Document
 
 
 
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
 
 

FORM 10-Q
 
(Mark One)
x
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended March 31, 2018

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 001-36067
 

FireEye, Inc.
(Exact name of registrant as specified in its charter)
 
 
Delaware
 
20-1548921
(State or other jurisdiction of
incorporation or organization)
 
(I.R.S. Employer
Identification Number)
 
601 McCarthy Blvd.
Milpitas, CA 95035
(408) 321-6300
(Address, including zip code, and telephone number, including area code, of registrant’s principal executive offices)
 

 
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 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  x No  ¨    

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  x    No  ¨

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, 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. (Check one):
Large accelerated filer
x
Accelerated filer
¨
Non-accelerated filer
¨ (Do not check if a smaller reporting company)
Smaller reporting company
¨
 
 
Emerging growth company
¨
If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act.  ¨
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).  Yes  ¨   No   x
The number of shares of the registrant's common stock outstanding as of May 1, 2018 was 191,928,725.


Table of Contents
TABLE OF CONTENTS


 
 
 
 
Page 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Item 4.
 
 
Item 5.
 
 
Item 6.
 
 
 
 
 
 
 
 
 
 



PART I — FINANCIAL INFORMATION
Item1.    Financial Statements
FIREEYE, INC.
Condensed Consolidated Balance Sheets
(In thousands, except per share data)
(Unaudited)
 
March 31,
2018
 
December 31, 2017*
ASSETS
 
 
 
Current assets:
 
 
 
Cash and cash equivalents
$
167,850

 
$
180,891

Short-term investments
718,536

 
715,911

Accounts receivable, net of allowance for doubtful accounts of $2,585 and $2,503 at March 31, 2018 and December 31, 2017, respectively
103,056

 
146,317

Inventories
6,806

 
5,746

Prepaid expenses and other current assets
102,851

 
93,799

Total current assets
1,099,099

 
1,142,664

Property and equipment, net
76,579

 
71,357

Goodwill
999,920

 
984,661

Intangible assets, net
180,875

 
187,388

Deposits and other long-term assets
69,912

 
72,767

TOTAL ASSETS
$
2,426,385

 
$
2,458,837

 
 
 
 
LIABILITIES AND STOCKHOLDERS’ EQUITY
 
 
 
CURRENT LIABILITIES:
 
 
 
Accounts payable
$
30,749

 
$
35,684

Accrued and other current liabilities
23,817

 
19,569

Accrued compensation
54,020

 
59,588

Deferred revenue, current portion
533,540

 
546,615

Total current liabilities
642,126


661,456

Convertible senior notes, net
789,272

 
779,578

Deferred revenue, non-current portion
352,596

 
363,485

Other long-term liabilities
22,957

 
22,102

Total liabilities
1,806,951


1,826,621

Commitments and contingencies (NOTE 10)

 

Stockholders' equity:
 
 
 
Common stock, par value of $0.0001 per share; 1,000,000 shares authorized, 191,905 shares and 187,105 shares issued and outstanding as of March 31, 2018 and December 31, 2017, respectively
19

 
19

Additional paid-in capital
2,952,085

 
2,891,441

Treasury stock, at cost; 3,333 shares as of March 31, 2018 and December 31, 2017
(150,000
)
 
(150,000
)
Accumulated other comprehensive loss
(4,476
)
 
(2,881
)
Accumulated deficit
(2,178,194
)
 
(2,106,363
)
Total stockholders’ equity
619,434


632,216

TOTAL LIABILITIES AND STOCKHOLDERS’ EQUITY
$
2,426,385


$
2,458,837

* Certain prior period amounts have been adjusted as a result of adoption of the new revenue recognition standard.
See accompanying notes to condensed consolidated financial statements.

1

Table of Contents
FIREEYE, INC.
Condensed Consolidated Statements of Operations
(In thousands, except per share data)
(Unaudited)

 
Three Months Ended March 31,
 
2018
 
2017*
Revenue:
 
 
 
Product, subscription and support
$
165,473

 
$
153,729

Professional services
33,597

 
31,030

Total revenue
199,070


184,759

Cost of revenue:
 
 
 
Product, subscription and support
47,429

 
46,423

Professional services
20,500

 
19,324

Total cost of revenue
67,929


65,747

Total gross profit
131,141


119,012

Operating expenses:
 
 
 
Research and development
66,196

 
58,352

Sales and marketing
97,251

 
98,988

General and administrative
28,418

 
27,615

Total operating expenses
191,865


184,955

Operating loss
(60,724
)

(65,943
)
Interest income
2,940

 
2,032

Interest expense
(12,717
)
 
(12,245
)
Other income (expense), net
(276
)
 
232

Loss before income taxes
(70,777
)

(75,924
)
Provision for income taxes
1,053

 
1,293

Net loss attributable to common stockholders
$
(71,830
)

$
(77,217
)
Net loss per share attributable to common stockholders, basic and diluted
$
(0.39
)
 
$
(0.45
)
Weighted average shares used in computing net loss per share attributable to common stockholders, basic and diluted
186,456

 
172,236

* Certain prior period amounts have been adjusted as a result of adoption of the new revenue recognition standard.
See accompanying notes to condensed consolidated financial statements.

2

Table of Contents
FIREEYE, INC.
Condensed Consolidated Statements of Comprehensive Loss
(In thousands)
(Unaudited)

 
Three Months Ended March 31,
 
2018
 
2017*
Net loss
$
(71,830
)
 
$
(77,217
)
Change in net unrealized gain / (losses) on available-for-sale investments, net of tax
(1,595
)
 
323

Comprehensive loss
$
(73,425
)

$
(76,894
)
* Certain prior period amounts have been adjusted as a result of adoption of the new revenue recognition standard.
See accompanying notes to condensed consolidated financial statements.

3

Table of Contents
FIREEYE, INC.
Condensed Consolidated Statements of Cash Flows
(In thousands)
(Unaudited)

 
Three Months Ended March 31,
 
2018
 
2017*
CASH FLOWS FROM OPERATING ACTIVITIES:
 
 
 
Net loss
$
(71,830
)
 
$
(77,217
)
Adjustments to reconcile net loss to net cash provided by (used in) operating activities:
 
 
 
Depreciation and amortization
22,389

 
26,365

Stock-based compensation
42,148

 
43,889

Non-cash interest expense related to convertible senior notes
9,694

 
9,226

Change in fair value of contingent earn-out liability

 
13

Deferred income taxes
(60
)
 
251

Other
1,342

 
2,120

Changes in operating assets and liabilities, net of business acquisitions:
 
 
 
Accounts receivable
42,986

 
22,021

Inventories
(1,373
)
 
(1,090
)
Prepaid expenses and other assets
(6,330
)
 
630

Accounts payable
(5,354
)
 
3,331

Accrued liabilities
4,254

 
(930
)
Accrued compensation
(5,568
)
 
(7,006
)
Deferred revenue
(23,965
)
 
(39,789
)
Other long-term liabilities
854

 
1,234

Net cash provided by (used in) operating activities
9,187


(16,952
)
CASH FLOWS FROM INVESTING ACTIVITIES:
 
 
 
Purchases of property and equipment and demonstration units
(14,487
)
 
(8,483
)
Purchases of short-term investments
(109,469
)
 
(98,480
)
Proceeds from maturities of short-term investments
104,711

 
94,689

Proceeds from sales of short-term investments

 
3,620

Business acquisitions, net of cash acquired
(5,977
)
 

Lease deposits
(116
)
 
(70
)
Net cash used in investing activities
(25,338
)

(8,724
)
CASH FLOWS FROM FINANCING ACTIVITIES:
 
 
 
Payments for contingent earn-outs

 
(38,928
)
Proceeds from exercise of equity awards
3,110

 
4,311

Net cash provided by (used in) financing activities
3,110


(34,617
)
Net change in cash and cash equivalents
(13,041
)
 
(60,293
)
Cash and cash equivalents, beginning of period
180,891

 
223,667

Cash and cash equivalents, end of period
$
167,850


$
163,374

SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION:
 
 
 
Cash paid for income taxes
$
646

 
$
727

SUPPLEMENTAL DISCLOSURES OF NON-CASH INVESTING AND FINANCING ACTIVITIES:
 
 
 
Common stock issued in connection with acquisitions
$
15,387

 
$

Purchases of property and equipment and demonstration units in accounts payable and accrued liabilities
$
13,773

 
$
5,922


4

Table of Contents
FIREEYE, INC.
Condensed Consolidated Statements of Cash Flows
(In thousands)
(Unaudited)

* Certain prior period amounts have been adjusted as a result of adoption of the new revenue recognition standard.
See accompanying notes to condensed consolidated financial statements.

5

Table of Contents
FIREEYE, INC.
Notes to Condensed Consolidated Financial Statements


1. Description of Business and Summary of Significant Accounting Policies
Description of Business
FireEye, Inc., with principal executive offices located in Milpitas, California, was incorporated as NetForts, Inc. on February 18, 2004, under the laws of the State of Delaware, and changed its name to FireEye, Inc. on September 7, 2005.
FireEye, Inc. and its wholly owned subsidiaries (collectively, the “Company”, “we”, “us” or “our”) provide comprehensive intelligence-based cybersecurity solutions that allow organizations to prepare for, prevent, respond to and remediate cyber attacks. Our portfolio of cyber security products and services is designed to detect and prevent attacks, as well as enable rapid discovery and response when a breach occurs. We accomplish this with products and services that adapt to changes in the threat environment in a cycle of innovation that incorporates our threat intelligence, machine-based technologies and cyber security expertise. Our core competitive advantages include:

Our high efficacy detection and prevention of known and unknown threats using machine-learning, behavioral analytics, and other intelligence-driven analysis (IDA) technologies, combined with our proprietary Multi-vector Virtual Execution (MVX) engine;
Our intelligence on threats and threat actors, based on the continuous flow of new attack data from our global network of sensors and virtual machines, as well as intelligence gathered by our security researchers, security operations analysts and incident responders; and
Our accumulated security expertise derived from responding to thousands of significant breaches over the past decade.

Our threat detection and prevention products encompass appliance-based, virtual and cloud solutions for network, email, and endpoint security, and provide the first line of defense against known and unknown attacks. These products are complemented by our network forensics, cloud-based threat intelligence and analytics, managed security services, cyber security consulting and incident response offerings. In combination, our products and services enable a proactive approach to cybersecurity that extends across the security operations cycle to reduce organizations’ overall cyber-risk at a lower total cost of ownership.
In January 2018, we completed the acquisition of privately held X15 Software, Inc. ("X15"), a data management company. As consideration for the acquisition, we paid cash consideration of $5.3 million and issued 1,016,334 shares of our common stock with an estimated fair value of $15.4 million.
In October 2017, we acquired Clean Communications Limited (d/b/a The Email Laundry) ("The Email Laundry"), a privately-held email security company. We paid cash consideration of $4.3 million and issued 259,425 shares of our common stock with an estimated fair value of $4.4 million.
We sell the majority of our products, subscriptions and services to end-customers through distributors, resellers, and strategic partners, with a lesser percentage of sales directly to end-customers.
Basis of Presentation and Consolidation
The accompanying unaudited condensed consolidated financial statements include the accounts of FireEye, Inc. and its wholly owned subsidiaries. All intercompany balances and transactions have been eliminated in consolidation.
The accompanying unaudited condensed consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States of America (“U.S. GAAP”), and following the requirements of the Securities and Exchange Commission (“SEC”), for interim reporting. As permitted under those rules, certain footnotes or other financial information that are normally required by U.S. GAAP can be condensed or omitted. These unaudited condensed consolidated financial statements have been prepared on the same basis as our annual consolidated financial statements and, in the opinion of management, reflect all adjustments, consisting only of normal recurring adjustments, that are necessary for a fair statement of our financial information. The results of operations for the three months ended March 31, 2018 are not necessarily indicative of the results to be expected for the year ending December 31, 2018 or for any other interim period or for any other future year. The balance sheet as of December 31, 2017 has been derived from audited consolidated financial statements at that date but does not include all of the information required by U.S. GAAP for annual consolidated financial statements.
The accompanying unaudited condensed consolidated financial statements and related financial information should be read in conjunction with the audited consolidated financial statements and the related notes thereto for the year ended December 31, 2017 included in our Annual Report on Form 10-K for the year ended December 31, 2017.
The Company adopted Accounting Standards Update (ASU) 2014-09, Revenue from Contracts with Customers (Topic 606), effective January 1, 2018 using the full retrospective method. The cumulative effect of the adoption was recognized as an increase to

6


accumulated deficit of $113 million on January 1, 2018 and impacted certain other prior period amounts. Certain amounts and disclosures set forth in this Form 10-Q have been updated to comply with the new standards.
Use of Estimates
The preparation of condensed consolidated financial statements in conformity with U.S. 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 revenue and expenses during the reporting period. Such management estimates include, but are not limited to, determining the nature and timing of satisfaction of performance obligations, determining the standalone selling price ("SSP") of performance obligations, subscriptions and services, commissions expense including the period of benefit of customer acquisition cost, bonus expense, future taxable income, contract manufacturer liabilities, litigation and settlement costs and other loss contingencies, fair value of our equity awards, achievement of targets for performance stock units, fair value of the liability and equity components of convertible senior notes and the purchase price allocation of acquired businesses. We base our estimates on historical experience and also on assumptions that we believe are reasonable. Changes in facts or circumstances may cause us to change our assumptions and estimates in future periods, and it is possible that actual results could differ from current or revised future estimates.
Summary of Significant Accounting Policies
Except for the accounting policies for revenue recognition and the associated treatments of, deferred revenue and, deferred cost of revenue and deferred commissions updated as a result of adopting ASU No. 2014-09, Revenue from Contracts with Customers (Topic 606), there have been no significant changes to our significant accounting policies as of and for the three months ended March 31, 2018, as compared to the significant accounting policies described in our Annual Report on Form 10-K for the year ended December 31, 2017.
Revenue from Contracts with Customers
Revenue is recognized when all of the following criteria are met:
Identification of the contract, or contracts, with a customer - A contract with a customer exists when (i) we enter into an enforceable contract with a customer that defines each party’s rights regarding the goods or services to be transferred and identifies the payment terms related to these goods or services, (ii) the contract has commercial substance and the parties are committed to perform and, (iii) we determine that collection of substantially all consideration to which it will be entitled in exchange for goods or services that will be transferred is probable based on the customer’s intent and ability to pay the promised consideration.
Identification of the performance obligations in the contract - Performance obligations promised in a contract are identified based on the goods or services that will be transferred to the customer that are both capable of being distinct, whereby the customer can benefit from the goods or 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 goods or services is separately identifiable from other promises in the contract. To the extent a contract includes multiple promised goods or services, we apply judgment to determine whether promised goods or services are capable of being distinct and distinct in the context of the contract. If these criteria are not met the promised goods or services are accounted for as a combined performance obligation.
Determination of the transaction price - The transaction price is determined based on the consideration to which we will be entitled in exchange for transferring goods or services to the customer adjusted for estimated variable consideration, if any. We typically estimate the transaction price impact of discounts offered to the customers for early payments on receivables or rebates based on sales target achievements. Constraints are applied when estimating variable considerations based on historical experience where applicable.
Allocation of the transaction price to the performance obligations in the contract -  If the contract contains a single performance obligation, the entire transaction price is allocated to the single performance obligation. Contracts that contain multiple performance obligations require an allocation of the transaction price to each performance obligation based on a relative SSP basis. Determination of SSP requires judgement. We determine standalone selling price taking into account available information such as historical selling prices of the performance obligation, geographic location, overall strategic pricing objective, market conditions and internally approved pricing guidelines related to the performance obligations.
Recognition of revenue when, or as, we satisfy performance obligation - We satisfy performance obligations either over time or at a point in time as discussed in further detail below. Revenue is recognized at or over the time the related performance obligation is satisfied by transferring a promised good or service to a customer.

7


Nature of products and services
We generate revenue from the sales of security appliances (products), subscriptions, support and maintenance and professional services, primarily through our indirect relationships with our partners or direct relationships with end customers through our direct sales force. We account for our performance obligations in accordance with the ASU No. 2014-09, Revenue from Contracts with Customers (Topic 606), and all related interpretations.
All of our security appliance deliverables include proprietary operating system software, which together with regular security intelligence updates deliver the essential functionality of our appliance-based security products. We combine intelligence dependent appliances and software licenses with the related intelligence subscription and support as a single performance obligation. As a result, we recognize intelligence dependent appliance and software license revenue ratably over the longer of the life of the related appliance and license when our contracts contain material right of renewal options or the contractual term, rather than recognizing revenue at the time of shipping. For the contracts where the term is less than the life of the appliance and license, the intelligence subscription and support revenue is recognized ratably over the contractual term with the allocated value of the material right performance obligations recognized in the period between the end of the contractual term and the useful life. Where our contracts do not contain material right of renewal options, or the contractual term is longer than the useful life, we expect to recognize intelligence dependent appliance and software license revenue ratably over the contractual term. Significant judgement is required in estimating the useful life of our security appliances that are dependent on intelligence and assessing the material rights associated with it.
Revenue from subscriptions to cloud-based services, which allow customers to use our hosted security software over a contracted period without taking possession of the software and managed services where FireEye manages security for the customer are recognized over the contractual term. We also have a small portion of our revenue from appliances and software that are not dependent on regular threat intelligence updates. Revenue from these appliances and software is therefore recognized at a point in time when ownership is transferred to our customers.

Professional services, which include incident response, compromise assessments, and other security consulting services are offered on a time and materials basis or through a fixed fee arrangement, and we recognize the associated revenue as the services are delivered.
Contract Balances
Accounts Receivable
Trade accounts receivable are recorded at the billable amount where we have the unconditional right to bill, net of allowances for doubtful accounts. The allowance for doubtful accounts is based on our assessment of the collectability of accounts. Management regularly reviews the adequacy of the allowance for doubtful accounts by considering the age of each outstanding invoice, each customer's expected ability to pay and collection history, when applicable, to determine whether a specific allowance is appropriate. Accounts receivable deemed uncollectible are charged against the allowance for doubtful accounts when identified.
Deferred Revenue (Contract Liabilities) and Contract Assets
Deferred revenue consists of amounts that have been invoiced and for which the Company has the right to bill, but that have not been recognized as revenue because the related goods or services have not been transferred. Deferred revenue that will be realized during the succeeding 12 month period is recorded as current, and the remaining deferred revenue is recorded as non-current. Deferred revenue presented in the consolidated balance sheet and notes thereto is net of contract assets. Our contract assets consist of assets typically resulting when revenue recognized exceeds the amount billed or billable to the customer due to allocation of transaction price. Contract assets amount is immaterial as of March 31, 2018 and December 31, 2017.
In instances where the timing of revenue recognition differs from the timing of invoicing, we have determined our contracts generally do not include a significant financing component. The primary purpose of our invoicing terms is to provide customers with simplified and predictable ways of purchasing our products and services, not to receive financing from our customers or to provide customers with financing. Examples include invoicing at the beginning of a subscription term with revenue recognized ratably over the contract period.
Assets Recognized from Costs to Obtain a Contract with a Customer
Deferred Commissions
Our customer acquisition costs are primarily related to sales commissions and related payroll taxes earned by our sales force and such costs are considered incremental costs to obtain a contract. Sales commissions for initial contracts are deferred and then amortized taking into consideration the pattern of transfer to which asset relate and may include expected renewal periods where renewal commissions are not commensurate with the initial commissions period. We typically recognize the initial commissions over the longer of the customer relationship (generally estimated to be four years) or over the same period as the initial revenue arrangement to which these costs relate. Renewal commissions not commensurate with the initial commissions paid are generally amortized over the renewal period. Deferred commissions that will amortize within the succeeding 12 month period are classified as current, and

8


included in prepaid expenses and other current assets on the consolidated balance sheet. The remaining balance is classified as non-current, and included in deposits and other long-term assets. As of December 31, 2017 and March 31, 2018, the amount of deferred commissions included in prepaid expenses and other current assets was $43.8 million and $45.4 million, respectively. The amount of deferred commissions included in deposits and other long-term assets as of December 31, 2017 and March 31, 2018 was $43.0 million and $41.6 million, respectively.
Deferred Costs of Revenue
Deferred costs of revenue consists of appliance related direct and incremental costs that are capitalized and will be amortized on a systematic basis that is consistent with the pattern of transfer to which the asset relates. Deferred costs of revenue that will be realized within the succeeding 12 month period are classified as current, and included in prepaid expenses and other current assets on the consolidated balance sheets. The remaining balance is classified as non-current, and included in deposits and other long-term assets. As of December 31, 2017 and March 31, 2018, the amount of deferred costs of revenue classified as current and included in prepaid expenses and other current assets was $18.4 million and $17.8 million, respectively. The amount of deferred costs of revenue classified as non-current and included in deposits and other long-term assets as of December 31, 2017 and March 31, 2018 was $19.7 million and $18.6 million, respectively.

ASC 606 Impact to Previously Reported Results
We adjusted our condensed consolidated financial statements from amounts previously reported due to the adoption of ASC 606. Select condensed consolidated balance sheet line items, which reflect the adoption of ASC 606, are as follows (in thousands):
 
As of December 31, 2017
Balance Sheet:
As Previously Reported
 
Impact of Adoption
 
As Adjusted
Accounts receivable, net
$
140,049

 
6,268

 
$
146,317

Prepaid expenses and other current assets
$
34,541

 
59,258

 
$
93,799

Deposits and other long-term assets
$
11,537

 
61,230

 
$
72,767

Deferred revenue, current portion
$
443,064

 
103,551

 
$
546,615

Deferred revenue, non-current portion
$
227,680

 
135,805

 
$
363,485

Stockholders' equity
$
744,816

 
(112,600
)
 
$
632,216

Select unaudited condensed consolidated statement of operations line items, which reflects the adoption of ASC 606, are as follows (in thousands):
 
Three Months Ended March 31, 2017
Condensed Consolidated Statement of Operations
As Previously Reported
 
Impact of Adoption
 
As Adjusted
Total revenue
$
173,738

 
11,021

 
$
184,759

Total cost of revenue
$
64,605

 
1,142

 
$
65,747

Total operating expenses
$
180,847

 
4,108

 
$
184,955

Loss before income taxes
$
(81,695
)
 
5,771

 
$
(75,924
)
Net loss attributable to common stockholders
$
(82,988
)
 
5,771

 
$
(77,217
)


9


Select unaudited condensed consolidated statement of cash flows line items, which reflects the adoption of ASC 606, are as follows (in thousands):
 
Three Months Ended March 31, 2017
Condensed Consolidated Statement of Cash flows
As Previously Reported
 
Impact of Adoption
 
As Adjusted
Cash flows from operating activities:
 
 
 
 
 
Net loss
$
(82,988
)
 
5,771

 
$
(77,217
)
Changes in operating assets and liabilities, net of business acquisitions:
 
 
 
 
 
Accounts receivable
$
14,584

 
7,437

 
$
22,021

Prepaid expenses and other assets
$
(4,619
)
 
5,249

 
$
630

Deferred revenue
$
(21,331
)
 
(18,458
)
 
$
(39,789
)
Recent Accounting Pronouncements
In February 2018, the FASB issued Accounting Standards Update (ASU) 2018-02 that provides companies with an option to reclassify stranded tax effects resulting from enactment of the Tax Cuts and Jobs Act ("TCJA") from accumulated other comprehensive income to retained earnings. The guidance will be effective for the Company beginning in the first quarter of 2019 with early adoption permitted, and would be applied either in the period of adoption or retrospectively to each period (or periods) in which the effect of the change in the tax rate as a result of TCJA is recognized. The Company has not made a determination as to which alternative methods it will use when it adopts this standard, but does not expect the adoption of this ASU to have a material impact on its results of operations, financial position and cash flows.
In January 2017, the FASB issued ASU 2017-04, Intangibles-Goodwill and Other (Topic 350): Simplifying the Test for Goodwill Impairment. This standard eliminates the requirement to calculate the implied fair value of goodwill to measure a goodwill impairment charge (i.e. Step 2 of the current guidance), instead measuring the impairment charge as the excess of the reporting unit's carrying amount over its fair value (i.e. Step 1 of the current guidance). The guidance is effective for us beginning in the first quarter of 2020, and should be applied prospectively. Early adoption is permitted for impairment testing dates after January 1, 2017. The adoption of this standard is not expected to have a significant impact on our consolidated financial statements.
In June 2016, the FASB issued ASU 2016-13, Financial Instruments—Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments. This standard changes the impairment model for most financial assets and certain other instruments by introducing a current expected credit loss (CECL) model. The CECL model is a more forward-looking approach based on expected losses rather than incurred losses, requiring entities to estimate and record losses expected over the remaining contractual life of an asset. The guidance is effective for us beginning in the first quarter of 2020. Early adoption beginning in 2019 is permitted. We are currently evaluating the impact the adoption of this guidance will have on our consolidated financial statements and related disclosures.
In February 2016, the FASB issued ASU No. 2016-02, Leases (Topic 842). This standard is intended to increase transparency and comparability among organizations by recognizing lease assets and lease liabilities on the balance sheet and disclosing key information about leasing arrangements. The guidance is effective for us beginning in the first quarter of 2019, and should be applied on a modified retrospective basis. Early adoption is permitted. We expect the adoption of this standard to have a material impact on our consolidated financial statements and related disclosures.

10


2. Fair Value Measurements
The accounting guidance for fair value measurements provides a framework for measuring fair value on either a recurring or nonrecurring basis, whereby the inputs used in our valuation techniques are assigned a hierarchical level. The following are the three levels of inputs to measure fair value:
Level 1: Observable inputs that reflect quoted prices (unadjusted) for identical assets or liabilities in active markets.
Level 2: Inputs that reflect quoted prices for identical assets or liabilities in less active markets; quoted prices for similar assets or liabilities in active markets; benchmark yields, reported trades, broker/dealer quotes, inputs other than quoted prices that are observable for the assets or liabilities; or inputs that are derived principally from or corroborated by observable market data by correlation or other means.
Level 3: Unobservable inputs that reflect our own assumptions incorporated in valuation techniques used to measure fair value. These assumptions are required to be consistent with market participant assumptions that are reasonably available.
We consider an active market to be one in which transactions for the asset or liability occur with sufficient frequency and volume to provide pricing information on an ongoing basis, and consider an inactive market to be one in which there are infrequent or few transactions for the asset or liability, the prices are not current, or price quotations vary substantially either over time or among market makers. Where appropriate, our own or the counterparty’s non-performance risk is considered in measuring the fair values of assets.
The following table presents our assets and liabilities measured at fair value on a recurring basis using the above input categories (in thousands):
 
As of March 31, 2018
 
As of December 31, 2017
Description
Level 1
 
Level 2
 
Level 3
 
Total
 
Level 1
 
Level 2
 
Level 3
 
Total
Assets
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Cash equivalents:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Money market funds
$
11

 
$

 
$

 
$
11

 
$
208

 
$

 
$

 
$
208

Treasury bills

 

 

 

 
3,098

 

 

 
3,098

Commercial Paper

 
1,997

 

 
1,997

 

 

 

 

Total cash equivalents
11

 
1,997

 

 
2,008

 
3,306

 

 

 
3,306

Short-term investments:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Certificates of deposit

 

 

 

 

 

 

 

Commercial paper

 

 

 

 

 
4,987

 

 
4,987

Corporate notes and bonds

 
445,141

 

 
445,141

 

 
438,024

 

 
438,024

U.S. Government agencies

 
273,395

 

 
273,395

 

 
272,900

 

 
272,900

Total short-term investments

 
718,536

 

 
718,536

 

 
715,911

 

 
715,911

Total assets measured at fair value
$
11

 
$
720,533

 
$

 
$
720,544

 
$
3,306

 
$
715,911

 
$

 
$
719,217

Liabilities
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Contingent earn-out
$

 
$

 
$

 
$

 
$

 
$

 
$

 
$

Total liabilities measured at fair value
$

 
$

 
$

 
$

 
$

 
$

 
$

 
$

We measure certain assets, including goodwill, intangible assets and our equity-method investment in a private company at fair value on a nonrecurring basis when there are identifiable events or changes in circumstances that may have a significant adverse impact on the fair value of these assets. No such events or changes occurred during the three months ended March 31, 2018.
The estimated fair value of the Convertible Senior Notes (as defined in Note 9) as of March 31, 2018 was determined to be $863.5 million, based on quoted market prices. We consider the fair value of the Convertible Senior Notes to be a Level 2 measurement as they are not actively traded.

11


3. Investments
Our investments consisted of the following (in thousands):
 
As of March 31, 2018
 
Amortized Cost
 
Gross Unrealized Gains
 
Gross Unrealized Losses
 
Estimated Fair Value
 
Cash and Cash Equivalent
 
Short-Term Investments
Commercial paper
1,997

 

 

 
1,997

 
1,997

 

Corporate notes and bonds
448,465

 

 
(3,324
)
 
445,141

 

 
445,141

U.S. Government agencies
274,547

 

 
(1,152
)
 
273,395

 

 
273,395

Total
$
725,009


$


$
(4,476
)

$
720,533

 
$
1,997

 
$
718,536

 
As of December 31, 2017
 
Amortized Cost
 
Gross Unrealized Gains
 
Gross Unrealized Losses
 
Estimated Fair Value
 
Cash and Cash Equivalents
 
Short-Term Investments
Commercial paper
4,989

 

 
(2
)
 
4,987

 

 
4,987

Corporate notes and bonds
439,851

 
2

 
(1,829
)
 
438,024

 

 
438,024

Treasury bills
3,098

 

 

 
3,098

 
3,098

 

U.S. Government agencies
273,950

 

 
(1,050
)
 
272,900

 

 
272,900

Total
$
721,888

 
$
2

 
$
(2,881
)

$
719,009

 
$
3,098

 
$
715,911

The following tables present the gross unrealized losses and related fair values of our investments that have been in a continuous unrealized loss position (in thousands):
 
As of March 31, 2018
 
Less Than 12 Months
 
Greater Than 12 Months
 
Total
 
Fair Value
 
Unrealized Loss
 
Fair Value
 
Unrealized Loss
 
Fair Value
 
Unrealized Loss
Commercial paper
1,997

 

 

 

 
1,997

 

Corporate notes and bonds
289,206

 
(2,494
)
 
155,935

 
(831
)
 
445,141

 
(3,325
)
U.S. Government agencies
113,531

 
(686
)
 
159,864

 
(465
)
 
273,395

 
(1,151
)
Total
$
404,734


$
(3,180
)

$
315,799


$
(1,296
)

$
720,533


$
(4,476
)
 
As of December 31, 2017
 
Less Than 12 Months
 
Greater Than 12 Months
 
Total
 
Fair Value
 
Unrealized Loss
 
Fair Value
 
Unrealized Loss
 
Fair Value
 
Unrealized Loss
Commercial paper
4,987

 
(2
)
 

 

 
4,987

 
(2
)
Corporate notes and bonds
284,499

 
(1,484
)
 
153,525

 
(345
)
 
438,024

 
(1,829
)
U.S. Government agencies
117,132

 
(486
)
 
155,768

 
(564
)
 
272,900

 
(1,050
)
Total
$
406,618


$
(1,972
)

$
309,293


$
(909
)

$
715,911


$
(2,881
)
Unrealized losses related to these investments are due to interest rate fluctuations as opposed to credit quality. In addition, we do not intend to sell, and it is not more likely than not that we would be required to sell, these investments before recovery of their cost basis. As a result, there is no other-than-temporary impairment for these investments as of March 31, 2018 and December 31, 2017.
The following table summarizes the contractual maturities of our investments at March 31, 2018 (in thousands):
 
Amortized Cost
 
Fair Value
Due within one year
$
394,371

 
$
392,611

Due within one to two years
330,639

 
327,922

Total
$
725,010

 
$
720,533

All available-for-sale securities have been classified as current, based on management's intent and ability to use the funds in current operations.
As of March 31, 2018, we held an 11.1% ownership interest in a private company, which is accounted for under the equity method based on our ability to exercise significant influence over operating and financial policies of the private company. This investment is classified within deposits and other long-term assets on our condensed consolidated balance sheets. The carrying value of this investment was $1.7 million as of March 31, 2018 and $2.1 million as of December 31, 2017.

12


4. Property and Equipment
Property and equipment, net consisted of the following (in thousands):
 
As of March 31, 2018
 
As of December 31, 2017
Computer equipment and software
$
152,429

 
$
144,438

Leasehold improvements
56,609

 
67,451

Furniture and fixtures
13,718

 
16,665

Machinery and equipment
447

 
447

Total property and equipment
223,203

 
229,001

Less: accumulated depreciation
(146,624
)
 
(157,644
)
Total property and equipment, net
$
76,579

 
$
71,357

Depreciation and amortization expense related to property, equipment and demonstration units during the three months ended March 31, 2018 and 2017 was $9.4 million and $11.0 million, respectively.
During the three months ended March 31, 2018 and 2017, we capitalized $4.9 million and $4.7 million, respectively, of software development costs primarily related to our cloud subscription offerings. Amortization expense related to capitalized software development costs during the three months ended March 31, 2018 and 2017 was $1.9 million and $0.8 million, respectively.
5. Business Combinations
Acquisition of The Email Laundry
On October 20, 2017, we acquired all of the outstanding shares of The Email Laundry, a privately held email security company, which is expected to enhance our current email offerings. In connection with this acquisition, we paid cash consideration of $4.3 million and issued 259,425 shares of our common stock with an estimated fair value of $4.4 million, resulting in total purchase consideration of $8.7 million. The purchase price is subject to customary working capital and related adjustments. The purchase price was allocated to intangible assets of $2.7 million, goodwill of $6.4 million and tangible net liabilities of $0.3 million. The intangible assets are composed of technology and customer relationships, each with an estimated weighted average useful life of 3 years. The goodwill is primarily attributable to the know-how of the workforce and is not expected to be deductible for U.S. federal income tax purposes. The results of operations of The Email Laundry have been included in our consolidated statements of operations from the acquisition date. Pro forma financial information has not been presented for this acquisition as the impact to our consolidated financial statements was not material.
Acquisition of X15 Software
On January 11, 2018, we acquired all of the outstanding shares of privately held X15, a data management company. We expect that the X15 technology will be incorporated into the foundation for our platform and analytics capabilities going forward. In connection with this acquisition, we paid cash consideration of $5.3 million and issued 1,016,334 shares of our common stock with an estimated fair value of $15.4 million, resulting in total purchase consideration of $20.7 million. The purchase price was allocated to intangible assets of $6.1 million, goodwill of $15.3 million and tangible net liabilities of $0.7 million. The intangible asset relates to developed technology with an estimated weighted average useful life of 3 years. The goodwill is primarily attributable to the know-how of the workforce and is not expected to be deductible for U.S. federal income tax purposes. The results of operations of X15 have been included in our consolidated statements of operations from the acquisition date. Pro forma financial information has not been presented for this acquisition as the impact to our consolidated financial statements was not material.
Goodwill and Purchased Intangible Assets
Goodwill increased approximately $15.3 million for the three months ended March 31, 2018 due to the acquisition of X15 Software, Inc. There were no other changes in the carrying amount of goodwill.

13


Purchased intangible assets consisted of the following (in thousands):
 
As of March 31, 2018
 
As of December 31, 2017
Developed technology
$
110,003

 
$
103,903

Content
158,700

 
158,700

Customer relationships
111,090

 
111,090

Contract backlog
12,500

 
12,500

Trade names
15,560

 
15,560

Non-competition agreements
1,400

 
1,400

Total intangible assets
409,253

 
403,153

Less: accumulated amortization
(228,378
)
 
(215,765
)
Total net intangible assets
$
180,875

 
$
187,388

Amortization expense of intangible assets during the three months ended March 31, 2018 and 2017 was $12.6 million and $14.8 million, respectively.
The expected future annual amortization expense of intangible assets as of March 31, 2018 is presented below (in thousands):
Years Ending December 31,
Amount
2018 (remaining nine months)
$
37,713

2019
48,441

2020
33,903

2021
29,337

2022
18,209

 and thereafter
13,272

Total
$
180,875

6. Restructuring Charges
We initiated a series of restructuring activities in February 2016, including a restructuring plan approved by our Board of Directors in August 2016 designed to reduce operating expenses and align our expense structure with our growth expectations. This restructuring plan resulted in a 10% reduction in our workforce, the consolidation of certain real estate facilities and the impairment of certain assets in 2016.
The following table sets forth a summary of restructuring activities during the three months ended March 31, 2018 (in thousands):
 
 
Facilities costs
Balance, December 31, 2017
 
$
935

Cash payments
 
(48
)
Other adjustments
 
(23
)
Balance, March 31, 2018
 
$
864

Other adjustments represent relief of unused benefits, changes in fair value and foreign currency fluctuations.
The remaining restructuring balance of $0.9 million at March 31, 2018 is for non-cancelable lease costs which we expect to pay over the terms of the related obligations through the third quarter of 2024, net of sublease income.
7. Deferred Commissions
We capitalize most of our commission expenses and related payroll taxes and amortize on a systematic basis that is consistent with the transfer to customer of the goods or services to which the asset relates. Changes in the balance of total deferred commissions during the three months ended March 31, 2018 are as follows (in thousands):
 
As of December 31, 2017
 
Commissions capitalized
 
Commissions recognized
 
As of March 31, 2018
Deferred Commissions
$
86,779

 
$
13,486

 
$
(13,253
)
 
$
87,012

There was no impairment loss in relation to the commissions capitalized for the periods presented.

14


8. Deferred Revenue
Deferred revenue consisted of the following (in thousands):
 
As of March 31, 2018
 
As of December 31, 2017*
Product, subscription and support, current
$
489,264

 
$
496,218

Professional services, current
44,276

 
50,397

Total deferred revenue, current
533,540

 
546,615

Product, subscription and support, non-current
352,269

 
363,313

Professional services, non-current
327

 
172

Total deferred revenue, non-current
352,596

 
363,485

Total deferred revenue
$
886,136

 
$
910,100

Changes to the unearned revenue during the three months ended March 31, 2018 are as follows (in thousands):
 
As of December 31, 2017*
 
Billings for the quarter
 
Revenue Recognized
 
As of March 31, 2018
Deferred Revenue
$
910,100

 
$
175,106

 
$
(199,070
)
 
$
886,136

Remaining Performance Obligations
Transaction price allocated to remaining performance obligations represents contracted revenue that has not yet been recognized, which includes deferred revenue and non-cancelable contracts that will be invoiced and recognized as revenue in future periods ("backlog"). While deferred revenue is recorded on our balance sheet as a liability, backlog is not recorded in revenue, unearned revenue or elsewhere in our consolidated financial statements until we establish a contractual right to invoice at which point they are recorded as revenue or deferred revenue as appropriate. As of March 31, 2018, the aggregate amount of the transaction price allocated to remaining performance obligations was $886.1 million in deferred revenue and $11.6 million in backlog. We have used the practical expedient to not disclose backlog related to the comparative period under ASC 606.
We expect that the amount of backlog relative to the total value of our contracts will change from year to year due to several factors, including the amount invoiced early in the contract term, the timing and duration of customer agreements, varying invoicing cycles of agreements and changes in customer financial circumstances. Accordingly, we believe that fluctuations in backlog are not always a reliable indicator of future revenues and we do not utilize backlog as a key management metric internally.
We expect to recognize these remaining performance obligations as follows (in percentages):
 
Total
 
Less than 1 year
 
1-2 years
 
2-3 years
 
More than 3 years
Deferred revenue
100%
 
60%
 
25%
 
11%
 
4%
Backlog
100%
 
38%
 
50%
 
12%
 
—%
*Certain prior period amounts have been adjusted as a result of adoption of the new revenue recognition standard.
9. Convertible Senior Notes
Convertible Senior Notes
In June 2015, we issued $460.0 million principal amount of 1.000% Convertible Senior Notes due 2035 (the “Series A Notes”) and $460.0 million principal amount of 1.625% Convertible Senior Notes due 2035 (the “Series B Notes” and together with the Series A Notes, the “Convertible Senior Notes”), including the full exercise of the initial purchasers' over-allotment option, in a private placement to qualified institutional purchasers pursuant to an exemption from registration provided by Section 4(a)(2) and Rule 144A under the Securities Act of 1933, as amended. The net proceeds after the initial purchasers' discount of $23.0 million and issuance costs of $0.5 million from the Convertible Senior Notes were $896.5 million. The Series A Notes and Series B Notes bear interest at 1.000% per year and 1.625% per year, respectively, payable semiannually in arrears on June 1 and December 1 of each year, beginning December 1, 2015. The Convertible Senior Notes mature on June 1, 2035, unless earlier repurchased, redeemed or converted.
The Convertible Senior Notes are unsecured obligations and rank senior in right of payment to any of our indebtedness that is expressly subordinated in right of payment to the Convertible Senior Notes. They rank equally in right of payment with all of our existing and future liabilities that are not expressly subordinated to the Convertible Senior Notes and effectively rank junior in right of payment to any of our

15


secured indebtedness to the extent of the value of the assets securing such indebtedness. They are structurally junior to all indebtedness and other liabilities (including trade payables) of our subsidiaries.
The Convertible Senior Notes do not contain any financial covenants and do not restrict us from paying dividends or issuing or repurchasing our other securities.
The initial conversion rate on each series of Convertible Senior Notes is 16.4572 shares of our common stock per $1,000 principal amount of Convertible Senior Notes, which is equivalent to an initial conversion price of approximately $60.76 per share of common stock. The conversion rate of each series of Convertible Senior Notes may be adjusted upon the occurrence of certain specified events, but not for accrued and unpaid interest.
Holders may convert the Convertible Senior Notes at their option in multiples of $1,000 principal amount prior to March 1, 2035, excluding the period from March 1, 2020 to June 1, 2020 in the case of the Series A Notes and March 1, 2022 to June 1, 2022 in the case of the Series B Notes, only under the following circumstances:
during any calendar quarter commencing after the calendar quarter ended on September 30, 2015 (and only during such calendar quarter), if the last reported sale price of the common stock for at least 20 trading days (whether or not consecutive) during a period of 30 consecutive trading days ending on the last trading day of the immediately preceding calendar quarter is greater than or equal to 130% of the conversion price for the Convertible Senior Notes of the relevant series on each applicable trading day;
during the five business day period after any five consecutive trading day period in which the trading price per $1,000 principal amount of Series A Notes or Series B Notes, as applicable, for each trading day of the measurement period was less than 98% of the product of the last reported sale price of our common stock and the conversion rate for the notes of the relevant series on each such trading day;
if we call any or all of the Convertible Senior Notes of a series for redemption, at any time prior to the close of business on the scheduled trading day immediately preceding the relevant redemption date; or
upon the occurrence of specified corporate events, as specified in each indenture governing the Convertible Senior Notes.
Regardless of the foregoing conditions, holders may convert their Convertible Senior Notes at their option in multiples of $1,000 principal amount at any time during the period from March 1, 2020 to June 1, 2020 in the case of the Series A Notes and during the period from March 1, 2022 to June 1, 2022 in the case of the Series B Notes, or after March 1, 2035 until maturity for either series of Convertible Senior Notes. Upon conversion, the Convertible Senior Notes can be settled in cash, shares of our common stock or any combination thereof at our option.
We may be required by holders of the Convertible Senior Notes to repurchase all or any portion of their Convertible Senior Notes at 100% of the principal amount plus accrued and unpaid interest, on each of June 1, 2020, June 1, 2025 and June 1, 2030, in the case of the Series A Notes, and each of June 1, 2022, June 1, 2025 and June 1, 2030 in the case of the Series B Notes. Holders may also require us to repurchase the Convertible Senior Notes if we undergo a "fundamental change," as defined in each indenture governing the Convertible Senior Notes, at a purchase price equal to 100% of the principal amount, plus accrued and unpaid interest.
Additionally, we may redeem for cash all or any portion of the Series B Notes on or after June 1, 2020 until June 1, 2022 if the last reported sale price of our common stock has been at least 130% of the conversion price then in effect for at least 20 trading days (whether or not consecutive) during any 30 consecutive trading day period (including the last trading day of such period) ending not more than three trading days immediately preceding the date we provide notice of redemption. We also may redeem for cash all or any portion of the Series A Notes on or after June 1, 2020 until maturity and all or any portion of the Series B Notes on or after June 1, 2022 until maturity, regardless of the foregoing sale price condition.
In accordance with accounting for debt with conversions and other options, we allocated the principal amount of the Convertible Senior Notes into liability and equity components. We also allocated the total amount of initial purchasers' discount and transaction costs incurred to the liability and equity components using the same proportions as the proceeds from the Convertible Senior Notes. Transaction costs of $0.4 million and $0.1 million and initial purchasers' discount of $17.6 million and $5.4 million were attributable to the liability component and equity component of the Convertible Senior Notes, respectively.

16


The liability and equity components of the Convertible Senior Notes consisted of the following (in thousands):
 
As of March 31, 2018
 
As of December 31, 2017
 
Series A Notes
 
Series B Notes
 
Series A Notes
 
Series B Notes
Liability component:
 
 
 
 
 
 
 
Principal
$
460,000

 
$
460,000

 
$
460,000

 
$
460,000

Less: Convertible senior notes discounts and issuance costs, net of amortization
(48,505
)
 
(82,223
)
 
(53,762
)
 
(86,660
)
Net carrying amount
$
411,495


$
377,777

 
$
406,238

 
$
373,340

 
 
 
 
 
 
 
 
Equity component, net of issuance costs
$
92,567

 
$
117,834

 
$
92,567

 
$
117,834

The unamortized discounts and issuance costs as of March 31, 2018 will be amortized over a weighted-average remaining period of approximately 3 years.
Interest expense for the three months ended March 31, 2018 related to the Convertible Senior Notes consisted of the following (in thousands):
 
Three Months Ended March 31, 2018
 
Series A Notes
 
Series B Notes
Coupon interest
$
1,150

 
$
1,869

Amortization of convertible senior notes discounts and issuance costs
5,257

 
4,437

Total interest expense recognized
$
6,407


$
6,306

 
 
 
 
Effective interest rate on the liability component
6.3
%
 
6.8
%
Interest expense for the three months ended March 31, 2017 related to the Convertible Senior Notes consisted of the following (in thousands):
 
Three Months Ended March 31, 2017
 
Series A Notes
 
Series B Notes
Coupon interest
$
1,150

 
$
1,869

Amortization of convertible senior notes discounts and issuance costs
4,993

 
4,232

Total interest expense recognized
$
6,143

 
$
6,101

 
 
 
 
Effective interest rate on the liability component
6.4
%
 
6.9
%
Prepaid Forward Stock Purchase
In connection with the issuance of the Convertible Senior Notes, we also entered into privately negotiated prepaid forward stock purchase transactions (each a “Prepaid Forward”) with one of the initial purchasers of the Convertible Senior Notes (the “Forward Counterparty”), pursuant to which we paid approximately $150.0 million. The amount of the prepaid is equivalent to approximately 3.3 million shares which are to be settled on or around June 1, 2020 and June 1, 2022, respectively, subject to any early settlement, in whole or in part, of each Prepaid Forward. The Prepaid Forwards are intended to facilitate privately negotiated derivative transactions by which investors in the Convertible Senior Notes will be able to hedge their investment in the Convertible Senior Notes. In the event we pay any cash dividends on our common stock, the Forward Counterparty will pay an equivalent amount back to us.
The related shares were accounted for as a repurchase of common stock, and are presented as Treasury Stock in the unaudited condensed consolidated balance sheets. The 3.3 million shares of common stock purchased under the Prepaid Forwards are excluded from weighted-average shares outstanding for basic and diluted EPS purposes although they remain legally outstanding.

17


10. Commitments and Contingencies
Leases
We lease our facilities under various non-cancelable operating leases, which expire on various dates through the year ending December 31, 2027. Rent expense is recognized using the straight-line method over the term of the lease. Rent expense, net of sublease income, was $4.6 million and $4.1 million for the three months ended March 31, 2018 and 2017, respectively.
The aggregate future non-cancelable minimum rental payments on our operating leases, as of March 31, 2018, are as follows (in thousands):
Years Ending December 31, 
Amount 
2018 (remaining nine months)
$
11,838

2019
13,557

2020
11,742

2021
10,722

2022
8,911

2023 and thereafter
31,654

Total
$
88,424

Total future non-cancelable minimum rental payments have not been reduced by future minimum sublease rentals totaling $6.2 million.
We are party to letters of credit totaling $3.3 million and $3.3 million as of March 31, 2018 and December 31, 2017, respectively, issued primarily in support of operating leases for several of our facilities. These letters of credit are collateralized by a line with our bank. No amounts have been drawn against these letters of credit.
Contract Manufacturer Commitments
Our independent contract manufacturers procure components and assemble our products based on our forecasts. These forecasts are based on estimates of future demand for our products, which are in turn based on historical trends and an analysis from our sales and product marketing organizations, adjusted for overall market conditions. In order to reduce manufacturing lead times and plan for adequate supply, we may issue forecasts and orders for components and products that are non-cancelable. As of March 31, 2018 and December 31, 2017, we had non-cancelable open orders of $11.4 million and $11.6 million, respectively. We are required to record a liability for firm, non-cancelable and unconditional purchase commitments with contract manufacturers and suppliers for quantities in excess of our future demand forecasts. As of March 31, 2018, we have not accrued any significant costs for such non-cancelable commitments.
Purchase Obligations
As of March 31, 2018, we had approximately $12.9 million of non-cancelable firm purchase commitments primarily for purchases of software and services. In those situations in which we have received delivery of the goods or services as of March 31, 2018 under purchase orders outstanding as of the same date, such amounts are reflected in the condensed consolidated balance sheet as accounts payable or accrued liabilities, and are excluded from the $12.9 million.
Litigation
From time to time, we are involved in claims and legal proceedings that arise in the ordinary course of business. Any claims or proceedings against us, whether meritorious or not, could be time consuming, result in costly litigation, require significant amounts of management time, result in the diversion of significant operational resources, or require us to enter into agreements which may not be available on terms favorable to us or at all.

To the extent there is a reasonable possibility that a loss exceeding amounts already recognized may be incurred, and the amount of such additional loss would be material, we will either disclose the estimated additional loss or state that such an estimate cannot be made. We do not currently believe that it is reasonably possible that additional losses in connection with litigation arising in the ordinary course of business would be material.
Indemnification
Under the indemnification provisions of our standard sales related contracts, we agree to defend our customers against third-party claims asserting infringement of certain intellectual property rights, which may include patents, copyrights, trademarks, or trade secrets, and to pay judgments entered on such claims. Our exposure under these indemnification provisions is generally limited to the total amount paid by our customer under the agreement. However, certain agreements include indemnification provisions that could potentially expose us to losses in excess of the amount received under the agreement. In addition, we indemnify

18


our officers, directors, and certain key employees for actions taken while they are or were serving in good faith in such capacities. Through March 31, 2018, there have been no claims under any indemnification provisions.
11. Common Shares Reserved for Issuance
Under our amended and restated certificate of incorporation, we are authorized to issue 100,000,000 shares of convertible preferred stock with a par value of $0.0001 per share, none of which were issued and outstanding as of March 31, 2018 or December 31, 2017.
Under our amended and restated certificate of incorporation, we are authorized to issue 1,000,000,000 shares of common stock with a par value of $0.0001 per share as of March 31, 2018 and December 31, 2017. Each share of common stock outstanding is entitled to one vote. The holders of common stock are also entitled to receive dividends whenever funds are legally available and when declared by our Board of Directors, subject to the prior rights of holders of all classes of convertible preferred stock outstanding.
We had reserved shares of common stock for issuance as follows (in thousands):
 
As of March 31, 2018
 
As of December 31, 2017
Reserved under stock award plans
41,602

 
35,838

Convertible Senior Notes
15,141

 
15,141

ESPP
4,856

 
2,985

Total
61,599

 
53,964

12. Equity Award Plans
We have operated under our 2013 Equity Incentive Plan ("2013 Plan") since our initial public offering ("IPO") in September 2013. Our 2013 Plan provides for the issuance of restricted stock and the granting of options, stock appreciation rights, performance shares, performance units and restricted stock units to our employees, officers, directors and consultants. Our 2013 Plan provides for annual increases in the number of shares available for issuance on the first day of each fiscal year. Awards granted under the 2013 Plan vest over the periods determined by our Board of Directors or compensation committee of our Board of Directors, generally four years, and stock options granted under the 2013 Plan expire no more than ten years after the date of grant. In the case of an incentive stock option granted to an employee who at the time of grant owns stock representing more than 10% of the total combined voting power of all classes of stock, the exercise price shall be no less than 110% of the fair value per share on the date of grant, and the award shall expire five years from the date of grant. For options granted to any other employee, the per share exercise price shall be no less than 100% of the fair value per share on the date of grant. In the case of non-statutory stock options and options granted to consultants, the per share exercise price shall be no less than 100% of the fair value per share on the date of grant. Stock that is purchased prior to vesting is subject to our right of repurchase at any time following termination of the participant's service for so long as such stock remains unvested. Approximately 12.8 million shares and 11.7 million shares of our common stock were reserved for future grants as of March 31, 2018 and December 31, 2017, respectively, under the 2013 Plan.
Our 2013 Employee Stock Purchase Plan ("ESPP") allows eligible employees to acquire shares of our common stock at 85% of the lower of the fair market value of our common stock on the first trading day of each offering period or on the exercise date. Our ESPP provides for annual increases in the number of shares available for issuance on the first day of each fiscal year. An aggregate of approximately 4.9 million shares and 3.0 million shares of common stock were available for future issuance as of March 31, 2018 and December 31, 2017, respectively, under our ESPP.
From time to time, we also grant restricted common stock or restricted stock awards outside of our equity incentive plans to certain employees in connection with acquisitions.

19


Stock Option Activity
A summary of the activity for our stock option changes during the reporting period and a summary of information related to options outstanding and options exercisable are presented below (in thousands, except per share amounts and contractual life years):
 
Options Outstanding
 
Number of
Shares
 
Weighted-
Average
Exercise
Price
(per share)
 
Weighted-
Average
Contractual
Life (years)
 
Aggregate
Intrinsic
Value
Balance — December 31, 2017
4,433

 
$
12.31

 
4.8
 
$
28,090

Exercised
(445
)
 
6.99

 
 
 
4,498

Cancelled
(68
)
 
32.41

 
 
 
 
Balance — March 31, 2018
3,920

 
$
12.56

 
4.7
 
$
34,167

Options exercisable — March 31, 2018
3,920

 
$
12.56

 
4.7
 
$
34,167

Restricted Stock Award (RSA) and Restricted Stock Unit (RSU) Activity
A summary of the activity for our restricted common stock, RSAs and RSUs, including those subject to performance conditions, during the reporting period and a summary of information related to unvested restricted common stock, RSAs and RSUs, including those with vesting subject to the achievement of a performance condition, are presented below (in thousands, except per share amounts and contractual life years):
 
Number of
Shares
 
Weighted-
Average
Grant Date
Fair Value
(per share)
 
Weighted-
Average
Contractual
Life (years)
 
Aggregate
Intrinsic
Value
Unvested balance — December 31, 2017
20,017

 
$
17.09

 
1.3
 
$
284,255

Granted
9,313

 
14.95

 
 
 
 
Vested
(3,340
)
 
16.68

 
 
 
 
Cancelled
(885
)
 
18.22

 
 
 
 
Unvested balance — March 31, 2018
25,105

 
$
16.20

 
1.7
 
$
425,075

Unvested awards for which the requisite service period has not been rendered and vesting is subject to the achievement of a performance condition — March 31, 2018
1,139

 
$
16.17

 
1.9
 
$
19,289

Stock-Based Compensation
We record stock-based compensation based on the fair value as determined on the date granted. We determine the fair value of stock options and shares of common stock to be issued under the ESPP using the Black-Scholes option-pricing model. The fair value of restricted stock units and restricted stock awards equals the market value of the underlying stock on the date of grant. We grant performance-based restricted stock units and restricted stock awards to certain employees which vest upon the achievement of certain performance conditions, subject to the employees’ continued service relationship with us. We assess the probability of vesting at each reporting period and adjust our compensation cost based on this probability assessment. We recognize such compensation expense on a straight-line basis over the employee's requisite service period.

20


The following table summarizes the assumptions used in the Black-Scholes option-pricing model to determine fair value of our common shares to be issued under the ESPP for the offering periods beginning in November 2017:
 
Three Months Ended March 31, 2018
 
Three Months Ended March 31, 2017
Fair value of common stock
$14.14 - $15.65
 
$13.12-$14.12
Risk-free interest rate
1.05% - 1.62%
 
0.38% - 0.79%
Expected term (in years)
0.5 - 1.0
 
0.5 - 1.0
Volatility
29% - 52%
 
57% - 63%
Dividend yield
—%
 
—%
Stock-based compensation expense related to stock options, ESPP and restricted stock units awards is included in the condensed consolidated statements of operations as follows (in thousands):
 
Three Months Ended March 31,
 
2018
 
2017
Cost of product, subscription and support revenue
$
3,622

 
$
4,360

Cost of professional services revenue
3,902

 
3,672

Research and development
14,353

 
14,525

Sales and marketing
12,977

 
14,015

General and administrative
7,294

 
7,317

Total
$
42,148


$
43,889

As of March 31, 2018, total compensation cost related to stock-based awards not yet recognized was $327.5 million, which is expected to be amortized on a straight-line basis over the weighted-average remaining vesting period of approximately 2.7 years.
13. Income Taxes
We account for income taxes under the asset and liability method. Under this method, deferred income tax assets and liabilities are determined based upon the difference between the financial statement carrying amounts and the tax basis of assets and liabilities and are measured using the enacted tax rate expected to apply to taxable income in the years in which the differences are expected to be reversed.
We recognized a provision for income taxes of $1.1 million and $1.3 million for the three months ended March 31, 2018 and 2017, respectively. For both the three months ended March 31, 2018 and 2017, the provision for income taxes is primarily comprised of income taxes in foreign jurisdictions and withholding taxes.
14. Net Loss per Share
Basic net loss per share is calculated by dividing net loss by the weighted average number of common shares outstanding during the period, less shares subject to repurchase, and excludes any dilutive effects of employee share based awards and warrants. Diluted net income per common share is computed giving effect to all potentially dilutive common shares, including common stock issuable upon exercise of stock options, conversion of the Convertible Senior Notes, and unvested restricted common stock and stock units. As we had net losses for the three months ended March 31, 2018 and 2017, all potential common shares were determined to be anti-dilutive.
The following table sets forth the computation of net loss per common share (in thousands, except per share amounts):
 
Three Months Ended March 31,
 
2018
 
2017*
Numerator:
 
 
 
Net loss
$
(71,830
)
 
$
(77,217
)
Denominator:
 
 
 
Weighted average number of shares outstanding—basic and diluted
186,456
 
172,236

Net loss per share—basic and diluted
$
(0.39
)

$
(0.45
)
* Certain prior period amounts have been adjusted as a result of adoption of the new revenue recognition standard.

21


The following outstanding options and unvested shares were excluded (as common stock equivalents) from the computation of diluted net loss per common share for the periods presented as their effect would have been anti-dilutive (in thousands):
 
As of March 31,
 
2018
 
2017
Options to purchase common stock
3,920

 
7,019

Unvested early exercised common shares

 

Unvested restricted stock awards and units
25,105

 
24,983

Convertible senior notes
15,141

 
15,141

ESPP shares
639

 
784

15. Employee Benefit Plan
401(k) Plan
We have established a 401(k) tax-deferred savings plan (the “401(k) Plan”) which permits participants to make contributions by salary deduction pursuant to Section 401(k) of the Internal Revenue Code of 1986, as amended. All participants’ interests in their deferrals are 100% vested when contributed. We are responsible for administrative costs of the 401(k) Plan and have made no matching contributions into our 401(k) Plan since inception. Under the 401(k) Plan, pre-tax contributions are allocated to each participant’s individual account and are then invested in selected investment alternatives according to the participants’ directions. The 401(k) Plan is intended to qualify under Sections 401(a) and 501(a) of the Code. As a tax-qualified retirement plan, contributions to the 401(k) Plan and earnings on those contributions are not taxable to the employees until distributed, and all contributions are deductible by us when and if made.
16. Segment and Major Customers Information
Disaggregation of revenue by geography
We conduct business globally and are primarily managed on a geographic basis. Our Chief Executive Officer, who is our chief operating decision maker, reviews financial information presented on a consolidated basis accompanied by information about revenue by geographic region for purposes of allocating resources and evaluating financial performance. We define our regions into United States ("US"), Europe, the Middle East, and Africa ("EMEA"), Asia Pacific and Japan ("APAC"), and all remaining geographies (primarily Latin America and Canada) included in Others. There are no segment managers who are held accountable for operations, operating results, and plans for levels, components, or types of products or services below the consolidated unit level. Accordingly, we are considered to be in a single reportable segment and operating unit structure.
Revenue by geographic region based on the billing address is as follows (in thousands):
 
Three Months Ended March 31,
 
2018
 
2017*
 
2018
 
2017*
 
2018
 
2017*
 
2018
 
2017*
 
US
 
EMEA
 
APAC
 
Other
Product and related subscription and support
$
73,628

 
$
71,197

 
$
21,925

 
$
18,472

 
$
19,748

 
$
17,758

 
$
5,792

 
$
4,757

Cloud subscription and managed services
29,855

 
30,941

 
6,645

 
4,058

 
5,409

 
5,018

 
2,471

 
1,527

Professional services
22,465

 
23,147

 
5,448

 
2,871

 
2,498

 
2,969

 
3,186

 
2,044

Total revenue
$
125,948

 
$
125,285

 
$
34,018

 
$
25,401

 
$
27,655

 
$
25,745

 
$
11,449

 
$
8,328

We generate revenue from sales of our products and related subscriptions and support, cloud subscription and managed services, and professional services. Our product and related subscription and support revenue consists primarily of revenue from the sale of our intelligence-dependent security appliances and software, subscriptions to our dynamic threat intelligence (DTI) updates, and support and maintenance. Our intelligent-dependent security appliances include NX (network security), EX (email security), HX (endpoint security), and FX (file security). Product and related subscription and support also includes our enterprise forensic solutions (PX) network forensics appliance and our central management system (CMS) management appliance. Because these PX and CMS appliances are not dependent on regular threat intelligence updates, revenue is recognized upon shipment. Cloud subscription and managed services consists of revenue from the sale of our cloud-based email security, our Threat Analytics Platform (TAP), our Helix orchestration and automation platform, and our standalone threat intelligence subscriptions. Professional services revenue consists of revenue from the sale of security consulting services, including incident response,

22


compromise and security program assessments, red teaming and training. The following table depicts the disaggregation of revenue according to revenue type and is consistent with how we evaluate our financial performance (in thousands):
 
Three Months Ended March 31,
 
2018

2017*
Revenue by Category
 
 
 
Product and related subscription and support
$
121,092

 
$
112,184

Cloud subscription and managed services
44,381

 
41,545

Professional services
33,597

 
31,030

Total revenue
$
199,070

 
$
184,759

Disaggregation of long lived assets by geography
Long lived assets by geographic region based on physical location is as follows (in thousands):
 
As of March 31, 2018
 
As of December 31, 2017
Property and Equipment, net:
 
 
 
United States
$
66,453

 
$
60,202

International
10,126

 
11,155

Total property and equipment, net
$
76,579

 
$
71,357

For each of the three months ended March 31, 2018 and 2017, one distributor represented 20% and 19%, respectively, and one reseller represented 15% and 12%, respectively, of the Company's total revenue. As of March 31, 2018 and December 31, 2017, no customer represented 10% or more of the Company's net accounts receivable balance.
*Certain prior period amounts have been adjusted as a result of adoption of the new revenue recognition standard.
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 our condensed consolidated financial statements and related notes appearing elsewhere in this Quarterly Report on Form 10-Q and our Annual Report on Form 10-K for the year ended December 31, 2017. The following discussion and analysis contains forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended. These statements include, but are not limited to, statements regarding:
the evolution of the threat landscape facing our customers and prospects;
our ability , and effects of our efforts, to educate the market regarding the advantages of our security solutions;
our ability to continue to grow revenues;
our future financial and operating results;
our business plan and our ability to effectively manage our growth and associated investments;
beliefs and objectives for future operations;
our ability to expand our leadership position in advanced network security;
our ability to attract and retain customers and to expand our solutions footprint within each of these customers;
our expectations concerning customer retention rates as well as expectations for the value of subscriptions and services renewals;
our ability to maintain our competitive technological advantages against new entrants in our industry;
our ability to timely and effectively scale and adapt our existing technology;
our ability to innovate new products and bring them to market in a timely manner;
our ability to maintain, protect, and enhance our brand and intellectual property;
our ability to expand internationally;
the effects of increased competition in our market and our ability to compete effectively;

23


cost of revenue, including changes in costs associated with products, manufacturing and customer support;
operating expenses, including changes in research and development, sales and marketing, and general and administrative expenses;
anticipated income tax rates;
potential attrition and other impacts associated with restructuring;
sufficiency of cash to meet cash needs for at least the next 12 months;
our ability to generate cash flows from operations and free cash flows;
our ability to capture new, and renew existing, contracts with the United States and international governments;
our expectations concerning relationships with third parties, including channel partners and logistics providers;
the release of new products;
economic and industry trends or trend analysis;
the attraction, training, integration and retention of qualified employees and key personnel;
future acquisitions of or investments in complementary companies, products, subscriptions or technologies; and
the effects of seasonal trends on our results of operations.
as well as other statements regarding our future operations, financial condition and prospects, and business strategies. Forward-looking statements generally can be identified by words such as “anticipates,” “believes,” “estimates,” “expects,” “intends,” “plans,” “predicts,” “projects,” “will be,” “will continue,” “will likely result,” and similar expressions. These forward-looking statements are based on current expectations and assumptions that are subject to risks and uncertainties, which could cause our actual results to differ materially from those reflected in the forward-looking statements. Factors that could cause or contribute to such differences include, but are not limited to, those discussed in this Quarterly Report on Form 10-Q, and in particular, the risks discussed under the caption “Risk Factors” in Item 1A of Part II of this Quarterly Report on Form 10-Q and those discussed in other documents we file with the SEC. We undertake no obligation to revise or publicly release the results of any revision to these forward-looking statements, except as required by law. Given these risks and uncertainties, readers are cautioned not to place undue reliance on such forward-looking statements.
Overview
We provide comprehensive intelligence-based cybersecurity solutions that allow organizations to prepare for, prevent, respond to and remediate cyber attacks. Our portfolio of cybersecurity products and services is designed to detect and prevent attacks as well as enable rapid discovery and response when a breach occurs.
Our Business Model
We generate revenue from sales of our product and related subscriptions and support, from sales of our cloud subscriptions and managed security services, and from professional services. Our product and related subscription and support revenue consists primarily of revenue from the sale of our intelligence-dependent security appliances and software, subscriptions to our dynamic threat intelligence (DTI) updates, and support and maintenance. Our intelligent-dependent security appliances include NX (network security), EX (email security), HX (endpoint security), and FX (file security). We require customers to purchase a subscription to our Dynamic Threat Intelligence (DTI) and to support and maintenance services when they purchase any of these appliance-based detection and prevention products, generally for a one or three-year term. Revenue from sales of our intelligence-dependent security appliances and software is recognized over the longer of the life of the related appliance and license or the contractual term, rather than at the time of shipping. Revenue from subscriptions and support related to our security appliances is recognized ratably over the contractual term. A small portion of our product and related subscription and support revenue is from the sale of our enterprise forensic solutions (PX) network forensics appliance and our central management system (CMS) management appliance that are not dependent on regular security intelligence updates. Revenue from PX and CMS is therefore recognized at the point in time when ownership is transferred to our customer, typically at shipment.

Cloud subscriptions and managed services consists of revenue from the sale of our cloud-based email security, our Threat Analytics Platform (TAP), our Helix orchestration and automation platform, and our standalone threat intelligence subscriptions. Revenue from subscriptions to cloud-based software and our managed services is recognized over the contractual term, generally one or three years.
Sales of our intelligence-dependent appliances and software, subscription and support services initially increase our deferred revenue. Deferred revenue from our product subscription and support sales totaled $841.5 million and $859.5 million as of March 31, 2018 and December 31, 2017, respectively. Amortization of this deferred revenue has contributed to the increase in our product,

24


subscription and support revenue. For the three months ended March 31, 2018 and 2017, product, subscription and support revenue as a percentage of total revenue was 83% and 83%, respectively.
Growth in our subscription and services revenue is the result of the deferral of the initial subscription and services agreements, as well as growth in the renewals of such agreements as initial subscription and services agreements expire. Our retention rate of customers with subscriptions and support contracts expiring in the 12 months ended March 31, 2018 was consistent with historical retention rates, and we expect to maintain these strong retention rates in the future.
We also offer professional services, including incident response and other security consulting services for our customers who have experienced a cyber security breach or require assistance assessing the resilience of their networks. Our professional services are offered on a time and materials basis, through a fixed fee arrangement, or on a retainer basis. Revenue from these professional services is recognized as the services are delivered. Some professional services are prepaid, and revenue is deferred until services are delivered. Deferred revenue from professional services for the three months ended March 31, 2018 and December 31, 2017 was $44.6 million and $50.6 million, respectively.
Key Business Metrics
We monitor the key business metrics set forth below to help us evaluate growth trends, establish budgets, measure the effectiveness of our sales and marketing efforts, and assess operational efficiencies. We discuss revenue and gross margin below under “Components of Operating Results.” Deferred revenue, billings (a non-GAAP metric), net cash flow provided by (used in) operating activities, and free cash flow (a non-GAAP metric) are discussed immediately below the following table (in thousands, except percentages).
 
Three Months Ended or As of
 
March 31,
 
2018

2017*
Product, subscription and support revenue
$
165,473

 
$
153,729

Professional services revenue
33,597

 
31,030

Total revenue
$
199,070


$
184,759

Year-over-year percentage increase
8
%
 
 
Gross margin percentage
66
%
 
64
%
Deferred revenue, current
$
533,540

 
$
498,664

Deferred revenue, non-current
$
352,596

 
$
389,296

Billings (non-GAAP)
$
175,106

 
$
144,970

Net cash provided by (used in) operating activities
$
9,187

 
$
(16,952
)
Free cash flow (non-GAAP)
$
(5,300
)
 
$
(25,435
)
Deferred revenue. Our deferred revenue consists of amounts that we have the right to bill and which have been invoiced, but have not yet been recognized as revenue as of period end. The majority of our deferred revenue consists of the unamortized balance of revenue from previously invoiced and non-cancelable contracts consisting of intelligence-based security appliances, subscriptions to our threat intelligence, security-as-a-service and support and maintenance contracts. Because invoiced amounts for such contracts can be for multiple years, we classify our deferred revenue as current or non-current depending on when we expect to recognize the related revenue. If the deferred revenue is expected to be recognized within 12 months it is classified as current, otherwise, the deferred revenue is classified as non-current. We monitor our deferred revenue balance because it represents a significant portion of revenue to be recognized in future periods.
Billings. Billings are a non-GAAP financial metric that we define as revenue recognized in accordance with generally accepted accounting principles, or GAAP, plus the change in deferred revenue from the beginning to the end of the period, excluding deferred revenue assumed through acquisitions. We consider billings to be a useful metric for management and investors, as a supplement to the corresponding GAAP measure, because billings drive deferred revenue, which is an important indicator of the health and visibility of trends in our business, and represent a significant percentage of future revenue. However, it is important to note that other companies, including companies in our industry, may not use billings, may define billings differently, may have different billing frequencies, or may use other financial measures to evaluate their performance, all of which could reduce the usefulness of billings as a comparative measure. A reconciliation of billings to revenue, the most directly comparable financial measure calculated and presented in accordance with GAAP, is provided below (in thousands):

25


 
Three Months Ended March 31,
 
2018

2017*
Revenue
$
199,070

 
$
184,759

Add: Deferred revenue, end of period
886,136

 
887,960

Less: Deferred revenue, beginning of period
910,100

 
927,749

Billings (non-GAAP)
$
175,106

 
$
144,970

We have provided disaggregation of billings below (in thousands):
 
Three Months Ended March 31,
 
2018
 
2017*
Product and related subscription and support
90,365

 
76,930

Cloud subscription and managed services
57,110

 
35,349

Professional Services
27,631

 
32,691

Billings (non-GAAP)
$
175,106

 
$
144,970

Net cash provided by (used in) operating activities. We monitor net cash provided by (used in) operating activities as a measure of our overall business performance. Our net cash provided by (used in) operating activities is driven in large part by sales of our products and from up-front payments for both subscriptions and support and maintenance services. Monitoring net cash provided by (used in) operating activities enables us to analyze our financial performance without the non-cash effects of certain items, such as depreciation, amortization, and stock-based compensation costs, thereby allowing us to better understand and manage the cash needs of our business.
Free cash flow. Free cash flow is a non-GAAP financial measure we define as net cash provided by (used in) operating activities, the most directly comparable GAAP financial measure, less purchases of property and equipment and demonstration units. 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 our business that, after the purchases of property and equipment and demonstration units, can be used by us for strategic opportunities, including investing in our business, making strategic acquisitions and strengthening our balance sheet if and when generated. However, it is important to note that other companies, including companies in our industry, may not use free cash flow, may calculate free cash flow differently, or may use other financial measures to evaluate their performance, all of which could reduce the usefulness of free cash flow as a comparative measure. A reconciliation of free cash flow to cash flow provided by (used in) operating activities is provided below (in thousands):
 
Three Months Ended March 31,
 
2018
 
2017*
Net cash provided by (used in) operating activities
$
9,187

 
$
(16,952
)
Less: purchase of property and equipment and demonstration units
14,487

 
8,483

Free cash flow (non-GAAP)
$
(5,300
)
 
$
(25,435
)
Net cash used in investing activities
$
(25,338
)
 
$
(8,724
)
Net cash provided by (used in) financing activities
$
3,110

 
$
(34,617
)
*Certain prior period amounts have been adjusted as a result of adoption of the new revenue recognition standard.
Factors Affecting our Performance
Market Adoption. We rely on market education to raise awareness of today’s cyber attacks and articulate the need for our security solutions and, in particular, the reasons to purchase our products. Our prospective customers often do not have a specific portion of their IT budgets allocated for products that address the next generation of advanced cyber attacks. Additionally, the market for security operations and automation management platforms such as FireEye Helix is in the early stages of development.
We invest heavily in sales and marketing efforts to increase market awareness, educate prospective customers and drive adoption of our products, subscriptions and services. This market education is critical to creating new IT budget dollars or allocating more of existing IT budget dollars to advanced threat protection and management solutions and, in particular, our products and the FireEye Helix platform. The degree to which prospective customers recognize the mission critical need for advanced threat protection solutions and security operations management solutions, including our FireEye Helix platform, will drive our ability to acquire new customers and increase renewals and follow-on sales opportunities, which, in turn, will affect our future financial performance.

26


Sales Productivity. Our sales organization consists of in-house sales teams who work in collaboration with external channel partners to identify new sales prospects, sell additional products, subscriptions and services, and provide post-sale support. Our sales teams are organized by territory to target large enterprise and government customers, who typically have sales cycles that can last several months or more. We have also expanded our inside sales teams to work with channel partners to expand our customer base of small and medium enterprises, or SMEs, as well as manage renewals of subscription and support contracts.
Newly hired sales and marketing employees typically require several months to establish prospect relationships and achieve full sales productivity. In addition, although we believe our investments in market education have increased awareness of us and our solutions globally, sales teams in certain international markets may face local markets with limited awareness of us and our solutions, or have specific requirements that are not available with our solutions. All of these factors will influence the timing and overall levels of sales productivity, impacting the rate at which we will be able to convert prospects to sales and drive revenue growth.
Retention Rates. New or existing customers who purchase our intelligence-dependent security appliances are required to purchase a one or three year subscription to our DTI cloud and support and maintenance services. New or existing customers who purchase our PX network forensic appliances or our CMS management appliances are required to purchase support and maintenance services for a term of one or three years.
We believe our customer retention rate is an important metric to measure the long-term value of our customer agreements. We define retention rate as the percentage of customers at the end of the previous period that are up for renewal in the current period that remain customers at the end of the current period on a trailing twelve month basis. We believe our ability to maintain strong customer retention rates will have a material impact on our future sales of product, subscription and services and therefore our future financial performance.
Follow-On Sales. After the initial sale to a new customer, we focus on expanding our relationship with the customer to sell additional products, subscriptions and services. To grow our revenue, it is important that our customers make additional purchases of our products, subscriptions and services. Sales to our existing customer base can take the form of incremental sales of security appliances, subscriptions and services, either to deploy our platform into additional parts of their network to protect additional threat vectors, or to extend their internal security resources with our managed and professional security services. Our opportunity to expand our customer relationships through follow-on sales will increase as we add new customers, broaden our product portfolio with additional subscriptions and services and enhance the functionality of our existing products and the Helix platform. Follow-on sales lead to increased revenue over the lifecycle of a customer relationship and can significantly increase the return on our sales and marketing investments. With many of our large enterprise and government customers, we have realized follow-on sales that were multiples of the value of their initial purchases.
Components of Operating Results
Revenue
We generate revenue from the sales of our products, subscriptions and services. As discussed further in recent accounting pronouncements, “Critical Accounting Policies and Estimates-Revenue Recognition” under “Management’s Discussion and Analysis of Financial Condition and Results of Operations” in our Annual Report on Form 10-K for the year ended December 31, 2017, revenue is recognized when a contract has been entered into with a customer, the performance obligation(s) is(are) identified, the transaction price is determined and has been allocated to the performance obligation(s) and only then for each performance obligation after we have satisfied that performance obligation.
Product, subscription and support revenue. Our product, subscription and support revenue is generated from sales of our intelligent-dependent security appliances and related subscriptions and support, as well as cloud-based subscriptions and managed services. We combine intelligence-dependent appliances and software licenses with the mandatory intelligence subscriptions and support as a single performance obligation. We recognize intelligence-dependent appliance and software license revenue ratably over the longer of the life of the related appliance and license or the contractual term, rather than at the time of shipping, when our contracts contain material right of renewal options. For our contracts in which the term is less than the life of the appliance and license, the mandatory intelligence subscription and support is recognized ratably over the contractual term with the allocated value of the material right performance obligations being recognized in the period between the end of the contractual term and the useful life. Where our contracts do not contain material right of renewal options, or the contractual term is longer than the useful life, we expect to recognize the intelligence-dependent appliance and software license revenue ratably over the contractual term. Revenue from our cloud subscriptions and managed services is recognized ratably over the contractual term, typically one or three years.
Professional services revenue. Professional services, which includes incident response, compromise assessments, and other security consulting services, are offered on a time-and-material basis, through a fixed fee arrangement, or on a retainer basis. We recognize the associated revenue as the services are delivered. Some professional services are prepaid, and revenue is deferred until services are delivered.

27


Cost of Revenue
Our total cost of revenue consists of cost of product revenue and cost of subscription and services revenue. Personnel costs associated with our operations and global customer support organizations consist of salaries, benefits, bonuses and stock-based compensation. Overhead costs consist of certain facilities, depreciation and information technology costs.
Cost of product, subscription and support revenue. Cost of product, subscription and support revenue primarily consists of costs paid to our third-party contract manufacturers for our appliances and personnel, other costs in our manufacturing operations department, and personnel costs associated with maintaining our Dynamic Threat Intelligence updates and our global customer support operations. Our cost of product revenue also includes product testing costs, shipping costs and allocated overhead costs. If revenue from sales of product, subscriptions and support declines, the cost of product, subscription and support revenue may increase as a percentage of product, subscription and support revenue due to the fixed nature of a portion of these costs.
Cost of professional services revenue. Cost of professional services revenue primarily consists of personnel costs for our services organization and allocated overhead costs. If sales of our services decline or we are unable to maintain our changeability rates, our cost of services revenue may increase as a percentage of professional services revenue.
Gross Margin
Gross margin, or gross profit as a percentage of revenue, has been and will continue to be affected by a variety of factors, including our average selling price, the mix of products sold, the mix of revenue among products, subscriptions and services and manufacturing costs. We expect our gross margins to fluctuate over time depending on these factors.
Operating Expenses
Our operating expenses consist of research and development, sales and marketing and general and administrative expenses. Personnel costs are the most significant component of operating expenses and consist of salaries, benefits, bonuses, stock-based compensation and, with regard to sales and marketing expense, sales commissions. Operating expenses also include allocated overhead costs consisting of certain facilities, depreciation and information technology costs.
Research and development. Research and development expense consists primarily of personnel costs and allocated overhead. Research and development expense also includes prototype related expenses. We expect research and development expense to remain relatively flat in absolute terms, but to decrease as a percentage of total revenue.
Sales and marketing. Sales and marketing expense consists primarily of personnel costs, partner referral fees, incentive commission costs and allocated overhead. Commission costs capitalized and amortized based on the useful life amortization period taking into consideration the pattern of transfer to which the asset relates and the expected renewal periods during which renewal commissions are not commensurate with the initial commissions paid. When initial commissions are higher than (not-commensurate) renewal commissions, we recognize the incremental portion of initial commissions over an estimated renewal period. The commensurate portion will be recognized over the same period as the initial revenue arrangement to which it relates. Additionally, our appliance related cost of goods sold are capitalized and amortized on a systematic basis that is consistent with the pattern of transfer to which the asset relates.
Sales and marketing expense also includes costs for market development programs, promotional and other marketing activities, travel, depreciation of proof-of-concept evaluation units and outside consulting costs. We expect sales and marketing expense to remain relatively flat in absolute terms, but decrease as a percentage of total revenue. These costs are recognized as incurred.
General and administrative. General and administrative expense consists of personnel costs, professional service costs and allocated overhead. General and administrative personnel include our executive, finance, human resources, facilities and legal organizations. Professional service costs consist primarily of legal, auditing, accounting and other consulting costs. We expect general and administrative expense to remain relatively flat in absolute terms, but to decrease as a percentage of total revenue.

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Interest Income
Interest income consists of interest earned on our cash and cash equivalent and investment balances. We have historically invested our cash in money-market funds and other short-term, high quality securities. We expect interest income to vary each reporting period depending on our average investment balances during the period, types and mix of investments and market interest rates.
Interest Expense
Interest expense is primarily a result of our convertible senior notes, consisting of interest at the stated rate (coupon) and amortization of discounts and issuance costs.
Other Income (Expense), Net
Other income (expense), net includes gains or losses on the disposal of fixed assets, gains or losses from our equity-method investment, foreign currency re-measurement gains and losses and foreign currency transaction gains and losses. We expect other income (expense), net to fluctuate depending primarily on foreign exchange rate movements.
Provision for (Benefit from) Income Taxes
Provision for income taxes primarily relates to income taxes payable in foreign jurisdictions in which we conduct business, withholding taxes, and state income taxes in the United States. The provision is offset by tax benefits primarily related to the reversal of valuation allowances previously established against our deferred tax assets. Should the tax benefits exceed the provision, then a net tax benefit from income taxes is reflected for the period. Income in certain countries may be taxed at statutory tax rates that are lower than the U.S. statutory tax rate. As a result, our overall effective tax rate over the long-term may be lower than the U.S. federal statutory tax rate due to net income being subject to foreign income tax rates that are lower than the U.S. federal statutory rate.

29


Results of Operations
The following table summarizes our results of operations for the periods presented and as a percentage of our total revenue for those periods. The period-to-period comparison of results is not necessarily indicative of results for future periods.
 
Three Months Ended March 31,
 
2018
 
2017*
 
Amount
 
% of total Revenue
 
Amount
 
% of total Revenue
 
(Dollars in thousands)
Revenue:
 
 
 
 
 
 
 
Product, subscription and support
$
165,473

 
83
 %
 
$
153,729

 
83
 %
Professional services
33,597

 
17

 
31,030

 
17

Total revenue
199,070

 
100

 
184,759

 
100

Cost of revenue:
 
 
 
 
 
 
 
Product, subscription and support
47,429

 
24

 
46,423

 
25

Professional services
20,500

 
10

 
19,324

 
10

Total cost of revenue
67,929

 
34

 
65,747

 
36

Total gross profit
131,141

 
66

 
119,012

 
64

Operating expenses:
 
 
 
 
 
 
 
Research and development
66,196

 
33

 
58,352

 
32

Sales and marketing
97,251

 
49

 
98,988

 
54

General and administrative
28,418

 
14

 
27,615

 
15

Total operating expenses
191,865

 
96

 
184,955

 
100

Operating loss
(60,724
)
 
(31
)
 
(65,943
)
 
(36
)
Interest income
2,940

 
1

 
2,032

 
1

Interest expense
(12,717
)
 
(6
)
 
(12,245
)
 
(7
)
Other expense, net
(276
)
 

 
232

 

Loss before income taxes
(70,777
)
 
(36
)
 
(75,924
)
 
(41
)
Provision for income taxes
1,053

 
1

 
1,293

 
1

Net loss attributable to common stockholders
$
(71,830
)
 
(36
)%
 
$
(77,217
)
 
(42
)%
*Certain prior period amounts have been adjusted as a result of adoption of the new revenue recognition standard.

30


Comparison of the Three Months Ended March 31, 2018 and 2017
Revenue
 
Three Months Ended March 31,
 
2018
 
2017*
 
Change  
 
Amount
 
% of Total Revenue
 
Amount
 
% of Total Revenue
 
Amount
 
%
 
(Dollars in thousands)
Revenue:
 
 
 
 
 
 
 
 
 
 
 
Product, subscription and support
$
165,473

 
83
%
 
$
153,729

 
83
%
 
$
11,744

 
8
%
Professional services
33,597

 
17

 
31,030

 
17

 
2,567

 
8

Total revenue
$
199,070

 
100
%
 
$
184,759

 
100
%
 
$
14,311

 
8
%