Proofpoint, Inc.
PROOFPOINT INC (Form: 10-Q, Received: 04/27/2017 16:07:31)
Table of Contents

UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
__________________________________
FORM 10-Q
þ
 
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the Quarterly Period Ended March 31, 2017
OR

o
 
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  
(State or other jurisdiction of  
incorporation or organization)
 
51-0414846  
(I.R.S. employer  
identification no.)

892 Ross Drive
Sunnyvale, California  
(Address of principal executive offices)
 
94089  
(Zip Code)

(408) 517-4710
__________________________________
(Registrant’s telephone number, including area code)

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 þ NO o

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted 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 and post such files).     
YES þ NO o

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 þ  
 
Accelerated filer o
 
 
Non-accelerated filer o
(Do not check if a smaller reporting company)
 
Smaller reporting company o
 
Emerging growth company o

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. o

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

Shares of Proofpoint, Inc. common stock, $0.0001 par value per share, outstanding as of April 21, 2017 : 43,721,302 shares.




Table of Contents



TABLE OF CONTENTS


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,
 
December 31,
 
2017
 
2016
Assets
 
 
 
Current assets:
 
 
 
Cash and cash equivalents
$
381,862

 
$
345,426

Short-term investments
31,015

 
51,325

Accounts receivable, net of allowance for doubtful accounts of $207 and $216 as of March 31, 2017 and December 31, 2016, respectively
62,443

 
72,951

Inventory
472

 
598

Deferred product costs
1,749

 
1,829

Deferred commissions
18,513

 
21,168

Prepaid expenses and other current assets
13,372

 
17,498

Total current assets
509,426

 
510,795

Property and equipment, net
58,404

 
52,523

Deferred product costs
299

 
310

Goodwill
167,270

 
167,270

Intangible assets, net
57,538

 
61,708

Long-term deferred commissions
4,479

 
4,496

Other assets
10,542

 
4,558

Total assets
$
807,958

 
$
801,660

Liabilities and Stockholders’ Equity
 
 
 
Current liabilities:
 
 
 
Accounts payable
$
12,068

 
$
15,297

Accrued liabilities
37,071

 
50,765

Capital lease obligations
32

 
32

Deferred rent
484

 
409

Deferred revenue
277,069

 
259,109

Total current liabilities
326,724

 
325,612

Convertible senior notes
371,941

 
366,541

Long-term capital lease obligations
83

 
91

Long-term deferred rent
2,630

 
2,413

Other long-term liabilities
10,552

 
9,008

Long-term deferred revenue
59,300

 
53,072

Total liabilities
771,230

 
756,737

Commitments and contingencies (note 5)
 
 
 
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; 43,623 and 43,015 shares issued and outstanding at March 31, 2017 and December 31, 2016, respectively
4

 
4

Additional paid-in capital
532,314

 
514,034

Accumulated other comprehensive loss
(3
)
 
(7
)
Accumulated deficit
(495,587
)
 
(469,108
)
Total stockholders’ equity
36,728

 
44,923

Total liabilities and stockholders’ equity
$
807,958

 
$
801,660

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,
 
2017
 
2016
Revenue:
 
 
 
Subscription
$
110,925

 
$
77,397

Hardware and services
2,325

 
1,606

Total revenue
113,250

 
79,003

Cost of revenue: (1)(2)
 
 
 
Subscription
28,321

 
21,682

Hardware and services
4,055

 
3,142

Total cost of revenue
32,376

 
24,824

Gross profit
80,874

 
54,179

Operating expense: (1)(2)
 
 
 
Research and development
29,606

 
22,653

Sales and marketing
58,732

 
46,523

General and administrative
10,487

 
10,604

Total operating expense
98,825

 
79,780

Operating loss
(17,951
)
 
(25,601
)
Interest expense
(5,966
)
 
(5,800
)
Other (expense) income, net
(129
)
 
2

Loss before provision for income taxes
(24,046
)
 
(31,399
)
Provision for income taxes
(1,434
)
 
(257
)
Net loss
$
(25,480
)
 
$
(31,656
)
Net loss per share, basic and diluted
$
(0.59
)
 
$
(0.77
)
Weighted average shares outstanding, basic and diluted
43,230

 
41,093

 
 
 
 
(1) Includes stock-based compensation expense as follows:
 
 
Cost of subscription revenue
$
2,376

 
$
1,638

Cost of hardware and services revenue
$
439

 
$
353

Research and development
$
7,050

 
$
5,602

Sales and marketing
$
7,897

 
$
6,818

General and administrative
$
4,612

 
$
4,072

(2) Includes intangible amortization expense as follows:
 
 
Cost of subscription revenue
$
3,188

 
$
2,117

Research and development
$
15

 
$
15

Sales and marketing
$
967

 
$
1,273

See accompanying Notes to the Condensed Consolidated Financial Statements.

4

Table of Contents

Proofpoint, Inc.
Condensed Consolidated Statements of Comprehensive Loss
(In thousands)
(Unaudited)

 
Three Months Ended
March 31,
 
2017
 
2016
Net loss
$
(25,480
)
 
$
(31,656
)
Other comprehensive income, net of tax:
 
 
 
Unrealized gain on short-term investments, net
4

 
21

Comprehensive loss
$
(25,476
)
 
$
(31,635
)


See accompanying Notes to the Condensed Consolidated Financial Statements.

5

Table of Contents
Proofpoint, Inc.
Condensed Consolidated Statements of Cash Flows
(In thousands)
(Unaudited)

 
Three Months Ended
March 31,
 
2017
 
2016
Cash flows from operating activities
 
 
 
Net loss
$
(25,480
)
 
$
(31,656
)
Adjustments to reconcile net loss to net cash provided by operating activities:
 
 
 
Depreciation and amortization
9,299

 
7,236

Loss on disposal of property and equipment
11

 
189

Amortization of investment premiums, net of accretion of purchase discounts
48

 
50

Recovery of allowance for doubtful accounts
(9
)
 
(17
)
Stock-based compensation
22,374

 
18,483

Change in fair value of contingent earn-outs
(1,446
)
 

Amortization of debt issuance costs and accretion of debt discount
5,404

 
5,096

Foreign currency transaction loss (gain)
142

 
(224
)
Changes in assets and liabilities, net of effect of acquisitions:
 
 
 
Accounts receivable
10,450

 
(879
)
Inventory
126

 
(96
)
Deferred product costs
91

 
164

Deferred commissions
2,671

 
1,481

Prepaid expenses
(848
)
 
(257
)
Other current assets
344

 
56

Deferred income taxes
(2,355
)
 
(126
)
Long-term assets
(3,900
)
 
3

Accounts payable
(1,585
)
 
1,472

Accrued liabilities
651

 
(2,868
)
Deferred rent
292

 
9

Deferred revenue
24,189

 
19,302

Net cash provided by operating activities
40,469

 
17,418

Cash flows from investing activities
 
 
 
Proceeds from sales and maturities of short-term investments
32,922

 
54,639

Purchase of short-term investments
(12,655
)
 
(26,980
)
Purchase of property and equipment
(12,251
)
 
(7,838
)
Receipt from escrow account
2,566

 

Net cash provided by investing activities
10,582

 
19,821

Cash flows from financing activities
 
 
 
Proceeds from issuance of common stock
2,325

 
1,872

Withholding taxes related to restricted stock net share settlement
(14,510
)
 
(6,698
)
Repayments of equipment loans and capital lease obligations
(8
)
 
(8
)
   Holdback payments for prior acquisitions

 
(1,397
)
   Contingent consideration payment
(2,566
)
 

Net cash used in financing activities
(14,759
)
 
(6,231
)
Effect of exchange rate changes on cash and cash equivalents
144

 
228

Net increase in cash and cash equivalents
36,436

 
31,236

Cash and cash equivalents
 
 
 
Beginning of period
345,426

 
346,205

End of period
$
381,862

 
$
377,441

 
 
 
 
Supplemental disclosure of noncash investing and financing information
 
 
 
Unpaid purchases of property and equipment and asset retirement obligations
$
4,562

 
$
4,559

Liability awards converted to equity
$
8,307

 
$
6,059

See accompanying Notes to the Condensed Consolidated Financial Statements.

6

Table of Contents

Proofpoint, Inc.
Notes to Condensed Consolidated Financial Statements
(Unaudited)
(Dollars and share amounts in thousands, except per share amounts)
1. The Company and Summary of Significant Accounting Policies
The Company
Proofpoint, Inc. (the “Company”) was incorporated in Delaware in June 2002 and is headquartered in California.
Proofpoint, Inc. is a leading security-as-a-service provider that enables large and mid-sized organizations worldwide to defend, protect, archive and govern their most sensitive data. The Company's security-as-a-service platform is comprised of an integrated suite of on-demand data protection solutions, including threat protection, incident response, regulatory compliance, archiving, governance, eDiscovery, and secure communication.

Basis of Presentation and Consolidation

These condensed consolidated financial statements include the accounts of the Company and its wholly-owned subsidiaries. All inter-company 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, 2016 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, 2017 are not necessarily indicative of the results to be expected for the year ending December 31, 2017 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, 2016 included in the Company’s Annual Report on Form 10-K filed with the SEC. The Company’s significant accounting policies are described in Note 1 to those audited consolidated financial statements.

Use of Estimates

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

Goodwill and Intangible Assets
Goodwill represents the excess of the purchase price of the acquired enterprise over the fair value of identifiable assets acquired and liabilities assumed. The Company performs an annual goodwill impairment test during the fourth quarter of a calendar year and more frequently if an event or circumstances indicates that impairment may have occurred. For the purposes of impairment testing, the Company has determined that it has one operating segment and one reporting unit. The Company performs a two-step impairment test of goodwill whereby the fair value of the reporting unit is compared to its carrying value. If the fair value of the reporting unit exceeds the carrying value of the net assets assigned to that unit, goodwill is not considered impaired and further testing is not required. If the carrying value of the net assets assigned to the reporting unit exceeds the fair value of the reporting unit, then the Company must perform the second step of the impairment test in order to determine the implied fair value of the reporting unit’s goodwill. If the carrying value of a reporting unit’s goodwill exceeds its

7


implied fair value, then impairment loss equal to the difference is recorded. The identification and measurement of goodwill impairment involves the estimation of the fair value of the Company. The estimate of fair value of the Company, based on the best information available as of the date of the assessment, is subjective and requires judgment, including management assumptions about expected future revenue forecasts and discount rates, changes in the overall economy, trends in the stock price and other factors. No impairment indicators were identified by the Company as of March 31, 2017 .

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

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

 
Low
 
High
Patents
4
 
5
Developed technology
3
 
7
Customer relationships
2
 
7
Non-compete agreements
2
 
4
Order backlog
1
 
3
Trade names and trademarks
1
 
5
    
Revenue Recognition
The Company derives its revenue primarily from two sources: (1) subscription revenue for rights related to the use of the security-as-a-service platform and (2) hardware, training and professional services revenue provided to customers related to their use of the platform. The Company records its revenues net of any value added or sales tax. Subscription revenue is derived from a subscription‑based enterprise licensing model with contract terms typically ranging from one to three years, and consists of (i) subscription fees from the licensing of the security-as-a-service platform, (ii) subscription fees for access to the on-demand elements of the platform and (iii) subscription fees for the right to access the Company’s customer support services.

Revenue is recognized when all of the following criteria have been met:

Persuasive evidence of an arrangement exists;

Delivery has occurred or services have been rendered;

Sales price is fixed or determinable; and

Collectability is reasonably assured.

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.

From time to time, certain third parties that the Company has an arrangement with provide the Company with referrals for which the Company pays a referral fee. The referral fee paid could vary depending on the level of effort. These fees are recorded in sales and marketing expense in proportion to the related revenue streams consistent with the sales commissions accounting. The Company did not incur any material referral fee expenses during the three months ended March 31, 2017 and 2016.
    
The Company applies industry-specific software revenue recognition guidance to transactions involving the licensing of software, as well as related support, training, and other professional services. The Company has analyzed all of the elements included in its multiple element software arrangements and has determined that it does not have sufficient VSOE of fair value

8


to allocate revenue to its subscription and software license agreements, support, training and professional services. The Company defers all revenue under the software arrangement until the commencement of the subscription services and any associated professional services. Once the subscription services and the associated professional services have commenced, the entire fee from the arrangement is recognized ratably over the remaining period of the arrangement. If the professional services are essential to the functionality of the subscription, then the revenue recognition does not commence until such services are completed.

The Company's revenue arrangements typically include subscription services to its security-as-a-service platform. These hosted on demand service arrangements do not provide customers with the right to take possession of the software supporting the hosted services. Certain arrangements also include the sale of hardware appliances. Revenue from hardware appliances containing software components and hardware components that function together to deliver the hardware appliance's essential functionality is excluded from the scope of the industry specific revenue recognition guidance. The Company recognizes revenue from its hosted on demand services in accordance with general revenue recognition accounting guidance. Only revenue derived from the licensing of the software is recognized in accordance with the industry specific revenue guidance.
    
When a sales arrangement contains multiple elements, such as hardware appliances, subscription services, customer support services, and/or professional services, the Company allocates revenue to each unit of accounting or element based on a selling price hierarchy. An element constitutes a separate unit of accounting when the delivered item has standalone value and delivery of the undelivered element is probable and within the Company's control. When applying the relative selling price method, the Company determines the selling price for each deliverable using vendor-specific objective evidence (“VSOE”) of selling price. If VSOE does not exist, the Company uses third-party evidence (“TPE”) of selling price. If neither VSOE nor TPE of selling price exist for a deliverable, the Company uses its best estimate of selling price ("BESP") for that deliverable. Revenue allocated to each element is then recognized when the basic revenue recognition criteria are met for each element. The Company determines BESP for an individual element within a multiple element revenue arrangement using the same methods utilized to determine the selling price of an element sold on a standalone basis. The Company estimates the selling price for its subscription solutions by considering internal factors such as historical pricing practices and it estimates the selling price of hardware and other services using a cost plus model.

Hardware appliance revenue is recognized upon shipment. Subscription and support revenue are recognized over the contract period commencing on the start date of the contract. Professional services and training, when sold with hardware appliances or subscription and support services, are accounted for separately when those services have standalone value. In determining whether professional services and training services can be accounted for separately from subscription and support services, the Company considers the following factors: availability of the services from other vendors, the nature of the services, and the dependence of the subscription services on the customer’s decision to buy the professional services. If professional services and training do not qualify for separate accounting, the Company recognizes the professional services and training ratably over the contract term of the subscription services.

Delivery generally occurs when the hardware appliance is delivered to a common carrier freight on board shipping point by the Company or the hosted service has been activated and communicated to the customer accordingly. The Company’s fees are typically considered to be fixed or determinable at the inception of an arrangement and are negotiated at the outset of an arrangement, generally based on specific products and quantities to be delivered. In the event payment terms are provided that differ significantly from the Company's standard business practices, the fees are deemed to not be fixed or determinable and revenue is recognized as the fees become paid.

The Company assesses collectability based on a number of factors, including credit worthiness of the customer and past transaction history of the customer. Through March 31, 2017 , the Company has not experienced significant credit losses.

Deferred Revenue
Deferred revenue primarily consists of billings or payments received in advance of revenue recognition from the sale of the Company’s subscription fees, training and professional services. Once the revenue recognition criteria are met, this revenue is recognized ratably over the term of the associated contract.

Deferred Commissions
Deferred commissions are the direct and incremental selling costs that are associated with the Company's customer contracts and consist of sales commissions paid to the Company's direct sales force and referral fees paid to independent third-

9


parties. The commissions are amortized to sales and marketing expense over the non-cancelable terms of the related contracts with the Company's customers. The commissions payments, which are paid in full the month after the customer's service commences, are a direct and incremental cost of the revenue arrangements. Direct sales commissions are deferred when earned and amortized over the same period that revenues are recognized for the related non-cancelable contract.

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, 2017 and 2016 .
Accounting Pronouncements Adopted in 2017
In March 2016, the Financial Accounting Standards Board (FASB) issued Accounting Standards Update No. 2016-09, Compensation-Stock Compensation (Topic 718): Improvements to Employee Share-Based Payment Accounting (ASU 2016-09). The ASU 2016-09 is effective for the Company beginning in the first quarter of 2017. This ASU simplifies various aspects related to how share-based payments are accounted for and presented in the financial statements, including forfeitures, income taxes and statutory tax withholding requirements.
    
As a result of adopting ASU 2016-09, the Company has made an accounting policy election to account for forfeitures as they occur. This change has been applied on a modified retrospective basis, resulting in a cumulative-effect adjustment to increase accumulated deficit by $999  as of January 1, 2017, the date of adoption. The adoption of this ASU also requires that excess tax benefits and tax deficiencies be recorded in the statement of operations as opposed to additional paid-in capital when the awards vest or are settled, and has been applied on a prospective basis starting January 1, 2017. As a result of the adoption, the Company's deferred tax assets include certain deferred tax assets as of March 31, 2017, that arose directly from tax deductions related to equity compensation greater than compensation recognized for financial reporting in the amount of  $79,300 , which is fully offset by the valuation allowance. The adoption of ASU 2016-09 as it relates to the accounting for minimum statutory withholding tax requirements has no impact on the Company's current consolidated financial statements or on any prior period financial statements presented.

ASU 2016-09 also requires changes in the classification of shares withheld to pay employee taxes and excess tax benefits in the consolidated statements of cash flows. The ASU requires that cash paid by an employer when directly withholding shares for tax-withholding purposes be classified as a financing activity and be applied retrospectively to all prior periods presented. As these cash flows have previously been presented as financing activities, there is no change resulting from the adoption of this ASU. ASU 2016-09 also requires excess tax benefits to be classified as an operating activity, consistent with other income tax cash flows, and may be applied either on a retrospective or prospective basis. The Company has elected to apply this amendment on a prospective basis, as there is no impact to its prior period consolidated statements of cash flows. As such, prior periods have not been adjusted.
    
Recent Accounting Pronouncements Not Yet Effective
In January 2017, FASB issued Accounting Standards Update 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 will be the amount by which a reporting unit's carrying value exceeds its fair value, not to exceed the carrying amount of goodwill. The update to the standard is effective for interim and annual periods beginning after December 15, 2019, with early adoption permitted, and should be applied prospectively. The Company does not expect ASU 2017-04 to have a material impact on its financial statements.

In January 2017, FASB issued Accounting Standards Update No. 2017-01,  Business Combinations (Topic 805) Clarifying the Definition of Business  (ASU 2017-01). ASU 2017-01 clarifies the definition of a business with the objective of adding guidance to assist entities with evaluating whether transactions should be accounted for as acquisitions (or disposals) of assets or businesses. The update to the standard is effective for interim and annual periods beginning after December 15, 2017, and applied prospectively. Early adoption is permitted. The Company is currently evaluating the impact of the adoption of ASU 2017-01 on its consolidated financial statements.


10


In October 2016, FASB issued Accounting Standards Update No. 2016-16,  Income Taxes: Intra-Entity Transfers of Assets Other Than Inventory  (ASU 2016-16). ASU 2016-16 eliminates the requirement to defer the recognition of current and deferred income taxes for intra-entity asset transfer until the asset has been sold to an outside party. Therefore, an entity should recognize the income tax consequences of an intra-entity transfer of an asset other than inventory when the transfer occurs. ASU 2016-16 is effective for interim and annual reporting periods beginning after December 15, 2017. Early adoption is permitted as of the first interim period and the amendments should be applied on a modified retrospective basis through a cumulative-effect adjustment directly to retained earnings as of the beginning of the period of adoption. The Company is currently evaluating the impact of the adoption of ASU 2016-16 on its consolidated financial statements.
    
In August 2016, FASB issued Accounting Standards Update No. 2016-15, Statement of Cash Flows (Topic 230): Classification of Certain Cash Receipts and Cash Payments (ASU 2016-15). ASU 2016-15 clarifies how certain cash receipts and payments should be classified in the statement of cash flows, including the potential cash settlement of the Company's convertible senior notes. If the Company elects to cash settle its convertible senior notes (see Note 6 "Convertible Senior Notes"), repayment of the principal amounts will be bifurcated between (i) cash outflows for operating activities for the portion related to accreted interest attributable to debt discounts arising from the difference between the coupon interest rate and the effective interest rate, and (ii) financing activities for the remainder. See Note 6 "Convertible Senior Notes" regarding timing of settlement. The update to the standard is effective for interim and annual periods beginning after December 15, 2017, and requires adoption on a retrospective transition method unless it is impracticable to apply.

In June 2016, FASB issued an Accounting Standards Update 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 will require the use of an expected loss model in place of the currently used incurred loss method. Under this model, entities will be required to estimate the lifetime expected credit loss on such instruments and record an allowance to offset the amortized cost basis of the financial asset, resulting in a net presentation of the amount expected to be collected on the financial asset. The update to the standard is effective for interim and annual periods beginning after December 15, 2019. The Company is currently evaluating the impact of the adoption of ASU 2016-13 on its consolidated financial statements.

In February 2016, FASB issued Accounting Standards Update No. 2016-02, Leases (Topic 842) (ASU 2016-02), which requires lessees to put most leases on their balance sheets but recognize the expenses on their statements of operations in a manner similar to current practice. ASU 2016-02 states that a lessee would recognize a lease liability for the obligation to make lease payments and a right-to-use asset for the right to use the underlying asset for the lease term. The new standard is effective for interim and annual periods beginning after December 15, 2018 and early adoption is permitted. While the Company is currently assessing the impact ASU 2016-02 will have on the Company's consolidated financial statements, the Company expects the primary impact to its consolidated financial position upon adoption will be the recognition, on a discounted basis, of the Company's minimum commitments under non-cancelable operating leases on its consolidated balance sheets resulting in the recording of right of use assets and lease obligations.

In May 2014, FASB issued Accounting Standards Update No. 2014-09,  Revenue from Contracts with Customers: Topic 606  (ASU 2014-09), to supersede nearly all existing revenue recognition guidance under U.S. GAAP. The core principle of ASU 2014-09 is to recognize revenues when promised goods or services are transferred to customers in an amount that reflects the consideration that is expected to be received for those goods or services. ASU 2014-09 defines a five-step process to achieve this core principle and, in applying this revenue recognition process, it is possible more judgment and estimates may be required than under existing U.S. GAAP including identifying performance obligations in the contract, estimating the amount of variable consideration to include in the transaction price and allocating the transaction price to each separate performance obligation. Originally, ASU 2014-09 would be effective for the Company starting January 1, 2017 using either of two methods: (i) retrospective to each prior reporting period presented with the option to elect certain practical expedients as defined within ASU 2014-09; or (ii) retrospective with the cumulative effect of initially applying ASU 2014-09 recognized at the date of initial application and providing certain additional disclosures as defined per ASU 2014-09. In July 2015, FASB voted to amend ASU 2014-09 by approving a one-year deferral of the effective date as well as providing the option to early adopt the standard on the original effective date. FASB has issued several updates to the standard which (i) clarify the application of the principal versus agent guidance (ASU 2016-08); (ii) clarify the guidance on inconsequential and perfunctory promises and licensing (ASU 2016-10) and (iii) narrow-scope improvements and practical expedients (ASU 2016-12).

The Company expects to adopt ASU 2014-09 effective January 1, 2018 using full retrospective transition method. The Company's ability to apply the requirements retrospectively to all prior periods presented is dependent on system readiness, including software procured from third-party providers, and the completion of its analysis of information necessary to restate prior period financial statements. While the Company is continuing to assess all the potential impacts this standard will have on

11


its consolidated financial statements and related disclosures, and as such it does not know and cannot reasonably estimate quantitative information related to the impact of this standard on its consolidated financial statements at this time, the Company currently expects the new standard to impact the timing of revenue and expense recognition for certain contracts related to some on-premise offerings, in which the Company grants customers the right to deploy its subscription services on the customer's own servers. As such, the Company may be required to recognize as revenue a portion of the sales price upon delivery of the software compared to the current practice of recognizing the entire sales price ratably over a subscription period. Additionally, the Company expects that some contract costs, including sales commissions, will be amortized over a period that is longer than the Company’s current policy of amortizing the deferred amounts over the specific revenue contract-terms for each individual order.

2. 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 each acquisition, 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 each acquired company's net identifiable assets acquired and, as a result, goodwill was recorded in connection with each acquisition. Goodwill related to each acquisition below 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.

2016 Acquisitions

FireLayers

On October 24, 2016 (the "FireLayers Acquisition Date"), pursuant to the terms of a share purchase agreement, the Company acquired all shares of FireLayers, Ltd. ("FireLayers"), a provider of solutions for organizations to control and protect their cloud applications. With this acquisition, the Company will extend Targeted Attack Protection to SaaS applications, enabling customers to protect their employees from advanced malware using SaaS applications.

The Company has provisionally estimated fair values of acquired tangible assets, intangible assets and liabilities at the FireLayers Acquisition Date. The amounts reported are considered provisional as the Company is completing the valuation work to determine the fair value of certain assets and liabilities acquired, largely with respect to working capital adjustments. The results of operations and the provisional fair values of the acquired assets and liabilities assumed have been included in the accompanying consolidated financial statements since the FireLayers Acquisition Date.

The total purchase price was $45,616 , net of cash acquired of $210 . Of the cash consideration paid, $7,740 was held in escrow to secure indemnification obligations, which has not been released as of the filing date of this Quarterly Report on Form 10-Q.

Per the terms of the share purchase agreement, unvested stock options held by FireLayers employees were canceled and exchanged for unvested stock options to purchase shares of the Company's common stock. The fair value of $1,326 of these unvested options, which are subject to the recipient's continued service with the Company and thus excluded from the purchase price, will be recognized ratably as stock-based compensation expense over the required service period. Also, as part of the FireLayers share purchase agreement, 111 shares of restricted stock were issued to certain key employees with the total fair value of $8,669 (see Note 7), which was not included in the purchase price. The shares of restricted stock are subject to forfeiture if employment terminates prior to the lapse of the restrictions, and their fair value is expensed as stock-based compensation expense over the vesting period.

Fair value of acquired assets and liabilities assumed

12



The following table summarizes the estimated fair values of acquired assets and liabilities:

 
Estimated
Fair Value
Estimated
Useful Life (in years)
Current assets acquired
$
432

N/A
Developed technology
22,600

5
Fixed assets
52

N/A
Deferred tax liability, net
(3,530
)
N/A
Other liabilities assumed
(540
)
N/A
Additional-paid-in-capital
(176
)
N/A
Goodwill
26,988

Indefinite
 
$
45,826

 

Return Path

On August 24, 2016 (the "Return Path Acquisition Date"), pursuant to the terms of an asset purchase agreement, the Company acquired Return Path, Inc.'s ("Return Path") Email Fraud Protection ("EFP") business unit. Return Path's EFP business, which provides standards-based DMARC authentication and proprietary sender-analysis capabilities, will be integrated into the Company's suite of email protection solutions to further enhance its business email compromise capabilities.

The Company has provisionally estimated fair values of acquired tangible assets, intangible assets and liabilities at the Return Path Acquisition Date. The amounts reported are considered provisional as the Company is completing the valuation work to determine the fair value of certain assets and liabilities acquired. The results of operations and the provisional fair values of the acquired assets and liabilities assumed have been included in the accompanying condensed consolidated financial statements since the Return Path Acquisition Date.
    
The total purchase price was $17,513 , of which $9,162 was classified and recorded as contingent consideration on the balance sheet as of the Return Path Acquisition Date. The Company expects to pay the contingent consideration within two years depending on the timing of contract assignments following the Return Path acquisition date and the maximum potential payment amount could be up to $9,644 .

The fair value of the contingent consideration liability was determined as of the acquisition date using unobservable inputs. These inputs include the estimated amount and timing of future contract assignments, the probability of success and a risk-adjusted discount rate to adjust the probability-weighted cash flows to present value.

Fair value of acquired assets

The following table summarizes the estimated fair values of acquired assets and liabilities:

 
Estimated
Fair Value
Estimated
Useful Life (in years)
Customer relationships
$
7,600

6
Developed technology
3,900

4
Order backlog
700

1
Deferred revenue assumed
(1,200
)
N/A
Goodwill
6,513

Indefinite
 
$
17,513

 

3. Intangible Assets
Intangible assets, excluding goodwill, consisted of the following:

13


 
March 31, 2017
 
December 31, 2016
 
Gross
Carrying
Amount
 
Accumulated
Amortization
 
Net
Carrying
Amount
 
Gross
Carrying
Amount
 
Accumulated
Amortization
 
Net
Carrying
Amount
Developed technology
$
83,769

 
$
(41,230
)
 
$
42,539

 
$
83,769

 
$
(38,042
)
 
$
45,727

Customer relationships
17,700

 
(3,664
)
 
14,036

 
17,943

 
(3,228
)
 
14,715

Trade names and patents
930

 
(720
)
 
210

 
930

 
(667
)
 
263

Order backlog
1,600

 
(847
)
 
753

 
1,600

 
(597
)
 
1,003

 
$
103,999

 
$
(46,461
)
 
$
57,538

 
$
104,242

 
$
(42,534
)
 
$
61,708

Amortization of intangible assets expense was $4,170 and $3,405 for the three months ended March 31, 2017 and 2016 , respectively.
Future estimated amortization of intangible assets expense as of March 31, 2017 are presented below:
Year ending December 31,
 
2017, remainder
$
12,211

2018
15,291

2019
11,926

2020
9,221

2021
7,422

Thereafter
1,467

 
$
57,538


4. Fair Value Measurements and Investments
Fair Value Measurements
Fair value is defined as the price that would be received to sell an asset or paid to transfer a liability (i.e., the “exit price”) in an orderly transaction between market participants at the measurement date. A hierarchy for inputs used in measuring fair value has been defined to minimize the use of unobservable inputs by requiring the use of observable market data when available. Observable inputs are inputs that market participants would use in pricing the asset or liability based on active market data. Unobservable inputs are inputs that reflect the Company’s assumptions about the assumptions market participants would use in pricing the asset or liability based on the best information available in the circumstances.
The fair value hierarchy prioritizes the inputs into three broad levels:
Level 1: Quoted (unadjusted) prices in active markets for identical assets or liabilities.
The Company’s Level 1 assets generally consist of money market funds.
Level 2: Observable inputs other than quoted prices included in Level 1, such as quoted prices for similar assets or liabilities in active markets; quoted prices for identical or similar assets or liabilities in markets that are not active; or other inputs that are observable or can be corroborated by observable market data for substantially the full term of the asset or liability.
The Company’s Level 2 assets and liabilities generally consist of corporate debt securities, commercial papers, U.S. agency and Treasury securities and convertible senior notes.
Level 3: Unobservable inputs to the valuation methodology that are supported by little or no market activity and that are significant to the measurement of the fair value of the assets or liabilities. Level 3 assets and liabilities include those whose fair value measurements are determined using pricing models, discounted cash flow methodologies or similar valuation techniques, as well as significant management judgment or estimation.

14


In connection with the acquisition of Return Path, a liability was recognized on Return Path Acquisition Date for the estimate of the fair value of the Company's contingent payment. The Company determined the fair value of the Acquisition-related contingent liability based on the estimated amount and timing of future contract assignments, and the probability of success. This fair value measurement is based on significant inputs not observable in the market and thus represent Level 3 measurement.
The following tables summarize, for each category of assets or liabilities carried at fair value, the respective fair value as of March 31, 2017 and December 31, 2016 and the classification by level of input within the fair value hierarchy:
 
Balance as of
March 31,
2017
 
Quoted Prices
in Active
Markets for
Identical
Assets
(Level 1)
 
Significant
Other
Observable
Inputs
(Level 2)
 
Unobservable
Inputs
(Level 3)
Assets
 
 
 
 
 
 
 
Cash equivalents:
 
 
 
 
 
 
 
Money market funds
$
291,288

 
$
291,288

 
$

 
$

Corporate debt securities
11,213

 

 
11,213

 

U.S. agency securities
1,998

 

 
1,998

 

Commercial paper
17,695

 

 
17,695

 

Short-term investments:
 
 
 
 
 
 
 
Corporate debt securities
10,409

 

 
10,409

 

Commercial papers
16,709

 

 
16,709

 

U.S. agency securities
1,948

 

 
1,948

 

U.S. Treasury securities
1,949

 

 
1,949

 

Total financial assets
$
353,209

 
$
291,288

 
$
61,921

 
$

 
 
 
 
 
 
 
 
Liabilities
 
 
 
 
 
 
 
Acquisition-related contingent consideration liability
$
4,221

 
$

 
$

 
$
4,221


15


 
Balance as of
December 31,
2016
 
Quoted Prices
in Active
Markets for
Identical
Assets
(Level 1)
 
Significant
Other
Observable
Inputs
(Level 2)
 
Unobservable
Inputs
(Level 3)
Assets
 
 
 
 
 
 
 
Cash equivalents:
 
 
 
 
 
 
 
Money market funds
$
304,020

 
$
304,020

 
$

 
$

Corporate debt securities
2,139

 

 
2,139

 

Commercial paper
13,243

 

 
13,243

 

Short-term investments:
 
 
 
 
 
 
 
Corporate debt securities
24,450

 

 
24,450

 

Commercial paper
22,979

 

 
22,979

 

U.S. agency securities
1,946

 

 
1,946

 

U.S. Treasury securities
1,950

 

 
1,950

 

Total financial assets
$
370,727

 
$
304,020

 
$
66,707

 
$

 
 
 
 
 
 
 
 
Liabilities
 
 
 
 
 
 
 
Acquisition-related contingent consideration liability
$
8,233

 
$

 
$

 
$
8,233

Based on quoted market prices as of March 31, 2017 , the fair values of the 0.75% and 1.25% Convertible Senior Notes were approximately $262,092 and $385,889 , respectively, determined using Level 2 inputs as they are not actively traded in markets.
The following table represents a reconciliation of the Acquisition-related contingent consideration liability measured at fair value on a recurring basis, using significant unobservable inputs (Level 3):
 
Fair Value Measurements Using Significant Unobservable Inputs (Level 3)
Balance as of December 31, 2016
$
8,233

Payments during the period
(2,566
)
Adjustments to fair value during the period recorded in General and Administrative expenses
(1,446
)
Balance as of March 31, 2017
$
4,221

The carrying amounts of the Company's cash equivalents, accounts receivable and accounts payable approximate their fair values due to their short maturities.
Investments
The cost and fair value of the Company’s cash and cash equivalents and available-for-sale investments as of March 31, 2017 and December 31, 2016 were as follows:

16


 
March 31, 2017
 
Cost Basis
 
Unrealized Gains
 
Unrealized Losses
 
Fair Value
Cash and cash equivalents:
 
 
 
 
 
 
 
Cash
$
59,668

 
$

 
$

 
$
59,668

Money market funds
291,288

 

 

 
291,288

Corporate debt securities
11,216

 

 
(3
)
 
11,213

U.S. agency securities
1,998

 

 

 
1,998

Commercial paper
17,695

 

 

 
17,695

Total
$
381,865

 
$

 
$
(3
)
 
$
381,862

 
 
 
 
 
 
 
 
Short-term investments:
 
 
 
 
 
 
 
Corporate debt securities
$
10,411

 
$

 
$
(2
)
 
$
10,409

Commercial paper
16,709

 

 

 
16,709

U.S. agency securities
1,948

 

 

 
1,948

U.S. Treasury securities
1,950

 

 
(1
)
 
1,949

Total
$
31,018

 
$

 
$
(3
)
 
$
31,015

 
December 31, 2016
 
Cost Basis
 
Unrealized Gains
 
Unrealized Losses
 
Fair Value
Cash and cash equivalents:
 
 
 
 
 
 
 
Cash
$
26,024

 
$

 
$

 
$
26,024

Money market funds
304,020

 

 

 
304,020

Corporate debt securities
2,140

 

 
(1
)
 
2,139

Commercial papers
13,243

 

 

 
13,243

Total
$
345,427

 
$

 
$
(1
)
 
$
345,426

 
 
 
 
 
 
 
 
Short-term investments:
 
 
 
 
 
 
 
Corporate debt securities
$
24,458

 
$

 
$
(8
)
 
$
24,450

Commercial papers
22,979

 

 

 
22,979

U.S. agency securities
1,945

 
1

 

 
1,946

U.S. Treasury securities
1,950

 

 

 
1,950

Total
$
51,332

 
$
1

 
$
(8
)
 
$
51,325

As of March 31, 2017 and December 31, 2016 , all investments mature in less than one year. Estimated fair values for marketable securities are based on quoted market prices for the same or similar instruments.
The Company reviews its investments on a quarterly basis to identify and evaluate investments that have an indication of possible impairment and has determined that no other-than-temporary impairments were required to be recognized during three months ended March 31, 2017 .
5. Commitments and Contingencies
Operating Leases
The Company leases certain of its facilities under non-cancellable operating leases with various expiration dates through 2025.

Premises rent expense was $1,779 and $1,179 for the three months ended March 31, 2017 and 2016 , respectively.


17


Capital Lease

In July 2015, the Company entered into a lease agreement (the "July 2015 Lease") to lease certain office equipment with expiration in August 2020. The July 2015 Lease bears an annual interest rate of 6.5% . The lease is secured by fixed assets used in the Company's office locations.
At March 31, 2017 , future annual minimum lease payments under non-cancellable operating and capital leases were as follows:
 
Capital
Leases
 
Operating
Leases
Year ending December 31,
 
 
 
2017, remainder
$
33

 
$
10,623

2018
39

 
13,343

2019
37

 
11,241

2020
21

 
5,074

2021

 
2,220

Thereafter

 
5,622

Total minimum lease payments
130

 
$
48,123

Less: Amount representing interest
(15
)
 
 
Present value of capital lease obligations
115

 
 
Less: current portion
(32
)
 
 
Long-term portion of capital lease obligations
$
83

 
 

Contingencies

Under the indemnification provisions of the Company's customer agreements, the Company agrees to indemnify and defend and hold harmless its customers against, among other things, infringement of any patent, trademark or copyright under any country's laws or the misappropriation of any trade secret arising from the customers' legal use of the Company's solutions. The exposure to the Company under these indemnification provisions is generally limited to the total amount paid by the customers under the applicable customer agreement. However, certain indemnification provisions potentially expose the Company to losses in excess of the aggregate amount paid to the Company by the customer under the applicable customer agreement. To date, there have been no claims against the Company or its customers pursuant to these indemnification provisions.

Legal Contingencies

From time to time, the Company may be involved in legal proceedings and subject to claims in the ordinary course of business. For lawsuits where the Company is the defendant, the Company is in the process of defending these litigation matters, and while there can be no assurances and the outcomes of these matters are currently not determinable, the Company currently believes that there are no existing claims or proceedings that are likely to have a material adverse effect on the Company's financial position, results of operations or cash flows.

6. Convertible Senior Notes

0.75% Convertible Senior Notes due June 2020

On June 17, 2015 , the Company issued $200,000 principal amount of 0.75% Convertible Senior Notes (the "0.75% Notes") due 2020 in a private offering to qualified institutional buyers ("Holders") pursuant to Rule 144A under the Securities Act of 1934, as amended (the "Securities Act"). The initial Holders of the 0.75% Notes also had an option to purchase an additional $30,000 in principal amount which was exercised in full. The net proceeds after the agent's discount and issuance costs of $6,581 from the 0.75% Notes offering were approximately $223,419 . The Company uses the net proceeds for working capital and general corporate purposes, which may include funding the Company's operations, capital expenditures, and potential acquisitions of businesses, products or technologies believed to be of strategic importance. The 0.75% Notes bear interest at 0.75% per year, payable semi-annually in arrears every June 15 and December 15, beginning on December 15, 2015.

18



The 0.75% Notes are unsecured and rank senior in right of payment to any indebtedness expressly subordinated in right of payment to the 0.75% Notes. They rank equally with the Company's other existing and future unsecured indebtedness that is not subordinated and are structurally subordinated to any current or future secured indebtedness to the extent of the value of the assets securing the indebtedness and other liabilities of the Company's subsidiaries.

The initial conversion rate is 12.3108 shares of the Company’s common stock per $1 principal amount of notes which equates to 2,831 shares of common stock, or a conversion price equivalent of $81.23 per share of common stock. Throughout the term of the 0.75% Notes, the conversion rate may be adjusted upon the occurrence of certain events, such as the payment of cash dividends or issuance of stock warrants. The 0.75% Notes mature on June 15, 2020 , unless repurchased, redeemed or converted in accordance with their terms prior to such date.

At the Company's option, on or after June 20, 2018 , the Company will be able to redeem all or a portion of the 0.75% Notes at 100% of the principal amount, plus any accrued and unpaid interest, under certain conditions. The Company may redeem the 0.75% Notes in shares of the Company’s common stock, cash, or some combination of each.

Prior to December 15, 2019 , the 0.75% Notes will be convertible at the option of the Holders only upon the satisfaction of certain conditions and during certain periods if any of the following events occur:

during the calendar quarter commencing after September 30, 2015, if the last reported sale price of the Company's common stock is greater than or equal to 130% of the applicable conversion price on each such trading day for at least 20 trading days (whether or not consecutive) during the period of 30 consecutive trading days ending on the last trading day of the preceding calendar quarter;
during the 5 business day period after any 5 consecutive trading day period in which the trading price, as defined, per $1 principal amount of the 0.75% Notes for each trading day of such measurement period was less than 98% of the product of the last reported sale price of the Company's common stock and the applicable conversion rate on each such trading day;
upon a notice of redemption by the Company; or
upon the occurrence of specified corporate transactions.

Subsequent to December 15, 2019 , Holders may convert their 0.75% Notes at the applicable conversion rate at any time prior to the close of business on the second scheduled trading day immediately preceding the maturity date.

Holders of the 0.75% Notes also have the right to require the Company to repurchase all or a portion of the 0.75% Notes at 100% of the principal amount, plus accrued and unpaid special interest, if any, upon the occurrence of certain fundamental changes to the Company.

In accordance with the authoritative accounting guidance, the Company allocated the total amount of the 0.75% Notes into liability and equity components. The carrying value of the liability component at issuance was calculated as the present value of its cash flows using a discount rate of 6.5% based on the a blended rate between the yield rate for a Moody's B1 rating and the average debt rate for comparable convertible transactions from similar companies. The difference between the 0.75% Notes principal and the carrying value of the liability component, representing the value of conversion premium assigned to the equity component, was recorded as an increase to additional paid in capital and as a debt discount on the issuance date. The equity component is being accreted using the effective interest rate method over the period from the issuance date through June 15, 2020 as a non-cash charge to interest expense. The amount recorded to additional paid in capital is not remeasured as long as it continues to meet the conditions for equity classification. Upon issuance of the 0.75% Notes, the Company recorded $174,359 as debt and $55,641 as additional paid in capital within stockholders' equity.
 
Additionally, the debt discount and issuance costs were allocated based on the total amount incurred to the liability and equity components using the same proportions as the proceeds from the 0.75% Notes. The equity issuance costs of $1,592 were recorded as a decrease to additional paid-in capital at the issuance date.

1.25% Convertible Senior Notes due December 2018    

On December 11, 2013 , the Company issued $175,000 principal amount of 1.25% Convertible Senior Notes (the "1.25% Notes," and together with the 0.75% Notes, the “Notes”) due 2018 in a private offering to Holders pursuant to Rule 144A under the Securities Act. The initial Holders of the 1.25% Notes also had an option to purchase an additional $26,250 in principal amount which was exercised in full. The net proceeds after the agent's discount and issuance costs of $5,803 from the

19


1.25% Notes offering were approximately $195,446 . The Company uses the net proceeds for working capital and general corporate purposes, which may include funding the Company's operations, capital expenditures, and potential acquisitions of businesses, products or technologies believed to be of strategic importance. The 1.25% Notes bear interest at 1.25% per year, payable semi-annually in arrears every June 15 and December 15, beginning on June 15, 2014.

On July 5, 2016, the Company and the Trustee executed a supplemental indenture to address an administrative issue with the timing of a redemption notice. The amendment did not adversely affect the right of any holder and therefore did not require their consent. There were no other changes to terms of the Notes.

The 1.25% Notes are unsecured and rank senior in right of payment to any indebtedness expressly subordinated in right of payment to the 1.25% Notes. They rank equally with the Company's other existing and future unsecured indebtedness that is not subordinated and are structurally subordinated to any current or future secured indebtedness to the extent of the value of the assets securing the indebtedness and other liabilities of the Company's subsidiaries.

The initial conversion rate is 25.6271 shares of the Company’s common stock per $1 principal amount of notes which equates to 5,158 shares of common stock, or a conversion price equivalent of $39.02 per share of common stock. Throughout the term of the 1.25% Notes, the conversion rate may be adjusted upon the occurrence of certain events, such as the payment of cash dividends or issuance of stock warrants. The 1.25% Notes mature on December 15, 2018 , unless repurchased, redeemed or converted in accordance with their terms prior to such date.

At the Company's option, on or after December 20, 2016 , the Company will be able to redeem all or a portion of the 1.25% Notes at 100% of the principal amount, plus any accrued and unpaid interest, under certain conditions. The Company may redeem the 1.25% Notes in shares of the Company’s common stock, cash, or some combination of each.

Prior to June 15, 2018 , the 1.25% Notes will be convertible at the option of the Holders only upon the satisfaction of certain conditions and during certain periods if any of the following events occur:

during the calendar quarter commencing after March 31, 2014, if the last reported sale price of the Company's common stock is greater than or equal to 130% of the applicable conversion price on each such trading day for at least 20 trading days (whether or not consecutive) during the period of 30 consecutive trading days ending on the last trading day of the preceding calendar quarter;
during the 5 business day period after any 5 consecutive trading day period in which the trading price, as defined, per $1 principal amount of the 1.25% Notes for each trading day of such measurement period was less than 98% of the product of the last reported sale price of the Company's common stock and the applicable conversion rate on each such trading day;
upon a notice of redemption by the Company; or
upon the occurrence of specified corporate transactions.

Subsequent to June 15, 2018 , Holders may convert their 1.25% Notes at the applicable conversion rate at any time prior to the close of business on the second scheduled trading day immediately preceding the maturity date.

Holders of the 1.25% Notes also have the right to require the Company to repurchase all or a portion of the 1.25% Notes at 100% of the principal amount, plus accrued and unpaid special interest, if any, upon the occurrence of certain fundamental changes to the Company.

In accordance with the authoritative accounting guidance, the Company allocated the total amount of the 1.25% Notes into liability and equity components. The carrying value of the liability component at issuance was calculated as the present value of its cash flows using a discount rate of 6.5% based on the a blended rate between the yield rate for a Moody's B1-rating and the average debt rate for comparable convertible transactions from similar companies. The difference between the 1.25% Notes principal and the carrying value of the liability component, representing the value of conversion premium assigned to the equity component, was recorded as an increase to additional paid in capital and as a debt discount on the issuance date. The equity component is being accreted using the effective interest rate method over the period from the issuance date through December 15, 2018 as a non-cash charge to interest expense. The amount recorded to additional paid in capital is not remeasured as long as it continues to meet the conditions for equity classification. Upon issuance of the 1.25% Notes, the Company recorded $156,672 as debt and $44,578 as additional paid in capital within stockholders' equity.
 

20


Additionally, the discount and issuance costs were allocated based on the total amount incurred to the liability and equity components using the same proportions as the proceeds from the 1.25% Notes. The equity issuance costs of $1,285 were recorded as a decrease to additional paid-in capital at the issuance date.

The following tables presents the carrying values of all Notes as of March 31, 2017 and December 31, 2016:    

 
March 31, 2017
 
0.75% Notes
 
1.25% Notes
 
Total
Liability component:
 
 
 
 
 
Principal
$
230,000

 
$
201,246

 
$
431,246

Less: debt discount and issuance costs, net of amortization
(41,024
)
 
(18,281
)
 
(59,305
)
Net carrying amount
$
188,976

 
$
182,965

 
$
371,941

 
 
 
 
 
 
Equity component (1)
$
54,049

 
$
43,293

 
$
97,342


 
December 31, 2016
 
0.75% Notes
 
1.25% Notes
 
Total
Liability component:
 
 
 
 
 
Principal
$
230,000

 
$
201,250

 
$
431,250

Less: debt discount and issuance costs, net of amortization
(43,896
)
 
(20,813
)
 
(64,709
)
Net carrying amount
$
186,104

 
$
180,437

 
$
366,541

 
 
 
 
 
 
Equity component (1)
$
54,049

 
$
43,293

 
$
97,342


(1) Recorded on the accompanying Condensed Consolidated Balance Sheets as additional paid-in capital, net of the $2,877 issuance costs.

For the three months ended March 31, 2017 and 2016 , the Company incurred the following interest expense related to the Notes:

 
Three Months Ended
March 31,
 
2017
 
2016
Interest expense related to contractual interest coupon
$
1,060

 
$
1,060

Amortization of debt discount and issuance costs
5,404

 
5,096

 
$
6,464

 
$
6,156


7. Stock Equity Plans

Stock-Based Compensation Plans
On March 30, 2012, the Board of Directors and the Company’s stockholders approved the 2012 Equity Incentive Plan (the "2012 Plan"), which became effective in April 2012. The Company has four  equity incentive plans: the Company’s 2002 stock option plan (the “2002 Plan”), the 2012 Plan and two FireLayers plans assumed by the Company upon the acquisition of FireLayers in October 2016. Upon the Company's initial public offering, all shares that were reserved under the 2002 Plan but not issued, and shares issued but subsequently returned to the plan through forfeitures, cancellations and repurchases became part of the 2012 Plan and no further shares will be granted pursuant to the 2002 Plan. No further shares will be granted pursuant to either FireLayers plans. All outstanding stock awards under the 2002 Plan, the two FireLayers plans and 2012 Plan will continue to be governed by their existing terms. Under the 2012 Plan, the Company has the ability to issue incentive stock options (“ISOs”), nonstatutory stock options (“NSOs”), restricted stock awards, stock bonus awards, stock appreciation rights

21


("SARs"), restricted stock units ("RSUs"), and performance stock units ("PSUs"). The 2012 Plan also allows direct issuance of common stock to employees, outside directors and consultants at prices equal to the fair market value at the date of grant of options or issuance of common stock. Additionally, the 2012 Plan provides for the grant of performance cash awards to employees, directors and consultants. The Company has the right to repurchase any unvested shares (at the option exercise price) of common stock issued directly or under option exercises. The right of repurchase generally expires over the vesting period.
Stock bonus and other liability awards are accounted for as liability-classified awards, because the obligations are based predominantly on fixed monetary amounts that are generally known at the inception of the obligation, to be settled with a variable number of shares of the Company's common stock.
Under the equity incentive plans, the term of an option grant shall not exceed ten years from the date of its grant and options generally vest over a three to four -year period, with vesting on a monthly or annual interval. Under the 2012 Plan, 20,316 shares of common stock are reserved for issuance to eligible participants. As of March 31, 2017 , 5,785 shares were available for future grant. Restricted stock awards generally vest over a four -year period.
Stock Options

The fair value of options granted is estimated on the grant date using the Black-Scholes option valuation model. This valuation model for stock-based compensation expense requires the Company to make assumptions and judgments about the variables used in the calculation, including the expected term (weighted-average period of time that the options granted are expected to be outstanding), the volatility of the common stock price and the assumed risk-free interest rate. The Company accounts for forfeitures as they occur.
 
The estimate for expected life of options granted reflects the midpoint of the vesting term and the contractual life computed utilizing the simplified method as allowed by the SEC staff. The Company does not have significant historical share option exercise experience and hence considers the expected term assumption calculated using the simplified method to be reasonable. The risk-free interest rate used was the Federal Reserve Bank's constant maturities interest rate commensurate with the expected life of the options in effect at the time of the grant. The expected dividend yield was zero, as the Company does not anticipate paying a dividend within the relevant time frame.

There were no options granted during the three months ended March 31, 2017 and 2016.

The Company realized no income tax benefit from stock option exercises in each of the periods presented due to recurring losses and the valuation allowances for deferred tax assets.

Stock option activity under the Plan is as follows:

 
Shares subject to Options Outstanding
 
Number of
Shares
 
Weighted Average
Exercise Price
 
Weighted Average
Remaining Contractual Term
(in years)
 
Aggregate
Intrinsic
Value
Balance at December 31, 2016
3,183

 
$
18.91

 
5.39
 
$
164,842

Options exercised
(331
)
 
7.01

 
 
 
 
Options forfeited and canceled
(14
)
 
46.31

 
 
 
 
Balance at March 31, 2017
2,838

 
$
20.16

 
5.31
 
$
153,888


The total intrinsic value of options exercised was $24,078 and $14,153 for the three months ended March 31, 2017 and 2016 , respectively. Total cash proceeds from such option exercises were $2,316 and $2,042 for the three months ended March 31, 2017 and 2016 , respectively.

The fair value of option grants that vested was $2,712 and $3,231 for the three months ended March 31, 2017 and 2016 , respectively.

22

Table of Contents


As of March 31, 2017 , the Company had unamortized stock-based compensation expense of $10,417 related to stock options, that will be recognized over the average remaining vesting term of the options of 1.94  years.
    
Restricted Stock and Performance Stock Units

A following table summarized the activity of RSUs and PSUs:

 
RSUs and PSUs Outstanding
 
Number of
Shares
 
Granted Fair Value Per Unit
Awarded and unvested at December 31, 2016
3,465

 
$
56.11

Awards granted
695

 
80.33

Awards vested
(415
)
 
51.41

Awards forfeited
(160
)
 
60.23

Awarded and unvested at March 31, 2017
3,585

 
$
61.17


As of March 31, 2017 , there was $164,946 of unamortized stock-based compensation expense related to unvested RSUs, which is expected to be recognized over a weighted average period of 3.27 years.

The Company granted 177 and 105 PSUs in the three months ended March 31, 2017 and 2016, respectively. The PSU vesting conditions were based on individual performance targets. Unamortized expense was $23,128 as of March 31, 2017.
Stock Bonus and Other Liability Awards
The total accrued liability for the stock bonus awards was $956 and $7,855 as of March 31, 2017 and December 31, 2016, respectively.
During the three months ended March 31, 2017 and 2016, 85 and 93 shares, respectively, of common stock earned under the stock bonus program were issued. Stock based compensation expense related to stock bonus program was $796 and $1,035 for the three months ended March 31, 2017 and 2016, respectively.
In March 2015, the Company issued liability awards with a fair value of $6,885 , which vest annually over a three-year period and are subject to continuous service and other conditions. The liability awards will be settled with a variable number of shares of the Company's common stock. During the three months ended March 31, 2017 and 2016, 29 and 45 shares, respectively, were vested and issued. The Company recognized $565 and $572 of stock-based compensation expense related to these liability awards for the three months ended March 31, 2017 and 2016, respectively.
Employee Stock Purchase Plan
On March 30, 2012, the Board of Directors and the Company’s stockholders approved the 2012 Employee Stock Purchase Plan (the "ESPP"), which became effective in April 2012. A total of 745 shares of the Company's common stock were initially reserved for future issuance under the ESPP. The number of shares reserved for issuance under the ESPP will increase automatically on January 1 of each of the first eight years commencing with 2013 by the number of shares equal to 1% of the Company's shares outstanding on the immediately preceding December 31, but not to exceed 1,490 shares, unless the Board of Directors, in its discretion, determines to make a smaller increase. As of March 31, 2017 , there were 1,790 shares of the Company's common stock available for future issuance under the ESPP.
As of March 31, 2017 , the Company expects to recognize $503 of the total unamortized compensation cost related to employee purchases under the ESPP over a weighted average period of 0.1 years.
Restricted Stock

23

Table of Contents

The Company granted 111 shares of restricted stock in the fourth quarter of 2016 to certain key employees with the total fair value of $8,669 and three-year annual vesting. The Company recognized $712 of stock based compensation expense in the three month periods ended March 31, 2017. As of March 31, 2017, there was $7,411 of unamortized stock-based compensation expense related to the unvested shares of restricted stock. The shares of restricted stock are subject to forfeiture if employment terminates prior to the lapse of the restrictions, and are expensed over the vesting period. They are considered issued and outstanding shares of the Company at the grant date and have the same rights as other shares of common stock.
8. Net Loss per Share
Basic net loss per share of common stock is calculated by dividing the net loss by the weighted‑average number of shares of common stock outstanding for the period. The weighted‑average number of shares of common stock used to calculate basic net loss per share of common stock excludes those shares subject to repurchase related to stock options or restricted stock that were exercised or issued prior to vesting as these shares are not deemed to be issued for accounting purposes until they vest. Diluted net loss per share of common stock is computed by dividing the net loss using the weighted‑average number of shares of common stock, excluding common stock subject to repurchase, and, if dilutive, potential shares of common stock outstanding during the period. Basic and diluted net loss per common share was the same for all periods presented as the impact of all potentially dilutive securities outstanding was anti-dilutive.

The following table presents the potentially dilutive common shares outstanding that were excluded from the computation of diluted net loss per share for the periods presented because including them would have been anti-dilutive:

 
As of March 31,
 
2017
 
2016
Stock options to purchase common stock
2,838

 
3,722

Restricted stock units
3,585

 
3,440

Employee stock purchase plan
92

 
81

Common stock subject to repurchase
127

 
78

Bonus and other liability awards
41

 
120

1.25% Convertible senior notes
5,158

 
5,158

0.75% Convertible senior notes
2,831

 
2,831

Total
14,672

 
15,430


9. Segment Reporting
Operating segments are reported in a manner consistent with the internal reporting supported and defined by the components of an enterprise about which separate financial information is available, provided and is evaluated regularly by the chief operating decision maker in deciding how to allocate resources and in assessing performance. The Company’s chief operating decision maker is its Chief Executive Officer. The Company’s Chief Executive Officer reviews financial information presented on a consolidated basis. The Company has one business activity, and there are no segment managers who are held accountable for operations, operating results and plans for levels or components below the consolidated unit level. Accordingly, the Company determined that it has one operating and reportable segment.
The following sets forth total revenue by solutions offered by the Company and by geographic area. Revenue by geographic area is based upon the billing address of the customer:
 
Three Months Ended
March 31,
 
2017
 
2016
Total revenue by solution:
 
 
 
Protection and Advanced Threat
$
84,480

 
$
56,462

Archiving, Privacy and Governance
28,770

 
22,541

Total revenue
$
113,250

 
$
79,003



24

Table of Contents

 
Three Months Ended
March 31,
 
2017
 
2016
Total revenue:
 
 
 
United States
$
94,560

 
$
65,449

Rest of world
18,690

 
13,554

Total revenue
$
113,250

 
$
79,003


Long-lived assets by geographic area are presented below:

 
As of
March 31,
 
As of
December 31,
 
2017
 
2016
Long-lived assets:
 
 
 
United States
$
49,137

 
$
43,789

Rest of world
9,267

 
8,734

Total long‑lived assets
$
58,404

 
$
52,523


10. Income Taxes
The Company’s quarterly provision for income taxes is based on an estimated effective annual income tax rate. The Company’s quarterly provision for income taxes also includes the tax impact of certain unusual or infrequently occurring items, if any, including changes in judgment about valuation allowances and effects of changes in tax laws or rates, in the interim period in which they occur.

Income tax expense for the three months ended March 31, 2017 was $1,434 on pre-tax losses of $24,046 . The Company recognized income tax expense of $257 on pre-tax losses of $31,399 in the three months ended March 31, 2016. The income tax rate for the three months ended March 31, 2017 and 2016 varies from the United States statutory income tax rate primarily due to valuation allowances in the United States whereby pre-tax losses and income do not result in the recognition of corresponding income tax benefits and expenses.

The Company's effective tax rate for the three months ended March 31, 2017 and 2016 was negative 6.0% and negative 0.8% , respectively.

The Company reviews the likelihood that it will realize the benefit of its deferred tax assets and, therefore, the need for valuation allowances, on a quarterly basis. There is no corresponding income tax benefit recognized with respect to losses incurred and no corresponding income tax expense recognized with respect to earnings generated in jurisdictions with a valuation allowance. This causes variability in the Company’s effective tax rate. The Company intends to maintain the valuation allowances until it is more likely than not that the net deferred tax assets will be realized.

During the three months ended March 31, 2017, the Company transferred certain intellectual property rights from its wholly owned subsidiary in Israel to the United States. Although the transfer of intellectual property rights between consolidated entities did not result in any gain in the consolidated results of operations, the transfer did result in a taxable gain in Israel. Taxes incurred related to the intercompany transaction have been treated as a prepaid tax asset in the Company’s consolidated balance sheet and amortized to income tax expense over the life of the intellectual property. The amount of tax amortized to the provision for income taxes for the three months ended March 31, 2017 was approximately $209 and the amount of the prepaid tax asset was $3,842 as of March 31, 2017.

As of March 31, 2017, the Company's gross uncertain tax benefits totaled $10,139 , excluding related accrued interest and penalties of $207 . As of March 31, 2017, $4,910 of the Company's uncertain tax benefits, including related accrued interest and penalties, would affect the effective tax rate if recognized. During the three months ended March 31, 2017, the Company's gross uncertain tax benefits increased $4,292 . The increase is comprised of a $4,304 increase for tax positions taken in the current period, primarily due to the transfer of intellectual property rights, a $5 increase for tax positions taken in prior periods, offset by a $17 decrease related to statute of limitation expirations.


25

Table of Contents

The Company is currently under audit by the Israel Tax Authority for tax years 2013 through 2017. Related to the audit by the Israel Tax Authority it is reasonably possible that Company’s uncertain tax positions could change within the next 12 months. An estimate of the range of any change cannot be made. The Company believes it has recorded all appropriate provisions for all jurisdictions and open years. However, the Company can give no assurance that taxing authorities will not propose adjustments that would increase its tax liabilities. The Company is not currently under audit by the IRS or any similar taxing authority in any other material jurisdiction.



26

Table of Contents

ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS.
The following discussion and analysis of our financial condition and results of operations should be read in conjunction with the (1) unaudited condensed consolidated financial statements and the related notes thereto included elsewhere in this Quarterly Report on Form 10-Q, and (2) the audited consolidated financial statements and notes thereto and management’s discussion and analysis of financial condition and results of operations for the year ended December 31, 2016 included in our 2016 Annual Report on Form 10-K. This Quarterly Report on Form 10-Q contains “forward-looking statements” within the meaning of Section 21E of the Securities Exchange Act of 1934, as amended (the “Exchange Act”). These statements are often identified by the use of words such as “may,” “will,” “expect,” “believe,” “anticipate,” “intend,” “could,” “estimate,” or “continue,” and similar expressions or variations. Such forward-looking statements are subject to risks, uncertainties and other factors that could cause actual results and the timing of certain events to differ materially from future results expressed or implied by such forward-looking statements. Factors that could cause or contribute to such differences include, but are not limited to, those identified herein, and those discussed in the section titled “Risk Factors”, set forth in Part II, Item 1A of this Form 10-Q and in our other SEC filings, including our 2016 Annual Report on Form 10-K. We disclaim any obligation to update any forward-looking statements to reflect events or circumstances after the date of such statements.
Overview
Proofpoint is a leading security-as-a-service ("SaaS") provider that enables large and mid-sized organizations worldwide to defend, protect, archive and govern their most sensitive data. Our SaaS platform is comprised of an integrated suite of on-demand data protection solutions, including threat protection and incident response, regulatory compliance, archiving, data governance and eDiscovery, and secure communication. Our solutions are built on a flexible, cloud-based platform and leverage a number of proprietary technologies, including big data analytics, machine learning, deep content inspection, secure storage, advanced encryption, intelligent message routing, dynamic malware analysis, threat correlation, and virtual execution environments, to address today’s rapidly changing threat landscape.

Our platform addresses this growing challenge by not only protecting data as it flows into and out of the enterprise via on-premise and cloud-based email, instant messaging, social media and other web-based applications, but also by keeping track of this information as it is modified and distributed throughout the enterprise for compliance and data loss prevention, and securely archiving these communications for compliance and discovery. We address four important problems for the enterprise:

protecting users from the advanced attacks that target them via email, social media and mobile applications;

preventing the theft or inadvertent loss of sensitive information and, in turn, ensuring compliance with regulatory data protection mandates;

collecting, retaining, governing and discovering sensitive data for compliance and litigation support; and

enabling organizations to respond quickly to security issues, providing both the intelligence and the context to prioritize incidents and orchestrate remediation actions.

Our platform and its associated solutions are sold to customers on a subscription basis and can be deployed through our unique cloud-based architecture that leverages both our global data centers as well as optional points-of-presence behind our customers’ firewalls. Our flexible deployment model enables us to deliver superior security and compliance while maintaining the favorable economics afforded by cloud computing, creating a competitive advantage for us over legacy on-premise and cloud-only offerings.

We were founded in 2002 to provide a unified solution to help enterprises address their growing data security requirements. Our first solution was commercially released in 2003 to combat the burgeoning problem of spam and viruses and their impact on corporate email systems. To address the evolving threat landscape and the adoption of communication and collaboration systems beyond corporate email and networks, we have broadened our solutions to defend against a wide range of threats, protect against outbound security risks, and archive and govern corporate information. As the threat environment has continued to evolve, we have dedicated significant resources to meet the ongoing challenges that this highly dynamic environment creates for our customers such as investing significantly to expand the breadth of our data protection platform as

27

Table of Contents

these expenditures are primarily in connection with the replacement and upgrade of equipment to lower the cost of deployment as well as to improve the efficiency for our cloud-based architecture.

Our business is based on a recurring revenue model. Our customers pay a subscription fee to license the various components of our SaaS platform for a contract term that is typically one to three years. At the end of the license term, customers may renew their subscription and in each year since the launch of our first solution in 2003, we have maintained a renewal rate with our existing customers over 90% . We derive this retention rate by calculating the total annually recurring subscription revenue from customers currently using our SaaS platform and dividing it by the total annually recurring subscription revenue from both these current customers as well as all business lost through non-renewal. A growing number of our customers increase their annual subscription fees after their initial purchase by broadening their use of our platform or by adding more users, and these sales have consistently represented more than 15% of our billings each year since 2008.

We market and sell our solutions worldwide both directly through our sales teams and indirectly through a hybrid model where our sales organization actively assists our network of distributors and resellers. We also derive a lesser portion of our total revenue from the license of our solutions to strategic partners who offer our solutions in conjunction with one or more of their own products or services.

Our solutions are designed to be implemented, configured and operated without the need for any training or professional services. We offer various trainings and professional services for those customers that seek to develop deeper expertise in the use of our solutions or would like assistance with complex configurations or the importing of data. In some cases, we provide a hardware appliance to those customers that elect to host elements of our solution behind their firewall. Increasing adoption of virtualization in the data center has led to a decline in the sales of our hardware appliances and a shift towards our software-based virtual appliances, which are delivered as a download via the Internet. Our hardware and services offerings carry lower margins and are provided as a courtesy to our customers. We expect the overall proportion of revenue derived from the hardware and services offerings to generally remain below 5% of our total revenue.

Historically, the majority of our revenue was derived from our customers in the United States. We believe the markets outside of the United States offer an opportunity for growth and we intend to make additional investments in sales and marketing to expand in these markets. Revenue from customers outside of the United States grew 38% for the three months ended March 31, 2017 as compared to the prior year period. One partner accounted for 12% of our total revenue for the three months ended March 31, 2017, although the partner sold to a number of end-users, none of which accounted for more than 10% of our total revenue. The partner's sales were spread across many individual customers, all of which have a direct relationship with us as part of their access to our demand services. There were no individual customers or partners that accounted for more than 10% of our total revenue for the three months ended March 31, 2016 .

We have not been profitable to date and will need to grow revenue at a rate faster than our investments in cost of revenue and operating expenses in order to achieve profitability, as discussed in more detail below.

Key Opportunities and Challenges
The total costs associated with the teams tasked with closing business with new customers and additional business with our existing customers have represented more than 90% of our total sales and marketing costs since 2008. Although we expect customers to be profitable over the duration of the customer relationship, the upfront costs typically exceed related revenue during the earlier periods of a contract. As a result, while our practice of invoicing our customers for the entire amount of the contract at the start of the term provides us with a relatively immediate contribution to cash flow, the revenue is recognized ratably over the term of the contract, and hence contributions toward operating income are limited in the period where the sales and marketing costs are incurred. Accordingly, an increase in the mix of new customers as a percentage of total customers would likely negatively impact our near-term operating results. On the other hand, we expect that an increase in the mix of existing customers as a percentage of total customers would positively impact our operating results over time. As we accumulate customers that continue to renew their contracts, we anticipate that our mix of existing customers will increase, contributing to a decrease in our sales and marketing costs as a percentage of total revenue and a commensurate improvement in our operating income.

As part of maintaining our SaaS platform, we provide ongoing updates and enhancements to the platform services both in terms of the software as well as the underlying hardware and data center infrastructure. These updates and enhancements are provided to our customers at no additional charge as part of the subscription fees paid for the use of our platform. While more traditional products eventually become obsolete and require replacement, we are constantly updating and maintaining our cloud-based services and as such they operate with a continuous product life cycle. Much of this work is

28

Table of Contents

designed to both maintain and enhance the customers' experience over time while also lowering our costs to deliver the service. Our SaaS platform is a shared infrastructure that is used by all of our customers. Accordingly, the costs of the platform are spread in a relatively uniform manner across the entire customer base and no specific infrastructure elements are directly attached to any particular customer. As such, in the event that a customer chooses to not renew its subscription, the underlying resources are reallocated either to new customers or to accommodate the expanding needs of our existing customers and, as a result, we do not believe that the loss of any particular customer has a meaningful impact on our gross profit as long as we continue to grow our customer base.

To date, our customers have primarily used our solutions in conjunction with email messaging content. We have developed solutions to address new and evolving messaging solutions such as social media and file sharing applications, but these solutions are relatively nascent. If customers increase their use of these new messaging solutions in the future, we anticipate that our growth in revenue associated with older email messaging solutions may slow over time. Although revenue associated with our social media and file sharing applications has not been material to date, we believe that our ability to provide security, archiving, governance and discovery for these new solutions will be viewed as valuable by our existing customers, enabling us to derive revenue from these new forms of messaging and communication.

While the majority of our current and prospective customers run their email systems on premise, we believe that there is a trend for large and mid-sized enterprises to migrate these systems to the cloud. While our current revenue derived from customers using cloud-based email systems continues to grow as a percentage of our total revenue, many of these cloud-based email solutions offer some form of threat protection and governance services, potentially mitigating the need for customers to buy these capabilities from third parties such as ourselves. We believe that we can continue to provide security, archiving, governance, and discovery solutions that are differentiated from the services offered by cloud-based email providers, and as such our platform will continue to be viewed as valuable to enterprises once they have migrated their email services to the cloud, enabling us to continue to derive revenue from this new trend toward cloud-based email deployment models.

With the majority of our business, we invoice our customers for the entire contract amount at the start of the term and these amounts are recorded as deferred revenue on our balance sheet, with the dollar weighted average duration of these contracts for any given period over the past three years typically ranging from 14 to 20 months. As a result, while our practice of invoicing customers for the entire amount of the contract at the start of the term provides us with a relatively immediate contribution to cash flow, the revenue is recognized ratably over the term of the contract, and hence contributions toward operating income are realized over an extended period. As such, our efforts to improve our profitability require us to invest far less in operating expenses than the cash flow generated by our business might otherwise allow. As we strive to invest in an effort to continue to increase the size and scale of our business, we expect that the level of investment afforded by our growth in revenue should be sufficient to fund the investments needed to drive revenue growth and broaden our product line.
    
Considering all of these factors, we do not expect to be profitable on a GAAP basis in the near term and in order to achieve profitability we will need to grow revenue at a rate faster than our investments in operating expenses and cost of revenue.

We intend to grow our revenue through acquiring new customers by investing in our sales and marketing activities. We believe that an increase in new customers in the near term will result in a larger base of renewal customers, which, over time, we expect to be more profitable for us.

Sales and marketing is our largest expense and hence a significant contributing factor to our operating losses. We believe that our opportunity to improve our return on investment on sales and marketing costs relies primarily on our ongoing ability to cost-effectively renew our business with existing customers, thereby lowering our overall sales and marketing costs as a percentage of revenue as the mix of revenue derived from this more profitable renewal activity increases over time. Therefore, we anticipate that our initial significant investments in sales and marketing activities will, over time, generate a larger base of more profitable customers. Cost of subscription revenue is also a significant expense for us, and we expect to continue to build on the improvements over the past years, such as in replacing third-party technology with our proprietary technology and improving the utilization of our fixed investments in equipment and infrastructure, in order to provide the opportunity for improved subscription gross margins over time. Although we plan to continue enhancing our solutions, we intend to lower our rate of investment in research and development as a percentage of revenue over time by deriving additional revenue from our existing platform of solutions rather than by adding entirely new categories of solutions. In addition, as personnel costs are one of the primary drivers of the increases in our operating expenses, we plan to reduce our historical rate of headcount growth over time.

Key Metrics

29

Table of Contents


We regularly review a number of metrics, including the following key metrics presented in the table below, to evaluate our business, measure our performance, identify trends in our business, prepare financial projections and make strategic decisions. Many of these key metrics, such as non-GAAP gross margin, billings and free cash flows, are non-GAAP measures. This non-GAAP information is not necessarily comparable to non-GAAP information of other companies. Users of this financial information should consider the types of events and transactions for which adjustments have been made.
 
Three Months Ended
March 31,
 
2017
 
2016
 
(dollars in thousands)
Total revenue
$
113,250

 
$
79,003

Growth
43
%
 
37
%
Gross margin percentage
71
%
 
69
%
Non-GAAP gross margin
77
%
 
74
%
Billings (non-GAAP)
$
137,438

 
$
98,305

Growth
40
%
 
48
%
Free cash flows (non-GAAP)
$
28,218

 
$
9,580

Non-GAAP gross margin
We define non-GAAP gross margin as non-GAAP gross profit divided by GAAP revenue. We define non-GAAP gross profit as GAAP gross profit, adjusted to exclude stock-based compensation expense and the amortization of intangibles associated with acquisitions. We consider this non-GAAP financial measure to be a useful metric for management and investors because it excludes the effect of stock-based compensation expense and the amortization of intangibles associated with acquisitions so that our management and investors can compare our business operating results over multiple periods, and compare the Company's financial results with other companies in its industry, many of which present similar non-GAAP financial measure. However, there are a number of limitations related to the use of non-GAAP gross margin versus gross margin calculated in accordance with GAAP. For example, stock-based compensation has been and will continue to be for the foreseeable future a significant recurring expense in our business. Stock-based compensation is an important part of our employees’ compensation and impacts their performance. In addition, the components of the costs that we exclude in our calculation of non-GAAP gross margin may differ from the components that our peer companies exclude when they report their non-GAAP results.  Management compensates for these limitations by providing specific information regarding the GAAP amounts excluded from non-GAAP gross margin and evaluating non-GAAP gross margin together with gross margin calculated in accordance with GAAP.
The following table presents the reconciliation of gross margin to Non-GAAP gross margin for the three months ended March 31, 2017 and 2016 :
 
Three Months Ended
March 31,
 
2017
 
2016
 
(in thousands)
GAAP gross profit
$
80,874

 
$
54,179

GAAP gross margin
71
%
 
69
%
Plus:
 
 
 
Stock-based compensation expense
2,815

 
1,991

Intangible amortization expense
3,188

 
2,117

Non-GAAP gross profit
$
86,877

 
$
58,287

Non-GAAP gross margin
77
%
 
74
%

30

Table of Contents

Billings
We have included billings, a non‑GAAP financial measure, in this report because it is a key measure used by our management and board of directors to manage our business and monitor our near term cash flows. We define billings as total revenue plus change in deferred revenue during a period, less deferred revenue from acquisitions. We have provided reconciliation between total revenue, the most directly comparable GAAP financial measure, and billings. Accordingly, we believe that billings provides useful information to investors and others in understanding and evaluating our operating results in the same manner as our management and board of directors.

Our use of billings as a non-GAAP measure has limitations as an analytical tool, and you should not consider it in isolation or as a substitute for revenue or an analysis of our results as reported under GAAP. Some of these limitations are:
Billings is not a substitute for revenue, as trends in billings are not necessarily directly correlated to trends in revenue;
Billings is affected by a combination of factors including the timing of renewals, the sales of our solutions to both new and existing customers, the relative duration of contracts sold, and the relative amount of business derived from strategic partners. As each of these elements has unique characteristics in the relationship between billings and revenue, our billings activity is not necessarily closely correlated to revenue; and
Other companies, including companies in our industry, may not use billings, may calculate billings differently, or may use other financial measures to evaluate their performance ‑ all of which reduce the usefulness of billings as a comparative measure.
Our deferred revenue consists of amounts that have been invoiced but have not been recognized as revenue as of the period end. 
The following table presents the reconciliation of total revenue to billings for the three months ended March 31, 2017 and 2016 :
 
Three Months Ended
March 31,
 
2017
 
2016
 
(in thousands)
Total revenue
$
113,250

 
$
79,003

Deferred revenue
 
 
 
Ending
336,369

 
243,028

Beginning
312,181

 
223,726

Net change
24,188

 
19,302

Less: deferred revenue contributed by acquisitions

 

Billings
$
137,438

 
$
98,305

Free cash flows
We define free cash flow as net cash provided by operating activities minus capital expenditures. We consider free cash flow to be a liquidity measure that provides useful information to management and investors about the amount of cash generated by the business that, after the acquisition of property and equipment, can be used for strategic opportunities, including investing in our business, making strategic acquisitions, and strengthening the balance sheet. Analysis of free cash flow facilitates management’s comparisons of our operating results to competitors’ operating results. A limitation of using free cash flow versus the GAAP measure of net cash provided by operating activities as a means for evaluating our company is that free cash flow does not represent the total increase or decrease in the cash balance from operations for the period because it excludes cash used for capital expenditures during the period. Management compensates for this limitation by providing

31

Table of Contents

information about our capital expenditures on the face of the cash flow statement and in the "Liquidity and Capital Resources" section below.
 
Three Months Ended
March 31,
 
2017
 
2016
 
(in thousands)
GAAP cash flows provided by operating activities:
$
40,469

 
$
17,418

Less:
 
 
 
Purchases of property and equipment
(12,251
)
 
(7,838
)
Non-GAAP free cash flows
$
28,218

 
$
9,580


Critical Accounting Policies and Estimates
The discussion and analysis of our financial condition and results of operations is based upon our accompanying Condensed Consolidated Financial Statements, which have been prepared in accordance with U.S. GAAP. The preparation of these financial statements requires us to make estimates, assumptions and judgments that can have significant impact on the reported amounts of assets and liabilities, revenues and expenses, and related disclosure of contingent assets and liabilities at the date of our financial statements. We base our estimates, assumptions and judgments on historical experience and various other factors that we believe to be reasonable under the circumstances. Actual results may differ from these estimates under different assumptions or conditions. On a regular basis we evaluate our estimates, assumptions and judgments and make changes accordingly.
We believe that the estimates, assumptions and judgments involved in revenue recognition, deferred commissions, stock-based compensation expense, fair value of assets acquired and liabilities assumed in business combinations, impairment assessment of goodwill, intangible assets and other long-lived assets, loss contingency, and recognition and measurement of current and deferred income taxes have the greatest potential impact on our accompanying Condensed Consolidated Financial Statements, and consider these to be our critical accounting estimates. Historically, our estimates, assumptions and judgments relative to our critical accounting policies have not differed materially from actual results. The critical accounting estimates associated with these policies are described in our 2016 Annual Report on Form 10-K, under “Management’s Discussion and Analysis of Financial Condition and Results of Operations.” There have been no material changes to our significant accounting policies as compared to the significant accounting policies described in our 2016 Annual Report on Form 10-K for the year ended December 31, 2016.
Components of Our Results of Operations
Revenue
We derive our revenue primarily through the license of various solutions and services on our security-as-a-service platform on a subscription basis, supplemented by the sales of training, professional services and hardware depending upon our customers' requirements.

Subscription. We license our platform and its associated solutions and services on a subscription basis. The fees are charged on a per user, per year basis. Subscriptions are typically one to three years in duration. We invoice our customers upon signing for the entire term of the contract. The invoiced amounts billed in advance are treated as deferred revenue on the balance sheet and are recognized ratably, in accordance with the appropriate revenue recognition guidelines, over the term of the contract. We also derive a portion of our subscription revenue from the license of our solutions to strategic partners. We bill these strategic partners monthly. We expect our subscription revenue will continue to grow and remain above 95% of our total revenue.

Hardware and services. We provide hardware appliances as a convenience to our customers and as such it represents a small part of our business. Our solutions are designed to be implemented, configured and operated without the need for any training or professional services. For those customers that seek to develop deeper expertise in the use of our solutions or would like assistance with complex configurations or the importing of data, we offer various training and professional services. We typically invoice the customer for hardware at the time of shipment. We typically invoice customers for services at the time the order is placed and recognize this revenue ratably over the term of the contract. On occasion, customers may retain us for special projects such as

32

Table of Contents

archiving import and export services; these types of services are recognized upon completion of the project. We expect the overall proportion of revenue derived from hardware and service offerings to generally remain below 5% of our total revenue.

Cost of Revenue
Our cost of revenues consists of cost of subscription revenue and cost of hardware and services revenue. Personnel costs, which consist of salaries, benefits, bonuses, stock-based compensation, data center costs and hardware costs are the most significant components of our cost of revenues. We expect personnel costs to continue to increase in absolute dollars as we hire new employees to continue to grow our business.

Cost of Subscription Revenue. Cost of subscription revenue primarily includes personnel costs, consisting of salaries, benefits, bonuses, and stock-based compensation, for employees who provide support services to our customers and operate our data centers. Other costs include fees paid to contractors who supplement our support and data center personnel; expenses related to the use of third-party data centers in both the United States and internationally; depreciation of data center equipment; amortization of licensing fees and royalties paid for the use of third-party technology; amortization of internally developed intangible assets; and the amortization of intangible assets acquired through business combinations. Growth in subscription revenue generally consumes production resources, requiring us to gradually increase our cost of subscription revenue in absolute dollars as we expand our investment in data center equipment, the third-party data center space required to house this equipment, and the personnel needed to manage this higher level of activity.

Cost of Hardware and Services Revenue. Cost of hardware and services revenue includes personnel costs for employees who provide training and professional services to our customers as well as the cost of server hardware shipped to our customers that we procure from third parties and configure with our software solutions.

Operating Expenses
Our operating expenses consist of research and development, sales and marketing, and general and administrative expenses. Personnel costs, which consist of salaries, benefits, bonuses, and stock-based compensation, are the most significant component of our operating expenses. We expect personnel costs to continue to increase in absolute dollars as we hire new employees to continue to grow our business. Our headcount has increased 31% from December 31, 2015 to December 31, 2016. As a result of this growth in headcount, operating expenses have increased significantly over these periods. We expect personnel costs to continue to increase in absolute dollars as we hire new employees to continue to grow our business.

Research and Development. Research and development expenses include personnel costs, consulting services and depreciation. We believe that these investments have played an important role in broadening the capabilities of our platform over the course of our operating history, enhancing the relevance of our solutions in the market in general and helping us to retain our customers over time. We expect to continue to devote substantial resources to research and development in an effort to continuously improve our existing solutions as well as to develop new offerings. We believe that these investments are necessary to maintain and improve our competitive position. However, over the longer term, we intend to monitor these costs so as to decrease this spending as a percentage of total revenue. Our research efforts include both software developed for our internal use on behalf of our customers as well as software elements to be used by our customers in their own facilities. To date, our capitalized costs on software developed for internal use on behalf of our customers were not material. For the software developed for use on our customers’ premises, the costs associated with the development work between technological feasibility and the general availability has not been material and as such we have not capitalized any of these development costs to date.

Sales and Marketing. Sales and marketing expenses include personnel costs, sales commissions, and other costs including travel and entertainment, marketing and promotional events, public relations and marketing activities. These costs also include amortization of intangible assets as a result of our past acquisitions. Due to our continued investment in growing our sales and marketing operations, both domestically and internationally, headcount increases were reflected in higher compensation expense consistent with our revenue growth. Our sales personnel are typically not immediately productive, and therefore the increase in sales and marketing expenses we incur when we add new sales representatives is not immediately offset by increased revenue and may not result in increased revenue over the long-term if these new sales people fail to become productive. The timing of our hiring of new sales personnel and the rate at which they generate incremental revenue will affect our future financial performance. We expect that sales and marketing expenses will continue to increase in absolute dollars and be among the most significant components of our operating expenses.


33

Table of Contents

General and Administrative. General and administrative expenses consist of personnel costs, consulting services, audit fees, tax services, legal expenses and other general corporate items. As a result of our operational growth, we expect our general and administrative expenses to increase in absolute dollars in future periods as we continue to expand our operations and hire additional personnel.

Interest expense
Interest expense consists of interest income earned on our cash, cash equivalents and short-term investments, the interest expense related to our convertible senior notes and our capital lease payments.

Other Income (Expense), Net
Other income (expense), net, consists primarily of the net effect of foreign currency transaction gains and losses.

(Provision for) Benefit from Income Taxes
For 2013 and prior years, the (provision for) benefit from income taxes was related to state and foreign income taxes. As we have incurred operating losses in all periods to date and recorded a full valuation allowance against our deferred tax assets, we have not historically recorded a provision for federal income taxes. However, in the years ended December 31, 2016 and 2015, we recognized $0.4 million and $0.1 million, respectively, of deferred tax expense in the U.S. related to amortization of tax goodwill on business acquisitions. We also recognized a $0.8 million deferred tax benefit in 2014 related to the release of U.S. valuation allowances as a result of business acquisitions. For the quarter ended March 31, 2017, we recognized $0.8 million of deferred tax expense in the U.S. related to amortization of tax goodwill and a change in fair value of an acquisition-related contingent consideration payment. Realization of any of our deferred tax assets depends upon future earnings, the timing and amount of which are uncertain. Utilization of our net operating losses and research and development credits may be subject to substantial annual limitation due to the ownership change limitations provided by the Internal Revenue Code and similar state provisions. Analyses have been conducted to determine whether an ownership change had occurred since inception. The analyses have indicated that although ownership changes have occurred in prior years, the net operating losses and research and development credits would not expire before utilization as a result of the ownership change. In the event we have subsequent changes in ownership, net operating losses and research and development credit carryovers could be limited and may expire unutilized as a result of the subsequent ownership change.
Recent Accounting Pronouncements
Refer to Note 1 of the notes to our condensed consolidated financial statements in Part I, Item 1 of this Quarterly Report on Form 10-Q for a full description of recent accounting pronouncements.

Results of Operations
The following table is a summary of our consolidated statements of operations and results of operations as a percentage of our total revenue for those periods.

34


 
Three Months Ended
March 31,
 
2017
 
2016
 
Amount
 
% of revenue
 
Amount
 
% of revenue
 
($ in thousands)
Revenue:
 
 
 
 
 
 
 
Subscription
$
110,925

 
98
 %
 
$
77,397

 
98
 %
Hardware and services
2,325

 
2

 
1,606

 
2

Total revenue
113,250

 
100

 
79,003

 
100

Cost of revenue:
 
 
 
 
 
 
 
Subscription
28,321

 
25

 
21,682

 
27

Hardware and services
4,055

 
4

 
3,142

 
4

Total cost of revenue
32,376

 
29

 
24,824

 
31

Gross profit
80,874

 
71

 
54,179

 
69

Operating expense:
 
 
 
 
 
 
 
Research and development
29,606

 
26

 
22,653

 
29

Sales and marketing
58,732

 
52

 
46,523

 
59

General and administrative
10,487

 
9

 
10,604

 
13

Total operating expense
98,825

 
87

 
79,780

 
101

Operating loss
(17,951
)
 
(16
)
 
(25,601
)
 
(32
)
Interest expense
(5,966
)
 
(5
)
 
(5,800
)
 
(8
)
Other (expense) income, net
(129
)
 

 
2

 

Loss before provision for income taxes
(24,046
)
 
(21
)
 
(31,399
)
 
(40
)
Provision for income taxes
(1,434
)
 
(1
)
 
(257
)
 

Net loss
$
(25,480
)
 
(22
)%
 
$
(31,656
)
 
(40
)%

Comparison of the three months ended March 31, 2017 and 2016 :
Revenue
 
Three Months Ended
March 31,
 
2017
 
2016
 
% Change
 
(in thousands)
 
 
Revenue
 
 
 
 
 
Subscription
$
110,925

 
$
77,397

 
43
%
Hardware and services
2,325

 
1,606

 
45

Total revenue
$
113,250

 
$
79,003

 
43
%
Subscription revenue for the three months ended March 31, 2017 increased $33.5 million , or 43% , as compared to the corresponding period last year. The increase was primarily due to a $28.4 million increase in subscription revenue contributed from the United States. To a lesser extent, for the same period, there was an increase of $5.1 million in revenue contributed from international locations. The increase in subscription revenue was due to the increased demand for our advanced threat solutions, increase in add-on activity and renewal rate being in excess of 90%.

35

Table of Contents

Hardware and services revenue for the three months ended March 31, 2017 increased $0.7 million , or 45% , as compared to the corresponding period last year primarily due to higher revenue from professional services.
Cost of Revenue
 
Three Months Ended
March 31,
 
2017
 
2016
 
% Change
 
(in thousands)
 
 
Cost of revenue
 
 
 
 
 
Subscription
$
28,321

 
$
21,682

 
31
%
Hardware and services
4,055

 
3,142

 
29

Total cost of revenue
$
32,376

 
$
24,824

 
30
%
Cost of subscription revenue for the three months ended March 31, 2017 increased  $6.6 million , or  31% , as compared to the corresponding period last year. The increase was primarily due to increases in operations-related expenses of $4.7 million due to increased headcount, depreciation expense as a result of higher capital expenditures to support our growth, increase in network expenses and intangible amortization expense of developed technology from the acquisitions. Additionally, support-related expenses increased $2.1 million primarily due to higher headcount and third-party service costs.

Cost of hardware and services revenue for the three months ended March 31, 2017 increased $0.9 million , or 29% , as compared to the corresponding period last year, primarily due to an increase in professional service costs as our headcount increased.
    
Operating Expenses
 
Three Months Ended
March 31,
 
2017
 
2016
 
% Change
 
(in thousands)
 
 
Research and development
$
29,606

 
$
22,653

 
31
%
Percent of total revenue
26
%
 
29
%
 
 
Research and development expenses increased $7.0 million , or 31% , for the three months ended March 31, 2017, as compared to the corresponding period last year. The increase in headcount on a worldwide basis resulted in increased personnel-related expenses of $5.8 million. Corporate and facilities expenses increased $1.3 million due to higher headcount.

 
Three Months Ended
March 31,
 
2017
 
2016
 
% Change
 
(in thousands)
 
 
Sales and marketing
$
58,732

 
$
46,523

 
26
%
Percent of total revenue
52
%
 
59
%
 
 
Sales and marketing expenses increased $12.2 million , or 26% , for the three months ended March 31, 2017, as compared to the corresponding period last year. The increase in headcount on a worldwide basis resulted in increased personnel-related and commissions expenses of $10.1 million, which include an increase in stock-based compensation expense of $1.1 million. Corporate and facilities expenses increased $0.7 million due to higher headcount. Additionally, expense for lead generation, trade shows, advertising and other initiatives increased $0.5 million. Travel expenses increased $0.9 million for the three months ended March 31, 2017 as compared to the same period last year.

36

Table of Contents

 
 
Three Months Ended
March 31,
 
2017
 
2016
 
% Change
 
(in thousands)
 
 
General and administrative
$
10,487

 
$
10,604

 
-1
 %
Percent of total revenue
9
%
 
13
%
 
 
General and administrative expenses decreased $0.1 million , or 1% , for the three months ended March 31, 2017, as compared to the corresponding period last year. The decrease for the three months ended March 31, 2017, was primarily due to a decrease in litigation and settlement expense of $1.2 million related to the Finjan lawsuit and settlement, a decrease in fair value of acquisition-related contingent consideration liability of $1.4 million (see Note 4) offset by an increase in personnel costs of $1.6 million due to higher headcount and an increase in recruiting and consulting expense of $0.6 million.

Interest Expense
 
Three Months Ended
March 31,
 
2017
 
2016
 
% Change
 
(in thousands)
 
 
Interest expense
$
(5,966
)
 
$
(5,800
)
 
3
%
The change in interest expense for the three months ended March 31, 2017 as compared to the three months ended March 31, 2016, was not material.

Other Income (Expense), Net
 
Three Months Ended
March 31,
 
2017
 
2016
 
% Change
 
(in thousands)
 
 
Other income (expense), net
$
(129
)
 
$
2

 
(6550
%)
Other expense, net, increased $0.1 million for the three months ended March 31, 2017, as compared to the corresponding period last year, primarily due to fluctuations in foreign currency exchange rates.

Provision for Income Taxes

 
Three Months Ended
March 31,
 
2017
 
2016
 
% Change
 
(in thousands)
 
 
Provision for income taxes
$
(1,434
)
 
$
(257
)
 
458
%
Provision for income taxes increased $1.2 million for the three months ended March 31, 2017, primarily due to an increase in foreign current tax expense due to increase in spending in certain foreign subsidiaries who operate on a cost-plus

37

Table of Contents

basis, an increase in deferred tax liabilities related to business acquisitions, and an increase in deferred tax liabilities related to a change in the fair value of an acquisition-related continent consideration payment.

Liquidity and Capital Resources
As of March 31, 2017 , we had $381.9 million in cash and cash equivalents and $31.0 million in short-term investments, for a total of $412.9 million . See Note 6 "Convertible Senior Notes" to the condensed consolidated financial statements for discussion of the Notes.

As of March 31, 2017 , we had approximately $11.6 million of cash and cash equivalents at our foreign subsidiaries. We estimated that no material U.S. income taxes would have to be provided if all of the undistributed earnings of our foreign subsidiaries were repatriated back to the United States as substantially all earnings from our foreign subsidiaries are previously taxed income.
    
We plan to grow our customer base by continuing to emphasize investments in sales and marketing to add new customers, expand our customers’ use of our platform, and maintain high renewal rates. We also expect to incur additional cost of subscription revenue in accordance with the resulting growth in our customer base. We believe that the combination of our ongoing improvements in gross margins, the benefits of lower sales and marketing costs associated with our renewal activity, and the fact that our contracts are structured to bill our customers in advance should enable us to improve our cash flow from operations as we grow. Based on our current level of operations and anticipated growth, both of which are expected to be consistent with recent quarters, we believe that our existing sources of liquidity will be sufficient to fund our operations for at least the next 12 months. Our future capital requirements will depend on many factors, including our rate of revenue growth, the expansion of our sales and marketing activities, and the timing and extent of spending to support product development efforts and expansion into new territories, and the timing of introductions of new features and enhancements to our solutions. To the extent that existing cash and cash equivalents and cash from operations are insufficient to fund our future activities, we may need to raise additional funds through public or private equity or debt financing. We have invested, and plan to continue investing in acquiring complementary businesses, applications and technologies, and may continue to make such investments in the future, any of which could also require us to seek equity or debt financing in addition to our Notes. Additional funds may not be available on terms favorable to us or at all.
Cash Flows
The following table sets forth a summary of our consolidated cash flows for the periods indicated:
 
Three Months Ended
March 31,
 
2017
 
2016
 
(in thousands)
Net cash provided by operating activities
$
40,469

 
$
17,418

Net cash provided by investing activities
$
10,582

 
$
19,821

Net cash used in financing activities
$
(14,759
)
 
$
(6,231
)
Net Cash Flows Provided by Operating Activities
Our net loss and cash flows from operating activities are significantly influenced by our investments in headcount and data center operations to support anticipated growth. Our cash flows are also influenced by cash payments from customers. We invoice customers for the entire contract amount at the start of the term, and as such our cash flow from operations is also affected by the length of a customer contract.
Net cash provided by operating activities in the three months ended March 31, 2017 was $40.5 million , as compared to $17.4 million provided in the three months ended March 31, 2016. The increase of $23.1 million was primarily due to:
a decrease in net loss of $6.2 million ;

38

Table of Contents

an increase in amortizatio