The following discussion and analysis of our financial condition and results of operations should be read in conjunction with the condensed consolidated financial statements and related notes included elsewhere in this Quarterly Report on Form 10-Q and with our Management's Discussion and Analysis of Financial Condition and Results of Operations included in our Annual Report on Form 10-K for the year endedJuly 31, 2022 (the "Fiscal 2022 Form 10-K"), filed with theSEC onSeptember 15, 2022 . As discussed in the section titled "Special Note Regarding Forward-Looking Statements," the following discussion contains forward-looking statements that involve risks and uncertainties. Our actual results could differ materially from those discussed below. Factors that could cause or contribute to such difference include, but are not limited to, those identified below and those discussed in the section titled "Risk Factors" and elsewhere in this Quarterly Report on Form 10-Q. Our fiscal year end isJuly 31 , and our fiscal quarters end onOctober 31 ,January 31 ,April 30 andJuly 31 . Our fiscal year endedJuly 31, 2022 is referred to as fiscal 2022 and our fiscal year endingJuly 31, 2023 is referred to as fiscal 2023.
Overview
Zscaler was incorporated in 2007, during the early stages of cloud adoption and mobility, based on a vision that the internet would become the new corporate network as the cloud becomes the new data center. We predicted that with rapid cloud adoption and increasing workforce mobility, traditional perimeter security approaches would provide inadequate protection for users and data and an increasingly poor user experience. We pioneered a cloud platform, theZscaler Zero Trust Exchange, that represents a fundamental shift in the architectural design and approach to networking and security. We generate revenue primarily from sales of subscriptions to access our cloud platform, together with related support services. We also generate an immaterial amount of revenue from professional and other services, which consist primarily of fees associated with mapping, implementation, network design and training. Our subscription pricing is primarily calculated on a per-user basis. We recognize subscription and support revenue ratably over the life of the contract, which is generally one to three years. As ofJuly 31, 2022 , we had expanded our operations to over 6,700 customers across major industries, with users in 185 countries. Government agencies and some of the largest enterprises in the world rely on us to support their digital transformation, including more than 600 of the Forbes Global 2000 as ofJuly 31, 2022 . We operate our business as one reportable segment. Our revenue has experienced significant growth in recent periods. For three months endedOctober 31, 2022 and 2021, our revenue was$355.5 million and$230.5 million , respectively. We have incurred net losses in all periods since our inception. For the three months endedOctober 31, 2022 and 2021, our net loss was$68.2 million and$90.8 million , respectively. We expect we will continue to incur net losses for the foreseeable future, as we continue to invest in our sales and marketing organization to take advantage of our market opportunity, to invest in research and development efforts to enhance the functionality of our cloud platform, to incur additional compliance and other related costs as we operate as a public company, and to address any legal matters and related accruals, as further described in Note 9, Commitments and Contingencies, of the condensed consolidated financial statements included elsewhere in this Quarterly Report on Form 10-Q.
Impact of macroeconomic conditions and COVID-19
Recent changes in macroeconomic conditions such as high inflation and recessionary environments can cause uncertainty in our business. For the three months endedOctober 31, 2022 , we experienced growth in total revenue but also saw increased scrutiny and a longer approval process for transactions, particularly larger deals. Macroeconomic conditions, including inflation and continued uncertainty regarding the current and future political and economic environment, may impact the future demand for subscriptions of our cloud platform. InMarch 2020 , theWorld Health Organization declared the COVID-19 outbreak to be a pandemic. As a result of the COVID-19 pandemic, we modified certain aspects of our business, including restricting employee travel, requiring 27
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employees to work from home, transitioning our employee onboarding and training processes to remote or online programs, and canceling certain events and meetings, among other modifications. In April of 2022, we began re-opening certain of our offices. We have also permitted business travel and invited employees to return to work on a voluntary basis. We will continue to actively monitor and evaluate the situation and may take further actions that alter our business operations as may be required by federal, state or local authorities or that we determine are in the best interests of our employees, customers, partners, suppliers and stockholders. The effects of these operational modifications are unknown and may not be known until future reporting periods. While we have not experienced significant disruptions to our operations or financial performance from the COVID-19 pandemic to date, we are unable to accurately predict the full impact that COVID-19 will have due to numerous uncertainties, including the duration of the outbreak, the current or a future resurgence of the outbreak in connection with new variants and mutations, the widespread distribution and long-term efficacy of vaccines, the efficacy of vaccines against new variants or mutations, actions that may be taken by governmental authorities, the impact on our business including our sales cycle, sales execution and marketing efforts, and the impact to the business of our customers, vendors and partners. For further discussion of the challenges and risks we confront related to the COVID-19 pandemic, please refer to Part II, Item 1A Risk Factors of this Quarterly Report on Form 10-Q.
Certain Factors Affecting Our Performance
Increased Internet Traffic and Adoption of
The adoption of cloud applications and infrastructure, explosion of internet traffic volumes and shift to mobile-first computing generally, and the pace at which enterprises adopt the internet as their corporate network in particular, impact our ability to drive market adoption of our cloud platform. We believe that most enterprises are in the early stages of a broad transformation to the cloud. Organizations are increasingly relying on the internet to operate their businesses, deploying new SaaS applications and migrating internally managed line-of-business applications to the cloud. However, the growing dependence on the internet has increased exposure to malicious or compromised websites, and sophisticated hackers are exploiting the gaps left by legacy network security appliances. To securely access the internet and transform their networks, organizations must also make fundamental changes in their network and security architectures. We believe that most organizations have yet to fully make these investments. Since we enable organizations to securely embrace digital transformation, we believe that the imperative for organizations to securely move to the cloud will increase demand for our cloud platform and broaden our customer base. New Customer Acquisition We believe that our ability to increase the number of customers, and more significantly, customers in the Forbes Global 2000, on our cloud platform is an indicator of our market penetration and our future business opportunities. As ofJuly 31, 2022 and 2021, we had over 6,700 and over 5,600 customers, respectively, across all major geographies. As ofJuly 31, 2022 , we had over 600 of the Forbes Global 2000 as customers. Our ability to continue to grow these numbers will increase our future opportunities for renewals and follow-on sales. We believe that we have significant room to capture additional market share and intend to continue to invest significantly in sales and marketing to engage our prospective customers, increase brand awareness, further leverage our channel partnerships and drive adoption of our solution.
Follow-On Sales
We typically expand our relationship with our customers over time. While most of our new customers route all of their internet-bound web traffic through our cloud platform, some of our customers initially use our services for specific users or specific security functionality. We leverage our land-and-expand model with the goal of generating incremental revenue, often within the term of the initial subscription, by increasing sales to our existing customers in one of three ways:
•expanding deployment of our cloud platform to cover additional users;
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•upgrading to a more advanced Business or Transformation edition; and
•selling a subscription to a new solution or product, for example selling a ZPA subscription to a ZIA customer or a ZIA subscription to a ZPA customer.
These purchases increase the Annual Recurring Revenue ("ARR") attributable to our customers over time. To establish ARR for a customer, we use the total amount of each order booked to compute the annual recurring value of revenue that we would recognize if the customer continues to renew all contractual subscriptions. For example, a contract for$3.0 million with a contractual term of three years would have ARR of$1.0 million as long as our customer uses our cloud platform.
Investing in Business Growth
Since our founding, we have invested significantly in growing our business. We intend to continue (i) investing in our research and development organization and our development efforts to offer new solutions on our cloud platform and (ii) dedicating resources to update and upgrade our existing solutions. In addition, we expect our general and administrative expenses to increase in absolute dollars in the foreseeable future, as we continue to operate as a public company, and address any legal matters and related accruals, as further described in Note 9, Commitments and Contingencies, of the condensed consolidated financial statements included elsewhere in this Quarterly Report on Form 10-Q. We also intend to continue to invest significantly in sales and marketing to grow and train our sales force, broaden our brand awareness and expand and deepen our channel partner relationships. While these planned investments will increase our operating expenses in the short term, we believe that over the long term these investments will help us to expand our customer base and grow our business. We also are investing in programs to increase recognition of our brand and solutions, including joint marketing activities with our channel partners and strategic partners. While we expect our operating expenses to increase in absolute dollars in the foreseeable future as a result of these activities, we intend to balance these investments in future growth with a continued focus on managing our results of operations and investing judiciously. In the long term we anticipate that these investments will positively impact our business and results of operations.
Key Business Metrics and Other Financial Measures
We review a number of operating and financial metrics, including the following key metrics, to measure our performance, identify trends, formulate business plans and make strategic decisions.
Dollar-Based Net Retention Rate
We believe that dollar-based net retention rate is a key metric to measure the long-term value of our customer relationships because it is driven by our ability to retain and expand the recurring revenue generated from our existing customers. Our dollar-based net retention rate compares the recurring revenue from a set of customers against the same metric for the prior 12-month period on a trailing basis. Because our customers have repeat buying patterns and the average term of our contracts is more than 12 months, we measure this metric over a set of customerswho were with us as of the last day of the same reporting period in the prior fiscal year. Our dollar-based net retention rate includes customer attrition. We have not experienced a material increase in customer attrition rates in recent periods. For the trailing 12 months endedOctober 31, 2022 and 2021, the dollar-based net retention rate was above 125%.
We calculate our dollar-based net retention rate as follows:
Denominator: To calculate our dollar-based net retention rate as of the end of a reporting period, we first establish the ARR from all active subscriptions as of the last day of the same reporting period in the prior fiscal year. This effectively 29
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represents recurring dollars that we expect in the next 12-month period from the cohort of customers that existed on the last day of the same reporting period in the prior fiscal year. Numerator: We measure the ARR for that same cohort of customers representing all subscriptions based on confirmed customer orders booked by us as of the end of the reporting period. Dollar-based net retention rate is obtained by dividing the numerator by the denominator. Our dollar-based net retention rate may fluctuate due to a number of factors, including the performance of our cloud platform, our success in selling bigger deals, including deals for all employees with our higher-end bundles, selling multiple-pillars from the start of our contract with new customers, faster upsells within a year, the timing and the rate of ARR expansion of our existing customers, potential changes in our rate of renewals and other risk factors described elsewhere in this Quarterly Report on Form 10-Q.
Non-GAAP Financial Measures
In addition to our results determined in accordance with GAAP, we believe the following non-GAAP measures are useful in evaluating our operating performance. We use the following non-GAAP financial information to evaluate our ongoing operations and for internal planning and forecasting purposes. We believe that non-GAAP financial information, when taken collectively, may be helpful to investors because it provides consistency and comparability with past financial performance. However, non-GAAP financial information is presented for supplemental informational purposes only, has limitations as an analytical tool and should not be considered in isolation or as a substitute for financial information presented in accordance with GAAP. In particular, free cash flow is not a substitute for cash provided by operating activities. Additionally, the utility of free cash flow as a measure of our liquidity is further limited as it does not represent the total increase or decrease in our cash balance for a given period. In addition, other companies, including companies in our industry, may calculate similarly-titled non-GAAP measures differently or may use other measures to evaluate their performance, all of which could reduce the usefulness of our non-GAAP financial measures as tools for comparison. A reconciliation is provided below for each non-GAAP financial measure to the most directly comparable financial measure stated in accordance with GAAP. Investors are encouraged to review the related GAAP financial measures and the reconciliation of these non-GAAP financial measures to their most directly comparable GAAP financial measures, and not to rely on any single financial measure to evaluate our business.
Non-GAAP Gross Profit and Non-GAAP Gross Margin
We define non-GAAP gross profit as GAAP gross profit excluding stock-based compensation expense and related payroll taxes and amortization expense of acquired intangible assets. We define non-GAAP gross margin as non-GAAP gross profit as a percentage of revenue.
Three Months Ended October 31, 2022 2021 (in thousands) GAAP Gross profit$ 278,851 $ 178,348 Add: Stock-based compensation expense and related payroll taxes 8,661 5,319 Amortization expense of acquired intangible assets 1,939 2,056 Non-GAAP gross profit$ 289,451 $ 185,723 GAAP Gross margin 78 % 77 % Non-GAAP gross margin 81 % 81 % 30
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Non-GAAP Income from Operations and Non-GAAP Operating Margin
We define non-GAAP income from operations as GAAP loss from operations, excluding stock-based compensation expense and related payroll taxes and amortization expense of acquired intangible assets. We define non-GAAP operating margin as non-GAAP income from operations as a percentage of revenue.
Three Months Ended October 31, 2022 2021 (in thousands) GAAP loss from operations$ (69,087) $ (74,371) Add: Stock-based compensation expense and related payroll taxes 108,636 96,094 Amortization expense of acquired intangible assets 2,552 2,226 Non-GAAP income from operations$ 42,101 $ 23,949 GAAP operating margin (19) % (32) % Non-GAAP operating margin 12 % 10 %
Free Cash Flow and Free Cash Flow Margin
Free cash flow is a non-GAAP financial measure that we calculate as net cash provided by operating activities less purchases of property, equipment and other assets and capitalized internal-use software. Free cash flow margin is calculated as free cash flow divided by revenue. We believe that free cash flow and free cash flow margin are useful indicators of liquidity that provide information to management and investors about the amount of cash generated from our operations that, after the investments in property, equipment and other assets and capitalized internal-use software, can be used for strategic initiatives, including investing in our business and strengthening our financial position. Free cash flow includes the cyclical impact of inflows and outflows resulting from contributions to our employee stock purchase plan for which the purchase period of approximately six months ends in each of our second and fourth fiscal quarter. As ofOctober 31, 2022 , the accrued employee payroll contributions to our ESPP was$12.6 million , which will be used to purchase shares at the end of the current purchase period ending onDecember 15, 2022 . Payroll contributions ultimately used to purchase shares will be reclassified to stockholders' equity upon issuance of the shares during our second quarter of fiscal 2023. 31
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Table of Contents Three Months Ended October 31, 2022 2021 (in thousands) Net cash provided by operating activities$ 128,457 $ 93,271
Less:
Purchases of property, equipment and other assets (25,202) (6,454) Capitalized internal-use software (7,641) (3,450) Free cash flow$ 95,614 $ 83,367 As a percentage of revenue: Net cash provided by operating activities 36 % 40 %
Less:
Purchases of property, equipment and other assets (7) % (3) % Capitalized internal-use software (2) % (1) % Free cash flow margin 27 % 36 % Calculated Billings Calculated billings is a non-GAAP financial measure that we believe is a key metric to measure our periodic performance. Calculated billings represents our total revenue plus the change in deferred revenue in a period. Calculated billings in any particular period aims to reflect amounts invoiced for subscriptions to access our cloud platform, together with related support services for our new and existing customers. We typically invoice our customers annually in advance, and to a lesser extent quarterly in advance, monthly in advance or multi-year in advance. Calculated billings increased$92.4 million , or 37%, for the three months endedOctober 31, 2022 over the three months endedOctober 31, 2021 . As calculated billings continues to grow in absolute terms, we expect our calculated billings growth rate to trend down over time. We also expect that calculated billings will be affected by seasonality in terms of when we enter into agreements with customers; and the mix of billings in each reporting period as we typically invoice customers annually in advance, and to a lesser extent quarterly in advance, monthly in advance or multi-year in advance. Three Months Ended October 31, 2022 2021 (in thousands) Revenue $ 355,548$ 230,517 Add: Total deferred revenue, end of period 1,005,713 647,816 Less: Total deferred revenue, beginning of period (1,021,123) (630,601) Calculated billings $ 340,138$ 247,732
Components of Results of Operations
Revenue
We generate revenue primarily from sales of subscriptions to access our cloud platform, together with related support services. Subscription and related support services accounted for approximately 97% of our revenue for each of the three months endedOctober 31, 2022 and 2021. Our contracts with our customers do not at any time provide the customer with the right to take possession of the software that runs our cloud platform. Our customers may also purchase professional services, such as mapping, implementation, network design and training. Professional services account for an immaterial portion of our revenue. 32
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We generate revenue from contracts with typical durations ranging from one to three years. We typically invoice our customers annually in advance, and to a lesser extent quarterly in advance, monthly in advance or multi-year in advance. We recognize revenue ratably over the life of the contract. Amounts that have been invoiced are recorded in deferred revenue, or they are recorded in revenue if the revenue recognition criteria have been met. Subscriptions that are invoiced annually in advance or multi-year in advance represent a significant portion of our short-term and long-term deferred revenue in comparison to invoices issued quarterly in advance or monthly in advance. Accordingly, we cannot predict the mix of invoicing schedules in any given period. We generally experience seasonality in terms of when we enter into agreements with our customers. We typically enter into a higher percentage of agreements with new customers, as well as renewal agreements with existing customers, in our second and fourth fiscal quarters. However, because we recognize revenue ratably over the terms of our subscription contracts, a substantial portion of the revenue that we report in each period is attributable to the recognition of deferred revenue relating to agreements that we entered into during previous periods. Consequently, increases or decreases in new sales or renewals in any one period may not be immediately reflected as revenue for that period. Accordingly, the effect of downturns in sales and market acceptance of our platform, and potential changes in our rate of renewals, may not be fully reflected in our results of operations until future periods.
Cost of Revenue
Cost of revenue includes expenses related to operating our cloud platform in data centers, depreciation of our data center equipment, amortization of our capitalized internal-use software, amortization of intangible assets acquired through our business acquisitions and allocated overhead expenses (i.e., facilities, IT, depreciation expense and amortization expense). Cost of revenue also includes employee-related expenses, including salaries, bonuses, stock-based compensation expense and employee benefit expenses associated with our customer support and cloud operations organizations. As our customers expand and increase the use of our cloud platform driven by additional applications and connected devices, our cost of revenue will increase due to higher bandwidth and data center expenses. However, we expect to continue to benefit from economies of scale as our customers increase the use of our cloud platform. We intend to continue to invest additional resources in our cloud platform and our customer support organizations as we grow our business. The level and timing of investment in these areas could affect our cost of revenue in the future.
Gross Profit and Gross Margin
Gross profit, or revenue less cost of revenue, and gross margin, or gross profit as a percentage of revenue, have been and will continue to be affected by various factors, including the timing of our acquisition of new customers and our renewals of and follow-on sales to existing customers, the average sales price of our services, mix of services offered in our solutions, including new product introductions, the data center and bandwidth costs associated with operating our cloud platform, the extent to which we expand our customer support and cloud operations organizations and the extent to which we can increase the efficiency of our technology, infrastructure and data centers through technological improvements. We expect our gross profit to increase in absolute dollars and our gross margin to increase slightly over the long term, although our gross profit and gross margin could fluctuate from period to period depending on the interplay of all of the above factors.
Operating Expenses
Our operating expenses consist of sales and marketing, research and development and general and administrative expenses. Personnel expenses are the most significant component of operating expenses and consist of salaries, benefits, bonuses, stock-based compensation expense and, with respect to sales and marketing expenses, sales commissions that are recognized as expenses over the period of benefit. Operating expenses also include overhead expenses for facilities, IT, depreciation expense and amortization expense. 33
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Sales and Marketing
Sales and marketing expenses consist primarily of employee compensation and related expenses, including salaries, bonuses and benefits for our sales and marketing employees, sales commissions that are recognized as expenses over the period of benefit, stock-based compensation expense, marketing programs, travel and entertainment expenses, expenses for conferences and events, amortization of intangible assets acquired through our business acquisitions and allocated overhead expenses. We capitalize our sales commissions and associated payroll taxes and recognize them as expenses over the estimated period of benefit. The amount recognized in our sales and marketing expenses reflects the amortization of expenses previously deferred as attributable to each period presented in this Quarterly Report on Form 10-Q, as described below under "Critical Accounting Policies and Estimates." We intend to continue to make significant investments in our sales and marketing organization to drive additional revenue, further penetrate the market and expand our global customer base. As a result, we expect our sales and marketing expenses to continue to increase in absolute dollars and to be our largest operating expense category for the foreseeable future. In particular, we will continue to invest in growing and training our sales force, broadening our brand awareness and expanding and deepening our channel partner relationships. However, we expect our sales and marketing expenses to decrease as a percentage of our revenue over the long term, although our sales and marketing expenses may fluctuate as a percentage of our revenue from period to period due to the timing and extent of these expenses. Research and Development Our research and development expenses support our efforts to add new products, new features to our existing offerings and to ensure the reliability, availability and scalability of our solutions. Our cloud platform is software-driven, and our research and development teams employ software engineers in the design, and the related development, testing, certification and support, of these solutions. Accordingly, a majority of our research and development expenses result from employee-related expenses, including salaries, bonuses and benefits, stock-based compensation expense and expenses associated with technology tools used by our engineers. We expect our research and development expenses to continue to increase in absolute dollars for the foreseeable future, as we continue to invest in research and development efforts to enhance the functionality of our cloud platform, improve the reliability, availability and scalability of our platform and access new customer markets. However, we expect our research and development expenses to decrease as a percentage of our revenue over the long term, although our research and development expenses may fluctuate as a percentage of our revenue from period to period due to the timing and extent of these expenses.
General and Administrative
General and administrative expenses consist primarily of employee-related expenses, including salaries and bonuses, stock-based compensation expense and employee benefit expenses for our finance, legal, human resources and administrative personnel, as well as professional fees for external legal services (including certain litigation-related expenses), accounting and other related consulting services. The litigation-related expenses include professional fees and related expenses incurred by us in defending or settling significant claims that we deem not to be in the ordinary course of our business and, if applicable, accruals related to estimated losses in connection with these claims. We expect our general and administrative expenses to increase in absolute dollars for the foreseeable future, as we continue to incur compliance expenses, and other related expenses necessary to operate as a public company, and due to any legal matters and related accruals, as further described in Note 9, Commitments and Contingencies, to the condensed consolidated financial statements included elsewhere in this Quarterly Report on Form 10-Q. However, we expect our general and administrative expenses to decrease as a percentage of our revenue over the long term, although our general and administrative expenses may fluctuate as a percentage of our revenue from period to period due to the timing and extent of these expenses. In particular, litigation-related expenses related to significant litigation claims may result in significant fluctuations from period to period as they are inherently subject to change and difficult to estimate. 34
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Interest Expense
Interest expense consists primarily of amortization of debt discount and issuance costs and recognition of contractual interest expense related to the Notes. See Note 8, Convertible Senior Notes, of the condensed consolidated financial statements included elsewhere in this Quarterly Report on Form 10-Q. EffectiveAugust 1, 2022 , we adopted ASU 2020-06. The adoption of this standard resulted in the elimination of the amortization of the debt discount as interest expense and the portion of the issuance costs initially allocated to equity is now classified as debt and amortized as interest expense.
Interest Income
Interest income consists primarily of income earned on our cash equivalents and short-term investments.
Other Expense, Net
Other expense, net consists primarily of foreign currency transaction gains and losses and changes in fair value of our non-designated derivative instruments.
Provision for Income Taxes
Our provision for income taxes consists primarily of income and withholding taxes in the foreign jurisdictions, andU.S. income taxes from a tax law change related to mandatory capitalization of research and development expenses for tax years startingJanuary 1, 2022 . Inthe United States , we have recorded deferred tax assets for which we provide a full valuation allowance, which includes net operating loss carryforwards and research and development tax credits. We expect to maintain this full valuation allowance for the foreseeable future as it is more likely than not that some or all of those deferred tax assets may not be realized based on our history of losses. Additionally, in theU.K. , we have recorded deferred tax assets for which we provide a full valuation allowance, which includes net operating loss carryforwards. We expect to maintain this full valuation allowance for the foreseeable future as it is more likely than not that some or all of those deferred tax assets may not be realized based on our history of losses. 35
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Results of Operations
The following tables set forth our results of operations for the periods presented in dollars and as a percentage of our revenue:
Three Months Ended October 31, 2022 2021 (in thousands) Revenue$ 355,548 $ 230,517 Cost of revenue (1)(2) 76,697 52,169 Gross profit 278,851 178,348 Operating expenses: Sales and marketing (1)(2) 228,836
153,786
Research and development (1)(2) 74,946
65,216
General and administrative (1) 44,156 33,717 Total operating expenses 347,938 252,719 Loss from operations (69,087) (74,371) Interest income 7,865 473 Interest expense (3) (1,331) (13,835) Other expense, net (863) (589) Loss before income taxes (63,416) (88,322) Provision for income taxes 4,746 2,479 Net loss$ (68,162) $ (90,801) (1) Includes stock-based compensation expense and related payroll taxes as follows: Cost of revenue$ 8,661 $ 5,319 Sales and marketing 55,469 43,464 Research and development 25,233 28,570 General and administrative 19,273 18,741 Total$ 108,636 $ 96,094 (2) Includes amortization expense of acquired intangible assets as follows: Cost of revenue$ 1,939 $ 2,056 Sales and marketing 178 170 Research and development 435 - Total$ 2,552 $ 2,226
(3) Includes amortization of debt discount and issuance costs
$ 13,476 as follows: 36
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Table of Contents Three Months Ended October 31, 2022 2021 Revenue 100% 100% Cost of revenue 22 23 Gross margin 78 77 Operating expenses Sales and marketing 64 67 Research and development 21 28 General and administrative 12 14 Total operating expenses 97 109 Operating margin (19) (32) Interest income 2 - Interest expense (1) (6) Other expense, net - - Loss before income taxes (18) (38) Provision for income taxes 1 1 Net loss (19)% (39)% 37
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Comparison of the Three Months Ended
Revenue Three Months Ended October 31, Change 2022 2021 $ % (in thousands) Revenue$ 355,548 $ 230,517 $ 125,031 54 % Revenue increased by$125.0 million , or 54%, for the three months endedOctober 31, 2022 , compared to the three months endedOctober 31, 2021 . The increase in revenue was driven by an increase in users and sales of additional subscriptions to existing customers, which contributed$83.3 million in additional revenue. The remainder of the increase was primarily attributable to the addition of new customers, as we increased our customer base by 18% fromOctober 31, 2021 toOctober 31, 2022 .
Cost of Revenue and Gross Margin
Three Months Ended October 31, Change 2022 2021 $ % (in thousands) Cost of revenue$ 76,697 $ 52,169 $ 24,528 47 % Gross margin 78 % 77 % Cost of revenue increased by$24.5 million , or 47%, for the three months endedOctober 31, 2022 , compared to the three months endedOctober 31, 2021 . The overall increase in cost of revenue was driven primarily by the expanded use of our cloud platform by existing and new customers, which led to an increase of$11.9 million for data center and equipment related costs for hosting and operating our cloud platform. Additionally, our employee-related expenses increased by$9.7 million , inclusive of an increase of$3.4 million in stock-based compensation expense, driven primarily by a 62% increase in headcount in our customer support and cloud operations organizations fromOctober 31, 2021 toOctober 31, 2022 . The remainder of the increase was primarily attributable to increased expenses of$1.8 million for facility and IT services. Gross margin increased from 77% for the three months endedOctober 31, 2021 to 78% for the three months endedOctober 31, 2022 . The increase in gross margin is primarily due to the additional hardware costs incurred in the three months endedOctober 31, 2021 . Operating Expenses Sales and Marketing Expenses Three Months Ended October 31, Change 2022 2021 $ % (in thousands) Sales and marketing expenses$ 228,836 $ 153,786 $ 75,050 49 % Sales and marketing expenses increased by$75.1 million , or 49%, for the three months endedOctober 31, 2022 , compared to the three months endedOctober 31, 2021 . The increase was primarily due to a 50% increase in headcount fromOctober 31, 2021 toOctober 31, 2022 , resulting in an increase of$48.7 million in employee-related expenses, inclusive of an increase of$12.9 million in stock-based compensation expense, and an increase of$11.2 million in sales commissions 38
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expense. The remainder of the increase was primarily attributable to increased expenses of$13.8 million in travel expense,$6.1 million for facility and IT services and$2.7 million in marketing and advertising expense.
Research and Development Expenses
Three Months Ended October 31, Change 2022 2021 $ % (in thousands)
Research and development expenses $ 74,946
15 % Research and development expenses increased by$9.7 million , or 15%, for the three months endedOctober 31, 2022 , compared to the three months endedOctober 31, 2021 , as we continued to develop and enhance the functionality of our cloud platform and integrate technologies acquired through our business combinations. The increase was primarily driven by an increase of$10.9 million in employee-related expenses, excluding stock-based compensation expense which decreased in the three months endedOctober 31, 2022 . This increase in employee-related expenses was driven by a 58% increase in headcount fromOctober 31, 2021 toOctober 31, 2022 . The remainder of the increase in research and development expenses was primarily attributable to increased expenses of$3.6 million in facility, software and equipment related expenses to support our growth. These increases were partially offset by a decrease in stock-based compensation expense of$2.7 million , primarily as a result of the resignation of our President inOctober 2022 which resulted in the reversal of$9.9 million of stock-based compensation expense associated with the cancellation of unvested incentive equity awards in the three months endedOctober 31, 2022 . The net increase was further offset by higher capitalized internal-use software development costs of$4.2 million to support the enhancement and growth of our cloud platform.
General and Administrative Expenses
Three Months Ended October 31, Change 2022 2021 $ % (in thousands)
General and administrative expenses $ 44,156
31 % General and administrative expenses increased by$10.4 million , or 31%, for the three months endedOctober 31, 2022 , compared to the three months endedOctober 31, 2021 . The overall increase was primarily due to an increase of$4.2 million in employee-related expenses, inclusive of an increase of$1.6 million in stock-based compensation expense, driven in part by a 65% increase in headcount fromOctober 31, 2021 toOctober 31, 2022 . The remainder of the increase was primarily attributable to increased expenses of$2.9 million for professional services and$1.3 million for facility related expenses. Interest Income Three Months Ended October 31, Change 2022 2021 $ % (in thousands) Interest income $ 7,865$ 473 $ 7,392 1,563 %
Interest income increased by
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Table of Contents Interest Expense Three Months Ended October 31, Change 2022 2021 $ % (in thousands) Interest expense$ (1,331) $ (13,835) $ (12,504) (90) % Interest expense decreased by$12.5 million for the three months endedOctober 31, 2022 , compared to the three months endedOctober 31, 2021 . The decrease in interest expense was primarily due to the derecognition of the unamortized debt discount as a result of the adoption of ASU 2020-06. For further information refer to Note 1, Business and Summary of Significant Accounting Policies of our condensed consolidated financial statements included elsewhere in this Quarterly Report on Form 10-Q. Other Expense, Net Three Months Ended October 31, Change 2022 2021 $ % (in thousands) Other expense, net $ (863)$ (589) $ (274) (47) % Other expense, net increased by$0.3 million for the three months endedOctober 31, 2022 compared to the three months endedOctober 31, 2021 . The increase was primarily driven by fluctuations in foreign currency transactions gains and losses. Provision for Income Taxes Three Months Ended October 31, Change 2022 2021 $ % (in thousands) Provision for income taxes $ 4,746$ 2,479 $ 2,267 91 % Our provision for income taxes increased by$2.3 million for the three months endedOctober 31, 2022 , compared to the three months endedOctober 31, 2021 . The increase in the provision for income taxes for the three months endedOctober 31, 2022 was due to the increase in our pre-tax income in the foreign jurisdictions in which we conduct business, and the impact of a tax law change related to mandatory capitalization of research and development expenses in theU.S. for tax-purposes, which was enacted as part of the Tax Cuts and Jobs Act of 2017 and became effective onJanuary 1, 2022 . Our provision for income taxes for interim periods is determined using an estimate of our annual effective tax rate, adjusted for discrete items, if any, that arise during the period. Each fiscal quarter, we update our estimate of the annual effective tax rate, and if the estimated annual effective tax rate changes, we make a cumulative adjustment in such periods. Our quarterly tax provision, and estimate of our annual effective tax rate, is subject to variation due to several factors, including variability in pre-tax income or loss, the mix of jurisdictions to which such income relates, changes in how we do business and tax law developments. Our estimated annual effective tax rate for the year differs from theU.S. statutory rate of 21% primarily due to the benefit of a portion of our earnings being taxed at rates lower than theU.S. statutory rate. 40
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The realization of deferred tax assets is dependent upon the generation of sufficient taxable income of the appropriate character in future periods. We assess our ability to realize our deferred tax assets on a quarterly basis and we establish a valuation allowance if it is more-likely-than-not that some portion of the deferred tax assets will not be realized. We weigh all available positive and negative evidence, including our earnings history and results of recent operations, scheduled reversals of deferred tax liabilities, projected future taxable income and tax planning strategies. Due to the weight of objectively verifiable negative evidence, including our history of losses in certain jurisdictions, we believe that it is more likely than not that ourU.S. federal, state, andU.K. deferred tax assets will not be realized. Accordingly, we have maintained a valuation allowance on ourU.S. federal, state, andU.K. deferred tax assets.
Liquidity and Capital Resources
As ofOctober 31, 2022 , our principal sources of liquidity were cash, cash equivalents and short-term investments totaling$1,824.8 million which were held for working capital and general corporate purposes. Our cash equivalents and investments consist of highly liquid investments in money market funds,U.S. treasury securities,U.S. government agency securities and corporate debt securities. InJune 2020 , we completed the private offering of the Notes with an aggregate principal amount of$1,150.0 million . The total net proceeds from the offering, after deducting initial purchase discount and issuance costs, was$1,130.5 million . In connection with the Notes, we entered into the Capped Call transactions which are expected to reduce the potential dilution of our common stock upon any conversion of the Notes and/or offset any cash payments we could be required to make in excess of the principal amount of converted Notes. We used an aggregate amount of$145.2 million of the net proceeds of the Notes to purchase the Capped Calls. We have generated significant losses from operations, as reflected in our accumulated deficit of$956.2 million as ofOctober 31, 2022 . We expect to continue to incur operating losses and have in the past and may in the future generate negative cash flows due to expected investments to grow our business, including potential business acquisitions and other strategic transactions. We believe that our existing cash, cash equivalents and short-term investments will be sufficient to fund our operating and capital needs for at least the next 12 months from the issuance of our financial statements. Our foreseeable cash needs, in addition to our recurring operating costs, include our expected capital expenditures to support expansion of our infrastructure and workforce, lease obligations, purchase commitments, potential business acquisitions and other strategic transactions. Our assessment of the period of time through which our financial resources will be adequate to support our operations is a forward-looking statement and involves risks and uncertainties. Our actual results could vary as a result of, and our future capital requirements, both near-term and long-term, will depend on, many factors, including our growth rate, the timing and extent of spending to support our research and development efforts, the expansion of sales and marketing and international operating activities, the timing of new introductions of solutions or features, and the continuing market acceptance of our services, the impact of macroeconomic conditions, such as high inflation and recessionary environments, and the impact of COVID-19 pandemic to our and our customers', vendors' and partners' businesses. We have and may in the future enter into arrangements to acquire or invest in complementary businesses, services and technologies, including intellectual property rights. We have based this estimate on assumptions that may prove to be wrong, and we could use our available capital resources sooner than we currently expect. Additionally, some of the factors that may influence our operations are not within our control, such as general economic conditions, geopolitical developments and the impact of the COVID-19 pandemic. We may be required to seek additional equity or debt financing. In the event that additional financing is required from outside sources, we may not be able to raise it on terms acceptable to us or at all. If we are unable to raise additional capital when desired, or if we cannot expand our operations or otherwise capitalize on our business opportunities because we lack sufficient capital, our business, operating results and financial condition would be adversely affected. We typically invoice our customers annually in advance, and to a lesser extent quarterly in advance, monthly in advance or multi-year in advance. Therefore, a substantial source of our cash is from such prepayments, which are included 41
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on our consolidated balance sheets as a contract liability. Deferred revenue consists of the unearned portion of billed fees for our subscriptions, which is subsequently recognized as revenue in accordance with our revenue recognition policy. As ofOctober 31, 2022 , we had deferred revenue of$1,005.7 million , of which$913.1 million was recorded as a current liability and is expected to be recorded as revenue in the next 12 months, provided all other revenue recognition criteria have been met. Subscriptions that are invoiced annually in advance or multi-year in advance contribute significantly to our short-term and long-term deferred revenue in comparison to our invoices issued quarterly in advance or monthly in advance. Accordingly, we cannot predict the mix of invoicing schedules in any given period. As ofOctober 31, 2022 , we did not have any relationships with unconsolidated organizations or financial partnerships, such as structured finance or special purpose entities, which would have been established for the purpose of facilitating off-balance sheet arrangements or other contractually narrow or limited purposes.
The following table summarizes our cash flows for the periods presented:
Three Months Ended October 31, 2022 2021 (in thousands) Net cash provided by operating activities $ 128,457$ 93,271 Net cash used in investing activities $ (57,702)$ (67) Net cash provided by financing activities $ 980$ 2,594 Operating Activities Net cash provided by operating activities during the three months endedOctober 31, 2022 was$128.5 million , which resulted from a net loss of$68.2 million , adjusted for non-cash charges of$150.2 million and net cash inflows of$46.5 million from changes in operating assets and liabilities. Non-cash charges primarily consisted of$105.2 million for stock-based compensation expense,$22.3 million for amortization of deferred contract acquisition costs,$11.9 million for depreciation and amortization expense,$7.1 million for non-cash operating lease costs,$2.6 million for amortization expense of acquired intangible assets. Net cash inflows from changes in operating assets and liabilities were primarily the result of$130.6 million in accounts receivable, primarily due to timing of billings and collections, an increase of$3.6 million in accrued expenses, other current and noncurrent liabilities and an increase of$3.0 million in accounts payable. Net cash inflows were partially offset by cash outflows resulting from a decrease of$32.8 million in accrued compensation, an increase of$26.8 million in deferred contract acquisition costs, a decrease of$15.3 million in deferred revenue, a decrease of$8.3 million in operating lease liabilities and an increase of$7.6 million in prepaid expenses, other current and noncurrent assets. Net cash provided by operating activities during the three months endedOctober 31, 2021 was$93.3 million , which resulted from a net loss of$90.8 million , adjusted for non-cash charges of$138.0 million and net cash inflows of$46.1 million from changes in operating assets and liabilities. Non-cash charges primarily consisted of$89.9 million for stock-based compensation expense,$14.9 million for amortization of deferred contract acquisition costs,$13.5 million for amortization of debt discount and issuance costs,$9.0 million for depreciation and amortization expense,$6.0 million for non-cash operating lease costs,$2.7 million for amortization of investment premiums, net of accretion of purchase discounts and$2.2 million for amortization expense of acquired intangible assets. Net cash inflows from changes in operating assets and liabilities were primarily the result of$84.9 million in accounts receivable, primarily due to timing of billings and collections, and an increase of$17.4 million in deferred revenue, primarily from advanced invoicing in accordance with our subscription contracts. Net cash inflows were partially offset by cash outflows resulting from an increase of$24.0 million in deferred contract acquisition costs, a decrease of$21.0 million in accrued compensation, a decrease of$5.9 million in operating lease liabilities, an increase of$4.1 million in prepaid expenses, other current and noncurrent assets. 42
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Investing Activities
Net cash used in investing activities during the three months endedOctober 31, 2022 of$57.7 million was primarily attributable to the purchases of short-term investments of$210.3 million and capital expenditures of$32.8 million , primarily to support the growth and expansion of our cloud platform. These activities were partially offset by proceeds from the maturity of short-term investments of$186.1 million . Net cash used in investing activities during the three months endedOctober 31, 2021 of$0.1 million was primarily attributable to the purchases of short-term investments of$312.8 million and capital expenditures of$9.9 million , primarily to support the growth and expansion of our cloud platform. These activities were partially offset by proceeds from the maturity of short-term investments of$322.7 million .
Financing Activities
Net cash provided by financing activities of
Net cash provided by financing activities of
Contractual Obligations and Commitments
During the three months endedOctober 31, 2022 , there have been no material changes outside the ordinary course of business to our contractual obligations and commitments from those disclosed in Management's Discussion and Analysis of Financial Condition and Results of Operations, set forth in Part II, Item 7, of our Fiscal 2022 Form 10-K.
Critical Accounting Policies and Estimates
Our financial statements are prepared in accordance with GAAP. The preparation of these financial statements requires us to make estimates and assumptions that affect the reported amounts of assets, liabilities, revenue and expenses, as well as related disclosures. We evaluate our estimates and assumptions on an ongoing basis. Our estimates are based on historical experience and various other assumptions that we believe to be reasonable under the circumstances. Our actual results could differ from these estimates. We refer to accounting estimates of this type as critical accounting policies and estimates, which we discuss below. Our significant accounting policies are discussed in Note 1, Business and Summary of Significant Accounting Policies, of our consolidated financial statements included in our Fiscal 2022 Form 10-K. There have been no significant changes to these policies for the three months endedOctober 31, 2022 , except as described in Note 1, Business and Summary of Significant Accounting Policies to our condensed consolidated financial statements included elsewhere in this Quarterly Report on Form 10-Q.
Recently Issued Accounting Pronouncements
Refer to Note 1, Business and Summary of Significant Accounting Policies, to the condensed consolidated financial statements included elsewhere in this Quarterly Report on Form 10-Q for more information regarding recently issued accounting pronouncements. 43
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