10-Q 1 pfpt-10q_20190331.htm 10-Q pfpt-10q_20190331.htm

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

FORM 10-Q

QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the Quarterly Period Ended March 31, 2019

OR

TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the Transition Period from____to____

Commission File Number 001-35506

PROOFPOINT, INC.

(Exact name of Registrant as specified in its charter)

 

Delaware

 

51-0414846

(State or other jurisdiction of

incorporation or organization)

 

(I.R.S. employer

identification no.)

892 Ross Drive

Sunnyvale, California

 

94089

(Address of principal executive offices)

 

(Zip Code)

 

(408) 517-4710

 

(Registrant’s telephone number, including area code)

Securities registered pursuant to Section 12(b) of the Act:

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Sections 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. YES NO

Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit such files). YES   NO

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer, a smaller reporting company, or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer”, “smaller reporting company” and “emerging growth company” in Rule 12b-2 of the Exchange Act.

 

Large accelerated filer

 

 

Accelerated filer

Non-accelerated filer

 

 

Smaller reporting company

 

 

 

 

Emerging growth company

 

If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act.

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes ☐ No

 

Title of each class

Trading Symbol(s)

Name of each exchange on which registered

Common Stock

PFPT

NASDAQ

Shares of Proofpoint, Inc. common stock, $0.0001 par value per share, outstanding as of April 19, 2019: 55,674,845 shares.

 


Table of Contents

 

TABLE OF CONTENTS

 

 

 

Page

PART I. FINANCIAL INFORMATION

 

 

 

 

 

ITEM 1. FINANCIAL STATEMENTS (UNAUDITED):

 

3

 

 

 

Condensed Consolidated Balance Sheets as of March 31, 2019 and December 31, 2018

 

3

 

 

 

Condensed Consolidated Statements of Operations for the Three Months Ended March 31, 2019 and 2018

 

4

 

 

 

Condensed Consolidated Statements of Comprehensive Loss for the Three Months Ended March 31, 2019 and 2018

 

5

 

 

 

Condensed Consolidated Statements of Stockholders' Equity for the Three Months Ended March 31, 2019 and 2018

 

6

 

 

 

Condensed Consolidated Statements of Cash Flows for the Three Months Ended March 31, 2019 and 2018

 

7

 

 

 

Notes to Condensed Consolidated Financial Statements

 

9

 

 

 

ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

 

25

 

 

 

ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

 

37

 

 

 

ITEM 4. CONTROLS AND PROCEDURES

 

38

 

 

 

PART II. OTHER INFORMATION

 

 

 

 

 

ITEM 1. LEGAL PROCEEDINGS

 

39

 

 

 

ITEM 1A. RISK FACTORS

 

39

 

 

 

ITEM 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS

 

54

 

 

 

ITEM 3. DEFAULTS UPON SENIOR SECURITIES

 

54

 

 

 

ITEM 4. MINE SAFETY DISCLOSURES

 

54

 

 

 

ITEM 5. OTHER INFORMATION

 

54

 

 

 

ITEM 6. EXHIBITS

 

55

 

 

 

SIGNATURES

 

56

 

 

 

2


Table of Contents

 

PART I. FINANCIAL INFORMATION

ITEM 1.  FINANCIAL STATEMENTS.

Proofpoint, Inc.

Condensed Consolidated Balance Sheets

(In thousands, except per share amounts)

(Unaudited)

 

 

 

March 31, 2019

 

 

December 31, 2018

 

Assets

 

 

 

 

 

 

 

 

Current assets:

 

 

 

 

 

 

 

 

Cash and cash equivalents

 

$

216,586

 

 

$

185,392

 

Short-term investments

 

 

40,405

 

 

 

46,307

 

Accounts receivable, net

 

 

163,139

 

 

 

199,194

 

Inventory

 

 

612

 

 

 

481

 

Deferred product costs

 

 

1,703

 

 

 

1,800

 

Deferred commissions

 

 

37,986

 

 

 

37,391

 

Prepaid expenses and other current assets

 

 

21,824

 

 

 

16,872

 

Total current assets

 

 

482,255

 

 

 

487,437

 

Property and equipment, net

 

 

68,361

 

 

 

70,627

 

Operating lease right-of-use assets

 

 

54,635

 

 

 

 

Long-term deferred product costs

 

 

300

 

 

 

303

 

Goodwill

 

 

457,274

 

 

 

460,425

 

Intangible assets, net

 

 

126,346

 

 

 

136,645

 

Long-term deferred commissions

 

 

71,038

 

 

 

69,989

 

Other assets

 

 

9,029

 

 

 

7,592

 

Total assets

 

$

1,269,238

 

 

$

1,233,018

 

Liabilities and Stockholders’ Equity

 

 

 

 

 

 

 

 

Current liabilities:

 

 

 

 

 

 

 

 

Accounts payable

 

$

14,735

 

 

$

20,237

 

Accrued liabilities

 

 

71,019

 

 

 

90,719

 

Deferred rent

 

 

 

 

 

829

 

Operating lease liabilities

 

 

23,851

 

 

 

 

Deferred revenue

 

 

499,024

 

 

 

490,296

 

Total current liabilities

 

 

608,629

 

 

 

602,081

 

Long-term deferred rent

 

 

 

 

 

3,757

 

Long-term operating lease liabilities

 

 

35,011

 

 

 

 

Other long-term liabilities

 

 

7,278

 

 

 

6,812

 

Long-term deferred revenue

 

 

111,209

 

 

 

107,834

 

Total liabilities

 

 

762,127

 

 

 

720,484

 

Commitments and contingencies (Note 7)

 

 

 

 

 

 

 

 

Stockholders’ equity:

 

 

 

 

 

 

 

 

Convertible preferred stock, $0.0001 par value; 5,000 shares

   authorized; no shares issued and outstanding

 

 

 

 

 

 

Common stock, $0.0001 par value; 200,000 shares authorized; 55,607

   and 55,149 shares issued and outstanding at March 31, 2019 and

   December 31, 2018, respectively

 

 

6

 

 

 

6

 

Additional paid-in capital

 

 

1,130,711

 

 

 

1,107,953

 

Accumulated other comprehensive income (loss)

 

 

1

 

 

 

(7

)

Accumulated deficit

 

 

(623,607

)

 

 

(595,418

)

Total stockholders’ equity

 

 

507,111

 

 

 

512,534

 

Total liabilities and stockholders’ equity

 

$

1,269,238

 

 

$

1,233,018

 

 

See accompanying Notes to the Condensed Consolidated Financial Statements.

3


Table of Contents

 

Proofpoint, Inc.

Condensed Consolidated Statements of Operations

(In thousands, except per share amounts)

(Unaudited)

 

 

 

Three Months Ended March 31,

 

 

 

2019

 

 

2018

 

Revenue:

 

 

 

 

 

 

 

 

Subscription

 

$

199,584

 

 

$

158,787

 

Hardware and services

 

 

3,353

 

 

 

3,674

 

Total revenue

 

 

202,937

 

 

 

162,461

 

Cost of revenue:(1)(2)

 

 

 

 

 

 

 

 

Subscription

 

 

48,252

 

 

 

42,198

 

Hardware and services

 

 

6,991

 

 

 

4,859

 

Total cost of revenue

 

 

55,243

 

 

 

47,057

 

Gross profit

 

 

147,694

 

 

 

115,404

 

Operating expense:(1)(2)

 

 

 

 

 

 

 

 

Research and development

 

 

53,249

 

 

 

43,732

 

Sales and marketing

 

 

97,004

 

 

 

77,897

 

General and administrative

 

 

25,825

 

 

 

17,525

 

Total operating expense

 

 

176,078

 

 

 

139,154

 

Operating loss

 

 

(28,384

)

 

 

(23,750

)

Interest income (expense)

 

 

1,178

 

 

 

(2,821

)

Other (expense) income, net

 

 

(452

)

 

 

343

 

Loss before income taxes

 

 

(27,658

)

 

 

(26,228

)

(Provision for) benefit from income taxes

 

 

(620

)

 

 

14,072

 

Net loss

 

$

(28,278

)

 

$

(12,156

)

Net loss per share, basic and diluted

 

$

(0.51

)

 

$

(0.24

)

Weighted average shares outstanding, basic and diluted

 

 

55,335

 

 

 

50,504

 

 

(1) Includes stock-based compensation expense as follows:

 

 

 

 

 

 

 

 

Cost of subscription revenue

 

$

3,875

 

 

$

3,451

 

Cost of hardware and services revenue

 

$

906

 

 

$

591

 

Research and development

 

$

11,499

 

 

$

10,035

 

Sales and marketing

 

$

13,754

 

 

$

11,502

 

General and administrative

 

$

10,987

 

 

$

5,493

 

 

 

(2) Includes intangible amortization expense as follows:

 

 

 

 

 

 

 

 

Cost of subscription revenue

 

$

6,762

 

 

$

5,776

 

Research and development

 

$

 

 

$

15

 

Sales and marketing

 

$

3,537

 

 

$

2,415

 

 

 

See accompanying Notes to the Condensed Consolidated Financial Statements.

 

 

 

 

 

 

 

 

 

4


Table of Contents

 

Proofpoint, Inc.

Condensed Consolidated Statements of Comprehensive Loss

(In thousands)

(Unaudited)

 

 

 

Three Months Ended March 31,

 

 

 

2019

 

 

2018

 

Net loss

 

$

(28,278

)

 

$

(12,156

)

Other comprehensive income, net of tax:

 

 

 

 

 

 

 

 

Unrealized gain on short-term investments, net

 

 

8

 

 

 

7

 

Comprehensive loss

 

$

(28,270

)

 

$

(12,149

)

 

See accompanying Notes to the Condensed Consolidated Financial Statements.

5


Table of Contents

 

Proofpoint, Inc.

Condensed Consolidated Statements of Stockholders’ Equity

(In thousands, except per share amounts)

(Unaudited)

 

 

 

Three months ended March 31, 2019

 

 

 

Common Stock

 

 

Additional

Paid-In

 

 

Accumulated

Other

Comprehensive

 

 

Accumulated

 

 

Total

Stockholders’

 

 

 

Shares

 

 

Amount

 

 

Capital

 

 

Income (Loss)

 

 

Deficit

 

 

Equity

 

Balances at December 31, 2018

 

 

55,149

 

 

$

6

 

 

$

1,107,953

 

 

$

(7

)

 

$

(595,418

)

 

$

512,534

 

Cumulative effect of adjustment from

   adoption of ASC 842

 

 

 

 

 

 

 

 

 

 

 

 

 

 

89

 

 

 

89

 

Net loss

 

 

 

 

 

 

 

 

 

 

 

 

 

 

(28,278

)

 

 

(28,278

)

Unrealized gain on short-term

   investments

 

 

 

 

 

 

 

 

 

 

 

8

 

 

 

 

 

 

8

 

Stock-based compensation expense

 

 

 

 

 

 

 

 

34,735

 

 

 

 

 

 

 

 

 

34,735

 

Common stock issued

 

 

688

 

 

 

 

 

 

13,756

 

 

 

 

 

 

 

 

 

13,756

 

Tax withholding upon vesting of

   restricted stock awards

 

 

(230

)

 

 

 

 

 

(25,733

)

 

 

 

 

 

 

 

 

(25,733

)

Balances at March 31, 2019

 

 

55,607

 

 

$

6

 

 

$

1,130,711

 

 

$

1

 

 

$

(623,607

)

 

$

507,111

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Three months ended March 31, 2018

 

 

 

Common Stock

 

 

Additional

Paid-In

 

 

Accumulated

Other

Comprehensive

 

 

Accumulated

 

 

Total

Stockholders’

 

 

 

Shares

 

 

Amount

 

 

Capital

 

 

Income (Loss)

 

 

Deficit

 

 

Equity

 

Balances at December 31, 2017

 

 

50,325

 

 

$

5

 

 

$

787,572

 

 

$

(9

)

 

$

(488,453

)

 

$

299,115

 

Cumulative effect of adjustment from

   adoption of ASU 2016-16

 

 

 

 

 

 

 

 

 

 

 

 

 

 

(3,216

)

 

 

(3,216

)

Net loss

 

 

 

 

 

 

 

 

 

 

 

 

 

 

(12,156

)

 

 

(12,156

)

Unrealized gain on short-term

   investments

 

 

 

 

 

 

 

 

 

 

 

7

 

 

 

 

 

 

7

 

Stock-based compensation expense

 

 

 

 

 

 

 

 

29,387

 

 

 

 

 

 

 

 

 

29,387

 

Common stock issued

 

 

687

 

 

 

 

 

 

11,548

 

 

 

 

 

 

 

 

 

11,548

 

Tax withholding upon vesting of

   restricted stock awards

 

 

(199

)

 

 

 

 

 

(20,991

)

 

 

 

 

 

 

 

 

(20,991

)

Balances at March 31, 2018

 

 

50,813

 

 

$

5

 

 

$

807,516

 

 

$

(2

)

 

$

(503,825

)

 

$

303,694

 

 

See accompanying Notes to the Condensed Consolidated Financial Statements.

6


Table of Contents

 

Proofpoint, Inc.

Condensed Consolidated Statements of Cash Flows

(In thousands)

(Unaudited)

 

 

 

Three Months Ended March 31,

 

 

 

2019

 

 

2018

 

Cash flows from operating activities

 

 

 

 

 

 

 

 

Net loss

 

$

(28,278

)

 

$

(12,156

)

Adjustments to reconcile net loss to net cash provided by operating activities:

 

 

 

 

 

 

 

 

Depreciation and amortization

 

 

18,660

 

 

 

15,524

 

Stock-based compensation

 

 

41,021

 

 

 

31,072

 

Change in fair value of contingent consideration

 

 

 

 

 

(79

)

Amortization of debt issuance costs and accretion of debt discount

 

 

 

 

 

3,053

 

Amortization of deferred commissions

 

 

11,271

 

 

 

8,374

 

Amortization of operating lease right-of-use assets

 

 

5,634

 

 

 

 

Deferred income taxes

 

 

(60

)

 

 

(14,772

)

Other

 

 

734

 

 

 

(213

)

Changes in assets and liabilities:

 

 

 

 

 

 

 

 

Accounts receivable

 

 

35,616

 

 

 

(1,436

)

Inventory

 

 

(131

)

 

 

127

 

Deferred product costs

 

 

100

 

 

 

(106

)

Deferred commissions

 

 

(12,915

)

 

 

(9,214

)

Prepaid expenses

 

 

(6,369

)

 

 

(3,896

)

Other current assets

 

 

222

 

 

 

1,652

 

Long-term assets

 

 

(469

)

 

 

114

 

Accounts payable

 

 

(4,305

)

 

 

5,011

 

Accrued liabilities

 

 

(12,547

)

 

 

(11,751

)

Deferred rent

 

 

 

 

 

114

 

Operating lease liabilities

 

 

(6,188

)

 

 

 

Deferred revenue

 

 

12,103

 

 

 

23,504

 

Net cash provided by operating activities

 

 

54,099

 

 

 

34,922

 

Cash flows from investing activities

 

 

 

 

 

 

 

 

Proceeds from maturities of short-term investments

 

 

32,273

 

 

 

31,500

 

Proceeds from sales of short-term investments

 

 

 

 

 

11,931

 

Purchase of short-term investments

 

 

(26,373

)

 

 

(13,761

)

Purchase of property and equipment

 

 

(5,477

)

 

 

(8,539

)

Receipt from escrow account

 

 

 

 

 

555

 

Acquisition of business, net of cash acquired

 

 

 

 

 

(223,786

)

Net cash provided by (used in) investing activities

 

 

423

 

 

 

(202,100

)

Cash flows from financing activities

 

 

 

 

 

 

 

 

Proceeds from issuance of common stock

 

 

1,105

 

 

 

2,678

 

Withholding taxes related to restricted stock net share settlement

 

 

(24,623

)

 

 

(20,043

)

Repayments of equipment loans and capital lease obligations

 

 

 

 

 

(12

)

Contingent consideration payment

 

 

 

 

 

(555

)

Net cash used in financing activities

 

 

(23,518

)

 

 

(17,932

)

Effect of exchange rate changes on cash, cash equivalents and

   restricted cash

 

 

206

 

 

 

374

 

Net increase (decrease) in cash, cash equivalents and restricted cash

 

 

31,210

 

 

 

(184,736

)

Cash, cash equivalents and restricted cash

 

 

 

 

 

 

 

 

Beginning of period

 

 

186,152

 

 

 

286,660

 

End of period

 

$

217,362

 

 

$

101,924

 

Supplemental disclosure of noncash investing and financing information

 

 

 

 

 

 

 

 

Unpaid purchases of property and equipment and asset retirement

   obligations

 

$

3,338

 

 

$

5,432

 

Operating lease right-of-use assets exchanged for lease obligations

 

$

745

 

 

$

 

Liability awards converted to equity

 

$

12,651

 

 

$

8,870

 

7


Table of Contents

 

 

 

 

March 31, 2019

 

 

March 31, 2018

 

Reconciliation of cash, cash equivalents and restricted cash as shown in

   the consolidated statement of cash flows

 

 

 

 

 

 

 

 

Cash and cash equivalents

 

$

216,586

 

 

$

101,411

 

Restricted cash included in prepaid expenses and other current assets

 

 

284

 

 

 

241

 

Restricted cash included in other non-current assets

 

 

492

 

 

 

272

 

Total cash, cash equivalents and restricted cash

 

$

217,362

 

 

$

101,924

 

 

See accompanying Notes to the Condensed Consolidated Financial Statements.

8


Table of Contents

 

Proofpoint, Inc.

Notes to Condensed Consolidated Financial Statements

(Unaudited)

(Dollars and share amounts in thousands, except per share amounts)

1. The Company and Summary of Significant Accounting Policies

The Company

Proofpoint, Inc. (the “Company”) was incorporated in Delaware in June 2002 and is headquartered in California.

Proofpoint, Inc. is a leading security-as-a-service provider that enables large and mid-sized organizations worldwide to defend, protect, archive and govern their most sensitive data. The Company’s security-and compliance platform is comprised of an integrated suite of threat protection, information protection, and brand protection solutions, including email protection, advanced threat protection, email authentication, data loss prevention, SaaS application protection, response orchestration and automation, digital risk, web browser isolation, email encryption, archiving, eDiscovery, supervision, secure communication, phishing simulation and security awareness computer-based training.

Correction of Classification of Short-term and Long-term Deferred Revenue

Management has determined that in the Company’s consolidated financial statements for the year ended December 31, 2018, short-term deferred revenue was overstated by $2,446, or 0.5%, in its consolidated balance sheet as of December 31, 2018. The Company has revised the December 31, 2018 consolidated balance sheet to correct the classification from short-term deferred revenue to long-term deferred revenue. The correction had no impact on the results of operations or cash flows of the Company.

Basis of Presentation and Consolidation

These condensed consolidated financial statements include the accounts of the Company and its wholly-owned subsidiaries. All intercompany transactions and balances have been eliminated in consolidation.

These condensed consolidated financial statements have been prepared in accordance with United States generally accepted accounting principles (“GAAP”), pursuant to the rules and regulations of the Securities and Exchange Commission (the “SEC”). Certain information and note disclosures have been condensed or omitted pursuant to such rules and regulations. The accompanying Condensed Consolidated Balance Sheet as of December 31, 2018 is derived from audited financial statements as of that date but does not include all of the information and footnotes required by accounting principles generally accepted in the United States for complete financial statements. The unaudited condensed consolidated financial statements have been prepared on the same basis as the annual financial statements and, in the opinion of management, reflect all adjustments, which include only normal recurring adjustments, necessary for a fair statement of the periods presented. The results of operations for the three months ended March 31, 2019 are not necessarily indicative of the results to be expected for the year ending December 31, 2019 or for other interim periods or for future years.

These condensed consolidated financial statements should be read in conjunction with the Company’s audited consolidated financial statements and accompanying notes for the year ended December 31, 2018 included in the Company’s Annual Report on Form 10-K filed with the SEC. The Company’s significant accounting policies are described in Note 1 to those audited consolidated financial statements.

Use of Estimates

The preparation of financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements, and the reported amounts of expenses during the reporting period. Actual results could differ from those estimates and such difference may be material to the financial statements.

Goodwill and Intangible Assets

Goodwill represents the excess of the purchase price of the acquired enterprise over the fair value of identifiable assets acquired and liabilities assumed. The Company performs an annual goodwill impairment test during the fourth quarter of a calendar year and more frequently if an event or circumstances indicates that impairment may have occurred. For the purposes of impairment testing, the Company has determined that it has one operating segment and one reporting unit. The

9


Table of Contents

 

Company performs a two-step impairment test of goodwill whereby the fair value of the reporting unit is compared to its carrying value. If the fair value of the reporting unit exceeds the carrying value of the net assets assigned to that unit, goodwill is not considered impaired and further testing is not required. If the carrying value of the net assets assigned to the reporting unit exceeds the fair value of the reporting unit, then the Company must perform the second step of the impairment test in order to determine the implied fair value of the reporting unit’s goodwill. If the carrying value of a reporting unit’s goodwill exceeds its implied fair value, then impairment loss equal to the difference is recorded. The identification and measurement of goodwill impairment involves the estimation of the fair value of the Company. The estimate of fair value of the Company, based on the best information available as of the date of the assessment, is subjective and requires judgment, including management assumptions about expected future revenue forecasts and discount rates, changes in the overall economy, trends in the stock price and other factors. No impairment indicators were identified by the Company as of March 31, 2019.

Intangible assets consist of developed technology, customer relationships, non-compete arrangements, trademarks and patents and order backlog. The values assigned to intangibles are based on estimates and judgments regarding expectations for success and life cycle of solutions and technologies acquired.

Intangible assets are amortized on a straight-line basis over their estimated lives, which approximate the pattern in which the economic benefits of the intangible assets are consumed, as follows (in years):

 

 

 

Low

 

 

High

 

Patents

 

 

4

 

 

 

5

 

Developed technology

 

 

3

 

 

 

7

 

Customer relationships

 

 

2

 

 

 

8

 

Order backlog

 

 

1

 

 

 

3

 

Trade names and trademarks

 

 

1

 

 

 

5

 

 

Comprehensive Loss

Comprehensive loss includes all changes in equity that are not the result of transactions with stockholders. The Company’s comprehensive loss consists of its net loss and changes in unrealized gains (losses) from its available-for-sale investments. The Company had no material reclassifications out of accumulated other comprehensive loss into net loss for the three months ended March 31, 2019 and 2018.

Accounting Pronouncements Adopted in 2019

In February 2016, the Financial Accounting Standards Board ("FASB") issued ASU No. 2016-02, Leases (Topic 842) (“ASU 2016-02” or “ASC 842”), which requires lessees to record most leases on their balance sheets but recognize the expenses in their statements of operations in a manner similar to current practice. ASU 2016-02 states that a lessee needs to recognize a lease liability for the obligation to make lease payments and a right-to-use(“ROU”) asset for the right to use the underlying asset for the lease term.

The Company adopted ASU 2016-02 in the first quarter of 2019, utilizing the modified retrospective transition approach through a cumulative-effect adjustment to the opening accumulated deficit balance as of January 1, 2019.

Refer to Note 6 “Leases” for more information regarding the impact of the adoption of ASU 2016-02 on the Company's financial statements.

Recent Accounting Pronouncements Not Yet Effective

In August 2018, the FASB issued ASU No. 2018-15, Intangibles—Goodwill and Other—Internal-Use Software (Subtopic 350-40): Customer’s Accounting for Implementation Costs Incurred in a Cloud Computing Arrangement That Is a Service Contract (“ASU 2018-15”). ASU 2018-15 aligns the requirements for capitalizing implementation costs incurred in a hosting arrangement that is a service contract with the requirements for capitalizing implementation costs incurred to develop or obtain internal-use software. The update to the standard is effective for interim and annual periods beginning after December 15, 2019, with early adoption permitted. Entities can choose to adopt the ASU 2018-15 prospectively or retrospectively. The Company is currently assessing the impact ASU 2018-15 will have on its consolidated financial statements.

In January 2017, the FASB issued ASU No. 2017-04, Intangibles - Goodwill and Other (Topic 350): Simplifying the Accounting for Goodwill Impairment (“ASU 2017-04”). ASU 2017-04 removes the requirement to perform a hypothetical purchase price allocation to measure goodwill impairment. A goodwill impairment charge will be the amount by which a

10


Table of Contents

 

reporting unit’s carrying value exceeds its fair value, not to exceed the carrying amount of goodwill. The update to the standard is effective for interim and annual periods beginning after December 15, 2019, with early adoption permitted, and should be applied prospectively. The Company does not expect ASU 2017-04 to have a material impact on its consolidated financial statements.

In June 2016, the FASB issued ASU No. 2016-13, Financial Instruments - Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments (“ASU 2016-13”). ASU 2016-13 changes the impairment model for most financial assets, and requires the use of an expected loss model in place of the currently used incurred loss method. Under this model, entities will be required to estimate the lifetime expected credit loss on such instruments and record an allowance to offset the amortized cost basis of the financial asset, resulting in a net presentation of the amount expected to be collected on the financial asset. The update to the standard is effective for interim and annual periods beginning after December 15, 2019. The Company is currently evaluating the impact of the adoption of ASU 2016-13 on its consolidated financial statements.

2. Revenue, Deferred Revenue and Deferred Contract Costs 

The core principle of ASC 606 is to recognize revenue to depict the transfer of services or products to customers in an amount that reflects the consideration the Company expects to be entitled to in exchange for those services or products. The principle is achieved through the following five-step approach:

 

Identification of the contract, or contracts, with the customer - The Company considers the terms and conditions of the contract and its customary business practice in identifying its contracts under ASC 606. The Company determines it has a contract with a customer when the contract is approved, the Company can identify each party’s rights regarding the services and products to be transferred, the Company can identify the payment terms for the services and products, the Company has determined the customer has the ability and intent to pay and the contract has commercial substance. At contract inception, the Company evaluates whether two or more contracts should be combined and accounted for as a single contract and whether the combined contract or single contract includes more than one performance obligation. The Company applies 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.

 

Identification of the performance obligation in the contract - Performance obligations promised in a contract are identified based on the services or products that will be transferred to the customer that are both i) capable of being distinct, whereby the customer can benefit from the service or product either on its own or together with other resources that are readily available from third parties or from the Company, and ii) distinct in the context of the contract, whereby the transfer of the services or products is separately identifiable from other promises in the contract. To the extent a contract includes multiple promised services or products, the Company applies judgment to determine whether promised services or products are capable of being distinct and distinct in the context of the contract. If these criteria are not met the promised services or products are accounted for as a combined performance obligation.

 

Determination of the transaction price - The transaction price is determined based on the consideration to which the Company expects to be entitled in exchange for transferring services and products to the customer. Variable consideration is included in the transaction price if, in the Company’s judgment, it is probable that a significant future reversal of cumulative revenue under the contract will not occur. None of the Company’s contracts contain a significant financing component.

 

Allocation of the transaction price to the 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, or SSP, basis.

 

Recognition of revenue when, or as, the Company satisfies a performance obligation - The Company recognizes revenue when control of the services or products are transferred to the customers, in an amount that reflects the consideration the Company expects to be entitled to in exchange for those services or products. The Company records its revenue net of any value added or sales tax.

The Company generates sales directly through its sales team and, to a growing extent, through its channel partners. Sales to channel partners are made at a discount and revenues are recorded at this discounted price once all revenue recognition criteria are met. Channel partners generally receive an order from an end-customer prior to placing an order with the Company, and these partners do not carry any inventory of the Company’s products or solutions. Payment from channel

11


Table of Contents

 

partners is not contingent on the partner’s success in sales to end-customers. In the event that the Company offers rebates, joint marketing funds, or other incentive programs to a partner, recorded revenues are reduced by these amounts accordingly.

Payment terms on invoiced amounts are typically 30 to 45 days.

Disaggregation of Revenue

The Company derives its revenue primarily from: (1) subscription service revenue; (2) subscription software revenue, and (3) hardware and services, which include professional service and training revenue provided to customers related to their use of the platform.

The following table presents the Company’s revenue disaggregation:

 

 

 

Three Months Ended March 31,

 

 

 

2019

 

 

2018

 

Subscription service revenue

 

$

194,402

 

 

$

152,620

 

Subscription software revenue

 

 

5,182

 

 

 

6,167

 

Hardware and services

 

 

3,353

 

 

 

3,674

 

Total revenue

 

$

202,937

 

 

$

162,461

 

 

Subscription service revenue

Subscription service revenue is derived from a subscription-based enterprise licensing model with contract terms typically ranging from one to three years, and consists of (1) subscription fees from the licensing of the Company’s security-as-a-service platform and it’s various components, (2) subscription fees for software with support and related future updates where the software updates are critical to the customers’ ability to derive benefit from the software due to the fast changing nature of the technology. These function together as one performance obligation, and (3) subscription fees for the right to access the Company’s customer support services for software with significant standalone functionality and support services for hardware. The hosted on-demand service arrangements do not provide customers with the right to take possession of the software supporting the hosted services. Support revenue is derived from ongoing security updates, upgrades, bug fixes, and maintenance. A time-elapsed method is used to measure progress because the Company transfers control evenly over the contractual period. Accordingly, the fixed consideration related to subscription service revenue is generally recognized on a straight-line basis over the contract term beginning on the date access is provided, as long as other revenue recognition criteria have been met. Most of the company’s contracts are non-cancelable over the contract term. Customers typically have the right to terminate their contract for cause if the Company fails to perform in accordance with the contractual terms. Some of the Company’s customers have the option to purchase additional subscription services at a stated price. These options are evaluated on a case-by-case basis but generally do not provide a material right as they are priced at or above the Company’s SSP and, as such, would not result in a separate performance obligation.

Subscription software revenue

Subscription software revenue is primarily derived from term-based software that is deployed on the customers’ own servers and has significant standalone functionality, is recognized upon transfer of control to the customer. The control for subscription software is transferred at the later of delivery to the customer or the software license start date.

Hardware and services

Hardware revenue consists of amounts derived from the sale of the Company’s on-premise hardware appliance, which is recognized upon passage of control, which occurs upon shipment of the product. Professional services revenue consists of fees associated with consulting, implementation and training services for assisting customers in implementing and expanding the use of the Company’s services and products. These services are distinct from subscription, subscription software licenses and hardware. Professional services do not result in significant customization of the Company’s services and products. The Company recognizes revenue related to the professional services as they are performed.

12


Table of Contents

 

Contracts with multiple performance obligations

Most of the Company’s contracts with customers contain multiple performance obligations that are distinct and accounted for separately. The transaction price allocated to subscription services and subscription software that does not have significant standalone functionality is determined by considering factors such as historical pricing practices, and the selling price of hardware and professional services is estimated using a cost plus model. The selling price for support of a functional subscription software license is calculated as a percentage of functional subscription software license value which is derived by analyzing internal pricing practice, customer expectations, and industry practice.

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 the Company’s services or products do not meet certain service level commitments, the Company’s customers are entitled to receive service credits representing a form of variable consideration. The Company has not historically experienced any significant incidents affecting the defined levels of reliability and performance as required by the Company’s subscription contracts. Accordingly, any estimated refunds related to these contracts in the condensed consolidated financial statements are not material during the periods presented.

Unbilled accounts receivables

Unbilled accounts receivable represents amounts for which the Company has recognized revenue, pursuant to its revenue recognition policy, for software licenses already delivered and professional services already performed, but billed in arrears and for which the Company believes it has an unconditional right to payment. The unbilled accounts receivable balance, included in accounts receivable in the condensed consolidated balance sheet, was $1,261 and $1,276 as of March 31, 2019 and December 31, 2018.

Deferred commissions

The Company capitalizes sales commissions and associated payroll taxes paid to internal sales personnel, and referral fees paid to independent third-parties, that are incremental to the acquisition of customer contracts. These costs are recorded as deferred commissions on the condensed consolidated balance sheets. The Company determines whether costs should be deferred based on its sales compensation plans, if the commissions are incremental and would not have occurred absent the customer contract. Sales commissions for renewal of a subscription contract are not considered commensurate with the commissions paid for the acquisition of the initial subscription contract given the substantive difference in commission rate between new and renewal contracts. Commissions paid upon the initial acquisition of a contract are amortized over an estimated period of benefit of five years while commissions paid related to renewal contracts are amortized over a contractual renewal period. Amortization is recognized based on the expected future revenue streams under the customer contracts. Amortization of deferred sales commissions is included in sales and marketing expense in the accompanying condensed consolidated statements of operations. The Company determines the period of benefit for commissions paid for the acquisition of the initial subscription contract by taking into consideration its initial estimated customer life and the technological life of the Company’s software and related significant features. The Company classifies deferred commissions as current or long-term based on the timing of when the Company expects to recognize the expense. The Company periodically reviews these deferred commission costs to determine whether events or changes in circumstances have occurred that could impact the period of benefit of these deferred contract acquisition costs. There were no material impairment losses recorded during the periods presented.

For the three months ended March 31, 2019 and 2018, the Company capitalized $12,915 and $9,214 of commission costs, respectively, and amortized $11,271 and $8,374, respectively.

Deferred product costs

Deferred product costs are the incremental costs to fulfill a contract that are directly associated with each non-cancellable customer contract and primarily consist of royalty payments made to third parties, from whom the Company has obtained licenses to integrate certain software into its products. The deferred product costs are recognized based on the contractual term, and included in cost of revenue in the accompanying condensed consolidated statements of operations. The Company classifies deferred product costs as current or long-term based on the timing of when the Company expects to recognize the expense.

13


Table of Contents

 

For the three months ended March 31, 2019 and 2018, the Company capitalized $687 and $678 of deferred product costs, respectively, and amortized $786 and $572, respectively.

Deferred revenue

The Company records deferred revenue when cash payments are received, or invoices are issued in advance of the Company’s performance, and generally recognizes revenue over the contractual term. The Company recognized $175,884 and $131,612 of revenue during the three months ended March 31, 2019 and 2018, respectively, that was included in the deferred revenue balances at the beginning of the respective periods.

The Company recognized $1,553 and $2,008 of revenue during the three months ended March 31, 2019 and 2018, respectively, related to the performance obligations satisfied in prior periods.

Remaining performance obligations

Contracted revenue as of March 31, 2019 that has not yet been recognized (“contracted not recognized”) was $468,374, which includes deferred revenue and non-cancellable amounts that will be invoiced and recognized as revenue in future periods and excludes contracts with an original expected length of one year or less. The Company expects 63% of contracted and not recognized revenue to be recognized over the next twelve months, 36% in years two and three, with the remaining balance recognized thereafter.

3. Acquisitions

Acquisitions are accounted for under the purchase method of accounting in which the tangible and identifiable intangible assets and liabilities of each acquired company are recorded at their respective fair values as of each acquisition date, including an amount for goodwill representing the difference between the respective acquisition consideration and fair values of identifiable net assets. The Company believes that for the acquisition below, the combined entities will achieve savings in corporate overhead costs and opportunities for growth through expanded geographic and customer segment diversity with the ability to leverage additional products and capabilities. These factors, among others, contributed to a purchase price in excess of the estimated fair value of the acquired company’s net identifiable assets acquired and, as a result, goodwill was recorded in connection with the acquisition. Goodwill related to the acquisition below is not deductible for tax purposes.

While the Company uses its best estimates and assumptions as part of the purchase price allocation process to value assets acquired and liabilities assumed at the acquisition date, these estimates and assumptions are subject to refinement. When additional information becomes available, such as finalization of negotiations of working capital adjustments and tax related matters, the Company may revise its preliminary purchase price allocation. As a result, during the preliminary purchase price allocation period, which may be up to one year from the acquisition date, the Company may record adjustments to the assets acquired and liabilities assumed, with the corresponding offset to goodwill. Subsequent to the purchase price allocation period, adjustments to assets acquired or liabilities assumed are recognized in the operating results.

2018 Acquisition

Wombat Security Technologies, Inc.

On February 28, 2018 (the “Wombat Acquisition Date”), pursuant to the terms of the merger agreement, the Company acquired all shares of Wombat Security Technologies, Inc. (“Wombat”), a leader for phishing simulation and security awareness computer-based training. By collecting data from Wombat’s PhishAlarm solution, the Company has access to data on phishing campaigns as seen by non-Company customers, providing broader visibility and insight to the Proofpoint Nexus platform.

With this acquisition, the Company’s customers can leverage the industry’s first solution combining the Company’s advanced threat protection with Wombat’s phishing simulation and computer-based security awareness training. With the combined solutions, the Company’s customers can:

 

Use real detected phishing attacks for simulations, assessing users based on the threats that are actually targeting them;

 

Both investigate and take action on user-reporting phishing, leveraging orchestration and automation to find real attacks, quarantine emails in users’ inboxes, and lock user accounts to limit risk;

 

Train users in the moment immediately after they click for both simulated and real phishing attacks.

14


Table of Contents

 

The Company also expects to achieve savings in corporate overhead costs for the combined entities. These factors, among others, contributed to a purchase price in excess of the estimated fair value of acquired net identifiable assets and, as a result, goodwill was recorded in connection with the acquisition.

At the Wombat Acquisition Date, the consideration transferred was $222,215, net of cash acquired of $13,452. Of the consideration transferred, $22,500 was held in escrow to secure indemnification obligations, which has not been released as of the filing date of this Quarterly Report on Form 10-Q.

Per the terms of the merger agreement, unvested in-the-money stock options held by Wombat employees were canceled and paid off using the same amount per option as for the common share less applicable exercise price for each option. The fair value of $1,580 of these unvested options was attributed to pre-combination service and included in consideration transferred. The fair value of unvested options of $1,571 was allocated to post-combination services and expensed in the three months ended March 31, 2018. Also, as part of the merger agreement, 51 shares of the Company’s common stock were deferred for certain key employees with the total fair value of $5,458 (see Note 9 “Equity Award Plans”), which was not included in the purchase price. The deferred shares are subject to forfeiture if employment terminates prior to the lapse of the restrictions, and their fair value is expensed as stock-based compensation expense over the vesting period.

The following table summarizes the fair values of tangible assets acquired, liabilities assumed, intangible assets and goodwill:

 

 

Fair Value

 

 

Estimated

Useful Life (in years)

Current assets

 

$

23,344

 

 

N/A

Fixed assets

 

 

954

 

 

N/A

Customer relationships

 

 

37,800

 

 

7

Order backlog

 

 

6,800

 

 

2

Core/developed technology

 

 

35,200

 

 

4

Trade name

 

 

2,400

 

 

4

Deferred revenue

 

 

(14,700

)

 

N/A

Deferred tax liability, net

 

 

(14,725

)

 

N/A

Other liabilities

 

 

(1,120

)

 

N/A

Goodwill

 

 

159,714

 

 

Indefinite

 

 

$

235,667

 

 

 

 

4. Goodwill and Intangible Assets

The goodwill activity and balances are presented below:

 

 

 

 

 

Beginning balance as of December 31, 2018

 

$

460,425

 

Acquisition during period

 

 

 

Purchase accounting adjustments

 

 

(3,151

)

Closing balance as of March 31, 2019

 

$

457,274

 

 

Intangible assets, excluding goodwill, consisted of the following:

 

 

 

March 31, 2019

 

 

December 31, 2018

 

 

 

Gross

Carrying

Amount

 

 

Accumulated

Amortization

 

 

Net

Carrying

Amount

 

 

Gross

Carrying

Amount

 

 

Accumulated

Amortization

 

 

Net

Carrying

Amount

 

Developed technology

 

$

154,069

 

 

$

(86,287

)

 

$

67,782

 

 

$

154,069

 

 

$

(79,525

)

 

$

74,544

 

Customer relationships

 

 

71,400

 

 

 

(17,703

)

 

 

53,697

 

 

 

71,400

 

 

 

(15,166

)

 

 

56,234

 

Trade names and patents

 

 

3,330

 

 

 

(1,580

)

 

 

1,750

 

 

 

3,330

 

 

 

(1,430

)

 

 

1,900

 

Order backlog

 

 

6,800

 

 

 

(3,683

)

 

 

3,117

 

 

 

6,800

 

 

 

(2,833

)

 

 

3,967

 

 

 

$

235,599

 

 

$

(109,253

)

 

$

126,346

 

 

$

235,599

 

 

$

(98,954

)

 

$

136,645

 

 

 

15


Table of Contents

 

Amortization of intangible assets expense was $10,299 and $8,206 for the three months ended March 31, 2019 and 2018, respectively.

Future estimated amortization of intangible assets expense as of March 31, 2019 are presented below:

 

Year ending December 31,

 

 

 

 

2019, remainder

 

$

29,651

 

2020

 

 

34,966

 

2021

 

 

31,098

 

2022

 

 

13,401

 

2023

 

 

7,312

 

Thereafter

 

 

9,918

 

 

 

$

126,346

 

 

5. Fair Value Measurements and Investments

Fair Value Measurements

Fair value is defined as the price that would be received to sell an asset or paid to transfer a liability (i.e., the “exit price”) in an orderly transaction between market participants at the measurement date. A hierarchy for inputs used in measuring fair value has been defined to minimize the use of unobservable inputs by requiring the use of observable market data when available. Observable inputs are inputs that market participants would use in pricing the asset or liability based on active market data. Unobservable inputs are inputs that reflect the Company’s assumptions about the assumptions market participants would use in pricing the asset or liability based on the best information available in the circumstances.

The fair value hierarchy prioritizes the inputs into three broad levels:

 

Level 1: Quoted (unadjusted) prices in active markets for identical assets or liabilities. The Company’s Level 1 assets generally consist of money market funds.

 

Level 2: Observable inputs other than quoted prices included in Level 1, such as quoted prices for similar assets or liabilities in active markets; quoted prices for identical or similar assets or liabilities in markets that are not active; or other inputs that are observable or can be corroborated by observable market data for substantially the full term of the asset or liability. The Company’s Level 2 assets and liabilities generally consist of corporate debt securities, commercial papers, U.S. agency and Treasury securities.

 

Level 3: Unobservable inputs to the valuation methodology that are supported by little or no market activity and that are significant to the measurement of the fair value of the assets or liabilities. Level 3 assets and liabilities include those whose fair value measurements are determined using pricing models, discounted cash flow methodologies or similar valuation techniques, as well as significant management judgment or estimation.

The following tables summarize, for each category of assets or liabilities carried at fair value, the respective fair value as of March 31, 2019 and December 31, 2018 and the classification by level of input within the fair value hierarchy:

 

 

 

March 31, 2019

 

 

 

Total

 

 

Level 1

 

 

Level 2

 

 

Level 3

 

Assets

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Cash equivalents:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Money market funds

 

$

167,781

 

 

$

167,781

 

 

$

 

 

$

 

Commercial paper

 

 

9,972

 

 

 

 

 

 

9,972

 

 

 

 

Short-term investments:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Commercial paper

 

 

32,815

 

 

 

 

 

 

32,815

 

 

 

 

Corporate debt securities

 

 

5,603

 

 

 

 

 

 

5,603

 

 

 

 

U.S. Treasury securities

 

 

1,987

 

 

 

 

 

 

1,987