ZSCALER, INC. The following discussion and analysis of our financial condition and results of operations should be read in conjunction with our consolidated financial statements and related notes included elsewhere in this Annual Report on Form 10-K. 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 Annual Report on Form 10-K. Our fiscal year end isJuly 31 , and our fiscal quarters end onOctober 31 ,January 31 ,April 30 andJuly 31 . Our fiscal years endedJuly 31, 2020 ,July 31, 2019 andJuly 31, 2018 are referred to as fiscal 2020, fiscal 2019 and fiscal 2018, respectively. 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, 2020 , we had expanded our operations to over 4,500 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 450 of the Forbes Global 2000 as ofJuly 31, 2020 . We operate our business as one reportable segment. Our revenue has experienced significant growth in recent periods. For fiscal 2020, fiscal 2019 and fiscal 2018, our revenue was$431.3 million ,$302.8 million and$190.2 million , respectively, representing year-over-year growth rate for fiscal 2020 and fiscal 2019 of 42% and 59%, respectively. However, we have incurred net losses in all periods since our inception. For fiscal 2020, fiscal 2019 and fiscal 2018, our net loss was$115.1 million ,$28.7 million and$33.6 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 further detail in Note 10, Commitments and Contingencies, of our consolidated financial statements included elsewhere in this Annual Report on Form 10-K. Initial Public Offering InMarch 2018 , we completed our initial public offering (IPO) of common stock, in which we sold 13.8 million shares. The shares were sold at an IPO price of$16.00 per share for net proceeds of$205.3 million , after deducting underwriters' discounts and commissions of$15.5 million . In connection with the IPO, we incurred offering costs of$6.2 million which were recorded within stockholders' equity as a reduction of the net proceeds received from the IPO. Immediately prior to the closing of the IPO, all our outstanding shares of convertible preferred stock were automatically converted into 72.5 million shares of common stock on a one-to-one basis. 58 -------------------------------------------------------------------------------- Impacts of COVID-19 InMarch 2020 , theWorld Health Organization declared the COVID-19 outbreak to be a pandemic. As a result of the COVID-19 pandemic, we have modified certain aspects of our business, including restricting employee travel, requiring employees to work from home, transitioning our employee onboarding and training processes to remote or online programs, and canceling certain events and meetings, among other modifications. We will continue to actively monitor and evaluate the situation and may take further actions that alter our business operations as may be required by federal, state or local authorities or that we determine are in the best interests of our employees, customers, partners, suppliers and stockholders. The effects of these operational modifications are unknown and may not be known until future reporting periods. While we have not experienced significant disruptions from the COVID-19 outbreak to date, we are unable to accurately predict the full impact that the COVID-19 pandemic will have due to numerous uncertainties, including the duration of the outbreak, actions that may be taken by governmental authorities, the impact on our business including our sales cycle, sales execution, and marketing efforts, and the impact to the business of our customers, vendors, and partners. For further discussion of the challenges and risks we confront related to the COVID-19 pandemic, please refer to Part I, Item 1A Risk Factors of this Annual Report on Form 10-K. 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, 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, and more significantly customers in the Forbes Global 2000, on our cloud platform is an indicator of our market penetration and our future business opportunities. As ofJuly 31, 2020 , 2019 and 2018, we had over 4,500, 3,900 and 3,250 customers, respectively, across all major geographies. As ofJuly 31, 2020 , we had over 450 of the Forbes Global 2000 as customers. Our ability to continue to grow these numbers 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: 59 -------------------------------------------------------------------------------- Table of Contents •expanding deployment of our cloud platform to cover additional users; •upgrading to a more advanced Business, Transformation or Secure Transformation suite; and •selling a subscription to a new solution or product, for example selling a ZPA subscription to a ZIA customer or a ZIA subscription to a ZPA customer. These purchases increase the Annual Recurring Revenue ("ARR") attributable to our customers over time. To establish ARR for a customer, we use the total amount of each order booked to compute the annual recurring value of revenue that we would recognize if the customer continues to renew all contractual subscriptions. For example, a contract for$3.0 million with a contractual term of three years would have ARR of$1.0 million as long as our customer uses our cloud platform. 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 10, Commitments and Contingencies, of our consolidated financial statements included elsewhere in this Annual Report on Form 10-K. 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. 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 customerswho 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. 60 -------------------------------------------------------------------------------- Table of Contents 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, including deals for all employees with our ZIA Transformation bundle, faster upsells within a year, 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 Annual Report on Form 10-K. Trailing 12 Months Ended July 31, 2020 2019 2018 Dollar-based net retention rate 120% 118%
117%
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 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. 61
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Year Ended July 31,
2020 2019 2018
(in thousands)
Gross profit $ 335,536 $ 243,167 $ 152,299
Add:
Stock-based compensation expense 7,318 2,926 757
Amortization expense of acquired intangible assets 2,030 512 -
Non-GAAP gross profit $ 344,884 $ 246,605 $ 153,056
Gross margin 78 % 80 % 80 %
Non-GAAP gross margin 80 % 81 % 80 %
Non-GAAP Income (Loss) from Operations and Non-GAAP Operating Margin
We define non-GAAP income (loss) 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 (loss)
from operations as a percentage of revenue. The excluded litigation-related
expenses are professional fees and related costs incurred by us in defending or
settling 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.
Year Ended July 31,
2020 2019 2018
(in thousands)
Loss from operations $ (113,956) $ (35,313) $ (34,624)
Add:
Stock-based compensation expense 121,395 46,423 11,224
Litigation-related expenses 18,356 13,079 8,039
Asset impairment related to facility exit(1) 746 - -
Amortization expense of acquired intangible assets 3,384 908 -
Non-GAAP income (loss) from operations $ 29,925 $ 25,097 $ (15,361)
Operating margin (26) % (12) % (18) %
Non-GAAP operating margin 7 % 8 % (8) %
(1) Consists of asset impairment charges related to the relocation of our
corporate headquarters.
Change in Non-GAAP Measures Presentation
Effective August 1, 2020 , the beginning of Zscaler's fiscal year ending July 31,
2021 , Zscaler will present employer payroll taxes related to employee equity
award transactions, which is a cash expense, under a caption titled "stock-based
compensation expense and related payroll taxes." These payroll taxes will be
excluded from our non-GAAP results as these are tied to the timing and size of
the exercise or vesting of the underlying equity awards and the price of
Zscaler's common stock at the time of vesting or exercise, which may vary from
period to period independent of the operating performance of Zscaler's business.
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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 operating activities less purchases of property, equipment and other
assets 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
assets 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 of July 31, 2020 , employee contributions to our employee stock
purchase plan was $3.5 million , which will be reclassified to additional paid-in
capital upon issuance of the shares during our second quarter of fiscal 2021.
Year Ended
2020 2019 2018
(in thousands)
Net cash provided by operating activities $ 79,317 $ 58,027 $ 17,307
Less:
Purchases of property, equipment and other assets (43,072) (25,520) (13,397)
Capitalized internal-use software (8,737) (3,162) (1,773)
Free cash flow $ 27,508 $ 29,345 $ 2,137
As a percentage of revenue:
Net cash provided by operating activities 18 % 19 % 9 %
Less:
Purchases of property, equipment and other assets (10) (8) (7) Capitalized internal-use software (2) (1) (1) Free cash flow margin 6 % 10 % 1 % 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 for 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$159.8 million , or 41%, in fiscal 2020 over fiscal 2019, and$132.4 million , or 51%, in fiscal 2019 over fiscal 2018. 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. 63
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Year Ended July 31,
2020 2019 2018
(in thousands)
Revenue $ 431,269 $ 302,836 $ 190,174
Add: Total deferred revenue, end of period 369,767 251,202 164,023
Less: Total deferred revenue, beginning of period (251,202) (164,023) (96,619)
Calculated billings $ 549,834
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%, 99% and 99% of our revenue for
fiscal 2020, fiscal 2019 and fiscal 2018, respectively. 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
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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.
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, including new
product introductions, 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 our gross margin to increase slightly 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 Annual
Report on Form 10-K, 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
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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.
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 or settling 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 10, Commitments and Contingencies
to, our consolidated financial statements included elsewhere in this Annual
Report on Form 10-K. 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 Expense
Interest expense consists primarily of amortization of debt discount and
issuance costs and contractual interest expense for our convertible senior notes
issued in June 2020 .
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 fiscal 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 13, Stock-Based Compensation, of our
consolidated financial statements included elsewhere in this Annual Report on
Form 10-K.
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, offset by the
tax benefit for excess stock-based compensation deduction and partial release of
our U.S. valuation allowance related to the acquisition of Cloudneeti
Corporation ("Cloudneeti") and Edgewise Networks Inc. ("Edgewise"). We have not
recorded any U.S. federal income tax expense. In the U.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
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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 the U.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.
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:
Year Ended July 31,
2020 2019 2018
(in thousands)
Revenue $ 431,269 $ 302,836 $ 190,174
Cost of revenue(1)(2) 95,733 59,669 37,875
Gross profit 335,536 243,167 152,299
Operating expenses:
Sales and marketing(1)(2) 277,981 169,913 116,409
Research and development(1)(2) 97,879 61,969 39,379
General and administrative(1)(3)(4) 73,632 46,598 31,135 Total operating expenses 449,492 278,480 186,923 Loss from operations (113,956) (35,313) (34,624) Interest income 6,477 7,730 2,236 Interest expense(5) (5,025) - - Other income (expense), net (224) (329) 79 Loss before income taxes (112,728) (27,912) (32,309) Provision for income taxes 2,388 743 1,337 Net loss$ (115,116) $ (28,655) $ (33,646) _____ (1) Includes stock-based compensation expense as follows: Cost of revenue$ 7,318 $ 2,926 $ 757 Sales and marketing 66,539 23,118 5,044 Research and development 30,173 15,090 3,045 General and administrative 17,365 5,289 2,378 Total$ 121,395 $ 46,423 $ 11,224 (2) Includes amortization expense of acquired intangible assets as follows: Cost of revenue$ 2,030 $ 512 $ - Sales and marketing 74 10 - Research and development 1,280 386 - Total$ 3,384 $ 908 $ -
(3) Includes asset impairment related to facility exit as follows:
$ - $ -
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(4) Includes litigation-related expenses as follows:
(5) Includes amortization of debt discount and issuance costs as follows:$ 4,885 $ - $ - Year Ended July 31, 2020 2019 2018 Revenue 100% 100% 100% Cost of revenue 22 20 20 Gross margin 78 80 80 Operating expenses Sales and marketing 64 56 61 Research and development 23 21 21 General and administrative 17 15 16 Total operating expenses 104 92 98 Operating margin (26) (12) (18) Interest income 1 3 1 Interest Expense (1) - - Other income (expense), net - -
-
Loss before income taxes (26) (9)
(17)
Provision for income taxes 1 - 1
Net loss (27)% (9)% (18)%
Comparison of Fiscal 2020 and Fiscal 2019
Revenue
Year Ended July 31, Change
2020 2019 $ %
(in thousands)
Revenue $ 431,269 $ 302,836 $ 128,433 42 %
Revenue increased by $128.4 million , or 42%, in fiscal 2020, compared to fiscal
2019. The increase in revenue was driven by an increase in users and sales of
additional subscriptions to existing customers, which contributed $98.6 million
in revenue, as reflected by our dollar-based net retention rate of 120% for the
trailing 12 months ended July 31, 2020 . The remainder of the increase was
attributable to the addition of new customers, as we increased our customer base
by 17% from July 31, 2019 to July 31, 2020 .
Cost of Revenue and Gross Margin
Year Ended July 31, Change
2020 2019 $ %
(in thousands)
Cost of revenue $ 95,733 $ 59,669 $ 36,064 60 %
Gross margin 78 % 80 %
68-------------------------------------------------------------------------------- Table of Contents Cost of revenue increased by$36.1 million , or 60%, in fiscal 2020, compared to fiscal 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$24.8 million for data center and equipment related costs for hosting and operating our cloud platform. Additionally, our employee-related expenses increased by$10.0 million , inclusive of an increase of$4.4 million in stock-based compensation expense, driven primarily by a 6% increase in headcount in our customer support and cloud operations organizations fromJuly 31, 2019 toJuly 31, 2020 and by the shift from granting stock options to restricted stock units. Gross margin decreased from 80% to 78% in fiscal 2020 as compared to fiscal 2019. The decline in gross margin is primarily due to the cost incurred for our increased use of public cloud infrastructure to manage the increased ZPA traffic which resulted from our customers' employees working from home beginningMarch 2020 . While the public cloud allows us to quickly meet increases in customer demand, using public cloud infrastructure to manage traffic is significantly more expensive compared to using our data centers. Operating Expenses Sales and Marketing Expenses Year Ended July 31, Change 2020 2019 $ % (in thousands) Sales and marketing$ 277,981 $ 169,913 $ 108,068 64 % Sales and marketing expenses increased by$108.1 million , or 64%, for fiscal 2020, compared to fiscal 2019. The increase was primarily due to a 54% increase in headcount fromJuly 31, 2019 toJuly 31, 2020 , resulting in an increase of$92.6 million in employee-related expenses, inclusive of an increase of$43.4 million in stock-based compensation expense, and an increase of$9.7 million in sales commissions expense. Additionally, our sales and marketing expenses increased by$7.0 million primarily due to growth of certain major sales and marketing events held during fiscal 2020, including ourZenith Live events. The remainder of the increase was primarily attributable to increased expenses of$2.2 million in costs related to in-person and virtual events and$3.9 million for facility and IT services. Research and Development Expenses Year Ended July 31, Change 2020 2019 $ % (in thousands) Research and development$ 97,879 $ 61,969 $ 35,910 58 % Research and development expenses increased by$35.9 million , or 58%, for fiscal 2020, compared to fiscal 2019 as we continued to develop and enhance the functionality of our cloud platform. The increase was primarily driven by an increase of$34.7 million in employee-related expenses, inclusive of an increase of$15.1 million in stock-based compensation expense, driven by a 38% increase in headcount fromJuly 31, 2019 toJuly 31, 2020 and by our shift from granting stock options to granting restricted stock units. The remainder of the increase was primarily attributable to increased expenses of$4.4 million for facility, software and equipment related expenses to support our growth. Expense increases were partially offset by higher capitalized internal-use software development costs of$5.6 million to support the enhancement and growth of our cloud platform. 69 -------------------------------------------------------------------------------- Table of Contents General and Administrative Expenses Year Ended July 31, Change 2020 2019 $ % (in thousands) General and administrative$ 73,632 $ 46,598 $ 27,034 58 % General and administrative expenses increased by$27.0 million , or 58%, for fiscal 2020, compared to fiscal 2019. The overall increase was primarily due to an increase of$16.4 million in employee-related expenses, inclusive of a net increase of$12.1 million in stock-based compensation expense, driven by a 29% increase in headcount fromJuly 31, 2019 toJuly 31, 2020 , and also by our shift from granting stock options to granting restricted stock units. Additionally, we recognized an increase of$5.2 million in legal expenses, which is primarily attributable to a$15.0 million litigation settlement payment to Broadcom in fiscal 2020, partially offset by lower legal fees in fiscal 2020. For further information on litigation settlements, refer to Note 10, Commitments and Contingencies, of our consolidated financial statements included elsewhere in this Annual Report on Form 10-K. The remainder of the increase was primarily attributable to$1.9 million in professional services and$1.2 million for insurance premiums. Interest Expense Year Ended July 31, Change 2020 2019 $ % (in thousands) Interest expense$ (5,025) $ -$ (5,025) 100 % Interest expense increased by$5.0 million or 100% for fiscal 2020, compared to fiscal 2019. The increase is due to amortization of debt discount and contractual interest expense for our Notes issued inJune 2020 . For further information on the Notes, refer to Note 8, Convertible Senior Notes, of our consolidated financial statements included elsewhere in this Annual Report on Form 10-K. Interest Income Year Ended July 31, Change 2020 2019 $ % (in thousands) Interest income$ 6,477 $ 7,730 $ (1,253) (16) % Interest income decreased by$1.3 million , or 16%, for fiscal 2020, compared to fiscal 2019. The decrease was primarily driven by lower market interest rates earned on cash equivalents and short-term investments. Other Income (expense), net Year Ended July 31, Change 2020 2019 $ % (in thousands) Other income (expense), net$ (224) $ (329) $ 105 (32) % Other income (expense), net increased by$0.1 million , or 32%, for fiscal 2020, compared to fiscal 2019. The increase was primarily driven by fluctuations in foreign currency transaction gains and losses for fiscal 2020, compared to fiscal 2019. 70 --------------------------------------------------------------------------------
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Provision for Income Taxes
Year Ended July 31, Change
2020 2019 $ %
(in thousands)
Provision for income taxes $ 2,388 $ 743 $ 1,645 221 %
Our provision for income taxes increased by $1.6 million , or 221%, for fiscal
2020, compared to fiscal 2019, primarily related to income and withholding taxes
in the foreign jurisdictions in which we operate. The current year income tax
expense was partially offset by the tax benefit associated with the acquisition
of intangible assets from Cloudneeti and Edgewise which reduced our deferred tax
asset and the related valuation allowance. For further information, refer to
Note 14, Income Taxes, of our consolidated financial statements included
elsewhere in this Annual Report on Form 10-K. Our effective tax rate of (2.1)%
and (2.7)% in fiscal 2020 and fiscal 2019, respectively, differs from the
applicable U.S. statutory federal income tax rate due to our valuation allowance
against our U.S. federal, state, and U.K. deferred tax assets as well as our
foreign income being taxed at different rates than the U.S. statutory rate. The
overall income tax expense recorded for the current fiscal year is driven by
income taxes for the foreign countries in which we operate, offset by the tax
benefit from the release of a portion of our valuation allowance on deferred tax
assets as a result of deferred taxes recorded in the purchase accounting as part
of the acquisition of Cloudneeti and Edgewise.
On December 22, 2017 , the Tax Cuts and Jobs Act of 2017, or the Tax Act, was
enacted. The Tax Act contains several key tax provisions that affect us,
including, but not limited to, reducing the U.S. federal corporate tax rate from
34% to 21%, imposing a one-time mandatory transition tax on previously untaxed
foreign earnings and changing rules related to the use of net operating loss
carryforwards created in tax years beginning after December 31, 2017 . Because of
the full valuation allowance recorded against our U.S. federal deferred tax
assets, there was no income tax expense (or benefit) recognized related to the
Tax Act.
While we believe our current valuation allowance is sufficient, we assess the
need for an adjustment to the valuation allowance on a quarterly basis. The
assessment is based on our estimates of future sources of taxable income for the
jurisdictions in which we operate and the periods over which our deferred tax
assets will be realizable. In the event we determine that we will be able to
realize all or part of our net deferred tax assets in the future, the valuation
allowance will be reversed in the period in which we make such determination.
The release of a valuation allowance against deferred tax assets may cause
greater volatility in the effective tax rate in the periods in which it is
reversed.
Comparison of Fiscal 2019 and Fiscal 2018
Revenue
Year Ended July 31, Change
2019 2018 $ %
(in thousands)
Revenue $ 302,836 $ 190,174 $ 112,662 59 %
Revenue increased by $112.7 million , or 59%, in fiscal 2019, compared to fiscal
2018. The increase in revenue was driven by an increase in users and sales of
additional subscriptions to existing customers, which contributed $88.2 million
in revenue, as reflected by our dollar-based net retention rate of 118% for the
trailing 12 months ended July 31, 2019 . The remainder of the increase was
attributable to the addition of new customers, as we increased our customer base
by 18% from July 31, 2018 to July 31, 2019 .
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Cost of Revenue and Gross Margin
Year Ended July 31, Change
2019 2018 $ %
(in thousands)
Cost of revenue $ 59,669 $ 37,875 $ 21,794 58 %
Gross margin 80 % 80 %
Cost of revenue increased by $21.8 million , or 58%, for fiscal 2019, compared to
fiscal 2018. The overall increase in cost of revenue was driven by expanded use
of our cloud platform by existing and new customers which led to an increase of
$11.0 million for data center and equipment related costs for hosting and
operating our cloud platform for our expanded customer base. Additionally, our
employee-related expenses increased by $8.7 million , inclusive of an increase of
$2.2 million in stock-based compensation expense, driven primarily by a 52%
increase in headcount in our customer support and cloud operations organizations
from July 31, 2018 to July 31, 2019 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 $1.1 million in facility and
IT expenses.
Gross margin remained flat for fiscal 2019 compared to fiscal 2018 as our cost
of providing our services were proportionately offset by growth in our revenue.
Operating Expenses
Sales and Marketing Expenses
Year Ended July 31, Change
2019 2018 $ %
(in thousands)
Sales and marketing $ 169,913 $ 116,409 $ 53,504 46 %
Sales and marketing expenses increased by $53.5 million , or 46%, for fiscal
2019, compared to fiscal 2018. The increase was primarily driven by an increase
of $35.2 million in employee-related expenses, inclusive of an increase of $18.1
million in stock-based compensation expense, and an increase of $6.7 million in
sales commissions expense, driven by a 38% increase in headcount in our sales
and marketing organization from July 31, 2018 to July 31, 2019 . The increase in
stock-based compensation expense was also attributable to 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
$5.9 million in marketing and advertising expenses, $2.8 million in travel
expenses and $2.1 million in facility and IT expenses.
Research and Development Expenses
Year Ended July 31, Change
2019 2018 $ %
(in thousands)
Research and development $ 61,969 $ 39,379 $ 22,590 57 %
Research and development expenses increased by $22.6 million , or 57%, for fiscal
2019, compared to fiscal 2018 as we continued to develop and enhance the
functionality of our cloud platform. The increase was primarily driven by an
increase of $21.3 million in employee-related expenses, inclusive of an increase
of $12.0 million in stock-based compensation expense, driven by a 36% increase
in headcount from July 31,2018 to July 31,2019 and by our shift from granting
stock options to granting restricted stock units subsequent to our IPO. The
remainder of the increase was primarily attributable to increased expenses of
$1.2 million for facility and IT expenses.
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General and Administrative Expenses
Year Ended July 31, Change
2019 2018 $ %
(in thousands)
General and administrative $ 46,598 $ 31,135 $ 15,463 50 %
General and administrative expenses increased by $15.5 million , or 50%, for
fiscal 2019, compared to fiscal 2018. The overall increase was primarily due to
an increase of $6.3 million in employee-related expenses, inclusive of a net
increase of $2.9 million in stock-based compensation expense, driven by a 37%
increase in headcount from July 31, 2018 to July 31, 2019 , and also by our shift
from granting stock options to granting restricted stock units subsequent to our
IPO. Additionally, we recognized an increase of $6.1 million in legal expenses,
which is primarily attributable to $4.1 million expense recognized as a result
of a legal settlement reached with Finjan in April 2019 . For further information
on this settlement refer to Note 10, Commitments and Contingencies, of our
consolidated financial statements included elsewhere in this Annual Report on
Form 10-K. The remainder of increase was primarily attributable to $1.7 million
in professional services as we transitioned to being a public company and $0.4
million in facility and IT expenses.
Interest Income
Year Ended July 31, Change
2019 2018 $ %
(in thousands)
Interest income $ 7,730 $ 2,236 $ 5,494 246 %
Interest income increased by $5.5 million , or 246%, for fiscal 2019, compared to
fiscal 2018. The increase was primarily driven by increased interest income
earned from our investments in cash equivalents and short-term investments, as a
result of additional cash received from our IPO and cash generated from
operations.
Other Income (Expense), net
Year Ended July 31, Change
2019 2018 $ %
(in thousands)
Other income (expense), net $ (329) $ 79 $ (408) (516) %
Other income (expense), net decreased by $0.4 million , or 516%, for fiscal 2019,
compared to fiscal 2019. The decrease was primarily driven by fluctuations in
foreign currency transaction gains and losses for fiscal 2019, compared to
fiscal 2018.
Provision for Income Taxes
Year Ended July 31, Change
2019 2018 $ %
(in thousands)
Provision for income taxes $ 743 $ 1,337 $ (594) (44) %
Our provision for income taxes increased by $0.6 million , or 44%, for fiscal
2019, compared to fiscal 2018. The decrease in the provision for income taxes
was primarily due to a non-recurring tax benefit associated with the acquisition
of intangible assets from Appsulate, Inc. , which reduced our deferred tax asset
and the related valuation allowance. For further information, refer to Note 14,
Income Taxes, of our consolidated financial statements included elsewhere in
this Annual Report on Form 10-K. Our effective tax rate of (2.7)% and (4.1)% in
fiscal 2019 and fiscal 2018, respectively, differs from the applicable U.S.
statutory federal income tax rate due to our valuation allowance against our
U.S. federal, state, and U.K.
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deferred tax assets as well as our foreign income being taxed at different rates
than the U.S. statutory rate. The overall income tax expense recorded for the
current fiscal year is driven by income taxes for the foreign countries in which
we operate, offset by the tax benefit from the release of a portion of our
valuation allowance on deferred tax assets as a result of deferred taxes
recorded in purchase accounting as part of the acquisition of Appsulate, Inc.
On December 22, 2017 , the Tax Cuts and Jobs Act of 2017, or the Tax Act, was
enacted. The Tax Act contains several key tax provisions that affect us,
including, but not limited to, reducing the U.S. federal corporate tax rate from
34% to 21%, imposing a one-time mandatory transition tax on previously untaxed
foreign earnings and changing rules related to the use of net operating loss
carryforwards created in tax years beginning after December 31, 2017 . Because of
the full valuation allowance recorded against our U.S. federal deferred tax
assets, there was no income tax expense (or benefit) recognized related to the
Tax Act.
While we believe our current valuation allowance is sufficient, we assess the
need for an adjustment to the valuation allowance on a quarterly basis. The
assessment is based on our estimates of future sources of taxable income for the
jurisdictions in which we operate and the periods over which our deferred tax
assets will be realizable. In the event we determine that we will be able to
realize all or part of our net deferred tax assets in the future, the valuation
allowance will be reversed in the period in which we make such determination.
The release of a valuation allowance against deferred tax assets may cause
greater volatility in the effective tax rate in the periods in which it is
reversed.
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Quarterly Results of Operations and Other Data
The following sets forth selected unaudited quarterly consolidated statements of
operations data for each of the eight quarters in the period ended July 31,
2020 . The unaudited quarterly statements of operations data set forth below have
been prepared on the same basis as our audited consolidated financial statements
and, in the opinion of management, reflect all adjustments, consisting only of
normal recurring adjustments, that are necessary for the fair statement of such
data. The following quarterly financial data should be read in conjunction with
our consolidated financial statements and the related notes included elsewhere
in this Annual Report on Form 10-K. Our historical results are not necessarily
indicative of the results that may be expected in the future, and the results
for any quarter are not necessarily indicative of results to be expected for a
full year or any other period.
Consolidated Statements of Operations
Three Months Ended
Oct. 31 Jan. 31 Apr. 30 Jul. 31 Oct. 31 Jan. 31 Apr. 30 Jul. 31
2018 2019 2019 2019 2019 2020 2020 2020
(in thousands)
Revenue $ 63,298 $ 74,302 $ 79,128 $ 86,108 $ 93,590 $ 101,268 $ 110,524 $ 125,887
Cost of revenue(1)(2) 12,099 15,271 14,960 17,339 19,558 20,238 24,579 31,358
Gross profit 51,199 59,031 64,168 68,769 74,032 81,030 85,945 94,529
Operating expenses:
Sales and marketing(1)(2) 36,545 38,756 45,295 49,317 59,411 61,621 67,727 89,222
Research and development(1)(2) 13,186 15,071 16,499 17,213 20,271 20,706 24,117 32,785
General and administrative(1)(3)(4) 10,131 10,386 15,911 10,170 12,625 28,983 14,615 17,409
Total operating expenses 59,862 64,213 77,705 76,700 92,307 111,310 106,459 139,416
Loss from operations (8,663) (5,182) (13,537) (7,931) (18,275) (30,280) (20,514) (44,887)
Interest income 1,590 1,924 2,081 2,135 2,022 1,855 1,528 1,072
Interest expense(5) - - - - - - - (5,025)
Other income (expense), net (188) 250 (144) (247) (29) (13) 70 (252)
Loss before income taxes (7,261) (3,008) (11,600) (6,043) (16,282) (28,438) (18,916) (49,092)
Provision (benefit) for income taxes(6) 327 547 636 (767) 794 716 421 457
Net loss $ (7,588) $ (3,555) $ (12,236) $ (5,276) $ (17,076) $ (29,154) $ (19,337) $ (49,549)
Net loss per share, basic and diluted $ (0.06) $ (0.03) $ (0.10) $ (0.04) $ (0.13) $ (0.23) $ (0.15) $ (0.38)
_____
(1) Includes stock-based compensation expense as follows:
Cost of revenue $ 503 $ 619 $ 686 $ 1,118 $ 1,381 $ 1,580 $ 1,614 $ 2,743
Sales and marketing 2,801 5,517 6,459 8,341 10,039 11,943 15,119 29,438
Research and development 2,795 4,398 4,194 3,703 4,874 6,077 6,738 12,484
General and administrative 1,487 2,693 1,936 (827) 2,082 4,266 4,299 6,718
Total $ 7,586 $ 13,227 $ 13,275 $ 12,335 $ 18,376 $ 23,866 $ 27,770 $ 51,383
_____
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(2) Includes amortization expense of acquired intangible assets as follows:
Three Months Ended
Oct. 31 Jan. 31 Apr. 30 Jul. 31 Oct. 31 Jan. 31 Apr. 30 Jul. 31
2018 2019 2019 2019 2019 2020 2020 2020
(in thousands)
Cost of revenue $ - $ 144 $ 163 $ 205 $ 205 $ 205 $ 348 $ 1,272
Sales and marketing - - 3 7 8 8 8 50
Research and development 95 - - 291 566 429 285 -
Total $ 95 $ 144 $ 166 $ 503 $ 779 $ 642 $ 641 $ 1,322
(3) Includes asset
impairment related to
facility exit as follows : $ - $ - $ - $
- $ -
(4) Includes litigation-related expenses as follows:$ 2,174 $ 1,768 $ 6,164 $ 2,973 $ 2,007 $ 16,334 $ 12 $ 3 (5) Includes amortization of debt discount and issuance costs as follows: $ - $ - $ - $ - $ - $ - $ -$ 4,885 (6) In the fiscal quarter endedJuly 31, 2019 ,April 30, 2020 andJuly 31, 2020 , we recorded a tax benefit of$1.4 million ,$0.5 million and$0.6 million , respectively, associated with intangible assets recognized as a result of our acquisition ofAppsulate, Inc. , Cloudneeti and Edgewise, respectively. For further information, refer to Note 6, Business Combinations, of our consolidated financial statements included elsewhere in this Annual Report on Form 10-K. Consolidated Statements of Operations as a Percentage of Revenue Three Months Ended Oct. 31 Jan. 31 Apr. 30 Jul. 31 Oct. 31 Jan. 31 Apr. 30 Jul. 31 2018 2019 2019 2019 2019 2020 2020 2020 Revenue 100 % 100 % 100 % 100 % 100 % 100 % 100 % 100 % Cost of revenue 19 21 19 20 21 20 22 25 Gross profit 81 79 81 80 79 80 78 75 Operating expenses: Sales and marketing 58 52 57 57 63 61 62 71 Research and development 21 20 21 20 22 20 22 26 General and administrative 16 14 20 12 13 29 13 14 Total operating expenses 95 86 98 89 98 110 97 111 Loss from operations (14) (7) (17) (9) (19) (30) (19) (36) Interest income 3 3 2 2 2 2 1 1 Interest expense - - - - - - - (4) Other income (expense), net - - - - - - 1 - Loss before income taxes (11) (4) (15) (7) (17) (28) (17) (39) Provision (benefit) for income taxes 1 1 - (1) 1 1 - - Net loss (12) % (5) % (15) % (6) % (18) % (29) % (17) % (39) % 76
-------------------------------------------------------------------------------- Table of Contents Quarterly Trends The sequential increase in the net loss for the fiscal quarter endedJanuary 31, 2020 was primarily due to a$15.0 million payment to Broadcom inJanuary 2020 in connection with the legal settlement of the Symantec Cases. For further information refer to Note 10, Commitments and Contingencies, of our consolidated financial statements included elsewhere in this Annual Report Form 10-K. The sequential increase in the net loss for the fiscal quarter endedJuly 31, 2020 was primarily due to an increase in stock-based compensation expense as a result of attainment of performance related equity awards and higher overall compensation expense as a result of an increase in headcount, primarily in sales and marketing and research and development organizations. Liquidity and Capital Resources As ofJuly 31, 2020 , our principal sources of liquidity were cash, cash equivalents and short-term investments totaling$1,370.6 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. InJune 2020 , we completed our private offering of our Notes with an aggregate principal amount of$1,150.0 million . The total net proceeds from the offering, after deducting initial purchase discount and issuance costs, was$1,130.5 million . In connection with the Notes, we entered into capped call transactions which are expected to reduce the potential dilution of our common stock upon any conversion of the Notes and/or offset any cash payments we could be required to make in excess of the principal amount of converted Notes. We used an aggregate amount of$145.2 million of the net proceeds of the Notes to purchase the capped calls. InMarch 2018 , upon completion of our IPO, we received net proceeds of$205.3 million , net of underwriters' discounts and commissions of$15.5 million . In connection with the IPO, we incurred offering costs of$6.2 million which were recorded into stockholders' equity as a reduction of the net proceeds received from the IPO. We have generated significant operating losses from operations, as reflected in our accumulated deficit of$339.6 million as ofJuly 31, 2020 . We expect to continue to incur operating losses and have in the past and may in the future generate negative cash flows due to expected investments to grow our business, including potential business acquisitions and other strategic transactions. 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 foreseeable cash needs, in addition to our recurring operating costs, include our expected capital expenditures in support of expanding our infrastructure and workforce, lease obligations, purchase commitments, income and other taxes, potential business acquisitions and other strategic transactions. 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, and the impact of the COVID-19 pandemic to our and our customers', vendors' and partners' businesses. 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. Additionally, some of the factors that may influence our operations are not within our control, such as general economic conditions, and length and severity of 77 -------------------------------------------------------------------------------- Table of Contents the COVID-19 pandemic. 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 ofJuly 31, 2020 , we had deferred revenue of$369.8 million , of which$337.3 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: Year Ended July 31, 2020 2019 2018 (in thousands)
Net cash provided by operating activities
$ 17,307 Net cash used in investing activities$ (1,038,162) $ (162,074) $ (178,103) Net cash provided by financing activities$ 1,022,212 $ 46,384
Operating Activities Net cash provided by operating activities during fiscal 2020 was$79.3 million , which resulted from a net loss of$115.1 million , adjusted for non-cash charges of$185.8 million and net cash inflows of$8.6 million from changes in operating assets and liabilities. Non-cash charges primarily consisted of$121.4 million for stock-based compensation expense,$24.9 million for amortization of deferred contract acquisition costs,$17.7 million for depreciation and amortization expense,$13.6 million for non-cash operating lease costs,$4.9 million for amortization of debt discount and issuance costs,$3.4 million for amortization expense of acquired intangible assets,$0.7 million for impairment of assets,$0.1 million for amortization (accretion) of investments purchased at a premium (discount), partially offset by deferred income taxes of$1.2 million . Net cash inflows from changes in operating assets and liabilities were primarily the result of an increase of$118.0 million in deferred revenue from advance invoicing in accordance with our subscription contracts, an increase of$27.9 million in accrued compensation, an increase of$2.3 million in accrued expenses, other current and noncurrent liabilities and an increase of$0.9 million in accounts payable. Net cash inflows were partially offset by cash outflows resulting from an increase of$65.1 million in deferred contract acquisition costs, as our sales commission payments increased due to the addition of new customers and expansion of our existing customer subscriptions, an increase of$54.2 million in accounts receivable primarily due to timing of billings and collections, an increase of$13.6 million in prepaid expenses, other current and noncurrent assets and a decrease of$7.6 million in operating lease liabilities primarily due to lease payments, net of tenant incentives received. Net cash provided by operating activities during fiscal 2019 was$58.0 million , which resulted from a net loss of$28.7 million , adjusted for non-cash charges of$73.1 million and net cash inflows of$13.6 million from changes in operating assets and liabilities. Non-cash charges primarily consisted of$46.4 million for stock-based compensation expense,$18.7 78 -------------------------------------------------------------------------------- Table of Contents million for amortization of deferred contract acquisition costs,$10.4 million for depreciation and amortization expense and$0.9 million for amortization expense of acquired intangible assets, partially offset by accretion of purchased discounts, net of amortization of investment premiums of$2.2 million and deferred income taxes of$1.4 million . Net cash inflows from changes in operating assets and liabilities were primarily the result of an increase of$87.2 million in deferred revenue from advance invoicing in accordance with our subscription contracts and an increase of$0.5 million in accounts payable. Net cash inflows were partially offset by cash outflows resulting from an increase of$32.5 million in deferred contract acquisition costs, as our sales commission payments increased due to the addition of new customers and expansion of our existing customer subscriptions, an increase of$31.7 million in accounts receivable primarily due to customer growth, an increase of$7.6 million in prepaid expenses, other current and noncurrent assets, a decrease of$1.8 million in accrued compensation, primarily due to decrease in accrued contributions under the employee stock purchase plan as a result of a longer withholding period related to our first purchase period ended inDecember 2018 , and a decrease of$0.3 million in accrued expenses, other current and noncurrent liabilities. Net cash provided by operating activities during fiscal 2018 was$17.3 million , which resulted from a net loss of$33.6 million , adjusted for non-cash charges of$32.5 million , and net cash inflows of$18.4 million from changes in operating assets and liabilities. Non-cash charges primarily consisted of$8.0 million for depreciation and amortization expense,$13.2 million for amortization of deferred contract acquisition costs and$11.2 million for stock-based compensation expense. Net cash inflows from changes in operating assets and liabilities were primarily the result of a$67.4 million increase in deferred revenue from advance invoicing in accordance with our subscription contracts and an aggregate$13.9 million increase in accrued compensation and accrued expenses and other liabilities. The cash inflows were partially offset by cash outflows resulting from a$34.4 million increase in deferred contract acquisition costs, as our sales commission payments increased due to addition of new customers and expansion of our existing customer subscriptions, and a$22.6 million increase in accounts receivable due to timing of collections and a$5.1 million increase in prepaid expenses and other assets as we supported our business growth, and a$0.8 million decrease in accounts payable. Investing Activities Net cash used in investing activities during fiscal 2020 of$1,038.2 million was primarily attributable to the purchases of short-term investments of$1,255.6 million , capital expenditures of$51.8 million to support our cloud platform and investments in leasehold improvements associated with our new corporate headquarters to accommodate our headcount growth,$39.6 million for payments for business acquisitions, net of cash acquired, in connection with our acquisition of Cloudneeti and Edgewise and$2.0 million for an investment in a privately-held company. These activities were partially offset by proceeds from the maturities of short-term investments of$289.8 million and sales of short-term investments of$21.1 million . Net cash used in investing activities during fiscal 2019 of$162.1 million was primarily attributable to the purchases of short-term investments of$335.2 million , capital expenditures to support our cloud platform and increased headcount, including increased office space needs of$28.7 million , payments for business acquisitions, net of cash acquired, of$11.4 million and payments for acquired intangible assets of$1.5 million . These transactions were partially offset by proceeds from the maturities of short-term investments of$199.7 million and sales of short-term investments of$15.0 million . Net cash used in investing activities during fiscal 2018 of$178.1 million resulted primarily from investments in capital expenditures to support our cloud platform, additional office space and headcount. Financing Activities Net cash provided by financing activities of$1,022.2 million during fiscal 2020 was primarily attributable to$1,130.5 million in proceeds from the issuance of our Notes, net of debt discount and issuance costs,$21.6 million in proceeds from 79 -------------------------------------------------------------------------------- Table of Contents the exercise of stock options and$15.3 million in proceeds from issuance of common stock under the employee stock purchase plan. These transactions were partially offset by purchases of capped calls for$145.2 million related to issuance of convertible senior notes. Net cash provided by financing activities of$46.4 million during fiscal 2019 was primarily attributable to$29.9 million in proceeds from the exercise of stock options, driven mainly by the end of our initial public offering lock-up period inSeptember 2018 ,$16.4 million in proceeds from issuance of common stock under the employee stock purchase plan and$1.9 million in proceeds from repayments of notes receivable for early exercised stock options. Proceeds were partially offset by$1.8 million in payments for offering costs related to our IPO. Net cash provided by financing activities of$208.4 million during fiscal 2018 was primarily attributable to$205.3 million in proceeds from the completion of our IPO (net of underwriters' discounts and commissions of$15.5 million ),$5.3 million in proceeds from repayments of notes receivable for the exercise of stock options,$5.0 million in proceeds from the exercise of stock options and$0.9 million in proceeds from early exercised stock options. These proceeds were partially offset by$3.8 million in payments for repurchases of common stock related to early exercised stock options and$4.3 million in payments for offering costs related to our IPO. Contractual Obligations and Commitments The following table summarizes our contractual obligations asJuly 31, 2020 : Payments Due by Period Less Than 1 1 to 3 3 to 5 More Than Total Year Years Years 5 Years (in thousands) Real estate arrangements$ 44,046 $ 7,840 $ 13,255 $ 13,465 $ 9,486 Co-location and bandwidth arrangements 40,032 20,305 19,713 14 - Convertible senior notes(1) 1,157,211 1,457 2,875 1,152,879 - Non-cancelable purchase arrangements 28,226 18,231 9,695 300 - Other current liabilities(2) 2,525 2,525 - - - Total$ 1,272,040 $ 50,358 $ 45,538 $ 1,166,658 $ 9,486
_____
(1) Includes the principal and future interest payments related to our Notes. For additional information refer to Note 8, Convertible Senior Notes, of our consolidated financial statements included elsewhere in this Annual Report on Form 10-K. (2) Includes holdback amounts associated with business acquisitions, 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 can be cancelled without a significant penalty are not included in the table above. Off-Balance Sheet Arrangements As ofJuly 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. 80 -------------------------------------------------------------------------------- As ofJuly 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 9, Operating Leases to our consolidated financial statements included elsewhere in this Annual Report on Form 10-K. 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. The critical accounting estimates, assumptions and judgments that we believe have the most significant impact on our consolidated financial statements are described below. Revenue Recognition We adopted Accounting Standards Codification ("ASC") Topic 606, Revenue From Contracts With Customers ("ASC 606"), effective as ofAugust 1, 2017 . In accordance with ASC 606, revenue is recognized when a customer obtains control of promised services. The amount of revenue recognized reflects the consideration that we expect to be entitled to receive in exchange for these services. To achieve the core principle of this standard, we apply the following five steps: 1) Identify the contract with a customer We consider the terms and conditions of the contracts and our customary business practices in identifying our contracts under ASC 606. We determine we have a contract with a customer when the contract is approved, we can identify each party's rights regarding the services to be transferred, we can identify the payment terms for the services, we have determined the customer to have the ability and intent to pay, and the contract has commercial substance. We apply judgment in determining the customer's ability and intent to pay, which is based on a variety of factors, including the customer's historical payment experience or, in the case of a new customer, credit and financial information pertaining to the customer. 2) Identify the performance obligations in the contract Performance obligations promised in a contract are identified based on the services that will be transferred to the customer that are both capable of being distinct, whereby the customer can benefit from the service either on its own or together with other resources that are readily available from third parties or from us, and are distinct in the context of the contract, whereby the transfer of the services is separately identifiable from other promises in the contract. Our performance obligations consist of (i) our subscription and support services and (ii) professional and other services. 3) Determine the transaction price The transaction price is determined based on the consideration to which we expect to be entitled in exchange for transferring services to the customer. Variable consideration is included in the transaction price if, in our judgment, it is probable that a significant future reversal of cumulative revenue under the contract will not occur. None of our contracts contain a significant financing component. 4) Allocate the transaction price to performance obligations in the contract 81 -------------------------------------------------------------------------------- Table of Contents If the contract contains a single performance obligation, the entire transaction price is allocated to the single performance obligation. Contracts that contain multiple performance obligations require an allocation of the transaction price to each performance obligation based on a relative standalone selling price, or SSP. 5) Recognize revenue when or as we satisfy a performance obligation Revenue is recognized at the time the related performance obligation is satisfied by transferring the promised service to a customer. Revenue is recognized when control of the services is transferred to our customers, in an amount that reflects the consideration that we expect to receive in exchange for those services. We generate all our revenue from contracts with customers and apply judgment in identifying and evaluating any terms and conditions in contracts which may impact revenue recognition. Subscription and Support Revenue We generate revenue primarily from sales of subscriptions to access our cloud platform, together with related support services to our customers. Arrangements with customers do not provide the customer with the right to take possession of our software operating our cloud platform at any time. Instead, customers are granted continuous access to our cloud platform over the contractual period. A time-elapsed output method is used to measure progress because we transfer control evenly over the contractual period. Accordingly, the fixed consideration related to subscription and support revenue is generally recognized on a straight-line basis over the contract term beginning on the date that our service is made available to the customer. The typical subscription and support term is one to three years. Most of our contracts are non-cancelable over the contractual term. Customers typically have the right to terminate their contracts for cause if we fail to perform in accordance with the contractual terms. Some of our customers have the option to purchase additional subscription and support services at a stated price. These options generally do not provide a material right as they are priced at our SSP. Professional and Other Services Revenue Professional and other services revenue consists of fees associated with providing deployment advisory services that educate and assist our customers on the best use of our solutions, as well as advise customers on best practices as they deploy our solution. These services are distinct from subscription and support services. Professional services do not result in significant customization of the subscription service. Revenue from professional services provided on a time and materials basis is recognized as the services are performed. Total professional and other services revenue has historically been insignificant. Contracts with Multiple Performance Obligations Most of our contracts with customers contain multiple promised services consisting of (i) our subscription and support services and (ii) professional and other services that are distinct and accounted for separately. The transaction price is allocated to the separate performance obligations on a relative SSP basis. We determine SSP based on our overall pricing objectives, taking into consideration the type of subscription and support services and professional and other services, the geographical region of the customer and the number of users. Variable Consideration Revenue from sales is recorded at the net sales price, which is the transaction price, and includes estimates of variable consideration. The amount of variable consideration that is included in the transaction price is constrained, and is included in the net sales price only to the extent that it is probable that a significant reversal in the amount of the cumulative revenue will not occur when the uncertainty is resolved. 82 -------------------------------------------------------------------------------- Table of Contents If our services do not meet certain service level commitments, our customers are entitled to receive service credits, and in certain cases, refunds, each representing a form of variable consideration. We have not historically experienced any significant incidents affecting the defined levels of reliability and performance as required by our subscription contracts. Accordingly, any estimated refunds related to these agreements in the consolidated financial statements were not material during the periods presented. We provide rebates and other credits within our contracts with certain customers which are estimated based on the most likely amounts expected to be earned or claimed on the related sales transaction. Overall, the transaction price is reduced to reflect our estimate of the amount of consideration to which we are entitled based on the terms of the contract. Estimated rebates and other credits were not material during the periods presented. Contract Balances Contract liabilities consist of deferred revenue and include payments received in advance of performance under the contract. Such amounts are recognized as revenue over the contractual period. We receive payments from customers based upon contractual billing schedules; accounts receivable are recorded when the right to consideration becomes unconditional. Payment terms on invoiced amounts are typically 30 days. Contract assets include amounts related to our contractual right to consideration for both completed and partially completed performance obligations that may not have been invoiced and such amounts have been insignificant to date. Costs to Obtain and Fulfill a Contract We capitalize sales commissions and associated payroll taxes paid to internal sales personnel that are incremental to the acquisition of channel partner and direct customer contracts. These costs are recorded as deferred contract acquisition costs on the consolidated balance sheets. We determine whether costs should be deferred based on our sales compensation plans, if the commissions are in fact incremental and would not have occurred absent the customer contract. Sales commissions for renewal of a contract are not considered commensurate with the commissions paid for the acquisition of the initial contract given the substantive difference in commission rates in proportion to their respective contract values. Commissions paid upon the initial acquisition of a contract are amortized over an estimated period of benefit of five years while commissions paid for renewal contracts are amortized over the contractual term of the renewals. Amortization is recognized on a straight-line basis commensurate with the pattern of revenue recognition. We determine the period of benefit for commissions paid for the acquisition of the initial contract by taking into consideration the expected subscription term and expected renewals of our customer contracts, the duration of our relationships with customers, customer retention data, our technology development life cycle and other factors. Management exercises judgment to determine the period of benefit to amortize contract acquisition costs by considering factors such as expected renewals of customer contracts, duration of customer relationships and our technology development life cycle. Although we believe that the historical assumptions and estimates we have made are reasonable and appropriate, different assumptions and estimates could materially impact our reported financial results. Amortization of deferred contract acquisition costs is included in sales and marketing expense in the consolidated statements of operations. We periodically review these deferred costs to determine whether events or changes in circumstances have occurred that could impact the period of benefit of these deferred contract acquisition costs. 83 -------------------------------------------------------------------------------- Table of Contents Business Combinations We account for our business combinations using the acquisition method of accounting, which requires, among other things, allocation of the fair value of purchase consideration to the tangible and intangible assets acquired and liabilities assumed at their estimated fair values on the acquisition date. The excess of the fair value of purchase consideration over the values of these identifiable assets and liabilities is recorded as goodwill. When determining the fair value of assets acquired and liabilities assumed, we make estimates and assumptions, especially with respect to intangible assets. Our estimates of fair value are based upon assumptions believed to be reasonable, but which are inherently uncertain and unpredictable and, as a result, actual results may differ from estimates. During the measurement period, not to exceed one year from the date of acquisition, we may record adjustments to the assets acquired and liabilities assumed, with a corresponding offset to goodwill if new information is obtained related to facts and circumstances that existed as of the acquisition date. After the measurement period, any subsequent adjustments are reflected in the consolidated statements of operations. Acquisition costs, such as legal and consulting fees, are expensed as incurred. Operating Leases We enter into operating lease arrangements for real estate assets related to office space and co-location assets related to space and racks at data center facilities. We determine if an arrangement contains a lease at its inception by assessing whether there is an identified asset and whether the arrangement conveys the right to control the use of the identified asset in exchange for consideration. Operating leases related balances are included in "operating lease right-of-use assets," "operating lease liabilities," and "operating lease liabilities, noncurrent" in our consolidated balance sheets. Right-of-use assets represent our right to use an underlying asset for the lease term and lease liabilities represent our obligation to make payments arising from the lease. Operating lease right-of-use assets and lease liabilities are recognized at the lease commencement date based on the present value of lease payments over the lease term. Lease payments consist of the fixed payments under the arrangement. The operating lease liabilities are adjusted for any unpaid lease incentives, such as tenant improvement allowances. Variable costs, such as maintenance and utilities based on actual usage, are not included in the measurement of right-to-use assets and lease liabilities but are expensed when the event determining the amount of variable consideration to be paid occurs. As the implicit rate of our leases is not determinable, we use an incremental borrowing rate ("IBR") based on the information available at the lease commencement date in determining the present value of lease payments. The lease expense is recognized on a straight-line basis over the lease term. We generally use the base, non-cancelable lease term when recognizing the right-of-use assets and lease liabilities, unless it is reasonably certain that a renewal or termination option will be exercised. We account for lease components and non-lease components as a single lease component. Leases with a term of twelve months or less are not recognized on the consolidated balance sheets. We recognize lease expense for these leases on a straight-line basis over the term of the lease. Stock-Based Compensation Compensation expense related to stock-based awards granted to employees and non-employees is calculated based on the fair value of stock-based awards on the date of grant. We recognize stock-based compensation expense over an award's requisite service period based on the award's fair value. Stock-based compensation for common stock options is recognized based on the fair value of the awards granted, determined using the Black-Scholes option pricing model and a single option award approach. Stock-based compensation expense is recognized on a straight-line basis over the requisite service period, generally four years. 84 -------------------------------------------------------------------------------- Table of Contents Stock-based compensation for purchase rights granted under the employee stock purchase plan is based on the Black-Scholes option pricing model fair value of the number of awards estimated as of the beginning of the offering period. Stock-based compensation expense is recognized following the straight-line attribution method over the offering period. Stock-based compensation for restricted stock units is measured based on the market closing price of our common stock on the grant date. Stock-based compensation expense is recognized on a straight-line basis over the requisite service period, generally four years. Stock-based compensation for performance stock awards ("PSAs") which have the same grant date and service inception date, is based on the probable number of shares to be attained and the market closing price of our common stock at the grant date. For PSAs where the service inception date of the awards precedes the grant date, stock-based compensation expense is recognized based on the number of PSAs for which it is probable that the performance condition will be met, using the accelerated attribution method and the market closing price of our common stock at each reporting date up to the grant date. The number of these PSAs for which it is probable that the performance condition will be met is determined using management's best estimate at the end of each reporting period. At the completion of the performance period for these PSAs, any RSUs earned under the PSAs are granted upon approval of the compensation committee of our board of directors. Prior to our IPO, the fair value of our common stock for financial reporting purposes was determined considering numerous objective and subjective factors and required judgment to determine the fair value of common stock as of each grant date. Subsequent to the IPO, we determine the fair value using the market closing price of our common stock on the date of grant. Our use of the Black-Scholes option pricing model to estimate the fair value of stock options requires the input of highly subjective assumptions. The assumptions used to determine the fair value of the option awards represent management's best estimates. These estimates involve inherent uncertainties and the application of management's judgment. These assumptions and estimates are as follows: •Fair Value of Common Stock. Prior to our IPO, the fair value of the common stock underlying our stock options was determined by our board of directors, after considering contemporaneous third-party valuations and input from management. Our board of directors considered this independent valuations and other factors, including, but not limited to, expected operating and financial performance, our stage of development, current business conditions and projections, history and the timing of the introduction of new services, our financial condition and market performance of comparable publicly traded companies to establish the fair value of our common stock at the time of grant of the option. The valuations of our common stock were determined in accordance with the guidelines outlined in theAmerican Institute of Certified Public Accountants Practice Aid , Valuation ofPrivately-Held-Company Equity Securities Issued as Compensation. After the IPO, we used the publicly quoted price as reported on The Nasdaq Global Select Market as the fair value of our common stock. •Expected Term. The expected term represents the period that our stock-based awards are expected to be outstanding. The expected term assumptions were determined based on the vesting terms, exercise terms and contractual lives of the options. The expected term was estimated using the simplified method allowed underSEC guidance. •Volatility. Since we do not have sufficient trading history of our common stock, the expected volatility may be determined based on a mix between the historical volatility of our common stock and the historical stock volatilities of our comparable publicly-traded companies for the period we do not have trading history of our common stock. Comparable companies consist of public companies in our industry, which are similar in size, stage of life cycle and financial leverage. 85 -------------------------------------------------------------------------------- Table of Contents •Risk-Free Interest Rate. We base the risk-free interest rate used in the Black-Scholes option pricing model on the implied yield available onU.S. Treasury zero-coupon issues with a remaining term equivalent to that of the options for each expected term. •Dividend Yield. The expected dividend assumption is based on our current expectations about our anticipated dividend policy. As we have no history of paying any dividends, we used an expected dividend yield of zero. We estimated the fair value of employee stock options using the Black-Scholes option pricing model with the following assumptions: Year Ended July 31(1) 2020 2018 Expected term (in years) 6.1 4.6 - 5.1 Expected stock price volatility 46.07%
40.3% - 42.3%
Risk-free interest rate 1.69% 1.7% - 2.8%
Dividend yield 0.0% 0.0%
(1) There were no stock options granted during fiscal 2019.
The fair value of the purchase rights granted under the employee stock purchase
plan was estimated on the date of grant using the Black-Scholes option pricing
model with the following assumptions:
Year Ended July 31,
2020 2019 2018
Expected term (in years) 0.5 - 2.0 0.5 - 2.0 0.5 - 2.3
Expected stock price volatility 53.6% - 73.6% 44.0% - 61.9% 30.7% - 53.2%
Risk-free interest rate 0.2% - 1.7% 1.9% - 2.7% 2.0% - 2.6%
Dividend yield 0.0% 0.0% 0.0%
Convertible Senior Notes
In accounting for the issuance of our Notes, we separate the Notes into
liability and equity components. The carrying amounts of the liability component
is calculated by measuring the fair value of similar liabilities that do not
have associated convertible features. The carrying amount of the equity
component representing the conversion option was determined by deducting the
fair value of the liability component from the par value of the Notes as a
whole. This difference represents the debt discount that is amortized to
interest expense over the respective terms of the Notes using the effective
interest rate method. The equity component was recorded in additional paid-in
capital and is not remeasured as long as it continues to meet the conditions for
equity classification.
In accounting for the related debt issuance costs, we allocate the total amount
incurred to the liability and equity components of the Notes based on their
relative values. Issuance costs attributable to the liability component are
being amortized to interest expense over the contractual term of the Notes. The
issuance costs attributable to the equity component were netted against the
equity component representing the conversion option in additional paid-in
capital.
To the extent that we receive the Notes conversion requests prior to the
maturity of the Notes, a portion of the equity component is classified as
temporary equity, which is measured as the difference between the principal and
net carrying amount of the Notes requested for conversion. Upon settlement of
the conversion requests, the difference between the fair value and the amortized
book value of the liability component of the Notes requested for conversion is
recorded as a gain or
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loss on early note conversion. The fair value of the Notes is measured based on
a similar liability that does not have an associated convertible feature based
on the remaining term of the Notes.
Income Taxes
We are subject to federal, state and local taxes in the United States as well as
in other tax jurisdictions or countries in which we conduct business. Earnings
generated by our non-U.S. activities are related to applicable transfer pricing
requirements under local country income tax laws. We account for uncertain tax
positions based on those positions taken or expected to be taken in a tax
return. We determine if the amount of available support indicates that it is
more likely than not that the tax position will be sustained on audit, including
resolution of any related appeals or litigation processes. We then measure the
tax benefit as the largest amount that is more than 50% likely to be realized
upon settlement.
We have a full valuation allowance for our net deferred tax assets generated
from our U.S. and U.K. operations. We will continue to assess the need for such
valuation allowance on our deferred tax assets by evaluating both positive and
negative evidence that may exist. Any adjustment to the deferred tax asset
valuation allowance would be recorded in the periods in which the adjustment is
determined to be required.
On December 22, 2017 , the Tax Cuts and Jobs Act of 2017, or the Tax Act, was
enacted. The Tax Act contains several key tax provisions that affect us,
including, but not limited to, reducing the U.S. federal corporate tax rate from
34% to 21%, imposing a one-time mandatory transition tax on previously untaxed
foreign earnings and changing rules related to the use of net operating loss
carryforwards created in tax years beginning after December 31, 2017 . Because of
the full valuation allowance recorded against our U.S. federal deferred tax
assets, there was no income tax expense (or benefit) recognized related to the
Tax Act.
JOBS Act Extended Transition Period
As a result of the market value of our common stock held by our non-affiliates
as of January 31, 2019 , we ceased to be an "emerging growth company" ("EGC"), as
defined in the Jumpstart Our Business Startups Act of 2012 (the "JOBS Act"),
with our transition to a large accelerated filer status as of July 31, 2019 . As
an EGC, we elected not to avail ourselves of the extended transition periods
available for complying with new or revised accounting pronouncements applicable
to public companies that are not emerging growth companies. Accordingly, the
transition to a large accelerated filer did not have an impact to our
consolidated financial statements.
Recently Issued Accounting Pronouncements
Refer to Note 1, Business and Summary of Significant Accounting Policies, to our
consolidated financial statements included elsewhere in this Annual Report on
Form 10-K for more information regarding recently issued accounting
pronouncements.
Item 7A. Quantitative and Qualitative Disclosures about Market Risk
We have operations in the United States and internationally, and we are exposed
to market risk in the ordinary course of our business.
Interest Rate Risk
As of July 31, 2020 , we had cash, cash equivalents and short-term investments
totaling $1,370.6 million , which were held for working capital 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. The primary
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objectives of our investment activities are the preservation of capital, the
fulfillment of liquidity needs and the fiduciary control of cash and
investments. We do not enter into investments for trading or speculative
purposes. The carrying amount of our cash equivalents reasonably approximates
fair value, due to the short maturities of these instruments. Our investments
are exposed to market risk due to a fluctuation in interest rates, which may
affect our interest income and the fair market value of our investments. As of
July 31, 2020 , the effect of a hypothetical 100 basis point change in interest
rates would have changed the fair value of our investments in available-for-sale
securities by $10.3 million . Fluctuations in the fair value of our investments
in available-for-sale securities caused by a change in interest rates (gains or
losses on the carrying amount) are recorded in other comprehensive income
(loss), and are realized only if we sell the underlying securities prior to
maturity.
Convertible Senior Notes
In June 2020 , we issued our Notes with an aggregate principal amount of $1,150.0
million . In connection with the issuance of the Notes, we entered into privately
negotiated capped call transactions with certain counterparties (the "Capped
Calls"). The Capped Calls are expected generally to offset the potential
dilution to our common stock as a result of any conversion of the Notes.
The Notes have a fixed annual interest rate of 0.125%, accordingly, we do not
have economic interest rate exposure on the Notes. However, the fair value of
the Notes is exposed to interest rate risk. Generally, the fair value of the
Notes will increase as interest rates fall and decrease as interest rates rise.
We carry the Notes at face value less unamortized discount and issuance costs on
our balance sheet, and we present the fair value for required disclosure
purposes only. In addition, the fair value of the Notes also fluctuates when the
market price of our common stock fluctuates. The fair value was determined based
on the quoted bid price of the Notes in an over-the-counter market on the last
trading day of the reporting period. For further information refer to Note 8,
Convertible Senior Notes, to our consolidated financial statements included
elsewhere in this Annual Report on Form 10-K.
Foreign Currency Risk
The vast majority of our sales contracts are denominated in U.S. dollars, with a
small number of contracts denominated in foreign currencies. A portion of our
operating expenses are incurred outside the United States , denominated in
foreign currencies and subject to fluctuations due to changes in foreign
currency exchange rates, particularly changes in the British Pound, Indian Rupee
and Euro. Additionally, fluctuations in foreign currency exchange rates may
cause us to recognize transaction gains and losses in our consolidated
statements of operations. The effect of a hypothetical 10% change in foreign
currency exchange rates applicable to our business would not have a material
impact on our historical consolidated financial statements for fiscal 2020,
fiscal 2019 and fiscal 2018. As the impact of foreign currency exchange rates
has not been material to our historical operating results, we have not entered
into derivative or hedging transactions, but we may do so in the future if our
exposure to foreign currency becomes more significant.
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Item 8. Financial Statements and Supplementary Data
Index to Consolidated Financial Statements
Page
Report of Independent Registered Public Accounting Firm 90
Consolidated Financial Statements:
Consolidated Balance Sheets as of July 31, 20 20 and 201 9 93
Consolidated Statements of Operations for the years ended
94
Consolidated Statements of Comprehensive Loss for the years ended
20 20 , 201 9 and 201 8 95
Consolidated Statements of Redeemable Convertible Preferred Stock and
Stockholders' Equity (Deficit) for the years ended
20 20 , 201 9 and 201 8 96
Consolidated Statements of Cash Flows for years ended
97
Notes to Consolidated Financial Statements 99
The supplementary financial information required by this Item 8, is included in
Part II, Item 7, Management's Discussion and Analysis of Financial Condition and
Results of Operations, under the caption "Quarterly Results of Operations and
Other Data," which is incorporated herein by reference. 75
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REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
To the Board of Directors and Stockholders of Zscaler, Inc.
Opinions on the Financial Statements and Internal Control over Financial
Reporting
We have audited the accompanying consolidated balance sheets of Zscaler, Inc.
and its subsidiaries (the "Company") as of July 31, 2020 and 2019, and the
related consolidated statements of operations, of comprehensive loss, of
redeemable convertible preferred stock and stockholders' equity (deficit) and of
cash flows for each of the three years in the period ended July 31, 2020 ,
including the related notes (collectively referred to as the "consolidated
financial statements"). We also have audited the Company's internal control over
financial reporting as of July 31, 2020 , based on criteria established in
Internal Control - Integrated Framework (2013) issued by the Committee of
Sponsoring Organizations of the Treadway Commission (COSO).
In our opinion, the consolidated financial statements referred to above present
fairly, in all material respects, the financial position of the Company as of
July 31, 2020 and 2019, and the results of its operations and its cash flows for
each of the three years in the period ended July 31, 2020 in conformity with
accounting principles generally accepted in the United States of America . Also
in our opinion, the Company maintained, in all material respects, effective
internal control over financial reporting as of July 31, 2020 , based on criteria
established in Internal Control - Integrated Framework (2013) issued by the
COSO.
Change in Accounting Principle
As discussed in Note 1 to the consolidated financial statements, the Company
changed the manner in which it accounts for leases effective August 1, 2019 .
Basis for Opinions
The Company's management is responsible for these consolidated financial
statements, for maintaining effective internal control over financial reporting,
and for its assessment of the effectiveness of internal control over financial
reporting, included in Management's Report on Internal Control Over Financial
Reporting appearing under Item 9A. Our responsibility is to express opinions on
the Company's consolidated financial statements and on the Company's internal
control over financial reporting based on our audits. We are a public accounting
firm registered with the Public Company Accounting Oversight Board (United
States ) (PCAOB) and are required to be independent with respect to the Company
in accordance with the U.S. federal securities laws and the applicable rules and
regulations of the Securities and Exchange Commission and the PCAOB.
We conducted our audits in accordance with the standards of the PCAOB. Those
standards require that we plan and perform the audits to obtain reasonable
assurance about whether the consolidated financial statements are free of
material misstatement, whether due to error or fraud, and whether effective
internal control over financial reporting was maintained in all material
respects.
Our audits of the consolidated financial statements included performing
procedures to assess the risks of material misstatement of the consolidated
financial statements, whether due to error or fraud, and performing procedures
that respond
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to those risks. Such procedures included examining, on a test basis, evidence
regarding the amounts and disclosures in the consolidated financial statements.
Our audits also included evaluating the accounting principles used and
significant estimates made by management, as well as evaluating the overall
presentation of the consolidated financial statements. Our audit of internal
control over financial reporting included obtaining an understanding of internal
control over financial reporting, assessing the risk that a material weakness
exists, and testing and evaluating the design and operating effectiveness of
internal control based on the assessed risk. Our audits also included performing
such other procedures as we considered necessary in the circumstances. We
believe that our audits provide a reasonable basis for our opinions.
Definition and Limitations of Internal Control over Financial Reporting
A company's internal control over financial reporting is a process designed to
provide reasonable assurance regarding the reliability of financial reporting
and the preparation of financial statements for external purposes in accordance
with generally accepted accounting principles. A company's internal control over
financial reporting includes those policies and procedures that (i) pertain to
the maintenance of records that, in reasonable detail, accurately and fairly
reflect the transactions and dispositions of the assets of the company; (ii)
provide reasonable assurance that transactions are recorded as necessary to
permit preparation of financial statements in accordance with generally accepted
accounting principles, and that receipts and expenditures of the company are
being made only in accordance with authorizations of management and directors of
the company; and (iii) provide reasonable assurance regarding prevention or
timely detection of unauthorized acquisition, use, or disposition of the
company's assets that could have a material effect on the financial statements.
Because of its inherent limitations, internal control over financial reporting
may not prevent or detect misstatements. Also, projections of any evaluation of
effectiveness to future periods are subject to the risk that controls may become
inadequate because of changes in conditions, or that the degree of compliance
with the policies or procedures may deteriorate.
Critical Audit Matters
The critical audit matter communicated below is a matter arising from the
current period audit of the consolidated financial statements that was
communicated or required to be communicated to the audit committee and that (i)
relates to accounts or disclosures that are material to the consolidated
financial statements and (ii) involved our especially challenging, subjective,
or complex judgments. The communication of critical audit matters does not alter
in any way our opinion on the consolidated financial statements, taken as a
whole, and we are not, by communicating the critical audit matter below,
providing a separate opinion on the critical audit matter or on the accounts or
disclosures to which it relates.
Revenue recognition - Identifying and evaluating terms and conditions in
contracts
As described in Note 1 to the consolidated financial statements, management
applies the following steps in their determination of revenue to be recognized:
1) identification of the contract with a customer; 2) identification of the
performance obligations in the contract; 3) determination of the transaction
price; 4) allocation of the transaction price to the performance obligations in
the contract; and 5) recognition of revenue when, or as, the Company satisfies a
performance obligation. Management applies judgment in identifying and
evaluating any terms and conditions in contracts which may impact revenue
recognition. For the fiscal year ended July 31, 2020 , the Company's revenue was
$431 million .
The principal considerations for our determination that performing procedures
relating to revenue recognition, specifically the identification and evaluation
of terms and conditions in contracts, is a critical audit matter are the
significant amount of effort and judgment required by management in identifying
and evaluating terms and conditions in contracts that impact revenue
recognition. This in turn led to a high degree of auditor judgment and
significant audit effort in performing our audit procedures to evaluate whether
terms and conditions in contracts were appropriately identified and evaluated by
management.
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Addressing the matter involved performing procedures and evaluating audit
evidence in connection with forming our overall opinion on the consolidated
financial statements. These procedures included testing the effectiveness of
controls relating to the revenue recognition process, including controls related
to the identification and evaluation of terms and conditions in contracts that
impact revenue recognition. These procedures also included, among others,
testing the completeness and accuracy of management's identification and
evaluation of the terms and conditions in contracts by examining revenue
arrangements on a test basis and testing management's process of identifying and
evaluating the terms and conditions in contracts, including management's
determination of the impact of those terms and conditions on revenue
recognition.
/s/ PricewaterhouseCoopers LLP
San Jose, California
September 17, 2020 We have served as the Company's auditor since 2015.
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ZSCALER, INC.
Consolidated Balance Sheets
(in thousands, except per share amounts)
July 31,
2020 2019
Assets
Current assets:
Cash and cash equivalents $ 141,851 $ 78,484
Short-term investments 1,228,722 286,162
Accounts receivable, net 147,584 93,341
Deferred contract acquisition costs 32,240 21,219
Prepaid expenses and other current assets 31,396 16,880
Total current assets 1,581,793 496,086
Property and equipment, net 75,734 41,046
Operating lease right-of-use assets 36,119 -
Deferred contract acquisition costs, noncurrent 77,675 48,566
Acquired intangible assets, net 24,024 8,708
Goodwill 30,059 7,479
Other noncurrent assets 8,054 2,277
Total assets $ 1,833,458 $ 604,162
Liabilities and Stockholders' Equity
Current liabilities:
Accounts payable $ 5,233 $ 6,208
Accrued expenses and other current liabilities 16,361 12,810
Accrued compensation 49,444 21,544
Deferred revenue 337,263 221,387
Operating lease liabilities 15,600 -
Total current liabilities 423,901 261,949
Convertible senior notes, net 861,615 -
Deferred revenue, noncurrent 32,504 29,815
Operating lease liabilities, noncurrent 28,023 -
Other noncurrent liabilities 2,586 3,840
Total liabilities 1,348,629 295,604
Commitments and contingencies (Note 10)
Stockholders' Equity
Preferred stock; $0.001 par value; 200,000 shares authorized as
of July 31, 2020 and 2019, respectively; no shares issued and
outstanding as of July 31, 2020 and 2019 - -
Common stock;
127
Additional paid-in capital 823,804 532,618
Accumulated other comprehensive income 463 268
Accumulated deficit (339,571) (224,455)
Total stockholders' equity 484,829 308,558
Total liabilities and stockholders' equity $
1,833,458
The accompanying notes are an integral part of these consolidated financial
statements.
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ZSCALER, INC.
Consolidated Statements of Operations
(in thousands, except per share amounts)
Year Ended July 31,
2020 2019 2018
Revenue $ 431,269 $ 302,836 $ 190,174
Cost of revenue 95,733 59,669 37,875
Gross profit 335,536 243,167 152,299
Operating expenses:
Sales and marketing 277,981 169,913 116,409
Research and development 97,879 61,969 39,379
General and administrative 73,632 46,598 31,135
Total operating expenses 449,492 278,480 186,923
Loss from operations (113,956) (35,313) (34,624)
Interest income 6,477 7,730 2,236
Interest expense (5,025) - -
Other income (expense), net (224) (329) 79
Loss before income taxes (112,728) (27,912) (32,309)
Provision for income taxes 2,388 743 1,337
Net loss $
(115,116)
- - (6,332)
Net loss attributable to common stockholders $ (115,116) $ (28,655) $ (39,978)
Net loss per share attributable to common
stockholders, basic and diluted $
(0.89)
129,323 123,566 63,881
The accompanying notes are an integral part of these consolidated financial
statements.
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ZSCALER, INC.
Consolidated Statements of Comprehensive Loss
(in thousands)
Year Ended July 31,
2020 2019 2018
Net loss $ (115,116) $ (28,655) $ (33,646)
Other comprehensive income (loss), net of tax:
Unrealized net gains (losses) on available-for-sale
securities 195 392 (124)
Total 195 392 (124)
Comprehensive loss $
(114,921)
The accompanying notes are an integral part of these consolidated financial
statements.
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ZSCALER, INC.
Consolidated Statements of Redeemable Convertible Preferred Stock and
Stockholders' Equity (Deficit)
(in thousands)
Redeemable Notes
Convertible Additional Receivable Accumulated Other Total
Preferred Stock Common Stock Paid-In From Comprehensive Income Accumulated Stockholders' Equity
Shares Amount Shares Amount Capital Stockholders (Loss) Deficit (Deficit)
Balance as of July 31, 2017 72,501 $ 200,977 32,359 $ 18 $ 18,734 $ (7,878) $ - $ (162,016) $ (151,142)
Cumulative effect of accounting change - - - - 438 - - (438) -
Accretion of Series C and D redeemable convertible preferred stock
- 6,332 - - (6,332) - - - (6,332)
Issuance of common stock upon exercise of stock options - - 1,712 2 4,983 - - -
4,985
Issuance of common stock related to early exercised stock options - - 180 - - - - - - Repurchases of unvested common stock - - (788) - - 214 - - 214
Repayments of principal amount on notes receivable from stockholders
- - - - - 5,346 - - 5,346
Accrued interest on notes receivable from stockholders, net of repayments - - - - - 267 - - 267 Vesting of early exercised stock options - - - 12 3,243 - - -
3,255
Issuance of common stock upon initial public
offering, net of underwriting discounts of
- - 13,800 14 198,866 - - - 198,880
Conversion of redeemable convertible preferred stock to common stock upon initial public offering (72,501) (207,309) 72,501 73 207,236 - - - 207,309 Stock-based compensation - - - - 11,224 - - - 11,224 Unrealized net losses on available-for-sale-securities - - - - - - (124) - (124) Net loss - - - - - - - (33,646) (33,646) Balance as of July 31, 2018 -
- 119,764 119 438,392 (2,051) (124) (196,100) 240,236
Cumulative effect of accounting change - - - - (300) - - 300 - Issuance of common stock upon exercise of stock options - - 6,277 7 29,855 - - -
29,862
Issuance of common stock under the employee stock purchase plan - - 1,131 1 16,435 - - -
16,436
Vesting of restricted stock units - - 89 - - - - - - Repurchases of unvested common stock - - (8) - - - - - -
Repayments of principal amount on notes receivable from stockholders
- - - - - 1,905 - - 1,905
Accrued interest on notes receivable from stockholders, net of repayments - - - - - 146 - - 146 Adjustment to initial public offering costs - - - - 300 - - - 300 Vesting of early exercised stock options - - - - 983 - - - 983 Stock-based compensation - - - - 46,953 - - - 46,953 Unrealized net gains on available-for-sale-securities - - - - - - 392 - 392 Net loss - - - - - - - (28,655) (28,655) Balance as of July 31, 2019 -
- 127,253 127 532,618 - 268 (224,455) 308,558
Issuance of common stock upon exercise of stock options - - 3,450 4 21,598 - - -
21,602
Issuance of common stock under the employee stock purchase plan - - 817 1 15,332 - - -
15,333
Vesting of restricted stock units - - 1,297 1 (1) - - - - Vesting of early exercised stock options - - - - 463 - - - 463 Stock-based compensation - - - - 125,675 - - - 125,675 Equity component of convertible senior notes, net of deferred tax - - - - 273,364 - - -
273,364
Purchases of capped calls related to convertible senior notes - - - - (145,245) - - - (145,245) Unrealized net gains on available-for-sale-securities - - - - - - 195 - 195 Net loss - - - - - - - (115,116) (115,116) Balance as of July 31, 2020 - $
- 132,817 $ 133 $ 823,804 $ - $ 463 $ (339,571) $ 484,829
The accompanying notes are an integral part of these consolidated financial
statements.
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ZSCALER, INC.
Consolidated Statements of Cash Flows
(in thousands)
Year Ended July 31,
2020 2019 2018
Cash Flows From Operating Activities
Net loss $ (115,116) $ (28,655) $ (33,646)
Adjustments to reconcile net loss to cash provided by
operating activities:
Depreciation and amortization expense 17,734 10,398 7,988
Amortization expense of acquired intangible assets 3,384 908 -
Amortization of deferred contract acquisition costs 24,922 18,651 13,181
Amortization of debt discount and issuance costs 4,885 - -
Noncash operating lease costs 13,555 - -
Stock-based compensation expense 121,395 46,423 11,224
Amortization (accretion) of investments purchased at a
premium (discount) 50 (2,181) -
Deferred income taxes (1,172) (1,392) -
Impairment of assets 746 - -
Other 321 284 130Changes in operating assets and liabilities, net of effects of business acquisitions: Accounts receivable
(54,222) (31,730) (22,559)
Deferred contract acquisition costs (65,052) (32,526) (34,429)
Prepaid expenses, other current and noncurrent assets (13,580) (7,642) (5,068)
Accounts payable 862 495 (779)
Accrued expenses, other current and noncurrent liabilities 2,292
(336) 2,076
Accrued compensation 27,900 (1,849) 11,785
Deferred revenue 118,017 87,179 67,404
Operating lease liabilities (7,604) - -
Net cash provided by operating activities 79,317 58,027 17,307
Cash Flows From Investing Activities
Purchases of property, equipment and other assets (43,072) (25,520) (13,397)
Capitalized internal-use software (8,737) (3,162) (1,773)
Acquired intangible assets - (1,480) -
Payments for business acquisitions, net of cash acquired (39,601)
(11,432) -
Investment in a privately held company (2,000) - -
Purchases of short-term investments (1,255,629) (335,186) (163,366)
Proceeds from maturities of short-term investments 289,785 199,716 433
Proceeds from sale of short-term investments 21,092 14,990 -
Net cash used in investing activities (1,038,162) (162,074) (178,103)
Cash Flows From Financing Activities
Proceeds from initial public offering, net of underwriting
discounts and commissions - - 205,344
Payments of offering costs related to initial public offering
- (1,797) (4,336)
Proceeds from issuance of common stock upon exercise of stock options
21,602 29,862 4,985
Proceeds from issuance of common stock related to early exercised stock options
- - 869
Proceeds from issuance of common stock under the employee stock purchase plan
15,333 16,436 -
Proceeds from issuance of convertible senior notes, net of issuance costs
1,130,522 - -
Purchases of capped calls related to convertible senior notes
(145,245) - -
Repurchases of unvested common stock - (22) (3,811)
Repayments of notes receivable from stockholders - 1,905 5,346
Net cash provided by financing activities 1,022,212 46,384 208,397
Net increase (decrease) in cash, cash equivalents and restricted cash
63,367 (57,663) 47,601
Cash, cash equivalents and restricted cash at beginning of period
78,484 136,147 88,546
Cash, cash equivalents and restricted cash at end of period
$ 78,484 $ 136,147 Supplemental Disclosure of Cash Flow Information: Cash paid for income taxes, net of tax refunds$ 2,525 $ 1,770 $ 870 Noncash activities Net change in purchased equipment included in accounts payable and accrued expenses$ (1,486)
$ - $ - Accretion of Series C and D redeemable convertible preferred stock
$ -
$ -
$ - $ - $ 214
Vesting of early exercised common stock options $ 463 $ 983 $ 3,255
Net change in deferred offering costs accrued $ -
$ - $ - $ 207,309
Reconciliation of cash, cash equivalents and restricted
cash to the consolidated balance sheets:
Cash and cash equivalents $ 141,851 $ 78,484 $ 135,579
Restricted cash, current - - 236
Restricted cash, current and noncurrent - - 332
Total cash, cash equivalents and restricted cash $ 141,851 The accompanying notes are an integral part of these consolidated financial
statements.
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ZSCALER, INC.
Notes to Consolidated Financial Statements
Note 1. Business and Summary of Significant Accounting Policies
Description of the Business
Zscaler, Inc. ("Zscaler ," the "Company," "we," "us," or "our") is a cloud
security company that developed a platform incorporating core security
functionalities needed to enable users to safely utilize authorized applications
and services based on an organization's policies. Our solution is a
purpose-built, multi-tenant, distributed cloud platform that secures access for
users and devices to applications and services, regardless of location. We
deliver our solutions using a software-as-a-service ("SaaS") business model and
sell subscriptions to customers to access our cloud platform, together with
related support services. We were incorporated in Delaware in September 2007 and
conduct business worldwide, with presence in North America , Europe and Asia . Our
headquarters are in San Jose, California .
Reverse Stock Split
In March 2018 , our board of directors approved an amendment to the Company's
amended and restated certificate of incorporation effecting a 2-for-3 reverse
stock split of the Company's issued and outstanding shares of common stock and
convertible preferred stock. The reverse stock split was effected on March 1,
2018 . The par value of the common stock and the convertible preferred stock was
not adjusted as a result of the reverse stock split. All issued and outstanding
share and per share amounts included in the accompanying consolidated financial
statements have been adjusted to reflect this reverse stock split for all
periods presented.
Initial Public Offering
In March 2018 , we completed our initial public offering ("IPO") of common stock,
in which we sold 13.8 million shares. The shares were sold at an IPO price
of $16.00 per share for net proceeds of $205.3 million , after deducting
underwriters' discounts and commissions of $15.5 million . In connection with the
IPO, we incurred offering costs of $6.2 million which were recorded within
stockholders' equity as a reduction of the net proceeds received from the IPO.
Immediately prior to the closing of the IPO, all our outstanding shares of
convertible preferred stock were automatically converted into $72.5 million
shares of common stock on a one-to-one basis.
Fiscal Year
Our fiscal year ends on July 31 . References to fiscal 2020, for example, refer
to our fiscal year ended July 31, 2020 .
Principles of Consolidation
The accompanying consolidated financial statements include the accounts of the
Company and its wholly owned subsidiaries and have been prepared in conformity
with accounting principles generally accepted in the United States ("U.S.
GAAP"). All intercompany balances and transactions have been eliminated in
consolidation.
Use of Estimates
The preparation of consolidated financial statements in conformity with U.S.
GAAP requires management to make estimates, judgments and assumptions that
affect the amounts reported and disclosed in the financial statements and
accompanying notes. Such estimates include, but are not limited to, the
determination of revenue recognition, deferred revenue, deferred contract
acquisition costs, valuation of acquired intangible assets, the period of
benefit generated from our
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deferred contract acquisition costs, allowance for doubtful accounts, valuation
of common stock options and stock-based awards, useful lives of property and
equipment, useful lives of acquired intangible assets, valuation of deferred tax
assets and liabilities, loss contingencies related to litigation, fair value and
effective interest rate of our convertible senior notes, valuation of strategic
investments and the discount rate used for operating leases. Management
determines these estimates and assumptions based on historical experience and on
various other assumptions that are believed to be reasonable. Actual results
could differ significantly from these estimates, and such differences may be
material to the consolidated financial statements.
Due to the COVID-19 pandemic, there is ongoing uncertainty and significant
disruption in the global economy and financial markets. We are not aware of any
specific event or circumstances that would require an update to our estimates,
judgments or assumptions or a revision to the carrying value of our assets or
liabilities as of the date of issuance of these financial statements. These
estimates, judgments and assumptions may change in the future, as new events
occur or additional information is obtained.
Foreign Currency
The functional currency of our foreign subsidiaries is the U.S. dollar.
Accordingly, monetary assets and liabilities of our foreign subsidiaries are
re-measured into U.S. dollars at the exchange rates in effect at the reporting
date, non-monetary assets and liabilities are re-measured at historical rates,
revenue and expenses are re-measured at average exchange rates in effect during
each reporting period. Foreign currency transaction gains and losses are
recorded in other income (expense), net in the consolidated statements of
operations. We recognized re-measurement losses of $0.3 million , $0.3 million
and $0.1 million for fiscal 2020, fiscal 2019 and fiscal 2018, respectively.
JOBS Act Extended Transition Period
As a result of the market value of our common stock held by our non-affiliates
as of January 31, 2019 , we ceased to be an "emerging growth company" ("EGC"), as
defined in the Jumpstart Our Business Startups Act of 2012 (the "JOBS Act"),
with our transition to a large accelerated filer status as of July 31, 2019 . As
an EGC, we elected not to avail ourselves of the extended transition periods
available for complying with new or revised accounting pronouncements applicable
to public companies that are not emerging growth companies. Accordingly, the
transition to a large accelerated filer did not have an impact to our
consolidated financial statements.
Concentration of Risks
We generate revenue primarily from sale of subscriptions to access our cloud
platform, together with related support services. Our sales team, along with our
channel partner network of global telecommunications service providers, system
integrators and value-added resellers (collectively "channel partners"), sells
our services worldwide to organizations of all sizes. Due to the nature of our
services and the terms and conditions of our contracts with our channel
partners, our business could be affected unfavorably if we are not able to
continue our relationships with them.
Our financial instruments that are exposed to concentrations of credit risk
consist primarily of cash, cash equivalents, short-term investments and accounts
receivable. Although we deposit our cash with multiple financial institutions,
the deposits, at times, may exceed federally insured limits. Cash equivalents
and short-term investments consist of highly liquid investments in money market
funds, U.S. treasury, U.S. agency securities and corporate debt securities,
which are invested through financial institutions in the United States .
We grant credit to our customers in the normal course of business. We monitor
the financial condition of our customers to reduce credit risk. Refer to Note 2,
Revenue Recognition, for information regarding customers with concentration of
10% of more of the total balance of accounts receivable, net.
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Segment Information
We operate as one reportable and operating segment. Our chief operating decision
maker is our chief executive officer, who reviews financial information
presented on a consolidated basis for purposes of making operating decisions,
assessing financial performance and allocating resources.
Revenue Recognition
We adopted Accounting Standards Codification ("ASC") Topic 606, Revenue From
Contracts With Customers ("ASC 606"), effective as of August 1, 2017 . In
accordance with ASC 606, revenue is recognized when a customer obtains control
of promised services. The amount of revenue recognized reflects the
consideration that we expect to be entitled to receive in exchange for these
services. To achieve the core principle of this standard, we apply the following
five steps:
1) Identify the contract with a customer
We consider the terms and conditions of the contracts and our customary business
practices in identifying our contracts under ASC 606. We determine we have a
contract with a customer when the contract is approved, we can identify each
party's rights regarding the services to be transferred, we can identify the
payment terms for the services, we have determined the customer has the ability
and intent to pay and the contract has commercial substance. We apply judgment
in determining the customer's ability and intent to pay, which is based on a
variety of factors, including the customer's historical payment experience or,
in the case of a new customer, credit and financial information pertaining to
the customer.
2) Identify the performance obligations in the contract
Performance obligations promised in a contract are identified based on the
services that will be transferred to the customer that are both capable of being
distinct, whereby the customer can benefit from the service either on its own or
together with other resources that are readily available from third parties or
from us, and are distinct in the context of the contract, whereby the transfer
of the services is separately identifiable from other promises in the contract.
Our performance obligations consist of (i) our subscription and support services
and (ii) professional and other services.
3) Determine the transaction price
The transaction price is determined based on the consideration to which we
expect to be entitled in exchange for transferring services to the customer.
Variable consideration is included in the transaction price if, in our judgment,
it is probable that a significant future reversal of cumulative revenue under
the contract will not occur. None of our contracts contain a significant
financing component.
4) Allocate the transaction price to performance obligations in the contract
If the contract contains a single performance obligation, the entire transaction
price is allocated to the single performance obligation. Contracts that contain
multiple performance obligations require an allocation of the transaction price
to each performance obligation based on a relative standalone selling price
("SSP").
5) Recognize revenue when or as we satisfy a performance obligation
Revenue is recognized at the time the related performance obligation is
satisfied by transferring the promised service to a customer. Revenue is
recognized when control of the services is transferred to our customers, in an
amount that reflects the consideration that we expect to receive in exchange for
those services. We generate all our revenue from contracts with customers and
apply judgment in identifying and evaluating any terms and conditions in
contracts which may impact revenue recognition.
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Subscription and Support Revenue
We generate revenue primarily from sales of subscriptions to access our cloud
platform, together with related support services to our customers. Arrangements
with customers do not provide the customer with the right to take possession of
our software operating our cloud platform at any time. Instead, customers are
granted continuous access to our cloud platform over the contractual period. A
time-elapsed output method is used to measure progress because we transfer
control evenly over the contractual period. Accordingly, the fixed consideration
related to subscription and support revenue is generally recognized on a
straight-line basis over the contract term beginning on the date that our
service is made available to the customer.
The typical subscription and support term is one to three years. Most of our
contracts are non-cancelable over the contractual term. Customers typically have
the right to terminate their contracts for cause if we fail to perform in
accordance with the contractual terms. Some of our customers have the option to
purchase additional subscription and support services at a stated price. These
options generally do not provide a material right as they are priced at our SSP.
Professional and Other Services Revenue
Professional and other services revenue consists of fees associated with
providing deployment advisory services that educate and assist our customers on
the best use of our solutions, as well as advise customers on best practices as
they deploy our solution. These services are distinct from subscription and
support services. Professional services do not result in significant
customization of the subscription service. Revenue from professional services
provided on a time and materials basis is recognized as the services are
performed. Total professional and other services revenue has historically not
been material.
Contracts with Multiple Performance Obligations
Most of our contracts with customers contain multiple promised services
consisting of: (i) our subscription and support services and (ii) professional
and other services that are distinct and accounted for separately. The
transaction price is allocated to the separate performance obligations on a
relative SSP basis. We determine SSP based on our overall pricing objectives,
taking into consideration the type of subscription and support services and
professional and other services, the geographical region of the customer and the
number of users.
Variable Consideration
Revenue from sales is recorded at the net sales price, which is the transaction
price, and includes estimates of variable consideration. The amount of variable
consideration that is included in the transaction price is constrained and is
included in the net sales price only to the extent that it is probable that a
significant reversal in the amount of the cumulative revenue will not occur when
the uncertainty is resolved.
If our services do not meet certain service level commitments, our customers are
entitled to receive service credits, and in certain cases, refunds, each
representing a form of variable consideration. We have historically not
experienced any significant incidents affecting the defined levels of
reliability and performance as required by our subscription contracts.
Accordingly, estimated refunds related to these agreements were not material to
the periods presented.
We provide rebates and other credits within our contracts with certain
customers, which are estimated based on the value expected to be earned or
claimed on the related sales transaction. Overall, the transaction price is
reduced to reflect our estimate of the amount of consideration to which we are
entitled based on the terms of the contract. Estimated rebates and other credits
were not material during the periods presented.
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Accounts Receivable and Allowance
Accounts receivable are recorded at the invoiced amount and are non-interest
bearing. Accounts receivable are stated at their net realizable value, net of an
allowance for doubtful accounts. We have a well-established collections history
from our customers. Credit is extended to customers based on an evaluation of
their financial condition and other factors. In determining the necessary
allowance for doubtful accounts, management considers the current aging and
financial condition of our customers, the amount of receivables in dispute and
current payment patterns. The allowance for doubtful accounts has historically
not been material. There were no material write-offs recognized in the periods
presented. Accordingly, the movements in the allowance for doubtful accounts
were not material for any of the periods presented. We do not have any
off-balance-sheet credit exposure related to our customers.
Cash Equivalents and Short-Term Investments
We classify all highly liquid investments purchased with an original maturity of
90 days or less from the date of purchase as cash equivalents and all highly
liquid investments with original maturities beyond 90 days at the time of
purchase as short-term investments. Our cash equivalents and short-term
investments consist of highly liquid investments in money market funds, U.S.
treasury securities, U.S. government agency securities and corporate debt
securities.
We classify our investments as available-for-sale investments and present them
within current assets since these investments represent funds available for
current operations and we have the ability and intent, if necessary, to
liquidate any of these investments in order to meet our liquidity needs within
the next 12 months and expected investments to grow our business, including
potential business acquisitions and other strategic transactions. Our
investments are carried at fair value, with unrealized gains and losses, net of
tax, reported in accumulated other comprehensive income (loss) within
stockholders' equity.
Our investments are reviewed periodically to determine whether a decline in a
security's fair value below the amortized cost basis is other-than-temporary. If
the cost of an individual investment exceeds its fair value, we consider
available quantitative and qualitative factors such as the length of time and
extent to which the market value has been less than the cost, the financial
condition and near-term prospects of the issuer and our intent to sell, or
whether it is more likely than not we will be required to sell the investment
before recovery of the investment's amortized cost basis. If we believe that a
decline in fair value is determined to be other-than-temporary, we write down
these investments to fair value. There were no impairments recognized on our
investments during the periods presented.
Interest income, amortization (accretion) of investments purchased at a premium
(discount), realized gains and losses and declines in fair value judged to be
other-than-temporary on our available-for-sale securities are included in
interest income, net in the consolidated statements of operations. We use the
specific identification method to determine the cost in calculating realized
gains and losses upon the sale of these investments.
Strategic Investments
Our strategic investments consist of non-marketable equity investment in
privately-held companies in which we do not have a controlling interest or
significant influence. We have elected to apply the measurement alternative for
equity investments that do not have readily determinable fair value, measuring
them at cost, less any impairment, plus or minus adjustments resulting from
observable price changes in orderly transactions for the identical or a similar
security of the issuer. An impairment loss is recorded when events or
circumstances indicates a decline in value has occurred. We include these
strategic investments within other noncurrent assets in our consolidated balance
sheets.
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Fair Value of Financial Instruments Our financial instruments consist of cash equivalents, short-term investments, accounts receivable, accounts payable, accrued liabilities and convertible senior notes. Cash equivalents and short-term investments are recorded at fair value. Accounts receivable, accounts payable and accrued liabilities are stated at their carrying value, which approximates fair value due to the short-time to the expected receipt or payment date. Assets recorded at fair value on a recurring basis in the consolidated balance sheets, consisting of cash equivalents and short-term investments, are categorized in accordance with the fair value hierarchy based upon the level of judgment associated with the inputs used to measure their fair values. Convertible senior notes are carried at the initially allocated liability value less unamortized debt discount and issuance costs on its consolidated balance sheet, and it presents the fair value of the convertible senior notes at each reporting period for disclosure purposes only. Property and Equipment Property and equipment, net are stated at historical cost net of accumulated depreciation. Property and equipment, excluding leasehold improvements, are depreciated using the straight-line method over the estimated useful lives of the respective assets, generally ranging from three to five years. Leasehold improvements are amortized using the straight-line method over the shorter of the estimated useful lives of the respective assets or the lease term. Expenditures for maintenance and repairs are expensed as incurred and significant improvements and betterments that substantially enhance the life of an asset are capitalized. Capitalized Internal-Use Software Development Costs We capitalize certain costs incurred during the application development stage in connection with software development for our cloud security platform. Costs related to preliminary project activities and post-implementation activities are expensed as incurred. Capitalized costs are recorded as part of property and equipment in the consolidated balance sheets. Maintenance and training costs are expensed as incurred. Capitalized internal-use software is amortized on a straight-line basis over its estimated useful life, which is generally three years, and is recorded as cost of revenue in the consolidated statements of operations. Capitalization of development costs, inclusive of stock-based compensation, of software for internal-use in fiscal 2020, fiscal 2019 and fiscal 2018 was$13.2 million ,$3.7 million and$1.8 million , respectively. Amortization expense of capitalized software for internal-use in fiscal 2020, fiscal 2019 and fiscal 2018 was$1.4 million ,$1.0 million and$0.9 million , respectively. Business Combinations We account for our business combinations using the acquisition method of accounting, which requires, among other things, allocation of the fair value of purchase consideration to the tangible and intangible assets acquired and liabilities assumed at their estimated fair values on the acquisition date. The excess of the fair value of purchase consideration over the values of these identifiable assets and liabilities is recorded as goodwill. When determining the fair value of assets acquired and liabilities assumed, we make estimates and assumptions, especially with respect to intangible assets. Our estimates of fair value are based upon assumptions believed to be reasonable, but which are inherently uncertain and unpredictable and, as a result, actual results may differ from estimates. During the measurement period, not to exceed one year from the date of acquisition, we may record adjustments to the assets acquired and liabilities assumed, with a corresponding offset to goodwill if new information is obtained related to facts and circumstances that existed as of the acquisition date. After the measurement period, any subsequent adjustments are reflected in the consolidated statements of operations. Acquisition costs, such as legal and consulting fees, are expensed as incurred. 103 -------------------------------------------------------------------------------- Table of ContentsGoodwill and Other Long-Lived Assets, including Acquired Intangible AssetsGoodwill represents the excess of the fair value of purchase consideration in a business combination over the fair value of net tangible and intangible assets acquired.Goodwill amounts are not amortized, but rather tested for impairment at least annually or more often if circumstances indicate that the carrying value may not be recoverable. No indications of impairment of goodwill were noted during the periods presented. Acquired intangible assets consist of identifiable intangible assets, including developed technology and customer relationships, resulting from business combinations. Acquired finite-lived intangible assets are initially recorded at fair value and are amortized on a straight-line basis over their estimated useful lives. Amortization expense of developed technology and customer relationships is recorded primarily within cost of revenues, sales and marketing and research and development expenses, respectively, in the consolidated statements of operations. Long-lived assets, such as property and equipment and acquired intangible assets, are reviewed for impairment whenever events or changes in circumstances indicate that their carrying amounts may not be recoverable. We measure the recoverability of these assets by comparing the carrying amounts to the future undiscounted cash flows that these assets are expected to generate. If the total of the future undiscounted cash flows are less than the carrying amount of an asset, we record an impairment charge for the amount by which the carrying amount of the asset exceeds the fair value. In fiscal 2020, we recognized asset impairments of$0.7 million in general and administrative expenses in our consolidated statement of operations related primarily to the abandonment of a leased facility and relocation of our corporate headquarters. Deferred Offering Costs Deferred offering costs consisted of fees and expenses incurred in connection with the sale of our common stock in an IPO, including legal, accounting, printing and other IPO-related costs. Total deferred offering costs of$6.2 million were reclassified into stockholders' equity as a reduction of the net proceeds received from the IPO in fiscal 2018. Operating Leases We enter into operating lease arrangements for real estate assets related to office space and co-location assets related to space and racks at data center facilities. We determine if an arrangement contains a lease at its inception by assessing whether there is an identified asset and whether the arrangement conveys the right to control the use of the identified asset in exchange for consideration. Operating leases related balances are included in "operating lease right-of-use assets," "operating lease liabilities," and "operating lease liabilities, noncurrent" in our consolidated balance sheets. Right-of-use assets represent our right to use an underlying asset for the lease term and lease liabilities represent our obligation to make payments arising from the lease. Operating lease right-of-use assets and lease liabilities are recognized at the lease commencement date based on the present value of lease payments over the lease term. Lease payments consist of the fixed payments under the arrangement. The operating lease liabilities is adjusted for any unpaid lease incentives, such as tenant improvement allowances. Variable costs, such as maintenance and utilities based on actual usage, are not included in the measurement of right-to-use assets and lease liabilities but are expensed when the event determining the amount of variable consideration to be paid occurs. As the implicit rate of our leases is not determinable, we use an incremental borrowing rate ("IBR") based on the information available at the lease commencement date in determining the present value of lease payments. The lease expense is recognized on a straight-line basis over the lease term. We generally use the base, non-cancelable lease term when recognizing the right-of-use assets and lease liabilities, unless it is reasonably certain that a renewal or termination option will be exercised. We account for lease components and non-lease components as a single lease component. 104 -------------------------------------------------------------------------------- Table of Contents Leases with a term of twelve months or less are not recognized on the consolidated balance sheets. We recognize lease expense for these leases on a straight-line basis over the term of the lease. Stock-Based Compensation Compensation expense related to stock-based awards granted to employees and non-employees is calculated based on the fair value of stock-based awards on the date of grant. We recognize stock-based compensation expense over an award's requisite service period based on the award's fair value. Stock-based compensation for common stock options is recognized based on the fair value of the awards granted, determined using the Black-Scholes option pricing model and a single option award approach. Stock-based compensation expense is recognized on a straight-line basis over the requisite service period, generally four years. Stock-based compensation for purchase rights granted under the employee stock purchase plan is based on the Black-Scholes option pricing model fair value of the number of awards estimated as of the beginning of the offering period. Stock-based compensation expense is recognized following the straight-line attribution method over the offering period. Stock-based compensation for restricted stock units is measured based on the market closing price of our common stock on the grant date. Stock-based compensation expense is recognized on a straight-line basis over the requisite service period, generally four years. Stock-based compensation for performance stock awards ("PSAs") which have the same grant date and service inception date, is based on the probable number of shares to be attained and the market closing price of our common stock at the grant date. For PSAs where the service inception date of the awards precedes the grant date, stock-based compensation expense is recognized based on the number of PSAs for which it is probable that the performance condition will be met, using the accelerated attribution method and the market closing price of our common stock at each reporting date up to the grant date. The number of these PSAs for which it is probable that the performance condition will be met is determined using management's best estimate at the end of each reporting period. At the completion of the performance period for these PSAs, any earned PSAs are granted upon approval of the compensation committee of our board of directors. Prior to our IPO, the fair value of our common stock for financial reporting purposes was determined considering numerous objective and subjective factors and required judgment to determine the fair value of common stock as of each grant date. Subsequent to the IPO, we determine the fair value using the market closing price of our common stock on the date of grant. Convertible Senior Notes In accounting for the issuance of the convertible senior notes, we separate the convertible senior notes into liability and equity components. The carrying amounts of the liability component is calculated by measuring the fair value of similar liabilities that do not have associated convertible features. The carrying amount of the equity component representing the conversion option was determined by deducting the fair value of the liability component from the par value of the convertible senior notes as a whole. This difference represents the debt discount that is amortized to interest expense over the respective terms of the convertible senior notes using the effective interest rate method. The equity component was recorded in additional paid-in capital and is not remeasured as long as it continues to meet the conditions for equity classification. In accounting for the related debt issuance costs, we allocate the total amount incurred to the liability and equity components of the convertible senior notes based on their relative values. Issuance costs attributable to the liability component are being amortized to interest expense over the contractual term of the convertible senior notes. The issuance costs attributable to the equity component were netted against the equity component representing the conversion option in additional paid-in capital. 105 -------------------------------------------------------------------------------- Table of Contents To the extent that we receive the convertible senior notes conversion requests prior to their maturity, a portion of the equity component is classified as temporary equity, which is measured as the difference between the principal and net carrying amount of the convertible senior notes requested for conversion. Upon settlement of the conversion requests, the difference between the fair value and the amortized book value of the liability component of the convertible senior notes requested for conversion is recorded as a gain or loss on early note conversion. The fair value of the convertible senior notes is measured based on a similar liability that does not have an associated convertible feature based on the remaining term of the convertible senior notes. 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 our solutions. Accordingly, the majority of our research and development expenses result from employee-related costs, including salaries, bonuses and benefits and costs associated with technology tools used by our engineers. Advertising Expenses Advertising expenses are charged to sales and marketing expense in the consolidated statements of operations as incurred. We recognized advertising expense of$11.8 million ,$8.6 million and$3.4 million in fiscal 2020, fiscal 2019 and fiscal 2018, respectively. Warranties and Indemnification Our cloud platform is generally warranted to be free of defects under normal use and to perform substantially in accordance with the subscription agreement. Additionally, our contracts generally include provisions for indemnifying customers and channel partners against liabilities if our services infringe or misappropriate a third party's intellectual property rights. Costs and liabilities incurred as a result of warranties and indemnification obligations were not material during the periods presented. Legal Contingencies We may be subject to legal proceedings and litigation arising from time to time. We record a liability when we believe that it is both probable that a loss has been incurred and the amount can be reasonably estimated. We periodically evaluate developments in our legal matters that could affect the amount of liability that we accrue, if any, and adjust, as appropriate. Until the final resolution of any such matter for which we may be required to record a liability, there may be a loss exposure in excess of the liability recorded and such amount could be significant. We expense legal fees as incurred. Income Taxes We account for income taxes using the asset and liability method. Deferred income taxes are recognized by applying the enacted statutory tax rates applicable to future years to differences between the carrying amounts of existing assets and liabilities and their respective tax bases and net operating loss and tax credit carryforwards. The effect on deferred tax assets and liabilities of a change in tax rates is recognized in the period that includes the enactment date. The measurement of deferred tax assets is reduced, if necessary, by a valuation allowance to amounts that are more likely than not to be realized. We recognize tax benefits from uncertain tax positions only if we believe that it is more likely than not that the tax position will be sustained on examination by the taxing authorities based on the technical merits of the position. The tax benefits recognized in the financial statements from such positions are then measured based on the largest benefit that has a greater than 50% likelihood of being realized upon settlement. 106 -------------------------------------------------------------------------------- Table of Contents OnDecember 22, 2017 , the Tax Cuts and Jobs Act of 2017, or the Tax Act, was enacted. The Tax Act contains several key tax provisions that affect us, including, but not limited to, those reducing theU.S. federal corporate tax rate from 34% to 21%, imposing a one-time mandatory transition tax on previously untaxed foreign earnings and changing rules related to the use of net operating loss carryforwards created in tax years beginning afterDecember 31, 2017 . Because of the full valuation allowance recorded against ourU.S. federal deferred tax assets, there was no income tax expense (or benefit) recognized related to the Tax Act. Comprehensive Loss Comprehensive loss consists of two components, net loss and other comprehensive income (loss). Other comprehensive income (loss) refers to unrealized gains or losses on available-for-sale investments that are recorded as an element of stockholders' equity and are excluded from net loss. Net Loss Per Share Attributable to Common Stockholders Prior to the IPO, basic and diluted net loss per share attributable to common stockholders is presented in conformity with the two-class method required for participating securities. We consider all series of our convertible preferred stock to be participating securities. Under the two-class method, the net loss attributable to common stockholders is not allocated to the convertible preferred stock as the holders of our convertible preferred stock do not have a contractual obligation to share in our losses. Under the two-class method, net income is attributed to common stockholders and participating securities based on their participation rights. Under the two-class method, basic net loss per share attributable to common stockholders is computed by dividing the net loss attributable to common stockholders by the weighted-average number of shares of common stock outstanding during the period. Net loss attributable to common stockholders is calculated by adjusting the net loss for the accretion of redeemable convertible preferred stock outstanding during the period. Upon closing of the IPO, all shares of convertible preferred stock then outstanding were automatically converted into an equivalent number of shares of common stock on a one-to-one basis and their carrying amount reclassified into stockholders' equity (deficit). As ofJuly 31, 2020 and 2019, we did not have shares of preferred stock issued and outstanding. Diluted earnings per share attributable to common stockholders adjusts basic earnings per share for all potentially dilutive common stock equivalents outstanding during the period. Potentially dilutive securities consist of stock options, shares subject to repurchase from early exercised stock options, share purchase rights under the employee stock purchase plan, unvested restricted stock units ("RSUs"), unvested performance stock awards ("PSAs") and shares related to convertible senior notes. Since we have reported net losses for all periods presented, we have excluded all potentially dilutive securities from the calculation of the diluted net loss per share attributable to common stockholders as their effect is antidilutive and accordingly, basic and diluted net loss per share attributable to common stockholders is the same for all periods presented. Recently Adopted Accounting Pronouncements InFebruary 2016 , the FASB issued ASU No. 2016-02, Leases (Topic 842) ("ASU 2016-02"), as amended, which requires recognition of lease assets and liabilities for leases with terms of more than 12 months. This standard is effective for fiscal years beginning afterDecember 15, 2018 , with early adoption permitted. We adopted this standard effectiveAugust 1, 2019 using the transitional provision which allows for the adoption of Topic 842 to be applied on a modified retrospective basis at the beginning of the fiscal year of adoption. As such, the consolidated balance sheets for prior periods are not comparable to our fiscal 2020 periods. The adoption of this new standard resulted in the recognition of operating lease right-of-use assets of$16.9 million and operating lease liabilities of$18.0 million . We have elected the package of practical expedients permitted under the transition guidance, which allows us to carryforward our historical lease classification, our assessment on whether a contract is or contains a lease, and our initial direct costs for any leases that existed prior to adoption 107 -------------------------------------------------------------------------------- Table of Contents of the new standard. We have also elected to combine lease and non-lease components for real estate and co-location arrangements. In addition, we elected not to recognize lease liabilities and related right-of-use assets for leases that, at the lease commencement date, have a lease term of 12 months or less. InDecember 2019 , the FASB issued ASU No. 2019-12, Income Taxes (Topic 740) ("ASU 2019-12"): Simplifying the Accounting for Income Taxes. The new standard eliminates certain exceptions related to the approach for intraperiod tax allocation, the methodology for calculating income taxes in an interim period, and the recognition of deferred tax liabilities for outside basis differences related to changes in ownership of equity method investments and foreign subsidiaries. The guidance also simplifies aspects of accounting for franchise taxes and enacted changes in tax laws or rates, and clarifies the accounting for transactions that result in a step-up in the tax basis of goodwill. For public business entities, it is effective for fiscal years beginning afterDecember 15, 2020 , including interim periods within those fiscal years. Early adoption is permitted. We early adopted this standard as ofNovember 1, 2019 , and it did not have a material impact to our consolidated financial statements. Recently Issued Accounting Pronouncements Not Yet Adopted InJune 2016 , the FASB issued ASU No. 2016-13, Financial Instruments-Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments. This standard amends guidance on reporting credit losses for assets held at amortized cost basis and available-for-sale debt securities to require that credit losses on available-for-sale debt securities be presented as an allowance rather than as a write-down. The measurement of credit losses for newly recognized financial assets and subsequent changes in the allowance for credit losses are recorded in the statements of operations. This standard is effective for fiscal years beginning afterDecember 15, 2019 , with early adoption permitted. We will adopt this standard effectiveAugust 1, 2020 using the modified retrospective transition method. We are currently evaluating the potential impact of this standard on our consolidated financial statements and related disclosures, which is not expected to be material. InJune 2020 , the FASB issued ASU No. 2020-06, Debt with Conversion and Other Options (Subtopic 470-20) and Derivatives and Hedging - Contracts in Entity's Own Equity (Subtopic 815-40). This standard eliminates the beneficial conversion and cash conversion accounting models for convertible instruments. It also amends the accounting for certain contracts in an entity's own equity that are currently accounted for as derivatives because of specific settlement provisions. In addition, the new guidance modifies how particular convertible instruments and certain contracts that may be settled in cash or shares impact the diluted EPS computation. For public business entities, it is effective for fiscal years beginning afterDecember 15, 2021 , including interim periods within those fiscal years using the fully retrospective or modified retrospective method. Early adoption is permitted but no earlier than fiscal years beginning afterDecember 15, 2020 , including interim periods within those fiscal years. We are currently evaluating the potential impact of this standard on our consolidated financial statements. 108 -------------------------------------------------------------------------------- Table of Contents Note 2. Revenue Recognition Disaggregation of Revenue Subscription and support revenue is recognized over time and accounted for approximately 98%, 99% and 99% of our revenue in fiscal 2020, fiscal 2019 and fiscal 2018, respectively. The following table summarizes the revenue by region based on the shipping address of customerswho have contracted to use our cloud platform: Year Ended July 31, 2020 2019 2018 Amount % Revenue Amount % Revenue Amount % Revenue (in thousands, except for percentage data) United States$ 210,288 49 %$ 148,807 49 %$ 86,123 45 %Europe ,Middle East and Africa (*) 174,497 40 124,437 41 84,828 45 Asia Pacific 38,793 9 23,838 8 14,465 8 Other 7,691 2 5,754 2 4,758 2 Total$ 431,269 100 %$ 302,836 100 %$ 190,174 100 % _____
(*) Revenue from the
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The following table summarizes the revenue from contracts by type of customer:
Year Ended July 31,
2020 2019 2018
Amount % Revenue Amount % Revenue Amount % Revenue
(in thousands, except for percentage data)
Channel partners $ 414,908 96 % $ 289,579 96 % $ 175,798 92 %
Direct customers 16,361 4 13,257 4 14,376 8
Total $ 431,269 100 % $ 302,836 100 % $ 190,174 100 %
Significant Customers
No single customer accounted for 10% or more of the total revenue in the periods
presented. The following table summarizes the concentration of 10% or more of
the total balance of accounts receivable, net:
July 31,
2020 2019
Channel partner A 11 % 11 %
Channel partner B * 12 %
Channel partner C * 10 %
* Represents less than 10%.
Contract Balances
Contract liabilities consist of deferred revenue and include payments received
in advance of performance under the contract. Such amounts are recognized as
revenue over the contractual period. In fiscal 2020, fiscal 2019 and fiscal 2018
we recognized revenue of $220.9 million , $143.9 million and $85.3 million ,
respectively, that was included in the corresponding contract liability balance
at the beginning of the related fiscal year.
We receive payments from customers based upon contractual billing schedules and
accounts receivable are recorded when the right to consideration becomes
unconditional. Payment terms on invoiced amounts are typically 30 days but may
be up to 90 days for some of our channel partners. Contract assets include
amounts related to our contractual right to consideration for both completed and
partially completed performance obligations that may not have been invoiced and
such amounts have historically not been material.
Remaining Performance Obligations
The typical subscription and support term is one to three years. Most of our
subscription and support contracts are non-cancelable over the contractual term.
However, customers typically have the right to terminate their contracts for
cause, if we fail to perform. As of July 31, 2020 , the aggregate amount of the
transaction price allocated to remaining performance obligations was $782.8
million . We expect to recognize 55% of the transaction price over the next 12
months and 98% of the transaction price over the next three years, with the
remainder recognized thereafter.
Costs to Obtain and Fulfill a Contract
We capitalize sales commission and associated payroll taxes paid to internal
sales personnel that are incremental to the acquisition of channel partner and
direct customer contracts. These costs are recorded as deferred contract
acquisition costs in the consolidated balance sheets. We determine whether costs
should be deferred based on our sales compensation plans, if the commissions are
in fact incremental and would not have occurred absent the customer contract.
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Sales commissions for renewal of a contract are not considered commensurate with
the commissions paid for the acquisition of the initial contract given the
substantive difference in commission rates in proportion to their respective
contract values. Commissions paid upon the initial acquisition of a contract are
amortized over an estimated period of benefit of five years while commissions
paid for renewal contracts are amortized over the contractual term of the
renewals. Amortization of deferred contract acquisition costs is recognized on a
straight-line basis commensurate with the pattern of revenue recognition and
included in sales and marketing expense in the consolidated statements of
operations. We determine the period of benefit for commissions paid for the
acquisition of the initial contract by taking into consideration the expected
subscription term and expected renewals of our customer contracts, the duration
of our relationships with our customers, customer retention data, our technology
development lifecycle and other factors. We periodically review the carrying
amount of deferred contract acquisition costs to determine whether events or
changes in circumstances have occurred that could impact the period of benefit
of these deferred costs. We did not recognize any impairment losses of deferred
contract acquisition costs during the periods presented.
The following table summarizes the activity of the deferred contract acquisition
costs:
Year Ended July 31,
2020 2019 2018
(in thousands)
Beginning balance $ 69,785 $ 55,910 $ 34,662
Capitalization of contract acquisition costs 65,052 32,526 34,429
Amortization of deferred contract acquisition costs (24,922) (18,651) (13,181)
Ending balance$ 109,915 $
69,785
Deferred contract acquisition costs$ 32,240 $
21,219
Deferred contract acquisition costs, noncurrent 77,675 48,566 39,774
Total deferred contract acquisition costs$ 109,915 $
69,785
Sales commissions accrued but not paid as ofJuly 31, 2020 and 2019, totaled$21.0 million and$9.0 million , respectively, which are included within accrued compensation in the consolidated balance sheets. 111 -------------------------------------------------------------------------------- Table of Contents Note 3. Cash Equivalents and Short-Term Investments Cash equivalents and short-term investments consisted of the following as ofJuly 31, 2020 : Amortized Unrealized Unrealized Cost Gains Losses Fair Value (in thousands) Cash equivalents: Money market funds$ 51,690 $ - $ -$ 51,690 U.S. treasury securities 39,997 - (1) 39,996 U.S. government agency securities 14,997 - - 14,997 Total$ 106,684 $ -$ (1) $ 106,683 Short-term investments: U.S. treasury securities$ 415,539 $ 152 $ (127) $ 415,564 U.S. government agency securities 595,725 186 (114) 595,797 Corporate debt securities 216,879 569 (87) 217,361 Total$ 1,228,143 $ 907
Total cash equivalents and short-term investments$ 1,334,827 $ 907
Cash equivalents and short-term investments consisted of the following as ofJuly 31, 2019 : Amortized Unrealized Unrealized Cost Gains Losses Fair Value (in thousands) Cash equivalents: Money market funds$ 55,036 $ - $ -$ 55,036 Short-term investments: U.S. treasury securities$ 125,042 $ 248 $ (9) $ 125,281 U.S. government agency securities 64,689 7 (50) 64,646 Corporate debt securities 96,047 207 (19) 96,235 Total$ 285,778 $ 462
Total cash equivalents and short-term investments$ 340,814 $ 462 $ (78) $ 341,198
The amortized cost and fair value of our short-term investments based on their
stated maturities consisted of the following as of
Amortized
Cost Fair Value
(in thousands)
Due within one year $ 621,952 $ 622,392 Due between one and two years 606,191 606,330 Total
$ 1,228,143 $ 1,228,722 112 -------------------------------------------------------------------------------- Table of Contents Short-term investments that were in an unrealized loss position as ofJuly 31, 2020 consisted of the following : Less than 12 Months Greater than 12 Months Total Fair Unrealized Fair Unrealized Fair Unrealized Value Losses Value Losses Value Losses (in thousands) U.S. treasury securities$ 347,959 $ (127)
$ - $ -
(113) 5,502 (1) 346,005 (114)
Corporate debt securities 105,953 (87) - - 105,953 (87)
Total $ 794,415 $ (327) $ 5,502 $ (1) $ 799,917 $ (328) Short-term investments that were in an unrealized loss position as of
Less than 12 Months Greater than 12 Months Total
Fair Unrealized Fair Unrealized Fair Unrealized
Value Losses Value Losses Value Losses
(in thousands)
U.S. treasury securities $ 5,719 $ (9) $ - $ -
(37) 9,992 (13) 46,542 (50)
Corporate debt securities 14,279 (16) 8,364 (3) 22,643 (19)
Total $ 56,548 $ (62) $ 18,356 $ (16) $ 74,904 $ (78)
Unrealized losses of the above securities were primarily attributable to changes
in interest rates.
We review the individual securities that have unrealized losses in our
short-term investment portfolio on a regular basis to evaluate whether or not
any security has experienced an other-than-temporary decline in fair value. We
evaluate, among others, whether we have the intention to sell any of these
investments and whether it is not more likely than not that we will be required
to sell any of them before recovery of the amortized cost basis. Based on this
evaluation, we determined that there were no other-than-temporary impairments
associated with our short-term investments as of July 31, 2020 and July 31,
2019 .
Strategic Investments
During fiscal 2020, we invested in non-marketable equity securities of a
privately-held company. This investment is accounted for under the cost method
as we have less than 20% ownership and we do not have the ability to exercise
significant influence over the operations of this company. The carrying value of
this investment was $2.0 million as of July 31, 2020 , which is included within
other noncurrent assets in our consolidated balance sheets.
Note 4. Fair Value Measurements
Fair value is defined as the exchange price that would be received from sale of
an asset or paid to transfer a liability in the principal or most advantageous
market for the asset or liability in an orderly transaction between market
participants on the measurement date. We measure our financial assets and
liabilities at fair value at each reporting period using a fair value hierarchy
which requires us to maximize the use of observable inputs and minimize the use
of unobservable inputs when
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measuring fair value. A financial instrument's classification within the fair
value hierarchy is based upon the lowest level of input that is significant to
the fair value measurement. Three levels of inputs may be used to measure fair
value:
•Level I - Observable inputs are unadjusted quoted prices in active markets for
identical assets or liabilities;
•Level II - Observable inputs are quoted prices for similar assets and
liabilities in active markets or inputs other than quoted prices that are
observable for the assets or liabilities, either directly or indirectly through
market corroboration, for substantially the full term of the financial
instruments; and
•Level III - Unobservable inputs that are supported by little or no market
activity and that are significant to the fair value of the assets or
liabilities. These inputs are based on our own assumptions used to measure
assets and liabilities at fair value and require significant management judgment
or estimation.
Our money market funds are classified within Level I due to the highly liquid
nature of these assets and have quoted prices in active markets. Certain of our
investments in available-for-sale securities (i.e., U.S. treasury securities,
U.S. government agency securities and corporate securities) are classified
within Level II. The fair value of these securities is priced by using inputs
based on non-binding market consensus prices that are primarily corroborated by
observable market data or quoted market prices for similar instruments.
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Assets that are measured at fair value on a recurring basis consisted of the
following as of July 31, 2020 :
Level I Level II Level III
Quoted Prices
in Active Significant
Markets for Other Significant
Identical Observable Unobservable
Total Assets Inputs Inputs
(in thousands)
Cash equivalents:
Money market funds $ 51,690 $ 51,690 $ - $ -
U.S. treasury securities 39,996 - 39,996 -
U.S. government agency securities 14,997 - 14,997 -
Total $ 106,683 $ 51,690 $ 54,993 $ -
Short-term investments:
U.S. treasury securities $ 415,564 $ - $ 415,564 $ -
U.S. government agency securities 595,797 - 595,797 -
Corporate debt securities 217,361 - 217,361 -
Total $ 1,228,722 $ - $ 1,228,722 $ -
Total cash equivalents and short-term
$ 1,283,715 $ - investments
Assets that are measured at fair value on a recurring basis consisted of the
following as of
Level I Level II Level III
Quoted Prices
in Active Significant
Markets for Other Significant
Identical Observable Unobservable
Total Assets Inputs Inputs
(in thousands)
Cash equivalents:
Money market funds $ 55,036 $ 55,036 $ - $ -
Short-term investments:
U.S. treasury securities $ 125,281 $ - $ 125,281 $ -
U.S. government agency securities 64,646 - 64,646 -
Corporate debt securities 96,235 - 96,235 -
Total $ 286,162 $ - $ 286,162 $ -
Total cash equivalents and short-term
$ 286,162 $ - investments We did not have transfers between levels of the fair value hierarchy of assets measured at fair value during the periods presented. Refer to Note 8, Convertible Senior Notes, for the carrying amount and estimated fair value of our convertible senior notes as ofJuly 31, 2020 . 115 -------------------------------------------------------------------------------- Table of Contents Note 5. Property and Equipment Property and equipment consisted of the following: July 31, Estimated Useful Life 2020 2019 (in thousands) Hosting equipment 3 years$ 87,418 $ 56,910 Computers and equipment 3-5 years 3,875 2,837 Purchased software 3 years 1,311 1,311 Capitalized internal-use software 3 years 23,081 9,904 Furniture and fixtures 5 years 1,965 1,566 Leasehold improvements Shorter of useful life or lease term 8,712 2,255 Property and equipment, gross 126,362 74,783 Less: Accumulated depreciation and amortization (50,628) (33,737) Total property and equipment, net
We recognized depreciation and amortization expense on property and equipment of$17.7 million ,$10.4 million and$8.0 million in fiscal 2020, fiscal 2019 and fiscal 2018, respectively. Note 6. Business CombinationsEdgewise Networks Inc. OnMay 22, 2020 , we acquiredEdgewise Networks Inc. ("Edgewise"), a pioneer in securing application-to-application communications in public clouds and data centers. Edgewise customers measurably reduce the attack surface to lower the risk of application compromise and data breaches by simplifying the security of east-west communications through identity-based segmentation. With this acquisition, we will secure workloads and application-to-application communications for our customers. Pursuant to the terms of the purchase agreement, the aggregate purchase price consideration was approximately$30.7 million in cash, a portion of which was placed in escrow to partially secure our indemnification rights under the purchase agreement. Additionally, certain of Edgewise's employeeswho became our employees are entitled to receive additional consideration in the form of restricted stock units. These RSUs are subject to time-based vesting and will be recognized as stock-based compensation expense during the post-combination period. In connection with this acquisition, we completed a valuation of the acquired identifiable intangible assets as ofMay 22, 2020 in order to allocate the purchase price consideration. The purchase price allocation resulted in the recognition of$16.7 million of goodwill,$13.9 million of developed technology and$1.3 million of customer relationships. The developed technology was valued using a replacement cost approach, which is based on the cost of a market participant to reconstruct a substitute asset of comparable utility. The customer relationships were also valued using the replacement cost approach, which is based on the cost of a market participant would incur to generate the acquired portfolio of customers.Goodwill represents the excess of the purchase price paid over the fair value of the net assets acquired and is primarily attributable to the acquired workforce and expected operating synergies.Goodwill is not expected to be deductible for income tax purposes. We incurred approximately$0.6 million of acquisition related costs, which were recorded as general and administrative expenses in fiscal 2020. The acquisition qualified as a stock transaction for tax purposes. As a result, we recognized a deferred tax liability for approximately$0.6 million , generated primarily from the difference between the tax basis and fair value of the acquired developed technology and customer relationships, which increased goodwill by the same amount. As we have a full valuation 116 -------------------------------------------------------------------------------- Table of Contents allowance as ofJuly 31, 2020 , we recorded an income tax benefit as a result of the reduction of the valuation allowance due to establishment of the deferred tax liability in the consolidated statement of operations in fiscal 2020. Refer to Note 14, Income Taxes, for further information. The allocation of the purchase price consideration consisted of the following: Amount Estimated Useful Life (in thousands) Assets acquired: Cash and other assets $ 294 Operating lease right-of-use asset 630 Acquired intangible assets: Developed technology 13,900 5 years Customer relationships 1,300 5 years Goodwill 16,709 Total$ 32,833 Liabilities assumed: Accounts payable and accrued liabilities $ 333 Deferred revenue 540 Operating lease liability 630 Deferred tax liability 620 Total $ 2,123 Total purchase price consideration$ 30,710 Cloudneeti Corporation OnApril 16, 2020 , we acquiredCloudneeti Corporation ("Cloudneeti"), a cloud security posture management company, which prevents and remediates application misconfigurations in cloud service models, including SaaS; infrastructure as a service, or IaaS; and platform as a service, or PaaS. With this acquisition, we further provide our industry-leading data protection coverage for our customers. Pursuant to the terms of the purchase agreement, the aggregate purchase price consideration was approximately$8.9 million in cash, a portion of which was placed in escrow to partially secure our indemnification rights under the purchase agreement. Additionally, certain of Cloudneeti's employeeswho became our employees are entitled to receive additional consideration in the form of restricted stock units. These RSUs are subject to performance and time-based vesting and will be recognized as stock-based compensation expense during the post-combination period. In connection with this acquisition, we completed a valuation of the acquired identifiable intangible assets as ofApril 16, 2020 in order to allocate the purchase price consideration. The purchase price allocation resulted in the recognition of$5.9 million of goodwill and$3.5 million of developed technology. The developed technology was valued using a replacement cost approach, which is based on the cost of a market participant to reconstruct a substitute asset of comparable utility.Goodwill represents the excess of the purchase price paid over the fair value of the net assets acquired and is primarily attributable to the acquired workforce and expected operating synergies.Goodwill is not expected to be deductible for income tax purposes. We incurred approximately$0.5 million of acquisition related costs, which were recorded as general and administrative expenses in fiscal 2020. 117 -------------------------------------------------------------------------------- Table of Contents The acquisition qualified as a stock transaction for tax purposes. As a result, we recognized a deferred tax liability for approximately$0.5 million , generated primarily from the difference between the tax basis and fair value of the acquired developed technology, which increased goodwill by the same amount. As we have a full valuation allowance as ofJuly 31, 2020 , we recorded an income tax benefit as a result of the reduction of the valuation allowance due to establishment of the deferred tax liability in the consolidated statement of operations in fiscal 2020. Refer to Note 14, Income Taxes, for further information. The allocation of the purchase price consideration consisted of the following: Amount Estimated Useful Life (in thousands) Assets acquired: Cash and other assets $ 66 Acquired intangible assets: Developed technology 3,500 5 years Goodwill 5,871 Total$ 9,437 Liabilities assumed: Deferred tax liability $ 490 Other liabilities 12 Total $ 502 Total purchase price consideration$ 8,935 Appsulate, Inc. OnMay 29, 2019 , we completed the acquisitionAppsulate, Inc. ("Appsulate"), of an early stage software company. Pursuant to the terms of the purchase agreement, the aggregate purchase price was approximately$12.9 million , with a portion subject to a holdback to partially secure our indemnification rights under the purchase agreement. As ofJuly 31, 2020 and 2019, this holdback amount is reflected in our consolidated balance sheets within accrued expenses and other current liabilities and within other noncurrent liabilities, respectively. In connection with this acquisition, we completed a valuation of the acquired identifiable intangible assets as ofMay 29, 2019 , in order to allocate the purchase price consideration. The purchase price allocation resulted in the recognition of$7.3 million of goodwill and$7.0 million of developed technology. The developed technology was valued using a replacement cost approach, which is based on the cost of a market participant to reconstruct a substitute asset of comparable utility.Goodwill represents the excess of the purchase price paid over the fair value of the net assets acquired and is primarily attributable to the acquired workforce and expected operating synergies.Goodwill is not expected to be deductible for income tax purposes. We incurred approximately$0.3 million of acquisition related costs, which were recorded as general and administrative expenses in fiscal 2019. 118 -------------------------------------------------------------------------------- Table of Contents The acquisition qualified as a stock transaction for tax purposes. As a result, we recognized a deferred tax liability for approximately$1.4 million , generated primarily from the difference between the tax basis and fair value of the acquired developed technology, which increased goodwill by the same amount. As we have a full valuation allowance as ofJuly 31, 2019 , we recorded an income tax benefit as a result of the reduction of the valuation allowance due to establishment of the deferred tax liability in the consolidated statement of operations in fiscal 2019. Refer to Note 14, Income Taxes, for further information. The allocation of the purchase price consideration, consisted of the following: Amount Estimated Useful Life (in thousands) Assets acquired: Cash and cash equivalents $ 13 Acquired intangible assets: Developed technology 7,000 4 years Goodwill $ 7,281 Total$ 14,294 Liabilities assumed: Deferred tax liability $ 1,422
Total purchase price consideration
Other acquisitions In fiscal 2019, we also completed the acquisition of assets and other technology from a privately-held company with a purchase price of$1.1 million with a portion subject to a holdback to partially secure our indemnification rights under the purchase agreement. As ofJuly 31, 2020 and 2019, this holdback amount is reflected in our consolidated balance sheets within accrued expenses and other current liabilities and within other noncurrent liabilities, respectively. Intangible assets acquired and goodwill recorded for this acquisition were not material to our consolidated financial statements. Pro forma Financial Information The pro forma financial information of the above business acquisitions, assuming the acquisition had occurred as of the beginning of the fiscal year prior to the fiscal year of the acquisition, as well as revenue and earnings generated during the current fiscal year, were not material for disclosure purposes. 119 -------------------------------------------------------------------------------- Table of Contents Note 7.Goodwill and Acquired Intangible AssetsGoodwill The changes in the carrying amount of goodwill consisted of the following: Amount (in thousands) Balance as of July 31, 2019 $ 7,479 Goodwill acquired 22,580 Balance as of July 31, 2020$ 30,059 Acquired Intangible Assets Acquired intangible assets consist of developed technology and customer relationships acquired through our asset and business acquisitions. Acquired intangible assets are amortized using the straight-line method over their useful lives. Acquired intangible assets subject to amortization consisted of the following as ofJuly 31, 2020 and 2019: Weighted Average Remaining Gross Carrying Amount Accumulated Amortization Net Carrying Amount Useful life July 31, Amortization July 31, 2019 AdditionsJuly 31, 2020 July 31, 2019 ExpenseJuly 31, 2020 2019July 31, 2020 July 31, 2020 (in thousands) (years) Developed technology$ 9,456 $ 17,400 $ 26,856 $ (897)$ (3,309) $ (4,206) $ 8,559 $ 22,650 4.2 Customer relationships 160 1,300 1,460 (11) (75) (86) 149 1,374 4.7 Total$ 9,616 $ 18,700 $ 28,316 $ (908)$ (3,384) $ (4,292) $ 8,708 $ 24,024 4.3 The weighted-average useful life for developed technology and customer relationships as ofJuly 31, 2019 was 3.5 years and 4.7 years, respectively. During fiscal 2020, we recorded an aggregate of$17.4 million and$1.3 million of developed technology and customer relationships with an estimated average useful life of 5.0 years and 5.0 years, respectively, in connection with our acquisitions of Edgewise and Cloudneeti. Refer to Note 6, Business Acquisitions, for further information. Amortization expense of acquired intangible assets was$3.4 million and$0.9 million in fiscal 2020 and fiscal 2019, respectively. We did not have acquired intangible assets prior to fiscal 2019. Amortization expense of developed technology is recorded primarily within cost of revenues and research and development expenses in the consolidated statements of operations. Amortization expense of customer relationships is recorded within sales and marketing expenses in the consolidated statements of operations. 120
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Future amortization expense of acquired intangible assets consisted of the
following as of
Amortization Expense
(in thousands)
Year ending July 31,
2021 $ 6,308
2022 5,700
2023 5,196
2024 3,761
2025 3,059
Total $ 24,024
Note 8. Convertible Senior Notes
On June 25, 2020 , we issued $1,150.0 million in aggregate principal amount of
0.125% Convertible Senior Notes due 2025 (the "Notes"), including the exercise
in full by the initial purchasers of the Notes of their option to purchase an
additional $150.0 million principal amount of the Notes. The Notes bear interest
at a rate of 0.125% per year and interest is payable semiannually in arrears on
January 1 and July 1 of each year, beginning on January 1, 2021 . The Notes
mature on July 1, 2025 , unless earlier converted, redeemed or repurchased. The
total net proceeds from the offering, after deducting initial purchase discounts
and other debt issuance costs, was $1,130.5 million .
The Notes are unsecured obligations and do not contain any financial covenants
or restrictions on the payments of dividends, the incurrence of indebtedness or
the issuance or repurchase of securities by us or any of our subsidiaries.
The following table presents details of the Notes:
Initial Conversion Rate
per $1,000 Principal Initial Conversion Price Initial Number of Shares
(in thousands)
Notes 6.6315 shares $150.80 7,626
The Notes will be convertible at the option of the holders at any time prior to
the close of business on the business day immediately preceding April 1, 2025 ,
only under the following circumstances:
•During any fiscal quarter commencing after the fiscal quarter ending on October
31, 2020 (and only during such fiscal quarter), if the last reported sale price
of our common stock for at least 20 trading days (whether or not consecutive)
during a period of 30 consecutive trading days ending on and including, the last
trading day of the immediately preceding fiscal quarter is greater than or equal
to 130% of the conversion price on the Notes on each applicable trading day;
•During the five-business day period after any five consecutive trading day
period (the "measurement period") in which the trading price
per $1,000 principal amount of the Notes for each trading day of the measurement
period was less than 98% of the product of the last reported sale price of our
common stock and the conversion rate of the Notes on each such trading day;
•If we call any or all of the Notes for redemption, the Notes called for
redemption (or, at our election all Notes) may be submitted for conversion at
any time prior to the close of business on the second scheduled trading day
immediately preceding the redemption date; or
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•upon the occurrence of specified corporate events as set forth within the
indenture governing the Notes.
On or after April 1, 2025, until the close of business on the second scheduled
trading day immediately preceding the maturity date, holders may convert, all or
any portion of their Notes, in multiples of $1,000 principal amount, at the
option of the holder regardless of the foregoing circumstances. Upon conversion,
we will satisfy its conversion obligation by paying or delivering, as the case
may be, cash, shares of our common stock or a combination of cash and shares of
our common stock, at our election. It is our current intent to settle the
principal amount of the Notes in cash. During fiscal 2020, the conditions
allowing holders of the Notes to convert have not been met. The Notes were
therefore not convertible during fiscal 2020 and are classified as a noncurrent
liability in our consolidated balance sheet as of July 31, 2020.
We may not redeem the Notes prior to July 5, 2023. On or after July 5, 2023, and
prior to the 21st scheduled trading day immediately preceding the maturity date,
we may redeem for cash all or any portion of the Notes, at our option, if the
last reported sale price of our common stock has been at least 130% of the
conversion price then in effect for at least 20 trading days (whether or not
consecutive) during any 30 consecutive trading day period (including the last
trading day of such period) ending on, and including, the trading day
immediately preceding the date on which we provide notice of redemption at a
redemption price equal to 100% of the principal amount of the Notes to be
redeemed, plus accrued and unpaid interest to, but excluding, the redemption
date. No sinking fund is provided for the Notes. If we redeem less than all the
outstanding Notes, and only Notes called for redemption may be converted in
connection with such partial redemption, at least $100.0 million aggregate
principal amount of Notes must be outstanding and not subject to such partial
redemption as of the relevant redemption notice date.
In the event of a corporate event that constitutes a "fundamental change (as
defined in the indenture)", holders of the Notes may require us to purchase with
cash all or a portion of the Notes upon the occurrence of a fundamental change,
at a purchase price equal to 100% of the principal amount of the Notes plus any
accrued and unpaid special interest, if any. In addition, following certain
corporate events that occur prior to the maturity date, or if we issue a notice
of redemption, we will, in certain circumstances, increase the conversion rate
for a holder who elects to convert its Notes in connection with such corporate
event or notice of redemption, as the case may be.
In accounting for the issuance of the Notes and the related transaction costs,
we separated the Notes into liability and equity components. The carrying amount
of the liability component were initially calculated by measuring the fair value
of similar liabilities that do not have associated convertible features
utilizing the interest rate of 5.75%. The carrying amount of the equity
component representing the conversion option was $278.5 million and was
determined by deducting the fair value of the liability component from the par
value of the Notes. This difference represents the debt discount that is
amortized to interest expense over the term of the Notes using the effective
interest rate method. The equity component was recorded in additional paid-in
capital and is not remeasured as long as it continues to meet the conditions for
equity classification.
Total issuance costs of $19.5 million related to the Notes was allocated between
liability, totaling $14.8 million, and equity, totaling $4.7 million, in the
same proportion as the allocation of the total proceeds to the liability and
equity components. Issuance costs attributable to the liability component are
being amortized to interest expense over the term of the Notes. The excess of
the principal amount of the liability component over its carrying amount is
amortized to interest expense over the contractual term of the Notes at an
effective interest rate of 6.03%. The issuance costs attributable to the equity
component were netted against additional paid-in capital. The amount recorded
for the equity component of the Notes was $273.4 million, net of allocated
issuance costs of $4.7 million and deferred tax impact of $0.4 million.
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The net carrying amount of the liability component of the Notes is as follows:
July 31, 2020
(in thousands)
Principal amount $ 1,150,000
Less:
Unamortized debt discount 273,829
Unamortized debt issuance costs 14,556
Net carrying amount $ 861,615
The following table sets forth total interest expense recognized related to the Notes for fiscal 2020:
Amount
(in thousands)
Contractual interest expense $ 140
Amortization of debt discount 4,638
Amortization of issuance costs 247
Total $ 5,025
The total fair value of the Notes was $1,307.5 million as of July 31, 2020. The
fair value was determined based on the closing trading price per $1,000 of the
Notes as of the last day of trading for the period. We consider the fair value
of the Notes at July 31, 2020 to be a Level 2 measurement as they are not
actively traded. The fair value of the Notes is primarily affected by the
trading price of our common stock and market interest rates.
Capped Calls
In connection with the pricing of the Notes, we entered into capped call
transactions with the option counterparties (the "Capped Calls"). The Capped
Calls each have an initial strike price of $150.80 per share, subject to certain
adjustments, which corresponds to the initial conversion price of the Notes. The
Capped Calls have an initial cap price of $246.76 per share, subject to certain
adjustments. The capped call transactions are generally expected to reduce
potential dilution to our common stock upon any conversion of notes and/or
offset any cash payments we are required to make in excess of the principal
amount of converted notes, as the case may be, with such reduction and/or offset
subject to a cap. The Capped Calls are subject to adjustment upon the occurrence
of specified extraordinary events affecting us, including merger events, tender
offers and the announcement of such events. In addition, the Capped Calls are
subject to certain specified additional disruption events that may give rise to
a termination of the Capped Calls, including nationalization, insolvency or
delisting, changes in law, failures to deliver, insolvency filings and hedging
disruptions. For accounting purposes, the Capped Calls are separate
transactions, and not part of the terms of the Notes. As the Capped Calls
qualify for a scope exception from derivative accounting for instruments that
are both indexed to the issuer's own stock and classified in stockholder's
equity in its statement of financial position, the premium of $145.2 million
paid for the purchase of the Capped Calls has been recorded as a reduction to
additional paid-in capital and will not be remeasured.
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Note 9. Operating Leases
The following is a summary of our operating lease costs for fiscal 2020:
Real Estate Co-Location
Arrangements Arrangements Total
(in thousands)
Operating lease $ 5,020 $ 8,582 $ 13,602
Short-term lease cost 1,399 904 2,303
Variable lease cost 1,508 1,715 3,223
Sublease income (126) - (126)
Total operating lease costs $ 7,801 $ 11,201 $ 19,002
The following table present information about leases on our consolidated balance
sheet as of July 31, 2020:
Real Estate Co-Location
Arrangements Arrangements Total
(in thousands)
Operating lease right-of-use assets $ 16,990 $ 19,129 $ 36,119
Operating lease liabilities, current $ 5,307 $ 10,293 $ 15,600
Operating lease liabilities, noncurrent $ 17,849 $ 10,174 $ 28,023
At July 31, 2020, the real estate arrangements' weighted-average remaining lease
term and weighted-average discount rate for operating leases were 5.1 years and
4.8%, respectively. At July 31, 2020, the co-location arrangements'
weighted-average remaining lease term and weighted-average discount rate for
operating leases were 2.0 years and 3.2%. respectively.
Cash paid, net of tenant incentives for amounts included in the measurement of
operating lease liabilities was $7.6 million for fiscal 2020.
For fiscal 2019, the rent expense and bandwidth and co-location expenses was
$3.0 million and $13.8 million, respectively. For fiscal 2018, the rent expense
and bandwidth and co-location expenses was $2.5 million and $9.4 million,
respectively. Rent expense prior to fiscal 2020 was recognized in accordance
with ASC 840, Leases, using the straight-line method over the term of the lease.
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Maturities of operating lease liabilities consisted of the following as of July
31, 2020:
Real Estate Co-Location
Arrangements Arrangements Total
Year ending July 31, (in thousands)
2021 $ 6,299 $ 10,763 $ 17,062
2022 4,844 8,710 13,554
2023 4,111 1,653 5,764
2024 3,702 - 3,702
2025 3,362 - 3,362
Thereafter 3,903 - 3,903
Total future minimum lease payments 26,221 21,126 47,347
Less: Imputed interest 3,065 659 3,724
Total $ 23,156 $ 20,467 $ 43,623
As of July 31, 2020, we have entered into non-cancelable operating leases with a
term greater than 12 months that have not yet commenced with undiscounted future
minimum payments of $18.2 million, which are excluded from the above table.
These operating leases will commence between August 2020 and July 2023 with
lease terms ranging from 1.2 years to 6.0 years.
Future minimum payments under non-cancelable operating leases consisted of the
following as of July 31, 2019:
Real Estate Arrangements Data Center Arrangements Total
Year ending July 31, (in thousands)
2020 $ 4,624 $ 11,766 $ 16,390
2021 5,836 9,890 15,726
2022 4,871 5,533 10,404
2023 6,143 106 6,249
2024 6,509 - 6,509
Thereafter 15,977 - 15,977
Total $ 43,960 $ 27,295 $ 71,255
Note 10. Commitments and Contingencies
Non-cancelable Purchase Obligations
In the normal course of business, we enter into non-cancelable purchase
commitments with various parties to purchase products and services such as
technology equipment, subscription-based cloud service arrangements, corporate
events and consulting services. As of July 31, 2020 and 2019, we had outstanding
non-cancelable purchase obligations with a term of 12 months or longer of $20.0
million and $2.5 million, respectively.
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Legal Matters
Symantec Litigation
On December 12, 2016 and April 18, 2017, Symantec Corporation ("Symantec") filed
two separate complaints in the U.S. District Court for the District of Delaware ,
alleging that "Zscaler's cloud security platform" infringed multiple U.S.
patents held by Symantec (the "Symantec Cases"). The complaints in the Symantec
Cases sought compensatory damages, injunctions, enhanced damages and attorney
fees. In July and August 2017, the Symantec Cases were transferred to the U.S.
District Court for the Northern District of California . On November 4, 2019,
Broadcom, Inc. ("Broadcom") announced the completion of its acquisition of
certain assets and assumption of certain liabilities of Symantec's enterprise
security business, including all rights, titles, and interests in the patents
asserted in the Symantec Cases.
On January 12, 2020, we entered into a settlement and patent license agreement
with CA, Inc., a Broadcom affiliate, pursuant to which the Symantec Cases were
dismissed with prejudice effective as of January 13, 2020. In connection with
the settlement, we made a payment of $15.0 million to Broadcom, and Broadcom
provided us with patent licenses, a release and a covenant not to sue. We
determined that there is no material future economic benefit from the acquired
Broadcom license and accordingly, we recorded an expense of $15.0 million within
general and administrative expenses in the consolidated statement of operations
for fiscal 2020.
Finjan Litigation
On December 5, 2017, Finjan, Inc. filed a complaint, in the U.S. District Court
for the Northern District of California , alleging that certain of our products
infringed four U.S. patents held by Finjan, Inc. and seeking compensatory
damages, an injunction, enhanced damages and attorney fees. On April 30, 2019,
we entered into patent license and settlement agreements with Finjan, Inc. and
its affiliates (collectively "Finjan"), resolving all claims in the lawsuit, and
made a payment of $7.3 million to Finjan, Inc. Pursuant to the agreements,
Finjan provided us with a worldwide fully paid license to the broader Finjan
patent portfolio, releases for past damages, and covenants not to sue. On May 1,
2019, the court dismissed Finjan, Inc.'s complaint with prejudice. We determined
that there is no material future economic benefit from the acquired Finjan
license and accordingly, we recorded an incremental expense of $4.1 million
within general and administrative expenses in the consolidated statement of
operations in fiscal 2019. In prior periods, we had recorded accruals related to
this litigation for $0.7 million in fiscal 2018 and $2.5 million in fiscal 2017.
Other Litigation and Claims
In addition, from time to time we are a party to various litigation matters and
subject to claims that arise in the ordinary course of business, including
patent, commercial, product liability, employment, class action, whistleblower
and other litigation and claims, as well as governmental and other regulatory
investigations and proceedings. In addition, third parties may from time to time
assert claims against us in the form of letters and other communications. Except
as otherwise described above, there is no pending or threatened legal proceeding
to which we are a party that, in our opinion, is likely to have a material
adverse effect on our future financial results or operations; however, the
results of litigation and claims are inherently unpredictable. Regardless of the
outcome, litigation can have an adverse impact on us because of defense and
settlement costs, diversion of management resources and other factors. The
expense of litigation and the timing of this expense from period to period are
difficult to estimate, subject to change and could adversely affect our results
of operations.
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Note 11. Convertible Preferred Stock
Upon completion of our IPO, as further described in Note 1, Business and Summary
of Significant Accounting Policies, of these consolidated financial statements
all shares of convertible preferred stock then outstanding, totaling 72,500,750
shares, were automatically converted into an equivalent number of shares of
common stock on a one-to-one basis and their carrying value, totaling
$207.3 million, inclusive of accretion of Series C and D redeemable convertible
preferred stock of $24.7 million, was reclassified to stockholders' equity.
Prior to the IPO, we recognized accretion to the redemption price of Series C
and D redeemable convertible preferred stock. Accretion was recognized as a
reduction of additional paid-in capital with a corresponding increase to the
carrying value of Series C and D redeemable convertible preferred stock. Upon
completion of the IPO, the accretion rights of Series C and D redeemable
convertible preferred stock were terminated. We recognized accretion of Series C
and D redeemable convertible preferred stock of $6.3 million in fiscal 2018.
Note 12. Common Stock
Holders of our common stock are entitled to one vote for each share of common
stock held and are not entitled to receive dividends unless declared by our
board of directors.
Common Stock Reserved for Future Issuance
The following table summarizes our shares of common stock reserved for future
issuance:
July 31, 2020
(in thousands)
Equity awards outstanding:
Stock options 5,175
Unvested restricted stock units 8,069
Committed unvested performance stock awards, based on the target number of shares
434
Committed unvested restricted stock units not yet issued related to our acquisition of Edgewise
120
Unvested performance stock awards 1,294
Share purchase rights committed under the employee stock purchase plan
568
Equity awards available for future grants:
Equity incentive plans 16,564
Employee stock purchase plan 2,153
Total 34,377
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Note 13. Stock-Based Compensation
Equity Incentive Plans
We adopted the Fiscal Year 2018 Equity Incentive Plan (the "2018 Plan") in
fiscal 2018 and the 2007 Stock Plan (the "2007 Plan") in fiscal 2008,
collectively referred to as the "Plans." Equity incentive awards which may be
granted to eligible participants under the Plans include restricted stock units,
restricted stock, stock options, nonstatutory stock options, stock appreciation
rights, performance units and performance shares. With the establishment of the
2018 Plan, we no longer grant stock-based awards under the 2007 Plan and any
shares underlying stock options that expire or terminate or are forfeited or
repurchased by us under the 2007 Plan are automatically transferred to the 2018
Plan.
As of July 31, 2020, a total of 25.1 million shares of common stock have been
reserved for the issuance of equity awards under the 2018 Plan, of which 16.6
million shares were available for grant. The number of shares of common stock
available for issuance under the 2018 Plan also includes an annual increase on
the first day of each fiscal year pursuant to its automatic annual increase
provision.
Stock Options
The stock option activity consisted of the following for fiscal 2020:
Weighted-Average
Outstanding Weighted-Average Remaining Aggregate
Stock Exercise Contractual Term Intrinsic
Options Price (in years) Value
(in thousands, except per share amounts)
Balance as of July 31, 2019 8,861 $7.16 4.6 $ 683,294
Granted 150 $49.59
Exercised (3,450) $6.26 $ 242,416
Canceled, forfeited or expired (386) $8.31
Balance as of July 31, 2020 5,175 $8.90 4.0 $ 625,904
Exercisable and expected to vest as of
July 31, 2019 3,311 $5.60 4.0 $ 260,479
Exercisable and expected to vest as of
July 31, 2020 2,546 $6.46 3.5 $ 314,111
The aggregate intrinsic value of the options exercised represents the difference
between the fair value of our common stock on the date of exercise and their
exercise price. The total intrinsic value of options exercised for fiscal 2020,
fiscal 2019 and fiscal 2018 was $242.4 million, $300.9 million and $16.7
million, respectively. The weighted-average grant-date fair value per share of
awards granted for fiscal 2020 and fiscal 2018 was $22.76 and $3.77,
respectively.
We estimated the fair value of stock options using the Black-Scholes option
pricing model with the following assumptions:
Year Ended July 31(1)
2020 2018
Expected term (in years) 6.1 4.6 - 5.1
Expected stock price volatility 46.1% 40.3% - 42.3%
Risk-free interest rate 1.7% 1.7% - 2.8%
Dividend yield 0.0% 0.0%
(1) There were no stock options granted during fiscal 2019.
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Restricted Stock Units and Performance Stock Awards
The 2018 Plan allows for the grant of RSUs. Generally, RSUs are subject to a
four-year vesting period, with 25% of the shares vesting approximately one year
from the vesting commencing date and quarterly thereafter over the remaining
vesting term. We began granting RSUs in the fourth quarter of fiscal 2018.
The 2018 Plan also allows for the grant of PSAs. The right to earn the PSAs is
subject to achievement of the defined performance metrics and continuous
employment service. The performance metrics are defined and approved by the
compensation committee of our board of directors or by our senior management for
certain types of awards. Generally, earned PSAs are subject to additional
time-based vesting.
PSAs related to the fiscal 2019 performance period, totaling approximately
0.5 million shares with a weighted-average grant date fair value per share of
$36.90, were forfeited effective at the end of fiscal 2019, resulting in a
reversal of $3.8 million of accrued stock-based compensation expense recognized
in the nine months ended April 30, 2019. Accordingly, no stock-based
compensation expense was recognized for these awards in fiscal 2019.
As of July 31, 2020, we determined that the service inception date for 0.2
million PSAs preceded the grant date, and we recognized $10.5 million of
stock-based compensation expense associated with these PSAs in fiscal 2020.
As of July 31, 2020, there were 0.9 million outstanding PSAs for which the
performance metrics have not been defined as of such date. Accordingly, such
awards are not considered granted for accounting purposes as of July 31, 2020
and have been excluded from the below table.
The activity of RSUs and PSAs consisted of the following for fiscal 2020:
Weighted-Average Grant Date Aggregate
Underlying Shares Fair Value Intrinsic Value
(in thousands, except per share data)
Balance as of July 31, 2019 4,152 $48.51 $ 349,872
Granted 6,376 $65.81
Vested (1,297) $51.57 $ 93,754
Canceled or forfeited (678) $51.31
Balance as of July 31, 2020 8,553 $60.72 $ 1,110,694
Employee Stock Purchase Plan
We adopted the Fiscal Year 2018 Employee Stock Purchase Plan ("ESPP") in the
third quarter of fiscal 2018. As of July 31, 2020, a total of 4.7 million shares
of common stock have been reserved for issuance under the ESPP, out of which 2.7
million shares were available for grant. The number of shares reserved includes
an annual increase on the first day of each fiscal year pursuant to its
automatic annual increase provision. The ESPP provides for consecutive offering
periods that will typically have a duration of approximately 24 months in length
and is comprised of four purchase periods of approximately six months in length.
The offering periods are scheduled to start on the first trading day on or after
June 15 and December 15 of each year. During fiscal 2020, employees purchased
approximately 0.8 million shares of common stock under our ESPP at an average
purchase price of $18.76 per share, resulting in total cash proceeds of $15.3
million.
ESPP employee payroll contributions accrued at July 31, 2020 and 2019, was $3.5
million and $2.1 million, respectively, and are included within accrued
compensation in the consolidated balance sheets. Payroll contributions accrued
as of July 31, 2020 will be used to purchase shares at the end of the current
ESPP purchase period ending on December 15, 2020. Payroll contributions
ultimately used to purchase shares will be reclassified to additional paid-in
capital on the purchase date.
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The fair value of the purchase rights granted under the ESPP was estimated on
the date of grant using the Black-Scholes option pricing model with the
following assumptions:
Year Ended July 31,
2020 2019 2018
Expected term (in years) 0.5 - 2.0 0.5 - 2.0 0.5 - 2.3
Expected stock price volatility 53.6% - 73.6% 44.0% - 61.9% 30.7% - 53.2%
Risk-free interest rate 0.2% - 1.7% 1.9% - 2.7% 2.0% - 2.6%
Dividend yield 0.0% 0.0% 0.0%
Early Exercised Stock Options
The 2007 Plan allowed for the early exercise of stock options for certain
individuals as determined by our board of directors. The consideration received
for an early exercised stock option is considered to be a deposit of the
exercise price and the related proceed is initially recorded as a liability in
the consolidated balance and reclassified to additional paid-in capital as the
awards vest. Upon an employee's termination, we have the option to repurchase
unvested shares at a price per share equal to the lesser of the fair market
value of the shares at the time of the repurchase or the original purchase
price. We reclassified to additional paid-in capital $0.5 million, $1.0 million
and $3.2 million related to awards vested during fiscal 2020, fiscal 2019 and
fiscal 2018, respectively. As of July 31, 2020 and 2019, the number of shares of
common stock subject to repurchase was approximately 19,000 shares and 122,000
shares with an aggregate exercise price of $0.1 million and $0.6 million,
respectively. The liability for early exercised stock options is included within
accrued expenses and other current liabilities in the consolidated balance
sheets.
Notes Receivable from Stockholders
Prior to fiscal 2017, we entered into notes receivable agreements with certain
of our current and former executives and employees in connection with the
exercise of their stock options. The outstanding principal amount and related
accrued interest on the notes are presented as contra-equity in the consolidated
balance sheets until the notes are fully settled. During fiscal 2019, the
outstanding principal amount of $1.9 million and accrued interest of
$0.2 million were fully repaid.
Deferred Merger Consideration
In connection with the acquisition of Edgewise, as further described in Note 6,
Business Acquisitions, certain former employees (who became our employees on the
closing date of the business acquisition) are entitled to receive a deferred
merger consideration payable in shares of our authorized common stock. The
shares will be released on a quarterly basis over the vesting period of three
years beginning from the closing date. The fair value of these awards of $9.3
million will be recognized as stock-based compensation expense on a
straight-line basis over the vesting period within research and development
expenses in our consolidated statements of operations.
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Stock-based Compensation Expense
The components of stock-based compensation expense recognized in the
consolidated statements of operations consisted of the following:
Year Ended July 31,
2020 2019 2018
(in thousands)
Cost of revenue $ 7,318 $ 2,926 $ 757
Sales and marketing 66,539 23,118 5,044
Research and development 30,173 15,090 3,045
General and administrative 17,365 5,289 2,378
Total $ 121,395 $ 46,423 $ 11,224
As of July 31, 2020, the unrecognized stock-based compensation cost related to
outstanding equity-based awards, including awards for which the service
inception date has been met but the grant date has not been met, was $508.5
million, which is expected to be amortized over a weighted-average period of 3.1
years.
During fiscal 2020 and fiscal 2019, we capitalized $4.4 million and
$0.5 million, respectively of stock-based compensation associated with the
development of software for internal-use. Stock-based compensation related to
projects capitalized in fiscal 2018 was immaterial.
.
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Note 14. Income Taxes
The following table sets forth the geographical breakdown of the income (loss)
before the provision for income taxes:
Year ended July 31,
2020 2019 2018
(in thousands)
Domestic $ (123,085) $ (34,145) $ (36,455)
International 10,357 6,233 4,146Loss before provision for income taxes $ (112,728) $ (27,912) $ (32,309)
The following table sets forth the components of the provision for income taxes:
Year ended July 31,
2020 2019 2018
Current: (in thousands)
Federal $ - $ - $ -
State 45 64 (2)
Foreign 4,013 2,325 1,480
Total current tax expense 4,058 2,389 1,478
Deferred:
Federal (864) (1,431) -
State (243) (107) -
Foreign (563) (108) (141)
Total deferred tax expense (1,670) (1,646) (141)
Total provision for income taxes $ 2,388 $ 743 $ 1,337
The following table presents the reconciliation of the statutory federal income tax rate to our effective tax rate:
Year ended July 31,
2020 2019 2018
Tax at federal statutory rate 21.0 % 21.0% 21.0 %
State taxes 0.2 0.1 -
Impact of foreign rate differential - (0.9) 0.3
Meals and entertainment (0.2) (1.9) (1.3)
Stock-based compensation 37.0 147.2 (3.8)
Impact of U.S. tax reform - - (58.6)
Provision to return adjustments (0.3) 1.2 2.8
U.S. tax credits 6.8 10.0 3.7
Change in valuation allowance (65.0)
(176.9) 33.5
Withholding tax (1.1) (2.4) (1.1)
Other (0.5) (0.1) (0.6)
Effective tax rate (2.1) % (2.7) % (4.1) %
132-------------------------------------------------------------------------------- Table of Contents Our estimated effective tax rate for the periods presented differs from theU.S. statutory rate primarily due to our foreign earnings being taxed at different rates than theU.S. statutory rate and as well as the benefit of stock compensation deductions, offset by the impact of the valuation allowance we maintain against ourU.S. federal and state deferred tax assets. During fiscal 2018, the impact of the Tax Act includes the effect of remeasuring our deferred tax assets and liabilities at 21% plus the effects of the one-time mandatory transition tax which was offset by our valuation allowance. During fiscal 2020 and 2019, we recognized an income tax benefit of $1.1 million and $1.4 million, respectively, as a result of a release in our valuation allowance on deferred tax assets as a result of deferred taxes recorded as part of the acquisition accounting of Cloudneeti Corporation, Edgewise Networks Inc. and Appsulate, Inc. Refer to Note 6, Business Combinations, for further information. On December 22, 2017, the Tax Cuts and Jobs Act of 2017 or the Tax Act was enacted. The Tax Act contains several key tax provisions that affect us, including, but not limited to, reducing theU.S. federal corporate tax rate from 34% to 21% imposing a one-time mandatory transition tax on previously untaxed foreign earnings, and changing rules related to the use of net operating loss carryforwards created in tax years beginning after December 31, 2017. Because of the full valuation allowance recorded against ourU.S. federal deferred tax assets, there was no income tax expense (or benefit) recognized related to the Tax Act. The following table presents the tax effects of temporary differences that give rise to significant portions of our deferred tax assets and liabilities: July 31, 2020 2019 (in thousands) Deferred tax assets: Net operating losses carryovers $ 149,430 $ 87,413 Accruals and reserves 3,896 1,763 Deferred revenue 27,123 14,752 Tax credits carryovers 23,573 10,330 Stock-based compensation 14,218 6,112 Property and equipment 1,002 560 Operating lease liabilities 8,571 - Other 33 232 Gross deferred tax assets 227,846 121,162 Less: Valuation allowance (130,236) (103,732) Total deferred tax assets $ 97,610 $ 17,430 Deferred tax liabilities: Intangible assets (4,224) (1,178)
Deferred contract acquisition costs (24,727) (15,906) Convertible senior notes
(61,071) -
Operating lease right-of-use assets (6,978) -
Other (131) (89)
Total deferred tax liabilities $ (97,131) $ (17,173)
Net deferred tax assets $ 479 $ 257
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A deferred tax liability has not been recognized on the excess of the amount for
financial reporting over the tax basis of investments in foreign subsidiaries
that are indefinitely reinvested outside the U.S. Income taxes are generally
incurred upon a repatriation of assets, a sale, or a liquidation of the
subsidiary. The excess of the amount for financial reporting over the tax basis
in the investments in foreign subsidiaries, as well as the unrecognized deferred
tax liability, are not material for the periods presented.
The following table presents the change in the valuation allowance:
Year ended July 31,
2020 2019 2018
(in thousands)
Balance as of the beginning of the period $ 103,732 $ 45,578 $ 51,493
Change during the period 26,504 58,154 (5,915)
Balance as of the end of the period $ 130,236 $ 103,732 $ 45,578
The realization of deferred tax assets is dependent upon the generation of
sufficient taxable income of the appropriate character in future periods. We
regularly assess the ability to realize our deferred tax assets and 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, we believe that
it is more likely than not that our U.S. federal and, state deferred tax assets
will not be realized as of July 31, 2020 and 2019, and as such, we have
maintained a full valuation allowance against such deferred tax assets. During
fiscal 2019, we determined that due to the weight of objectively verifiable
negative evidence, our U.K. deferred tax assets are no longer more likely than
not to be realized in the future and a full valuation allowance was recorded and
has been maintained as of July 31, 2020.
The amount of the deferred tax asset considered realizable; however, could be
adjusted if estimates of future taxable income during the carryforward period
are reduced or increased or if objective negative evidence in the form of
cumulative losses is no longer present and additional weight may be given to
subjective evidence such as our projections for growth. In the event we
determine that we will be able to realize all or part of our net deferred tax
assets in the future, the valuation allowance against deferred tax assets will
be reversed in the period in which we make such determination. The release of a
valuation allowance against deferred tax assets may cause greater volatility in
the effective tax rate in the periods in which the valuation allowance is
released. The valuation allowance against our U.S. federal, state and U.K.
deferred tax assets increased by $26.5 million, $58.2 million and decreased by
$5.9 million in fiscal 2020, fiscal 2019 and fiscal 2018, respectively. The
decrease in the valuation allowance in fiscal 2018 was primarily related to the
change in the federal statutory rate, while the increase in the valuation
allowance in fiscal 2020 and fiscal 2019 was related to tax losses for which
insufficient positive evidence exists to support their realizability.
As of July 31, 2020 and 2019, we have net operating loss carryforwards for U.S.
federal income tax purposes of $626.3 million and $360.0 million, respectively,
which are available to offset future federal taxable income. Beginning in 2027,
$177.8 million of the federal net operating losses will begin to expire. The
remaining $448.5 million of the federal net operating losses will carry forward
indefinitely. As of July 31, 2020 and 2019, we have net operating loss
carryforwards for state income tax purposes of $177.1 million and
$109.5 million, respectively. Beginning in 2024, $164.7 million of state net
operating losses will begin to expire at different periods. The remaining $12.4
million of state net operating losses will carry forward indefinitely. As of
July 31, 2020 and 2019, we had foreign net operating loss carryforward of $19.5
million and $17.7 million, respectively, all of which will be carried forward
indefinitely.
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As of July 31, 2020, we had federal and California research and development tax
credit carryforwards of approximately $19.5 million and $14.5 million,
respectively. If not utilized, the federal credit carryforwards will begin
expiring at different periods beginning in 2033. The California credit will be
carried forward indefinitely.
Federal and state tax laws impose restrictions on the utilization of net
operating loss and research and development credit carryforwards in the event of
a change in our ownership as defined by the Internal Revenue Code, Sections 382
and 383. Under Section 382 and 383 of the Code, substantial changes in our
ownership and the ownership of acquired companies may limit the amount of net
operating loss and research and development credit carryforwards that are
available to offset taxable income. The annual limitation would not
automatically result in the loss of net operating loss or research and
development credit carryforwards but may limit the amount available in any given
future period.
We are subject to income taxes in the U.S. and various foreign jurisdictions. As
of July 31, 2020, all years are open for examination and may become subject to
examination in the future. Significant judgment is required in evaluating our
tax positions and determining our for income tax expense for the fiscal year.
During the ordinary course of business, there are transactions and calculations
for which the ultimate tax determination is uncertain. Our estimate of the
potential outcome of any tax position is subject to management's assessment of
relevant risks, facts and circumstances existing at that time. These
unrecognized tax benefits are established when we believe that certain positions
might be challenged despite of belief that our tax return positions are fully
supportable. We recognize interest and penalties associated with our
unrecognized tax benefits as a component of our income tax expense. For the
periods presented, we did not have material interest or penalties associated
with the unrecognized tax benefits in the consolidated financial statements.
We had $10.5 million of gross unrecognized tax benefits as of July 31, 2020,
none of which would affect our effective tax rate if recognized due to our U.S.
valuation allowance. The gross unrecognized tax benefits relate to income tax
positions which, if recognized, would be in the form of carryforward deferred
tax asset that would be offset by a valuation allowance. As of July 31, 2020, we
do not believe that our estimates, as otherwise provided for, on such tax
positions will significantly increase or decrease within the next twelve months.
The changes in our gross unrecognized tax benefits for fiscal 2020 consisted of
the following:
Amount
(in thousands)
Balance as of July 31, 2018 $ 2,622
Gross decrease for tax positions of prior fiscal years (288)
Gross increase for tax positions in fiscal 2019 2,093
Balance as of July 31, 2019 4,427
Gross increase for tax positions of prior fiscal years 1,611
Gross increase for tax positions of current fiscal year 4,471
Balance as of July 31, 2020 $ 10,509
Note 15. Net Loss Per Share Attributable to Common Stockholders
Basic and diluted net loss per share attributable to common stockholders is
presented in conformity with the two-class method required for participating
securities. We consider all series of our convertible preferred stock to be
participating securities. Under the two-class method, the net loss attributable
to common stockholders is not allocated to the convertible preferred stock as
the holders of our convertible preferred stock do not have a contractual
obligation to share in our losses. In March 2018, upon completion of our IPO,
all shares of convertible preferred stock then outstanding, were automatically
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converted into an equivalent number of shares of common stock on a one-to-one
basis. As of July 31, 2020 and 2019, we did not have shares of convertible
preferred stock issued and outstanding.
Basic net loss per share attributable to common stockholders is computed by
dividing the net loss by the weighted-average number of shares of common stock
outstanding during the period, less shares subject to repurchase. The diluted
net loss per share attributable to common stockholders is computed by giving
effect to all potential dilutive common stock equivalents outstanding for the
period. For purposes of this calculation, our stock options, shares subject to
repurchase from early exercised stock options, share purchase rights under the
employee stock purchase plan, unvested restricted stock units ("RSUs"), unvested
performance stock awards ("PSAs") and shares related to the Notes are considered
to be potential common stock equivalents.
Since we have reported net losses for all periods presented, we have excluded
all potentially dilutive securities from the calculation of the diluted net loss
per share attributable to common stockholders as their effect is antidilutive
and accordingly, basic and diluted net loss per share attributable to common
stockholders is the same for all periods presented.
The following table sets forth the computation of basic and diluted net loss per
share attributable to common stockholders:
Year Ended July 31,
2020 2019 2018
(in thousands, except per share data)
Net loss $ (115,116) $ (28,655) $ (33,646) Accretion of Series C and D redeemable convertible preferred stock
- - (6,332)
Net loss attributable to common stockholders $ (115,116)
$ (28,655) $ (39,978) Weighted-average shares used in computing net loss per share attributable to common stockholders, basic and diluted
129,323 123,566 63,881
Net loss per share attributable to common
stockholders, basic and diluted $ (0.89) $ (0.23) $ (0.63)
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The following table summarizes the outstanding potentially dilutive securities
that were excluded from the computation of diluted net loss per share
attributable to common stockholders because the impact of including them would
have been antidilutive:
July 31,
2020 2019 2018
(in thousands)
Outstanding stock options 5,175 8,861 16,175
Shares subject to repurchase from early exercised
stock options 19 122 423
Share purchase rights under the ESPP 568 913 2,044
Unvested RSUs 8,069 4,152 209
Unvested PSAs(1) 723 - -
Total 14,554 14,048 18,851
(1) The number of unvested PSAs is based on the target number of shares granted
and excludes unvested PSAs for which performance conditions have not been
established as of July 31, 2020, as they are not considered outstanding for
accounting purposes. Refer to Note 13, Stock-Based Compensation, for further
information.
The shares underlying the conversion option in the Notes were not considered in
the calculation of diluted net loss per share as the effect would have been
anti-dilutive. Based on the initial conversion price, the entire outstanding
principal amount of the Notes as of July 31, 2020 would have been convertible
into approximately 7.6 million shares of our common stock. Since we expect to
settle the principle amount of the Notes in cash, we use the treasury stock
method for calculating any potential dilutive effect on diluted net income per
share, if applicable. As a result, only the amount by which the conversion value
exceeds the aggregate principal amount of the Notes (the "conversion spread") is
considered in the diluted earnings per share computation. The conversion spread
has a dilutive impact on diluted net income per share when the average market
price of our common stock for a given period exceeds the initial conversion
price of $150.80 per share for the Notes. We excluded the potentially dilutive
effect of the conversion spread of the Notes as the average market price of our
common stock during the three months ended July 31, 2020 was less than the
conversion price of the Notes. In connection with the issuance of the Notes, we
entered into Capped Calls, which were not included for purposes of calculating
the number of diluted shares outstanding, as their effect would have been
anti-dilutive.
Note 16. Segment and Geographic Information
Our chief operating decision maker ("CODM") is our chief executive officer. We
derive our revenue primarily from sales of subscription services to our cloud
platform and related support services. Our CODM reviews financial information
presented on a consolidated basis for the purposes of allocating resources and
evaluating financial performance. Accordingly, we determined that we operate
as one operating segment.
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--------------------------------------------------------------------------------Our long-lived assets consist of property and equipment and operating lease right-of-use assets, which are summarized by geographic area as follows:
July 31,
2020(1) 2019
(in thousands)
United States $ 74,264 $ 28,847
Rest of the world 37,589 12,199
Total $ 111,853 $ 41,046
(1) On August 1, 2019, we adopted the new lease accounting standard ASU No.
2016-02, Leases (Topic 842) on a modified retrospective basis at the beginning
of the fiscal year of adoption.
Refer to Note 2, Revenue Recognition for information on revenue by geography.
Note 17. 401(k) Plan
We have a defined-contribution plan intended to qualify under Section 401 of the
Internal Revenue Code (the "401(k) Plan"). We contract with a third-party
provider to act as a custodian and trustee, and to process and maintain the
records of participant data. In fiscal 2020, we began contributing to the 401(k)
Plan, making matching contributions of $2.0 million.
Note 18. Related Party Transactions
We previously entered into notes receivable agreements with certain of our
current and former executives and employees in connection with the exercise of
their stock options. Outstanding notes receivable were fully repaid during
fiscal 2019. Refer to Note 13, Stock-Based Compensation, of these consolidated
financial statements for further information.
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