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Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations

The following discussion and analysis of our financial condition and results of operations should be read in conjunction with the consolidated financial statements and related notes included elsewhere in this Annual Report on Form 10-K. As discussed in the section titled "Special Note Regarding Forward-Looking Statements," the following discussion contains forward-looking statements that involve risks and uncertainties. Our actual results could differ materially from those discussed below. Factors that could cause or contribute to such difference include, but are not limited to, those identified below and those discussed in the section titled "Risk Factors" and elsewhere in this Annual Report on Form 10-K. Our fiscal year end is July 31, and our fiscal quarters end on October 31, January 31, April 30 and July 31. Our fiscal years ended July 31, 2021, July 31, 2020 and July 31, 2019 are referred to as fiscal 2021, fiscal 2020 and fiscal 2019, respectively.

Overview

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

We generate revenue primarily from sales of subscriptions to access our cloud platform, together with related support services. We also generate an immaterial amount of revenue from professional and other services, which consist primarily of fees associated with mapping, implementation, network design and training. Our subscription pricing is primarily calculated on a per-user basis. We recognize subscription and support revenue ratably over the life of the contract, which is generally one to three years. As of July 31, 2021, we had expanded our operations to over 5,600 customers across major industries, with users in 185 countries. Government agencies and some of the largest enterprises in the world rely on us to support their digital transformation, including more than 500 of the Forbes Global 2000 as of July 31, 2021.

We operate our business as one reportable segment. Our revenue has experienced significant growth in recent periods. For fiscal 2021, fiscal 2020 and fiscal 2019, our revenue was $673.1 million, $431.3 million and $302.8 million, respectively. We have incurred net losses in all periods since our inception. For fiscal 2021, fiscal 2020 and fiscal 2019, our net loss was $262.0 million, $115.1 million and $28.7 million, respectively. We expect we will continue to incur net losses for the foreseeable future, as we continue to invest in our sales and marketing organization to take advantage of our market opportunity, to invest in research and development efforts to enhance the functionality of our cloud platform, to incur additional compliance and other related costs as we operate as a public company, and to address any legal matters and related accruals, as further described in Note 11, Commitments and Contingencies, of the consolidated financial statements included elsewhere in this Annual Report on Form 10-K.

Impacts of COVID-19

In March 2020, the World Health Organization declared the COVID-19 outbreak to be a pandemic. As a result of the COVID-19 pandemic, we have modified certain aspects of our business, including restricting employee travel, requiring employees to work from home, transitioning our employee onboarding and training processes to remote or online programs, and canceling certain events and meetings, among other modifications. We will continue to actively monitor and evaluate the situation and may take further actions that alter our business operations as may be required by federal, state or local authorities or that we determine are in the best interests of our employees, customers, partners, suppliers and stockholders. The effects of these operational modifications are unknown and may not be known until future reporting periods. While we have not experienced significant disruptions to our operations or financial performance from the COVID-19 pandemic to date, we are unable to accurately predict the full impact that COVID-19 will have due to numerous uncertainties, including the duration of the outbreak, the current or a future resurgence of the outbreak in connection with new variants and mutations,

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the widespread distribution and long-term efficacy of vaccines, the efficacy of vaccines against new variants or mutations, actions that may be taken by governmental authorities, the impact on our business including our sales cycle, sales execution and marketing efforts, and the impact to the business of our customers, vendors and partners. For further discussion of the challenges and risks we confront related to the COVID-19 pandemic, please refer to Part I, Item 1A Risk Factors of this Annual Report on Form 10-K.

Certain Factors Affecting Our Performance

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

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

New Customer Acquisition

We believe that our ability to increase the number of customers, and more significantly customers in the Forbes Global 2000, on our cloud platform is an indicator of our market penetration and our future business opportunities. As of July 31, 2021, 2020 and 2019, we had over 5,600, 4,500 and over 3,900 customers, respectively, across all major geographies. As of July 31, 2021, we had over 500 of the Forbes Global 2000 as customers. Our ability to continue to grow these numbers will increase our future opportunities for renewals and follow-on sales. We believe that we have significant room to capture additional market share and intend to continue to invest significantly in sales and marketing to engage our prospective customers, increase brand awareness, further leverage our channel partnerships and drive adoption of our solution.

Follow-On Sales

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

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

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

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

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

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Investing in Business Growth

Since our founding, we have invested significantly in growing our business. We intend to continue (i) investing in our research and development organization and our development efforts to offer new solutions on our cloud platform and (ii) dedicating resources to update and upgrade our existing solutions. In addition, we expect our general and administrative expenses to increase in absolute dollars in the foreseeable future, as we continue to operate as a public company and address any legal matters and related accruals, as further described in Note 11, Commitments and Contingencies, of the consolidated financial statements included elsewhere in this Annual Report on Form 10-K.

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

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

Key Business Metrics and Other Financial Measures

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

Dollar-Based Net Retention Rate

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

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

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

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

Dollar-based net retention rate is obtained by dividing the numerator by the denominator. Our dollar-based net retention rate may fluctuate due to a number of factors, including the performance of our cloud platform, our success in selling bigger deals, including deals for all employees with our higher-end bundles, selling multiple-pillars from the start of our contract

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with new customers, faster upsells within a year, the timing and the rate of ARR expansion of our existing customers, potential changes in our rate of renewals and other risk factors described elsewhere in this Annual Report on Form 10-K.

Trailing 12 Months Ended July 31,

Dollar-based net retention rate 128% 120% 118%

Non-GAAP Financial Measures

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

Non-GAAP Gross Profit and Non-GAAP Gross Margin

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

Year Ended July 31,

(in thousands)

Add:

Stock-based compensation expense and related payroll taxes 15,272 7,851 3,453

Amortization expense of acquired intangible assets 6,468 2,030 512

Non-GAAP gross margin 81 % 80 % 82 %

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

We define non-GAAP income from operations as U.S. GAAP loss from operations excluding stock-based compensation expense and related payroll taxes, certain litigation-related expenses, amortization expense of acquired intangible assets and asset impairment related to facility exit. We define non-GAAP operating margin as non-GAAP income from operations as a percentage of revenue. The excluded litigation-related expenses are professional fees and related costs incurred by us in defending or settling against significant claims that we deem not to be in the ordinary course of our business and, if applicable, accruals related to estimated losses in connection with these claims. There are many uncertainties and potential outcomes associated with any litigation, including the expense of litigation, timing of such expenses, court rulings, unforeseen developments, complications and delays, each of which may affect our results of operations from period to period, as well as the unknown magnitude of the potential loss relating to any lawsuit, all of which are inherently subject to change, difficult to estimate and could adversely affect our results of operations.

Year Ended July 31,

(in thousands)

Add:

Amortization expense of acquired intangible assets 6,795 3,384 908

Asset impairment related to facility exit(1) 416 746 —

Operating margin (31) % (26) % (12) %

Non-GAAP operating margin 12 % 9 % 11 %

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

Change in Non-GAAP Measures Presentation

Effective August 1, 2020, the beginning of our fiscal year ending July 31, 2021, we began to present employer payroll taxes related to employee equity award transactions, which is a cash expense, as part of stock-based compensation expense in our non-GAAP results. These payroll taxes have been excluded from our non-GAAP results as they are tied to the timing and size of the exercise or vesting of the underlying equity awards and the price of our common stock at the time of vesting or exercise, which may vary from period to period independent of the operating performance of our business. Prior period amounts have been recast to conform to this presentation.

Free Cash Flow and Free Cash Flow Margin

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

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Free cash flow includes the cyclical impact of inflows and outflows resulting from contributions to our employee stock purchase plan, for which the purchase period of approximately six months ends in each of our second and fourth fiscal quarter. As of July 31, 2021, the accrued employee payroll contributions to our ESPP was $5.2 million, which will be used to purchase shares at the end of the current purchase period ending on December 15, 2022. Payroll contributions ultimately used to purchase shares will be reclassified to stockholders' equity upon issuance of the shares during our second quarter of fiscal 2022.

Year Ended July 31,

(in thousands)

Less:

Purchases of property, equipment and other assets (48,165) (43,072) (25,520)

As a percentage of revenue:

Net cash provided by operating activities 30 % 18 % 19 %

Less:

Purchases of property, equipment and other assets (7) (10) (8)

Capitalized internal-use software (2) (2) (1)

Free cash flow margin 21 % 6 % 10 %

Calculated Billings

Calculated billings is a non-GAAP financial measure that we believe is a key metric to measure our periodic performance. Calculated billings represents our total revenue plus the change in deferred revenue in a period. Calculated billings in any particular period aims to reflect amounts invoiced for subscriptions to access our cloud platform, together with related support services for our new and existing customers. We typically invoice our customers annually in advance, and to a lesser extent quarterly in advance, monthly in advance or multi-year in advance. Calculated billings increased $384.1 million, or 70%, in fiscal 2021 over fiscal 2020, and $159.8 million, or 41%, in fiscal 2020 over fiscal 2019. As calculated billings continues to grow in absolute terms, we expect our calculated billings growth rate to trend down over time. We also expect that calculated billings will be affected by seasonality in terms of when we enter into agreements with customers; and the mix of billings in each reporting period as we typically invoice customers annually in advance, and to a lesser extent quarterly in advance, monthly in advance or multi-year in advance.

Year Ended July 31,

(in thousands)

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Components of Results of Operations

Revenue

We generate revenue primarily from sales of subscriptions to access our cloud platform, together with related support services. These subscription and related support services accounted for approximately 97%, 98% and 99% of our revenue for fiscal 2021, fiscal 2020 and fiscal 2019, respectively. Our contracts with our customers do not at any time provide the customer with the right to take possession of the software that runs our cloud platform. Our customers may also purchase professional services, such as mapping, implementation, network design and training. Professional services account for an immaterial portion of our revenue.

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

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

Cost of Revenue

Cost of revenue includes expenses related to operating our cloud platform in data centers, depreciation of our data center equipment, related overhead costs and the amortization of our capitalized internal-use software. Cost of revenue also includes employee-related costs, including salaries, bonuses, stock-based compensation expense and employee benefit costs associated with our customer support and cloud operations organizations. Cost of revenue also includes overhead costs for facilities, IT, amortization and depreciation expense.

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

Gross Profit and Gross Margin

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

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extent to which we expand our customer support and cloud operations organizations and the extent to which we can increase the efficiency of our technology, infrastructure and data centers through technological improvements. We expect our gross profit to increase in absolute dollars and our gross margin to increase slightly over the long term, although our gross profit and gross margin could fluctuate from period to period depending on the interplay of all of the above factors.

Operating Expenses

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

Sales and Marketing

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

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

Research and Development

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

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General and Administrative

General and administrative expenses consist primarily of employee-related costs, including salaries and bonuses, stock-based compensation expense and employee benefit costs for our finance, legal, human resources and administrative personnel, as well as professional fees for external legal services (including certain litigation-related expenses), accounting and other related consulting services. The litigation-related expenses include professional fees and related costs incurred by us in defending or settling significant claims that we deem not to be in the ordinary course of our business and, if applicable, accruals related to estimated losses in connection with these claims. We expect our general and administrative expenses to increase in absolute dollars for the foreseeable future, as we continue to incur compliance costs and other related costs necessary to operate as a public company, and due to any legal matters and related accruals, as further described in Note 11, Commitments and Contingencies to, the consolidated financial statements included elsewhere in this Annual Report on Form 10-K. However, we expect our general and administrative expenses to decrease as a percentage of our revenue over the long term, although our general and administrative expenses may fluctuate as a percentage of our revenue from period to period due to the timing and extent of these expenses. In particular, litigation-related expenses related to significant litigation claims may result in significant fluctuations from period to period as they are inherently subject to change and difficult to estimate.

Interest Expense

Interest expense consists primarily of amortization of debt discount and issuance costs and recognition of contractual interest expense related to our Notes issued in June 2020. See Note 9, Convertible Senior Notes, of the consolidated financial statements included elsewhere in this Annual Report on Form 10-K.

Interest Income

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

Other Income (Expense), Net

Other income (expense), net consists primarily of foreign currency transaction gains and losses.

Provision for Income Taxes

Our provision for income taxes consists primarily of income and withholding taxes in the foreign jurisdictions in which we conduct business, offset by the tax benefit for excess stock-based compensation deduction. We have not recorded any U.S. federal income tax expense. In the United States, we have recorded deferred tax assets for which we provide a full valuation allowance, which includes net operating loss carryforwards and research and development tax credits. We expect to maintain this full valuation allowance for the foreseeable future as it is more likely than not that some or all of those deferred tax assets may not be realized based on our history of losses. Additionally, in the U.K., we have recorded deferred tax assets for which we provide a full valuation allowance, which includes net operating loss carryforwards. We expect to maintain this full valuation allowance for the foreseeable future as it is more likely than not that some or all of those deferred tax assets may not be realized based on our history of losses.

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Results of Operations

The following table sets forth our results of operations for the periods presented:

Year Ended July 31,

(in thousands)

Operating expenses:

_____

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

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

Research and development — 1,280 386

(4) Includes litigation-related expenses as follows: $ — $ 18,356 $ 13,079

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

Year Ended July 31,

Operating expenses

Research and development 26 23 21

General and administrative 15 17 15

Operating margin (31) (26) (12)

Interest income 1 1 3

Interest expense (8) (1) —

Other income (expense), net — — —

Loss before income taxes (38) (26) (9)

Provision for income taxes 1 1 —

Comparison of Fiscal 2021 and Fiscal 2020

Revenue

Year Ended July 31, Change

(in thousands)

Revenue increased by $241.8 million, or 56%, in fiscal 2021, compared to fiscal 2020. The increase in revenue was driven by an increase in users and sales of additional subscriptions to existing customers, which contributed $179.5 million in revenue, as reflected by our dollar-based net retention rate of 128% for the trailing 12 months ended July 31, 2021. The remainder of the increase was attributable to the addition of new customers, as we increased our customer base by 23% from July 31, 2020 to July 31, 2021.

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Cost of Revenue and Gross Margin

Year Ended July 31, Change

(in thousands)

Gross margin 78 % 78 %

Cost of revenue increased by $54.6 million, or 57%, in fiscal 2021, compared to fiscal 2020. The overall increase in cost of revenue was driven primarily by the expanded use of our cloud platform by existing and new customers, which led to an increase of $37.2 million for data center and equipment related costs for hosting and operating our cloud platform. Additionally, our employee-related expenses increased by $17.2 million, inclusive of an increase of $6.7 million in stock-based compensation expense, driven primarily by a 48% increase in headcount in our customer support and cloud operations organizations from July 31, 2020 to July 31, 2021.

Operating Expenses

Sales and Marketing Expenses

Year Ended July 31, Change

(in thousands)

Sales and marketing expenses increased by $181.4 million, or 65%, for fiscal 2021, compared to fiscal 2020. The increase was primarily due to a 59% increase in headcount from July 31, 2020 to July 31, 2021, resulting in an increase of $176.9 million in employee-related expenses, inclusive of an increase of $66.6 million in stock-based compensation expense, and an increase of $20.8 million in sales commissions expense. The remainder of the increase was primarily attributable to increased expenses of $6.6 million for facility and IT services and $4.6 million for professional services and $1.8 million in marketing and advertising expenses. Expense increases were partially offset by the decrease of $9.4 million in travel expenses due to the COVID-19 pandemic.

Research and Development Expenses

Year Ended July 31, Change

(in thousands)

Research and development expenses increased by $76.8 million, or 78%, for fiscal 2021, compared to fiscal 2020 as we continued to develop and enhance the functionality of our cloud platform. The increase was primarily driven by an increase of $71.4 million in employee-related expenses, inclusive of an increase of $37.6 million in stock-based compensation expense, driven by a 59% increase in headcount from July 31, 2020 to July 31, 2021. The remainder of the increase was primarily attributable to increased expenses of $5.1 million in facility, software and equipment related expenses to support our growth and $2.2 million for professional services. This increase was partially offset by higher capitalized internal-use software development costs of $1.4 million to support the enhancement and growth of our cloud platform.

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General and Administrative Expenses

Year Ended July 31, Change

(in thousands)

General and administrative expenses increased by $22.9 million, or 31%, for fiscal 2021, compared to fiscal 2020. The overall increase was primarily due to an increase of $37.1 million in employee-related expenses, inclusive of an increase of $26.2 million in stock-based compensation expense, driven in part by a 46% increase in headcount from July 31, 2020 to July 31, 2021. The remainder of the increase was primarily attributable to increased expenses of $2.7 million in professional services. This increase is partially offset by a decrease of $18.0 million in legal expenses, primarily attributable to a $15.0 million litigation settlement payment to Broadcom during fiscal 2020. For further information on the Broadcom settlement refer to Note 11, Commitments and Contingencies, of the consolidated financial statements included elsewhere in this Annual Report Form 10-K.

Interest Expense

Year Ended July 31, Change

(in thousands)

Interest expense increased by $48.3 million for fiscal 2021, compared to fiscal 2020 as a result of amortization of debt discount and recognition of contractual interest expense related to our Notes issued in June 2020. For further information on the Notes, refer to Note 9, Convertible Senior Notes, of the consolidated financial statements included elsewhere in this Annual Report on Form 10-K.

Interest Income

Year Ended July 31, Change

(in thousands)

Interest income decreased by $3.7 million, or 57%, for fiscal 2021, compared to fiscal 2020. The decrease was primarily driven by lower market interest rates earned on cash equivalents and short-term investments.

Other Income (expense), net

Year Ended July 31, Change

(in thousands)

Other income (expense), net increased by $1.4 million for fiscal 2021, compared to fiscal 2020. The increase was primarily driven by fluctuations in foreign currency transaction gains and losses.

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Provision for Income Taxes

Year Ended July 31, Change

(in thousands)

Our provision for income taxes increased by $2.5 million, or 103%, for fiscal 2021, compared to fiscal 2020, primarily related to income and withholding taxes in the foreign jurisdictions in which we operate. In fiscal 2020, we recognized a non-recurring income tax benefit associated with the acquisition of intangible assets from Cloudneeti Corporation ("Cloudneeti") and Edgewise Networks Inc. ("Edgewise") which reduced our income tax expense as compared to 2021. For further information, refer to Note 14, Income Taxes, of the consolidated financial statements included elsewhere in this Annual Report on Form 10-K. Our effective tax rate of (1.9)% and (2.1)% in fiscal 2021 and fiscal 2020, respectively, differs from the applicable U.S. statutory federal income tax rate due to our valuation allowance against our U.S. federal, state, and U.K. deferred tax assets as well as our foreign income being taxed at different rates than the U.S. statutory rate.

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

Comparison of Fiscal 2020 and Fiscal 2019

Revenue

Year Ended July 31, Change

(in thousands)

Revenue increased by $128.4 million, or 42%, in fiscal 2020, compared to fiscal 2019. The increase in revenue was driven by an increase in users and sales of additional subscriptions to existing customers, which contributed $98.6 million in revenue, as reflected by our dollar-based net retention rate of 120% for the trailing 12 months ended July 31, 2020. The remainder of the increase was attributable to the addition of new customers, as we increased our customer base by 17% from July 31, 2019 to July 31, 2020.

Cost of Revenue and Gross Margin

Year Ended July 31, Change

(in thousands)

Gross margin 78 % 80 %

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Cost of revenue increased by $36.1 million, or 60%, for fiscal 2020, compared to fiscal 2019. The overall increase in cost of revenue was driven primarily by the expanded use of our cloud platform by existing and new customers, which led to an increase of $24.8 million for data center and equipment related costs for hosting and operating our cloud platform. Additionally, our employee-related expenses increased by $10.0 million, inclusive of an increase of $4.4 million in stock-based compensation expense, driven primarily by a 6% increase in headcount in our customer support and cloud operations organizations from July 31, 2019 to July 31, 2020 and by the shift from granting stock options to restricted stock units.

Gross margin decreased from 80% to 78% in fiscal 2020 as compared to fiscal 2019. The decline in gross margin is primarily due to the cost incurred for our increased use of public cloud infrastructure to manage the increased ZPA traffic which resulted from our customers' employees working from home beginning March 2020. While the public cloud allows us to quickly meet increases in customer demand, using public cloud infrastructure to manage traffic is significantly more expensive compared to using our data centers.

Operating Expenses

Sales and Marketing Expenses

Year Ended July 31, Change

(in thousands)

Sales and marketing expenses increased by $108.1 million, or 64%, for fiscal 2020, compared to fiscal 2019. The increase was primarily due to a 54% increase in headcount from July 31, 2019 to July 31, 2020, resulting in an increase of $92.6 million in employee-related expenses, inclusive of an increase of $43.4 million in stock-based compensation expense, and an increase of $9.7 million in sales commissions expense. Additionally, our sales and marketing expenses increased by $7.0 million primarily due to growth of certain major sales and marketing events held during fiscal 2020, including our Zenith Live events. The remainder of the increase was primarily attributable to increased expenses of $2.2 million in costs related to in-person and virtual events and $3.9 million for facility and IT services.

Research and Development Expenses

Year Ended July 31, Change

(in thousands)

Research and development expenses increased by $35.9 million, or 58%, for fiscal 2020, compared to fiscal 2019 as we continued to develop and enhance the functionality of our cloud platform. The increase was primarily driven by an increase of $34.7 million in employee-related expenses, inclusive of an increase of $15.1 million in stock-based compensation expense, driven by a 38% increase in headcount from July 31, 2019 to July 31, 2020 and by our shift from granting stock options to granting restricted stock units. The remainder of the increase was primarily attributable to increased expenses of $4.4 million for facility, software and equipment related expenses to support our growth. Expense increases were partially offset by higher capitalized internal-use software development costs of $5.6 million to support the enhancement and growth of our cloud platform.

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General and Administrative Expenses

Year Ended July 31, Change

(in thousands)

General and administrative expenses increased by $27.0 million, or 58%, for fiscal 2020, compared to fiscal 2019. The overall increase was primarily due to an increase of $16.4 million in employee-related expenses, inclusive of a net increase of $12.1 million in stock-based compensation expense, driven by a 29% increase in headcount from July 31, 2019 to July 31, 2020, and also by our shift from granting stock options to granting restricted stock units. Additionally, we recognized an increase of $5.2 million in legal expenses, which is primarily attributable to a $15.0 million litigation settlement payment to Broadcom in fiscal 2020, partially offset by lower legal fees in fiscal 2020. For further information on litigation settlements, refer to Note 11, Commitments and Contingencies, of the consolidated financial statements included elsewhere in this Annual Report on Form 10-K. The remainder of the increase was primarily attributable to $1.9 million in professional services and $1.2 million for insurance premiums.

Interest Expense

Year Ended July 31, Change

(in thousands)

Interest expense increased by $5.0 million or 100% for fiscal 2020, compared to fiscal 2019. The increase is due to amortization of debt discount and contractual interest expense for our Notes issued in June 2020. For further information on the Notes, refer to Note 9, Convertible Senior Notes, of the consolidated financial statements included elsewhere in this Annual Report on Form 10-K.

Interest Income

Year Ended July 31, Change

(in thousands)

Interest income decreased by $1.3 million, or 16%, for fiscal 2020, compared to fiscal 2019. The decrease was primarily driven by lower market interest rates earned on cash equivalents and short-term investments.

Other Income (Expense), net

Year Ended July 31, Change

(in thousands)

Other income (expense), net $ (224) $ (329) $ 105 (32) %

Other income (expense), net increased by $0.1 million, or 32%, for fiscal 2020, compared to fiscal 2019. The increase was primarily driven by fluctuations in foreign currency transaction gains and losses for fiscal 2020, compared to fiscal 2019.

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Provision for Income Taxes

Year Ended July 31, Change

(in thousands)

Our provision for income taxes increased by $1.6 million, or 221%, for fiscal 2020, compared to fiscal 2019, primarily related to income and withholding taxes in the foreign jurisdictions in which we operate. The overall income tax expense recorded for fiscal 2020 was driven by income taxes for the foreign countries in which we operate partially offset by the tax benefit associated with the acquisition of intangible assets from Cloudneeti Corporation ("Cloudneeti") and Edgewise Networks Inc. ("Edgewise") which reduced our deferred tax asset and the related valuation allowance. For further information, refer to Note 14, Income Taxes, of the consolidated financial statements included elsewhere in this Annual Report on Form 10-K. Our effective tax rate of (2.1)% and (2.7)% in fiscal 2020 and fiscal 2019, respectively, differs from the applicable U.S. statutory federal income tax rate due to our valuation allowance against our U.S. federal, state, and U.K. deferred tax assets as well as our foreign income being taxed at different rates than the U.S. statutory rate.

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

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Quarterly Results of Operations and Other Data

The following sets forth selected unaudited quarterly consolidated statements of operations data for each of the eight quarters in the period ended July 31, 2021. The unaudited quarterly statements of operations data set forth below have been prepared on the same basis as our audited consolidated financial statements and, in the opinion of management, reflect all adjustments, consisting only of normal recurring adjustments, that are necessary for the fair statement of such data. The following quarterly financial data should be read in conjunction with the consolidated financial statements and the related notes included elsewhere in this Annual Report on Form 10-K. Our historical results are not necessarily indicative of the results that may be expected in the future, and the results for any quarter are not necessarily indicative of results to be expected for a full year or any other period.

Consolidated Statements of Operations

Three Months Ended

(in thousands)

Operating expenses:

_____

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

_____

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

Three Months Ended

(in thousands)

Research and development 566 429 285 — — — — —

(6) In the fiscal quarter ended April 30, 2020 and July 31, 2020, we recorded a tax benefit of $0.5 million and $0.6 million, respectively, associated with intangible assets recognized as a result of our acquisitions of Cloudneeti and Edgewise, respectively. For further information, refer to Note 6, Business Combinations, of the consolidated financial statements included elsewhere in this Annual Report on Form 10-K.

Consolidated Statements of Operations as a Percentage of Revenue

Three Months Ended

Operating expenses:

Interest income 3 2 1 1 1 — — —

Interest expense — — — (4) (9) (8) (7) (7)

Other income (expense), net — — 1 — — — — —

Provision for income taxes 1 1 — — 1 1 1 —

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Quarterly Trends

The sequential increase in the net loss for the fiscal quarter ended January 31, 2020 was primarily due to a $15.0 million payment to Broadcom in January 2020 in connection with the legal settlement of the Symantec Cases. For further information refer to Note 11, Commitments and Contingencies, of the consolidated financial statements included elsewhere in this Annual Report Form 10-K.

The sequential increase in the net loss for the fiscal quarter ended July 31, 2020 was primarily due to an increase in stock-based compensation expense as a result of attainment of performance related equity awards and higher overall compensation expense as a result of an increase in headcount, primarily in sales and marketing and research and development organizations.

Liquidity and Capital Resources

As of July 31, 2021, our principal sources of liquidity were cash, cash equivalents and short-term investments totaling $1,502.6 million, which were held for working capital and general corporate purposes. Our cash equivalents and investments consist of highly liquid investments in money market funds, U.S. treasury securities, U.S. government agency securities and corporate debt securities.

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

We have generated significant losses from operations, as reflected in our accumulated deficit of $601.6 million as of July 31, 2021. We expect to continue to incur operating losses and have in the past and may in the future generate negative cash flows due to expected investments to grow our business, including potential business acquisitions and other strategic transactions.

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

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We typically invoice our customers annually in advance, and to a lesser extent quarterly in advance, monthly in advance or multi-year in advance. Therefore, a substantial source of our cash is from such prepayments, which are included on the consolidated balance sheets as a contract liability. Deferred revenue consists of the unearned portion of billed fees for our subscriptions, which is subsequently recognized as revenue in accordance with our revenue recognition policy. As of July 31, 2021, we had deferred revenue of $630.6 million, of which $571.3 million was recorded as a current liability and is expected to be recorded as revenue in the next 12 months, provided all other revenue recognition criteria have been met. Subscriptions that are invoiced annually in advance or multi-year in advance contribute significantly to our short-term and long-term deferred revenue in comparison to our invoices issued quarterly in advance or monthly in advance. Accordingly, we cannot predict the mix of invoicing schedules in any given period.

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

Year Ended July 31,

(in thousands)

Operating Activities

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

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

Net cash provided by operating activities during fiscal 2020 was $79.3 million, which resulted from a net loss of $115.1 million, adjusted for non-cash charges of $185.8 million and net cash inflows of $8.6 million from changes in operating assets and liabilities. Non-cash charges primarily consisted of $121.4 million for stock-based compensation expense, $24.9 million for amortization of deferred contract acquisition costs, $17.7 million for depreciation and amortization expense, $13.6 million for non-cash operating lease costs, $4.9 million for amortization of debt discount and issuance costs, $3.4 million for amortization expense of acquired intangible assets, partially offset by deferred income taxes of $1.2 million.

Net cash inflows from changes in operating assets and liabilities were primarily the result of an increase of $118.0 million in deferred revenue from advance invoicing in accordance with our subscription contracts, an increase of $27.9

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million in accrued compensation, an increase of $2.3 million in accrued expenses, other current and noncurrent liabilities and an increase of $0.9 million in accounts payable. Net cash inflows were partially offset by cash outflows resulting from an increase of $65.1 million in deferred contract acquisition costs, as our sales commission payments increased due to the addition of new customers and expansion of our existing customer subscriptions, an increase of $54.2 million in accounts receivable primarily due to timing of billings and collections, an increase of $13.6 million in prepaid expenses, other current and noncurrent assets and a decrease of $7.6 million in operating lease liabilities primarily due to lease payments, net of tenant incentives received.

Net cash provided by operating activities during fiscal 2019 was $58.0 million, which resulted from a net loss of $28.7 million, adjusted for non-cash charges of $73.1 million and net cash inflows of $13.6 million from changes in operating assets and liabilities. Non-cash charges primarily consisted of $46.4 million for stock-based compensation expense, $18.7 million for amortization of deferred contract acquisition costs, $10.4 million for depreciation and amortization expense and $0.9 million for amortization expense of acquired intangible assets, partially offset by accretion of purchased discounts, net of amortization of investment premiums of $2.2 million and deferred income taxes of $1.4 million.

Net cash inflows from changes in operating assets and liabilities were primarily the result of an increase of $87.2 million in deferred revenue from advance invoicing in accordance with our subscription contracts and an increase of $0.5 million in accounts payable. Net cash inflows were partially offset by cash outflows resulting from an increase of $32.5 million in deferred contract acquisition costs, as our sales commission payments increased due to the addition of new customers and expansion of our existing customer subscriptions, an increase of $31.7 million in accounts receivable primarily due to customer growth, an increase of $7.6 million in prepaid expenses, other current and noncurrent assets, a decrease of $1.8 million in accrued compensation.

Investing Activities

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

Net cash used in investing activities during fiscal 2020 of $1,038.2 million was primarily attributable to the purchases of short-term investments of $1,255.6 million, capital expenditures of $51.8 million to support the growth of our cloud platform, $39.6 million for payments for business acquisitions, net of cash acquired, in connection with our acquisition of Cloudneeti and Edgewise and $2.0 million for strategic investments. These activities were partially offset by proceeds from the maturities and sales of short-term investments of $310.9 million.

Net cash used in investing activities during fiscal 2019 of $162.1 million was primarily attributable to the purchases of short-term investments of $335.2 million, capital expenditures to support the growth of our cloud platform and increased headcount, including increased office space needs of $28.7 million, payments for business acquisitions, net of cash acquired, of $11.4 million and payments for acquired intangible assets of $1.5 million. These transactions were partially offset by proceeds from the maturities of short-term investments of $214.7 million.

Financing Activities

Net cash provided by financing activities of $41.7 million during fiscal 2021 was attributable to $25.7 million in proceeds from issuance of common stock under the employee stock purchase plan and $18.2 million in proceeds from the

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exercise of stock options. These transactions were partially offset by a payment of deferred merger consideration related to a business acquisition for $2.3 million.

Net cash provided by financing activities of $1,022.2 million during fiscal 2020 was attributable to $1,130.5 million in proceeds from the issuance of our Notes, net of debt discount and issuance costs, $21.6 million in proceeds from the exercise of stock options and $15.3 million in proceeds from issuance of common stock under the employee stock purchase plan. These transactions were partially offset by purchases of capped calls for $145.2 million related to issuance of the Notes.

Net cash provided by financing activities of $46.4 million during fiscal 2019 was attributable to $29.9 million in proceeds from the exercise of stock options, driven mainly by the end of our initial public offering lock-up period in September 2018, $16.4 million in proceeds from issuance of common stock under the employee stock purchase plan and $1.9 million in proceeds from repayments of notes receivable for early exercised stock options. Proceeds were partially offset by $1.8 million in payments for offering costs related to our IPO.

Contractual Obligations and Commitments

The following table summarizes our contractual obligations as July 31, 2021:

Payments Due by Period

Total Less Than 1 Year 1 to 3Years 3 to 5Years More Than5 Years

(in thousands)

Other current liabilities(2) 250 250 — — —

_____

(1) Includes the principal and future interest payments related to our Notes. For additional information refer to Note 9, Convertible Senior Notes, of the consolidated financial statements included elsewhere in this Annual Report on Form 10-K.

(2) Includes holdback amounts associated with business acquisitions, which are payable upon the lapse of the contractual indemnification period.

The contractual commitment amounts in the table above are associated with agreements that are enforceable and legally binding. Obligations under contracts, including purchase orders, that can be cancelled without a significant penalty are not included in the table above.

Off-Balance Sheet Arrangements

As of July 31, 2021, we did not have any relationships with unconsolidated organizations or financial partnerships, such as structured finance or special purpose entities, which would have been established for the purpose of facilitating off-balance sheet arrangements or other contractually narrow or limited purposes.

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As of July 31, 2021, we had outstanding irrevocable standby unsecured letters of credits for an aggregate value of $3.0 million with a bank, which serve as security under certain real estate leases included in Note 10, Operating Leases to the consolidated financial statements included elsewhere in this Annual Report on Form 10-K.

Critical Accounting Policies and Estimates

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

The critical accounting policies, estimates, assumptions and judgments that we believe have the most significant impact on the consolidated financial statements are described below.

Revenue Recognition

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

1) Identify the contract with a customer

We consider the terms and conditions of the contracts and our customary business practices in identifying our contracts under ASC 606. We determine we have a contract with a customer when the contract is approved, we can identify each party’s rights regarding the services to be transferred, we can identify the payment terms for the services, we have determined the customer to have the ability and intent to pay, and the contract has commercial substance. We apply judgment in determining the customer’s ability and intent to pay, which is based on a variety of factors, including the customer’s historical payment experience or, in the case of a new customer, credit and financial information pertaining to the customer.

2) Identify the performance obligations in the contract

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

3) Determine the transaction price

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

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

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

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

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

Subscription and Support Revenue

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

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

Professional and Other Services Revenue

Professional and other services revenue consists of fees associated with providing deployment advisory services that educate and assist our customers on the best use of our solutions, as well as advise customers on best practices as they deploy our solution. These services are distinct from subscription and support services. Professional services do not result in significant customization of the subscription service. Revenue from professional services provided on a time and materials basis is recognized as the services are performed. Total professional and other services revenue has historically been insignificant.

Contracts with Multiple Performance Obligations

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

Variable Consideration

Revenue from sales is recorded at the net sales price, which is the transaction price, and includes estimates of variable consideration. The amount of variable consideration that is included in the transaction price is constrained, and is included in

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the net sales price only to the extent that it is probable that a significant reversal in the amount of the cumulative revenue will not occur when the uncertainty is resolved.

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

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

Contract Balances

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

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

Costs to Obtain and Fulfill a Contract

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

Sales commissions for renewal of a contract are not considered commensurate with the commissions paid for the acquisition of the initial contract given the substantive difference in commission rates in proportion to their respective contract values. Commissions paid upon the initial acquisition of a contract are amortized over an estimated period of benefit of five years while commissions paid for renewal contracts are amortized over the contractual term of the renewals. Amortization is recognized on a straight-line basis commensurate with the pattern of revenue recognition. We determine the period of benefit for commissions paid for the acquisition of the initial contract by taking into consideration the expected subscription term and expected renewals of our customer contracts, the duration of our relationships with customers, customer retention data, our technology development life cycle and other factors. Management exercises judgment to determine the period of benefit to amortize contract acquisition costs by considering factors such as expected renewals of customer contracts, duration of customer relationships and our technology development life cycle. Although we believe that the historical assumptions and estimates we have made are reasonable and appropriate, different assumptions and estimates could materially impact our reported financial results. Amortization of deferred contract acquisition costs is included in sales and marketing expense in the consolidated statements of operations. We periodically review these deferred costs to determine whether events or changes in circumstances have occurred that could impact the period of benefit of these deferred contract acquisition costs.

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Business Combinations

We account for our business combinations using the acquisition method of accounting, which requires, among other things, allocation of the fair value of purchase consideration to the tangible and intangible assets acquired and liabilities assumed at their estimated fair values on the acquisition date. The excess of the fair value of purchase consideration over the values of these identifiable assets and liabilities is recorded as goodwill. When determining the fair value of assets acquired and liabilities assumed, we make estimates and assumptions, especially with respect to intangible assets. Our estimates of fair value are based upon assumptions believed to be reasonable, but which are inherently uncertain and unpredictable and, as a result, actual results may differ from estimates. During the measurement period, not to exceed one year from the date of acquisition, we may record adjustments to the assets acquired and liabilities assumed, with a corresponding offset to goodwill if new information is obtained related to facts and circumstances that existed as of the acquisition date. After the measurement period, any subsequent adjustments are reflected in the consolidated statements of operations. Acquisition costs, such as legal and consulting fees, are expensed as incurred.

Derivative Instruments

We enter into foreign currency forward contracts, a portion of which we designate as cash flow hedges, in order to manage the volatility of cash flows that relate to our cost of revenues and operating expenses denominated in foreign currencies.

Gains or losses related to our cash flow hedges are recorded as a component of accumulated other comprehensive income (loss) (“AOCI”) on the consolidated statements of stockholders' equity until the forecasted transaction occurs in earnings. When the forecasted transaction occurs, the related gains and losses are reclassified into earnings within the financial statement line item associated with the underlying hedged transaction. If the underlying hedged transaction does not occur, or it becomes probable that the hedged transaction will not occur, the cumulative unrealized gain or loss is reclassified immediately from AOCI into earnings within the financial statement line item associated with the underlying hedged transaction. We measure hedge effectiveness using regression analysis at hedge inception and periodically thereafter. We include time value in our effectiveness assessment.

We recognize changes in the fair value of non-designated derivative instruments within other income (expense), net in the consolidated statements of operations in the same period that the fair value measurement occurs.

All of our derivative instruments are measured at fair value and reported on a gross basis on the consolidated balance sheets. Derivative instruments are classified in the consolidated statements of cash flows as cash from operating activities, which reflect the classification of the underlying hedged transactions.

Operating Leases

We enter into operating lease arrangements for real estate assets related to office space and co-location assets related to space and racks at data center facilities. We determine if an arrangement contains a lease at its inception by assessing whether there is an identified asset and whether the arrangement conveys the right to control the use of the identified asset in exchange for consideration. Operating leases related balances are included in "operating lease right-of-use assets," "operating lease liabilities," and "operating lease liabilities, noncurrent" in the consolidated balance sheets. Right-of-use assets represent our right to use an underlying asset for the lease term and lease liabilities represent our obligation to make payments arising from the lease. Operating lease right-of-use assets and lease liabilities are recognized at the lease commencement date based on the present value of lease payments over the lease term. Lease payments consist of the fixed payments under the arrangement. The operating lease liabilities are adjusted for any unpaid lease incentives, such as tenant improvement allowances. Variable costs, such as maintenance and utilities based on actual usage, are not included in the measurement of right-to-use assets and lease liabilities but are expensed when the event determining the amount of variable consideration to

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be paid occurs. As the implicit rate of our leases is not determinable, we use an incremental borrowing rate ("IBR") based on the information available at the lease commencement date in determining the present value of lease payments. The lease expense is recognized on a straight-line basis over the lease term.

We generally use the base, non-cancelable lease term when recognizing the right-of-use assets and lease liabilities, unless it is reasonably certain that a renewal or termination option will be exercised. We account for lease components and non-lease components as a single lease component.

Leases with a term of twelve months or less are not recognized on the consolidated balance sheets. We recognize lease expense for these leases on a straight-line basis over the term of the lease.

Stock-Based Compensation

Compensation expense related to stock-based awards granted to employees and non-employees is calculated based on the fair value of stock-based awards on the date of grant. We recognize stock-based compensation expense over an award’s requisite service period based on the award’s fair value.

Stock-based compensation for common stock options is recognized based on the fair value of the awards granted, determined using the Black-Scholes option pricing model. Stock-based compensation expense is recognized on a straight-line basis over the requisite service period, generally four years.

Stock-based compensation for purchase rights granted under the employee stock purchase plan is based on the Black-Scholes option pricing model fair value of the number of awards estimated as of the beginning of the offering period. Stock-based compensation expense is recognized following the straight-line attribution method over the offering period.

Stock-based compensation for restricted stock units is measured based on the market closing price of our common stock on the grant date. Stock-based compensation expense is recognized on a straight-line basis over the requisite service period, generally four years.

Stock-based compensation for performance stock awards (“PSAs”) which have the same grant date and service inception date, is based on the probable number of shares to be attained and the market closing price of our common stock at the grant date. For PSAs where the service inception date of the awards precedes the grant date, stock-based compensation expense is recognized based on the number of PSAs for which it is probable that the performance condition will be met, using the accelerated attribution method and the market closing price of our common stock at each reporting date up to the grant date. The number of these PSAs for which it is probable that the performance condition will be met is determined using management’s best estimate at the end of each reporting period. At the completion of the performance period for these PSAs, any earned PSAs are granted upon approval of the compensation committee of our board of directors.

Convertible Senior Notes

In accounting for the issuance of our Notes, we separated the Notes into liability and equity components. The carrying amounts of the liability component was calculated by measuring the fair value of similar liabilities that do not have associated convertible features. The carrying amount of the equity component representing the conversion option was determined by deducting the fair value of the liability component from the par value of the Notes as a whole. This difference represents the debt discount that is amortized to interest expense over the respective terms of the Notes using the effective interest rate method. The equity component was recorded in additional paid-in capital and is not remeasured as long as it continues to meet the conditions for equity classification.

In accounting for the related debt issuance costs, we allocated the total amount incurred to the liability and equity components of the Notes based on their relative values. Issuance costs attributable to the liability component are being

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amortized to interest expense over the contractual term of the Notes. The issuance costs attributable to the equity component were netted against the equity component representing the conversion option in additional paid-in capital.

To the extent that we receive the Notes conversion requests prior to the maturity of the Notes, a portion of the equity component is classified as temporary equity, which is measured as the difference between the principal and net carrying amount of the Notes requested for conversion. Upon settlement of the conversion requests, the difference between the fair value and the amortized book value of the liability component of the Notes requested for conversion is recorded as a gain or loss on early note conversion. The fair value of the Notes is measured based on a similar liability that does not have an associated convertible feature based on the remaining term of the Notes.

Income Taxes

We are subject to federal, state and local taxes in the United States as well as in other tax jurisdictions or countries in which we conduct business. Earnings generated by our non-U.S. activities are related to applicable transfer pricing requirements under local country income tax laws. We account for uncertain tax positions based on those positions taken or expected to be taken in a tax return. We determine if the amount of available support indicates that it is more likely than not that the tax position will be sustained on audit, including resolution of any related appeals or litigation processes. We then measure the tax benefit as the largest amount that is more than 50% likely to be realized upon settlement.

We have a full valuation allowance for our net deferred tax assets generated from our U.S. and U.K. operations. We will continue to assess the need for such valuation allowance on our deferred tax assets by evaluating both positive and negative evidence that may exist. Any adjustment to the deferred tax asset valuation allowance would be recorded in the periods in which the adjustment is determined to be required.

Recently Issued Accounting Pronouncements

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

Item 7A. Quantitative and Qualitative Disclosures about Market Risk

We have operations in the United States and internationally, and we are exposed to market risk in the ordinary course of our business.

Interest Rate Risk

As of July 31, 2021, we had cash, cash equivalents and short-term investments totaling $1,502.6 million, which were held for working capital purposes. Our cash equivalents and investments consist of highly liquid investments in money market funds, U.S. treasury securities, U.S. government agency securities and corporate debt securities. The primary objectives of our investment activities are the preservation of capital, the fulfillment of liquidity needs and the fiduciary control of cash and investments. We do not enter into investments for trading or speculative purposes. The carrying amount of our cash equivalents reasonably approximates fair value, due to the short maturities of these instruments. Our investments are exposed to market risk due to a fluctuation in interest rates, which may affect our interest income and the fair market value of our investments. As of July 31, 2021, the effect of a hypothetical 100 basis point change in interest rates would have changed the fair value of our investments in available-for-sale securities by $6.2 million. Fluctuations in the fair value of our investments in available-for-sale securities caused by a change in interest rates (gains or losses on the carrying amount) are recorded in other comprehensive income (loss), and are realized only if we sell the underlying securities prior to maturity.

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Convertible Senior Notes

In June 2020, we issued our Notes with an aggregate principal amount of $1,150.0 million. In connection with the issuance of the Notes, we entered into privately negotiated capped call transactions with certain counterparties (the "Capped Calls"). The Capped Calls are expected generally to offset the potential dilution to our common stock as a result of any conversion of the Notes.

The Notes have a fixed annual interest rate of 0.125%, accordingly, we do not have economic interest rate exposure on the Notes. However, the fair value of the Notes is exposed to interest rate risk. Generally, the fair value of the Notes will increase as interest rates fall and decrease as interest rates rise. We carry the Notes at face value less unamortized discount and issuance costs on our balance sheet, and we present the fair value for required disclosure purposes only. In addition, the fair value of the Notes also fluctuates when the market price of our common stock fluctuates. The fair value was determined based on the quoted bid price of the Notes in an over-the-counter market on the last trading day of the reporting period. For further information refer to Note 9, Convertible Senior Notes, to the consolidated financial statements included elsewhere in this Annual Report on Form 10-K.

Foreign Currency Risk

The vast majority of our sales contracts are denominated in U.S. dollars, with a small number of contracts denominated in foreign currencies. A portion of our operating expenses are incurred outside the United States, denominated in foreign currencies and subject to fluctuations due to changes in foreign currency exchange rates, particularly changes in the British Pound, Indian Rupee, Euro, Canadian dollar and Australian dollar. Additionally, fluctuations in foreign currency exchange rates may cause us to recognize transaction gains and losses in the consolidated statements of operations. The effect of a hypothetical 10% change in foreign currency exchange rates applicable to our business would not have a material impact on the consolidated financial statements for fiscal 2021, fiscal 2020 and fiscal 2019.

During the fiscal 2021, we implemented a foreign currency risk management program and entered into foreign currency forward contracts to hedge a portion of our forecasted foreign currency-denominated expenses. These foreign currency derivative contracts have a maturity up to 18 months or less and are designated as cash flow hedges to protect our earnings subjected to foreign currency risk.

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Item 8. Financial Statements and Supplementary Data

Index to Consolidated Financial Statements

Page

Report of Independent Registered Public Accounting Firm 91

Consolidated Financial Statements:

Notes to Consolidated Financial Statements 99

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REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

To the Board of Directors and Stockholders of Zscaler, Inc.

Opinions on the Financial Statements and Internal Control over Financial Reporting

We have audited the accompanying consolidated balance sheets of Zscaler, Inc. and its subsidiaries (the "Company") as of July 31, 2021 and 2020, and the related consolidated statements of operations, of comprehensive loss, of stockholders’ equity and of cash flows for each of the three years in the period ended July 31, 2021, including the related notes (collectively referred to as the "consolidated financial statements"). We also have audited the Company's internal control over financial reporting as of July 31, 2021, based on criteria established in Internal Control - Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO).

In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of the Company as of July 31, 2021 and 2020, and the results of its operations and its cash flows for each of the three years in the period ended July 31, 2021 in conformity with accounting principles generally accepted in the United States of America. Also in our opinion, the Company maintained, in all material respects, effective internal control over financial reporting as of July 31, 2021, based on criteria established in Internal Control - Integrated Framework (2013) issued by the COSO.

Change in Accounting Principle

As discussed in Note 1 to the consolidated financial statements, the Company changed the manner in which it accounts for leases effective August 1, 2019.

Basis for Opinions

The Company's management is responsible for these consolidated financial statements, for maintaining effective internal control over financial reporting, and for its assessment of the effectiveness of internal control over financial reporting, included in Management’s Report on Internal Control Over Financial Reporting appearing under Item 9A. Our responsibility is to express opinions on the Company’s consolidated financial statements and on the Company's internal control over financial reporting based on our audits. We are a public accounting firm registered with the Public Company Accounting Oversight Board (United States) (PCAOB) and are required to be independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB.

We conducted our audits in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audits to obtain reasonable assurance about whether the consolidated financial statements are free of material misstatement, whether due to error or fraud, and whether effective internal control over financial reporting was maintained in all material respects.

Our audits of the consolidated financial statements included performing procedures to assess the risks of material misstatement of the consolidated financial statements, whether due to error or fraud, and performing procedures that respond to those risks. Such procedures included examining, on a test basis, evidence regarding the amounts and disclosures in the

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consolidated financial statements. Our audits also included evaluating the accounting principles used and significant estimates made by management, as well as evaluating the overall presentation of the consolidated financial statements. Our audit of internal control over financial reporting included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, and testing and evaluating the design and operating effectiveness of internal control based on the assessed risk. Our audits also included performing such other procedures as we considered necessary in the circumstances. We believe that our audits provide a reasonable basis for our opinions.

Definition and Limitations of Internal Control over Financial Reporting

A company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company’s internal control over financial reporting includes those policies and procedures that (i) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (ii) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (iii) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the financial statements.

Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.

Critical Audit Matters

The critical audit matter communicated below is a matter arising from the current period audit of the consolidated financial statements that was communicated or required to be communicated to the audit committee and that (i) relates to accounts or disclosures that are material to the consolidated financial statements and (ii) involved our especially challenging, subjective, or complex judgments. The communication of critical audit matters does not alter in any way our opinion on the consolidated financial statements, taken as a whole, and we are not, by communicating the critical audit matter below, providing a separate opinion on the critical audit matter or on the accounts or disclosures to which it relates.

Revenue recognition – Identifying and evaluating terms and conditions in contracts

As described in Note 1 to the consolidated financial statements, management applies the following steps in their determination of revenue to be recognized: 1) identification of the contract with a customer; 2) identification of the performance obligations in the contract; 3) determination of the transaction price; 4) allocation of the transaction price to the performance obligations in the contract; and 5) recognition of revenue when, or as, the Company satisfies a performance obligation. Management applies judgment in identifying and evaluating any terms and conditions in contracts which may impact revenue recognition. For the fiscal year ended July 31, 2021, the Company’s revenue was $673.1 million.

The principal considerations for our determination that performing procedures relating to revenue recognition, specifically the identification and evaluation of terms and conditions in contracts, is a critical audit matter are the significant amount of effort and judgment required by management in identifying and evaluating terms and conditions in contracts that impact revenue recognition. This in turn led to a high degree of auditor judgment, subjectivity and significant audit effort in performing our audit procedures to evaluate whether terms and conditions in contracts were appropriately identified and evaluated by management.

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Addressing the matter involved performing procedures and evaluating audit evidence in connection with forming our overall opinion on the consolidated financial statements. These procedures included testing the effectiveness of controls relating to the revenue recognition process, including controls related to the identification and evaluation of terms and conditions in contracts that impact revenue recognition. These procedures also included, among others, testing the completeness and accuracy of management’s identification and evaluation of the terms and conditions in contracts by examining revenue arrangements on a test basis and testing management’s process of identifying and evaluating the terms and conditions in contracts, including management’s determination of the impact of those terms and conditions on revenue recognition.

/s/ PricewaterhouseCoopers LLP

San Jose, California

We have served as the Company's auditor since 2015.

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ZSCALER, INC.

Consolidated Balance Sheets

(in thousands, except per share amounts)

Assets

Current assets:

Prepaid expenses and other current assets 31,269 31,396

Deferred contract acquisition costs, noncurrent 149,657 77,675

Liabilities and Stockholders’ Equity

Current liabilities:

Accrued expenses and other current liabilities 22,908 16,361

Operating lease liabilities, noncurrent 31,225 28,023

Commitments and contingencies (Note 11)

Stockholders’ Equity

Accumulated other comprehensive income (loss) (650) 463

The accompanying notes are an integral part of these consolidated financial statements.

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ZSCALER, INC.

Consolidated Statements of Operations

(in thousands, except per share amounts)

Year Ended July 31,

Operating expenses:

Net loss per share, basic and diluted $ (1.93) $ (0.89) $ (0.23)

The accompanying notes are an integral part of these consolidated financial statements.

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ZSCALER, INC.

Consolidated Statements of Comprehensive Loss

(in thousands)

Year Ended July 31,

Available-for-sale securities:

Cash flow hedging instruments:

Change in net unrealized gains and (losses) (228) — —

Net realized losses (gains) reclassified into net loss (399) — —

Net change on cash flow hedges (627) — —

The accompanying notes are an integral part of these consolidated financial statements.

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ZSCALER, INC.

Consolidated Statements of Stockholders’ Equity

(in thousands)

Shares Amount

Cumulative effect of accounting change — — (300) — — 300 —

Vesting of restricted units 89 — — — — — —

Repurchases of unvested common stock (8) — — — — — —

Adjustment to initial public offering costs — — 300 — — — 300

Vesting of early exercised stock options — — 983 — — — 983

Other comprehensive income — — — — 392 — 392

Vesting of restricted stock units 1,297 1 (1) — — — —

Vesting of early exercised stock options — — 463 — — — 463

Other comprehensive income — — — — 195 — 195

Vesting of restricted stock units 3,041 3 (3) — — — —

Vesting of early exercised stock options — — 93 — — — 93

Other comprehensive loss — — — — (1,113) — (1,113)

The accompanying notes are an integral part of these consolidated financial statements.

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ZSCALER, INC.

Consolidated Statements of Cash Flows

(in thousands)

Year Ended July 31,

Cash Flows From Operating Activities

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

Amortization expense of acquired intangible assets 6,795 3,384 908

Amortization of debt discount and issuance costs 51,923 4,885 —

Prepaid expenses, other current and noncurrent assets (3,388) (13,580) (7,642)

Accrued expenses, other current and noncurrent liabilities 6,532 2,292 (336)

Operating lease liabilities (22,051) (7,604) —

Cash Flows From Investing Activities

Purchases of property, equipment and other assets (48,165) (43,072) (25,520)

Acquired intangible assets — — (1,480)

Purchases of strategic investments (3,077) (2,000) —

Cash Flows From Financing Activities

Payments of offering costs related to initial public offering — — (1,797)

Payment of deferred consideration related to a business acquisition (2,250) — —

Purchases of capped calls related to convertible senior notes — (145,245) —

Repurchases of unvested common stock — — (22)

Repayments of notes receivable from stockholders — — 1,905

Supplemental Disclosure of Cash Flow Information:

Cash paid for income taxes, net of tax refunds $ 4,144 $ 2,525 $ 1,770

Cash paid for interest expense $ 1,462 $ — $ —

Non-cash activities

Vesting of early exercised common stock options $ 93 $ 463 $ 983

Net change in deferred offering costs accrued $ — $ — $ (2,097)

(1)We did not hold restricted cash for any periods presented.

The accompanying notes are an integral part of these consolidated financial statements.

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Notes to Consolidated Financial Statements

Note 1. Business and Summary of Significant Accounting Policies

Description of the Business

Zscaler, Inc. ("Zscaler," the "Company," "we," "us," or "our") is a cloud security company that developed a platform incorporating core security functionalities needed to enable fast and secure access to cloud resources based on identity, context and organization’s policies. Our solution is a purpose-built, multi-tenant, distributed cloud platform that secures user-to-app, app-to-app, and machine-to-machine communications, over any network and any location. We deliver our solutions using a software-as-a-service ("SaaS") business model and sell subscriptions to customers to access our cloud platform, together with related support services. We were incorporated in Delaware in September 2007 and conduct business worldwide, with presence in North America, Europe and Asia. Our headquarters are in San Jose, California.

Fiscal Year

Our fiscal year ends on July 31. References to fiscal 2021, for example, refer to our fiscal year ended July 31, 2021.

Principles of Consolidation

The accompanying consolidated financial statements include the accounts of the Company and its wholly owned subsidiaries and have been prepared in conformity with accounting principles generally accepted in the United States ("U.S. GAAP"). All intercompany balances and transactions have been eliminated in consolidation.

Use of Estimates

The preparation of consolidated financial statements in conformity with U.S. GAAP requires management to make estimates, judgments and assumptions that affect the amounts reported and disclosed in the financial statements and accompanying notes. Such estimates include, but are not limited to, the determination of revenue recognition, deferred revenue, deferred contract acquisition costs, valuation of acquired intangible assets, period of benefit generated from our deferred contract acquisition costs, allowance for doubtful accounts, valuation of common stock options and stock-based awards, useful lives of property and equipment, useful lives of acquired intangible assets, recoverability of goodwill, valuation of deferred tax assets and liabilities, loss contingencies related to litigation, fair value and effective interest rate of convertible senior notes, valuation of non-marketable equity investments and the discount rate used for operating leases. Management determines these estimates and assumptions based on historical experience and on various other assumptions that are believed to be reasonable. Actual results could differ significantly from these estimates, and such differences may be material to the consolidated financial statements.

Due to the COVID-19 pandemic, there is ongoing uncertainty and significant disruption in the global economy and financial markets. We are not aware of any specific event or circumstances that would require an update to our estimates, judgments or assumptions or a revision to the carrying value of our assets or liabilities as of the date of issuance of these consolidated financial statements. These estimates, judgments and assumptions may change in the future, as new events occur or additional information is obtained.

Foreign Currency

The functional currency of our foreign subsidiaries is the U.S. dollar. Accordingly, monetary assets and liabilities of our foreign subsidiaries are re-measured into U.S. dollars at the exchange rates in effect at the reporting date, non-monetary assets and liabilities are re-measured at historical rates, revenue and expenses are re-measured at average exchange rates in

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effect during each reporting period. Foreign currency transaction gains and losses are recorded in other income (expense), net in the consolidated statements of operations. Foreign currency remeasurement gains and losses and foreign currency transaction gains and losses are not significant to the consolidated financial statements.

Concentration of Risks

We generate revenue primarily from sale of subscriptions to access our cloud platform, together with related support services. Our sales team, along with our channel partner network of global telecommunications service providers, system integrators and value-added resellers (collectively "channel partners"), sells our services worldwide to organizations of all sizes. Due to the nature of our services and the terms and conditions of our contracts with our channel partners, our business could be affected unfavorably if we are not able to continue our relationships with them.

Our financial instruments that are exposed to concentrations of credit risk consist primarily of cash, cash equivalents, short-term investments and accounts receivable. Although we deposit our cash with multiple financial institutions, the deposits, at times, may exceed federally insured limits. Cash equivalents and short-term investments consist of highly liquid investments in money market funds, U.S. treasury, U.S. agency securities and corporate debt securities, which are invested through financial institutions in the United States.

We grant credit to our customers in the normal course of business. We monitor the financial condition of our customers to reduce credit risk. Refer to Note 2, Revenue Recognition, for information regarding customers with concentration of 10% or more of the total balance of accounts receivable, net.

Segment Information

We operate as one reportable and operating segment. Our chief operating decision maker is our chief executive officer, who reviews financial information presented on a consolidated basis for purposes of making operating decisions, assessing financial performance and allocating resources.

Revenue Recognition

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

1) Identify the contract with a customer

We consider the terms and conditions of the contracts and our customary business practices in identifying our contracts under ASC 606. We determine we have a contract with a customer when the contract is approved, we can identify each party’s rights regarding the services to be transferred, we can identify the payment terms for the services, we have determined the customer has the ability and intent to pay and the contract has commercial substance. We apply judgment in determining the customer’s ability and intent to pay, which is based on a variety of factors, including the customer’s historical payment experience or, in the case of a new customer, credit and financial information pertaining to the customer.

2) Identify the performance obligations in the contract

Performance obligations promised in a contract are identified based on the services that will be transferred to the customer that are both capable of being distinct, whereby the customer can benefit from the service either on its own or together with other resources that are readily available from third parties or from us, and are distinct in the context of the

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contract, whereby the transfer of the services is separately identifiable from other promises in the contract. Our performance obligations consist of (i) our subscription and support services and (ii) professional and other services.

3) Determine the transaction price

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

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

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

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

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

Subscription and Support Revenue

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

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

Professional and Other Services Revenue

Professional and other services revenue consists of fees associated with providing deployment advisory services that educate and assist our customers on the best use of our solutions, as well as advise customers on best practices as they deploy our solution. These services are distinct from subscription and support services. Professional services do not result in significant customization of the subscription service. Revenue from professional services provided on a time and materials basis is recognized as the services are performed. Total professional and other services revenue has historically not been material.

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Contracts with Multiple Performance Obligations

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

Variable Consideration

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

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

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

Accounts Receivable and Allowance

Accounts receivable are recorded at the invoiced amount and are non-interest bearing. Accounts receivable are stated at their net realizable value, net of an allowance for doubtful accounts. We have a well-established collections history from our customers. Credit is extended to customers based on an evaluation of their financial condition and other factors. In determining the necessary allowance for doubtful accounts, we estimate the lifetime expected credit losses against the existing accounts receivable balance. Our estimate is based on certain factors including historical loss rates, current economic conditions, reasonable and supportable forecasts and customer-specific circumstances. The allowance for doubtful accounts has historically not been material. There were no material write-offs recognized in the periods presented. Accordingly, the movements in the allowance for doubtful accounts were not material for any of the periods presented. We do not have any off-balance-sheet credit exposure related to our customers.

Cash Equivalents and Short-Term Investments

We classify all highly liquid investments purchased with an original maturity of 90 days or less from the date of purchase as cash equivalents and all highly liquid investments with original maturities beyond 90 days at the time of purchase as short-term investments. Our cash equivalents and short-term investments consist of highly liquid investments in money market funds, U.S. treasury securities, U.S. government agency securities and corporate debt securities.

We classify our investments as available-for-sale investments and present them within current assets since these investments represent funds available for current operations and we have the ability and intent, if necessary, to liquidate any of these investments in order to meet our liquidity needs or to grow our business, including for potential business acquisitions or other strategic transactions. Our investments are carried at fair value, with unrealized gains and losses unrelated to credit loss factors reported in accumulated other comprehensive income (loss) ("AOCI").

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Our investments are reviewed periodically when there is a decline in a security’s fair value below the amortized cost basis. We consider our intent to sell and whether it is more likely than not that we will be required to sell the securities before the recovery of its cost basis. If either of these criteria are triggered, the amortized cost basis of the debt security is written down to fair value through other income (expense), net. If neither criteria is met, we evaluate whether the decline in fair value below the amortized cost basis is related to credit-related factors or other factors such as interest rate fluctuations. The factors considered in this analysis include the extent the fair value is less than the amortized cost basis, whether there were changes to the rating of the security by a ratings agency, whether the issuer has failed to make scheduled interest payments and other adverse conditions as applicable. Credit-related impairment losses, limited by the amount that the fair value is less than the amortized cost basis, are recorded through an allowance for credit losses in other income (expense), net. For purposes of identifying and measuring credit-related impairments, our policy is to exclude the applicable accrued interest from both the fair value and amortized cost basis of the related debt security. Accrued interest receivable, net of the allowance for credit losses, if any, is recorded to prepaid expenses and other current assets. There were no credit-related impairments recognized on our investments during the periods presented.

Interest income, amortization (accretion) of investments purchased at a premium (discount) and realized gains and losses are included in interest income in the consolidated statements of operations. We use the specific identification method to determine the cost in calculating realized gains and losses upon the sale of these investments.

Strategic Investments

Our strategic investments consist of non-marketable equity investments of privately held companies. Investments in non-marketable equity investments of privately held companies without readily determinable fair values are measured using the measurement alternative, as we have less than 20% ownership and do not have the ability to exercise significant influence over their operations. The carrying amount of non-marketable equity investments is adjusted based on observable price changes from orderly transactions for identical or similar investments of the same issuer and by impairments, when events or circumstances indicate a decline in value has occurred. Non-marketable equity investments that have been remeasured during the period due to an observable event or impairment are classified within Level 3 in the fair value hierarchy because we estimate the value based on valuation methods which may include a combination of the observable transaction price at the transaction date and other unobservable inputs including volatility, rights, and obligations of the investments we hold. Our strategic investments are included within other noncurrent assets in the consolidated balance sheets and adjustments to their carrying amounts are recorded in other income (expense), net in the consolidated statements of operations. There were no material events or circumstances impacting the carrying amount of our strategic investments during the periods presented.

Fair Value of Financial Instruments

Our financial instruments consist of cash equivalents, short-term investments, accounts receivable, accounts payable, accrued liabilities and convertible senior notes. Cash equivalents and short-term investments are recorded at fair value. Accounts receivable, accounts payable and accrued liabilities are stated at their carrying value, which approximates fair value due to the short-time to the expected receipt or payment date. Assets recorded at fair value on a recurring basis in the consolidated balance sheets, consisting of cash equivalents and short-term investments, are categorized in accordance with the fair value hierarchy based upon the level of judgment associated with the inputs used to measure their fair values. Convertible senior notes are carried at the initially allocated liability value less unamortized debt discount and issuance costs on the consolidated balance sheets, and the fair value of the convertible senior notes is presented at each reporting period for disclosure purposes only.

Property and Equipment

Property and equipment, net are stated at historical cost net of accumulated depreciation. Property and equipment, excluding leasehold improvements, are depreciated using the straight-line method over the estimated useful lives of the

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respective assets, generally ranging from three to five years. Leasehold improvements are amortized using the straight-line method over the shorter of the estimated useful lives of the respective assets or the lease term. Expenditures for maintenance and repairs are expensed as incurred and significant improvements and betterments that substantially enhance the life of an asset are capitalized.

Capitalized Internal-Use Software Development Costs

We capitalize certain costs incurred during the application development stage in connection with software development for our cloud security platform. Costs related to preliminary project activities and post-implementation activities are expensed as incurred. Capitalized costs are recorded as part of property and equipment in the consolidated balance sheets. Maintenance and training costs are expensed as incurred. Capitalized internal-use software is amortized on a straight-line basis over its estimated useful life, which is generally three years, and is recorded as cost of revenue in the consolidated statements of operations. Capitalization of development costs, inclusive of stock-based compensation, of software for internal-use in fiscal 2021, fiscal 2020 and fiscal 2019 was $16.5 million, $13.2 million and $3.7 million, respectively. Amortization expense of capitalized software for internal-use in fiscal 2021, fiscal 2020 and fiscal 2019 was $5.9 million, $1.4 million and $1.0 million, respectively.

Business Combinations

We account for our business combinations using the acquisition method of accounting, which requires, among other things, allocation of the fair value of purchase consideration to the tangible and intangible assets acquired and liabilities assumed at their estimated fair values on the acquisition date. The excess of the fair value of purchase consideration over the values of these identifiable assets and liabilities is recorded as goodwill. When determining the fair value of assets acquired and liabilities assumed, we make estimates and assumptions, especially with respect to intangible assets. Our estimates of fair value are based upon assumptions believed to be reasonable, but which are inherently uncertain and unpredictable and, as a result, actual results may differ from estimates. During the measurement period, not to exceed one year from the date of acquisition, we may record adjustments to the assets acquired and liabilities assumed, with a corresponding offset to goodwill if new information is obtained related to facts and circumstances that existed as of the acquisition date. After the measurement period, any subsequent adjustments are reflected in the consolidated statements of operations. Acquisition costs, such as legal and consulting fees, are expensed as incurred.

Goodwill and Other Long-Lived Assets, including Acquired Intangible Assets

Goodwill represents the excess of the fair value of purchase consideration in a business combination over the fair value of net tangible and intangible assets acquired. Goodwill amounts are not amortized, but rather tested for impairment at least annually or more often if circumstances indicate that the carrying value may not be recoverable. No indications of impairment of goodwill were noted during the periods presented.

Acquired intangible assets consist of identifiable intangible assets, including developed technology and customer relationships, resulting from business combinations. Acquired finite-lived intangible assets are initially recorded at fair value and are amortized on a straight-line basis over their estimated useful lives. Amortization expense of developed technology and customer relationships is recorded primarily within cost of revenues and sales and marketing expenses, respectively, in the consolidated statements of operations.

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