The following discussion and analysis of our financial condition and results of operations should be read in conjunction with our condensed consolidated financial statements and related notes included elsewhere in this Quarterly Report on Form 10-Q and with our Management's Discussion and Analysis of Financial Condition and Results of Operations included in our Annual Report on Form 10-K for the year endedJuly 31, 2019 , filed with theSEC . As discussed in the section titled "Special Note Regarding Forward-Looking Statements," the following discussion contains forward-looking statements that involve risks and uncertainties. Our actual results could differ materially from those discussed below. Factors that could cause or contribute to such difference include, but are not limited to, those identified below and those discussed in the section titled "Risk Factors" and elsewhere in this Quarterly Report on Form 10-Q. Our fiscal year end isJuly 31 , and our fiscal quarters end onOctober 31 ,January 31 ,April 30 andJuly 31 . Our fiscal year endedJuly 31, 2019 is referred to as fiscal 2019 and our fiscal year endingJuly 31, 2020 is referred to as fiscal 2020. OverviewZscaler was incorporated in 2007, during the early stages of cloud adoption and mobility, based on a vision that the internet would become the new corporate network as the cloud becomes the new data center. We predicted that with rapid cloud adoption and increasing workforce mobility, traditional perimeter security approaches would provide inadequate protection for users and data and an increasingly poor user experience. We pioneered a security cloud that represents a fundamental shift in the architectural design and approach to network security. We generate revenue primarily from sales of subscriptions to access our cloud platform, together with related support services. We also generate an immaterial amount of revenue from professional and other services, which consist primarily of fees associated with mapping, implementation, network design and training. Our subscription pricing is calculated on a per-user basis. We recognize subscription and support revenue ratably over the life of the contract, which is generally one to three years. As ofJuly 31, 2019 , we had expanded our operations to over 3,900 customers across major industries, with users in 185 countries. Government agencies and some of the largest enterprises in the world rely on us to help them transform to the cloud, including more than 400 of the Forbes Global 2000 as ofJuly 31, 2019 . We operate our business as one reportable segment. Our revenue has experienced significant growth in recent periods. For six months endedJanuary 31, 2020 and 2019, our revenue was$194.9 million and$137.6 million , respectively. However, we have incurred net losses in all periods since our inception. For six months endedJanuary 31, 2020 and 2019, our net loss was$46.2 million and$11.1 million , respectively. We expect we will continue to incur net losses for the foreseeable future, as we continue investing in our sales and marketing organization to take advantage of our market opportunity, to invest in research and development efforts to enhance the functionality of our cloud platform, to incur additional compliance and other related costs as we operate as a public company, and address any legal matters and related accruals, as further described in Note 8, Commitments and Contingencies, of our condensed consolidated financial statements included elsewhere in this Quarterly Report on Form 10-Q. Certain Factors Affecting Our Performance Increased Internet Traffic and Adoption ofCloud-Based Software and Security The adoption of cloud applications and infrastructure, explosion of internet traffic volumes and shift to mobile-first computing generally, and the pace at which enterprises adopt the internet as their corporate network in particular, impact our ability to drive market adoption of our cloud platform. We believe that most enterprises are in the early stages of a broad transformation to the cloud. Organizations are increasingly relying on the internet to operate their businesses, deploying new SaaS applications and migrating internally managed line-of-business applications to the cloud. However, the growing dependence on the internet has increased exposure to malicious or compromised websites, and sophisticated hackers are exploiting the gaps left by legacy network security appliances. To securely access the internet and transform their networks, 25 -------------------------------------------------------------------------------- Table of Contents organizations must also make fundamental changes in their network and security architectures. We believe that most organizations have yet to fully make these investments. Since we enable organizations to securely transform to the cloud, we believe that the imperative for organizations to securely move to the cloud will increase demand for our cloud platform and broaden our customer base. New Customer Acquisition We believe that our ability to increase the number of customers on our cloud platform is an indicator of our market penetration and our future business opportunities. As ofJuly 31, 2019 and 2018, we had over 3,900 and over 3,250 customers, respectively, across all major geographies. As ofJuly 31, 2019 , we had over 400 of the Forbes Global 2000 as customers. Our ability to continue to grow this number will increase our future opportunities for renewals and follow-on sales. We believe that we have significant room to capture additional market share and intend to continue to invest significantly in sales and marketing to engage our prospective customers, increase brand awareness, further leverage our channel partnerships and drive adoption of our solution. Follow-On Sales We typically expand our relationship with our customers over time. While most of our new customers route all of their internet-bound web traffic through our cloud platform, some of our customers initially use our services for specific users or specific security functionality. We leverage our land-and-expand model with the goal of generating incremental revenue, often within the term of the initial subscription, by increasing sales to our existing customers in one of three ways: •expanding deployment of our cloud platform to cover additional users; •upgrading to a more advanced Business, Transformation or Secure Transformation suite; and •selling a ZPA subscription to a ZIA customer, a ZIA subscription to a ZPA customer, or other features on an a la carte basis. Investing in Business Growth Since our founding, we have invested significantly in growing our business. We intend to continue (i) investing in our research and development organization and our development efforts to offer new solutions on our platform and (ii) dedicating resources to update and upgrade our existing solutions. In addition, we expect our general and administrative expenses to increase in absolute dollars in the foreseeable future, as we continue to operate as a public company, and address any legal matters and related accruals, as further described in Note 8, Commitments and Contingencies, of our condensed consolidated financial statements included elsewhere in this Quarterly Report on Form 10-Q. We also intend to continue to invest significantly in sales and marketing to grow and train our sales force, broaden our brand awareness and expand and deepen our channel partner relationships. While these planned investments will increase our operating expenses in the short term, we believe that over the long term these investments will help us to expand our customer base and grow our business. We also are investing in programs to increase recognition of our brand and solutions, including joint marketing activities with our channel partners and strategic partners. While we expect our operating expenses to increase in absolute dollars in the foreseeable future, as a result of these activities, we intend to balance these investments in future growth with a continued focus on managing our results of operations and investing judiciously. In the long term we anticipate that these investments will positively impact our business and results of operations. 26 -------------------------------------------------------------------------------- Table of Contents Key Business Metrics and Other Financial Measures We review a number of operating and financial metrics, including the following key metrics, to measure our performance, identify trends, formulate business plans and make strategic decisions. Dollar-Based Net Retention Rate We believe that dollar-based net retention rate is a key metric to measure the long-term value of our customer relationships because it is driven by our ability to retain and expand the recurring revenue generated from our existing customers. Our dollar-based net retention rate compares the recurring revenue from a set of customers against the same metric for the prior 12-month period on a trailing basis. Because our customers have repeat buying patterns and the average term of our contracts is more than 12 months, we measure this metric over a set of customers who were with us as of the last day of the same reporting period in the prior fiscal year. Our dollar-based net retention rate includes customer attrition. We have not experienced a material increase in customer attrition rates in recent periods. We calculate our dollar-based net retention rate as follows: Denominator: To calculate our dollar-based net retention rate as of the end of a reporting period, we first establish the ARR from all active subscriptions as of the last day of the same reporting period in the prior fiscal year. This effectively represents recurring dollars that we expect in the next 12-month period from the cohort of customers that existed on the last day of the same reporting period in the prior fiscal year. Numerator: We measure the ARR for that same cohort of customers representing all subscriptions based on confirmed customer orders booked by us as of the end of the reporting period. Dollar-based net retention rate is obtained by dividing the numerator by the denominator. Our dollar-based net retention rate may fluctuate due to a number of factors, including the performance of our cloud platform; our success in selling bigger deals for all employees with our Transformation bundle and faster upsells within a year can reduce our dollar-based net retention rate in future periods; the timing and the rate of ARR expansion of our existing customers; potential changes in our rate of renewals and other risk factors described in this Quarterly Report on Form 10-Q. Trailing 12 Months
Ended Trailing 12 Months Ended
January 31, 2020 January 31, 2019 Dollar-based net retention rate 116% 118% Non-GAAP Financial Measures In addition to our results determined in accordance withU.S. GAAP, we believe the following non-GAAP measures are useful in evaluating our operating performance. We use the following non-GAAP financial information to evaluate our ongoing operations and for internal planning and forecasting purposes. We believe that non-GAAP financial information, when taken collectively, may be helpful to investors because it provides consistency and comparability with past financial performance. However, non-GAAP financial information is presented for supplemental informational purposes only, has limitations as an analytical tool and should not be considered in isolation or as a substitute for financial information presented in accordance withU.S. GAAP. In particular, free cash flow is not a substitute for cash used in operating activities. Additionally, the utility of free cash flow as a measure of our liquidity is further limited as it does not represent the total increase or decrease in our cash balance for a given period. In addition, other companies, including companies in our industry, may calculate similarly-titled non-GAAP measures differently or may use other measures to evaluate their performance, all of which could reduce the usefulness of our non-GAAP financial measures as tools for comparison. A reconciliation is provided below for each non-GAAP financial measure to the most directly comparable financial measure stated in accordance withU.S. GAAP. Investors are encouraged to review the related GAAP financial measures and the 27 -------------------------------------------------------------------------------- Table of Contents reconciliation of these non-GAAP financial measures to their most directly comparable GAAP financial measures, and not to rely on any single financial measure to evaluate our business. Non-GAAP Gross Profit and Non-GAAP Gross Margin We define non-GAAP gross profit as GAAP gross profit excluding stock-based compensation expense and amortization of acquired intangible assets. We define non-GAAP gross margin as non-GAAP gross profit as a percentage of revenue. Six Months Ended Three Months Ended January 31, January 31, 2020 2019 2020 2019 (in thousands) Gross profit$ 81,030 $ 59,031 $ 155,062 $ 110,230 Add: Stock-based compensation expense 1,580 619 2,961 1,122 Amortization expense of acquired 205 144 410 144 intangible assets Non-GAAP gross profit$ 82,815 $ 59,794 $ 158,433 $ 111,496 Gross margin 80 % 79 % 80 % 80 % Non-GAAP gross margin 82 % 80 % 81 % 81 % Non-GAAP Income from Operations and Non-GAAP Operating Margin We define non-GAAP income from operations as GAAP loss from operations excluding stock-based compensation expense, certain litigation-related expenses, asset impairment related to facility exit and amortization expense of acquired intangible assets. We define non-GAAP operating margin as non-GAAP income from operations as a percentage of revenue. The excluded litigation-related expenses are professional fees and related costs incurred by us in defending against significant claims that we deem not to be in the ordinary course of our business and, if applicable, accruals related to estimated losses in connection with these claims. There are many uncertainties and potential outcomes associated with any litigation, including the expense of litigation, timing of such expenses, court rulings, unforeseen developments, complications and delays, each of which may affect our results of operations from period to period, as well as the unknown magnitude of the potential loss relating to any lawsuit, all of which are inherently subject to change, difficult to estimate and could adversely affect our results of operations. Six Months Ended Three Months Ended January 31, January 31, 2020 2019 2020 2019 (in thousands) Loss from operations$ (30,280) $ (5,182) $ (48,555) $ (13,845) Add: Stock-based compensation expense 23,866 13,227 42,242 20,813 Litigation-related expenses 16,334 1,768 18,341 3,942 Amortization expense of acquired intangible 642 144 1,421 239
assets
Asset impairment related to facility exit (1) 316 - 316 - Non-GAAP income from operations$ 10,878 $ 9,957 $ 13,765 $ 11,149 Operating margin (30) % (7) % (25) % (10) % Non-GAAP operating margin 11 % 13 % 7 % 8 % ___________ 28
-------------------------------------------------------------------------------- Table of Contents (1) Consists of asset impairment charges related to the relocation of our corporate headquarters. Free Cash Flow and Free Cash Flow Margin Free cash flow is a non-GAAP financial measure that we calculate as net cash provided by (used in) operating activities less purchases of property, equipment and other and capitalized internal-use software. Free cash flow margin is calculated as free cash flow divided by revenue. We believe that free cash flow and free cash flow margin are useful indicators of liquidity that provide information to management and investors about the amount of cash generated from our operations that, after the investments in property, equipment and other and capitalized internal-use software, can be used for strategic initiatives, including investing in our business and strengthening our financial position. Free cash flow includes the cyclical impact of inflows and outflows resulting from contributions to our employee stock purchase plan for which the purchase period of approximately six months ends in each of our second and fourth fiscal quarter. As ofJanuary 31, 2020 , employee contributions to our employee stock purchase plan was$2.6 million , which will be reclassified to stockholders' equity upon issuance of the shares during our fourth quarter of fiscal 2020. In the three months endedJanuary 31, 2020 , we made a$15.0 million payment to Broadcom in connection with the settlement of the Symantec Cases. For further information on this settlement refer to Note 8, Commitments and Contingencies of our condensed consolidated financial statements included elsewhere in this Quarterly Report Form 10-Q. Six Months Ended Three Months Ended January 31, January 31, 2020 2019 2020 2019 (in thousands) Net cash provided by operating activities$ 5,431 $ 15,707 $ 26,860 $ 26,721 Less: Purchases of property, equipment and other (4,889) (3,193) (15,099) (8,607)
assets
Capitalized internal-use software (2,471) (547) (4,273) (903) Free cash flow$ (1,929) $ 11,967 $ 7,488 $ 17,211 As a percentage of revenue: Net cash provided by operating activities 5 % 21 % 14 % 20 %
Less:
Purchases of property, equipment and other (5) % (4) % (8) % (6) %
assets
Capitalized internal-use software (2) % (1) % (2) % (1) % Free cash flow margin (2) % 16 % 4 % 13 % Calculated Billings Calculated billings is a non-GAAP financial measure that we believe is a key metric to measure our periodic performance. Calculated billings represents our total revenue plus the change in deferred revenue in a period. Calculated billings in any particular period aims to reflect amounts invoiced for subscriptions to access our cloud platform, together with related support services related to our new and existing customers. We typically invoice our customers annually in advance, and to a lesser extent quarterly in advance, monthly in advance or multi-year in advance. Calculated billings increased$20.4 million , or 18%, for the three months endedJanuary 31, 2020 over the three months endedJanuary 31, 2019 , and$44.1 million , or 25%, for the six months endedJanuary 31, 2020 over the six months endedJanuary 31, 2019 . As calculated billings continues to grow in absolute terms, we expect our calculated billings growth rate to trend down over time. We also expect that calculated billings will be affected by seasonality in terms of when we enter into agreements with customers; and the mix of billings in each reporting period as we typically invoice customers annually in advance, and to a lesser extent quarterly in advance, monthly in advance or multi-year in advance. 29
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Table of Contents Six Months Ended Three Months Ended January 31, January 31, 2020 2019 2020 2019 (in thousands) Revenue$ 101,268 $ 74,302 $ 194,858 $ 137,600 Add: Total deferred revenue, end of 280,022 206,020 280,022 206,020
period
Less: Total deferred revenue, beginning (245,869) (165,279) (251,202) (164,023) of period Calculated billings$ 135,421 $ 115,043 $ 223,678 $ 179,597 Components of Results of Operations Revenue We generate revenue primarily from sales of subscriptions to access our cloud platform, together with related support services. These subscription and related support services accounted for approximately 98% and 97% of our revenue for the three months endedJanuary 31, 2020 and 2019, respectively, and approximately 98% for the six months endedJanuary 31, 2020 and 2019. Our contracts with our customers do not at any time provide the customer with the right to take possession of the software that runs our cloud platform. Our customers may also purchase professional services, such as mapping, implementation, network design and training. Professional services account for an immaterial portion of our revenue. We generate revenue from contracts with typical durations ranging from one to three years. We typically invoice our customers annually in advance, and to a lesser extent quarterly in advance, monthly in advance or multi-year in advance. We recognize revenue ratably over the life of the contract. Amounts that have been invoiced are recorded in deferred revenue, or they are recorded in revenue if the revenue recognition criteria have been met. Subscriptions that are invoiced annually in advance or multi-year in advance represent a significant portion of our short-term and long-term deferred revenue in comparison to invoices issued quarterly in advance or monthly in advance. Accordingly, we cannot predict the mix of invoicing schedules in any given period. We generally experience seasonality in terms of when we enter into agreements with our customers. We typically enter into a higher percentage of agreements with new customers, as well as renewal agreements with existing customers, in our second and fourth fiscal quarters. However, because we recognize revenue ratably over the terms of our subscription contracts, a substantial portion of the revenue that we report in each period is attributable to the recognition of deferred revenue relating to agreements that we entered into during previous periods. Consequently, increases or decreases in new sales or renewals in any one period may not be immediately reflected as revenue for that period. Accordingly, the effect of downturns in sales and market acceptance of our platform, and potential changes in our rate of renewals, may not be fully reflected in our results of operations until future periods. Cost of Revenue 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. As our customers expand and increase the use of our cloud platform driven by additional applications and connected devices, our cost of revenue will increase due to higher bandwidth and data center expenses. However, we expect to continue to benefit from economies of scale as our customers increase the use of our cloud platform. We intend to continue to invest additional resources in our cloud platform and our customer support organizations as we grow our business. The level and timing of investment in these areas could affect our cost of revenue in the future. 30 -------------------------------------------------------------------------------- Table of Contents Gross Profit and Gross Margin Gross profit, or revenue less cost of revenue, and gross margin, or gross profit as a percentage of revenue, have been and will continue to be affected by various factors, including the timing of our acquisition of new customers and our renewals of and follow-on sales to existing customers, the average sales price of our services, mix of services offered in our solutions, the data center and bandwidth costs associated with operating our cloud platform, the extent to which we expand our customer support and cloud operations organizations and the extent to which we can increase the efficiency of our technology, infrastructure and data centers through technological improvements. We expect our gross profit to increase in absolute dollars and gross margin to remain relatively unchanged over the long-term, although our gross profit and gross margin could fluctuate from period to period depending on the interplay of all of the above factors. Operating Expenses Our operating expenses consist of sales and marketing, research and development and general and administrative expenses. Personnel costs are the most significant component of operating expenses and consist of salaries, benefits, bonuses, stock-based compensation expense and, with respect to sales and marketing expenses, sales commissions that are recognized as expenses. Operating expenses also include overhead costs for facilities, IT, depreciation expense and amortization expense. Sales and Marketing Sales and marketing expenses consist primarily of employee compensation and related expenses, including salaries, bonuses and benefits for our sales and marketing employees, sales commissions that are recognized as expenses over the period of benefit, stock-based compensation expense, marketing programs, travel and entertainment expenses, expenses for conferences and events and allocated overhead costs. We capitalize our sales commissions and associated payroll taxes and recognize them as expenses over the estimated period of benefit. The amount recognized in our sales and marketing expenses reflects the amortization of cost previously deferred as attributable to each period presented in this Quarterly Report on Form 10-Q, as described below under "Critical Accounting Policies and Estimates." We intend to continue to make significant investments in our sales and marketing organization to drive additional revenue, further penetrate the market and expand our global customer base. As a result, we expect our sales and marketing expenses to continue to increase in absolute dollars and to be our largest operating expense category for the foreseeable future. In particular, we will continue to invest in growing and training our sales force, broadening our brand awareness and expanding and deepening our channel partner relationships. However, we expect our sales and marketing expenses to decrease as a percentage of our revenue over the long term, although our sales and marketing expenses may fluctuate as a percentage of our revenue from period to period due to the timing and extent of these expenses. Research and Development Our research and development expenses support our efforts to add new features to our existing offerings and to ensure the reliability, availability and scalability of our solutions. Our cloud platform is software-driven, and our research and development teams employ software engineers in the design, and the related development, testing, certification and support, of these solutions. Accordingly, a majority of our research and development expenses result from employee-related costs, including salaries, bonuses and benefits, stock-based compensation expense and costs associated with technology tools used by our engineers. We expect our research and development expenses to continue to increase in absolute dollars for the foreseeable future, as we continue to invest in research and development efforts to enhance the functionality of our cloud platform, improve the reliability, availability and scalability of our platform and access new customer markets. However, we expect our research and development expenses to decrease as a percentage of our revenue over the long term, although our research and development expenses may fluctuate as a percentage of our revenue from period to period due to the timing and extent of these expenses. 31 -------------------------------------------------------------------------------- Table of Contents General and Administrative General and administrative expenses consist primarily of employee-related costs, including salaries and bonuses, stock-based compensation expense and employee benefit costs for our finance, legal, human resources and administrative personnel, as well as professional fees for external legal services (including certain litigation-related expenses), accounting and other related consulting services. The litigation-related expenses include professional fees and related costs incurred by us in defending significant claims that we deem not to be in the ordinary course of our business and, if applicable, accruals related to estimated losses in connection with these claims. We expect our general and administrative expenses to increase in absolute dollars for the foreseeable future, as we continue to incur compliance costs, and other related costs necessary to operate as a public company, and due to any legal matters and related accruals, as further described in Note 8, Commitments and Contingencies to our condensed consolidated financial statements included elsewhere in this Quarterly Report on Form 10-Q. However, we expect our general and administrative expenses to decrease as a percentage of our revenue over the long term, although our general and administrative expenses may fluctuate as a percentage of our revenue from period to period due to the timing and extent of these expenses. In particular, litigation-related expenses related to significant litigation claims may result in significant fluctuations from period to period as they are inherently subject to change and difficult to estimate. Interest Income Interest income consist primarily of income earned on our cash equivalents and short-term investments and interest earned on outstanding notes receivable extended to certain current and former employees who early exercised their stock options. During the six months endedJanuary 31, 2019 , the principal amount and accrued interest of the outstanding notes receivable were fully repaid. For more information on these notes receivable, refer to Note 9, Stock-Based Compensation, of our consolidated financial statements included elsewhere in this Quarterly Report on Form 10-Q. Other Income (Expense), Net Other income (expense), net consists primarily of foreign currency transaction gains and losses. Provision for Income Taxes Our provision for income taxes consists primarily of income and withholding taxes in the foreign jurisdictions in which we conduct business and partially offset by the nonU.S. tax benefit for excess stock-based compensation deduction. We have not recorded anyU.S. federal income tax expense. In theU.S. we have recorded deferred tax assets for which we provide a full valuation allowance, which includes net operating loss carryforwards and tax credits. We expect to maintain this full valuation allowance for the foreseeable future as it is more likely than not that some or all of those deferred tax assets may not be realized based on our history of losses. Additionally, in theU.K. , we have recorded deferred tax assets for which we provide a full valuation allowance, which includes net operating loss carryforwards. We expect to maintain this full valuation allowance for the foreseeable future as it is more likely than not that some or all of those deferred tax assets may not be realized based on our history of losses. 32 -------------------------------------------------------------------------------- Table of Contents Results of Operations The following tables set forth our results of operations for the periods presented in dollars and as a percentage of our revenue: Six Months Ended Three Months Ended January 31, January 31, 2020 2019 2020 2019 (in thousands) Revenue$ 101,268 $ 74,302 $ 194,858 $ 137,600 Cost of revenue(1) (2) 20,238 15,271 39,796 27,370 Gross profit 81,030 59,031 155,062 110,230 Operating expenses: Sales and marketing(1) (2) 61,621 38,756 121,032 75,301 Research and development(1) (2) 20,706 15,071 40,977 28,257 General and administrative(1) (3) (4) 28,983 10,386 41,608 20,517 Total operating expenses 111,310 64,213 203,617 124,075 Loss from operations (30,280) (5,182) (48,555) (13,845) Interest income 1,855 1,924 3,877 3,514 Other income (expense), net (13) 250 (42) 62 Loss before income taxes (28,438) (3,008) (44,720) (10,269) Provision for income taxes 716 547 1,510 874 Net loss$ (29,154) $ (3,555) $ (46,230) $ (11,143) (1) Includes stock-based compensation expense as follows: Cost of revenue$ 1,580 $ 619 $ 2,961 $ 1,122 Sales and marketing 11,943 5,517 21,982 8,318 Research and development 6,077 4,398 10,951 7,193 General and administrative 4,266 2,693 6,348 4,180 Total$ 23,866 $ 13,227 $ 42,242 $ 20,813 (2) Includes amortization expense of acquired intangible assets as follows: Cost of revenue$ 205 $ 144 $ 410 $ 144 Sales and marketing 8 - 16 - Research and development 429 - 995 95 Total$ 642 $ 144 $ 1,421 $ 239 (3) Includes asset impairment related to facility exit as follows:$ 316 $ -
(4) Includes litigation-related expenses
$ 18,341 $ 3,942 as follows: 33
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Table of Contents Six Months Ended Three Months Ended January 31, January 31, 2020 2019 2020 2019 Revenue 100% 100% 100% 100% Cost of revenue 20 21 20 20 Gross margin 80 79 80 80 Operating expenses Sales and marketing 61 52 62 55 Research and development 20 20 21 20 General and administrative 29 14 21 15 Total operating expenses 110 86 104 90 Operating margin (30) (7) (25) (10) Interest income 2 3 2 3 Other income (expense), net - - - - Loss before income taxes (28) (4) (23) (7) Provision for income taxes 1 1 1 1 Net loss (29)% (5)% (24)% (8)% Comparison of the Three Months EndedJanuary 31, 2020 and 2019 Revenue Three Months Ended January 31, Change 2020 2019 $ % (in thousands) Revenue$ 101,268 $ 74,302 $ 26,966 36 % Revenue increased by$27.0 million , or 36% for the three months endedJanuary 31, 2020 , compared to the three months endedJanuary 31, 2019 . The increase in revenue was driven by an increase in users and sales of additional subscriptions to existing customers, which contributed$14.0 million in revenue, as reflected by our dollar-based net retention rate of 116% for the trailing 12 months endedJanuary 31, 2020 . The remainder of the increase was attributable to the addition of new customers, as we increased our customer base by 17% fromJanuary 31, 2019 toJanuary 31, 2020 . Cost of Revenue and Gross Margin Three Months Ended January 31, Change 2020 2019 $ % (in thousands) Cost of revenue$ 20,238 $ 15,271 $ 4,967 33 % Gross margin 80 % 79 % Cost of revenue increased by$5.0 million , or 33%, for the three months endedJanuary 31, 2020 , compared to the three months endedJanuary 31, 2019 . The overall increase in cost of revenue was driven primarily by the expanded use of our cloud platform by existing and new customers, which led to an increase of$3.1 million for data center and equipment related costs for hosting and operating our cloud platform. Additionally, our employee-related expenses increased by$2.2 million , inclusive of an increase of$1.0 million in stock-based compensation expense, driven primarily by a 31% increase in headcount in our customer support and cloud operations organizations fromJanuary 31, 2019 toJanuary 31, 2020 . Increases in cost of revenue were partially offset by decreased expenses of$1.2 million associated with certain one-time costs recognized in the three months endedJanuary 31, 2019 that were not present in the three months endedJanuary 31, 2020 . 34 -------------------------------------------------------------------------------- Table of Contents Gross margin increased from 79% during the three months endedJanuary 31, 2019 to 80% during the three months endedJanuary 31, 2020 . The increase in gross margin was primarily driven by certain one-time costs recognized in the three months endedJanuary 31, 2019 that were not present in the three months endedJanuary 31, 2020 . Operating Expenses Sales and Marketing Expenses Three Months Ended January 31, Change 2020 2019 $ % (in thousands) Sales and marketing$ 61,621 $ 38,756 $ 22,865 59 % Sales and marketing expenses increased by$22.9 million , or 59%, for the three months endedJanuary 31, 2020 , compared to the three months endedJanuary 31, 2019 . The increase was primarily due to an increase of$16.9 million in employee-related expenses, inclusive of an increase of$6.4 million in stock-based compensation expense, and an increase of$2.1 million in sales commissions expense, driven by a 35% increase in headcount fromJanuary 31, 2019 toJanuary 31, 2020 . The remainder of the increase was primarily attributable to increased expenses of$2.1 million in marketing and advertising expenses and$2.0 million in travel expenses. Research and Development Expenses Three Months Ended January 31, Change 2020 2019 $ % (in thousands) Research and development$ 20,706 $ 15,071 $ 5,635 37 % Research and development expenses increased by$5.6 million , or 37%, for the three months endedJanuary 31, 2020 , compared to the three months endedJanuary 31, 2019 as we continued to develop and enhance the functionality of our cloud platform. The increase was primarily driven by an increase of$5.6 million in employee-related expenses, inclusive of an increase of$1.7 million in stock-based compensation expense, driven by a 38% increase in headcount fromJanuary 31, 2019 toJanuary 31, 2020 . The remainder of the increase was primarily attributable to increased expenses of$2.0 million for facility, IT and professional services. Expense increases were partially offset by higher capitalized internal-use software development costs of$1.9 million to support the enhancement and growth of our cloud platform. General and Administrative Expenses Three Months Ended January 31, Change 2020 2019 $ % (in thousands) General and administrative$ 28,983 $ 10,386 $ 18,597 179 % General and administrative expenses increased by$18.6 million , or 179%, for the three months endedJanuary 31, 2020 , compared to the three months endedJanuary 31, 2019 . The increase was primarily due to a$15.0 million payment to Broadcom inJanuary 2020 in connection with the settlement of the Symantec Cases. For further information on this settlement refer to Note 8, Commitments and Contingencies of our condensed consolidated financial statements included elsewhere in this Quarterly Report Form 10-Q. The remaining of the increase was primarily driven by$2.6 million in employee-related costs, inclusive of an increase of$1.6 million in stock-based compensation expense, driven by a 35% increase in headcount fromJanuary 31, 2019 toJanuary 31, 2020 . 35 --------------------------------------------------------------------------------
Table of Contents Interest Income Three Months Ended January 31, Change 2020 2019 $ % (in thousands) Interest income$ 1,855 $ 1,924 $ (69) (4) % Interest income decreased by$0.1 million for the three months endedJanuary 31, 2020 , compared to the three months endedJanuary 31, 2019 . The decrease was driven by lower market interest rates. Other Income (Expense), Net Three Months Ended January 31, Change 2020 2019 $ % (in thousands) Other income (expense), net $ (13)$ 250 $ (263) (105) % Other income (expense), net decreased by$0.3 million for the three months endedJanuary 31, 2020 , compared to the three months endedJanuary 31, 2019 . The decrease was primarily driven by fluctuations in foreign currency transaction gains and losses for the three months endedJanuary 31, 2020 as compared to the three months endedJanuary 31, 2019 . Provision for Income Taxes Three Months Ended January 31, Change 2020 2019 $ % (in thousands) Provision for income taxes $ 716$ 547 $ 169 31 % Our provision for income taxes increased by$0.2 million for the three months endedJanuary 31, 2020 , compared to the three months endedJanuary 31, 2019 , primarily related to income taxes in the foreign jurisdictions in which we operate. Our tax provision for interim periods is determined using an estimate of our annual effective tax rate, adjusted for discrete items, if any, that arise during the period. Each quarter, we update our estimate of the annual effective tax rate, and if the estimated annual effective tax rate changes, we make a cumulative adjustment in such period. Our quarterly tax provision, and estimate of our annual effective tax rate, is subject to variation due to several factors, including variability in pre-tax income or loss, the mix of jurisdictions to which such income relates, changes in how we do business, and tax law developments. Our estimated annual effective tax rate for the year differs from theU.S. statutory rate of 21% primarily due to the benefit of a portion of our earnings being taxed at rates lower than theU.S. statutory rate. The realization of deferred tax assets is dependent upon the generation of sufficient taxable income of the appropriate character in future periods. We assess our ability to realize our deferred tax assets on a quarterly basis and we establish a valuation allowance if it is more-likely-than-not that some portion of the deferred tax assets will not be realized. We weigh all available positive and negative evidence, including our earnings history and results of recent operations, scheduled reversals of deferred tax liabilities, projected future taxable income and tax planning strategies. Due to the weight of objectively verifiable negative evidence, including our history of losses in certain jurisdictions, we believe that it is more likely than not that ourU.S. federal, state, andU.K. deferred tax assets will not be realized. Accordingly, we have maintained a valuation allowance on ourU.S. federal, state, andU.K. deferred tax assets. 36
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Table of Contents Comparison of the Six Months EndedJanuary 31, 2020 and 2019 Revenue Six Months Ended January 31, Change 2020 2019 $ % (in thousands) Revenue$ 194,858 $ 137,600 $ 57,258 42 % Revenue increased by$57.3 million , or 42% for the six months endedJanuary 31, 2020 , compared to the six months endedJanuary 31, 2019 . The increase in revenue was driven by an increase in users and sales of additional subscriptions to existing customers, which contributed$36.2 million in revenue, as reflected by our dollar-based net retention rate of 116% for the trailing 12 months endedJanuary 31, 2020 . The remainder of the increase was attributable to the addition of new customers, as we increased our customer base by 17% fromJanuary 31, 2019 toJanuary 31, 2020 . Cost of Revenue and Gross Margin Six Months Ended January 31, Change 2020 2019 $ % (in thousands) Cost of revenue$ 39,796 $ 27,370 $ 12,426 45 % Gross margin 80 % 80 % Cost of revenue increased by$12.4 million , or 45%, for the six months endedJanuary 31, 2020 , compared to the six months endedJanuary 31, 2019 . The overall increase in cost of revenue was driven primarily by the expanded use of our cloud platform by existing and new customers, which led to an increase of$7.2 million for data center and equipment related costs for hosting and operating of our cloud platform for our expanded customer base. Additionally, our employee-related expenses increased by$4.7 million , inclusive of an increase of$1.8 million in stock-based compensation expense, driven primarily by a 31% increase in headcount in our customer support and cloud operations organizations fromJanuary 31, 2019 toJanuary 31, 2020 and by the shift from granting stock options to restricted stock units subsequent to our IPO. Gross margin remained unchanged at 80% for the six months endedJanuary 31, 2019 compared to the six months endedJanuary 31, 2020 . Operating Expenses Sales and Marketing Expenses Six Months Ended January 31, Change 2020 2019 $ % (in thousands) Sales and marketing$ 121,032 $ 75,301 $ 45,731 61 % Sales and marketing expenses increased by$45.7 million , or 61%, for the six months endedJanuary 31, 2020 , compared to the six months endedJanuary 31, 2019 . The increase was primarily due to an increase of$33.1 million in employee-related expenses, inclusive of an increase of$13.7 million in stock-based compensation expense, and an increase of$4.1 million in sales commission expense, driven by a 35% increase in headcount fromJanuary 31, 2019 toJanuary 31, 2020 and by the shift from granting stock options to restricted stock units subsequent to our IPO. Additionally, our sales and marketing expenses increased by$6.6 million primarily due to growth of certain major sales and marketing events held 37 -------------------------------------------------------------------------------- Table of Contents during the six months endedJanuary 31, 2020 , including ourZenith Live events. The remainder of the increase was primarily attributable to increased expenses of$3.8 million in travel expenses. Research and Development Expenses Six Months Ended January 31, Change 2020 2019 $ % (in thousands) Research and development$ 40,977 $ 28,257 $ 12,720 45 % Research and development expenses increased by$12.7 million , or 45%, for the six months endedJanuary 31, 2020 , compared to the six months endedJanuary 31, 2019 as we continued to develop and enhance the functionality of our cloud platform. The increase was primarily driven by an increase of$12.3 million in employee-related expenses, inclusive of an increase of$3.8 million in stock-based compensation expense, driven by a 38% increase in headcount fromJanuary 31, 2019 toJanuary 31, 2020 and by the shift from granting stock options to restricted stock units subsequent to our IPO. The remainder of the increase was primarily attributable to increased expenses of$2.9 million for facility and equipment related expenses to support our growth. Expense increases were partially offset by decreased expenses of$3.4 million , as a result of higher capitalization of development costs for internal-use software to support the enhancement and growth of our cloud platform. General and Administrative Expenses Six Months Ended January 31, Change 2020 2019 $ % (in thousands) General and administrative$ 41,608 $ 20,517 $ 21,091 103 % General and administrative expenses increased by$21.1 million , or 103%, for the six months endedJanuary 31, 2020 , compared to the six months endedJanuary 31, 2019 . The increase was primarily due to a$15.0 million payment to Broadcom inJanuary 2020 in connection with the settlement of the Symantec Cases. For further information on this settlement refer to Note 8, Commitments and Contingencies of our condensed consolidated financial statements included elsewhere in this Quarterly Report Form 10-Q. The remainder of the increase was primarily driven by$4.2 million in employee-related costs, inclusive of an increase of$2.2 million in stock-based compensation expense, driven by a 35% increase in headcount fromJanuary 31, 2019 toJanuary 31, 2020 and by the shift from granting stock options to restricted stock units subsequent to our IPO. Interest Income Six Months Ended January 31, Change 2020 2019 $ % (in thousands) Interest income$ 3,877 $ 3,514 $ 363 10 % Interest income increased by$0.4 million for the six months endedJanuary 31, 2020 , compared to the six months endedJanuary 31, 2019 . The increase was primarily driven by our increased holdings of cash equivalents and short-term investments as compared to the six months endedJanuary 31, 2019 . 38 --------------------------------------------------------------------------------
Table of Contents Other Income (Expense), Net Six Months Ended January 31, Change 2020 2019 $ % (in thousands) Other income (expense), net $ (42)$ 62 $ (104) (168) % Other income (expense), net decreased by$0.1 million for the six months endedJanuary 31, 2020 , compared to the six months endedJanuary 31, 2019 . The decrease was primarily driven by fluctuations in foreign currency transaction gains and losses for the six months endedJanuary 31, 2020 as compared to the six months endedJanuary 31, 2019 . Provision for Income Taxes Six Months Ended January 31, Change 2020 2019 $ % (in thousands) Provision for income taxes$ 1,510 $ 874 $ 636 73 % Our provision for income taxes increased by$0.6 million for the six months endedJanuary 31, 2020 , compared to the six months endedJanuary 31, 2019 , primarily related to income taxes in the foreign jurisdictions in which we operate. Our tax provision for interim periods is determined using an estimate of our annual effective tax rate, adjusted for discrete items, if any, that arise during the period. Each quarter, we update our estimate of the annual effective tax rate, and if the estimated annual effective tax rate changes, we make a cumulative adjustment in such period. Our quarterly tax provision, and estimate of our annual effective tax rate, is subject to variation due to several factors, including variability in pre-tax income or loss, the mix of jurisdictions to which such income relates, changes in how we do business, and tax law developments. Our estimated annual effective tax rate for the year differs from theU.S. statutory rate of 21% primarily due to the benefit of a portion of our earnings being taxed at rates lower than theU.S. statutory rate. The realization of deferred tax assets is dependent upon the generation of sufficient taxable income of the appropriate character in future periods. We assess our ability to realize our deferred tax assets on a quarterly basis and we establish a valuation allowance if it is more-likely-than-not that some portion of the deferred tax assets will not be realized. We weigh all available positive and negative evidence, including our earnings history and results of recent operations, scheduled reversals of deferred tax liabilities, projected future taxable income and tax planning strategies. Due to the weight of objectively verifiable negative evidence, including our history of losses in certain jurisdictions, we believe that it is more likely than not that ourU.S. federal, state, andU.K. deferred tax assets will not be realized. Accordingly, we have maintained a valuation allowance on ourU.S. federal, state, andU.K. deferred tax assets. Liquidity and Capital Resources As ofJanuary 31, 2020 , our principal sources of liquidity were cash, cash equivalents and short-term investments totaling$384.9 million which were held for working capital and general corporate purposes. Our cash equivalents and investments consist of highly liquid investments in money market funds,U.S. treasury securities,U.S. government agency securities and corporate debt securities. We have generated significant operating losses from operations, as reflected in our accumulated deficit of$270.7 million as ofJanuary 31, 2020 . We expect to continue to incur operating losses and have in the past and may in the future generate negative cash flows from operations in future periods due to expected investments to grow our business. 39 -------------------------------------------------------------------------------- Table of Contents We believe that our existing cash, cash equivalents and short-term investments will be sufficient to fund our operating and capital needs for at least the next 12 months from the issuance of our financial statements. Our assessment of the period of time through which our financial resources will be adequate to support our operations is a forward-looking statement and involves risks and uncertainties. Our actual results could vary as a result of, and our future capital requirements, both near-term and long-term, will depend on, many factors, including our growth rate, the timing and extent of spending to support our research and development efforts, the expansion of sales and marketing and international operating activities, the timing of new introductions of solutions or features, and the continuing market acceptance of our services. We have and may in the future enter into arrangements to acquire or invest in complementary businesses, services and technologies, including intellectual property rights. We have based this estimate on assumptions that may prove to be wrong, and we could use our available capital resources sooner than we currently expect. We may be required to seek additional equity or debt financing. In the event that additional financing is required from outside sources, we may not be able to raise it on terms acceptable to us or at all. If we are unable to raise additional capital when desired, or if we cannot expand our operations or otherwise capitalize on our business opportunities because we lack sufficient capital, our business, operating results and financial condition would be adversely affected. We typically invoice our customers annually in advance, and to a lesser extent quarterly in advance, monthly in advance or multi-year in advance. Therefore, a substantial source of our cash is from such prepayments, which are included on our consolidated balance sheets as a contract liability. Deferred revenue consists of the unearned portion of billed fees for our subscriptions, which is subsequently recognized as revenue in accordance with our revenue recognition policy. As ofJanuary 31, 2020 , we had deferred revenue of$280.0 million , of which$251.2 million was recorded as a current liability and is expected to be recorded as revenue in the next 12 months, provided all other revenue recognition criteria have been met. Subscriptions that are invoiced annually in advance or multi-year in advance contribute significantly to our short-term and long-term deferred revenue in comparison to our invoices issued quarterly in advance or monthly in advance. Accordingly, we cannot predict the mix of invoicing schedules in any given period. The following table summarizes our cash flows for the periods presented: Six Months Ended January 31, 2020 2019 (in thousands) Net cash provided by operating activities$ 26,860 $
26,721
Net cash used in investing activities$ (40,902) $
(119,283)
Net cash provided by financing activities$ 12,092 $
24,270
Operating Activities Net cash provided by operating activities during the six months endedJanuary 31, 2020 was$26.9 million , which resulted from a net loss of$46.2 million , which included a$15.0 million payment to Broadcom inJanuary 2020 in connection with the settlement of the Symantec Cases (refer to Note 8, Commitments and Contingencies, Legal Matters, included in Part I, Item 1 of this Quarterly Report on Form 10-Q), adjusted for non-cash charges of$68.9 million and net cash inflows of$4.2 million from changes in operating assets and liabilities. Non-cash charges primarily consisted of$42.2 million for stock-based compensation expense,$11.4 million for amortization of deferred contract acquisition costs,$7.5 million for depreciation and amortization expense,$6.2 million for noncash operating lease costs and$1.4 million for amortization expense of acquired intangible assets. Net cash inflows from changes in operating assets and liabilities were primarily the result of an increase of$28.8 million in deferred revenue from advanced invoicing in accordance with our subscription contracts and an increase of$3.5 million in accrued compensation. Net cash inflows were partially offset by cash outflows resulting from an increase of$15.7 million in deferred contract acquisition costs, as our sales commission payments increased due to addition of new customers and expansion of our existing customer subscriptions, a decrease of$5.2 million 40 -------------------------------------------------------------------------------- Table of Contents in operating lease liabilities primarily due to lease payments, an increase of$4.0 million in prepaid expenses, other current and noncurrent assets to balance our working capital requirements, an increase of$1.4 million in accounts receivable primarily due to timing of billings and collections and a decrease of$1.2 million in accrued expenses, other current and noncurrent liabilities. Net cash provided by operating activities during the six months endedJanuary 31, 2019 was$26.7 million , which resulted from a net loss of$11.1 million , adjusted for non-cash charges of$33.6 million and net cash inflows of$4.3 million from changes in operating assets and liabilities. Non-cash charges primarily consisted of$20.8 million for stock-based compensation expense,$8.8 million of amortization of deferred contract acquisition costs and$4.7 million of depreciation and amortization expense, partially offset by accretion of purchase discounts, net of amortization of investment premiums of$1.1 million . Net cash inflows from changes in operating assets and liabilities were primarily the result of an increase of$42.0 million in deferred revenue from advanced invoicing in accordance with our subscription contracts and an increase of$1.0 million in accrued expenses and other current and noncurrent liabilities. Net cash inflows were partially offset by cash outflows resulting from an increase of$13.9 million in accounts receivable primarily due to seasonality in terms of when we enter into agreements with customers, an increase of$13.5 million in deferred contract acquisition costs as our sales commission payments increased due to addition of new customers and expansion of our existing customer subscriptions, a decrease of$7.9 million in accrued compensation, primarily due to issuance of common stock under our employee stock purchase plan, an increase of$2.8 million in prepaid expenses, other current and noncurrent assets and a decrease of$0.8 million in accounts payable. Investing Activities Net cash used in investing activities during the six months endedJanuary 31, 2020 of$40.9 million was primarily attributable to the purchases of short-term investments of$147.5 million and capital expenditures of$19.4 million to support the growth of our cloud platform and investments in leasehold improvements associated with our new corporate headquarters to support our headcount growth. These activities were partially offset by proceeds from the maturities of short-term investments of$126.0 million . Net cash used in investing activities during the six months endedJanuary 31, 2019 of$119.3 million was primarily attributable to the purchase of short-term investments of$179.9 million , investments in capital expenditures of$9.5 million to support our cloud platform and headcount and payments for acquired intangible assets of$1.5 million . These activities were partially offset by proceeds from the maturities of short-term investments of$71.6 million . Financing Activities Net cash provided by financing activities of$12.1 million during the six months endedJanuary 31, 2020 was primarily attributable to$6.8 million in proceeds from the exercise of stock options and$5.3 million in proceeds from issuance of common stock under the employee stock purchase plan. Net cash provided by financing activities of$24.3 million during the six months endedJanuary 31, 2019 was primarily due to$15.5 million in proceeds from the exercise of stock options, primarily as a result of the termination of our initial public offering lock-up period ending inSeptember 2018 ,$8.7 million in proceeds from issuance of common stock under the employee stock purchase plan and$1.9 million in proceeds from the repayment of the outstanding principal amount of the notes receivable for early exercised stock options. Proceeds were partially offset by$1.8 million in payments of offering costs related to our IPO. 41 -------------------------------------------------------------------------------- Table of Contents Contractual Obligations and Commitments The following table summarizes our contractual obligations as ofJanuary 31, 2020 : Payments Due by Period Less Than 1 1 to 3 3 to 5 More Than Total Year Years Years 5 Years (in thousands) Real estate arrangements(1)$ 45,575 $ 6,551 $ 12,975 $ 13,302 $ 12,747 Co-location arrangements(1) 29,232 15,357 13,875 - - Non-cancelable purchase obligations 21,913 18,181 3,432 300 - Other current liabilities(2) 2,525 2,525 - - - Total$ 99,245 $ 42,614 $ 30,282 $ 13,602 $ 12,747 _____ (1) Amounts are reflected on an undiscounted basis. For additional information refer to Note 7, Operating leases of our condensed consolidated financial statements included elsewhere in this Quarterly Report Form 10-Q. (2) Includes holdback amounts associated with business combinations, which are payable upon the lapse of the contractual indemnification period. The contractual commitment amounts in the table above are associated with agreements that are enforceable and legally binding. Obligations under contracts, including purchase orders, that we can cancel without a significant penalty are not included in the table above. Off-Balance Sheet Arrangements As ofJanuary 31, 2020 , we did not have any relationships with unconsolidated organizations or financial partnerships, such as structured finance or special purpose entities, which would have been established for the purpose of facilitating off-balance sheet arrangements or other contractually narrow or limited purposes. As ofJanuary 31, 2020 , we had outstanding irrevocable standby unsecured letters of credits for an aggregate value of$3.1 million with a bank, which serve as security under certain real estate leases included in Note 7, Operating Leases to our condensed consolidated financial statements included elsewhere in this Quarterly Report on Form 10-Q. Critical Accounting Policies and Estimates Our financial statements are prepared in accordance withU.S. GAAP. The preparation of these financial statements requires us to make estimates and assumptions that affect the reported amounts of assets, liabilities, revenue and expenses, as well as related disclosures. We evaluate our estimates and assumptions on an ongoing basis. Our estimates are based on historical experience and various other assumptions that we believe to be reasonable under the circumstances. Our actual results could differ from these estimates. We refer to accounting estimates of this type as critical accounting policies and estimates, which we discuss below. Our significant accounting policies are discussed in Note 1, Business and Summary of Significant Accounting Policies to our consolidated financial statements included in our Form 10-K filed with theSEC onSeptember 18, 2019 . There have been no significant changes to these policies for the six months endedJanuary 31, 2020 , except as described in Note 1, Business and Summary of Significant Accounting Policies to our condensed consolidated financial statements included elsewhere in this Quarterly Report on Form 10-Q. 42 -------------------------------------------------------------------------------- Table of Contents Recently Issued Accounting Pronouncements Refer to Note 1, Business and Summary of Significant Accounting Policies to our condensed consolidated financial statements included elsewhere in this Quarterly Report on Form 10-Q for more information regarding recently issued accounting pronouncements. 43
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