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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, 2020

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)

 

(408517-4710

 

(Registrant’s telephone number, including area code)

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

Title of each class

Trading Symbol(s)

Name of each exchange on which registered

Common Stock , $0.0001 par value per share,

PFPT

NASDAQ Global Select Market

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

Shares of Proofpoint, Inc. common stock, $0.0001 par value per share, outstanding as of April 24, 2020: 57,303,438 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, 2020 and December 31, 2019

 

3

 

 

 

Condensed Consolidated Statements of Operations for the Three Months Ended March 31, 2020 and 2019

 

4

 

 

 

Condensed Consolidated Statements of Comprehensive Loss for the Three Months Ended March 31, 2020 and 2019

 

5

 

 

 

Condensed Consolidated Statements of Stockholders' Equity for the Three Months Ended March 31, 2020 and 2019

 

6

 

 

 

Condensed Consolidated Statements of Cash Flows for the Three Months Ended March 31, 2020 and 2019

 

7

 

 

 

Notes to Condensed Consolidated Financial Statements

 

9

 

 

 

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

 

27

 

 

 

ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

 

39

 

 

 

ITEM 4. CONTROLS AND PROCEDURES

 

40

 

 

 

PART II. OTHER INFORMATION

 

 

 

 

 

ITEM 1. LEGAL PROCEEDINGS

 

41

 

 

 

ITEM 1A. RISK FACTORS

 

41

 

 

 

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

 

59

 

 

 

ITEM 3. DEFAULTS UPON SENIOR SECURITIES

 

59

 

 

 

ITEM 4. MINE SAFETY DISCLOSURES

 

59

 

 

 

ITEM 5. OTHER INFORMATION

 

59

 

 

 

ITEM 6. EXHIBITS

 

60

 

 

 

SIGNATURES

 

61

 

 

 

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, 2020

 

 

December 31, 2019

 

Assets

 

 

 

 

 

 

 

 

Current assets:

 

 

 

 

 

 

 

 

Cash and cash equivalents

 

$

921,743

 

 

$

847,555

 

Short-term investments

 

 

23,927

 

 

 

43,385

 

Accounts receivable, net

 

 

172,082

 

 

 

265,741

 

Inventory

 

 

377

 

 

 

1,249

 

Deferred product costs

 

 

2,946

 

 

 

2,723

 

Deferred commissions

 

 

48,039

 

 

 

47,250

 

Prepaid expenses and other current assets

 

 

27,873

 

 

 

22,081

 

Total current assets

 

 

1,196,987

 

 

 

1,229,984

 

Property and equipment, net

 

 

79,591

 

 

 

73,512

 

Operating lease right-of-use assets

 

 

54,960

 

 

 

51,852

 

Long-term deferred product costs

 

 

417

 

 

 

581

 

Goodwill

 

 

687,517

 

 

 

687,517

 

Intangible assets, net

 

 

171,046

 

 

 

186,023

 

Long-term deferred commissions

 

 

90,053

 

 

 

90,305

 

Other assets

 

 

17,690

 

 

 

17,737

 

Total assets

 

$

2,298,261

 

 

$

2,337,511

 

Liabilities and Stockholders’ Equity

 

 

 

 

 

 

 

 

Current liabilities:

 

 

 

 

 

 

 

 

Accounts payable

 

$

9,242

 

 

$

16,311

 

Accrued liabilities

 

 

109,067

 

 

 

119,423

 

Operating lease liabilities

 

 

18,166

 

 

 

20,202

 

Deferred revenue

 

 

604,838

 

 

 

615,874

 

Total current liabilities

 

 

741,313

 

 

 

771,810

 

Convertible senior notes

 

 

757,965

 

 

 

749,620

 

Long-term operating lease liabilities

 

 

38,917

 

 

 

36,223

 

Other long-term liabilities

 

 

33,157

 

 

 

19,172

 

Long-term deferred revenue

 

 

168,730

 

 

 

168,189

 

Total liabilities

 

 

1,740,082

 

 

 

1,745,014

 

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; 57,260

   and 56,784 shares issued and outstanding at March 31, 2020 and

   December 31, 2019, respectively

 

 

6

 

 

 

6

 

Additional paid-in capital

 

 

1,357,999

 

 

 

1,318,084

 

Accumulated other comprehensive income

 

 

5

 

 

 

1

 

Accumulated deficit

 

 

(799,831

)

 

 

(725,594

)

Total stockholders’ equity

 

 

558,179

 

 

 

592,497

 

Total liabilities and stockholders’ equity

 

$

2,298,261

 

 

$

2,337,511

 

 

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,

 

 

 

2020

 

 

2019

 

Revenue:

 

 

 

 

 

 

 

 

Subscription

 

$

244,069

 

 

$

199,584

 

Hardware and services

 

 

5,705

 

 

 

3,353

 

Total revenue

 

 

249,774

 

 

 

202,937

 

Cost of revenue:(1)(2)

 

 

 

 

 

 

 

 

Subscription

 

 

59,848

 

 

 

48,252

 

Hardware and services

 

 

9,083

 

 

 

6,991

 

Total cost of revenue

 

 

68,931

 

 

 

55,243

 

Gross profit

 

 

180,843

 

 

 

147,694

 

Operating expense:(1)(2)

 

 

 

 

 

 

 

 

Research and development

 

 

69,895

 

 

 

53,249

 

Sales and marketing

 

 

123,162

 

 

 

97,004

 

General and administrative

 

 

29,555

 

 

 

25,825

 

Total operating expense

 

 

222,612

 

 

 

176,078

 

Operating loss

 

 

(41,769

)

 

 

(28,384

)

Interest expense

 

 

(8,920

)

 

 

 

Other income, net

 

 

4,621

 

 

 

726

 

Loss before income taxes

 

 

(46,068

)

 

 

(27,658

)

Provision for income taxes

 

 

(28,169

)

 

 

(620

)

Net loss

 

$

(74,237

)

 

$

(28,278

)

Net loss per share, basic and diluted

 

$

(1.30

)

 

$

(0.51

)

Weighted average shares outstanding, basic and diluted

 

 

56,974

 

 

 

55,335

 

 

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

 

 

 

 

 

 

 

 

Cost of subscription revenue

 

$

5,542

 

 

$

3,875

 

Cost of hardware and services revenue

 

$

1,371

 

 

$

906

 

Research and development

 

$

15,605

 

 

$

11,499

 

Sales and marketing

 

$

18,519

 

 

$

13,754

 

General and administrative

 

$

10,528

 

 

$

10,987

 

 

 

(2) Includes intangible amortization expense as follows:

 

 

 

 

 

 

 

 

Cost of subscription revenue

 

$

9,938

 

 

$

6,762

 

Sales and marketing

 

$

4,513

 

 

$

3,537

 

 

 

See accompanying Notes to the Condensed Consolidated Financial Statements.

 

 

 

 

 

 

 

 

 

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Proofpoint, Inc.

Condensed Consolidated Statements of Comprehensive Loss

(In thousands)

(Unaudited)

 

 

 

Three Months Ended March 31,

 

 

 

2020

 

 

2019

 

Net loss

 

$

(74,237

)

 

$

(28,278

)

Other comprehensive income, net of tax:

 

 

 

 

 

 

 

 

Unrealized gain on short-term investments, net

 

 

4

 

 

 

8

 

Comprehensive loss

 

$

(74,233

)

 

$

(28,270

)

 

See accompanying Notes to the Condensed Consolidated Financial Statements.

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Proofpoint, Inc.

Condensed Consolidated Statements of Stockholders’ Equity

(In thousands, except per share amounts)

(Unaudited)

 

 

 

Three months ended March 31, 2020

 

 

 

Common Stock

 

 

Additional

Paid-In

 

 

Accumulated

Other

Comprehensive

 

 

Accumulated

 

 

Total

Stockholders’

 

 

 

Shares

 

 

Amount

 

 

Capital

 

 

Income (Loss)

 

 

Deficit

 

 

Equity

 

Balances at December 31, 2019

 

 

56,784

 

 

$

6

 

 

$

1,318,084

 

 

$

1

 

 

$

(725,594

)

 

$

592,497

 

Net loss

 

 

 

 

 

 

 

 

 

 

 

 

 

 

(74,237

)

 

 

(74,237

)

Unrealized gain on short-term investments

 

 

 

 

 

 

 

 

 

 

 

4

 

 

 

 

 

 

4

 

Stock-based compensation expense

 

 

 

 

 

 

 

 

47,975

 

 

 

 

 

 

 

 

 

47,975

 

Common stock issued

 

 

687

 

 

 

 

 

 

16,278

 

 

 

 

 

 

 

 

 

16,278

 

Tax withholding upon vesting of restricted stock awards

 

 

(211

)

 

 

 

 

 

(24,338

)

 

 

 

 

 

 

 

 

(24,338

)

Balances at March 31, 2020

 

 

57,260

 

 

$

6

 

 

$

1,357,999

 

 

$

5

 

 

$

(799,831

)

 

$

558,179

 

 

 

 

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

 

 

See accompanying Notes to the Condensed Consolidated Financial Statements.

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Proofpoint, Inc.

Condensed Consolidated Statements of Cash Flows

(In thousands)

(Unaudited)

 

 

 

Three Months Ended March 31,

 

 

 

2020

 

 

2019

 

Cash flows from operating activities

 

 

 

 

 

 

 

 

Net loss

 

$

(74,237

)

 

$

(28,278

)

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

 

 

 

 

 

 

 

 

Depreciation and amortization

 

 

23,470

 

 

 

18,660

 

Stock-based compensation

 

 

51,565

 

 

 

41,021

 

Amortization of debt issuance costs and accretion of debt discount

 

 

8,345

 

 

 

 

Amortization of deferred commissions

 

 

14,633

 

 

 

11,271

 

Noncash lease costs

 

 

6,426

 

 

 

5,634

 

Deferred income taxes

 

 

(325

)

 

 

(60

)

Other

 

 

(1,181

)

 

 

734

 

Changes in assets and liabilities:

 

 

 

 

 

 

 

 

Accounts receivable

 

 

93,453

 

 

 

35,616

 

Inventory

 

 

872

 

 

 

(131

)

Deferred product costs

 

 

(58

)

 

 

100

 

Deferred commissions

 

 

(15,170

)

 

 

(12,915

)

Prepaid expenses

 

 

(6,290

)

 

 

(6,369

)

Other current assets

 

 

(282

)

 

 

222

 

Long-term assets

 

 

(96

)

 

 

(469

)

Accounts payable

 

 

(6,017

)

 

 

(4,305

)

Accrued liabilities

 

 

14,720

 

 

 

(12,547

)

Operating lease liabilities

 

 

(7,159

)

 

 

(6,188

)

Deferred revenue

 

 

(10,495

)

 

 

12,103

 

Net cash provided by operating activities

 

 

92,174

 

 

 

54,099

 

Cash flows from investing activities

 

 

 

 

 

 

 

 

Proceeds from maturities of short-term investments

 

 

39,232

 

 

 

32,273

 

Purchase of short-term investments

 

 

(19,876

)

 

 

(26,373

)

Purchase of property and equipment

 

 

(12,359

)

 

 

(5,477

)

Net cash provided by investing activities

 

 

6,997

 

 

 

423

 

Cash flows from financing activities

 

 

 

 

 

 

 

 

Proceeds from issuance of common stock

 

 

2,966

 

 

 

1,105

 

Withholding taxes related to restricted stock net share settlement

 

 

(27,600

)

 

 

(24,623

)

Net cash used in financing activities

 

 

(24,634

)

 

 

(23,518

)

Effect of exchange rate changes on cash, cash equivalents and restricted cash

 

 

(907

)

 

 

206

 

Net increase in cash, cash equivalents and restricted cash

 

 

73,630

 

 

 

31,210

 

Cash, cash equivalents and restricted cash

 

 

 

 

 

 

 

 

Beginning of period

 

 

857,907

 

 

 

186,152

 

End of period

 

$

931,537

 

 

$

217,362

 

 

 

 

 

 

 

 

 

 

 

 

Three Months Ended March 31,

 

 

 

2020

 

 

2019

 

Supplemental disclosure of noncash investing and financing activities

 

 

 

 

 

 

 

 

Unpaid purchases of property and equipment and asset retirement

   obligations

 

$

4,789

 

 

$

3,338

 

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

 

$

9,535

 

 

$

745

 

Liability awards converted to equity

 

$

13,313

 

 

$

12,651

 

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March 31, 2020

 

 

March 31, 2019

 

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

   the consolidated statement of cash flows

 

 

 

 

 

 

 

 

Cash and cash equivalents

 

$

921,743

 

 

$

216,586

 

Restricted cash included in prepaid expenses and other current assets

 

 

3,223

 

 

 

284

 

Restricted cash included in other non-current assets

 

 

6,571

 

 

 

492

 

Total cash, cash equivalents and restricted cash

 

$

931,537

 

 

$

217,362

 

 

See accompanying Notes to the Condensed Consolidated Financial Statements.

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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. (“Proofpoint”, “we”, “us”, “our” or the “Company”) was incorporated in Delaware in June 2002 and is headquartered in California.

Proofpoint 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.

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, 2019 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, 2020 are not necessarily indicative of the results to be expected for the year ending December 31, 2020 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, 2019 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.

Reclassifications

Certain reclassifications have been made to prior year balances in order to conform to the current period presentation. “Interest income” has been reclassified from “Interest income (expense)” to “Other income, net” in the condensed consolidated statements of operations. The reclassifications had no impact on previously reported net loss or accumulated deficit.

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.

Due to the Coronavirus (“COVID-19”) pandemic, there has been uncertainty and disruption in the global economy and financial markets. The Company is not aware of any specific event or circumstance that would require an update to its estimates or judgments or a revision of the carrying value of its assets or liabilities as of March 31, 2020. While there was not a material impact to our consolidated financial statements as of and for the quarter ended March 31, 2020, these estimates

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may change, as new events occur and additional information is obtained, as well as other factors related to COVID-19 that could result in material impacts to our consolidated financial statements in future reporting periods.

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. To test goodwill for impairment, the Company compares the reporting unit’s carrying value with its fair value. If the carrying value of the reporting unit exceeds the reporting unit’s fair value, then the impairment charge equal to the difference is recorded; however, the loss recognized would not exceed the total amount of goodwill allocated to the reporting unit. 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, 2020.

Intangible assets consist of developed technology, customer relationships, non-compete arrangements, trademarks and patents, order backlog, and in-process research and development asset. 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

 

 

2

 

 

 

7

 

Customer relationships

 

 

2

 

 

 

8

 

Order backlog

 

 

1

 

 

 

3

 

Trade names and trademarks

 

 

1

 

 

 

5

 

The in-process research and development asset is not amortized until the associated project is completed.

 

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, 2020 and 2019.

Accounting Pronouncements Adopted in 2020

In August 2018, the Financial Accounting Standards Board ("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 Company adopted ASU 2018-15 on January 1, 2020 prospectively. The adoption of ASU 2018-15 did not have a material impact on its condensed 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 is the amount by which a reporting unit’s carrying value exceeds its fair value, not to exceed the carrying amount of goodwill.

The Company adopted ASU 2017-04 on January 1, 2020 prospectively. The adoption of ASU 2017-14 did not have an impact on its condensed consolidated financial statements.

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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 are 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 Company adopted ASU 2016-13 on January 1, 2020, utilizing the modified retrospective approach. The adoption of ASU 2016-13 did not have a material impact on its condensed consolidated financial statements as credit losses are not expected to be significant based on historical collection trends, the financial condition of partners and customers, and external market factors. The Company will continue to actively monitor the impact of the COVID-19 pandemic on expected credit losses.

Recent Accounting Pronouncements Not Yet Effective

In December 2019, the FASB issued ASU No. 2019-02, Income Taxes (Topic 740): Simplifying the Accounting for Income Taxes (“ASU 2019-12”). ASU 2019-12 removes 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. ASU 2019-12 also amends other aspects of the guidance to help simplify and promote consistent application of GAAP. The guidance is effective for interim and annual periods beginning after December 15, 2020, with early adoption permitted. The Company is currently assessing the impact that the adoption of ASU 2019-12 will have 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 Company applies significant judgment in identifying and evaluating any terms and conditions in contracts which may impact revenue recognition. 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.

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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 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,

 

 

 

2020

 

 

2019

 

Subscription service revenue

 

$

236,721

 

 

$

194,402

 

Subscription software revenue

 

 

7,348

 

 

 

5,182

 

Hardware and services

 

 

5,705

 

 

 

3,353

 

Total revenue

 

$

249,774

 

 

$

202,937

 

 

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

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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.

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 $4,970 and $3,261 as of March 31, 2020 and December 31, 2019, respectively.

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, 2020 and 2019, the Company capitalized $15,170 and $12,915 of commission costs, respectively, and amortized $14,633 and $11,271, 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

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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.

For the three months ended March 31, 2020 and 2019, the Company capitalized $1,176 and $687 of deferred product costs, respectively, and amortized $1,119 and $786, 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 $218,622 and $175,884 of revenue during the three months ended March 31, 2020 and 2019, respectively, that was included in the deferred revenue balances at the beginning of the respective periods.

The Company recognized $1,060 and $1,553 of revenue during the three months ended March 31, 2020 and 2019, respectively, related to the performance obligations satisfied in prior periods.

Remaining performance obligations

Contracted revenue as of March 31, 2020 that has not yet been recognized (“contracted not recognized”) was $654,489, 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 60% of contracted and not recognized revenue to be recognized over the next twelve months, 38% 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 acquisitions described 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 companies’ net identifiable assets acquired and, as a result, goodwill was recorded in connection with the acquisitions. Goodwill related to the acquisitions of ObserveIT, Ltd. and Meta Networks, Ltd. is 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.

2019 Acquisitions

ObserveIT, Ltd.

On November 25, 2019 (the “ObserveIT Acquisition Date”), pursuant to the terms of the share purchase agreement, the Company acquired all shares of ObserveIT, Ltd. (“ObserveIT”). ObserveIT provides detection and prevention from insider threats solutions including data loss detection and response, user activity monitoring, incident response and compliance.

By combining ObserveIT’s endpoint agent technology and data risk analytics with the Company’s information classification, threat detection and intelligence, the Company has an insight into user activity with their sensitive data, wherever it resides, and the ability to immediately remediate risk.

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. The results of operations and the

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fair values of the acquired assets and liabilities assumed have been included in the accompanying consolidated financial statements since the ObserveIT Acquisition Date.

At the ObserveIT Acquisition Date, the consideration transferred was $213,747, net of cash acquired of $4,752. Of the consideration transferred, $3,250 was held in escrow to secure indemnification obligations.

Per the terms of the share purchase agreement, unvested stock options held by ObserveIT employees were canceled and exchanged for the Company’s unvested stock options. The fair value of $446 of these unvested awards was attributed to pre-combination services and was included in consideration transferred. The fair value of $5,427 was allocated to post-combination services. The unvested awards are subject to the recipient’s continued service with the Company and $5,427 is recognized ratably as stock-based compensation expense over the required remaining service period.  

Also, as part of the share purchase agreement, the unvested restricted shares of a certain employee of ObserveIT were exchanged into the right to receive $532 of deferred cash consideration. The deferred cash consideration is presented as restricted cash on the Company’s consolidated balance sheet s as of March 31, 2020 and December 31, 2019. The deferred cash consideration of $485 was allocated to post-combination expense and was not included in the purchase price. The deferred cash consideration is subject to forfeiture if employment terminates prior to the lapse of the restrictions, and the fair value is expensed as compensation expense over the three-year vesting period.

The Discounted Cash Flow Method was used to value the acquired developed technology, in-process research and development asset, customer relationships and order backlog. The Relief from Royalty Method was used to value the acquired trade name. Management applied significant judgment in estimating the fair values of these intangible assets, which involved the use of significant assumptions with respect to forecasted revenue, forecasted operating results and discount rates.

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

 

 

Estimated

Fair Value

 

 

Estimated

Useful Life

(in years)

 

Current assets

 

$

10,603

 

 

N/A

 

Fixed assets

 

 

2,132

 

 

N/A

 

Operating lease right-of-use asset

 

 

2,669

 

 

N/A

 

Other assets