Zscaler, Inc. (ZS) FY 2023 MD&A

Item 7. 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 consolidated financial statements and related notes included elsewhere in this Annual Report on Form 10-K. As discussed in the section titled "Special Note Regarding Forward-Looking Statements," the following discussion contains forward-looking statements that involve risks and uncertainties. Our actual results could differ materially from those discussed below. Factors that could cause or contribute to such difference include, but are not limited to, those identified below and those discussed in the section titled "Risk Factors" and elsewhere in this Annual Report on Form 10-K. Our fiscal year end is July 31, and our fiscal quarters end on October 31, January 31, April 30, and July 31. Our fiscal years ended July 31, 2023, July 31, 2022 and July 31, 2021 are referred to as fiscal 2023, fiscal 2022 and fiscal 2021, respectively.

Overview

Zscaler was incorporated in 2007, during the early stages of cloud adoption and mobility, based on a vision that the internet would become the new corporate network as the cloud becomes the new data center. We predicted that with rapid cloud adoption and increasing workforce mobility, traditional perimeter security approaches would provide inadequate protection for users and data and an increasingly poor user experience. We pioneered a cloud platform, the Zscaler Zero Trust Exchange, that represents a fundamental shift in the architectural design and approach to networking and security.

We generate revenue primarily from sales of subscriptions to access our cloud platform, together with related support services. We also generate an immaterial amount of revenue from professional and other services, which consist primarily of fees associated with mapping, implementation, network design and training. Our subscription pricing is primarily calculated on a per-user basis. We recognize subscription and support revenue ratably over the life of the contract, which is generally one to three years. As of July 31, 2023, we had expanded our operations to over 7,700 customers across major industries, with users in 185 countries. Government agencies and some of the largest enterprises in the world rely on us to support their digital transformation, including more than 640 of the Forbes Global 2000 as of July 31, 2023.

We operate our business as one reportable segment. Our revenue has experienced significant growth in recent periods. For fiscal 2023, fiscal 2022 and fiscal 2021, our revenue was $1,617.0 million, $1,090.9 million and $673.1 million, respectively. We have incurred net losses in all periods since our inception. For fiscal 2023, fiscal 2022 and fiscal 2021, our net loss was $202.3 million, $390.3 million and $262.0 million, respectively. We expect we will continue to incur net losses for the foreseeable future, as we continue to invest in our sales and marketing organization to take advantage of our market opportunity, to invest in research and development efforts to enhance the functionality of our cloud platform, to incur additional compliance and other related costs as we operate as a public company, and to address any legal matters and related accruals, as further described in Note 12, Commitments and Contingencies, of the consolidated financial statements included elsewhere in this Annual Report on Form 10-K.

Impact of macroeconomic conditions and global health crises like the COVID-19 pandemic

Recent changes in macroeconomic conditions such as high inflation and potential recessionary environments can cause uncertainty in our business. For the fiscal 2023, we experienced growth in total revenue but also saw increased customer scrutiny and a longer approval process for transactions, particularly larger deals, in comparison to the prior fiscal period, as potential new customers are taking longer to make purchasing decisions and requiring additional approvals for large expenditures in response to the challenging economic environment. Macroeconomic conditions, including inflation and continued uncertainty regarding the current and future political and economic environment, may impact the future demand for subscriptions of our cloud platform.

In March 2020, the World Health Organization declared the COVID-19 outbreak to be a pandemic. While we have not to date experienced significant disruptions to our operations or financial performance as a result of a health crisis, including the COVID-19 pandemic, we are unable to predict the impact of this or similar future events due to numerous uncertainties,

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including the emergence or resurgence of an outbreak in connection with COVID-19 or a similar virus, actions that may be taken by governmental authorities, the impact on our business including our sales cycle, sales execution and marketing efforts, and the impact to the business of our customers, vendors and partners. For further discussion of the challenges and risks we confront related to macroeconomic conditions and global health crises, like the COVID-19 pandemic, please refer to Part II, Item 1A Risk Factors of this Annual Report on Form 10-K.

Certain Factors Affecting Our Performance

Increased Internet Traffic and Adoption of Cloud-Based Software and Security

The adoption of cloud applications and infrastructure, explosion of internet traffic volumes and shift to mobile-first computing generally, and the pace at which enterprises adopt the internet as their corporate network in particular, impact our ability to drive market adoption of our cloud platform. We believe that most enterprises are in the early stages of a broad transformation to the cloud. Organizations are increasingly relying on the internet to operate their businesses, deploying new SaaS applications and migrating internally managed line-of-business applications to the cloud. However, the growing dependence on the internet has increased exposure to malicious or compromised websites, and sophisticated hackers are exploiting the gaps left by legacy network security appliances. To securely access the internet and transform their networks, organizations must also make fundamental changes in their network and security architectures. We believe that most organizations have yet to fully make these investments. Since we enable organizations to securely embrace digital transformation, we believe that the imperative for organizations to securely move to the cloud will increase demand for our cloud platform and broaden our customer base.

New Customer Acquisition

We believe that our ability to increase the number of customers, and more significantly customers in the Forbes Global 2000, on our cloud platform is an indicator of our market penetration and our future business opportunities. As of July 31, 2023, 2022 and 2021, we had over 7,700, 6,700 and 5,600 customers, respectively, across all major geographies. As of July 31, 2023, we had over 640 of the Forbes Global 2000 as customers. Our ability to continue to grow these numbers will increase our future opportunities for renewals and follow-on sales. We believe that we have significant room to capture additional market share and intend to continue to invest significantly in sales and marketing to engage our prospective customers, increase brand awareness, further leverage our channel partnerships and drive adoption of our solution. However, as a result of the challenging economic environment, potential new customers are increasingly taking longer to make purchasing decisions and requiring additional approvals for large expenditures. We expect customer cautiousness to continue in the near term, elongating our sales cycles and the timing of large deals.

Follow-On Sales

We typically expand our relationship with our customers over time. While most of our new customers route all of their internet-bound web traffic through our cloud platform, some of our customers initially use our services for specific users or specific security functionality. We leverage our land-and-expand model with the goal of generating incremental revenue, often within the term of the initial subscription, by increasing sales to our existing customers in one of three ways:

•expanding deployment of our cloud platform to cover additional users;

•upgrading to a more advanced Business or Transformation edition; and

•selling a subscription to a new solution or product, for example selling a ZPA subscription to a ZIA customer or a ZIA subscription to a ZPA customer.

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These purchases increase the Annual Recurring Revenue ("ARR") attributable to our customers over time. To establish ARR for a customer, we use the total amount of each order booked to compute the annual recurring value of revenue that we would recognize if the customer continues to renew all contractual subscriptions. For example, a contract for $3.0 million with a contractual term of three years would have an ARR of $1.0 million as long as our customer uses our cloud platform.

Investing in Business Growth

Since our founding, we have invested significantly in growing our business. We intend to continue (i) investing in our research and development organization and our development efforts to offer new solutions on our cloud platform and (ii) dedicating resources to update and upgrade our existing solutions. In addition, we expect our general and administrative expenses to increase in absolute dollars in the foreseeable future, as we continue to operate as a public company and address any legal matters and related accruals, as further described in Note 12, Commitments and Contingencies, of the consolidated financial statements included elsewhere in this Annual Report on Form 10-K.

We also intend to continue to invest significantly in sales and marketing to grow and train our sales force, broaden our brand awareness and expand and deepen our channel partner relationships. While these planned investments will increase our operating expenses in the short term, we believe that over the long term these investments will help us to expand our customer base and grow our business. We also are investing in programs to increase recognition of our brand and solutions, including joint marketing activities with our channel partners and strategic partners.

While we expect our operating expenses to increase in absolute dollars in the foreseeable future, as a result of these activities, we intend to balance these investments in future growth with a continued focus on managing our results of operations and investing judiciously. In the long term we anticipate that these investments will positively impact our business and results of operations.

Key Business Metrics and Other Financial Measures

We review a number of operating and financial metrics, including the following key metrics, to measure our performance, identify trends, formulate business plans and make strategic decisions.

Dollar-Based Net Retention Rate

We believe that dollar-based net retention rate is a key metric to measure the long-term value of our customer relationships because it is driven by our ability to retain and expand the recurring revenue generated from our existing customers. Our dollar-based net retention rate compares the recurring revenue from a set of customers against the same metric for the prior 12-month period on a trailing basis. Because our customers have repeat buying patterns and the average term of our contracts is more than 12 months, we measure this metric over a set of customers who were with us as of the last day of the same reporting period in the prior fiscal year. Our dollar-based net retention rate includes customer attrition. We have not experienced a material increase in customer attrition rates in recent periods. For the trailing 12 months ended July 31, 2023 and 2022, the dollar-based net retention rate was 121% and above 125%, respectively.

We calculate our dollar-based net retention rate as follows:

•Denominator: To calculate our dollar-based net retention rate as of the end of a reporting period, we first establish the ARR from all active subscriptions as of the last day of the same reporting period in the prior fiscal year. This effectively represents recurring dollars that we expect in the next 12-month period from the cohort of customers that existed on the last day of the same reporting period in the prior fiscal year.

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•Numerator: We measure the ARR for that same cohort of customers representing all subscriptions based on confirmed customer orders booked by us as of the end of the reporting period.

Dollar-based net retention rate is obtained by dividing the numerator by the denominator. Our dollar-based net retention rate may fluctuate due to a number of factors, including the performance of our cloud platform, our success in selling bigger deals, including deals for all employees with our higher-end bundles, selling multiple-pillars from the start of our contract with new customers, faster upsells within a year, the timing and the rate of ARR expansion of our existing customers, potential changes in our rate of renewals and other risk factors described elsewhere in this Annual Report on Form 10-K.

Non-GAAP Financial Measures

In addition to our results determined in accordance with GAAP, we believe the following non-GAAP measures are useful in evaluating our operating performance. We use the following non-GAAP financial information to evaluate our ongoing operations and for internal planning and forecasting purposes. We believe that non-GAAP financial information, when taken collectively, may be helpful to investors because it provides consistency and comparability with past financial performance. However, non-GAAP financial information is presented for supplemental informational purposes only, has limitations as an analytical tool and should not be considered in isolation or as a substitute for financial information presented in accordance with GAAP. In particular, free cash flow is not a substitute for cash provided by operating activities. Additionally, the utility of free cash flow as a measure of our liquidity is further limited as it does not represent the total increase or decrease in our cash balance for a given period. In addition, other companies, including companies in our industry, may calculate similarly-titled non-GAAP measures differently or may use other measures to evaluate their performance, all of which could reduce the usefulness of our non-GAAP financial measures as tools for comparison. A reconciliation is provided below for each non-GAAP financial measure to the most directly comparable financial measure stated in accordance with GAAP. Investors are encouraged to review the related GAAP financial measures and the reconciliation of these non-GAAP financial measures to their most directly comparable GAAP financial measures, and not to rely on any single financial measure to evaluate our business.

Non-GAAP Gross Profit and Non-GAAP Gross Margin

We define non-GAAP gross profit as GAAP gross profit excluding stock-based compensation expense and related payroll taxes and amortization expense of acquired intangible assets. We define non-GAAP gross margin as non-GAAP gross profit as a percentage of revenue.

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Non-GAAP Income from Operations and Non-GAAP Operating Margin

We define non-GAAP income from operations as GAAP loss from operations excluding stock-based compensation expense and related payroll taxes, amortization expense of acquired intangible assets, asset impairment related to facility exit, and restructuring and other charges. We define non-GAAP operating margin as non-GAAP income from operations as a percentage of revenue.

(1) Consists of asset impairment charges related to the relocation of our corporate headquarters.

(2) In connection with a restructuring plan announced in March 2023, we incurred stock-based compensation expense of approximately $1.0 million, which is included in stock-based compensation expense and related payroll taxes.

Free Cash Flow and Free Cash Flow Margin

Free cash flow is a non-GAAP financial measure that we calculate as net cash provided by operating activities less purchases of property, equipment and other assets and capitalized internal-use software. Free cash flow margin is calculated as free cash flow divided by revenue. We believe that free cash flow and free cash flow margin are useful indicators of liquidity that provide information to management and investors about the amount of cash generated from our operations that, after the investments in property, equipment and other assets and capitalized internal-use software, can be used for strategic initiatives, including investing in our business, and strengthening our financial position.

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Free cash flow includes the cyclical impact of inflows and outflows resulting from contributions to our employee stock purchase plan for which the purchase period of approximately six months ends in each of our second and fourth fiscal quarters. As of July 31, 2023, the accrued employee payroll contributions to our ESPP was $7.4 million, which will be used to purchase shares at the end of the current purchase period ending on December 15, 2023. Payroll contributions ultimately used to purchase shares will be reclassified to stockholders' equity upon issuance of the shares during our second quarter of fiscal 2024.

Calculated Billings

Calculated billings is a non-GAAP financial measure that we believe is a key metric to measure our periodic performance. Calculated billings represents our total revenue plus the change in deferred revenue in a period. Calculated billings in any particular period aims to reflect amounts invoiced for subscriptions to access our cloud platform, together with related support services for our new and existing customers. We typically invoice our customers annually in advance, and to a lesser extent quarterly in advance, monthly in advance or multi-year in advance. Calculated billings increased $554.0 million, or 37%, in fiscal 2023 over fiscal 2022, and $547.5 million, or 59%, in fiscal 2022 over fiscal 2021. As calculated billings continues to grow in absolute terms, we expect our calculated billings growth rate to trend down over time. We also expect that calculated billings will be affected by seasonality in terms of when we enter into agreements with customers; and the mix of billings in each reporting period as we typically invoice customers annually in advance, and to a lesser extent quarterly in advance, monthly in advance or multi-year in advance.

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Components of Results of Operations

Revenue

We generate revenue primarily from sales of subscriptions to access our cloud platform, together with related support services. Subscription and related support services accounted for approximately 97% of our revenue for each of the fiscal 2023, fiscal 2022 and fiscal 2021, respectively. Our contracts with our customers do not at any time provide the customer with the right to take possession of the software that runs our cloud platform. Our customers may also purchase professional services, such as mapping, implementation, network design and training. Professional services account for an immaterial portion of our revenue.

We generate revenue from contracts with typical durations ranging from one to three years. We typically invoice our customers annually in advance, and to a lesser extent quarterly in advance, monthly in advance or multi-year in advance. We recognize revenue ratably over the life of the contract. Amounts that have been invoiced are recorded in deferred revenue, or they are recorded in revenue if the revenue recognition criteria have been met. Subscriptions that are invoiced annually in advance or multi-year in advance represent a significant portion of our short-term and long-term deferred revenue in comparison to invoices issued quarterly in advance or monthly in advance. Accordingly, we cannot predict the mix of invoicing schedules in any given period.

We generally experience seasonality in terms of when we enter into agreements with our customers. We typically enter into a higher percentage of agreements with new customers, as well as renewal agreements with existing customers, in our second and fourth fiscal quarters. However, because we recognize revenue ratably over the terms of our subscription contracts, a substantial portion of the revenue that we report in each period is attributable to the recognition of deferred revenue relating to agreements that we entered into during previous periods. Consequently, increases or decreases in new sales or renewals in any one period may not be immediately reflected as revenue for that period. Accordingly, the effect of downturns in sales and market acceptance of our platform, and potential changes in our rate of renewals, may not be fully reflected in our results of operations until future periods.

Cost of Revenue

Cost of revenue includes expenses related to operating our cloud platform in data centers, depreciation of our data center equipment, amortization of our capitalized internal-use software, amortization of intangible assets acquired through our business acquisitions and allocated overhead expenses (i.e., facilities, IT, depreciation expense and amortization expense). Cost of revenue also includes employee-related expenses, including salaries, bonuses, stock-based compensation expense and employee benefit expenses associated with our customer support and cloud operations organizations.

As our customers expand and increase the use of our cloud platform, driven by additional applications and connected devices, our cost of revenue will increase due to higher bandwidth and data center expenses. However, we expect to continue to benefit from economies of scale as our customers increase the use of our cloud platform. We intend to continue to invest additional resources in our cloud platform and our customer support organizations as we grow our business. The level and timing of investment in these areas could affect our cost of revenue in the future.

Gross Profit and Gross Margin

Gross profit, or revenue less cost of revenue, and gross margin, or gross profit as a percentage of revenue, have been and will continue to be affected by various factors, including the timing of our acquisition of new customers and our renewals of and follow-on sales to existing customers, the average sales price of our services, mix of services offered in our solutions, including new product introductions, the data center and bandwidth costs associated with operating our cloud platform, the extent to which we expand our customer support and cloud operations organizations and the extent to which we can increase

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the efficiency of our technology, infrastructure and data centers through technological improvements. We expect our gross profit to increase in absolute dollars and our gross margin to increase slightly over the long term, although our gross profit and gross margin could fluctuate from period to period depending on the interplay of all of the above factors.

Operating Expenses

Our operating expenses consist of sales and marketing expenses, research and development expenses, general and administrative expenses and restructuring and other charges. Personnel expenses are the most significant component of operating expenses and consist of salaries, benefits, bonuses, stock-based compensation expense and, with respect to sales and marketing expenses, sales commissions that are recognized as expenses over the period of benefit. Operating expenses also include overhead expenses for facilities, IT, depreciation expense and amortization expense.

Sales and Marketing

Sales and marketing expenses consist primarily of employee compensation and related expenses, including salaries, bonuses and benefits for our sales and marketing employees, sales commissions that are recognized as expenses over the period of benefit, stock-based compensation expense, marketing programs, travel and entertainment expenses, expenses for conferences and events, amortization of intangible assets acquired through our business acquisitions and allocated overhead expenses. We capitalize our sales commissions and associated payroll taxes and recognize them as expenses over the estimated period of benefit. The amount recognized in our sales and marketing expenses reflects the amortization of expenses previously deferred as attributable to each period presented in this Annual Report on Form 10-K, as described below under "Critical Accounting Policies and Estimates."

We intend to continue to make significant investments in our sales and marketing organization to drive additional revenue, further penetrate the market and expand our global customer base. As a result, we expect our sales and marketing expenses to continue to increase in absolute dollars and to be our largest operating expense category for the foreseeable future. In particular, we will continue to invest in growing and training our sales force, broadening our brand awareness and expanding and deepening our channel partner relationships. However, we expect our sales and marketing expenses to decrease as a percentage of our revenue over the long term, although our sales and marketing expenses may fluctuate as a percentage of our revenue from period to period due to the timing and extent of these expenses.

Research and Development

Our research and development expenses support our efforts to add new products, new features to our existing offerings and to ensure the reliability, availability and scalability of our solutions. Our cloud platform is software-driven, and our research and development teams employ software engineers in the design, and the related development, testing, certification and support, of these solutions. Accordingly, a majority of our research and development expenses result from employee-related expenses, including salaries, bonuses and benefits, stock-based compensation expense and expenses associated with technology tools used by our engineers. We expect our research and development expenses to continue to increase in absolute dollars for the foreseeable future, as we continue to invest in research and development efforts to enhance the functionality of our cloud platform, improve the reliability, availability and scalability of our platform and access new customer markets. However, we expect our research and development expenses to decrease as a percentage of our revenue over the long term, although our research and development expenses may fluctuate as a percentage of our revenue from period to period due to the timing and extent of these expenses.

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General and Administrative

General and administrative expenses consist primarily of employee-related expenses, including salaries and bonuses, stock-based compensation expense and employee benefit expenses for our finance, legal, human resources and administrative personnel, as well as professional fees for external legal services (including certain litigation-related expenses), accounting and other related consulting services. The litigation-related expenses include professional fees and related expenses incurred by us in defending or settling significant claims that we deem not to be in the ordinary course of our business and, if applicable, accruals related to estimated losses in connection with these claims. We expect our general and administrative expenses to increase in absolute dollars for the foreseeable future, as we continue to incur compliance expenses and other related expenses necessary to operate as a public company, and due to any legal matters and related accruals, as further described in Note 12, Commitments and Contingencies, to the consolidated financial statements included elsewhere in this Annual Report on Form 10-K. However, we expect our general and administrative expenses to decrease as a percentage of our revenue over the long term, although our general and administrative expenses may fluctuate as a percentage of our revenue from period to period due to the timing and extent of these expenses. In particular, litigation-related expenses related to significant litigation claims may result in significant fluctuations from period to period, as they are inherently subject to change and difficult to estimate.

Restructuring and Other Charges

Restructuring and other charges occur when we commit to a restructuring plan, the restructuring plan identifies all significant actions, the period of time to complete the restructuring plan indicates that significant changes to the restructuring plan are not likely and employees who are impacted have been notified of the pending involuntary termination. A restructuring plan generally includes significant actions involving employee-related severance charges, employee-related benefits, stock-based compensation expense related to the modification of equity incentive awards and other charges associated with the restructuring (the "restructuring charges"). Restructuring charges are accrued in the period in which it is probable that the employees are entitled to the restructuring benefits and the amounts can be reasonably estimated.

Interest Expense

Interest expense consists primarily of amortization of debt discount and issuance costs, recognition of contractual interest expense related to the Notes, and gains and losses related to changes in the fair value of interest rate swaps. Refer to Note 8, Derivative Instruments and Note 10, Convertible Senior Notes, of our consolidated financial statements included elsewhere in this Annual Report on Form 10-K. Effective August 1, 2022, we adopted ASU 2020-06. The adoption of this standard resulted in the elimination of the amortization of the debt discount as interest expense and the portion of the issuance costs initially allocated to equity is now classified as debt and amortized as interest expense. For further information, refer to Note 1, Business and Summary of Significant Accounting Policies, of our consolidated financial statements included elsewhere in this Annual Report on Form 10-K.

Interest Income

Interest income consists primarily of income earned on our cash equivalents and short-term investments.

Other Income (Expense), Net

Other income (expense), net consists primarily of foreign currency transaction gains and losses and changes in fair value of our non-designated derivative instruments.

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Provision for Income Taxes

Our provision for income taxes consists primarily of income and withholding taxes in the foreign jurisdictions, and U.S. income taxes from a tax law change related to mandatory capitalization of research and development expenses for tax years starting January 1, 2022. In the United States, we have recorded deferred tax assets for which we provide a full valuation allowance, which includes net operating loss carryforwards and research and development tax credits. We expect to maintain this full valuation allowance for the foreseeable future as it is more likely than not that some or all of those deferred tax assets may not be realized based on our history of losses. Additionally, in the U.K., we have recorded deferred tax assets for which we provide a full valuation allowance, which includes net operating loss carryforwards. We expect to maintain this full valuation allowance for the foreseeable future as it is more likely than not that some or all of those deferred tax assets may not be realized based on our history of losses.

Results of Operations

The following tables set forth our results of operations for the periods presented in dollars and as a percentage of our revenue:

_____

(1) Includes stock-based compensation expense and related payroll taxes as follows:

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(2) Includes amortization expense of acquired intangible assets as follows:

(5) Effective August 1, 2022, we adopted ASU 2020-06 using the modified retrospective method under which prior period amounts have not been adjusted. This standard resulted in our convertible senior notes being accounted for as a single unit of debt and we will no longer be required to record the conversion feature in equity. This further eliminated the need for amortization of the debt discount as interest expense and the portion of the issuance costs initially allocated to equity is now classified as debt and amortized as interest expense. For further information refer to Note 1, Business and Summary of Significant Accounting Policies of our consolidated financial statements included elsewhere in this Annual Report on Form 10-K.

The following table sets forth our results of operations for the periods presented as a percentage of our revenue:

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Comparison of Fiscal 2023 and Fiscal 2022

Revenue

Revenue increased by $526.0 million, or 48%, in fiscal 2023, compared to fiscal 2022. The increase was driven primarily by an increase in users and sales of additional subscriptions to existing customers, which contributed $440.6 million in additional revenue. The remainder of the increase was primarily attributable to the addition of new customers, as we increased our customer base by 14%.

Cost of Revenue and Gross Margin

Cost of revenue increased by $120.6 million, or 50%, in fiscal 2023, compared to fiscal 2022. The overall increase was driven primarily by the expanded use of our cloud platform by existing and new customers, which led to an increase of $68.2 million for data center and equipment related costs for hosting and operating our cloud platform. Additionally, our employee-related expenses increased by $41.8 million, inclusive of an increase of $15.3 million in stock-based compensation expense, driven primarily by a 25% increase in headcount in our customer support and cloud operations organizations. The remainder of the increase was primarily attributable to increased expenses of $7.4 million in facility and IT services.

Gross margin remained flat at 78% for fiscal 2023 compared to fiscal 2022 as our cost of providing our services were proportionately offset by growth in our revenue.

Operating Expenses

Sales and Marketing Expenses

Sales and marketing expenses increased by $218.6 million, or 30%, for fiscal 2023, compared to fiscal 2022. The increase was driven primarily by a 15% increase in headcount, resulting in an increase of $160.8 million in employee-related expenses, inclusive of an increase of $24.5 million in stock-based compensation expense, and an increase of $36.7 million in sales commissions expense. The remainder of the increase was primarily attributable to increased expenses of $20.8 million in travel expenses, $17.8 million in marketing and advertising expense and $17.9 million in facility and IT services.

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Research and Development Expenses

Research and development expenses increased by $60.6 million, or 21%, for fiscal 2023, compared to fiscal 2022, as we continued to develop and enhance the functionality of our cloud platform and integrate technologies acquired through our business combinations. The increase was driven primarily by an increase of $54.8 million in employee-related expenses, exclusive of stock-based compensation expense, primarily due to a 23% increase in headcount. The remainder of the increase was primarily attributable to increased expenses of $12.1 million in facility, software and equipment related expenses to support our growth and $2.1 million in professional services. The increase was partially offset by higher capitalized internal-use software of $10.4 million to support the enhancement and growth of our cloud platform as well as due to a decrease in stock-based compensation expense of $0.4 million. Stock-based compensation expense decreased primarily because of the resignation of our President, who led research and development activities, in October 2022 and resulted in the reversal of $9.9 million of stock-based compensation expense associated with the cancellation of unvested equity incentive awards in fiscal 2023.

General and Administrative Expenses

General and administrative expenses increased by $25.8 million, or 17%, for fiscal 2023, compared to fiscal 2022. The increase was driven primarily by an increase of $17.0 million in employee-related expenses, exclusive of stock-based compensation expense, primarily due to a 23% increase in headcount. The remainder of the increase was primarily attributable to increased expenses of $6.6 million in professional services and $3.0 million in facility and IT services to support our growth. The increase was partially offset by a decrease in stock-based compensation expense of $5.3 million as a result of an executive equity incentive award for which the vesting term was completed in the fiscal quarter ended October 31, 2022.

Restructuring and Other Charges

On March 1, 2023, we announced a restructuring plan as a part of our planned efforts to streamline operations and to align people, roles and projects to our strategic priorities. These actions included the reduction of our worldwide headcount by approximately 3%. We completed the restructuring plan by the end of fiscal 2023, resulting in $7.6 million of restructuring charges, consisting of $6.6 million of employee severance and benefit charges, and $1.0 million of stock-based compensation expense related to modified equity incentive awards. For further information refer to Note 9, Restructuring and Other Charges, of our consolidated financial statements included elsewhere in this Annual Report on Form 10-K.

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Interest Income

Interest income increased by $55.9 million for fiscal 2023, compared to fiscal 2022. The increase was driven primarily by higher interest rates and our increased balance of cash equivalents and short-term investments.

Interest Expense

Interest expense decreased by $50.0 million for fiscal 2023, compared to fiscal 2022. The decrease was driven primarily by a decrease of $51.3 million as a result of the adoption of ASU 2020-06, which resulted in the elimination of the debt discount and related amortization as interest expense and the classification of the portion of the debt issuance costs initially allocated to equity within the carrying amount of the Notes, which shall be recognized as interest expense. The decrease was partially offset by an increase in interest expense of $1.2 million due to fair value hedge adjustments related to our Notes. For further information refer to Note 1, Business and Summary of Significant Accounting Policies, and Note 8, Derivative Instruments, of our consolidated financial statements included elsewhere in this Annual Report on Form 10-K.

Other Expense, net

Other expense, net decreased by $2.3 million for fiscal 2023, compared to fiscal 2022. The decrease was driven primarily by fluctuations in foreign currency transactions gains and losses.

Provision for Income Taxes

Our provision for income taxes increased by $13.1 million, or 197%, for fiscal 2023, compared to fiscal 2022. The increase was driven primarily by the increase in our pre-tax income in the foreign jurisdictions in which we conduct business, as well as the U.S. federal and state income tax impacts of the mandatory capitalization of research and development expenses incurred during the year. Additionally, the provision for income taxes in fiscal 2022 was lower than fiscal 2023 due to an income tax benefit of $1.0 million associated with the acquisition of intangible assets from ShiftRight, Inc. ("ShiftRight") and another business acquisition, and by an income tax benefit of $1.5 million for the refund of withholding taxes related to prior fiscal periods. For further information, refer to Note 15, Income Taxes, of the consolidated financial statements included elsewhere in this Annual Report on Form 10-K. Our effective tax rate of (10.9)% and (1.7)% in fiscal

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2023 and fiscal 2022, respectively, differs from the applicable U.S. statutory federal income tax rate due to our valuation allowance against our U.S. federal, state, and U.K. deferred tax assets as well as our foreign income being taxed at different rates than the U.S. statutory rate.

While we believe our current valuation allowance is sufficient, we assess the need for an adjustment to the valuation allowance on a quarterly basis. The assessment is based on our estimates of future sources of taxable income for the jurisdictions in which we operate and the periods over which our deferred tax assets will be realizable. In the event we determine that we will be able to realize all or part of our net deferred tax assets in the future, the valuation allowance will be reversed in the period in which we make such determination. The release of a valuation allowance against deferred tax assets may cause greater volatility in the effective tax rate in the periods in which it is reversed.

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Comparison of Fiscal 2022 and Fiscal 2021

Revenue

Revenue increased by $417.8 million, or 62%, in fiscal 2022, compared to fiscal 2021. The increase in revenue was driven by an increase in users and sales of additional subscriptions to existing customers, which contributed $337.6 million in additional revenue. The remainder of the increase was attributable to the addition of new customers, as we increased our customer base by 20%.

Cost of Revenue and Gross Margin

Cost of revenue increased by $92.0 million, or 61%, in fiscal 2022, compared to fiscal 2021. The overall increase was driven primarily by the expanded use of our cloud platform by existing and new customers, which led to an increase of $42.4 million for data center and equipment related costs for hosting and operating our cloud platform. Additionally, our employee-related expenses increased by $41.6 million, inclusive of an increase of $9.8 million in stock-based compensation expense, driven primarily by a 70% increase in headcount in our customer support and cloud operations organizations. The remainder of the increase was primarily attributable to increased expenses of $2.5 million for professional services and $2.0 million for facility and IT services.

Gross margin remained flat at 78% for fiscal 2022 compared to fiscal 2021 as our cost of providing our services were proportionately offset by growth in our revenue.

Operating Expenses

Sales and Marketing Expenses

Sales and marketing expenses increased by $275.8 million, or 60%, for fiscal 2022, compared to fiscal 2021. The increase was driven primarily by a 54% increase in headcount, resulting in an increase of $201.1 million in employee-related expenses, inclusive of an increase of $58.0 million in stock-based compensation expense, and an increase of $32.9 million in sales

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commissions expense. The remainder of the increase was primarily attributable to increased expenses of $23.0 million in marketing and advertising expense, $17.1 million in travel expenses, $16.0 million in facility and IT services and $11.4 million in professional services.

Research and Development Expenses

Research and development expenses increased by $114.5 million, or 66%, for fiscal 2022, compared to fiscal 2021 as we continued to develop and enhance the functionality of our cloud platform. The increase was driven primarily by an increase of $109.4 million in employee-related expenses, inclusive of an increase of $50.5 million in stock-based compensation expense, driven by a 54% increase in headcount. The remainder of the increase was primarily attributable to increased expenses of $11.1 million in facility, software and equipment related expenses to support our growth and $2.9 million in professional services. This increase was partially offset by higher capitalized internal-use software of $10.6 million to support the enhancement and growth of our cloud platform.

General and Administrative Expenses

General and administrative expenses increased by $55.2 million, or 57%, for fiscal 2022, compared to fiscal 2021. The overall increase was driven primarily by an increase of $48.7 million in employee-related expenses, inclusive of an increase of $32.7 million in stock-based compensation expense, primarily due to a 65% increase in headcount. The remainder of the increase was primarily attributable to increased expenses of $2.6 million in facility and IT services.

Interest Income

Interest income increased by $1.8 million, or 63%, for fiscal 2022, compared to fiscal 2021. The increase was driven primarily by higher interest rates and our increased balance of cash equivalents and short-term investments.

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Interest Expense

Interest expense increased by $3.2 million for fiscal 2022, compared to fiscal 2021 as a result of higher amortization of debt discount and recognition of contractual interest expense related to our Notes issued in June 2020. For further information on the Notes, refer to Note 10, Convertible Senior Notes, of the consolidated financial statements included elsewhere in this Annual Report on Form 10-K.

Other Income (Expense), net

Other income (expense), net decreased by $5.4 million for fiscal 2022, compared to fiscal 2021. The decrease was driven primarily by fluctuations in foreign currency transaction gains and losses.

Provision for Income Taxes

Our provision for income taxes increased by $1.8 million, or 37%, for fiscal 2022, compared to fiscal 2021. The increase was primarily related to income and withholding taxes in the foreign jurisdictions in which we operate. The increase in the provision for income taxes was due to the increase in our non-U.S. pre-tax income in the foreign jurisdictions in which we conduct business. The provision for income taxes in fiscal 2022 was offset by an income tax benefit of $1.0 million associated with the acquisition of intangible assets from ShiftRight, Inc. ("ShiftRight") and another business acquisition, and by an income tax benefit of $1.5 million for the refund of withholding taxes related to prior fiscal periods. For further information, refer to Note 15, Income Taxes, of the consolidated financial statements included elsewhere in this Annual Report on Form 10-K. Our effective tax rate of (1.7)% and (1.9)% in fiscal 2022 and fiscal 2021, respectively, differs from the applicable U.S. statutory federal income tax rate due to our valuation allowance against our U.S. federal, state, and U.K. deferred tax assets as well as our foreign income being taxed at different rates than the U.S. statutory rate.

While we believe our current valuation allowance is sufficient, we assess the need for an adjustment to the valuation allowance on a quarterly basis. The assessment is based on our estimates of future sources of taxable income for the jurisdictions in which we operate and the periods over which our deferred tax assets will be realizable. In the event we determine that we will be able to realize all or part of our net deferred tax assets in the future, the valuation allowance will be reversed in the period in which we make such determination. The release of a valuation allowance against deferred tax assets may cause greater volatility in the effective tax rate in the periods in which it is reversed.

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Liquidity and Capital Resources

As of July 31, 2023, our principal sources of liquidity were cash, cash equivalents and short-term investments totaling $2,100.2 million, which were held for working capital and general corporate purposes. Our cash equivalents and investments consist of highly liquid investments in money market funds, U.S. treasury securities, U.S. government agency securities and corporate debt securities.

In June 2020, we completed the private offering of the Notes with an aggregate principal amount of $1,150.0 million. The total net proceeds from the offering, after deducting initial purchase discount and issuance costs, was $1,130.5 million. In connection with the Notes, we entered into the Capped Call transactions which are expected to reduce the potential dilution of our common stock upon any conversion of the Notes and/or offset any cash payments we could be required to make in excess of the principal amount of converted Notes. We used an aggregate amount of $145.2 million of the net proceeds of the Notes to purchase the Capped Calls.

We have generated significant losses from operations, as reflected in our accumulated deficit of $1,090.4 million as of July 31, 2023. We expect to continue to incur operating losses and have in the past and may in the future generate negative cash flows due to expected investments to grow our business, including potential business acquisitions and other strategic transactions.

We believe that our existing cash, cash equivalents and short-term investments will be sufficient to fund our operating and capital needs for at least the next 12 months from the issuance of our financial statements. Our foreseeable cash needs, in addition to our recurring operating costs, include our expected capital expenditures to support expansion of our infrastructure and workforce, lease obligations, purchase commitments, potential business acquisitions and other strategic transactions. Our assessment of the period of time through which our financial resources will be adequate to support our operations is a forward-looking statement and involves risks and uncertainties. Our actual results could vary as a result of, and our future capital requirements, both near-term and long-term, will depend on, many factors, including our growth rate, the timing and extent of spending to support our research and development efforts, the expansion of sales and marketing and international operating activities, the timing of new introductions of solutions or features, and the continuing market acceptance of our services, the impact of macroeconomic conditions, such as high inflation and recessionary environments, and global health crises like the COVID-19 pandemic to our and our customers', vendors' and partners' businesses. We have and may in the future enter into arrangements to acquire or invest in complementary businesses, services and technologies, including intellectual property rights. We have based this estimate on assumptions that may prove to be wrong, and we could use our available capital resources sooner than we currently expect. Additionally, some of the factors that may influence our operations are not within our control, such as general economic conditions, geopolitical developments and the impact of global health crises like the COVID-19 pandemic. We may be required to seek additional equity or debt financing. In the event that additional financing is required from outside sources, we may not be able to raise it on terms acceptable to us or at all. If we are unable to raise additional capital when desired, or if we cannot expand our operations or otherwise capitalize on our business opportunities because we lack sufficient capital, our business, operating results and financial condition would be adversely affected.

We typically invoice our customers annually in advance, and to a lesser extent quarterly in advance, monthly in advance or multi-year in advance. Therefore, a substantial source of our cash is from such prepayments, which are included on our consolidated balance sheets as a contract liability. Deferred revenue consists of the unearned portion of billed fees for our subscriptions, which is subsequently recognized as revenue in accordance with our revenue recognition policy. As of July 31, 2023, we had deferred revenue of $1,439.7 million, of which $1,281.1 million was recorded as a current liability and is expected to be recorded as revenue in the next 12 months, provided all other revenue recognition criteria have been met. Subscriptions that are invoiced annually in advance or multi-year in advance contribute significantly to our short-term and

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long-term deferred revenue in comparison to our invoices issued quarterly in advance or monthly in advance. Accordingly, we cannot predict the mix of invoicing schedules in any given period.

As of July 31, 2023, we did not have any relationships with unconsolidated organizations or financial partnerships, such as structured finance or special purpose entities, which would have been established for the purpose of facilitating off-balance sheet arrangements or other contractually narrow or limited purposes.

The following table summarizes our cash flows for the periods presented:

Operating Activities

Net cash provided by operating activities during fiscal 2023 was $462.3 million, which resulted from a net loss of $202.3 million, adjusted for non-cash charges of $636.1 million and net cash inflows of $28.6 million from changes in operating assets and liabilities. Non-cash charges primarily consisted of $444.8 million for stock-based compensation expense, $98.7 million for amortization of deferred contract acquisition costs, $55.8 million for depreciation and amortization expense, $32.2 million for non-cash operating lease costs, $11.1 million for amortization expense of acquired intangible assets and $3.9 million for amortization of debt discount and issuance costs, partially offset by amortization (accretion) of investments purchased at a premium (discount) of $6.6 million and $3.3 million for net unrealized gains on hedging transactions.

Net cash inflows from changes in operating assets and liabilities were primarily the result of an increase of $418.6 million in deferred revenue from advance invoicing in accordance with our subscription contracts, an increase of $26.8 million in accrued expenses, other current and noncurrent liabilities and an increase of $24.5 million in accrued compensation. Net cash inflows were partially offset by cash outflows resulting from an increase of $183.9 million in accounts receivable primarily due to timing of billings and collections, an increase of $177.0 million in deferred contract acquisition costs, as our sales commission payments increased due to the addition of new customers and expansion of our existing customer subscriptions, an increase of $39.9 million in prepaid expenses, other current and noncurrent assets, a decrease of $32.2 million in operating lease liabilities primarily due to lease payments and a decrease of $8.4 million in accounts payable.

Net cash provided by operating activities during fiscal 2022 was $321.9 million, which resulted from a net loss of $390.3 million, adjusted for non-cash charges of $614.7 million and net cash inflows of $97.5 million from changes in operating assets and liabilities. Non-cash charges primarily consisted of $409.6 million for stock-based compensation expense, $68.5 million for amortization of deferred contract acquisition costs, $55.1 million for amortization of debt discount and issuance costs, $40.5 million for depreciation and amortization expense, $25.6 million for non-cash operating lease costs, $9.0 million for amortization expense of acquired intangible assets and $6.6 million for amortization of investment premiums, net of accretion of purchase discounts.

Net cash inflows from changes in operating assets and liabilities were primarily the result of an increase of $391.2 million in deferred revenue from advance invoicing in accordance with our subscription contracts, an increase of $18.3 million in accrued compensation, an increase of $14.4 million in accounts payable and an increase of $13.4 million in accrued expenses, other current and noncurrent liabilities. Net cash inflows were partially offset by cash outflows resulting from an

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increase of $158.5 million in deferred contract acquisition costs, as our sales commission payments increased due to the addition of new customers and expansion of our existing customer subscriptions, an increase of $143.3 million in accounts receivable primarily due to timing of billings and collections, a decrease of $27.7 million in operating lease liabilities primarily due to lease payments and an increase of $10.3 million in prepaid expenses, other current and noncurrent assets.

Net cash provided by operating activities during fiscal 2021 was $202.0 million, which resulted from a net loss of $262.0 million, adjusted for non-cash charges of $418.5 million and net cash inflows of $45.6 million from changes in operating assets and liabilities. Non-cash charges primarily consisted of $258.5 million for stock-based compensation expense, $51.9 million for amortization of debt discount and issuance costs, $40.6 million for amortization of deferred contract acquisition costs, $29.7 million for depreciation and amortization expense, $21.0 million for non-cash operating lease costs, $11.7 million for amortization of investments premiums, net of accretion of purchase discounts, $6.8 million for amortization expense of acquired intangible assets, partially offset by deferred income taxes of $2.4 million.

Net cash inflows from changes in operating assets and liabilities were primarily the result of an increase of $262.4 million in deferred revenue from advance invoicing in accordance with our subscription contracts, an increase of $43.9 million in accrued compensation, an increase of $7.5 million in accounts payable and an increase of $6.5 million in accrued expenses, other current and noncurrent liabilities. Net cash inflows were partially offset by cash outflows resulting from an increase of $137.7 million in deferred contract acquisition costs, as our sales commission payments increased due to the addition of new customers and expansion of our existing customer subscriptions, an increase of $111.6 million in accounts receivable primarily due to timing of billings and collections, a decrease of $22.1 million in operating lease liabilities primarily due to lease payments and an increase of $3.4 million in prepaid expenses, other current and noncurrent assets.

Investing Activities

Net cash used in investing activities during fiscal 2023 of $259.3 million was primarily attributable to the purchases of short-term investments of $1,064.1 million, capital expenditures of $128.7 million to support the growth and expansion of our cloud platform, $15.6 million, net of cash acquired for business acquisitions, and $3.2 million for purchases of strategic investments. These activities were partially offset by proceeds from the maturities and sales of short-term investments of $952.4 million.

Net cash provided by investing activities during fiscal 2022 of $374.1 million was primarily attributable to the proceeds from the maturities of short-term investments of $1,334.9 million These activities were partially offset by purchases of short-term investments of $844.9 million, capital expenditures of $90.6 million to support the growth and expansion of our cloud platform and $25.3 million, net of cash acquired for business acquisitions.

Net cash used in investing activities during fiscal 2021 of $109.7 million was primarily attributable to the purchases of short-term investments of $815.5 million, capital expenditures of $58.3 million to support the growth of our cloud platform, $40.5 million, net of cash acquired for business acquisitions and expenditures on strategic investments of $3.1 million. These activities were partially offset by proceeds from the maturities and sales of short-term investments of $807.7 million.

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Financing Activities

Net cash provided by financing activities of $46.0 million during fiscal 2023 was primarily attributable to $42.3 million in proceeds from issuance of common stock under the ESPP and $3.9 million in proceeds from the exercise of stock options.

Net cash provided by financing activities of $41.3 million during fiscal 2022 was primarily attributable to $34.6 million in proceeds from issuance of common stock under the ESPP and $6.9 million in proceeds from the exercise of stock options.

Net cash provided by financing activities of $41.7 million during fiscal 2021 was attributable to $25.7 million in proceeds from issuance of common stock under the ESPP and $18.2 million in proceeds from the exercise of stock options. These transactions were partially offset by a payment of deferred merger consideration related to a business acquisition for $2.3 million.

Contractual Obligations and Commitments

Our principal commitments consist of obligations under our convertible senior notes, real estate arrangements, co-location and bandwidth arrangements and non-cancelable purchase obligations. For additional information, Refer to Note 10, Convertible Senior Notes, Note 11, Operating Leases and Note 12, Commitments and Contingencies, of the consolidated financial statements included elsewhere in this Annual Report on Form 10-K.

Critical Accounting Policies and Estimates

Our financial statements are prepared in accordance with GAAP. The preparation of these financial statements requires us to make estimates and assumptions that affect the reported amounts of assets, liabilities, revenue and expenses, as well as related disclosures. We evaluate our estimates and assumptions on an ongoing basis. Our estimates are based on historical experience and various other assumptions that we believe to be reasonable under the circumstances. Our actual results could differ from these estimates.

We have identified certain accounting policies that are significant to the preparation of our financial statements. These accounting policies are important for an understanding of our financial condition and results of operations. Critical accounting policies are those that are most important to the presentation of our financial condition and results of operations and require management’s subjective or complex judgment, often as a result of the need to make estimates about the effect of matters that are inherently uncertain and may change in subsequent periods. While our significant accounting policies are more fully described in the notes to the consolidated financial statements appearing elsewhere in this Annual Report on Form 10-K, we believe the following accounting policies have the most significant impact on the consolidated financial statements.

Revenue Recognition

In accordance with Accounting Standards Codification ("ASC") Topic 606, Revenue From Contracts With Customers ("ASC 606"), revenue is recognized when a customer obtains control of promised services. The amount of revenue recognized reflects the consideration that we expect to be entitled to receive in exchange for these services. To achieve the core principle of this standard, we apply the following five steps:

1) Identify the contract with a customer

We consider the terms and conditions of the contracts and our customary business practices in identifying our contracts under ASC 606. We determine we have a contract with a customer when the contract is approved, we can identify each party’s rights regarding the services to be transferred, we can identify the payment terms for the services, we have determined the customer to have the ability and intent to pay, and the contract has commercial substance. We apply judgment in

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determining the customer’s ability and intent to pay, which is based on a variety of factors, including the customer’s historical payment experience or, in the case of a new customer, credit and financial information pertaining to the customer.

2) Identify the performance obligations in the contract

Performance obligations promised in a contract are identified based on the services that will be transferred to the customer that are both capable of being distinct, whereby the customer can benefit from the service either on its own or together with other resources that are readily available from third parties or from us, and are distinct in the context of the contract, whereby the transfer of the services is separately identifiable from other promises in the contract. Our performance obligations consist of (i) our subscription and support services and (ii) professional and other services.

3) Determine the transaction price

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

4) Allocate the transaction price to performance obligations in the contract

If the contract contains a single performance obligation, the entire transaction price is allocated to the single performance obligation. Contracts that contain multiple performance obligations require an allocation of the transaction price to each performance obligation based on a relative standalone selling price ("SSP").

5) Recognize revenue when or as we satisfy a performance obligation

Revenue is recognized at the time the related performance obligation is satisfied by transferring the promised service to a customer. Revenue is recognized when control of the services is transferred to our customers, in an amount that reflects the consideration that we expect to receive in exchange for those services. We generate all our revenue from contracts with customers and apply judgment in identifying and evaluating any terms and conditions in contracts which may impact revenue recognition.

Subscription and Support Revenue

We generate revenue primarily from sales of subscriptions to access our cloud platform, together with related support services to our customers. Arrangements with customers do not provide the customer with the right to take possession of our software operating our cloud platform at any time. Instead, customers are granted continuous access to our cloud platform over the contractual period. A time-elapsed output method is used to measure progress because we transfer control evenly over the contractual period. Accordingly, the fixed consideration related to subscription and support revenue is generally recognized on a straight-line basis over the contract term beginning on the date that our service is made available to the customer.

The typical subscription and support term is one to three years. Most of our contracts are non-cancelable over the contractual term. Customers typically have the right to terminate their contracts for cause if we fail to perform in accordance with the contractual terms. Some of our customers have the option to purchase additional subscription and support services at a stated price. These options generally do not provide a material right as they are priced at our SSP.

Professional and Other Services Revenue

Professional and other services revenue consists of fees associated with providing deployment advisory services that educate and assist our customers on the best use of our solutions, as well as advise customers on best practices as they deploy

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our solution. These services are distinct from subscription and support services. Professional services do not result in significant customization of the subscription service. Revenue from professional services provided on a time and materials basis is recognized as the services are performed. Total professional and other services revenue has historically been insignificant.

Contracts with Multiple Performance Obligations

Most of our contracts with customers contain multiple promised services consisting of (i) our subscription and support services and (ii) professional and other services that are distinct and accounted for separately. The transaction price is allocated to the separate performance obligations on a relative SSP basis. We determine SSP based on our overall pricing objectives, taking into consideration the type of subscription and support services and professional and other services, the geographical region of the customer and the number of users.

Variable Consideration

Revenue from sales is recorded at the net sales price, which is the transaction price, and includes estimates of variable consideration. The amount of variable consideration that is included in the transaction price is constrained, and is included in the net sales price only to the extent that it is probable that a significant reversal in the amount of the cumulative revenue will not occur when the uncertainty is resolved.

If our services do not meet certain service level commitments, our customers are entitled to receive service credits, and in certain cases, refunds, each representing a form of variable consideration. We have not historically experienced any significant incidents affecting the defined levels of reliability and performance as required by our subscription contracts. Accordingly, any estimated refunds related to these agreements in the consolidated financial statements were not material during the periods presented.

We provide rebates and other credits within our contracts with certain customers which are estimated based on the most likely amounts expected to be earned or claimed on the related sales transaction. Overall, the transaction price is reduced to reflect our estimate of the amount of consideration to which we are entitled based on the terms of the contract. Estimated rebates and other credits were not material during the periods presented.

Contract Balances

Contract liabilities consist of deferred revenue and include payments received in advance of performance under the contract. Such amounts are recognized as revenue over the contractual period.

We receive payments from customers based upon contractual billing schedules; accounts receivable are recorded when the right to consideration becomes unconditional. Payment terms on invoiced amounts are typically 30 days. Contract assets include amounts related to our contractual right to consideration for both completed and partially completed performance obligations that may not have been invoiced and such amounts have been insignificant to date.

Costs to Obtain and Fulfill a Contract

We capitalize sales commissions and associated payroll taxes paid to sales personnel that are incremental to the acquisition of channel partner and direct customer contracts. These costs are recorded as deferred contract acquisition costs on the consolidated balance sheets. We determine whether costs should be deferred based on our sales compensation plans, if the commissions are in fact incremental and would not have occurred absent the customer contract.

Sales commissions for renewal of a contract are not considered commensurate with the commissions paid for the acquisition of the initial contract given the substantive difference in commission rates in proportion to their respective

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contract values. Commissions paid upon the initial acquisition of a contract are amortized over an estimated period of benefit of five years while commissions paid for renewal contracts are amortized over the contractual term of the renewals. Amortization is recognized on a straight-line basis commensurate with the pattern of revenue recognition. We determine the period of benefit for commissions paid for the acquisition of the initial contract by taking into consideration the expected subscription term and expected renewals of our customer contracts, the duration of our relationships with customers, customer retention data, our technology development life cycle and other factors. Management exercises judgment to determine the period of benefit to amortize contract acquisition costs by considering factors such as expected renewals of customer contracts, duration of customer relationships and our technology development life cycle. Although we believe that the historical assumptions and estimates we have made are reasonable and appropriate, different assumptions and estimates could materially impact our reported financial results. Amortization of deferred contract acquisition costs is included in sales and marketing expense in the consolidated statements of operations. We periodically review these deferred costs to determine whether events or changes in circumstances have occurred that could impact the period of benefit of these deferred contract acquisition costs.

Recently Issued Accounting Pronouncements

Refer to Note 1, Business and Summary of Significant Accounting Policies, to the consolidated financial statements included elsewhere in this Annual Report on Form 10-K for more information regarding recently issued accounting pronouncements.