A quick reminder of what’s going on with Domo, and then some math to figure out how correct the twittering class is about Domo’s results.
Domo’s IPO filing was met with a round of incredulity that went on and on when the filing was made public last week.
The document often serves as a moment of pride for companies looking to abandon youthful indiscretion and submit to the rigor of regular public disclosures. For Domo, however, it was nearly a confession: Yes, we spent all the money that we raised. No, we aren’t as big as you might have guessed. Yes, our GAAP net losses are high. But so is our cash burn!
You get the idea. But in light of this useful LA Times summary of the issues inherent in granting the company’s founder and CEO nearly complete voting control of the firm, it’s worth us exploring what that founder-friendliness got the host of investors who poured capital into the technology company
(Domo, per its website, claims to be “an operating system that allows you to run your entire business on your phone.” Domo’s service collects a firm’s data, which is then compiled and displayed in a visual format on mobile devices.)
So what did investors get for a seed round, a $10 million angel round, a dual-part Series A that tipped the scales at more than $50 million, a $60 million Series B, a $125 million Series C, and a Series D that went on from April 2015 to April 2017 and totaled around $441 million?
For its total external capital raises of nearly $700 million, Domo delivered this:
- Trailing twelve-month revenue of $95 million through the quarter ending April 30, 2018.
- ARR of $106.7 million, calculated by multiplying the firm’s subscription revenue during the April 30, 2018, quarter by four.
- An accumulated deficit of $803.3 million as of April 30, 2018.
- Long-term debt of $96.1 million.
- Operating cash burn of $148.7 million in its fiscal year ending January 31, 2018.
- Operating cash burn of $36.9 million in the quarter ending April 30, 2018.
- And total cash on hand of $71.9 million as of April 30, 2018.
So how bad is all of that? Pretty bad. One quick perspective for fun: Domo’s quarterly sales and marketing spend is higher than its revenue and has been in every single quarter that the firm reported in its S-1.
Domo is, therefore, an inefficient company. But how inefficient compared to other companies? Let’s take a peek at a few VC-approved metrics to get our hands on Domo’s operating results.
I promise this will be fun.
Magic, 40, And Hype
Since the company generates over 80 percent of its revenue from subscription software, we will use three simple SaaS metrics to determine the health of Domo: the Magic Number, the Rule of 40, and the Hype Factor.
To keep square and tidy, we’ll use definitions written by venture capitalists themselves to make sure that I’m not stacking the snark deck.
The Magic Number is a way for SaaS companies to figure out their sales efficiency both quickly and simply. Here’s Scale Venture Partners’ own Rory O’Driscoll on what a Magic Number is for SaaS companies:
Looking at SaaS deals over the past ten year at Scale, we have found that a simple calculation is highly predictive of which companies have a profitable subscription business model and which ones do not. Take the change in subscription revenue between two quarters, annualize it (multiply by four), and divide the result by the sales and marketing spend for the earlier of the two quarters.
That’s simple enough. Crunchbase News calculated Domo’s Magic Number using the above definition and Scale’s own calculator, built just for this purpose, to generate two results: one inclusive of the firm’s full revenue and one only using its subscription revenue. In the case of the former, Domo’s magic number came out to 0.2; in the latter, it rose to 0.3.
How does that compare to what’s good and bad? Here’s the second half of the paragraph from Scale that we just quoted:
A result greater than 1x, has proven to be a compelling business investment, a result below .5x is a company that still has not figured out it’s model, and a result in between, is a deal that will probably get to success and cashflow breakeven but only in a relatively capital in-efficient way. We called this the Magic Number.
So, by that metric, Domo’s Magic Number is pretty poor.
Now, later-stage companies can have lower sales efficiency compared to their younger rivals. That point is made well by Redpoint’s Tomasz Tunguz here. However, even that caveat doesn’t really change the fact that Domo’s sales and marketing spend is simply staggering compared to its revenue growth, per the venture capitalists’ own public metrics.
Update: Per Neil Harrington on Twitter, Omniture’s Josh James deserves a note for helping popularize the Magic Number.
Rule of 40
Moving on, let’s talk about the Rule of 40. It’s a way for companies to figure out if they are burning too much to grow. Here’s Foundry Group’s Brad Feld, a smart cookie in my experience:
The 40% rule is that your growth rate + your profit should add up to 40%. So, if you are growing at 20%, you should be generating a profit of 20%. If you are growing at 40%, you should be generating a 0% profit. If you are growing at 50%, you can lose 10%. If you are doing better than the 40% rule, that’s awesome.
Feld notes before the above definition that the Rule fo 40 is “for SaaS companies at scale,” which is, by his assessment, “at least $50 million in revenue.” Domo fits that bill, as we saw a bit ago, so we can Rule of 40 it and get a result that we can trust.
But what counts as revenue is tricky as Domo is a mix of services and subscription. Happily, Feld has some good notes on how to handle that, stating that year-over-year MRR growth is the best way to calculate revenue growth for a Rule of 40 test.
The closest we can get to that is year-over-year quarterly subscription revenue growth. This is slightly more conservative than looking at MRR year-over-year as we’re counting in two smaller months as part of the quarter, something that we need to keep in mind.
Now, profit. How should we calculate that? Sadly, Feld recommends that we use EBITDA (with caveats for infrastructure spend). That’s tough as Domo doesn’t break out EBITDA. To compensate, we will use two other numbers that do something similar to EBIDTA, namely strip out some costs to get a more flexible definition of profit: operating profit and operating cashflow.
We’re picking operating losses as it is slightly less strict than net loss, and operating cashflow is an even looser metric that is cash-centric. It’s a way to approach accounting that some SaaS folks prefer.
That in hand, here’s the set of figures that we’ll use:
- Domo subscription revenue, quarter ending April 30, 2017: $19.103 million.
- Domo subscription revenue, quarter ending April 30, 2018: $26.663 million.
- Year-over-year subscription revenue growth (stand-in YoY MRR expansion): 39.6 percent.
- Domo operating income as a percent of aggregate revenue, quarter ending April 30, 2018: -134.6 percent.
- Domo operating cashflow as a percent of aggregate revenue, quarter ending April 30, 2018: -115.5 percent.
(We used aggregate revenue to compare operating income and cashflow to be conservative. By comparing the company’s faster-growing revenue source (subscription) growth to its percent losses calculated against its broadest revenue result, we’re giving Domo the best shot that we can at meeting the Rule of 40.)
We can now add our revenue growth rate of 39.6 percent to our two selected profit metrics of -134.6 percent and -115.5 percent to see if we get to +40. Adding them we get -95.0 and -75.9. Those are dramatically under +40.
This metric took more work to figure out, but given the goshdarn scampering miss from Domo, I think we can rest safely. Even if we made a small error in our logical progression, by this measure, the firm is still too damn unprofitable.
Finally, let’s explore the idea of hype. Our prior two metrics were technical-ish attempts to get under the skin of Domo as a SaaS company
Here is where we are doing something a bit different. To explain hype, here’s Dave Kellogg, a CEO, investor, and SaaS-world-participant:
In terms of hype, one metric I use is what I call the hype ratio = VC / ARR. On the theory that SaaS startups input venture capital (VC) and output two things — annual recurring revenue (ARR) and hype — by analogy, heat and light, this is a good way to measure how efficiently they generate ARR.
You can see where this is going. Here’s Kellogg on the results:
Domo’s hype ratio is 6.4. Put the other way, Domo converts VC into ARR at a 15% rate. The other 85% is, per my theory, hype. You give them $1 and you get $0.15 of heat, and $0.85 of light. It’s one of the most hyped companies I’ve ever seen.
We checked his math using our above-listed ARR result for Domo, and its capital raised to date (via Crunchbase) and got a hype ratio of 6.5, rounded. So we agree with his results.
The Three Metric Problem
Domo’s Magic Number tell us, at the moment, its sales and marketing spend is inefficient. That conclusion is backed up by Domo’s Rule of 40 calculation, which is deeply negative. That result is unsurprising; who would have expected an expensive and inefficient sales process to lead to profits? And, finally, the firm’s Hype Ratio shows how the firm spent the money that it managed to raise. Much hype, little ARR, which fits into our prior results.
And that’s why the firm’s S-1 dropped with the dull thud of a steak onto wet cement. Yuck.
Top Image: iStock VOLHA RAMANCHUK
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