over the last several years.
October 27, 2021 32

Exhibit 34 - CHKP Non-GAAP Gross Margin, 2015-2020

Exhibit 34 shows CHKP’s non-
FY15.
.
Exhibit 35 - CHKP Gross Margin by Segment; 2015-2020

Exhibit 35 shows CHKP’s total
since FY15.
.
October 27, 2021 33

Exhibit 36 - CHKP Revenue by Segment, 2015-2020

Exhibit 36 shows CHKP’s mix
.
Cloudera, Inc. (CLDR) — Not-Covered

Non-GAAP Gross Margin: 82.7% in FY21A
"Cost of revenue for subscriptions primarily consists of personnel costs including salaries,
bonuses, travel costs, benefits and stock-based compensation for employees providing technical
support for our subscription customers, allocated shared costs (including rent and information
technology) and amortization of certain acquired intangible assets from business combinations.
Cost of revenue for services primarily consists of personnel costs including salaries, bonuses,
benefits and stock-based compensation, fees to subcontractors associated with service contracts,
travel costs and allocated shared costs (including rent and information technology)."
What's included: Personnel, IT, depreciation and amortization, and fees to subcontractors
associated with service contracts.
• Revenue mix. As professional services have shrunk from nearly one-quarter of the business to
under 10%, overall gross margins have dramatically improved.
• Product mix. We believe CDP on-premise should be higher margin than the legacy Cloudera
platform.
• Pricing. Greater pricing pressure should serve as a drag on gross margins.
• Deployment. Most of CLDR is on-premise or self-managed, but CDP Public Cloud is expected
to be a drag on gross margins due to CLDR taking on hosting costs (although this will likely be
less of a margin hit than Atlas is for MDB).
October 27, 2021 34

Exhibit 37 - CLDR Non-GAAP Gross Margin by Segment, FY17A-FY21A

Exhibit 37 shows CLDR's
non-GAAP gross margins
from FY17-FY21. Overall
subscription gross margins
have improved from mix-
shift, while subscription gross
margins benefit from on-
premise deployments.
.
Exhibit 38 - CLDR Revenue Mix by Segment, FY17A-FY21A

Exhibit 38 shows CLDR's
revenue mix of subscription
vs. services.
.
October 27, 2021 35

Coupa Software, Inc. (COUP)

Subscription
"Cost of subscription consists primarily of expenses related to hosting our service and providing
customer support. Significant expenses are comprised of data center capacity costs; personnel
and related costs directly associated with our cloud infrastructure and customer support,
including salaries, benefits, bonuses and stock-based compensation; allocated overhead; and
amortization of acquired developed technology and capitalized software development costs."
Professional Services and Other Cost of Revenues

"Cost of professional services and other cost of revenues consist primarily of personnel and
related costs directly associated with our professional services and training departments,
including salaries, benefits, bonuses and stock-based compensation; the costs of contracted
third-party vendors, amortization of acquired developed technology; and allocated overhead.
These costs are generally expensed in the period incurred.
Professional services associated with the implementation and configuration of our subscription
platform are performed directly by our services team, as well as by contracted third-party
vendors. In cases in which third-party vendors invoice us for services performed for our customers,
those fees are accrued over the requisite service period."
What's included: Hosting, customer support, personnel, overhead, amortization, customer

support, cost of contracted third-party vendors.
• Revenue mix. COUP has a relatively high professional services mix (13% of revenue in FY21),
which serves as a drag on overall gross margins.
• M&A. COUP has been very acquisitive throughout its history and M&A tends to weigh on gross
margins, especially the most recent deal of LLamasoft.
• Coupa Pay. While Pay is likely small today, we believe it is a drag on gross margin and expect
a future drag as Pay grows.
October 27, 2021 36

Exhibit 39 - COUP Non-GAAP Gross Margin by Segment, FY16A-FY21A

Exhibit 39 shows COUP's non-
FY16-FY21. Gross margins
have declined over the past
few years, likely from mix-
shift and M&A. Margins will
also see pressure in the near-
term from the LLamasoft
acquisition.
.
Exhibit 40 - COUP Revenue Mix by Segment, FY15A-FY21A

Exhibit 40 shows COUP's
revenue mix of subscription
vs. services.
.
October 27, 2021 37

Coursera Inc (COUR)

Definition (from S-1):
"Cost of revenue consists of content costs in the form of fees paid to educator partners and
expenses associated with the operation of our platform. These expenses include the cost of
servicing both paid learner and educator partner support requests, hosting and bandwidth costs,
amortization of acquired technology and internal-use software, customer payment processing
fees, and allocated depreciation and facilities costs.
Content costs only apply to Consumer and Enterprise offerings; there is no content cost
attributable to our Degrees offering. Content costs as a percentage of revenue are lower for our
Enterprise offerings, due to a lower effective percentage payable to educator partners compared
with sales to Consumer customers. We expect Enterprise and Degrees to become a larger portion
of the overall business and as our mix changes the content cost will decrease as a percentage
of total revenue."
What's included: Content costs (Consumer and Enterprise segments), paid learner and educator
partner support, hosting/bandwidth costs, depreciation and amortization, and customer
payment processing.
What's not included: The cost to support unpaid learners. We believe this should be included in
cost of revenues rather than sales and marketing.
• Revenue mix. Consumer is the lowest gross margin business (55% in 2020), while Enterprise is
higher gross margin (~70%) and Degrees is 100% gross margin. As the mix skews more heavily
towards Enterprise and Degrees, we should see overall gross margins improve towards the
75%+ long-term target.
• Content costs and product mix. Content is the biggest cost associated with Consumer and
Enterprise and the type of content makes a difference. In 2Q, a higher mix of higher margin
Professional Certificate courses led to consumer gross margins improving ~1,200 bps Y/Y.
• Network efficiency. Generally, the traditional software costs are unallocated, but have been
around 10% of revenue.
October 27, 2021 38

Exhibit 41 - COUR Non-GAAP Gross Margin by Segment, 2017-2020

Exhibit 41 shows COUR's
Non-GAAP gross margins by
segment from 2017-2020.
Overall gross margins have
improved as a result of mix-
shift and we expect margins to
continue to improve.
.
Exhibit 42 - COUR Revenue Mix by Segment, 2017-2020

Exhibit 42 shows COUR's
revenue mix of its segments
from 2017-2020.
.
October 27, 2021 39

salesforce.com, inc. (CRM)

"Cost of subscription and support revenues primarily consists of expenses related to delivering
our service and providing support, including the costs of data center capacity, certain fees paid
to various third parties for the use of their technology, services and data and employee-related
costs such as salaries and benefits.
Cost of professional services and other revenues consists primarily of employee-related costs
associated with these services, including stock-based expenses, the cost of subcontractors and
certain third-party fees. We expect the cost of professional services to be approximately in line
with revenues from professional services in future fiscal periods. We believe that this investment
in professional services facilitates the adoption of our service offerings."
What's included: Hosting, royalties, personnel.
• Revenue mix. Professional services is generally a low part of the overall mix, but CRM also
is generally only breakeven on services, which serves as a meaningful drag to overall gross
margins.
• M&A. CRM has been rather acquisitive and generally, we believe deals weigh on gross margins.
• Deployment. Some of CRM's acquired businesses (namely Tableau) have a meaningful on-
premise component, which likely has higher gross margins than SaaS.
Exhibit 43 - CRM Non-GAAP Gross Margin by Segment, FY17A-FY21A

Exhibit 43 shows CRM's Non-
GAAP gross margins by line
item from FY16-FY20. Gross
margins have fallen slightly,
likely as a result of M&A.
.
October 27, 2021 40

Exhibit 44 - CRM Revenue Mix by Segment, FY17A-FY21A

Exhibit 44 shows CRM's
revenue mix by line item since
FY16.
.
CrowdStrike Holdings, Inc. (CRWD)

“Subscription cost of revenue consists primarily of costs related to hosting our cloud-based Falcon
platform in data centers, amortization of our capitalized internal-use software, employee-related
costs such as salaries and bonuses, stock-based compensation expense, benefits costs associated
with our operations and support personnel, software license fees, property and equipment
depreciation, amortization of acquired intangibles, and an allocated portion of facilities and
administrative costs.
Professional services cost of revenue consists primarily of employee-related costs, such as

salaries and bonuses, stock-based compensation expense, technology, property and equipment
depreciation, and an allocated portion of facilities and administrative costs.”
• Mix-shift between subscription and services.

• Greater hosting costs with an increasing numbers of new customers, new cloud modules and
additional data storage.
• The company plans to continue to invest in headcount and the cloud platform as business
scales.
• Overall breach levels drive incident response services.
• Though services has lower gross margin, it is a good lead generator for subscriptions.
October 27, 2021 41

Exhibit 45 - CRWD Non-GAAP Gross Margin, 2018-2021

Exhibit 45 shows CRWD’s non-
FY18.
.
Exhibit 46 - CRWD Gross Margin by Segment, 2018-2021

Exhibit 46 shows CRWD’s total
since FY18.
.
October 27, 2021 42

Exhibit 47 - CRWD Rvenue by Segment, 2018-2021

Exhibit 47 shows CRWD’s mix
.
Cornerstone OnDemand, Inc. (CSOD) — Not-Covered

"Cost of revenue consists primarily of costs related to hosting the Company’s products and
delivery of professional services, and includes the following:
• Personnel and related expenses, including stock-based compensation;

• Expenses for network-related infrastructure and IT support;
• Delivery of contracted professional services and ongoing customer support and customer
success initiatives;
• Payments to external service providers contracted to perform implementation services;
• Depreciation of data centers, and amortization of: capitalized software costs, developed
technology software license rights, and technology-related intangible assets from acquisitions;
and
• Content and licensing fees, and referral fees.
In addition, the Company allocates a portion of overhead, such as rent, IT costs, depreciation and
amortization, and employee benefits costs, to cost of revenue based on headcount. The costs
associated with providing professional services are recognized as incurred when the services are
performed. Out-of-pocket travel costs related to the delivery of professional services are typically
reimbursed by the customer and are accounted for as cost of revenue in the period in which the
cost is incurred."
What's included: Headcount, infrastructure, licensing fees, depreciation and amortization.
October 27, 2021 43

• Revenue mix. CSOD has been deliberately shrinking its professional services practice and,
as a result, seen subscription grow to 95%+ of revenue, up from ~80% in 2016. We believe
subscription (which does include "recurring services") is higher gross margin than professional
services.
• M&A. CSOD made a major acquisition with Saba software, which likely served as a drag on
gross margins.
• Product mix. Some products likely have a lower gross margin profile, such as content (which
comes with royalties).
Exhibit 48 - CSOD Non-GAAP Gross Margins, 2016-2020

Exhibit 48 shows CSOD's non-
2016-2020. Margins declined
in 2020, likely as a result of
the Saba acquisition.
.
Exhibit 49 - CSOD Revenue Mix by Segment, 2016-2020

Exhibit 49 shows CSOD's
revenue mix by line item from
2016-2020.
.
October 27, 2021 44

Citrix Systems, Inc. (CTXS)

“Cost of subscription, support and services revenues consists primarily of compensation and other
personnel-related costs of providing technical support, consulting and cloud capacity costs, as
well as the costs related to providing our offerings delivered via the cloud and hardware costs
related to certain on-premise subscription offerings. Cost of product and license revenues consists
primarily of hardware, shipping expense, royalties, product media and duplication, manuals and
packaging materials. Also included in cost of net revenues is amortization and impairment of
product related intangible assets.”
• Mix-shift between subscription, support and services and product and license revenue.
• Cost of product and license revenue includes hardware.
• Additional SaaS offerings could drive gross margins slightly lower.
Exhibit 50 - CTXS Non-GAAP Gross Margin, 2017-2020
Exhibit 50 shows CTXS’ non-
FY17.
.
October 27, 2021 45

Exhibit 51 shows CTXS’ total Exhibit 51 - CTXS Gross Margin by Segment, 2017-2020
since FY17.
.
Exhibit 52 - CTXS Revenue by Segment, 2017-2020

Exhibit 52 shows CTXS’ mix
.
October 27, 2021 46

CommVault Systems, Inc. (CVLT)

“Cost of Software and Products Revenue, consists primarily of the cost of appliance hardware,
third-party royalties and other costs such as media, manuals, translation and distribution costs;
and
Cost of Services Revenue, consists primarily of salary and employee benefit costs in providing
customer support and other professional services as well as third party hosting fees.”
• Mix-shift between software and services.

• Lower cost of sales associated with appliances.
• Transition to a software-only model with introduction of HyperScale X.
• Overall though, gross margins have remained relatively stable.
Exhibit 53 - CVLT Non-GAAP Gross Margin, 2018-2021

Exhibit 53 shows CVLT’s non-
FY18.
.
October 27, 2021 47

Exhibit 54 - CVLT Gross Margin by Segment, 2018-2021

Exhibit 54 shows CVLT’s total
since FY18.
.
Exhibit 55 - CVLT Revenue by Segment, 2018-2021

Exhibit 55 shows CVLT’s
mix between software and
.
October 27, 2021 48

Clearwater Analytics Holdings Inc. (CWAN)

"Cost of revenue consists of expenses related to delivery of revenue-generating services, including

expenses associated with client services, onboarding, reconciliation and agreements related
to the purchase of data used in the provision of our services. Salary and benefits for certain
personnel associated with supporting these functions, in addition to allocated overhead and
depreciation for facilities, are also included in cost of revenue."
What's included: Infrastructure, headcount, third party data.
• AUM on platform. Growth of AUM that customers use on Clearwater's platform is the principal
driver and the company benefits from scale efficiencies as AUM grows. Additionally, more
complex or unique assets can have incremental costs related to personnel and third party data
services.
• Client services. Clearwater has a large client services organization which can benefit from scale
efficiencies (larger clients) or be negatively impacted if the client count of smaller investment
organizations grows substantially.
• Third party data services. Asset pricing relies on data from third party services. We believe
that this is a largely fixed cost (specific assets do not need to be repriced for multiple clients).
• Services mix. Clearwater does not disclose costs related to implementation/onboarding. We
expect that this is small as a percentage of revenue and expect mix to decrease due to scale
and continued efficiencies in the onboarding process.
Exhibit 56 - CWAN Non-GAAP Gross Margins, 2019A-2020A and 1H21A

Exhibit 56 shows CWAN's
Non-GAAP Gross Margins for
2019A-2020A and 1H21A.
.
October 27, 2021 49

Dropbox, Inc. (DBX)

"Our cost of revenue consists primarily of expenses associated with the storage, delivery, and
distribution of our platform for both paying users and free users, also known as Basic users.
These costs, which we refer to as infrastructure costs, include depreciation of our servers
located in co-location facilities that we lease and operate, rent and facilities expense for those
datacenters, network and bandwidth costs, support and maintenance costs for our infrastructure
equipment, and payments to third-party datacenter service providers. Cost of revenue also
includes costs, such as salaries, bonuses, employer payroll taxes and benefits, travel-related
expenses, and stock-based compensation, which we refer to as employee-related costs, for
employees whose primary responsibilities relate to supporting our infrastructure and delivering
user support. Other non-employee costs included in cost of revenue include credit card fees
related to processing customer transactions, and allocated overhead, such as facilities, including
rent, utilities, depreciation on leasehold improvements and other equipment shared by all
departments, and shared information technology costs. In addition, cost of revenue includes
amortization of developed technologies, professional fees related to user support initiatives, and
property taxes related to the datacenters.
We plan to continue increasing the capacity and enhancing the capability and reliability of our
infrastructure to support user growth and increased use of our platform. We expect that cost of
revenue will increase in absolute dollars in future periods."
What's included: Infrastructure, headcount, payment processing, cost to support free users.
• Infrastructure efficiency. DBX runs its own infrastructure and moved almost entirely off AWS,
which led to gross margins improving from 33% in 2015 (when DBX was paying duplicative
costs) to nearly 80% (we note non-GAAP gross margins are above 80% in 1H21).
• Free users. Only ~2.3% of DBX users are paid users and DBX puts the cost associated with free
users as a cost of revenue line item (a stance we agree with).
• Product mix. DBX likely sees higher gross margins on premium SKUs, as well as with add-ons
like HelloSign.
October 27, 2021 50

Exhibit 57 - DBX Non-GAAP Gross Margins, 2015-2020

Exhibit 57 shows DBX's Non-
2015. Gross margins have
improved dramatically singe
migrating off AWS (and
stopping the duplicative costs)
and are now near 80%, in
spite of the large free user
base.
.
Duck Creek Technologies, Inc. (DCT)

Non-GAAP Gross Margin: 59.1% in FY20A; 61.2% in FY21E
"Our cost of revenue has fixed and variable components and depends on the type of revenue
earned in each period. Cost of revenue includes amortization expense associated with acquired
technology and other operating expenses directly related to the cost of products and services,
including depreciation expense. We expect our cost of revenue to increase in absolute dollars
as we continue to hire personnel, to provide hosting services, technical support and consulting
services to our growing customer base.
Cost of Subscriptions
Our cost of subscription revenue is primarily comprised of cloud infrastructure costs, royalty
fees paid to third parties, amortization of acquired technology intangible assets and personnel-
related expenses for our SaaS operations teams, including salaries and other direct personnel-
related costs.
Cost of Licenses
Our cost of license revenue is primarily comprised of royalty fees paid to third parties and
amortization of acquired technology intangible assets.
Cost of Maintenance and Support
Our cost of maintenance and support revenue is comprised of personnel-related expenses for
our technical support team, including salaries and other direct personnel-related costs. While
we expect the cost of maintenance and support revenue will increase in the near term, it may
decrease in the future if we successfully transition our term and perpetual license customers to
our SaaS solutions.
October 27, 2021 51

Cost of Professional Services
Our cost of professional services revenue is primarily comprised of personnel-related expenses

for our professional service employees and contractors, including salaries and other direct
personnel-related costs."
What's included: Infrastructure, royalties, amortization, personnel
• Cloud transition. DCT is undergoing a cloud transition and as SaaS has grown from 21% of
revenue to nearly 50% this year, overall gross margins have declined, since SaaS is lower gross
margin than both license and maintenance.
• Cloud scale and maturity. As the cloud transition plays out, DCT is also seeing meaningful
subscription gross margin expansion, driven by scale, maturity of the platform, and accounting.
In addition, as DCT sees more multi-tenancy, that should serve as a tailwind to gross margins.
• Architecture. DCT's subscription business is primarily single-tenant cloud, which is lower gross
margin than multi-tenant.
• Services mix. DCT has one of the highest services mixes in software, which is understandable
given the level of customization needed, as well as the fact that DCT was spun out of Accenture.
We expect the services mix to decline as more professional services are offloaded onto the
partner ecosystem, as well as SaaS having a lower professional services attach rate.
• Services philosophy. DCT also has the highest services gross margins we've seen in software
(in fact, DCT has higher services gross margins than ACN's overall gross margins). We expect
services gross margins to remain 40%+, which means the drag from the services mix is less
severe than if services was lossmaking.
Exhibit 58 - DCT Non-GAAP Gross Margin by Segment, FY17A-FY21E

Exhibit 58 shows DCT's Non-
item from FY17A-FY21E. While
overall gross margins have
declined from mix-shift to
SaaS, SaaS gross margins
have improved ~900 bps
over the past few years from
infrastructure efficiency and
scale.
.
October 27, 2021 52

Exhibit 59 - DCT Revenue Mix by Segment, FY17A-FY21E

Exhibit 59 shows DCT's
FY17A-FY21E.
.
Datadog Inc (DDOG)

“Cost of revenue primarily consists of expenses related to providing our products to customers,
including payments to our third-party cloud infrastructure providers for hosting our software,
personnel-related expenses for operations and global support, including salaries, benefits,
bonuses and stock-based compensation, payment processing fees, information technology,
depreciation and amortization related to the amortization of acquired intangibles and internal-
use software and other overhead costs such as allocated facilities.”
• With one revenue line item, gross margin may fluctuate over time due to the amount and
timing of investments to expand products and geographic coverage.
• With scale, we expect gross margins to improve slightly.
October 27, 2021 53

Exhibit 60 - DDOG Non-GAAP Gross Margin

Exhibit 60 shows DDOG’s non-
FY17.
.
DocuSign, Inc. (DOCU)

Non-GAAP Gross Margin: 79.0% in FY21A
"Cost of Subscription Revenue
Cost of subscription revenue primarily consists of expenses related to hosting our software suite
and providing support. These expenses consist of employee-related costs, including salaries,
bonuses, benefits, stock-based compensation and other related costs, as well as personnel costs
for employees associated with our technical infrastructure, customer success and customer
support. These expenses also consist of software and maintenance costs, third-party hosting fees,
outside services associated with the delivery of our subscription services, amortization expense
associated with capitalized internal-use software and acquired intangible assets, credit card
processing fees and allocated overhead costs.
Cost of Professional Services and Other Revenue
Cost of professional services and other revenue consists primarily of personnel costs for our
professional services delivery team, travel-related costs and allocated overhead costs."
What's included: Headcount, hosting, infrastructure, depreciation and amortization, payment

fees.
What's not included: DOCU does not explicitly state whether costs related to free trials are
included in cost of revenue or sales and marketing.
October 27, 2021 54

• Revenue mix. DOCU has one of the highest subscription mixes in software and that has only
grown over the past few years to 95%+ of revenue. We attribute this to DOCU's pre-built
integrations and ease of use.
• Services philosophy. DOCU treats professional services as a loss maker, which serves as a drag
on overall gross margin, in spite of best-in-class subscription gross margins.
• Product mix. We believe CLM is a lower gross margin product, which does drag down overall
subscription gross margins as it becomes a bigger portion of the business.
• Network efficiency. DOCU mostly owns its own infrastructure, which aids gross margins.
• Geography. In many smaller geographies, DOCU uses third-party infrastructure (mainly Azure),
which could slightly depress gross margins.
Exhibit 61 - DOCU Non-GAAP Gross Margin by Segment, FY17A-FY21A

Exhibit 61 shows DOCU's Non-
item from FY17A-FY21A. Gross
margins remain high, although
weighed down by the loss-
making services business (we
also believe CLM is a slight
headwind to gross margins).
.
Exhibit 62 - DOCU Revenue Mix by Segment, FY17A-FY21A

Exhibit 62 shows DOCU's
FY17A-FY21A
.
October 27, 2021 55

Dynatrace, Inc. (DT)

“Cost of subscription revenue includes all direct costs to deliver and support our subscription
products, including salaries, benefits, share-based compensation and related expenses such as
employer taxes, allocated overhead for facilities, IT, third-party hosting fees related to our cloud
services, and amortization of internally developed capitalized software technology. We recognize
these expenses as they are incurred.
Cost of service. Cost of service revenue includes salaries, benefits, share-based compensation and
related expenses such as employer taxes for our services organization, allocated overhead for
depreciation of equipment, facilities and IT. We recognize these expenses as they are incurred.”
• Mix-shift between classic license, subscription and professional services has driven gross
margins higher over the past few years.
• Hosting and associated cloud service costs.
• Headcount in cost of services.
Exhibit 63 - DT Non-GAAP Gross Margin, 2018-2021
Exhibit 63 shows DT’s non-
FY18.
.
October 27, 2021 56

Exhibit 64 - DT Gross Margin by Segment, 2018-2021

Exhibit 64 shows DT’s total
since FY18.
.
Exhibit 65 - DT Revenue by Segment, 2018-2021

Exhibit 65 shows DT’s mix
.
October 27, 2021 57

DoubleVerify Holdings, Inc. (DV)

"Cost of revenue primarily consists of platform hosting fees, data center costs, software and other
technology expenses, and other costs directly associated with data infrastructure; personnel
costs, including salaries, bonuses, stock-based compensation and benefits, directly associated
with the support and delivery of our software platform and data solutions; and costs from
revenue-sharing arrangements with our partners.”
• Mix of advertiser direct and advertiser programmatic revenue.

• Partner costs.
• Revenue-sharing arrangements.
• Higher software and technology costs around increased volumes.
Exhibit 66 - DV Non-GAAP Gross Margin, 2018-2020

Exhibit 66 shows DV’s non-
FY18.
.
Exhibit 67 - DV Revenue by Segment, 2018-2020

Exhibit 67 shows DV’s mix
between advertiser direct,
advertiser programmatic and
supply-side revenue since
FY18.
.
October 27, 2021 58

Elastic NV (ESTC)
“Cost of subscription – self-managed and SaaS consists primarily of personnel and related costs
for employees associated with supporting our subscription arrangements, certain third-party
expenses, and amortization of certain intangible and other assets. Personnel and related costs,
or personnel costs, comprise cash compensation, benefits and stock-based compensation to
employees, costs of third-party contractors, and allocated overhead costs. Third-party expenses
consist of cloud hosting costs and other expenses directly associated with our customer support.
We expect our cost of subscription – self-managed and SaaS to increase in absolute dollars as
our subscription revenue increases.
Cost of professional services revenue consists primarily of personnel costs directly associated
with delivery of training, implementation and other professional services, costs of third-
party contractors, facility rental charges and allocated overhead costs. We expect our cost of
professional services revenue to increase in absolute dollars as we invest in our business and as
professional services revenue increases.”
• Mix-shift between subscription and services.

• Timing of new customers and renewal of existing customers.
• Hosted services mix which could pressure gross margins slightly on ramping SaaS sales.
• Transaction and support case volume.
Exhibit 68 - ESTC Non-GAAP Gross Margin, 2017-2021

Exhibit 68 shows ESTC’s non-
FY17.
.
October 27, 2021 59

Exhibit 69 - ESTC Gross Margin by Segment, 2017-2021

Exhibit 69 shows ESTC’s total
since FY17.
.
Exhibit 70 - ESTC Revenue by Segment

Exhibit 70 shows ESTC’s mix
.
October 27, 2021 60

EverCommerce, Inc. (EVCM)

“Cost of revenue (exclusive of depreciation and amortization) consists primarily of employee

costs for our customer success teams, media expense related to our lead generation solutions,
campaign mail expense, contract services, hosting costs, partnership costs and promotional
costs.”
• Mix-shift between subscription and transaction fees and marketing technology solutions.
• Timing of size of acquisitions.
Exhibit 71 - EVCM Non-GAAP Gross Margin, 2019-2020
Exhibit 71 shows EVCM’s non-
FY19.
.
Exhibit 72 - EVCM Revenue by Segment, 2019-2020

Exhibit 72 shows EVCM’s mix
transaction fees, marketing
technology solutions and
other since FY19.
.
October 27, 2021 61

F5 Networks, Inc. (FFIV)

“Cost of net product revenues consist of finished products purchased from our contract
manufacturers, manufacturing overhead, freight, warranty, provisions for excess and obsolete
inventory and amortization expenses in connection with developed technology from acquisitions.
Cost of Net Service Revenues. Cost of net service revenues consist of the salaries and related
benefits of our professional services staff, travel, facilities and depreciation expenses.”
• Mix-shift between product and services as gross margins could improve over time with less
hardware and more software.
• Hardware costs paid to contract manufacturers.
• Third party software license fees.
• Software-as-a-service infrastructure costs.
• Services headcount.
Exhibit 73 - FFIV Non-GAAP Gross Margin, 2015-2020

Exhibit 73 shows FFIV’s non-
FY15.
.
October 27, 2021 62

Exhibit 74 - FFIV Gross Margin by Segment, 2015-2020

Exhibit 74 shows FFIV’s total
since FY15.
.
Exhibit 75 - FFIV Revenue by Segment

Exhibit 75 shows FFIV’s mix
between product and services
revenue since FY15.
.
October 27, 2021 63

Fastly, Inc. (FSLY)

Non-GAAP Gross Margin: 60.9% in 2020, 58.9% in 1H21.
Definition (from 10-K): "Cost of revenue consists primarily of fees paid for bandwidth, peering,
and colocation. Cost of revenue also includes personnel costs, such as salaries, benefits, bonuses,
and stock-based compensation for our customer support and infrastructure employees, and
non-personnel costs, such as amortization of capitalized internal-use software development
costs, depreciation of our network equipment and amortization of our intangible assets. Our
arrangements with network service providers require us to pay fees based on bandwidth use, in
some cases subject to minimum commitments, which may be underutilized. We expect our cost
of revenue to continue to increase on an absolute basis and may increase as a percentage of
revenue."
What's included: Bandwidth, peering, colocation, headcount, depreciation and amortization.
• Network efficiency. FSLY is a capital intensive business and, as such, will have structurally lower
gross margins than most SaaS businesses. If FSLY can better utilize its network, that should be
a tailwind to gross margins.
• Capital intensity. Because D&A is (rightfully) on the COGS line, years following heavy capital
investment will yield lower gross margins.
• Pricing. CDN faces pricing headwinds of ~15%-20% per year, which impacts gross margins,
especially in leaner years.
• Customer concentration. FSLY has high customer concentration (top five customers are ~25%
of revenue) and higher customer concentration typically leads to lower pricing.
• Product mix. While FSLY does not break out mix between CDN, edge, and security, we believe
an increasing mix-shift towards edge and security should aid gross margins.
Exhibit 76 - FSLY Non-GAAP Gross Margins, 2016-2020 and 1H21

Exhibit 76 shows FSLY's Non-
2016-2020 and 1H21. As
seen, gross margins have
improved meaningfully from
the bottom, but are reverting
back below 60% this year, with
lower growh rates.
.
October 27, 2021 64

Fortinet, Inc. (FTNT)

“Cost of product revenue. The majority of the cost of product revenue consists of third-party
contract manufacturers’ costs and the costs of materials used in production. Our cost of product
revenue also includes supplies, shipping costs, personnel costs associated with logistics and
quality control, facility-related costs, excess and obsolete inventory costs, warranty costs and
amortization of intangible assets. Personnel costs include direct compensation and benefits.
Cost of service revenue is primarily comprised of salaries, benefits and bonuses, as well as
stock-based compensation. Cost of service revenue also includes third-party repair and contract
fulfillment, data center and cloud hosting, supplies and facility-related costs.”
• Mix of hardware product and software license as gross margins could improve over time with
less hardware and more software.
• Direct and indirect product.
• Services impacted from renewals and subscription growth.
Exhibit 77 - FTNT Non-GAAP Gross Margin, 2015-2020
Exhibit 77 shows FTNT’s non-
FY15.
.
October 27, 2021 65

Exhibit 78 - FTNT Gross Margin by Segment, 2015-2020

Exhibit 78 shows FTNT’s total
since FY15.
.
Exhibit 79 - FTNT Revenue by Segment

Exhibit 79 shows FTNT’s mix
between product and service
revenue since FY15.
.
October 27, 2021 66

Guidewire Software, Inc. (GWRE) — Not-Covered

Non-GAAP Gross Margin: 42.6% in FY21A.
Definition (from 10-K): "Our cost of subscription and support revenue consists of personnel costs
for our cloud operations and technical support teams, cloud infrastructure costs, development
of online training curriculum, amortization of our intangible assets, and royalty fees paid to
third parties. Our cost of license revenue primarily consists of development of online training
curriculum, royalty fees paid to third parties, and amortization of our intangible assets. Our
cost of services revenue primarily consists of personnel costs for our professional service
employees, third-party contractors, and travel-related costs. In instances where we have primary
responsibility for the delivery of services, subcontractor fees are expensed as cost of services
revenue. In each case, personnel costs include salaries, bonuses, benefits, and stock-based
compensation.
We allocate overhead such as information technology support, information security, facilities,

and other administrative costs to all functional departments based on headcount. As such,
these general overhead expenses are reflected in cost of revenue and each functional operating
expense."
What's included: Headcount, infrastructure, amortization, royalties.
• Revenue mix. Overall gross margins have declined as a result of GWRE's ongoing (difficult)
cloud transition, even as services mix has declined. The primary reason for this has been the
decline in subscription gross margins.
• Subscription gross margins and the cloud transition. During the cloud transition, subscription
gross margins have declined meaningfully for a number of reasons (headcount, accounting,
duplicative costs). While GWRE does not break this out, we estimate subscription gross
margins have declined from ~45% in FY19 to ~25% in FY21. GWRE has stated that FY21 will
be the trough on subscription gross margins and expect gross margins to improve significantly
from here.
• Services philosophy. GWRE has traditionally made a profit on its professional services, but the
margin has meaningfully declined (by design, in our view). Given the high services attach, this
weighs on margins.
October 27, 2021 67

Exhibit 80 - GWRE Non-GAAP Gross Margin by Segment, FY17A-FY21A

Exhibit 80 shows GWRE's Non-
item from FY17A-FY21A. As
seen, margins have declined
materially during the cloud
transition. GWRE is targeting
~60% gross margins by FY 25
and ~67% over the long-term.
.
Exhibit 81 - GWRE Revenue Mix by Segment, FY17A-FY21A

Exhibit 81 shows GWRE's
FY17A-FY21A
.
Jamf Holding Corp (JAMF)

“Cost of subscription revenue consists primarily of employee compensation costs for employees
associated with supporting our subscription and support and maintenance arrangements, our
customer success function, and third-party hosting fees related to our cloud services. Employee
compensation and related costs include cash compensation and benefits to employees and
associated overhead costs.
October 27, 2021 68

Cost of services. Cost of services revenue consists primarily of employee compensation costs
directly associated with delivery of professional services and training, costs of third-party
integrators and other associated overhead costs.”
• Mix-shift between subscription, services and license.

• Cloud-based subscription customer mix and associated costs.
• Customer support team expansion.
• Technology and infrastructure costs.
Exhibit 82 - JAMF Non-GAAP Gross Margin, 2018-2020

Exhibit 82 shows JAMF’s non-
FY18.
.
Exhibit 83 - JAMF Revenue by Segment, 2018-2020

Exhibit 83 shows JAMF’s mix
between subscription, services
and license revenue since
FY18.
.
October 27, 2021 69

Limelight Networks, Inc. (LLNW) — Not-Covered

Non-GAAP Gross Margin: 37.0% in 2020; 22.7% in 1H21.
Definition (from 10-K): Below we provide LLNW's cost of revenue definition as stated in the
company's 10-K. LLNW provides a detailed breakdown of all components of cost of revenue
(Exhibit 84), a somewhat unique disclosure among companies in our extended software sector.
"Cost of revenue consists primarily of fees paid to network providers for bandwidth and
backbone, costs incurred for non-settlement free peering and connection to Internet service
providers, and fees paid to data center operators for housing of our network equipment in third
party network data centers, also known as co-location costs. Cost of revenue also includes leased
warehouse space and utilities, depreciation of network equipment used to deliver our content
delivery services, payroll and related costs, and share-based compensation for our network
operations and professional services personnel. Other costs include professional fees and outside
services, travel and travel-related expenses and royalty expenses."
Exhibit 84 - LLNW Cost of Revenue Breakdown, 2016-2020

of the components of LLNW's
cost of revenue from 2015 to
2020.
.
October 27, 2021 70

What's included: Content, infrastructure, support, payments, and licenses.
• Network efficiency. This is likely the most important driver, especially since LLNW owns its
network.
• Pricing. We look at LLNW's deteriorating gross margins as evidence of pricing pressure.
• Customer concentration. AMZN is LLNW's largest customer at 30%+ of revenue and likely
receives significantly discounted pricing, which lowers gross margins.
• Traffic mix. Some forms of traffic are likely lower gross margin (video streaming) than others
(software downloads). LLNW is attempting to enter security (via M&A), which could aid gross
margins.
• Capital intensity. LLNW is a capital intensive business, which always weighs on gross margins,
but in years with greater network buildout, gross margins will remain depressed.
Exhibit 85 - LLNW Non-GAAP Gross Margins, 2016-2020 & 1H21

Exhibit 85 shows Non-GAAP
gross margins from 2016-2020
and 1H21. As seen, gross
margins reached a high of
nearly 50% before dropping
to ~23% this year -- gross
margins more line with
construction than software.
.
October 27, 2021 71

McAfee Corp. (MCFE)

Non-GAAP Gross Margin: 79.5% in CY20.
“Our total cost of sales include fees paid under revenue share arrangements, amortization of
certain intangibles, transaction processing fees, the costs of providing delivery (i.e., hosting),
support, which include salaries and benefits for employees and fees related to third parties, and
technology licensing fees. We anticipate our total cost of sales to increase in absolute dollars as
we grow our net revenue. Cost of sales as a percentage of net revenue may vary from period
to period based on our investments in the business, the efficiencies we are able to realize going
forward as well as due to the accounting for payments to channel partners discussed in Factors
Affecting the Comparability of Our Results of Operations.
We expect the divestiture to lead to costs that were previously allocated to both segments to now
be part of continuing operations which will have a dilutive impact on gross margins.”
• Gross margins have improved ~200 bps over the past two years. We believe this is attributed
to an increasing mix of consumer in total revenue vs. the enterprise business.
• Consumer gross margin has improved ~230 bps over the past two years and accounted for
54% of the total gross profit in the most recent year. It has continued to improve into CY21.
• Gross margin for the consumer business is primarily driven by sale of subscriptions, with +85%
recurring revenues for the last two fiscal years.
• Given the divestiture of the lower margin enterprise business, we believe gross margin should
trend up in CY21.
Exhibit 86 - MCFE Non-GAAP Gross Margin, 2018-2020

Exhibit 86 shows MCFE’s non-
GAAP gross margin since
CY18.
.
October 27, 2021 72

Exhibit 87 - MCFE Gross Margin by Segment, 2018-2020

Exhibit 87 shows MCFE’s non-
CY18.
.
Exhibit 88 - MCFE Revenue by Segment, 2018-2020

Exhibit 88 shows MCFE’s
mix between enterprise and
consumer since CY18.
.
October 27, 2021 73

MongoDB, Inc. (MDB) — Not-Covered

Non-GAAP Gross Margin: 72.4% in FY21A.
Cost of Subscription Revenue
"Cost of subscription revenue primarily includes personnel costs, including salaries, bonuses
and benefits and stock-based compensation, for employees associated with our subscription
arrangements principally related to technical support and allocated shared costs, as well
as depreciation and amortization. Our cost of subscription revenue for our hosted as-a-
service solutions also includes third-party cloud infrastructure expenses. We expect our cost of
subscription revenue to increase in absolute dollars as our subscription revenue increases and,
depending on the results of MongoDB Atlas, our cost of subscription revenue may increase as a
percentage of subscription revenue as well.
Cost of Services Revenue
"Cost of services revenue primarily includes personnel costs, including salaries, bonuses and
benefits, and stock-based compensation, for employees associated with our professional service
contracts, as well as, travel costs, allocated shared costs and depreciation and amortization.
We expect our cost of services revenue to increase in absolute dollars as our services revenue
increases."
What's included: Headcount, depreciation and amortization, infrastructure (Atlas).
What's not included: It is unclear if Community Server is included in cost of revenue or in sales
and marketing.
• Atlas mix. Atlas, MDB's DBaaS offering, is lower gross margin (due to infrastructure costs) than
the traditional subscription offering and as the Atlas mix grows, this serves as a headwind for
gross margins. We estimate Atlas is ~70% subscription gross margin vs. ~80% for on-premise
subscription.
• Revenue mix. MDB has a relatively low services mix, which has declined over the past few years
(partly aided by Atlas adoption). This low services mix helps keep overall gross margins high.
• Free users. It is unclear if costs to support users of the free Community Server offering are in
COGS or sales and marketing. We believe it should be under cost of revenue and, if it is, then
greater free user adoption will serve as a headwind to gross margins.
• Network efficiency. This specifically impacts the Atlas business, which we believe is seeing
scale benefits.
October 27, 2021 74

Exhibit 89 - MDB Non-GAAP Gross Margin by Segment, FY17A-FY21A

Exhibit 89 shows MDB's Non-
item from FY17A-FY21A.
The decline in subscription
gross margins is likely led by
growing Atlas mix-shift.
.
Exhibit 90 - MDB Revenue Mix by Segment, FY17A-FY21A

Exhibit 90 shows MDB's
FY17A-FY21A.
.
October 27, 2021 75

Mimecast Limited (MIME)

“Cost of revenue primarily consists of expenses related to supporting and hosting our product
offerings and delivering our professional services. These costs consist primarily of personnel
and related costs including salaries, benefits, bonuses and share-based compensation expense
related to the management of our data centers, our customer support team and our professional
services team. In addition to these expenses, we incur third-party service provider costs such
as data center and networking expenses, allocated overhead costs, depreciation expense and
amortization expense related to capitalized software and acquired intangible assets. We allocate
overhead costs, such as rent and facility costs, information technology costs and employee
benefit costs to all departments based on headcount. As such, general overhead expenses are
reflected in cost of revenue and each operating expense category.”
• Gross margins have improved 350 bps in the past two years, which we think highlights the
efficiencies in the multi-tenant cloud model.
• MIME utilizes third-party data center hosting facilities to host its services, which likely is a slight
drag on gross margins.
Exhibit 91 - MIME Non-GAAP Gross Margin, 2015-2021

Exhibit 91 shows MIME’s non-
FY15.
.
October 27, 2021 76

Microsoft Corporation (MSFT)

“Cost of revenue includes: manufacturing and distribution costs for products sold and programs
licensed; operating costs related to product support service centers and product distribution
centers; costs incurred to include software on PCs sold by original equipment manufacturers
(“OEM”), to drive traffic to our websites, and to acquire online advertising space; costs incurred
to support and maintain online products and services, including datacenter costs and royalties;
warranty costs; inventory valuation adjustments; costs associated with the delivery of consulting
services; and the amortization of capitalized software development costs. Capitalized software
development costs are amortized over the estimated lives of the products.”
What's included: Manufacturing, distribution, infrastructure, headcount, amortization
• Segment mix. Different segments have different gross margin profile. For example, we believe
Productivity and Business Process is higher gross margin than Intelligent Cloud, which is higher
gross margin than More Personal Computing.
• Product mix. MSFT products span on-premise software, cloud software (at all layers),
hardware, consumer Internet, and gaming, to name a few areas. Our estimates of gross
margins by business are as follows:
○ On-premise software is likely the highest gross margin item (85%+)
○ Cloud software (ex-Azure and O365) is likely in line with the SaaS peer group (75%-80%)
○ LinkedIn had ~75% gross margins as a public company. We believe the asset is roughly back
to its steady state margins now that acquisition-related amortization has rolled off
○ Azure is likely lower gross margin (55%-60%), but we note ~25% of Azure revenue is SaaS
(EMS, including Azure Active Directory), which is higher gross margin than the IaaS piece
○ Consumer Internet is likely 50%-55% gross margins
○ Gaming is likely ~50% gross margins blended (with gaming software/services at ~70% gross
margins and Xbox consoles with negative gross margins)
○ Consumer hardware (e.g. Surface) likely has 20%-25% gross margins
• Cloud transition. As cloud becomes a greater portion of the overall software business, it serves
as a headwind to gross margins, as on-premise revenue is more profitable.
• Azure. We believe Azure's gross margins are meaningfully improving over time, but still below
overall gross margins. As Azure scales, we expect gross margin expansion.
Exhibit 92 - MSFT Non-GAAP Gross Margins, FY17-FY21
Exhibit 92 shows MSFT's non-
FY17
.
October 27, 2021 77

Datto Holding Corp. (MSP)

“Subscription cost of revenue consists of costs directly related to our subscription services,
including personnel costs related to operating our data centers and customer support operations,
hosting and data center related costs, third-party software licenses and allocated facilities and
overhead costs associated with delivering these services.
Device cost of revenue consists of hardware, manufacturing, shipping and logistics, personnel
costs and allocated facilities and overhead costs associated with delivering our devices. Our
Unified Continuity products rely on a mix of off-the-shelf hardware and custom designed
hardware. Our Networking devices generally consist of off-the-shelf hardware, although some
of our devices feature a unique industrial design.
Professional services and other cost of revenue consists primarily of personnel costs and allocated
facilities and overhead associated with delivering implementation and consulting services. Our
professional services implementations aim to ensure higher software utilization, greater upsell
opportunity and lower churn over time.
Depreciation and amortization cost of revenue consists of depreciation of our Datto Cloud
infrastructure and amortization of our acquired technology intangible assets.”
• Gross margin is driven primarily by subscription revenue, which represents 94% of the total
revenue.
• Total gross margin has increased ~780 bps in the past two years which we think is attributed to
the mix-shift towards higher margin subscription from lower margin device and professional
services.
• Subscription gross margin has increased ~520 bps in the past two years, partly due to increased
efficiencies realized from the sale of Unified Continuity solutions.
• Device and professional services gross margin has stayed in negative territory.
• Depreciation accounted for ~12% of the total cost of revenue and includes the costs related to
the infrastructure. Depreciation expense has gone up in the past two years, both in absolute
terms and as a percentage of the total cost of revenue. This is likely attributed to the ongoing
data center expansions in order to support growth.
October 27, 2021 78

Exhibit 93 - MSP Non-GAAP Gross Margin, 2018-2020

Exhibit 93 shows MSP’s non-
CY18.
.
Exhibit 94 - MSP Gross Margin by Segment, 2018-2020

Exhibit 94 shows MSP’s non-
CY18.
.
October 27, 2021 79

Exhibit 95 - MSP Revenue by Segment

Exhibit 95 shows MSP’s mix
between subscription, device
and professional services since
CY18.
.
N-able, Inc. (NABL)

“Cost of revenue consists of technical support personnel costs, public cloud infrastructure and
hosting fees, royalty fees and an allocation of overhead costs for our subscription revenue
and maintenance services. We allocate facilities, depreciation, benefits and IT costs based
on headcount. We amortize to cost of revenue capitalized costs of technologies acquired in
connection with the take private transaction of SolarWinds in early 2016 and our acquisitions.”
• Gross margin is primarily driven by the sale of subscriptions to the SaaS solutions. Gross margin
has remained largely flat over the past year.
• NABL utilizes third-party data center hosting facilities and public cloud infrastructure to host
its services, which likely is a slight drag on gross margins.
•
Exhibit 96 - NABL Non-GAAP Gross Margin, 2019-2020
Exhibit 96 shows NABL’s non-
CY19.
.
October 27, 2021 80

Cloudflare Inc (NET)

“Cost of revenue consists primarily of expenses that are directly related to providing our
service to our paying customers. These expenses include expenses related to operating in co-
location facilities, network and bandwidth costs, depreciation of our equipment located in co-
location facilities, certificate authority services costs for paying customers, related overhead
costs, the amortization of our capitalized internal-use software, and the amortization of acquired
developed technologies. Cost of revenue also includes employee-related costs, including salaries,
bonuses, benefits, and stock-based compensation for employees whose primary responsibilities
relate to supporting our paying customers. Other costs included in cost of revenue include credit
card fees related to processing customer transactions and allocated overhead costs.”
• Gross margin is primarily driven by the sale of subscriptions together with related support
services.
• Gross margin has declined ~140bps in the past three years. We think this is likely due to
investment in infrastructure including co-location facilities and network and bandwidth costs
to support the growing base of customers.
• That said, over time, we expect gross margins to trend back up as the company realizes
economies of scale.
• We also note the company includes the cost of free users in S&M vs COGS.
Exhibit 97 - NET Non-GAAP Gross Margin by Segment, 2017-2020

Exhibit 97 shows NET’s non-
CY17.
.
October 27, 2021 81

New Relic, Inc. (NEWR)

“Cost of revenue consists of expenses relating to data center operations, hosting-related costs,
payment processing fees, depreciation and amortization, consulting costs, and salaries and
benefits of operations and global customer support personnel. Salaries and benefits costs
associated with our operations and global customer support personnel consist of salaries,
benefits, bonuses, and stock-based compensation. We plan to continue increasing the capacity,
capability, and reliability of our infrastructure to support the growth of our customer adoption
and the number of products we offer, as customer usage continues to grow. Additionally, we are
continuing to build out services and functionality in the public cloud with a view to migrating our
entire platform over time from third-party data center hosting facilities to public cloud hosting
providers. We have decreased the amount of capital expenditures on hosting equipment for use
in our data center hosting facilities as we transition to greater dependence on cloud hosting
providers. This public cloud migration has resulted and will continue to result in significant
increased costs in the short term as we are incurring cloud migration costs as well as costs to
maintain our data center operations.”
What's included: Data center operations and public cloud hosting, payment processing fees,
D&A, headcount, and consulting
What's not included: Costs associated with the free tier offering is in sales and marketing
expenses
• Public cloud migration. New Relic is migrating to AWS/public cloud from in-house data centers,
significantly pressuring gross margins. New Relic's own data centers are still operational during
the transition, causing an annual $40M non-recurring headwind in FY22. In addition, some
R&D expenses were re-classified to cost of revenue.
• Pricing Transition. New Relic is also undergoing a transition to consumption-based pricing from
subscription. Data ingest is an important component of validating this transition. Currently,
revenue mix is 65% / 35% users / data and management sees this trending towards 70% /
30% in the intermediate term, a positive for gross margins. Mix shift to data would negatively
impact gross margins and vice versa.
• Changes To GTM. New Relic recently introduced a self-service model and pay-as-you-go
pricing, in order to capture more share down market in SMB/mid-market. In addition, New
Relic is broadening its overall reach through a focus on channel and strategic partnerships.
These go-to-market changes should increase the mix of revenue from users versus data ingest,
which would be a positive for gross margins as outlined above.
October 27, 2021 82

Exhibit 98 - NEWR Non-GAAP Gross Margins, FY16-FY21

Exhibit 98 shows NEWR's non-
FY16. The big decline in gross
margins in FY21 was largely
related to the public cloud
migration.
.
Exhibit 99 - NEWR Average Daily PB Ingest Per Month

Exhibit 99 shows NEWR's
monthly data ingestion
trends since transitioning to
a consumption-based pricing
model.
.
October 27, 2021 83

Exhibit 100 - NEWR Model Transition Progress

Exhibit 100 shows NEWR's
model transition progress
and forecast, with 71% of the
business on the consumption
model and projected to be
80% by FYE.
.
NICE Ltd (NICE)

Definition (from 20-F): N/A
Cloud Gross Profit
“Our gross profit on cloud revenue was $437.3 in 2020 compared to $305.9 in 2019, representing
an increase of $131.4 million, or 43.0%. Our gross profit of cloud revenue as percentage of cloud
revenue increased to 56.3% in 2020 compared to 51.3% in 2019. Increase in cloud gross profit
and margin is mainly attributed to scaling in our cloud business and efficiencies in our internal
operations.
Service Gross Profit
"Our gross profit on service revenue was $487.7 in 2020 compared to $490.1 in 2019,
representing a decrease of $2.4 million, or 0.5%, which is mainly attributed to decrease in
professional services revenue from fewer on-premise implementations resulting primarily from
our transition to increased cloud delivery of our solutions. As a percentage of service revenue,
our gross profit of service revenue increased to 70.9% in 2020 compared to 69.0% in 2019,
mainly due to increased efficiency in our services organization, and to a decrease in professional
services revenue from fewer on-premise implementations resulting primarily from our transition
to increased cloud delivery of our solutions."
Product Gross Profit
"Our gross profit on product revenue was $161.0 in 2020 compared to $246.2 in 2019,
representing a decrease of $85.2 million, or 34.6%, which is mainly attributed to the decrease
demand for our product based solutions as part of the transition to cloud adoption solutions. Our
October 27, 2021 84

gross profit of product revenue as percentage of product revenue decreased to 87.9% in 2020
compared to 91.5% in 2019, mainly due to a different mix of product solution sold during 2020.”
What's included: Headcount, channel and strategic partnerships, cloud infrastructure, SBC, and
amortization of intangible assets
• Total Revenue Mix. Cloud has lower gross margins than on-premise product or services
revenue. Therefore, revenue mix shift to cloud is a headwind to total gross margins as cloud
has grown to 47% of total revenue in 2020 from 9% in 2016.
• Cloud Growth And Mix Shift To Cloud. Within cloud, the largest piece is NICE CXOne which
is based on the inContact acquisition. While NICE does not break down the mix within cloud,
inContact was a public company prior to the acquisition. In 2015, 35% of inContact’s revenue
was network connectivity, which had 37.7% gross margins, while software was 65% of total
revenue and carried 58.8% gross margins. Since the acquisition, we believe mix has shifted to
software, serving as a tailwind to cloud gross margins (in 2020 cloud gross margins expanded
380 bps Y/Y) in addition to general scale efficiencies.
• Mix within Services. NICE's services segment includes maintenance (tied to on-premise
product revenue), which is likely higher gross margins, and professional services, which is
likely lower gross margins, We believe this segment is roughly 75% maintenance and 25%
professional services and that professional services was a higher percentage of revenue pre-
cloud.
• Business Segment Mix. NICE operates two businesses: 1) Customer Engagement; and 2)
Financial Crime and Compliance (FCC). Although NICE does not provide the gross margins for
each business, Customer Engagement is a lower operating margin segment at 19.9% in 2020,
versus FCC at 31.0% (we note the segments' margins were roughly even before the inContact
acquisition).
Exhibit 101 - NICE Non-GAAP Gross Margins, 2016-2020

Exhibit 101 shows NICE's
non-GAAP gross margins by
revenue source since 2016.
Cloud gross margins have
been improving since 2017
and allowed overall gross
margins to stay flat, even as
cloud mix has grown.
.
October 27, 2021 85

Exhibit 102 - NICE Revenue Mix, 2016-2020

Exhibit 102 shows NICE's
revenue mix since 2016
.
Exhibit 103 - NICE Revenue By Business Segment, 2016-2020

Exhibit 103 shows NICE
revenue mix by business
segment since 2016
.
October 27, 2021 86

NortlonLifeLock Inc. (NLOK)

“Cost of revenue includes technical support costs and service costs, royalty charges, inventory
write-offs, revenue share costs and payment processing fees.”
• Gross margin is primarily driven by the sale of software license subscription and the related
support and maintenance.
• Gross margins have improved 410 bps in the past two years, which we think is attributed to a
focus on the higher margin consumer business since the sale of the lower margin enterprise
business in 2019.
• Cost of revenue includes royalty charges and technical support costs which decreased in the
past year, driving improvement in the gross margin.
Exhibit 104 - NLOK Non-GAAP Gross Margin 2015-2020

Exhibit 104 shows NLOK’s non-
FY15.
.
NOW
Cost of Subscription
“Cost of subscription revenues consists primarily of expenses related to hosting our services
and providing support to our customers. These expenses are comprised of data center capacity
costs, which include colocation costs associated with our data centers as well as interconnectivity
between data centers, depreciation related to our infrastructure hardware equipment dedicated
for customer use, amortization of intangible assets, expenses associated with software, IT
services and dedicated customer support, personnel-related costs directly associated with data
center operations and customer support, including salaries, benefits, bonuses and stock-based
compensation and allocated overhead."
October 27, 2021 87

"Cost of professional services and other revenues consists primarily of personnel-related costs
directly associated with our professional services and training departments, including salaries,
benefits, bonuses and stock-based compensation, the costs of contracted third-party partners,
travel expenses and allocated overhead.
Professional services are performed directly by our services team, as well as by contracted
third-party partners. Fees paid by us to third-party partners are primarily recognized as cost
of revenues as the professional services are delivered. Cost of revenues associated with our
professional services engagements contracted with third-party partners as a percentage of
professional services and other revenues was 10%, 15% and 18% for the years ended December
31, 2020, 2019 and 2018, respectively.”
What's included: Hosting-related costs, headcount, SBC, third-party partners (10% of total
revenue), and allocated overhead
• Gross margin is made up of subscription and professional services and other segments.
• Subscription is the main driver and accounted for 99.2% of total gross margin in the latest year.
• Professional Service has slowly become less of the total gross margin mix, which has boosted
the gross margins since 2015.
Exhibit 105 - NOW Non-GAAP Gross Margins, 2016-2020

Exhibit 105 shows NOW's
revenue source since 2016
.
October 27, 2021 88

Exhibit 106 - NOW Revenue Mix, 2016-2020

Exhibit 106 shows NOW's
revenue mix shift to
subscription from professional
services since 2016
.
NetScout Systems, Inc. (NTCT)

“Cost of product revenue consists primarily of material components, manufacturing personnel

expenses, packaging materials, overhead and amortization of capitalized software, acquired
developed technology and core technology.
Cost of service revenue consists primarily of personnel, material, overhead and support costs.”
• Gross margin is driven by the sale of hardware, software-only and service offerings.
• Total gross margin has remained flat over the past two years, which we think is attributed to
the mix-shift from product to lower margin services business but also an increasing margin
trend in the product business.
• Product gross margin has improved ~300 bps in the past two years and accounted for 48% of
the total gross profit in the most recent year.
• Services gross margin has declined ~230 bps in the past two years and accounted for 52% of
October 27, 2021 89

Exhibit 107 - NTCT Non-GAAP Gross Margin, 2015-2021

Exhibit 107 shows NTCT’s non-
GAAP gross margin since FY15.
.
Exhibit 108 - NTCT Gross Margin by Segment, 2015-2021

Exhibit 108 shows NTCT’s non-
FY15.
.
October 27, 2021 90

Exhibit 109 - NTCT Revenue by Segment

Exhibit 109 shows NTCT’s mix
between product and service
since FY15.
.
Nutanix, Inc. (NTNX)

“Cost of product revenue consists of costs paid to third-party OEM partners, hardware costs,
personnel costs associated with our operations function, consisting of salaries, benefits, bonuses
and stock-based compensation, cloud-based costs associated with our SaaS offerings, and
allocated costs, consisting of certain facilities, depreciation and amortization, recruiting and
information technology costs allocated based on headcount.
Cost of support, entitlements and other services revenue includes personnel and operating costs
associated with our global customer support organization, as well as allocated costs. We expect
our cost of support, entitlements and other services revenue to increase in absolute dollars as
our support, entitlements and other services revenue increases.”
• Total gross margin has increased 420 bps over the past two years, likely driven by a mix-shift
towards subscriptions, which represent 89% of the total revenue in the most recent year.
the total gross profit in the most recent year. This is driven by a decrease in cost of product
revenue primarily due to decreases in hardware revenue resulting from management’s focus
on more software-only transactions.
• Services gross margin has improved ~610 bps in the past two years and accounted for 42% of
the total gross profit in the most recent year. This is driven by support, entitlements and other
services revenue growth at a higher rate than the increase in personnel-related costs.
• Services revenue has consistently increased as a percentage of total revenue, reflecting 49%
of the total revenue in the most recent year.
October 27, 2021 91

Exhibit 110 - NTNX Non-GAAP Gross Margin, 2015-2021

Exhibit 110 shows NTNX’s non-
.
Exhibit 111 - NTNX Gross Margin by Segment, 2015-2021

Exhibit 111 shows NTNX’s non-
FY15.
.
Exhibit 112 - NTNX Revenue by Segment, 2015-2021

Exhibit 112 shows NTNX’s mix
between product and support
and services since FY15.
.
October 27, 2021 92

Okta, Inc. (OKTA)

“Costs of revenue primarily consist of costs related to providing the Company’s cloud-based
platform to its customers, including third-party hosting fees, amortization of capitalized
internal-use software and finite-lived purchased developed technology, customer support, other
employee-related expenses for security, technical operations and professional services staff, and
allocated overhead costs."
“Cost of subscription primarily consists of expenses related to hosting our services and providing
support. These expenses include employee-related costs associated with our cloud-based
infrastructure and our customer support organization, third-party hosting fees, software and
maintenance costs, outside services associated with the delivery of our subscription services,
travel-related costs, amortization expense associated with capitalized internal-use software and
acquired technology, and allocated overhead.
We intend to continue to invest additional resources in our platform infrastructure and our
platform support organizations. As we continue to invest in technology innovation, we anticipate
that capitalized internal-use software costs and related amortization may increase. We expect
our investment in technology to expand the capability of our platform, enabling us to improve
our gross margin over time. The level and timing of investment in these areas could affect our
cost of subscription revenue in the future."
"Cost of professional services consists primarily of employee-related costs for our professional
services delivery team, travel-related costs, and costs of outside services associated with
supplementing our professional services delivery team. The cost of providing professional services
has historically been higher than the associated revenue we generate.”
What's included: Hosting, cloud infrastructure, headcount, SBC, amortization, and allocated
overhead
• Total gross margin has increased ~330 bps over the past two years, likely driven by a mix-shift
towards subscriptions which represent 95% of the total revenue in the most recent year.
• Subscription gross margin has improved ~70 bps in the past two years while it remained
largely flat in the past year. This is driven by higher subscription revenue but also higher
cost of revenue due to headcount cost, an increase in software license costs and third-party
hosting costs as management increases capacity to support growth. Longer term, management
expects subscription revenue gross margin to improve due to economies of scale.
• Services gross margin has remained negative, though it has shown consistent improvement.
October 27, 2021 93

Exhibit 113 - OKTA Non-GAAP Gross Margins, 2017-2021

Exhibit 113 shows OKTA's non-
item
.
Exhibit 114 - OKTA Revenue Breakdown, 2017-2021

Exhibit 114 shows OKTA's mix
shift to subscription revenue
from professional services
since FY17
.
October 27, 2021 94

Olo, Inc. (OLO)

“Platform cost of revenue primarily consists of costs directly related to our platform services,
including expenses for customer support and infrastructure personnel, including salaries, taxes,
benefits, bonuses, and stock-based compensation, which we refer to as personnel costs, third-
party software licenses, hosting, amortization of internal-use software, and allocated overhead.
We expect platform cost of revenue to increase in absolute dollars in order to support additional
customer and transaction volume growth on our platform and decline as a percent of revenue
over time.
Professional services and other cost of revenue primarily consists of the personnel costs of our
deployment team associated with delivering these services and allocated overhead.”
• Total gross margin has increased ~1,190 bps over the past year, likely driven by a mix-shift from
lower margin services towards the higher margin platform revenue, which now represents
94% of the total revenue.
• Platform gross margin has improved ~1,110 bps in the past year and accounted for 98% of the
total gross profit in the most recent year. This is driven by an increase in the platform revenue
and improved platform cost of revenue optimization.
• Services gross margin has declined ~940 bps in the past year and accounted for 2% of the total
gross profit in the most recent year. This is driven by a decrease in services revenue and an
increase in the cost of services due to higher compensation costs associated with additional
personnel to support growth in active locations.
Exhibit 115 - OLO Non-GAAP Gross Margin, 2019-2020

Exhibit 115 shows OLO’s non-
CY19.
.
October 27, 2021 95

Exhibit 116 - OLO Gross Margin by Segment, 2019-2020

Exhibit 116 shows OLO’s non-
CY19.
.
Exhibit 117 - OLO Revenue by Segment, 2019-2020

Exhibit 117 shows OLO’s
mix between platform and
services since CY19.
.
October 27, 2021 96

Palo Alto Networks, Inc. (PANW)

“Cost of revenue consists of cost of product revenue and cost of subscription and support revenue.
Cost of product revenue primarily includes costs paid to our manufacturing partners. Our cost of
product revenue also includes personnel costs, which consist of salaries, benefits, bonuses, share-
based compensation, and travel and entertainment associated with our operations organization,
amortization of intellectual property licenses, product testing costs, shipping and tariff costs, and
allocated costs. Allocated costs consist of certain facilities, depreciation, benefits, recruiting, and
information technology costs that we allocate based on headcount. We expect our cost of product
revenue to fluctuate with our product revenue.
Cost of subscription and support revenue includes personnel costs for our global customer
support and technical operations organizations, customer support and repair costs, third-party
professional services costs, data center and cloud hosting service costs, amortization of acquired
intangible assets and capitalized software development costs, and allocated costs. We expect our
cost of subscription and support revenue to increase as our installed end-customer base grows
and adoption of our cloud-based subscription offerings increases.”
• Total gross margin has declined 160 bps over the past two years, likely driven by product mix.
• Services gross margin has declined ~350 bps in the past two years and accounted for 74% of the
total gross profit in the most recent year. This is driven by increased costs to fulfill professional
services arrangements.
• Services revenue has consistently increased as a percentage of total revenue, reflecting 74%
of the total revenue in the most recent year.
Exhibit 118 - PANW Non-GAAP Gross Margin, 2015-2021

Exhibit 118 shows PANW’s
non-GAAP gross margin since
FY15.
.
October 27, 2021 97

Exhibit 119 - PANW Gross Margin by Segment, 2015-2021

Exhibit 119 shows PANW’s
non-GAAP gross margins since
FY15.
.
Exhibit 120 - PANW Revenue by Segment, 2015-2021

Exhibit 120 shows PANW’s mix
between product and services
since FY15.
.
October 27, 2021 98

UiPath Inc (PATH)

Definition (from 10-Q):
“Cost of licenses revenue consists of all direct costs to deliver our licenses to customers,
amortization of software development costs, direct costs related to third party software resales,
and amortization of acquired developed technology.
Cost of maintenance and support revenue primarily consists of personnel-related expenses

of our customer support and technical support teams, including salaries and bonuses, stock-
based compensation expense, and employee benefit costs. Cost of maintenance and support
revenue also includes third-party consulting services, hosting costs related to our hybrid and
cloud-based products, amortization of acquired developed technology and capitalized software
development costs related to cloud products, and allocated overhead. Overhead is allocated to
cost of maintenance and support revenue based on applicable headcount.”
• The license and maintenance and support segments both contribute similar amounts to gross
margin. The license segment made up ~63% of total gross profit and had a gross margin of
~99% in the latest year. The maintenance and support segment made up ~38% of total gross
profit and had a percent margin of ~90% in the latest year.
• The services segment has a negative gross margin and is seen as complimentary to the other
segments.
Exhibit 121 - PATH Non-GAAP Gross Margin by Segment, 2020-2021

Exhibit 121 shows PATH’s non-
.
October 27, 2021 99

Exhibit 122 - PATH Gross Margin by Segment, 2020-2021

Exhibit 122 shows PATH’s non-
FY20.
.
Exhibit 123 - PATH Revenue by Segment, 2020-2021

Exhibit 123 shows PATH’s
revenue mix since FY20.
.
October 27, 2021 100

PagerDuty, Inc. (PD)

“Cost of revenue primarily consists of expenses related to providing our platform to customers,
including personnel expenses for operations and global support, payments to our third-party
cloud infrastructure providers for hosting our software, payment processing fees, amortization
of capitalized internal-use software costs, amortization of acquired developed technology, and
allocated overhead costs for facilities, information technology, and other allocated overhead
costs. We will continue to invest additional resources in our platform infrastructure and our
customer support and success organizations to expand the capability of our platform and
ensure that our customers are realizing the full benefit of our offerings. The level and timing of
investment in these areas could affect our cost of revenue in the future.”
What's included: Cloud infrastructure, headcount, amortization of capitalized software and

acquired developed technology, and allocated overhead
• Gross margin is primarily driven by sale of cloud-hosted software subscriptions.

• Gross margins have improved 100 bps over the past two years, driven by efficiency from cloud
native infrastructure.
• Cost of revenue includes headcount and hosting costs, which increased in the past year to
support the growth in the revenue.
Exhibit 124 - PD Non-GAAP Gross Margins, 2018-2021

Exhibit 124 shows PD's non-
GAAP gross margin expansion
since FY18
.
October 27, 2021 101

Pegasystems Inc. (PEGA)

Definition (from 10-K): N/A
“Our cloud-based subscription model also requires that we rely on third parties to host our
products for our clients. We incur significant recurring third-party hosting expenses to deliver
our Pega Cloud offering that we do not incur for our perpetual and term license products. These
expenses may cause the gross margin we realize from our Pega Cloud sales to be lower than the
gross margin we realize from our perpetual and term license products. If we are unable to meet
these challenges effectively, our operating results and financial condition could be materially
adversely affected
The increase in gross profit in 2020 was primarily due to cost-efficiency gains as Pega Cloud grows
and scales as a result of our Cloud Transition and overall revenue growth.
The increase in consulting gross profit in 2020 was primarily due to a decrease in travel
and entertainment expenses and an increase in consultant utilization. Consultant utilization is
impacted by several factors, including the timing of new implementation projects and our scope
and level of involvement in these projects compared to that of our consulting partners and
enabled clients.”
What's included: Cloud infrastructure, headcount, consultants
• Revenue mix. PEGA has a high services mix at ~23% of revenue in 2020, which weighs on
gross margins (especially since services runs around breakeven). We expect the services mix
to decline over time, with greater cloud mix, more pre-built applications, and more services
offloaded to partners, which should help gross margins.
• Cloud transition. PEGA is undergoing a cloud transition and seen the percentage of revenue
coming from cloud grow from 5% to 20% in five years. Cloud carries lower gross margins than
on-premise license or maintenance.
• Cloud architecture. Pega Cloud operates on a single-tenant architecture, which is lower gross
margin than multi-tenant. Cloud gross margins have improved meaningfully to 63% last year,
but this still remains below typical SaaS gross margins. We expect cloud gross margins to
improve towards 70% over time, led by scale, more multi-tenant services, and leveraging
Kubernetes.
October 27, 2021 102

Exhibit 125 - PEGA Non-GAAP Gross Margins, 2017-2020

Exhibit 125 shows PEGA's
revenue segment since 2017.
Cloud gross margins have
improved meaningfully (2019
was a year of heavy cloud
architecture investment),
allowing overall gross margins
to improve.
.
Exhibit 126 - PEGA Revenue Breakdown, 2016-2020

Exhibit 126 shows PEGA's
revenue mix shift (mainly to
cloud) since 2016
.
October 27, 2021 103

Ping Identity Holding Corp. (PING)

“Subscription cost of revenue consists primarily of employee compensation costs for employee
associated with supporting our subscription arrangements and certain third-party expenses.
Employee compensation and related costs include cash compensation and benefits to employees,
stock-based compensation, costs of third-party contractors and associated overhead costs. Third-
party expenses consist of cloud infrastructure costs and other expenses directly associated with
our customer support. We expect our subscription cost of revenue to increase in absolute dollars
to the extent our subscription revenue increases.
Professional services and other cost of revenue consists primarily of employee compensation
costs directly associated with delivery of professional services and training, including stock-based
compensation, costs of third-party contractors, and facility rental charges and other associated
overhead costs. We expect our professional services and other cost of revenue to increase in
absolute dollars relative to the growth of our business.”
• Total gross margin has declined 420 bps over the past two years, likely driven by a decline in
subscription gross margin, which represents 99% of the total gross profit.
• Subscription gross margin declined ~390 bps in the past two years. This is attributed to an
increase in cost of subscription revenue due to increased headcount, ongoing maintenance
and support for an expanding customer base and increased hosting costs.
• Services gross margin has declined ~940 bps in the past two years and accounted for 1% of
October 27, 2021 104

Exhibit 127 - PING Non-GAAP Gross Margin by Segment, 2017-2021

Exhibit 127 shows PING’s
CY17.
.
Exhibit 128 - PING Gross Margin by Segment, 2017-2020

Exhibit 128 shows PING’s non-
CY17.
.
October 27, 2021 105

Exhibit 129 - PING Revenue by Segment, 2017-2020

Exhibit 129 shows PING’s mix
professional services since
CY17.
.
Palantir Technologies Inc. (PLTR)

“Cost of revenue primarily includes salaries, stock-based compensation expense, and benefits for
personnel involved in performing O&M and professional services, as well as third-party cloud
hosting services, allocated overhead, and other direct costs.
We expect that cost of revenue will increase in absolute dollars as our revenue grows and will
vary from period-to-period as a percentage of revenue.”
What's included: Headcount, cloud hosting, allocated overhead
What's not included: Capitalized software is in R&D, cloud hosting for pilots is in S&M, costs
associated with pilots are in S&M
• Revenue mix. PLTR's professional services mix is relatively low and most recognized revenue
is subscription, which aids gross margins.
• Definitions. PLTR's products do require a meaningful amount of customization, but PLTR
categorizes these costs in the sales and marketing line, not in COGS (pilot deployments are
typically done at "little or no cost" to the customer). We note most companies would categorize
these costs as professional services, not sales and marketing.
• Deployment. PLTR has a meaningful amount of on-premise revenue, although the size is not
disclosed. We believe PLTR's on-premise deployments are higher gross margin.
• Government vs. Commercial.
October 27, 2021 106

Exhibit 130 - PLTR Non-GAAP Gross Margins, 2018-2020

Exhibit 130 shows PLTR's non-
2018.
.
Exhibit 131 - PLTR Revenue Breakdown, 2018-2020

Exhibit 131 shows PLTR's
Government from Commercial
since 2018
.
October 27, 2021 107

PTC Inc. (PTC)

“Cost of revenue primarily consists of cost of license, support and cloud services and professional
services. Cost of revenue includes royalty expenses, outside service cost and travel costs.”
• License gross margin increased in FY’20 compared to FY’19 due to revenue increasing
significantly as a result of ASC 606 and the discontinuation of the cancellation clause, while
cost of license expenses increased only slightly. License revenue growth was driven by an 88%
(89% constant currency) increase in subscription license revenue year over year, partially offset
by a 54% (53% constant currency) decrease in perpetual license revenue.
• Support and cloud services gross margin decreased in FY’20 compared to FY’19 due to a
decrease in perpetual support revenue and increases in costs associated with our cloud
services business due to increased demand for those services, royalty expenses, and outside
service costs. This was partially offset by increases in subscription support and cloud services
revenue.
• Professional services gross margin decreased in FY’20 compared to FY’19 primarily due to a
decrease in revenue driven by the impact of the COVID-19 pandemic and a revenue reversal on
a fixed price professional services contract due to a change in the estimated cost to complete,
partially offset by decreases in outside services and travel costs.
Exhibit 132 - PTC Non-GAAP Gross Margin, 2016-2020

Exhibit 132 shows PTC’s non-
.
October 27, 2021 108

Exhibit 133 - PTC Revenue by Segment, 2016-2020

Exhibit 133 shows PTC’s
.
PowerSchool Holdings, Inc. (PWSC)

Definition (from S-1):
“Subscription and support cost of revenue consists of costs directly related to subscription
services, including personnel costs related to operating data centers and customer support
operations, hosting and data center related costs, third-party software licenses and allocated
facilities and overhead costs.
Service cost of revenue consists of personnel costs related to the delivery of the Company’s
service offerings, software, equipment, and information technology related expenses, third-party
contractor costs, as well as travel and allocated facilities and overhead costs.
License and other cost of revenue consists primarily of personnel costs associated with delivering
licenses, direct hardware costs, and allocated facilities and overhead costs.
Depreciation and amortization cost of revenue includes allocated depreciation of its computer
and software equipment related to the Company’s customer support operations, hosting and
data center related costs and amortization of the Company’s capitalized product development
costs and technology intangible assets.”
• Subscription and support is the main driver of gross margin, accounting for 92.0% of total gross
margin in the most recent year. Subscription and Support had a gross margin 71.1% in the
same year.
• The Service segment has much lower margins, with the 2 year average being 18.4%. This
segment only accounted for ~3.4% of total gross margin the previous two years.
• License and other has the highest segment gross margins at ~90.8%, but only accounted for
~4.5% of total gross margin.
October 27, 2021 109
Exhibit 134 - PWSC Non-GAAP Gross Margin, 2019-2020

Exhibit 134 shows PWSC’s
FY19.
.
Exhibit 135 - PWSC Gross Margin by Segment, 2019-2020

FY19.
.
October 27, 2021 110

Exhibit 136 - PWSC Revenue by Segment, 2019-2020

revenue mix since FY19
.
Qualys, Inc. (QLYS)

“Cost of revenues consists primarily of personnel expenses, comprised of salaries, benefits,

amortization of capitalized internal-use software, performance-based compensation and stock-
based compensation, for employees who operate our data centers and provide support services
to our customers. Other expenses include depreciation of data center equipment and physical
scanner appliances and computer hardware provided to certain customers as part of their
subscriptions, expenses related to the use of third-party data centers, amortization of software
and license fees, amortization of intangibles related to acquisitions, maintenance support, fees
paid to contractors who supplement or support our operations center personnel and overhead
allocations..”
• Gross margin is driven by subscription sales of security and compliance solutions.

• Changes in gross margin are influenced by annual subscription price changes and management
of software development costs.
• Overall gross margins have remained relatively stable.
October 27, 2021 111

Exhibit 137 - QLYS Non-GAAP Gross Margin by Segment, 2015-2020

Exhibit 137 shows QLYS’s non-
.
Rapid7 Inc. (RPD)

“Total cost of revenue consists of the costs of products and professional services. Cost of revenue
includes overhead costs for depreciation, facilities, IT, information security, and recruiting. Our
IT overhead costs include IT personnel compensation costs and costs associated with our IT
infrastructure. All overhead costs are allocated based on relative headcount.
Cost of products consists of personnel and related costs for our content, support, managed
service and cloud operations teams, including salaries and other payroll related costs, bonuses,
stock-based compensation and allocated overhead costs. Also included in cost of products are
software license fees, cloud computing costs and internet connectivity expenses directly related
to delivering our products, amortization of contract fulfillment costs, as well as amortization of
certain intangible assets including internally developed software.
Cost of professional services consists of personnel and related costs for our professional services
team, including salaries and other payroll related costs, bonuses, stock-based compensation,
costs of contracted third-party vendors, travel and entertainment expenses and allocated
overhead costs.”
• The products segment is the main contributor to total and percent margin. This segment
contains subscriptions, managed offerings, and licenses. Product account for 98.2% of total
gross margin in the most recent year.
• Professional services are a small part of total gross margin and lowers total gross margin
percent.
October 27, 2021 112

Exhibit 138 - RPD Gross Margin by Segment, 2015-2020

Exhibit 138 shows RPD’s non-
.
Exhibit 139 - RPD Gross Margin by Segment, 2015-2020

Exhibit 139 shows RPD’s non-
FY15.
.
October 27, 2021 113

Exhibit 140 - RPD Revenue by Segment, 2015-2020

Exhibit 140 shows RPD’s
.
SailPoint Technologies Holdings, Inc. (SAIL)

“Gross profit has been and will continue to be affected by various factors, including the mix of our
license, subscription, and services and other revenue, the costs associated with third-party cloud-
based hosting services for our SaaS offerings, contractor costs to supplement our staff levels
and the extent to which we expand our customer support and professional services and training
organizations.
Cost of license revenue consists of amortization expense for developed technology acquired and
third-party royalties.
Cost of subscription revenue consists primarily of employee-based costs (which consists of

employee compensation and allocated overhead), costs of our customer support organization,
contractor costs to supplement our staff levels, amortization expense for developed technology
acquired and third-party cloud-based hosting costs.
Cost of services and other revenue consists primarily of employee-based costs of our professional
services and training organizations, travel-related costs and contractor costs to supplement our
staff levels.”
• The License and Subscription segments are the main drivers of gross margin. License margin
was 99.6% and subscription margin was 83.6% in the latest year.
• The company has been transitioning to more subscription sales instead of license sales
recently. Subscription gross margin now makes up ~56% of total gross margin in the latest year
while License gross margin is ~41% of the total.
October 27, 2021 114

• Services and other revenues is about ~4% of total gross margin and has a lower percent margin
of 23.3% in the latest year.
Exhibit 141 - SAIL Non-GAAP Gross Margin, 2015-2020

Exhibit 141 shows SAIL’s non-
FY15.
.
Exhibit 142 - SAIL Gross Margin by Segment, 2015-2020

Exhibit 142 shows SAIL’s non-
FY15.
.
October 27, 2021 115

Exhibit 143 - SAIL Revenue by Segment, 2015-2020

Exhibit 143 shows SAIL’s
.
SecureWorks Corp. (SCWX)

“Cost of revenue consists primarily of personnel expenses, including salaries, benefits and
performance-based compensation for employees who maintain our Counter Threat Platform
and provide support services to our customers, as well as perform other critical functions. Also
included in cost of revenue are amortization of equipment and costs associated with hardware
utilized as part of providing subscription services, amortization of technology licensing fees,
amortization of intangible assets, fees paid to contractors who supplement or support our
solutions, maintenance fees and overhead allocations.”
• Gross margin is made up of sales and expenses from SaaS applications and managed security
services on a subscription basis and various professional services, including security and risk
consulting and incident response solutions.
• The majority of revenue (76% in latest year) and thus gross margin expansion is driven by the
subscription segment.
October 27, 2021 116

Exhibit 144 - SCWX Non-GAAP Gross Margin by Segment

Exhibit 144 shows SCWX’s
FY15.
.
Smartsheet, Inc. (SMAR)

“Cost of subscription revenue primarily consists of expenses related to hosting our services and
providing support, including employee-related costs such as salaries, wages, and related benefits,
third-party hosting fees, software and maintenance costs, amortization of acquisition-related
intangibles, payment processing fees, allocated overhead, costs of outside services to supplement
our internal teams, costs of Connectors between Smartsheet and third-party applications, and
travel-related expenses.
We intend to continue to invest in our platform infrastructure and our support organization. As
of January 31, 2021, we transitioned substantially all of our infrastructure from a combination
of third-party co-location data centers and public cloud service providers to the public cloud."
"Cost of professional services revenue consists primarily of employee-related costs for our
consulting and training teams, costs of outside services to supplement our internal teams,
allocated overhead, software-related costs, billable expenses, and travel-related costs.
Gross margin is calculated as gross profit expressed as a percentage of total revenue. Our gross
margin may fluctuate from period to period as our revenue mix fluctuates, and as a result of
the timing and amount of investments to expand our hosting capacity, our continued building of
application support and professional services teams, and increased share-based compensation
expense. As we continue to invest in technology innovation, we expect our gross margin to
moderately decline.”
What's included: Hosting (co-located and public cloud), headcount, amortization of intangibles,
payment processing fees, outside services, connectors
October 27, 2021 117

What's not included: Although not absolutely clear, we believe costs associated with 30-day free
trials are recorded as sales and marketing expense based on language in the 10-K.
• Revenue mix. SMAR's professional servicse mix is under 10%, which aids overall gross margins.
• Services philosophy. SMAR has typically run its professional services at a profit, which makes
the drag from professional services less severe.
• Migration to public cloud. SMAR migrated from using its own hosting to the public cloud,
which did slightly weigh on gross margins.
• Pricing. SMAR's high subscription gross margins suggest the company is not facing meaningful
pricing pressure.
Exhibit 145 - SMAR Non-GAAP Gross Margins, FY17-FY21

Exhibit 145 shows SMAR's
non-GAAP gross margins
by line item since FY17.
Subscription gross margins
have declined slightly as a
result of the transition to the
public cloud, but still remain
healthy.
.
Exhibit 146 - SMAR Revenue Breakdown, FY17-FY21

Exhibit 146 shows SMAR's
revenue mix since FY17
.
October 27, 2021 118

Splunk Inc. (SPLK)

“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.
Cost of cloud services revenues includes salaries, benefits, stock-based compensation and related
expenses such as employer taxes for our cloud services organization, allocated overhead for
depreciation of equipment, facilities and IT, amortization of acquired intangible assets and third-
party hosting fees.
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 and allocated overhead for depreciation of equipment, facilities
and IT.”
• Gross margin is currently driven mainly by the license segment which contributed 53.3% of
total gross margin in the latest year. The license segment has the highest margin percentage
of all the segments at ~98% in the latest year.
• Cloud Services is new as of 2019 and is increasingly becoming a larger part of total gross margin
at 18.3% of the total and the segment had a margin percent of ~59% in the latest year.
• Cloud Services is 28.4% of total gross margin and the segment had a margin percent of ~72%
in the latest year.
• Gross margins could drift a bit lower with additional cloud services sales.
Exhibit 147 - SPLK Non-GAAP Gross Margin by Segment, 2015-2021

Exhibit 147 shows SPLK’s non-
.
October 27, 2021 119

Exhibit 148 - SPLK Gross Margin by Segment, 2015-2021

Exhibit 148 shows SPLK’s non-
FY15.
.
Exhibit 149 - SPLK Revenue by Segment, 2015-2021

Exhibit 149 shows SPLK’s
.
October 27, 2021 120

Sumo Logic, Inc. (SUMO)

“Cost of revenue includes all direct costs to deliver and support our platform, including personnel
and related costs, third-party hosting fees related to our cloud platform, amortization of internal-
use software and acquired developed technology, as well as allocated facilities and IT costs.”
• Gross margin is mainly driven by the subscription services offered by the company.
• Increase in gross margin mainly comes from increased cost efficiencies related to cloud hosting
services.
Exhibit 150 - SUMO Non-GAAP Gross Margin, 2019-2021

Exhibit 150 shows SUMO’s
FY19.
.
October 27, 2021 121

SolarWinds Corp. (SWI)

“Cost of recurring revenue consists of technical support personnel costs, royalty fees, public cloud
infrastructure and hosting fees and an allocation of overhead costs for our subscription revenue
and maintenance services. Allocated costs consist of certain facilities, depreciation, benefits and
IT costs allocated based on headcount.”
• The majority of revenue and gross margin is made up of the subscription and maintenance
segments.
• Subscription revenue is non-licensed recurring revenue, and maintenance is provided with
perpetual licensed revenue, but is considered recurring and variable.
Exhibit 151 - SWI Non-GAAP Gross Margin by Segment, 2016-2020
Exhibit 151 shows SWI’s non-
.
Exhibit 152 - SWI Revenue by Segment, 2016-2021

Exhibit 152 shows SWI’s
.
October 27, 2021 122

Teradata Corporation (TDC)

“Cost of sales include the cost of recurring revenue, cost of perpetual software license and
hardware as well as the cost of consulting services.”
• The proportion of recurring, consulting, and perpetual software licenses and hardware.
• Changes in revenue mix can have an impact on gross profit and could move gross margins
higher over time.
• The proportion of various recurring revenue offerings that comprise the total of recurring
revenue. For example, a higher mix of subscriptions including hardware rentals could have a
negative impact on total recurring gross profit.
• Deal mix refers to the type of transactions closed within the period that generate the total
perpetual software license and hardware revenue. For example, a higher mix of hardware
versus software or the mix of Teradata versus third-party products can impact profitability.
Exhibit 153 - TDC Non-GAAP Gross Margin by Segment, 2017-2020

Exhibit 153 shows TDC’s non-
.
October 27, 2021 123

Exhibit 154 - TDC Gross Margin by Segment, 2017-2021

Exhibit 154 shows TDC’s non-
FY18.
.
Exhibit 155 - TDC Revenue by Segment, 2017-2020

Exhibit 155 shows TDC’s
.
October 27, 2021 124

Atlassian Corp. Plc (TEAM) — Not-Covered

Definition (from 20-F):
“Cost of revenues primarily consists of expenses related to hosting our cloud infrastructure, which
includes third-party hosting fees and depreciation associated with computer equipment and
software; compensation expenses for our employees, including share-based payment expense,
consulting and contractors costs, associated with our customer support and infrastructure service
teams; payment processing fees; amortization of acquired intangible assets; certain IT program
fees; and facilities and related overhead costs. To support our cloud-based infrastructure, we
utilize third-party managed hosting facilities and self-managed data centers. We allocate share-
based payment expense to personnel costs based on the expense category in which the employee
works. We allocate overhead such as information technology infrastructure, rent and occupancy
charges in each expense category based on headcount in that category. As such, general
overhead expenses are reflected in cost of revenues and operating expense categories.
Our cost of revenues also includes amortization of acquired intangible assets, such as the
amortization of the cost associated with an acquired company’s developed technology.”
What's included: Cloud infrastructure (hosting and depreciation), headcount, payment

processing, amortization of intangible assets, allocated overhead costs
What's not included: It is unclear if costs associated with free trials and free cloud editions for
core products (Jira, Confluence, Jira Service Management) are in cost of revenue or in sales and
marketing expense
• Revenue mix. TEAM has a very low professional services mix.

• Deployment. TEAM does not disclose gross margin by line item, but we expect on-premise
revenue is higher gross margin than cloud revenue.
• Cloud transition. As cloud (which is embedded in the subscription line) grows as a mix of
revenue, it will pressure gross margins overall. Given the end-of-life for many on-premise
products, we expect the cloud mix-shift to accelerate.
• Free trials and free users. We are unsure if this is included in COGS, but if it is, greater adoption
of free licenses could weigh on gross margins, especially the cloud versions that are offered
to incentivize cloud migrations.
October 27, 2021 125

Exhibit 156 - TEAM Non-GAAP Gross Margins, FY17-FY21

Exhibit 156 shows TEAM's
FY17
.
Exhibit 157 - TEAM Revenue Breadown, FY17-FY21

Exhibit 157 shows TEAM's
subscription since FY17
.
October 27, 2021 126

Twilio, Inc. (TWLO)

Cost of revenue consists primarily of fees paid to network service providers. Cost of revenue
also includes cloud infrastructure fees, direct costs of personnel, such as salaries and
stock#based compensation for our customer support employees, and non#personnel costs, such
as depreciation and amortization expense related to data centers and hosting equipment,
amortization of capitalized internal use software development costs and acquired intangibles.
Our arrangements with network service providers require us to pay fees based on the volume of
phone calls initiated or text messages sent, as well as the number of telephone numbers acquired
by us to service our customers. Our arrangements with our cloud infrastructure provider require
us to pay fees based on our server capacity consumption.
Our gross margin has been and will continue to be affected by a number of factors, including the
timing and extent of our investments in our operations, our product mix, our ability to manage
our network service provider and cloud infrastructure#related fees, including Application to
Person SMS fees, the mix of U.S. revenue compared to international revenue, changes in foreign
exchange rates and the timing of amortization of capitalized software development costs and
acquired intangibles and the extent to which we periodically choose to pass on our cost savings
from platform optimization efforts to our customers in the form of lower usage prices.
Historically, a substantial majority of our cost of revenue has been network service provider
fees. We continue to optimize our network service provider coverage and connectivity through
continuous improvements in routing and sourcing in order to lower the usage expenses we incur
for network service provider fees. As we benefit from our platform optimization efforts, we
sometimes pass these savings on to customers in the form of lower usage prices on our products
in an effort to drive increased usage and expand the reach and scale of our platform. In the near
term, we intend to operate our business to expand the reach and scale of our platform and to
grow our revenue, rather than to maximize our gross margins.”
What's included: Network service provider fees, cloud infrastructure, headcount, depreciation
of data centers and hosting, amortization of capitalized software and intangible assets
• Revenue mix. TWLO has one of the most complex gross margin stories in our coverage
universe. Different products have different gross margin profiles, due to the COGS profile of
each. Messaging is the lowest gross margin item, but also the biggest portion of the business
(noting that messaging accelerated during the pandemic). Over time, as TWLO moves “up the
stack”, we expect gross margins to improve as a result of higher gross margin items, especially
application services.
• Network fees. Related to the prior point, roughly 85% of the COGS structure is network fees
and within that, we believe ~30% are transit fees, while the remaining 70% are carrier fees,
which are entirely pass-through (effectively 0% gross margins).
• Pricing. To the extent TWLO faces pricing pressure from competitors (especially from
customers who multi-source), that could weigh on gross margins.
• Geography. International is significantly lower gross margin than domestic, especially in
geographies where TWLO doesn't have scale. We note that international is about half the voice
and messaging business (based on origin). International is such an important factor that not
October 27, 2021 127

only is international messaging lower gross margin than domestic messaging, but international
voice is lower gross margin than domestic messaging. In addition, we believe certain countries
where TWLO has scale (e.g. UK) have better gross margins than newer geographies.
• A2P/10DLC fees. These fees are generally 0% gross margin and lead to lower overall gross
margins. We believe there are some quarters where TWLO recognized no revenue from
A2P/10DLC, but did have costs, making it a negative gross margin item in those quarters.
• Syniverse partnership. As we outlined in our recent report, we believe the Syniverse
partnership could result in a 200+ bps uplift to domestic messaging gross margins.
Exhibit 158 - TWLO Non-GAAP Gross Margins, 2016-2020

Exhibit 158 shows TWLO's
2016. Gross margins peaked
in 2019 and have declined
since then. TWLO's gross
margins are complex and have
a number of drivers.
.
October 27, 2021 128

Exhibit 159 - TWLO International Revenue Mix, 2016-2020

Exhibit 159 shows TWLO's U.S.
and International revenue
mix since 2016. We note this
split is based on revenue, but
based on origin, the mix for
voice/messaging is closer to
50-50.
.
Exhibit 160 - TWLO Revenue Breakdown, 2017-1H20

revenue mix by product
segment from 2017-2019 and
in 1H20. This breakdown has
not been disclosed since.
.
October 27, 2021 129

Exhibit 161 - TWLO Non-GAAP Gross Margins by Product Segment in 1H20

product segment in 1H20 (has
not been disclosed since)
.
2U, Inc. (TWOU) — Not-Covered

Although TWOU does not report a cost of revenue line item, we treat curriculum and teaching
plus servicing and support as cost of revenue. We note TWOU only includes curriculum and
teaching as a cost of revenue line item (based on the last Analyst Day).
Curriculum and teaching
“Curriculum and teaching expense consists primarily of amounts due to universities for licenses
to use their brand names and other trademarks in connection with our short course and boot
camp offerings. The payments are based on contractually specified percentages of the tuition and
fees we receive from students in those offerings. Curriculum and teaching expense also includes
personnel and personnel-related expense for our short course and boot camp instructional staff."
Servicing and support
"Servicing and support expense consists primarily of personnel and personnel-related expense
associated with the management and operations of our educational offerings, as well as
supporting students and faculty members. Servicing and support expense also includes costs to
support our platform, facilitate in-program field placements and student immersions, and
assist with compliance requirements.”
What's included: License fees for short courses and boot camps (GetSmarter and Trilogy),
headcount (related to short courses, boot camps, support, servicing), placement services.
What's not included: Amortization of capitalized content and developed technology and hosting,
which we would consider to be cost of revenue line items.
October 27, 2021 130

• Revenue mix. Alternative credentials (based on the GetSmarter and Trilogy acquisitions)
recognize revenue on a gross basis (versus graduate on a net basis), which weighs on gross
margins. We expect this segment to grow as a percentage of revenue, which should drag down
overall gross margins. In addition, we would note that most of Trilogy's business (pre-COVID)
was in-person, which should be meaningfully lower gross margin than a software or online
services business.
• Program age and scale. More established programs likely have lower costs associated than
newly-launched programs.
Exhibit 162 - TWOU Non-GAAP Gross Margins, 2016-2020

Exhibit 162 shows TWOU's
2015
.
Exhibit 163 - TWOU Revenue Breakdown, 2016-2020

Exhibit 163 shows TWOU's
revenue mix shift since 2016,
with Alternative Credential
now a significant piece of total
revenue
.
October 27, 2021 131

Veeva Systems Inc (VEEV)

“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 and Amazon
Web Services, personnel related costs associated with hosting our subscription services and
providing support, including our data stewards, data acquisition costs, expenses associated with
computer equipment and software, allocated overhead, and amortization expense associated
with certain purchased intangibles related to our subscription services. 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, make additional investments
in the availability and security of our solutions, and make continued investments in data sources.”
“Cost of professional services and other revenues consists primarily of employee-related

expenses associated with providing these services. 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.”
What's included: Cloud infrastructure (AWS hosting), royalty payments (Salesforce.com, Zoom,
AWS Redshift), headcount, computer equipment and software, allocated overhead, and
amortization of intangible assets
• Revenue mix. Subscription has significantly higher gross margins than professional services;
as the subscription mix grows, we would expect gross margins to expand. We also note that
VEEV runs its services at a relatively healthy profit.
• Revenue mix in Vault. Vault has a meaningfully higher services mix than CRM, partly because
of the amount of new Vault applications launched. Over time, we expect the services attach
rate on Vault to decline, lowering the overall services mix.
• Product mix. As we illustrated in our case study, non-CRM products (primarily Vault) have
higher gross margins because of the lack of royalty payments.
• Royalty payments. CRM is the largest source of royalty paments (to Salesforce.com), but other
products also have royalty payments associated with them, including CRM Engage (Zoom) and
Nitro (AWS Redshift).
October 27, 2021 132

Exhibit 164 - VEEV Non-GAAP Gross Margins, FY17-FY21

Exhibit 164 shows VEEV's
revenue line item since FY17
.
Exhibit 165 - VEEV Non-GAAP Subscription Gross Margins Breakdown, FY17-FY21

non-GAAP subscription gross
margins breakdown (CRM vs.
non-CRM) since FY17
.
October 27, 2021 133

Exhibit 166 - VEEV Revenue Breakdown by Line Item, FY17-FY21

revenue mix by line item
which has been relatively
stable since FY17
.
Exhibit 167 - VEEV Revenue Breakdown by Product Segment, FY17-FY21

revenue mix shift to Vault
from Commercial Cloud since
FY17
.
October 27, 2021 134

VMware, Inc. (VMW)

“Cost of license revenue primarily consists of the cost of fulfillment of our SD-WAN offerings,
royalty costs in connection with technology licensed from third-party providers and amortization
of intangible assets. The cost of fulfillment software and hardware SD-WAN offerings includes
personnel costs and related overhead associated with delivery of our products.
Cost of subscription and SaaS revenue primarily includes personnel costs and related overhead
associated with hosted services supporting SaaS offerings. Additionally, cost of subscription
and SaaS revenue also includes depreciation of equipment supporting subscription and SaaS
offerings.
Cost of services revenue primarily includes the costs of personnel and related overhead to deliver
technical support for products and costs to deliver professional services. Additionally, cost of
services revenue includes depreciation of equipment supporting service offerings.”
• Gross margin is driven by the license, subscription and SaaS, and services segments.
• The license segment contributed 28.9% of the total gross margin with a margin percentage of
96.1% in the most recent year.
• The subscription and SaaS segment contributed 21.9% of the total gross margin with a gross
margin percentage of 85.2% in the most recent year.
• The Services segment contributed the most to total gross margin at 49.2% of the latest year
with a margin percentage of 80.6%. We note that maintenance/support is roughly 80% of the
services line and much higher gross margin than professional services.
Exhibit 168 - VMW Non-GAAP Gross Margin, 2018-2021

Exhibit 168 shows VMW’s
FY18.
.
October 27, 2021 135

Exhibit 169 shows VMW’s Exhibit 169 - VMW Gross Margin by Segment, 2018-2021
FY18.
.
Exhibit 170 - VMW Revenue by Segment, 2018-2021

Exhibit 170 shows VMW’s
.
October 27, 2021 136

Varonis Systems, Inc. (VRNS)

“Our cost of revenues consists of cost of maintenance and services revenues. Cost of maintenance
and services revenues consist primarily of salaries (including payroll tax expense related to
stock-based compensation), employee benefits (including commissions and bonuses) and stock-
based compensation for our maintenance and services employees; travel expenses; and allocated
overhead costs for facilities, IT and depreciation. We recognize expenses related to maintenance
and services as they are incurred. We expect that our cost of maintenance and services revenues
will increase in absolute dollars as we continue to invest in our customer success and professional
services teams and programs that support our subscription-based business model and our overall
renewals. This spending increased sequentially in each quarter of 2020 and, given our results and
the opportunities we see ahead, our incremental increase in investments was larger in the second
half of the year. We expect to continue to increase our investments in the business in the future.
Gross profit is total revenues less total cost of revenues. Gross margin is gross profit expressed
as a percentage of total revenues. As the majority of our expenses are relatively fixed quarter
over quarter and due to the seasonality of our business, the first quarter typically results in the
lowest gross margin as our first quarter revenues have historically been the lowest for the year.
Conversely, the fourth quarter typically results in the highest gross margin as our fourth quarter
revenues have historically been the highest for the year.
Amortization expense of developed technology and trademarks are recorded within cost of
revenues and sales and marketing, respectively, in the consolidated statements of operations.”
What's included: Headcount, allocated overhead costs (facilities, IT, depreciation), and
amortization of developed technology
• Gross margin is driven almost equally by the licenses and subscription and maintenance and
service segments.
• Quarter over quarter costs are fairly steady, so gross margin is mainly driven by pricing power
and control of variable costs.
• Gross margins have been pressures lightly by additional new subscription offerings.
October 27, 2021 137

Exhibit 171 - VRNS Non-GAAP Gross Margins, 2016-2020

Exhibit 171 shows VRNS' non-
2016
.
Exhibit 172 - VRNS Revenue Breakdown, 2016-2020

Exhibit 172 shows VRNS'
subscription since 2016
.
October 27, 2021 138

Verint Systems Inc. (VRNT)

“Cost of product revenue primarily consists of hardware material costs and royalties due to
third parties for software components that are embedded in our software solutions. Cost of
product revenue also includes amortization of capitalized software development costs, employee
compensation and related expenses associated with our global operations, facility costs, and
other allocated overhead expenses. In our Cyber Intelligence segment, cost of product revenue
also includes employee compensation and related expenses, contractor and consulting expenses,
and travel expenses, in each case for resources dedicated to project management and associated
product delivery.
Cost of service and support revenue primarily consists of employee compensation and related
expenses, contractor costs, hosting infrastructure costs, and travel expenses relating to
installation, training, consulting, and maintenance services. Cost of service and support revenue
also includes certain stock-based compensation expenses, facility costs, and other overhead
expenses. In accordance with GAAP and our accounting policy, the cost of service and support
revenue is generally expensed as incurred in the period in which the services are performed.”
• Mix-shift between software and professional services revenue.

• Employee headcount costs and travel expense.
• Data center and cloud costs associated with cloud revenue.
Exhibit 173 - VRNT Non-GAAP Gross Margin, 2020-2021
Exhibit 173 shows VRNT’s non-
FY20.
.
October 27, 2021 139

Exhibit 174 - VRNT Revenue BReakdown, 2020-2021

Exhibit 174 shows VRNT’s
mix between software and
professional services revenue
since FY20.
.
Workday, Inc. (WDAY)

“Costs of subscription services revenue consist primarily of employee-related expenses associated

with hosting our applications and providing customer support, data center expenses, and
depreciation of computer equipment and software."
"Costs of professional services revenue consist primarily of employee-related expenses associated

with these services, subcontractor expenses, and travel expenses.
We expect GAAP and non-GAAP costs of professional services as a percentage of total revenues
to continue to decline as we continue to rely on our service partners to deploy our applications
and as the number of our customers continues to grow.”
What's included: Hosting and datacenter infrastructure, headcount and subcontractors,

depreciation of computer equipment and software
• Revenue mix. WDAY has a relatively high professional services mix, but this has been declining
over time, raising the overall gross margin profile.
• M&A. WDAY has been somewhat acquisitive over the past few years, which may weigh on
overall gross margins.
October 27, 2021 140

Exhibit 175 - WDAY Non-GAAP Gross Margins, FY17-FY21
Exhibit 175 shows WDAY's
segment since FY17
.
Exhibit 176 - WDAY Revenue Breakdown, FY17-FY21

Exhibit 176 shows WDAY's mix
shift to subscription revenue
since FY17
.
October 27, 2021 141

Xometry, Inc. (XMTR)

Definition (from 10-Q):
“Cost of revenue primarily consists of the cost of the products that are manufactured by
the Company’s sellers for delivery to buyers on Xometry’s platform, internal production costs,
shipping costs and certain internal depreciation.”
• Gross margin is primarily effected by liquidity of the seller network and the efficiency of pricing.
• Adding more sellers to increase the amount of available products and services will add scale
to operations and increase gross margins.
• Additionally additional financial services offerings could boost gross margins over time.
Exhibit 177 - XMTR Non-GAAP Gross Margin, 2019-2020
Exhibit 177 shows XMTR’s
FY19.
.
Ziff Davis, Inc. (ZD)

Non-GAAP Gross Margin: 84.6% in 2020.
Definition (from 10-K): "Cost of revenues is primarily comprised of costs associated with network
operations, content fees, editorial and production costs, customer service, database hosting and
online processing fees.”
What's included: Content, infrastructure, support, payments, and licenses.
• Media vs. cloud mix. While cloud is higher EBITDA margin, media is higher gross margin. As
such, media comprising a greater portion of revenue helps raise overall gross margins.
• M&A. ZD is an acquisitive business and M&A likely weighs on gross margins until the
acquisition is fully digested and optimized.
October 27, 2021 142

• Content investments. On the media side, ZD has content development costs that impat gross
margins.
Exhibit 178 - ZD Revenue Mix, 2016A-2020A
Exhibit 178 shows JCOM's (ZD's
predecessor) revenue mix by
line item from 2016-2020.
.
Exhibit 179 - ZD Non-GAAP Gross Margins by Segment, 2016A-2020A

Exhibit 179 shows JCOM's non-
item from 2016-2020. We note
for purposes of this analysis,
we're using JCOM as a whole
and not separating out ZD/
CCSI (due to lack of historical
financials), but to a certain
extent, we can think of media
as a proxy for ZD and cloud as a
proxy for CCSI.
.
October 27, 2021 143

Zendesk, Inc. (ZEN) — Not-Covered

“Cost of revenue consists primarily of personnel costs (primarily including salaries, share-based
compensation, and benefits) for employees associated with our infrastructure, product support,
and professional service organizations, and expenses for hosting capabilities, primarily for
third-party managed hosting services and costs associated with our self-managed colocation
data centers. Cost of revenue also includes third-party license fees, payment processing
fees, amortization expense associated with acquired intangible assets, amortization expense
associated with capitalized internal-use software, and allocated shared costs. We allocate shared
costs such as facilities, information technology, and security costs to all departments based on
headcount. As such, allocated shared costs are reflected in cost of revenue and each operating
expense category.
We utilize third-party managed hosting facilities located in North America, Europe, Asia and
Australia to host our services, support our infrastructure, and support certain research and
development functions. In the first quarter of 2019, we completed the transition of our customers
from self-managed colocation data centers to third-party managed hosting services.
We intend to continue to invest additional resources in our infrastructure, professional service

organizations, and product support organically and through acquisitions. We expect that recent
and future business acquisitions will result in increased amortization expense of intangible assets
such as acquired technology. As we continue to invest in technology innovation, we expect to
continue to incur capitalized internal-use software costs and related amortization. We expect
these investments in technology to not only expand the capabilities of our solutions but also
to increase the efficiency of how we deliver these services, enabling us to improve our gross
margin over time, although our gross margin may decrease in the near-term and may vary from
period to period as our revenue fluctuates and as a result of the timing and amount of these
investments. To the extent that we continue to rely on third-party technology to provide certain
functionality within our solutions or for certain subscription plans or integrations, we expect
third-party license fees for technology that is incorporated in such solutions and subscription
plans to remain significant over time.”
What's included: Headcount, hosting (primarily third-party managed), third-party license,

payment processing, amortization of intangible assets and capitalized software, and allocated
overhead
What's not included: It is unclear if free trials (14 days) or free products are in sales and
marketing or cost of revenue
• Revenue mix. ZEN does not disclose the breakdown of subscription versus services, but we
believe the services mix is relatively low.
• Public cloud migration. ZEN migrated from co-located data centers to AWS. During the
transition, ZEN was likely paying duplicative costs, but now that the transition is complete,
gross margins have improved meaningfully.
October 27, 2021 144

Exhibit 180 - ZEN Non-GAAP Gross Margins, 2016-2020

Exhibit 180 shows ZEN non-
2016
.
ZoomInfo Technologies, Inc. (ZI)

“Cost of service, excluding amortization of acquired technology includes direct expenses related
to the support and operations of our SaaS services and related to our research teams,
including salaries, benefits, equity-based compensation, and related expenses, such as employer
taxes, allocated overhead for facilities, IT, third-party hosting fees, third-party data costs, and
amortization of internally developed capitalized software.
We anticipate that we will continue to invest in costs of service and that costs of service as a
percentage of revenue will stay consistent or modestly decrease as we realize operating leverage
in the business.
Amortization of acquired technology. Amortization of acquired technology includes amortization

expense for technology acquired in business combinations. We anticipate that amortization of
acquired technology will only increase if we make additional acquisitions in the future.”
What's included: Headcount, allocated overhead for facilities, IT, hosting, data, and amortization
of capitalized software
What's not included: GAAP results exclude the amortization of acquired technology (usually
included in GAAP but adjusted out of non-GAAP)
• Data costs. We expect that ZI gets scale benefits from third-party data costs; if ZI adds more
third-party data sources, that could weigh on margins.
• M&A. Acquisitions could weigh on gross margins, especially if any of the acquired businesses
have a meaningful professional services component.
October 27, 2021 145
Exhibit 181 - ZI Non-GAAP Gross Margins, 2018-2020

Exhibit 181 shows ZI non-
2018
.
October 27, 2021 146

Zoom Video Communications, Inc. (ZM)

“Cost of revenue primarily consists of costs related to hosting our unified communications
platform and providing general operating support services to our customers. These costs are
related to our co-located data centers, third-party cloud hosting, integrated third-party PSTN
services, personnel-related expenses, amortization of capitalized software development and
acquired intangible assets, royalty payments, and allocated overhead. We expect our cost of
revenue to increase in absolute dollars during the upcoming fiscal year, as we expand our data
center capacity due to increased usage stemming from the COVID-19 pandemic.
However, the cost of revenue as a percentage of revenue may decrease over time as we scale
our data centers to accommodate usage from our increased customer base and as the ratio of
free to paid users varies.”
What's included: Hosting (co-location, cloud, PTSN), headcount, amortization of capitalized

software and acquired intangible assets, royalty payments, and allocated overhead
• Revenue mix. Professional services is <2% of revenue, owing to the ease-of-use and
deployment. This low services mix serves as a meaningful tailwind to gross margins.
• Product mix. We believe Zoom Phone is lower gross margin than Meetings, owing to the
connectivity component. While ZM does not disclose the size of Phone today, as it becomes
a bigger part of the business, this could serve as a headwind to gross margins. Over time,
management expects Phone gross margins to improve towards Meetings' gross margin profile.
• Free users. ZM (correctly) categorizes free users as a COGS item, instead of an S&M item.
The big uptick in free users (including K-12, where the product was given out for free) led to
meaningful gross margin pressure during the pandemic. We do believe this is the right move
in the long-term.
• Network efficiency. During the pandemic, ZM had to lean more heavily on public cloud
providers (primarily AWS, but also OCI), which weighed on gross margins.
• Customer mix. We believe the ≤10 employee cohort is higher gross margin, purely on a
revenue basis (owing to lower utilization rates), but also believe that cohort drags along more
free users. As the mix shifts more heavily towards enterprise post-pandemic, we believe this
should serve as a tailwind to gross margins.
October 27, 2021 147

Exhibit 182 - ZM Non-GAAP Gross Margin, FY17-FY21

Exhibit 182 shows ZM's non-
FY17, including the significant
contraction in FY21 as a result
of rapid increases in free trial
volumes and data center
capacity utilization
.
Exhibit 183 - ZM Revenue Breakdown, FY17-FY21

Exhibit 183 shows ZM's rapid
revenue mix shift to <10
employees during COVID-19 in
FY21, however we expect that
mix to decline moving forward
as some paid consumers
churns post-COVID-19 to free
trials and corporate accounts
.
October 27, 2021 148

Zscaler, Inc. (ZS)

“Cost of revenue includes expenses related to operating our cloud platform in data centers,
depreciation of our data center equipment, related overhead costs and the amortization of our
capitalized internal-use software. Cost of revenue also includes employee-related costs, including
salaries, bonuses, stock-based compensation expense and employee benefit costs associated
with our customer support and cloud operations organizations. Cost of revenue also includes
overhead costs for facilities, IT, amortization and depreciation expense.”
• Gross margin is driven by the sales of their subscription business and related services.
• With scale the main negative impact is increased bandwidth and data center expenses.
Exhibit 184 - ZS Non-GAAP Gross Margin, 2018-2021
Exhibit 184 shows ZS’s non-
.
October 27, 2021 149

The Winner Effect

Over the past few years, we have observed a trend we dub the “Winner Effect”, whereby stocks
that have outperformed in the past have continued to outperform over time. This was the case in
2020, despite COVID, however, in 2021, this trend doesn't seem holding up to the same extent;
the stocks that performed the best in 2020 have not necessarily been the strongest performers
in 2021. Specifically, 90 of 108 software stocks rose in 2020, of which only 59 (66%) have been
positive in 2021. In contrast, in 2019, 79 software stocks rose, of which 70 (90%) rose in 2020.
Exhibit 185 - The Winner Effect in 2021
.
Source: RBC Capital Markets, FactSet
Exhibit 186 - The Winner Effect in 2020
.
October 27, 2021 150

Returns by Style
High growth software companies have outperformed low growth companies over the last few
years. In 2021 (Exhibit 187), this trend seems to be holding up with high growth (>20%) stocks
up 23% YTD, medium growth (10-20%) stocks up 13% YTD, and low-growth (<10%) stocks up 9%
YTD. From 2019 to present, high growth (>20%) stocks delivered a total 450% return or an 83%
CAGR versus medium growth (10-20%) stocks' return of 238% or a 42% CAGR and low growth
(<10%) stocks' return of 173% or a 24% CAGR.
Exhibit 187 - Stock Returns for High, Medium, and Low Growth Software, 2019-2021
.
October 27, 2021 151

Valuation
Our analysis of the software sector through this report is based on our proprietary RBC Software
Index ("The Index"). The index is an equal-weighted index of 153 publicly traded software
companies. Exhibit 188 shows the performance of the Index since 2016. Exhibits 189 and 190
show the components of the Index, separated by Application and Infrastructure software.
Exhibit 188 - RBC Software Index (end of 2016 = 100)
.
Source: RBC Capital Markets, Factset
October 27, 2021 152

Exhibit 189 - Application Software Comps
.
Source: RBC Capital Markets, Factset consensus for all names
October 27, 2021 153

Exhibit 190 - Infrastructure Software Comps
.
Source: RBC Capital Markets, Factset consensus for all names
October 27, 2021 154

Rule of 40
We see Rule of 40 as an important metric for investors, though perhaps more of a guideline than
a rule. The Rule attempts to take a holistic and balanced view of growth and profitability, with
the idea that organic revenue growth plus a profitability margin should exceed 40%. We choose
to use FCF margin as the measure of profitability, as we see it as a better metric than EBITDA
despite its greater volatility from year to year, and we also use multi-year averages, which we
believe reduced the problem of outlier years for both components of the measure.
Exhibit 191 shows the Rule of 40 for CY20 for every company in The Index. Exhibit 192 shows the
same but excluding Zoom which was a significant positive outlier.
Exhibit 191 - Rule of 40
.
Source: RBC Capital Markets, FactSet consensus
Exhibit 192 - Rule of 40 (excluding Zoom)
.
We view the Rule of 40 as useful for at least three reasons:
1. It is a simple but effective heuristic for identifying companies that are underperforming or
are executing at a high level. Software companies tend to converge around the 40% level, so
a company with a score of 20% almost certainly has significant room for improvement, while
a company with a score of 60% is almost certainly best-in-class.
2. It allows a normalized method for comparing companies at different points in their lifecycles.
A company growing 20% with 20% FCF margins is likely a better company than one growing
30% with FCF burn, or one that earns 25% margins and is growing less than 5%.
3. There is a reasonably strong correlation between a company’s Rule of 40 score and its
valuation. Across the full public software universe, there is a 30% correlation between the
two. Exhibit 193 shows this correlation, while Exhibit 194 shows the same, but excluding
outliers like ZM, SNOW, and PATH.
October 27, 2021 155
Exhibit 193 - Rule of 40 - RBC Software Index
.
Source: RBC Capital Markets, FactSet Consensus
October 27, 2021 156

Exhibit 194 - Rule of 40 - RBC Software Index (excluding outliers)
.
Caveats to keep in mind:
• Organic growth is not always easy to calculate, let alone disclosed. We can estimate it
fairly accurately within our active coverage list, but not across all 100+ software companies.
Acquisitions tend to be margin dilutive near-term, partially mitigating this problem in the
combined score, and we can adjust for larger deals, but the numbers will never be perfectly
clean.
• Out year consensus estimates may underestimate a company’s ongoing growth and earnings
power, especially given most management teams’ guidance philosophies. This is one reason
why we use multi-year averages.
• There is a lag between when a company makes an investment and its impact on revenue (and
vice versa). If a company is underinvesting now, particularly in long-term areas like R&D and
pipeline generation, it can boost margins short-term with only minimal revenue growth effects.
Again, this is a reason we use multi-year averages
• There is not a 1:1 trade-off between growth and margin from investors’ perspectives, based
on our experience, as investors value growth above margin in the current environment. For
example, a company growing 40% with breakeven margins would garner a higher multiple
than one growing 10% with 30% FCF margins. This is partly because a company can sacrifice
margin now and grow instead before focusing on margins, thus growing the terminal FCF (in
dollar terms) even if the long-term margin is the same.
October 27, 2021 157

IPOs
2021 has been a banner year for software IPOs, eclipsing prior years by a wide margin both
in terms of number of offerings and dollar raised. There have been a number of high-profile
software companies going public so far in 2021 including PATH, FRSH, TOST, MNDY, CFLT, and
S. We note that 2021 follows 2020, itself a record year with its own impressive list of public
offerings including PLTR, SNOW, and U.
Compared to the same period in 2020, the number of IPOs was up an eye-popping 125% and total
dollar amount raised was up 85%. Compared to the same periods in 2019 and 2018, number of
IPOs was up 227% and 125%, respectively, and total dollar raised compared to the same periods
in 2019 and 2018 was up 425% and 288%, respectively.
While some names have seen particularly strong reception (such as TOST's 56% day one pop),
we note that the magnitude of day one pops has rationalized a bit in 2021 compared to prior
years. The average day one pop for software IPOs that we've tracked was 20% in 2021 compared
to 62% and 50% in the same periods in 2020 and 2019, respectively. We would attribute this
rationalization to a few factors including healthy valuations at initial pricing, the volume of IPOs
(not to mention the tidal wave of SPACs which are excluded from this analysis), and some degree
of investor fatigue related to new offerings.
Looking forward to next year, we do see some puts and takes but overall we expect 2022 to be a
strong year for IPOs (albeit below 2021's record numbers). On the positive side, higher multiples
and greater appetite from investors for unprofitable companies (we note that Confluent had
negative (38%) non-GAAP operating margins in its last fiscal year) should help drive more
companies to public markets. On the other hand, the price rationalization among some high-
growth or digital transformation beneficiaries does point to a less-frothy or a (relatively) more
price-sensitive market and we do expect the “rush for the gates” on public offerings to subside
somewhat in 2022.
Exhibit 195 shows the number of software IPOs since 2016 and amount raised. We note that
SPACs are not included in this analysis.
Exhibit 195 - IPOs 2016-2021, count and funding raised ($, millions)
.
Source: RBC Capital Markets, FactSet, company reports
October 27, 2021 158

Exhibit 196 shows the average money raised per IPO (for purposes of money raised per IPO, we
exclude WORK, ASAN, PLTR, and AMPL as these direct listings raised no capital).
Exhibit 196 - $ Raised Per IPO, 2016-2021, in millions
.
Source: RBC Capital Markets, FactSet, company reports
Exhibit 197 shows the performance of the 100 software IPOs we’ve tracked since 2016. A vast
majority of software IPOs (82%) are still up from their IPO price, with only eighteen currently
trading below the IPO (or reference) price (including BLND, EVCM, MQ, MSP, ONTF, RXT, SUMO,
SWI, TUFN, VERX, WKME, ZETA). The aggregate return from IPO to date is 256%. Interestingly,
several of the recent IPOs have been bought including: TLND, MULE, CLDR, WORK, APTI, SEND,
CBLK, PVTL, and PS (returns reflect the closing price on the days the acquisitions closed).
Exhibit 197 - IPOs 2016-2021, stock returns
.
Exhibit 198 shows the performance of these software IPOs from the day one close, typically
thought to be the height of "IPO hype", to October 25th. The track record here is solid, with
64/100 companies up from day one close. The aggregate return for a theoretical investor who
bought all software stocks on day one close is up 148%, bolstered by 500%+ returns from multiple
October 27, 2021 159
stocks, including APPN, BAND, COUP, DOCU, EVBG, MDB, OKTA, TWLO, and ZS. This strong
performance illustrates why investors, both institutional and retail, continue to buy IPOs.
Exhibit 198 - IPOs 2016-2021, Stock Returns from Day 1 Close
.
As seen in Exhibit 199, many of these IPOs have high valuation multiples with 29 names in excess
of 20x EV/CY22E revenue out of 96 where consensus estimates are available. 49/96 eligible IPOs
are trading above the median software multiple of 12x EV/CY22E revenue and fourteen trading
above 30x EV/CY22E revenue.
Exhibit 199 - IPOs 2016-2021, consensus EV/Revenue
.
October 27, 2021 160

SPACs This quarter, we are adding a SPAC tracker for all software companies that have come public
via SPAC, including return versus $10/share (which is effectively the equivalent to an IPO price
or reference price). SPACs have become popular for a number of reasons, including the ability
to provide long-term forecasts, but also do note enterprise software SPAC traction has been
somewhat limited. The below companies are all companies that bill themselves as software
companies; however, we would note many of these companies are not included in the RBC
Software Index for various reasons, especially if a majority of revenue is not software. As we
note in the headline topic of this whitepaper, gross margins are a useful tool to separate true
software companies from “SaaS pretenders.”
Exhibit 200 - SPAC Returns From Initial Reference Price ($10/Share)

Exhibit 200 shows SPAC returns
versus $10/share (which is
effectively the equivalent to an
IPO price or reference price)
.
October 27, 2021 161

M&A
Since our last M&A update published in our previous whitepaper (see here), we counted 28
additional M&A deals in software. Now the number of M&A deals year-to-date is 148 in our
tracker, well ahead of recent years (45 in 2020, 51 in 2019, and 64 in 2018). On a dollar basis,
there has been an additional $18B in deal value since our last M&A update even after the mutual
termination of Zoom's acquisition of Five9 (we removed the associated $13.8B of deal value from
the tracker). Total deal value year-to-date in 2021 is $205B, well above totals in the past 5 years
with the next closest being $139B in 2018.
We highlight there were several large strategic acquisitions announced in 3Q21, the largest
of which was Intuit's $11.7B acquisition of email marketing vendor Mailchimp. Other notable
strategic deals in the quarter were Adobe's purchase of Frame.io for $1.3B and Qualtrics'
purchase of Clarabridge for $1.1B. Overall, we continue to see a healthy strategic M&A
environment with companies willing to pay a premium for strong assets, and we point to Intuit's
Mailchimp acquisition as an example of this. That said, we do see the large purchase price as
justified given Mailchimp's solid growth at scale (~$800M revenue in CY20 on ~20% growth),
strong secular trends, and the potential synergies of the combination.
Following large scale strategic M&A in software, shares of the acquirer often trade sideways (or
down), unless there are abundantly clear cross-selling synergies and the target is either accretive
to growth or margins. We point to Salesforce's acquisition of Slack, where the strategic rationale
wasn't immediately clear and investors expressed concerns on margin dilution. Salesforce shares
traded down (5%) from $260 when the deal was first reported in the media on Nov-25-2020
and fell an additional (9%) when the definitive agreement was confirmed by Salesforce on
Dec-1-2020. Despite several quarters of solid earnings reports following the announcement,
shares traded sideways until 9 months later in late Aug-2021 when the company was able to
alleviate some concerns over dilution. Salesforce is now trading ~$290, up 12% from the pre-
acquisition price vs. the NASDAQ up 24% over that same period. In contrast, Twilio's stock rose
8% on Oct-12-2020 when it announced its intent to acquire Segment and Bill.com shares were
up 18% on May-5-2021 announced its intent to acquire Divvy.
Although we still view stock as an attractive method of funding for strategic acquisitions
(especially with the rebound in software over the last few weeks), we expect all-stock (or mostly
stock) proposals to be less frequent and approached with heavy skepticism after the fall-out of
the Zoom-Five9 deal. Zoom shares dropped 12% following the company's F2Q earnings report
due to conservative guidance that fell short of investors' expectations. The stock was unable to
recover, ultimately leading to the disapproval of the merger by Five9 shareholders (since their
payout from the transaction decreased in lock-step with the decline in Zoom shares). Zoom
decided not to sweeten the deal with additional share dilution or adding in a cash component,
which we believe was surprising to most (see our note here).
Private equity firms continue to buy out public software companies, a trend we see continuing
indefinitely given the inherently strong margin and retention profile of SaaS. Some large
financial acquisitions in the quarter included Thoma Bravo's purchase of voice of the customer
vendor Medallia for $5.6B (pending close on 11/1), Clearlake Capital Group's buyout of talent
management vendor Cornerstone OnDemand for $4.5B, and Vista Equity Partners' takeout
of RPA vendor Blue Prism for $1.3B. We note the valuations for Medallia and Cornerstone
OnDemand were roughly 9x and 5x forward revenue estimates, respectively. This is about in-line
with other large PE takeouts earlier in the year (CLDR at 6x, PFPT at 7x, and TLND at 7x)
In our view, recent PE takeouts suggest the floor multiple for attractive acquisition candidates
(growing in the teens to low-20% range) is roughly 5x forward revenue. Of our coverage group,
we see New Relic and Dropbox as the most suitable candidates for private equity takeouts. New
October 27, 2021 162

Relic and Dropbox trade at EV/2022E revenue multiples of 6x and 5x, respectively, and Dropbox
while growing slower, generates strong FCF. In our view, Dropbox as well as Smartsheet are good
targets for strategic buyers as both could unlock significant value as part of a larger platform.
Smartsheet trades at a premium multiple of 13x EV/2022E revenue due to its premium growth.
On the flipside, we believe Microsoft and Zoom are the most likely to pursue large scale
transactions in our coverage group while DocuSign and Smartsheet are most likely to make
smaller, tuck-in acquisitions.
Exhibit 201 shows the number of deals and the aggregate deal value in each year since 2016.
We point out that we have selectively excluded certain acquisitions that we don't consider
as software transactions, such as Teledoc's acquisition of Livongo and Square's acquisition of
AfterPay. Additionally, we note that SPACs are not included in this analysis.
Exhibit 201 - M&A Count and Aggregate Value ($B), 2016-2021
.
October 27, 2021 163

Corporate Access Recap

NICE: We hosted investor meetings with VP of Investor Relations Marty Cohen. Our key
takeaways were: 1) cloud conversions from existing WFO customers are moving slow but have a
high ACV uplift and low (if any) churn; 2) we expect measured gross margin expansion to SaaS-
like high-70% margins; 3) we view NICE as benefiting from the move to a hybrid work future; and
4) management believes the future of work will be hybrid and expects to provide a longer term
tailwind to the business. For further reading, please see our note titled: "On the (Virtual) road
with NICE; Cloud, Competition, Margins, and Future of Work"
ZM: We hosted investor meetings with CFO Kelly Steckelberg, Head of Investor Relations Tom
McCallum, and Manager, Investor Relations Charles Eveslage. Our key takeaways were: 1)
Phone commentary was positive on GTM/traction (although pricing remains discounted); 2)
≤10 employee cohort revenue is expected to decline as a percent of revenue over the next 3-5
quarters; and 3) management didn't comment on the (at the time) pending deal with Five9
(which was terminated a few days later) but was bullish on Five9 noting a surprising number
of undisclosed enterprise logos. Further, management was positive on Zoom's potential in the
CCaaS space, mentioning its Video Engagement Center a number of times. For further reading,
please see our note titled: "On the (Virtual) Road with ZM; Phone, Five9, Churn, and Margins"
October 27, 2021 164

Top Picks
Rishi Jaluria's Top Picks
Zoom (ZM), Outperform $450 PT: Zoom is our top pick overall, as we believe the sharp
pullback (down ~50% from October 2020 highs) has created an attractive buying opportunity. We
attribute this underperformance to worries around how Zoom will perform post-pandemic and if
Zoom has pulled forward all of its TAM. We take the view that: 1) Zoom is a critical component to
enabling a hybrid work future; 2) Zoom has differentiated technology via its reliability, scalability,
and ease-of-use, which should fend off threats from Microsoft and Google; 3) Zoom will likely
broaden into a full-suite enterprise communication and collaboration platform, increasing the
value proposition; and 4) the long-term financial profile of Zoom is attractive, offering a long
runway of 20%+ growth and potential for sustainable 40%+ FCF margins.
Twilio (TWLO), Outperform $450 PT: In the post-pandemic world where technology is
increasingly becoming table stakes, we believe Twilio plays a crucial role in allowing companies
to communicate with the customer across all channels and that communications are at the
center of digital experiences. In addition, we like the expansion opportunities – in many ways, we
see Twilio as the next AWS, having opportunities to move “up the stack” beyond core text and
voice (areas that may eventually see companies in-house), including video, CCaaS, and marketing
(accelerated by the acquisition of Segment).
Veeva (VEEV), Outperform $400 PT: We like Veeva for four primary reasons: 1) Veeva’s domain
expertise and deep customer relationships have created a market leadership position and a
sustainable economic moat, limiting the threat of competition; 2) we see multiple growth drivers
for Veeva to maintain 20%+ subscription growth, including CDMS, Data Cloud, and Vault OLS
(outside of life sciences); 3) Veeva’s financial model is best-in-class, combining 20%+ organic
subscription growth with FCF margins approaching 40%; and 4) the life sciences market is
attractive, as it is a defensive industry that is also rather profitable and technology-forward.
Coursera (COUR), Outperform $50 PT: Coursera remains our favorite potential multi-bagger,
and we view the recent weakness in shares as an attractive entry point considering a number
of positive developments since IPO including: greater than expected sustainability with COVID-
tailwinds, upside to Consumer gross margins, and strong momentum in the Enterprise and
Degrees businesses. We like Coursera for four primary reasons: 1) sustainable competitive
advantage driven by its multi-segmented approach; 2) positive customer due diligence; 3)
irreversible and long-lasting tailwinds for the future of learning; and 4) Coursera is growing
rapidly even off incredibly tough comps and we see room for meaningful margin expansion to
25%+ margins at scale.
Microsoft (MSFT), Outperform $360 PT: We like Microsoft for its market leadership position in
many critical areas of software, strong momentum with Azure and Teams, and multiple growth
drivers. We see a number of potential catalysts including: continues mix-shift to Azure/O365
(which we expect could accelerate revenue and gross profit growth), upside on gaming, and
continued disclosures on Teams adoption (a critical part of Commercial segment growth in our
view).
Matt Hedberg's Top Picks

CrowdStrike (CRWD), Outperform $315 PT: We believe CrowdStrike is well positioned to
consolidate security spending with a cloud first and only model that is expanding beyond
protecting laptops and desktops and beyond AV into other areas such as VM, observability as
well as protecting cloud-based workload, something legacy AV vendors simply can’t do. At their
recent analyst day, management illustrated a path to $3B or more in ARR by FY/25, or an organic
October 27, 2021 165

+30% CAGR vs. $1B in FY/21. Beyond that, the company views $10B in ARR as the next goal,
though it didn’t discuss a timeframe. Driving these expectations is a $36B TAM today that is
anticipated to reach $106B by FY/25, supported by ~900M global PCs, ~6B mobile devices, ~70M
physical servers, and ~10B IoT devices. Additionally management noted a FY/25 OM target of
20-22%, and FCF margins +30%. We like the opportunity to expand its customer base from 10K
today to several hundred thousand as well as the ability to significantly increase the number of
modules per customer from 4.3 as of FY/21 out of a total of 19 today. As the company continues
to introduce new modules, they can be cross-sold at virtually no cost, thus improving growth and
profitably. In their most recent quarter, ARR grew 70% to nearly $1.3 billion while also generating
$74 million of FCF as CrowdStrike is unique in their ability to show durable growth at scale with
expanding profitability. This results in a Rule of 40 score of 92 (ARR growth + FCF margin) at
scale. We believe COIVD accelerated trends already in place including cloud workload migration
as security transformations are often a precursor to digital transformations.
Dynatrace (DT), Outperform $89 PT: As software continues to eat the world post-COVID, we
believe Dynatrace has a number of multi-year tailwinds within cloud monitoring to support
durable and profitable +30% ARR growth. As such, the growth formula remains consistent,
including: 1) 15–20% annual new logo growth (could be at the higher end of this range in FY/22
due to an easier COVID comp); 2) +30% quota rep growth; and 3) +120% NRR. We believe the
company primarily targets cloud workload for full stack monitoring (vs APM only), as selling its
platform back into on-premise workload at high price points remains a long-term opportunity.
# In Q2/21, we believe worldwide cloud infrastructure spend was ~$47B, growing 36%; we
think Dynatrace’s ability to wire up cloud-native workload remains robust, driven by its full-
stack monitoring platform that supports a multi-cloud world driven by Kubernetes adoption.
Additionally, hyper-scale partner revenue grew +4x last quarter, as they seem to be accelerating
new customer additions along with increasing GSI momentum, which expands the land-zone.
Management believes it is ~20% penetrated into its G15K target, where it estimates that ~70%
of IT spend exists. We think the path to 40–50% or more in global penetration as well as the
opportunity to sell several million of ARR into a G15K customer remains intriguing given that it
now has six mods vs. three at the time of IPO. We remain bullish on its ability to expand customer
wallet-share based on its platform approach, which commands premium pricing and a high ROI
as customers increase applications instrumented from 15–20% to much higher levels due to
Dynatrace automation and AI.
Elastic (ESTC), Outperform $200 PT: We believe Elastic is well positioned to expand their
share within several markets including enterprise search, site search, observability and security
monitoring. We are particularly bullish on the mix-shift to Elastic Cloud, which is now 30% of
revenue and could help keep revenue growth higher for longer. From a product perspective, we
are bullish on their Enterprise Search product, which could form the basis for other products. We
also believe their recent license change has accelerated customer adoption. We also believe the
company could benefit from additional growth disclosures, such as ARR, which could clear up the
discrepancy between revenue and billings. With a discounted valuation relative to growth peers,
we think the stock can work due to both upside to estimates, as well as multiple expansion.
ServiceNow (NOW), Outperform $775 PT: We think ServiceNow is well positioned to help
enterprises become more efficient through workflow automation; this should led to durable
growth and margin expansion. Management sees a $175B TAM in 2024 including IT Workflows
$61B, Customer Workflows $33B, Employee Workflows $20B, and Creator Workflows $36B.
The company has increased the size of its largest customer a few times in recent quarters,
and management believes its first $100M ACV customer is "around the corner". ServiceNow
continues to grow its offerings, and evolve its go-to-market, using a platform approach to
products and an increasingly verticalized approach to winning customers. As such, IT Workflows
are expected to decline from 86% of net-new ACV in 2020, to 45% in 2024, as both Customer/
October 27, 2021 166

Employee Workflows, and Creator Workflows/Other grow in the mix. With growing resources
also being invested in international markets, we see a long runway of 20%+ growth. Comments
that the company will use its balance sheet to create shareholder value suggest more tuck-
in M&A deals, and also a possible return of capital. ServiceNow is targeting 2024 subscription
revenue of $10B or more growing to $15B or more in 2026, with 2024 operating margins of 26.5%
and 33% FCF margins. We believe the "playbook" to get to $10B and $15B is largely the same
one as the company has used so far; organic innovation supplemented with tuck-in acquisitions
that are re-platformed.
Palo Alto Networks (PANW), Outperform $560 PT: Our bull thesis is predicated on continued
momentum in the company’s next-gen security stack, durable growth in its FWaaP business,
and margin expansion, which we think could attract incremental long-only buyers. We came
away from their recent analyst day incrementally bullish on the opportunity and the potential
to further institutionalize the stock. Three years ago, management didn’t appreciate the
amount of product development needed internally and through M&A, which resulted in margin
compression. Now, the product platform is “90% there”, and the focus is more on scaling sales
productivity than adding new products, which should importantly work margins higher from
here, as we believe the rate of M&A is likely to slow. New FY/24 targets reflect billings of $10B
(22% CAGR from FY/21), revenue of $8B (23% CAGR from FY/21), $3.25B in NGS ARR (40%
CAGR from FY/21), and mid-single-digit CAGR for product revenue from FY/21. Operating margins
are expected to increase 50–100 bps annually in FY/23–24 while FCF margins are expected
to increase 100–150 bps annually over the same horizon. Following analyst day we increased
our FY/22–24 FCF estimates, though our revenue and billings estimates were unchanged and
conservatively below the company’s long-term guidance framework, leaving room for beat/raise
opportunities. Management sees a $110B TAM in CY/24, up from $74B in CY/21E (14% CAGR), as
the number of cyberattacks continues to increase against an expanding targetable surface. Over
the last several years, we believe the company has expanded its NGFW leadership to become a
category leader across NGFW, zero trust, SDWAN, SOAR, XDR, VM, and ZTNA through the three
core areas of focus: Network Security, Prisma Cloud, and CORTEX; all delivered as a platform,
which could help the company consolidate share.
October 27, 2021 167

LinkedIn/Glassdoor Trackers
Exhibit 202 shows the sequential change in job postings (on LinkedIn) for 51 software companies
between 3Q21 and 2Q21. While we wouldn’t read too significantly into a sequential change,
especially when considering the current environment, we believe that job openings can be a
leading indicator of business momentum over time.
Exhibit 202 - Sequential Change in Job Postings (on LinkedIn), 3Q21 vs. 2Q21
.
Source: RBC Capital Markets, LinkedIn
Exhibit 203 shows the year-over-year change in job postings (on LinkedIn) for 44 software
companies between 3Q21 and 2Q21. Many of the names we tracked have significantly increased
their hiring initiatives relative to this time last year which makes sense considering lingering
uncertainty in the market in 3Q20. We note that this dataset only includes companies we have
data for in this time period.
Exhibit 203 - Annual Change in Job Postings (on LinkedIn), 3Q21 vs. 2Q20
.
October 27, 2021 168

Exhibit 204 shows the shows the sequential change in employee count (according to LinkedIn)
for 51 software companies between 3Q21 and 2Q21.
Exhibit 204 - Sequential Change in Employee Count (on LinkedIn), 3Q21 vs. 2Q21
.
Exhibit 205 shows the annual change in employee count (according to LinkedIn) for 44 software
companies between 3Q20 and 3Q21.
Exhibit 205 - Annual Change in Job Postings (on LinkedIn), 3Q21 vs. 2Q21
.
October 27, 2021 169

Exhibit 206 shows the Glassdoor ratings for 51 software companies.
Exhibit 206 - Glassdoor Ratings (out of 5), 3Q21
.
Source: RBC Capital Markets, Glassdoor
Exhibit 207 shows the Glassdoor CEO ratings for 51 software companies.
Exhibit 207 - Glassdoor CEO Ratings, 3Q21
.
Source: RBC Capital Markets, Glassdoor
October 27, 2021 170

Companies mentioned
ANSYS, Inc. (NASDAQ: ANSS US; $376.47; Sector Perform)
Adobe Inc. (NASDAQ: ADBE US; $642.50; Outperform)
Altair Engineering Inc. (NASDAQ: ALTR US; $77.44; Sector Perform)
Asana Inc (NYSE: ASAN US; $125.62; Sector Perform)
Autodesk, Inc. (NASDAQ: ADSK US; $312.80; Outperform)
Bentley Systems, Incorporated (NASDAQ: BSY US; $58.84; Outperform)
Box, Inc. (NYSE: BOX US; $25.82; Underperform)
Check Point Software Technologies Ltd. (NASDAQ: CHKP US; $120.36; Sector Perform)
Citrix Systems, Inc. (NASDAQ: CTXS US; $96.60; Sector Perform)
Clearwater Analytics Holdings Inc (NYSE: CWAN US; $24.81; Outperform)
Cloudflare, Inc. (NYSE: NET US; $185.36; Outperform)
Couchbase Inc (NASDAQ: BASE US; $38.19; Outperform)
Coupa Software Incorporated (NASDAQ: COUP US; $241.15; Sector Perform)
Coursera Inc (NYSE: COUR US; $33.55; Outperform)
CrowdStrike Holdings, Inc. (NASDAQ: CRWD US; $287.08; Outperform)
Datadog, Inc. (NASDAQ: DDOG US; $163.87; Sector Perform)
Datto Holding Corp (NYSE: MSP US; $24.01; Outperform)
DocuSign Inc (NASDAQ: DOCU US; $280.58; Outperform)
DoubleVerify Holdings Inc (NYSE: DV US; $38.30; Outperform)
Dropbox, Inc. (NASDAQ: DBX US; $30.44; Outperform)
Duck Creek Technologies Inc (NASDAQ: DCT US; $31.37; Outperform)
Dynatrace, Inc. (NYSE: DT US; $77.70; Outperform)
Elastic N.V. (NYSE: ESTC US; $171.92; Outperform)
EverCommerce Inc (NASDAQ: EVCM US; $19.31; Outperform)
F5 Networks, Inc. (NASDAQ: FFIV US; $203.90; Sector Perform)
Fastly Inc (NYSE: FSLY US; $49.86; Sector Perform)
HubSpot, Inc. (NYSE: HUBS US; $805.24; Outperform)
Jamf Holding Corp. (NASDAQ: JAMF US; $47.09; Outperform)
McAfee Corp (NASDAQ: MCFE US; $22.45; Sector Perform)
Microsoft Corporation (NASDAQ: MSFT US; $310.11; Outperform)
Mimecast Limited (NASDAQ: MIME US; $70.57; Outperform)
N-Able Inc (NYSE: NABL US; $13.21; Outperform)
NICE Ltd. (NASDAQ: NICE US; $279.79; Outperform)
NetScout Systems, Inc. (NASDAQ: NTCT US; $26.64; Sector Perform)
New Relic, Inc. (NYSE: NEWR US; $77.90; Sector Perform)
NortonLifeLock Inc. (NASDAQ: NLOK US; $26.35; Sector Perform)
Nutanix, Inc. (NASDAQ: NTNX US; $34.44; Outperform)
Okta Inc (NASDAQ: OKTA US; $255.71; Outperform)
Olo Inc. (NYSE: OLO US; $25.95; Outperform)
PTC Inc. (NASDAQ: PTC US; $127.60; Outperform)
PagerDuty, Inc. (NYSE: PD US; $42.95; Outperform)
Palantir Technologies Inc. (NYSE: PLTR US; $25.52; Sector Perform)
Palo Alto Networks, Inc. (NYSE: PANW US; $486.55; Outperform)
Pegasystems Inc. (NASDAQ: PEGA US; $127.93; Outperform)
Ping Identity Holding Corp. (NYSE: PING US; $28.00; Outperform)
Qualys, Inc. (NASDAQ: QLYS US; $119.07; Sector Perform)
Rapid7, Inc. (NASDAQ: RPD US; $126.63; Outperform)
SailPoint Technologies Holdings, Inc. (NYSE: SAIL US; $47.95; Outperform)
SecureWorks Corp. (NASDAQ: SCWX US; $17.65; Sector Perform)
ServiceNow, Inc. (NYSE: NOW US; $676.71; Outperform)
Smartsheet Inc. (NYSE: SMAR US; $71.19; Sector Perform)
October 27, 2021 171
SolarWinds Corporation (NYSE: SWI US; $18.48; Outperform)

Splunk Inc. (NASDAQ: SPLK US; $167.38; Outperform)
Sumo Logic, Inc. (NASDAQ: SUMO US; $17.26; Outperform)
Teradata Corporation (NYSE: TDC US; $57.48; Sector Perform)
Twilio Inc. (NYSE: TWLO US; $353.92; Outperform)
UiPath Inc (NYSE: PATH US; $53.50; Sector Perform)
VMware, Inc. (NYSE: VMW US; $158.08; Outperform)
Varonis Systems, Inc. (NASDAQ: VRNS US; $65.68; Outperform)
Veeva Systems Inc. (NYSE: VEEV US; $322.99; Outperform)
Workday, Inc. (NASDAQ: WDAY US; $282.76; Not Rated)
Xometry, Inc. (NASDAQ: XMTR US; $57.64; Sector Perform)
Ziff Davis, Inc. (NASDAQ: ZD US; $128.10; Outperform)
Zoom Video Communications, Inc. (NASDAQ: ZM US; $278.70; Outperform)
ZoomInfo Technologies Inc (NASDAQ: ZI US; $69.14; Outperform)
Zscaler Inc (NASDAQ: ZS US; $315.32; Outperform)
salesforce.com, inc. (NYSE: CRM US; $295.11; Outperform)
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Gross Margins in Software and What Drives Them

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Gross Margins in Software and What Drives Them

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RBC Capital Markets, LLC

Exhibit 1 - Software Gross Margins, Most Recent FY

October 27, 2021 2

Exhibit 2 - Software Gross Margins, Most Recent FY

October 27, 2021 3

Exhibit 3 - Software Gross Margins, 5YR Average

Exhibit 4 - Average EV/CY22E Revenue Multiple by Gross Margin

October 27, 2021 4

Factors that drive gross margins

October 27, 2021 5

October 27, 2021 6

Exhibit 5 - Veeva Gross Margin Components Overview

Takeaways from our analysis of Veeva's Gross Margins:

October 27, 2021 7

DocuSign Case Study

Exhibit 6 - DOCU Gross Margin Components Overview, FY16-FY21

Takeaways from our analysis of DOCU's gross margins:

1. Subscription has been growing consistently as a percentage of revenue to over 95%.

Caveats and Considerations

October 27, 2021 9

Company Specific Analysis

Definition (from 10-K):

Cost of product revenue is primarily comprised of third-party royalties, amortization related

What drives gross margins:

• Mix-shift between subscription, product and services.

October 27, 2021 10

Exhibit 7 - ADBE Non-GAAP Gross Margin, 2015-2020

Exhibit 8 - ADBE Revenue Breakdown, 2015-2020

October 27, 2021 11

Autodesk, Inc. (ADSK)

Definition (from 10-K):

What drives gross margins:

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Exhibit 9 - ADSK Non-GAAP Gross Margin by Segment, 2016-2021

Exhibit 10 - ADSK Revenue Breakdown, 2016-2021

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Akamai Technologies, Inc. (AKAM)

Exhibit 11 - AKAM Cost of Revenue Breakdown, 2016-2020

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What's included: Bandwidth, co-location, network, employees, network depreciation, and

Drivers of gross margins:

Exhibit 12 - AKAM Non-GAAP Gross Margins 2016-2020

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Exhibit 13 - AKAM Cash Gross Margins by Customer Division, 2017

Exhibit 14 - AKAM Revenue Breakdown, 2016-2020

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Altair Engineering Inc. (ALTR)

Definition (from 10-K):

What drives gross margins:

• Mix-shift between software, software related services, CES and innovation.

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Exhibit 15 - ALTR Non-GAAP Gross Margin, 2015-2020

Exhibit 16 - ALTR Gross Margin by Segment, 2015-2020

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Exhibit 17 - ALTR Revenue by Segment, 2015-2020

ANSYS, Inc. (ANSS)

Definition (from 10-K):

What drives gross margins:

• Mix-shift between software licenses and maintenance and services.

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Exhibit 18 - ANSS Non-GAAP Gross Margin, 2016-2020

Exhibit 19 - ANSS Gross Margin by Segment, 2016-2020

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Exhibit 20 - ANSS Revenue by Segment, 2016-2020