PROOFPOINT, INC. The following discussion and analysis of our financial condition and results of operations should be read in conjunction with our "Selected Consolidated Financial Data" and our consolidated financial statements and related notes included elsewhere in this Annual Report on Form 10-K. This discussion contains forward-looking statements that involve risks and uncertainties. Our actual results could differ materially from those forward-looking statements below. Factors that could cause or contribute to those differences include, but are not limited to, those identified below and those discussed in the section entitled "Risk Factors" included elsewhere in this Annual Report on Form 10-K. This Annual Report on Form 10-K contains "forward-looking statements" within the meaning of Section 21E of the Securities Exchange Act of 1934, as amended (the "Exchange Act"). These statements are often identified by the use of words such as "may," "will," "expect," "believe," "anticipate," "intend," "could," "estimate," or "continue," and similar expressions or variations. Such forward-looking statements are subject to risks, uncertainties and other factors that could cause actual results and the timing of certain events to differ materially from future results expressed or implied by such forward-looking statements. Factors that could cause or contribute to such differences include, but are not limited to, those identified herein, and those discussed in the section titled "Risk Factors", set forth in Part I, Item 1A of this Form 10-K. Except as required by law, we disclaim any obligation to update any forward-looking statements to reflect events or circumstances after the date of such statements. OverviewProofpoint is a leading next generation cybersecurity company that enables large and mid-sized organizations worldwide to protect their employees from advanced threats and compliance risks. Our security and compliance platform is comprised of an integrated suite of advanced threat protection, information protection, and brand protection solutions. These capabilities include email protection and authentication, advanced threat protection, data loss prevention, email encryption, SaaS application protection, response orchestration and automation, digital risk, security training, web browser isolation, archiving, eDiscovery, supervision, and secure communication. Our solutions are built on a flexible, cloud-based platform and leverage a number of proprietary technologies - including big data analytics, machine learning, deep content inspection, secure storage, advanced encryption, intelligent message routing, dynamic malware analysis, threat correlation, and virtual execution environments to address today's rapidly changing threat and compliance landscape. Our platform addresses this growing challenge by not only protecting data as it flows into and out of the enterprise via on-premises and cloud-based email, social media and other cloud applications, but also by keeping track of this information as it is modified and distributed throughout the enterprise for compliance and data loss prevention, and securely archiving these communications for compliance and discovery. We help organizations reduce their critical risk in five major ways:
• Protecting users from the advanced attacks that target them via email,
web, networks, social media, and cloud apps;
• Preventing the theft or inadvertent loss of sensitive information and, in
turn, ensuring compliance with regulatory data protection mandates;
• Improving the resilience of end users to the threats that target them andtraining them to be better caretakers of their organizations' critical
data;
• Collecting, retaining, supervising and discovering communications and
sensitive data for compliance and litigation support; and
• Enabling organizations to respond quickly to security issues, providing
both the intelligence and the context to prioritize incidents and
orchestrate remediation actions.
Our platform and its associated solutions are sold to customers on a
subscription basis and can be deployed through our unique cloud-based
architecture that leverages both our global data centers as well as optional
points-of-presence behind our customers' firewalls. Our flexible deployment
model enables us to deliver superior security and compliance while maintaining
the favorable economics afforded by cloud computing, creating a competitive
advantage for us over legacy on-premises and cloud-only offerings.
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We were founded in 2002 to provide a unified solution to help enterprises
address their growing data security requirements. Our first solution was
commercially released in 2003 to combat the burgeoning problem of spam and
viruses and their impact on corporate email systems. To address the evolving
threat landscape and the adoption of communication and collaboration systems
beyond corporate email and networks, we have broadened our solutions to defend
against a wide range of threats, including email, mobile apps and social media,
to protect the information people create from both compromise and compliance
risks, and to archive and govern corporate information. Today, our solutions are
used worldwide to protect well over 100 million end users at enterprise
customers, and millions more via service providers through our Cloudmark
division. As the threat environment has continued to evolve, we have dedicated
significant resources to meet the ongoing challenges that this highly dynamic
environment creates for our customers such as investing significantly to expand
the breadth of our data protection platform as these expenditures are primarily
in connection with the replacement and upgrade of equipment to lower the cost of
deployment as well as to improve the efficiency for our cloud-based
architecture.
Our business is based on a recurring revenue model. Our customers pay a
subscription fee to license the various components of our SaaS platform for a
contract term that is typically one to three years. At the end of the license
term, customers may renew their subscription and in each year since the launch
of our first solution in 2003, we have maintained a renewal rate with our
existing customers of over 90%. We derive this retention rate by calculating the
total annually recurring subscription revenue from customers currently using our
SaaS platform and dividing it by the total annually recurring subscription
revenue from both these current customers as well as all business lost through
non-renewal.
We market and sell our solutions worldwide both directly through our sales teams
and indirectly through a hybrid model where our sales organization actively
assists our network of distributors and resellers. We also derive a lesser
portion of our total revenue from the license of our solutions to strategic
partners who offer our solutions in conjunction with one or more of their own
products or services.
Our solutions are designed to be implemented, configured and operated without
the need for any training or professional services. We offer various training
and professional services for those customers that seek to develop deeper
expertise in the use of our solutions or would like assistance with complex
configurations or the importing of data. In some cases, we provide a hardware
appliance to those customers that elect to host elements of our solution behind
their firewall. Increasing adoption of virtualization in the data center has led
to a decline in the sales of our hardware appliances and a shift towards our
software-based virtual appliances, which are delivered as a download via the
Internet. Our hardware and services offerings carry lower margins and are
provided as a courtesy to our customers. We expect the overall proportion of
revenue derived from the hardware and services offerings to generally remain
below 5% of our total revenue.
Historically, the majority of our revenue was derived from our customers in the
United States . We believe the markets outside of the United States offer an
opportunity for growth and we intend to make additional investments in sales and
marketing to expand in these markets. Revenue from customers outside of the
United States grew 32% for the year ended December 31, 2019 as compared to the
prior year. In terms of customer concentration, there were two partners who
accounted for 12% and 11%, respectively, of our total revenue in 2019. In 2018
and 2017, one partner accounted for 12% of our total revenue in each year. These
partners sold to a number of end users, none of which accounted for more than
10% of our total revenue in 2019, 2018 and 2017.
We have not been profitable to date and will need to grow revenue at a rate faster than our investments in cost of revenue and operating expenses in order to achieve profitability, as discussed in more detail below.
Key Opportunities and Challenges
The total costs associated with the teams tasked with closing business with new
customers and additional business with our existing customers have represented
more than 90% of our total sales and marketing costs since 2008. Although we
expect customers to be profitable over the duration of the customer
relationship, the upfront costs typically exceed related revenue during the
earlier periods of a contract. As a result, while our practice of invoicing our
customers for the entire amount of the contract at the start of the term
provides us with a relatively immediate contribution to cash flow, the revenue
is recognized ratably over the term of the contract, and hence contributions
toward operating income are limited in the period where the sales and marketing
costs are incurred. Accordingly, an increase in the mix of new customers as a
percentage of total customers would likely negatively impact our near-term
operating results. On the other hand, we expect that an increase in the mix of
existing customers as a percentage of total customers would positively impact
our operating results over time. As we accumulate customers that continue to
renew their contracts, we anticipate that our mix of existing customers will
increase, contributing to a decrease in our sales and marketing costs as a
percentage of total revenue and a commensurate improvement in our operating
income.
As part of maintaining our SaaS platform, we provide ongoing updates and
enhancements to the platform services both in terms of the software as well as
the underlying hardware and data center infrastructure. These updates and
enhancements are provided to our customers at no additional charge as part of
the subscription fees paid for the use of our platform. While more traditional
products eventually become obsolete and require replacement, we are constantly
updating and maintaining our cloud-based services and as such they operate with
a continuous product life cycle. Much of this work is designed to both maintain
and enhance the
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customers' experience over time while also lowering our costs to deliver the
service. Our SaaS platform is a shared infrastructure that is used by all of our
customers. Accordingly, the costs of the platform are spread in a relatively
uniform manner across the entire customer base and no specific infrastructure
elements are directly attached to any particular customer. As such, in the event
that a customer chooses to not renew its subscription, the underlying resources
are reallocated either to new customers or to accommodate the expanding needs of
our existing customers and, as a result, we do not believe that the loss of any
particular customer has a meaningful impact on our gross profit as long as we
continue to grow our customer base.
To date, our customers have primarily used our solutions in conjunction with
email messaging content. We have developed solutions to address new and evolving
messaging solutions such as social media and file sharing applications, but
these solutions are relatively nascent. If customers increase their use of these
new messaging solutions in the future, we anticipate that our growth in revenue
associated with older email messaging solutions may slow over time. Although
revenue associated with our social media and file sharing applications has not
been material to date, we believe that our ability to provide security,
archiving, governance and discovery for these new solutions will be viewed as
valuable by our existing customers, enabling us to derive revenue from these new
forms of messaging and communication.
With the majority of our business, we invoice our customers for the entire
contract amount at the start of the term and these amounts are recorded as
deferred revenue on our balance sheet, with the dollar weighted average duration
of these contracts for any given period over the past three years typically
ranging from 14 to 20 months. As a result, while our practice of invoicing
customers for the entire amount of the contract at the start of the term
provides us with a relatively immediate contribution to cash flow, the revenue
is recognized ratably over the term of the contract, and hence contributions
toward operating income are realized over an extended period. As such, our
efforts to improve our profitability require us to invest far less in operating
expenses than the cash flow generated by our business might otherwise allow. As
we strive to invest in an effort to continue to increase the size and scale of
our business, we expect that the level of investment afforded by our growth in
revenue should be sufficient to fund the investments needed to drive revenue
growth and broaden our product line.
Considering all of these factors, we do not expect to be profitable on a GAAP
basis in the near term and in order to achieve profitability we will need to
grow revenue at a rate faster than our investments in operating expenses and
cost of revenue.
We intend to grow our revenue through acquiring new customers by investing in
our sales and marketing activities. We believe that an increase in new customers
in the near term will result in a larger base of renewal customers, which, over
time, we expect to be more profitable for us.
Sales and marketing is our largest expense and hence a significant contributing
factor to our operating losses. We believe that our opportunity to improve our
return on investment on sales and marketing costs relies primarily on our
ongoing ability to cost-effectively renew our business with existing customers,
thereby lowering our overall sales and marketing costs as a percentage of
revenue as the mix of revenue derived from this more profitable renewal activity
increases over time. Therefore, we anticipate that our initial significant
investments in sales and marketing activities will, over time, generate a larger
base of more profitable customers. Cost of subscription revenue is also a
significant expense for us, and we expect to continue to build on the
improvements over the past years, such as in replacing third-party technology
with our proprietary technology and improving the utilization of our fixed
investments in equipment and infrastructure, in order to provide the opportunity
for improved subscription gross margins over time. Although we plan to continue
enhancing our solutions, we intend to lower our rate of investment in research
and development as a percentage of revenue over time by deriving additional
revenue from our existing solutions rather than by adding entirely new
categories of solutions. In addition, as personnel costs are one of the primary
drivers of the increases in our operating expenses, we plan to reduce our
historical rate of headcount growth over time.
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Key Metrics
We regularly review a number of metrics, including the following key metrics
presented in the table below, to evaluate our business, measure our performance,
identify trends in our business, prepare financial projections and make
strategic decisions. Many of these key metrics, such as non-GAAP gross margin,
billings and free cash flow, are non-GAAP measures. This non-GAAP information is
not necessarily comparable to non-GAAP information of other companies. Users of
this financial information should consider the types of events and transactions
for which adjustments have been made.
Year Ended December 31,
2019 2018 2017
(in thousands)
Total revenue $ 888,190 $ 716,994 $ 519,681
Growth 24 % 38 % 37 %
Gross margin percentage 73 % 72 % 72 %
Non-GAAP gross margin 79 % 78 % 78 %
Billings (non-GAAP) $ 1,072,159 $ 875,323 $ 638,839
Growth 22 % 37 % 38 %
Free cash flows (non-GAAP) $ 207,315 $ 155,222 $ 106,728
Non-GAAP gross margin
We define non-GAAP gross margin as non-GAAP gross profit divided by GAAP
revenue. We define non-GAAP gross profit as GAAP gross profit, adjusted to
exclude stock-based compensation expense and the amortization of intangibles
associated with acquisitions. We consider this non-GAAP financial measure to be
a useful metric for management and investors because it excludes the effect of
stock-based compensation expense and the amortization of intangibles associated
with acquisitions so that our management and investors can compare our business
operating results over multiple periods, and compare our financial results with
other companies in its industry, many of which present similar non-GAAP
financial measure. However, there are a number of limitations related to the use
of non-GAAP gross margin versus gross margin calculated in accordance with GAAP.
For example, stock-based compensation has been and will continue to be for the
foreseeable future a significant recurring expense in our business. Stock-based
compensation is an important part of our employees' compensation and impacts
their performance. In addition, the components of the costs that we exclude in
our calculation of non-GAAP gross margin may differ from the components that our
peer companies exclude when they report their non-GAAP results. Management
compensates for these limitations by providing specific information regarding
the GAAP amounts excluded from non-GAAP gross margin and evaluating non-GAAP
gross margin together with gross margin calculated in accordance with GAAP.
The following table presents the reconciliation of gross margin to Non-GAAP
gross margin for the years ended
Year Ended December 31,
2019 2018 2017
(in thousands)
GAAP gross profit $ 651,976 $ 515,233 $ 376,303
GAAP gross margin 73 % 72 % 72 %
Plus:Stock-based compensation expense 20,967 16,299 12,528 Amortization of intangible assets 30,760 26,971 14,512 Non-GAAP gross profit
$ 703,703 $ 558,503 $ 403,343 Non-GAAP gross margin 79 % 78 % 78 % Billings We have included billings, a nonGAAP financial measure, in this report because it is a key measure used by our management and board of directors to manage our business and monitor our near term cash flows. We define billings as revenue recognized plus the change in deferred revenue and customer prepayments less unbilled accounts receivable from the beginning to the end of the period, but excluding additions to deferred revenue and customer prepayments from acquisitions. We have provided reconciliation between total revenue, the most directly comparable GAAP financial measure, and billings. Accordingly, we believe that billings provide useful information to investors and others in understanding and evaluating our operating results in the same manner as our management and board of directors. 38 -------------------------------------------------------------------------------- Our use of billings as a non-GAAP measure has limitations as an analytical tool, and you should not consider it in isolation or as a substitute for revenue or an analysis of our results as reported under GAAP. Some of these limitations are:
• Billings is not a substitute for revenue, as trends in billings are not
necessarily directly correlated to trends in revenue;
• Billings is affected by a combination of factors including the timing of
renewals, the sales of our solutions to both new and existing customers,
the relative duration of contracts sold, and the relative amount of
business derived from strategic partners. As each of these elements has
unique characteristics in the relationship between billings and revenue,
our billings activity is not necessarily closely correlated to revenue;
and
• Other companies, including companies in our industry, may not usebillings, may calculate billings differently, or may use other financial
measures to evaluate their performance all of which reduce the
usefulness of billings as a comparative measure.
Our deferred revenue consists of amounts that have been invoiced but have not been recognized as revenue as of the period end. Customer prepayments represent billed amounts for which the contract can be terminated and the customer has a right of refund. Unbilled accounts receivable represent amounts for which we have recognized revenue, pursuant to our revenue recognition policy, for subscription software already delivered and professional services already performed, but billed in arrears and for which we believe we have an unconditional right to payment.
The following table presents the reconciliation of total revenue to billings for
the years ended
Year Ended December 31,
2019 2018 2017
(in thousands)
Total revenue $ 888,190 $ 716,994 $ 519,681
Deferred revenue and customer prepayments
Ending 797,173 605,073 431,371
Beginning 605,073 431,371 295,996
Net change 192,100 173,702 135,375
Unbilled accounts receivable
Ending 2,255 1,276 603
Beginning 1,276 603 486
Net change (979 ) (673 ) (117 )
Less: deferred revenue and customer
prepayments contributed by acquisitions (7,152 ) (14,700 ) (16,100 )
Billings $ 1,072,159 $ 875,323 $ 638,839
Free cash flows
We define free cash flow as net cash provided by operating activities minus
capital expenditures. We consider free cash flow to be a liquidity measure that
provides useful information to management and investors about the amount of cash
generated by the business that, after the acquisition of property and equipment,
can be used for strategic opportunities, including investing in our business,
making strategic acquisitions, and strengthening the balance sheet. Analysis of
free cash flow facilitates management's comparisons of our operating results to
competitors' operating results. A limitation of using free cash flow versus the
GAAP measure of net cash provided by operating activities as a means for
evaluating our company is that free cash flow does not represent the total
increase or decrease in the cash balance from operations for the period because
it excludes cash used for capital expenditures during the period. Management
compensates for this limitation by providing information about our capital
expenditures on the face of the cash flow statement and in the "Liquidity and
Capital Resources" section below.
Year Ended December 31,
2019 2018 2017
(in thousands)
GAAP cash flows provided by operating activities:
$ 153,686 Less: Purchase of property and equipment (35,193 ) (29,522 ) (46,958 ) Non-GAAP free cash flows$ 207,315 $ 155,222 $ 106,728 39
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Components of Our Results of Operations
Revenue
We derive our revenue primarily through the license of various solutions and services on our security-as-a-service platform on a subscription basis, supplemented by the sales of training, professional services and hardware depending upon our customers' requirements.
Subscription. We license our platform and its associated solutions and services on a subscription basis. The fees are charged on a per user, per year basis. Subscriptions are typically one to three years in duration. We invoice our customers upon signing for the entire term of the contract. The invoiced non-cancellable amounts billed in advance are treated as deferred revenue on the balance sheet and are recognized ratably, in accordance with the appropriate revenue recognition guidelines, over the term of the contract. We also derive a portion of our subscription revenue from the license of our solutions to strategic partners. We bill these strategic partners monthly. We expect our subscription revenue will continue to grow and remain above 95% of our total revenue. Hardware and services. We provide hardware appliances as a convenience to our customers and as such it represents a small part of our business. Our solutions are designed to be implemented, configured and operated without the need for any training or professional services. For those customers that seek to develop deeper expertise in the use of our solutions or would like assistance with complex configurations or the importing of data, we offer various training and professional services. We typically invoice the customer for hardware at the time of shipment. We typically invoice customers for services at the time the order is placed and recognize this revenue as the services are performed. On occasion, customers may retain us for special projects such as archiving import and export services; these types of services are recognized upon completion of the project. We expect the overall proportion of revenue derived from hardware and service offerings to generally remain below 5% of our total revenue.
Cost of Revenue
Our cost of revenues consists of cost of subscription revenue and cost of hardware and services revenue. Personnel costs, which consist of salaries, benefits, bonuses, stock-based compensation, data center costs and hardware costs, are the most significant components of our cost of revenues. We expect personnel costs to continue to increase in absolute dollars as we hire new employees to continue to grow our business.
Cost of Subscription Revenue. Cost of subscription revenue primarily includes personnel costs, consisting of salaries, benefits, bonuses, and stock-based compensation, for employees who provide support services to our customers and operate our data centers. Other costs include fees paid to contractors who supplement our support and data center personnel; expenses related to the use of third-party data centers in boththe United States and internationally; depreciation of data center equipment; amortization of licensing fees and royalties paid for the use of third-party technology; amortization of internally developed intangible assets; and the amortization of intangible assets acquired through business combinations. Growth in subscription revenue generally consumes production resources, requiring us to gradually increase our cost of subscription revenue in absolute dollars as we expand our investment in data center equipment, the third-party data center space required to house this equipment, and the personnel needed to manage this higher level of activity. Cost of Hardware and Services Revenue. Cost of hardware and services revenue includes personnel costs for employees who provide training and professional services to our customers as well as the cost of server hardware shipped to our customers that we procure from third parties and configure with our software solutions. Operating Expenses Our operating expenses consist of research and development, sales and marketing, and general and administrative expenses. Personnel costs, which consist of salaries, benefits, bonuses, and stock-based compensation, are the most significant component of our operating expenses. Our headcount has increased from 2,047 employees as ofDecember 31, 2017 to 3,368 employees as ofDecember 31, 2019 . As a result of this growth in headcount, operating expenses have increased significantly over these periods. We expect personnel costs to continue to increase in absolute dollars as we hire new employees to continue to grow our business. 40
-------------------------------------------------------------------------------- Research and Development. Research and development expenses include personnel costs, consulting services and depreciation. We believe that these investments have played an important role in broadening the capabilities of our platform over the course of our operating history, enhancing the relevance of our solutions in the market in general and helping us to retain our customers over time. We expect to continue to devote substantial resources to research and development in an effort to continuously improve our existing solutions as well as to develop new offerings. We believe that these investments are necessary to maintain and improve our competitive position. However, over the longer term, we intend to monitor these costs so as to decrease this spending as a percentage of total revenue. Our research efforts include both software developed for our internal use on behalf of our customers as well as software elements to be used by our customers in their own facilities. To date, our capitalized costs on software developed for internal use on behalf of our customers were not material. For the software developed for use on our customers' premises, the costs associated with the development work between technological feasibility and the general availability has not been material and as such we have not capitalized any of these development costs to date. Sales and Marketing. Sales and marketing expenses include personnel costs, sales commissions, and other costs including travel and entertainment, marketing and promotional events, public relations and marketing activities. These costs also include amortization of intangible assets as a result of our past acquisitions. Due to our continued investment in growing our sales and marketing operations, both domestically and internationally, headcount increases were reflected in higher compensation expense consistent with our revenue growth. Our sales personnel are typically not immediately productive, and therefore the increase in sales and marketing expenses we incur when we add new sales representatives is not immediately offset by increased revenue and may not result in increased revenue over the long-term if these new sales people fail to become productive. The timing of our hiring of new sales personnel and the rate at which they generate incremental revenue will affect our future financial performance. We expect that sales and marketing expenses will continue to increase in absolute dollars and be among the most significant components of our operating expenses. General and Administrative. General and administrative expenses consist of personnel costs, consulting services, audit fees, tax services, legal expenses and other general corporate items. As a result of our operational growth, we expect our general and administrative expenses to increase in absolute dollars in future periods as we continue to expand our operations and hire additional personnel. Interest Expense
Interest expense consists of interest expense and loss on conversion related to our convertible senior notes.
Other Income, Net
Other income, net, consists primarily of interest income earned on our cash, cash equivalents and short-term investments, and the net effect of foreign currency transaction gains and losses.
(Provision for) Benefit from Income Taxes
For most of the prior years, our income tax expense or benefit were primarily related to state and foreign income taxes. As we have incurred operating losses in all periods to date and recorded a full valuation allowance against our deferred tax assets, we had not historically recorded a provision for federal income taxes. However, in the year endedDecember 31, 2017 , we recognized$0.2 million of deferred tax benefit in theU.S. related to amortization of tax goodwill on business acquisitions and$12.3 million of deferred tax benefit in theU.S. related to changes in the Company's valuation allowance resulting from theCloudmark, Inc. andWebLife Balance, Inc. business acquisitions. For the year endedDecember 31, 2018 , we recognized$14.7 million of deferred tax benefit in theU.S. related to changes in the Company's valuation allowance resulting from theWombat Security Technologies, Inc. acquisition. For the year endedDecember 31, 2019 , we recognized$0.3 million of deferred tax benefit in theU.S. related to amortization of tax goodwill on certain business acquisitions. Realization of any of our deferred tax assets depends upon future earnings, the timing and amount of which are uncertain. Utilization of our net operating losses and research and development credits may be subject to substantial annual limitation due to the ownership change limitations provided by the Internal Revenue Code and similar state provisions. Analyses have been conducted to determine whether an ownership change had occurred since inception. The analyses have indicated that although ownership changes have occurred in prior years, the net operating losses and research and development credits would not expire before utilization as a result of the ownership change. In the event we have subsequent changes in ownership, net operating losses and research and development credit carryovers could be limited and may expire unutilized as a result of the subsequent ownership change. 41
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Results of Operations
The following table is a summary of our consolidated statements of operations.
Year Ended December 31,
2019 2018 2017
(in thousands)
Revenue:
Subscription $ 875,006 $ 704,400 $ 506,355
Hardware and services 13,184 12,594 13,326
Total revenue 888,190 716,994 519,681
Cost of revenue:(1)
Subscription 206,997 180,253 125,832
Hardware and services 29,217 21,508 17,546
Total cost of revenue 236,214 201,761 143,378
Gross profit 651,976 515,233 376,303
Operating expense:(1)
Research and development 230,463 185,391 129,803
Sales and marketing 416,717 345,368 248,694
General and administrative 109,727 86,185 52,735
Total operating expense 756,907 616,944 431,232
Operating loss (104,931 ) (101,711 ) (54,929 )
Interest expense (12,526 ) (16,761 ) (28,608 )
Other income, net 7,109 1,491 3,785
Loss before income taxes (110,348 ) (116,981 ) (79,752 )
(Provision for) benefit from, income taxes (19,917 ) 13,232 9,950
Net loss $ (130,265 ) $ (103,749 ) $ (69,802 ) The following table sets forth our consolidated results of operations for the specified periods as a percentage of our total revenue for those periods.
Year Ended December 31,
2019 2018 2017
Revenue:
Subscription 99 % 98 % 97 %
Hardware and services 1 2 3
Total revenue 100 100 100
Cost of revenue:(1)
Subscription 24 25 24
Hardware and services 3 3 4
Total cost of revenue 27 28 28
Gross profit 73 72 72
Operating expense:(1)
Research and development 26 26 25
Sales and marketing 47 48 47
General and administrative 12 12 10
Total operating expense 85 86 82
Operating loss (12 ) (14 ) (10 )
Interest expense (1 ) (2 ) (5 )
Other income, net - - -
Loss before income taxes (13 ) (16 ) (15 )
(Provision for) benefit from income taxes (2 ) 2 2
Net loss (15 )% (14 )% (13 )%
(1) Includes stock-based compensation and amortization of intangible assets as
follows:
42
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Year Ended December 31,
2019 2018 2017
(in thousands)
Stock-based compensation:
Cost of subscription revenue $ 16,966 $ 14,012 $ 10,635 Cost of hardware and services revenue
$ 50,739 $ 40,204 $ 30,588 Sales and marketing$ 61,858 $ 50,320 $ 33,962 General and administrative$ 42,761 $ 35,885 $ 20,382 Amortization of intangible assets: Cost of subscription revenue$ 30,760 $ 26,971 $ 14,512 Research and development $ -$ 45 $ 60 Sales and marketing$ 14,888 $ 14,141 $ 3,934 Revenue Year Ended Year Ended December 31, Change December 31, Change 2019 2018 $ % 2018 2017 $ % (in thousands) (in thousands) Subscription$ 875,006 $ 704,400 $ 170,606
24 %
590 5 % 12,594 13,326 (732 ) (5 )%
Total revenue $ 888,190 $ 716,994 $ 171,196 24 % $ 716,994 $ 519,681 $ 197,313 38 %
Subscription revenue increased $170.6 million and $198.0 million , or 24% and
39%, respectively, for 2019 and 2018. These increases were due to a $128.6
million and $153.1 million increase in revenue from the United States and a
$42.0 million and $44.9 million increase from international customers for 2019
and 2018, respectively.
The increases in subscription revenue for 2019 and 2018 were due to the ongoing
demand for our solutions, increase in add-on activity and renewal rate being
higher than 90%. Our enterprise customer count, which consists of customers that
generate more than $10,000 in annual recurring revenue, increased from
approximately 6,100 at the end of 2018 to approximately 7,100, or 16%, at the
end of 2019. In addition, the number of customers with three or more products
increased 38% in 2019 as compared to 2018. Our enterprise customer count
increased from approximately 4,400 at the end of 2017 to approximately 6,100, or
39%, at the end of 2018. The revenue recognized from acquired deferred revenue
related to the acquisitions we made was $5.8 million , $20.8 million and $3.2
million in 2019, 2018 and 2017, respectively. The change in subscription revenue
due to pricing was not significant for either period.
Hardware and services revenue for 2019 increased $0.6 million or 5%, as compared
to 2018, primarily due to higher professional service revenue. The decrease in
hardware and services revenue in 2018 as compared to 2017 was $0.7 million or
5%, primarily due to lower professional service revenue.
Cost of Revenue
Year Ended Year Ended
December 31, Change December 31, Change
2019 2018 $ % 2018 2017 $ %
(in thousands) (in thousands)
Subscription $ 206,997 $ 180,253 $ 26,744 15
%
Cost of subscription revenue increased$26.7 million , or 15%, in 2019 as compared to 2018, and$54.4 million , or 43%, in 2018 as compared to 2017. The increases were primarily due to increases in operations-related expense of$13.9 million and$35.4 million , respectively, due to increased headcount, network expense due to an increase in usage, depreciation expense as a result of higher capital expenditures to support our growth, and larger amortization of intangible assets expense of developed technology from recent acquisitions. Additionally, support-related expenses increased$10.9 million and$13.3 million , respectively, primarily due to higher headcount and consulting costs. Data center costs increased$5.3 million in 2018 as compared to 2017 due to the expansion. Cost of hardware and services revenue for 2019 and 2018 increased$7.7 million and$4.0 million , or 36% and 23%, respectively, as compared to the year before, primarily due to an increase in professional service costs as our headcount increased. 43
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Operating Expenses
Year Ended Year Ended
December 31, Change December 31, Change
2019 2018 $ % 2018 2017 $ %
(in thousands) (in thousands)
Research and development
26 % 25 %
Research and development expenses increased $45.1 million and $55.6 million , or
24% and 43%, for 2019 and 2018, respectively. The increases were primarily due
to increases in personnel-related costs of $40.3 million and $46.1 million for
2019 and 2018, respectively, from higher headcount, including those from the
integration of the acquisitions in 2019 and 2018. Additionally, corporate
expense allocated to research and development increased $4.7 million and $7.9
million for 2019 and 2018, respectively, primarily due to higher costs from
expanded operations, higher allocated costs from facilities, human resources and
IT-related expense as we grew year-over-year. Outside service expenses increased
$1.0 million and travel related expenses increased $0.4 million in 2018 as
compared to 2017.
Year Ended Year Ended
December 31, Change December 31, Change
2019 2018 $ % 2018 2017 $ %
(in thousands)
(in thousands)
Sales and marketing
48 % 47 %
Sales and marketing expenses increased $71.3 million and $96.7 million , or 21%
and 39%, for 2019 and 2018, respectively. The increase in headcount on a
worldwide basis and increase in revenue resulted in increased personnel-related
and commissions costs of $59.7 million and $65.8 million , for 2019 and 2018,
respectively. Travel expenses increased $4.2 million and $4.5 million in 2019
and 2018, respectively. Corporate and facilities expenses allocated to sales and
marketing increased $2.6 million in 2019 and $6.1 million in 2018 due to costs
related to our acquisitions and higher allocated costs as the company expanded.
Marketing expenses related to lead generation, trade shows, advertising and
other initiatives increased $6.1 million in 2019 and $8.0 million in 2018.
Amortization expense of acquired intangible assets increased $0.7 million and
$10.2 million in 2019 and 2018, respectively.
Year Ended Year Ended
December 31, Change December 31, Change
2019 2018 $ % 2018 2017 $ %
(in thousands) (in thousands)
General and administrative
12 % 12 % 12 % 10 %
General and administrative expenses increased $23.5 million , or 27%, in 2019 as
compared to 2018, and $33.5 million , or 63%, in 2018 as compared to 2017.
Personnel-related costs increased $14.3 million and $25.6 million for 2019 and
2018, respectively, due to an increase in headcount to support our continued
growth as a public company. Corporate and facilities expense increased $2.2
million and $2.1 million for 2019 and 2018, respectively, primarily due to an
increase in headcount. Outside consulting and audit costs increased $3.6 million
and $1.8 million for 2019 and 2018, respectively, primarily due to investments
in business applications, and other accounting related costs. Acquisition
related costs increased $1.9 million and $1.8 million in 2019 and 2018 primarily
due to the business acquisitions made. Legal expense increased $0.9 million and
$1.4 million in 2019 and 2018.
Interest Expense
Year Ended Year Ended
December 31, Change December 31, Change
2019 2018 $ % 2018 2017 $ %
(in thousands) (in thousands)
Interest expense $ (12,526 ) $ (16,761 ) $ 4,235 (25 )% $ (16,761 ) $ (28,608 ) $ 11,847 (41 )%
Interest expense for 2019 was due to the 2024 Notes issued on August 23, 2019
and consisted of accretion of $11.7 million and cash interest expense of $0.8
million . Interest expense for 2018 consisted of the 2020 Notes accretion expense
of $8.4 million , loss on conversion of the 2020 Notes of $7.2 million and cash
interest expense of $1.2 million (see Note 10 "Convertible Senior Notes" to the
Consolidated Financial Statements).
Interest expense decreased $11.4 million in 2018, primarily due to decreases in
accretion expense and cash interest expense of $13.4 million and $3.0 million ,
respectively, because of conversions of the 2018 Notes in 2017 and the 2020
Notes in the third
44--------------------------------------------------------------------------------
quarter of 2018, offset by a
Other Income, Net
Year Ended Year Ended
December 31, Change December 31, Change
2019 2018 $ % 2018 2017 $ %
(in thousands) (in thousands)
Other income, net $ 7,109 $ 1,491 $ 5,618 377 % $ 1,491 $ 3,785 $ (2,294 ) (61 )% Other income, net increased$5.6 million in 2019 as compared to 2018 because of an increase in interest income of$6.3 million due to higher cash and investment balances, partially offset by a$0.9 million increase in foreign currency translation losses. Other income, net decreased$2.3 million in 2018 as compared to 2017, primarily due to a$1.5 million increase in foreign currency translation losses and$0.4 million reduction in interest income.
Benefit From (Provision For) Income Taxes
Year Ended Year Ended
December 31, Change December 31, Change
2019 2018 $ % 2018 2017 $ %
(in thousands) (in thousands)
(Provision for) benefit
from income taxes
Total provision for income taxes increased$33.1 million in 2019 as compared to 2018. The increase was primarily due to a transfer of intellectual property fromIsrael to theU.S. , which occurred in 2019 and resulted in$17.7 million of tax expense, combined with a$14.7 million deferred tax benefit, which occurred in 2018 related to changes in theU.S. valuation allowance resulting from the Wombat business acquisition. Total benefit from income taxes increased$3.3 million in 2018 as compared to 2017. The increase was primarily due to a$14.7 million deferred tax benefit from the Wombat business acquisition in 2018 as compared to a$12.3 million benefit from the businesses acquired in 2017 and a$1.1 million benefit forU.K. research and development credits recorded in 2018. 45
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Quarterly Results of Operations
The following table sets forth our unaudited quarterly consolidated statements of operations data for each of the eight quarters in the period endedDecember 31, 2019 . We have prepared the quarterly data on a basis consistent with our audited annual financial statements, including, in the opinion of management, all normal recurring adjustments necessary for the fair statement of the financial information contained in these statements. The historical results are not necessarily indicative of future results and should be read in conjunction with our consolidated financial statements and the related notes included elsewhere in this Annual Report on Form 10-K. Three Months Ended Dec. 31, Sept. 30, June 30, Mar. 31, Dec. 31, Sept. 30, June 30, Mar. 31, 2019 2019 2019 2019 2018 2018 2018 2018 (in thousands, except per share amounts) Consolidated Statements of Operations Data: Revenue: Subscription$ 240,367 $ 224,275 $ 210,780 $ 199,584 $ 195,089 $ 181,505 $ 169,019 $ 158,787 Hardware and services 3,062 3,110 3,659 3,353 3,390 2,674 2,856 3,674 Total revenue 243,429 227,385 214,439 202,937 198,479 184,179 171,875 162,461 Cost of revenue:(1) Subscription 55,789 52,308 50,648 48,252 46,758 45,679 45,618 42,198 Hardware and services 7,473 7,573 7,180 6,991 6,237 5,258 5,154 4,859 Total cost of revenue 63,262 59,881 57,828 55,243 52,995 50,937 50,772 47,057 Gross profit 180,167 167,504 156,611 147,694 145,484 133,242 121,103 115,404 Operating expense:(1) Research and development 61,969 60,060 55,185 53,249 48,215 45,917 47,527 43,732 Sales and marketing 111,374 105,502 102,837
97,004 92,554 90,006 84,911 77,897 General and administrative 29,633 26,388 27,881
25,825 25,754 23,877 19,029 17,525 Total operating expense 202,976 191,950 185,903 176,078 166,523 159,800 151,467 139,154 Operating loss (22,809 ) (24,446 ) (29,292 ) (28,384 ) (21,039 ) (26,558 ) (30,364 ) (23,750 ) Interest expense (8,828 ) (3,698 ) - - - (9,746 ) (3,531 ) (3,484 ) Other income (expense), net 3,544 2,180 659 726 550 224 (289 ) 1,006
Loss before income taxes (28,093 ) (25,964 ) (28,633 )
(27,658 ) (20,489 ) (36,080 ) (34,184 ) (26,228 ) (Provision for) benefit from income taxes (641 ) (18,376 ) (280 ) (620 ) (746 ) 20 (114 ) 14,072 Net loss$ (28,734 ) $ (44,340 ) $ (28,913 ) $ (28,278 ) $ (21,235 ) $ (36,060 ) $ (34,298 ) $ (12,156 ) Net loss per share, basic and diluted$ (0.51 ) $ (0.79 ) $ (0.52 ) $ (0.51 ) $ (0.39 ) $ (0.69 ) $ (0.67 ) $ (0.24 ) Weighted average shares outstanding, basic and diluted 56,474 56,014 55,768 55,335 54,805 52,184 50,935 50,504 (1) Includes stock-based compensation expense and amortization of intangible assets as follows: Three Months Ended Dec. 31, Sept. 30, June 30, Mar. 31, Dec. 31, Sept. 30, June 30, Mar. 31, 2019 2019 2019 2019 2018 2018 2018 2018 (in thousands) Stock-based compensation: Cost of subscription revenue$ 4,303 $ 4,519 $
4,269$ 3,875 $ 3,610 $ 3,503 $ 3,448 $ 3,451 Cost of hardware and services revenue 998 1,043 1,054 906 651 474 571 591 Research and development 12,983 13,735 12,522 11,499 10,505 9,678 9,986 10,035 Sales and marketing 15,790 16,515 15,799 13,754 13,245 13,191 12,382 11,502 General and administrative 9,897 9,871
12,006 10,987 11,732 11,250 7,410 5,493 Total stock-based compensation
expenses$ 43,971 $ 45,683 $ 45,650 $ 41,021 $ 39,743 $ 38,096 $ 33,797 $ 31,072 Amortization of intangible assets: Cost of subscription revenue$ 8,607 $ 7,886 $ 7,505 $ 6,762 $ 6,830 $ 7,121 $ 7,244 $ 5,776 Research and development - - - - - 15 15 15 Sales and marketing 4,085 3,632 3,634 3,537 3,762 3,982 3,982 2,415 Total amortization of intangible assets$ 12,692 $ 11,518 $ 11,139 $ 10,299 $ 10,592 $ 11,118 $ 11,241 $ 8,206 46
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The following unaudited table sets forth our consolidated results of operations data as a percentage of total revenue.
Three Months Ended
Dec. 31, Sept. 30, June 30, Mar. 31, Dec. 31, Sept. 30, June 30, Mar. 31,
2019 2019 2019 2019 2018 2018 2018 2018Consolidated Statements of
Operations Data: Revenue: Subscription 99 % 99 % 98 % 98 % 98 % 99 % 98 % 98 % Hardware and services 1 1 2 2 2 1 2 2 Total revenue 100 100 100 100 100 100 100 100 Cost of revenue: Subscription 23 23 24 24 24 25 27 26 Hardware and services 3 3 3 3 3 3 3 3 Total cost of revenue 26 26 27 27 27 28 30 29 Gross profit 74 74 73 73 73 72 70 71 Operating expense: Research and development 25 26 26 26 24 25 28 27 Sales and marketing 46 46 48 48 47 49 49 48 General and administrative 12 12 13 13 13 13 11 11 Total operating expense 83 84 87 87 84 87 88 86 Operating loss (9 ) (10 ) (14 ) (14 ) (11 ) (15 ) (18 ) (15 ) Interest expense (4 ) (2 ) - - - (5 ) (2 ) (2 ) Other income (expense), net 1 1 1 - - - - 1 Loss before income taxes (12 ) (11 ) (13 ) (14 ) (11 ) (20 ) (20 ) (16 ) (Provision for) benefit from income taxes - (8 ) - - - - - 9 Net loss (12 )% (19 )% (13 )% (14 )% (11 )% (20 )% (20 )% (7 )%
Liquidity and Capital Resources
As ofDecember 31, 2019 , we had$847.6 million in cash and cash equivalents and$43.4 million in short-term investments, for a total of$890.9 million . Also refer to Note 10 "Convertible Senior Notes" to the consolidated financial statements for discussion of the 2024 Notes. We plan to grow our customer base by continuing to emphasize investments in sales and marketing to add new customers, expand our customers' use of our platform, and maintain high renewal rates. We also expect to incur additional cost of subscription revenue in accordance with the resulting growth in our customer base. We believe that the combination of our ongoing improvements in gross margins, the benefits of lower sales and marketing costs associated with our renewal activity, and the fact that our contracts are structured to bill our customers in advance should enable us to improve our cash flow from operations as we grow. Based on our current level of operations and anticipated growth, both of which are expected to be consistent with recent quarters, we believe that our existing sources of liquidity will be sufficient to fund our operations for at least the next 12 months. Our future capital requirements will depend on many factors, including our rate of revenue growth, the expansion of our sales and marketing activities, and the timing and extent of spending to support product development efforts and expansion into new territories, and the timing of introductions of new features and enhancements to our solutions. To the extent that existing cash and cash equivalents and cash from operations are insufficient to fund our future activities, we may need to raise additional funds through public or private equity or debt financing. We have invested, and plan to continue investing in acquiring complementary businesses, applications and technologies, and may continue to make such investments in the future, any of which could also require us to seek equity or debt financing. Additional funds may not be available on terms favorable to us or at all. As ofDecember 31, 2019 , the amount of cash and cash equivalents held by our foreign subsidiaries was$51.3 million , including intercompany receivable balances. If these funds were needed for our operations inthe United States , we would be required to withhold foreign taxes on the funds repatriated of approximately$0.7 million . We have not recorded a liability for these taxes, as it is our intention that the majority of these funds are indefinitely reinvested outsidethe United States and our current plans do not demonstrate a need to repatriate these funds to ourUnited States operations. Due to negative earnings and profits in our foreign subsidiaries, we have not recorded a provisional tax liability relating to the one-time mandatory transition tax imposed by the Tax Act on our accumulated foreign earnings. As the Tax Act also eliminatesU.S. taxes on foreign subsidiary distributions, future earnings in foreign jurisdictions will be available for distribution to theU.S. without incrementalU.S. taxes. 47
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Cash Flows
The following table sets forth a summary of our consolidated cash flows for the
periods indicated:
Years Ended
December 31,
2019 2018 2017
(in thousands)
Net cash provided by operating activities $ 242,508 $ 184,744 $ 153,686
Net cash used in investing activities $ (349,465 ) $
(250,664 )
Net Cash Flows Provided by Operating Activities
Our net loss and cash flows from operating activities are significantly influenced by our investments in headcount and data center operations to support anticipated growth. Our cash flows are also influenced by cash payments from customers. We invoice customers for the entire contract amount at the start of the term, and as such our cash flow from operations is also affected by the length of a customer contract.
Net cash provided by operating activities was
• An increase in amortization of intangible assets of
acquired businesses, and an increase in depreciation of fixed assets of
• An increase in stock-based compensation expense of
the increase in headcount and grants made;
• An increase in amortization of debt issuance costs and accretion of debt
discount of
10 "Convertible Senior Notes" to the Consolidated Financial Statements);
• An increase in amortization of deferred commissions of
to an increase in revenue;
• A $23.3 million increase in noncash lease costs primarily due to the
adoption of ASC 842 effective January 1, 2019 ;
• A decrease in benefit from deferred income taxes of
primarily due to a decrease in valuation allowance due to the business
acquisition made in 2018;
• A decrease in accounts receivable change of $19.7 million due to the
timing of payments;
• An increase in accounts payable and accrued liabilities changes of
million primarily due to the timing of compensation and other payments;
and
• An increase in deferred revenue change of
billings.
The increase was offset by a$26.5 million increase in net loss,$7.2 million decrease in loss on conversion due to the 2020 Notes converted into common shares in the third quarter of 2018 (see Note 10 "Convertible Senior Notes" to the Consolidated Financial Statements),$24.5 million decrease in operating lease liabilities change primarily due to the adoption of ASC 842 effectiveJanuary 1, 2019 , an increase in deferred commissions change of$14.3 million due to higher billings, and an increase in prepaid expense change of$6.0 million due to the timing of payments.
Net cash provided by operating activities was
• An increase in amortization of intangible assets of
acquired businesses, and an increase in depreciation of fixed assets of
• An increase in stock-based compensation expense of
the increase in headcount and grants made;
• An increase in amortization of deferred commissions of
to an increase in revenue;
• An increase in loss on conversion of convertible notes of $4.5 million
due to their conversion (see Note 10 "Convertible Senior Notes" to the
Consolidated Financial Statements);
• An increase in accounts payable and accrued liabilities changes of
million and
and other payments; and
• An increase in deferred revenue change of
billings.
The increase was offset by a$33.9 million increase in net loss,$13.4 million decrease in amortization of debt issuance costs and accretion of debt discount due to the conversion of the convertible notes in 2017 and 2018 (see Note 10 "Convertible Senior 48
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Notes" to the Consolidated Financial Statements), an increase in accounts
receivable change of
Net Cash Flows Used in Investing Activities
Our primary investing activities consisted of acquisitions of businesses, capital expenditures in support of expanding our infrastructure and workforce and the purchase and sale of short-term investments. As our business grows, we expect our capital expenditures and our investment activity to continue to increase. We may also target other companies for acquisition. Net cash used in investing activities was$349.5 million in 2019 as compared to$250.7 million in 2018. The increase in cash used of$98.8 million was due to an increase in cash paid for business acquisitions of$93.4 million , a decrease in proceeds from sales of short-term investments of$11.9 million , an increase in purchase of short-term investments of$12.3 million , an increase in capital expenditure of$5.7 million , and a decrease in receipts from escrow account of$3.3 million , partially offset by an increase in maturities of short-term investments of$27.8 million . Net cash used in investing activities was$250.7 million in 2018 as compared to$190.4 million in 2017. The increase in cash used of$60.3 million was due to an increase in cash paid for business acquisitions of$68.4 million , a$36.5 million decrease in maturities of short-term investments, and a decrease in receipts from escrow account of$2.7 million , offset by an increase in proceeds from sales of short-term investments of$11.9 million , a decrease in purchase of short-term investments of$18.1 million , and a decrease in capital expenditures of$17.4 million .
Net Cash Flows Provided in Financing Activities
Net cash provided in financing activities was$778.7 million in 2019 as compared to$33.9 million used in 2018. The increase in cash provided of$812.6 million was primarily due to$901.3 million in proceeds from issuance of the 2024 Notes, net of costs, partially offset by$84.6 million used to purchase capped calls in connection with the issuance of the 2024 Notes, and a$5.3 million increase in withholding taxes paid related to restricted stock net share settlement. Net cash used in financing activities was$33.9 million in 2018 as compared to$23.2 million in 2017. The increase in cash used of$10.7 million was primarily due to a$17.9 million increase in withholding taxes paid related to restricted stock unit net share settlement, offset by a$1.9 million increase in proceeds from common stock issuance related to employee stock plans, and$5.5 million decrease in contingent consideration payment.
Contractual Obligations and Commitments
The following table summarizes our contractual obligations as ofDecember 31, 2019 (in thousands): Payment Due by Period Less Than More than 5 Total 1 Year 1-3 Years 3-5 Years years 0.25% Convertible Senior Notes due 2024$ 920,000 $ - $ -$ 920,000 $ - Operating lease obligations(1) 228,992 20,858 47,791 41,543 118,800 Purchase obligations(2) 100,215 42,078 58,058 79 - Total(3)$ 1,249,207 $ 62,936 $ 105,849 $ 961,622 $ 118,800
(1) Consists of contractual obligations under operating leases for office space
and data centers. It includes the lease for the new corporate headquarters
entered in
and
(2) Consists of minimum purchase commitment of products and services. Obligations
under contracts that we can cancel without a significant penalty were not
included in the table above.
(3) As we are unable to reasonably predict the timing of settlement of
liabilities related to unrecognized tax benefits, net, the table does not
include $15.8 million of such non-current liabilities included in Other
long-term liabilities recorded on our consolidated balance sheet as of
December 31, 2019 .
Off-Balance Sheet Arrangements
During the periods presented, we did not have, nor do we currently have, any
relationships with unconsolidated entities or financial partnerships, such as
entities often referred to 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. We are
therefore not exposed to any financing, liquidity, market or credit risk that
could arise if we had engaged in those types of relationships.
Under the indemnification provisions of our standard customer agreements, we
agree to indemnify, defend and hold harmless our customers against, among other
things, infringement of any patents, trademarks or copyrights under any
country's laws or the misappropriation of any trade secrets arising from the
customer's legal use of our solutions. Certain indemnification provisions
potentially expose us to losses in excess of the aggregate amount paid to us by
the customer under the applicable customer agreement. No material claims have
been made against us pursuant to these indemnification provisions to date.
49--------------------------------------------------------------------------------
Critical Accounting Policies and Estimates
Our management's discussion and analysis of our financial condition and results of operations are based on our consolidated financial statements, which have been prepared in accordance with GAAP. GAAP requires us to make certain estimates and judgments that can affect the reported amounts of assets and liabilities, the disclosure of contingencies, and the reported amounts of revenue and expenses. We base our estimates on historical experience and on various other assumptions that we believe to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities. If actual results or events differ materially from those contemplated by us in making these estimates, our reported financial condition and results of operations for future periods could be materially affected. See "Risk Factors" for certain matters that may affect our future financial condition or results of operations. An accounting policy is deemed to be critical if it requires an accounting estimate to be made based on assumptions about matters that are uncertain at the time the estimate is made, if different estimates reasonably could have been used, or if the changes in estimate that are reasonably likely to occur could materially impact the financial statements. Our significant accounting policies, including those considered to be critical accounting policies, are summarized in Note 1 "The Company and Summary of Significant Accounting Policies" to the accompanying consolidated financial statements in this report. The following critical accounting policies reflect significant judgments and estimates used in the preparation of our consolidated financial statements: • Revenue recognition; • Deferred commissions;
• Fair value of assets acquired and liabilities assumed in business
combinations;
• Impairment assessment of goodwill, intangible assets and other long-lived
assets
• Loss contingencies; and
• Recognition and measurement of current and deferred income taxes.
Revenue Recognition
The Company derives its revenue primarily from: (1) subscription service revenue; (2) subscription software revenue, and (3) hardware and services, which include professional service and training revenue provided to customers related to their use of the platform. Subscription service revenue is derived from a subscription-based enterprise licensing model with contract terms typically ranging from one to three years, and consists of (1) subscription fees from the licensing of the Company's security-as-a-service platform and it's various components, (2) subscription fees for software with support and related future updates where the software updates are critical to the customers' ability to derive benefit from the software due to the fast changing nature of the technology. These function together as one performance obligation, and (3) subscription fees for the right to access the Company's customer support services for software with significant standalone functionality and support services for hardware. Subscription software revenue is primarily derived from term-based software that is deployed on the customers' own servers and has significant standalone functionality, is recognized upon transfer of control to the customer. We apply significant judgment in identifying and evaluating any terms and conditions in contracts which may impact revenue recognition. Most of the Company's contracts with customers contain multiple performance obligations. Determining whether products and services are considered distinct performance obligations that should be accounted for separately versus together may require judgment. For these contracts, we account for individual performance obligations separately if they are distinct. The transaction price is allocated to individual performance obligation on a relative standalone selling price basis. The transaction price allocated to subscription services and subscription software that does not have significant standalone functionality is determined by considering factors such as historical pricing practices, and the selling price of hardware and professional services is estimated using a cost plus model. The selling price for support of a functional subscription software license is calculated as a percentage of functional subscription software license value which is derived by analyzing internal pricing practice, customer expectations, and industry practice.
Deferred Commissions
We capitalize sales commissions and associated payroll taxes paid to internal
sales personnel, and referral fees paid to independent third-parties, that are
incremental to the acquisition of customer contracts. These costs are recorded
as deferred commissions on the consolidated balance sheets. We determine whether
costs should be deferred based on sales compensation plans, if the commissions
are incremental and would not have occurred absent the customer contract. Sales
commissions for renewal of a subscription contract are not considered
commensurate with the commissions paid for the acquisition of the initial
subscription contract given the substantive difference in commission rate
between new and renewal contracts. Commissions paid upon the initial acquisition
of a contract are amortized over an estimated period of benefit of five years
while commissions paid related to renewal contracts are amortized over a
contractual renewal period. Amortization is recognized based on the expected
future revenue streams under the customer contracts. Amortization of deferred
sales commissions is included in sales and marketing expense in the
50
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accompanying consolidated statements of operations. We determine the period of
benefit for commissions paid for the acquisition of the initial subscription
contract by taking into consideration its initial estimated customer life and
the technological life of the Company's software and related significant
features.
Fair Value of Assets Acquired and Liabilities Assumed in Business Combinations
In each of our acquisitions, we used the purchase method of accounting which requires us to allocate the fair value of the total consideration transferred to tangible and identifiable intangible assets acquired and liabilities assumed based on their estimated fair values on the date of the acquisition, with the difference between the net assets acquired and the total consideration transferred recorded as goodwill. The fair values assigned, defined as the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between willing market participants, are based on significant estimates and assumptions determined by management. These estimates and assumptions are inherently uncertain and subject to refinement, as a result, during the adjustment period, which may be up to one year from the acquisition date, we may record adjustments to the assets acquired or liabilities assumed with any corresponding offset to goodwill. Upon conclusion of the measurement period or final determination of the values of assets acquired or liabilities assumed, whichever comes first, any subsequent adjustments are recorded within our consolidated statements of operations. We used either the Discounted Cash Flow Method, the Cost to Recreate Method or the Relief from Royalty Method to assign fair values to acquired identifiable intangible assets. Management applies significant judgment in estimating the fair value of these intangible assets, which involved the use of significant assumptions with respect to forecasted future revenue, forecasted operating results, cost and time to build the acquired technology, developer's profit, rate of return, royalty rates and discount rates. These models are based on reasonable estimates and assumptions given available facts and circumstances, including industry estimates and averages, as of the acquisition dates and are consistent with the plans and estimates that we use to manage our business. If the subsequent actual results and updated projections of the underlying business activity change compared with the estimates and assumptions used to develop these values, we could experience impairment charges. In addition, we have estimated the economic lives of certain acquired assets and these lives are used to calculate depreciation and amortization expense. If our estimates of the economic lives change, depreciation or amortization expenses could be accelerated or slowed. Accounting for business combinations requires our management to make significant estimates and assumptions, especially at the acquisition date including our estimates for intangible assets as described above, contractual obligations assumed, restructuring liabilities, pre-acquisition contingencies and contingent consideration, where applicable. Although we believe the assumptions and estimates we have made in the past have been reasonable and appropriate, they are based in part on historical experience and information obtained from the management of the acquired companies and are inherently uncertain.
Unanticipated events and circumstances may occur that may affect the accuracy or validity of such assumptions, estimates or actual results.
For a given acquisition, we may identify certain pre-acquisition contingencies as of the acquisition date and may extend our review and evaluation of these pre-acquisition contingencies throughout the measurement period in order to obtain sufficient information to assess whether we include these contingencies as a part of the fair value estimates of assets acquired and liabilities assumed and, if so, to determine their estimated amounts. If we cannot reasonably determine the fair value of a pre-acquisition contingency (non-income tax related) by the end of the measurement period, which is generally the case given the nature of such matters, we will recognize an asset or a liability for such pre-acquisition contingency if: (i) it is probable that an asset existed or a liability had been incurred at the acquisition date and (ii) the amount of the asset or liability can be reasonably estimated. Subsequent to the measurement period, changes in our estimates of such contingencies will affect earnings and could have a material effect on our results of operations and financial position. In addition, uncertain tax positions and tax related valuation allowances assumed in connection with a business combination are initially estimated as of the acquisition date. We reevaluate these items quarterly based upon facts and circumstances that existed as of the acquisition date with any adjustments to our preliminary estimates being recorded to goodwill if identified within the measurement period. Subsequent to the measurement period or our final determination of the tax allowance's or contingency's estimated value, whichever comes first, changes to these uncertain tax positions and tax related valuation allowances will affect our provision for income taxes in our consolidated statements of operations and could have a material impact on our results of operations and financial position.
We review goodwill for impairment annually and whenever events or changes in
circumstances indicate its carrying value may not be recoverable. For the
purposes of impairment testing, we have determined that we have one reporting
unit. We perform the two-step impairment test, whereby we compare the fair value
of the reporting unit to its carrying value. If the fair value of the reporting
unit exceeds the carrying value of the net assets assigned to that unit,
goodwill is not considered impaired and we are not required to perform further
testing. If the carrying value of the net assets assigned to the reporting unit
exceeds the fair value of the reporting unit, then we must perform the second
step of the impairment test in order to determine the implied fair value of the
51
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reporting unit's goodwill. If the carrying value of a reporting unit's goodwill
exceeds its implied fair value, then we would record impairment loss equal to
the difference. No impairment has been noted to date.
We periodically review the carrying amounts of intangible assets and other
long-lived assets for impairment whenever events or changes in circumstances
indicate that the carrying value of these assets may not be recoverable. We
measure the recoverability of these assets by comparing the carrying amount of
such assets (or asset group) to the future undiscounted cash flow we expect the
assets (or asset group) to generate. If we consider any of these assets to be
impaired, the impairment to be recognized equals the amount by which the
carrying value of the assets exceeds its fair value. We make judgments about the
recoverability of purchased intangible assets whenever events or changes in
circumstances indicate that impairment may exist.
Each period we evaluate the estimated remaining useful lives of intangible
assets and other long-lived assets to assess whether a revision to the remaining
periods of amortization is required. Assumptions and estimates about remaining
useful lives of our intangible and other long-lived assets are subjective. They
can be affected by a variety of factors, including external factors such as
industry and economic trends and internal factors such as changes in our
business strategy. Although we believe the historical assumptions and estimates
we have made are reasonable and appropriate, different assumptions and estimates
could materially impact our reported financial results. We did not recognize any
intangible asset impairment charges to date.
Loss contingencies
We evaluate contingent liabilities including threatened or pending litigation in accordance with the authoritative guidance on contingencies. We assess the likelihood of any adverse judgments or outcomes from potential claims or legal proceedings, as well as potential ranges of probable losses, when the outcomes of the claims or proceedings are probable and reasonably estimable. A determination of the amount of accrued liabilities required, if any, for these contingencies is made after the analysis of each separate matter. Because of uncertainties related to these matters, we base our estimates on the information available at the time of our assessment. As additional information becomes available, we reassess the potential liability related to our pending claims and litigation and may revise our estimates. Any revisions in the estimates of potential liabilities could have a material impact on our operating results and financial position. Income Taxes We determine our current and deferred tax provisions based on estimates and assumptions that could differ from the actual results reflected in our income tax returns filed during the subsequent year. We record adjustments based on filed returns when we have identified and finalized them, which is generally in the fourth quarters of the subsequent year forU.S. federal and state provisions, respectively. We have placed a full valuation allowance on all netU.S. deferred tax assets because realization of these tax benefits through future taxable income cannot be reasonably assured. We intend to maintain the valuation allowance until sufficient positive evidence exists to support the reversal of the valuation allowance. Any decision to reverse part or all of the valuation allowance would be based on our estimate of future profitability. If our estimate were to be wrong, we could be required to charge potentially significant amounts to income tax expense to establish a new valuation allowance. Our effective tax rate includes the impact of certain undistributed foreign earnings for which we partially provided taxes because we plan to reinvest the majority of such earnings indefinitely outsidethe United States . We plan foreign earnings remittance amounts based on projected cash flow needs as well as the working capital and long-term investment requirements of our foreign subsidiaries and our domestic operations. Material changes in our estimates of cash, working capital and long-term investment requirements in the various jurisdictions in which we do business could impact our effective tax rate. We are subject to income taxes inthe United States and certain foreign countries, and we are subject to corporate income tax audits in some of these jurisdictions. We believe that our tax return positions are fully supported, but tax authorities are likely to challenge certain positions, which may not be fully sustained. However, our income tax expense includes amounts intended to satisfy income tax assessments that result from these challenges. Determining the income tax expense for these potential assessments and recording the related assets and liabilities requires management judgments and estimates. We evaluate our uncertain tax positions in accordance with the guidance for accounting for uncertainty in income taxes. We believe that our liability for uncertain tax positions is adequate. We review our liability for uncertain tax positions quarterly, and we may adjust such liability because of proposed assessments by tax authorities, changes in facts and circumstances, issuance of new regulations or new case law, previously unavailable information obtained during the course of an examination, negotiations between tax authorities of different countries concerning our transfer prices, or the expiration of statutes of limitations.
Recent Accounting Pronouncements
Refer to Note 1 of the notes to our consolidated financial statements in Part
II, Item 8 of this Annual Report on Form 10-K for a full description of recent
accounting pronouncements.
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