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EX-31.2 - CERTIFICATION OF THE CHIEF FINANCIAL OFFICER PURSUANT TO SECTION 302 - Palo Alto Networks Incpanwex312q317.htm
EX-32.2 - CERTIFICATION OF THE CHIEF FINANCIAL OFFICER PURSUANT TO SECTION 906 - Palo Alto Networks Incpanwex322q317.htm
EX-32.1 - CERTIFICATION OF THE CHIEF EXECUTIVE OFFICER PURSUANT TO SECTION 906 - Palo Alto Networks Incpanwex321q317.htm
EX-31.1 - CERTIFICATION OF THE CHIEF EXECUTIVE OFFICER PURSUANT TO SECTION 302 - Palo Alto Networks Incpanwex311q317.htm



UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
_____________________ 
FORM 10-Q
 _____________________
(Mark One)
x
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended April 30, 2017
or
¨
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from             to             
Commission File Number 001-35594
Palo Alto Networks, Inc.
(Exact name of registrant as specified in its charter)  
 
Delaware
20-2530195
(State or other jurisdiction of
incorporation or organization)
(I.R.S. Employer
Identification No.)
4401 Great America Parkway
Santa Clara, California 95054
(Address of principal executive office, including zip code)
(408) 753-4000
(Registrant’s telephone number, including area code)

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.    Yes  x    No  ¨
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).    Yes  x    No  ¨
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company, or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company,” and “emerging growth company” in Rule 12b-2 of the Exchange Act.
Large accelerated filer
x
Accelerated filer
¨
Non-accelerated filer
¨ (Do not check if a smaller reporting company)
Smaller reporting company
¨
 
 
Emerging growth company
¨

If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act.  ¨
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).  Yes ¨    No  x
The number of shares outstanding of the registrant’s common stock as of May 17, 2017 was 91,823,907.
 




TABLE OF CONTENTS

 
 
 
 
 
Page
 
PART I - FINANCIAL INFORMATION
 
Item 1.
 
 
 
 
 
Item 2.
Item 3.
Item 4.
 
 
 
 
PART II - OTHER INFORMATION
 
Item 1.
Item 1A.
Item 2.
Item 6.
 

- 2 -


PART I
ITEM 1.
FINANCIAL STATEMENTS
PALO ALTO NETWORKS, INC.

CONDENSED CONSOLIDATED BALANCE SHEETS
(Unaudited, in millions, except per share data)

 
April 30, 2017
 
July 31, 2016
 
 
 
(As Adjusted)
Assets
 
 
 
Current assets:
 
 
 
Cash and cash equivalents
$
692.0

 
$
734.4

Short-term investments
680.0

 
551.2

Accounts receivable, net of allowance for doubtful accounts of $0.7 and $2.4 at April 30, 2017 and July 31, 2016, respectively
364.1

 
348.7

Prepaid expenses and other current assets
159.1

 
139.7

Total current assets
1,895.2

 
1,774.0

Property and equipment, net
192.3

 
117.2

Long-term investments
719.1

 
652.8

Goodwill
238.8

 
163.5

Intangible assets, net
56.5

 
44.0

Other assets
148.2

 
106.7

Total assets
$
3,250.1

 
$
2,858.2

Liabilities and stockholders’ equity
 
 
 
Current liabilities:
 
 
 
Accounts payable
$
33.2

 
$
30.2

Accrued compensation
76.4

 
73.5

Accrued and other liabilities
60.1

 
39.2

Deferred revenue
885.0

 
703.9

Total current liabilities
1,054.7

 
846.8

Convertible senior notes, net
518.4

 
500.2

Long-term deferred revenue
726.8

 
536.9

Other long-term liabilities
137.1

 
79.4

Commitments and contingencies (Note 8)


 


Stockholders’ equity:
 
 
 
Preferred stock; $0.0001 par value; 100.0 shares authorized; none issued and outstanding at April 30, 2017 and July 31, 2016

 

Common stock and additional paid-in capital; $0.0001 par value; 1,000.0 shares authorized; 91.8 and 90.5 shares issued and outstanding at April 30, 2017 and July 31, 2016, respectively
1,615.8

 
1,515.5

Accumulated other comprehensive income (loss)
(4.2
)
 
1.0

Accumulated deficit
(798.5
)
 
(621.6
)
Total stockholders’ equity
813.1

 
894.9

Total liabilities and stockholders’ equity
$
3,250.1

 
$
2,858.2

 
See notes to condensed consolidated financial statements.

- 3 -


PALO ALTO NETWORKS, INC.
 
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(Unaudited, in millions, except per share data)
 
 
Three Months Ended
 
Nine Months Ended
 
April 30,
 
April 30,
 
2017
 
2016
 
2017
 
2016
 
 
 
(As Adjusted)
 
 
 
(As Adjusted)
Revenue:
 
 
 
 
 
 
 
Product
$
164.2

 
$
162.1

 
$
496.8

 
$
479.7

Subscription and support
267.6

 
183.7

 
755.7

 
498.0

Total revenue
431.8

 
345.8

 
1,252.5

 
977.7

Cost of revenue:
 
 
 
 
 
 
 
Product
49.7

 
43.2

 
137.7

 
126.9

Subscription and support
74.0

 
51.7

 
200.4

 
141.4

Total cost of revenue
123.7

 
94.9

 
338.1

 
268.3

Total gross profit
308.1

 
250.9

 
914.4

 
709.4

Operating expenses:
 
 
 
 
 
 
 
Research and development
86.0

 
74.0

 
260.1

 
207.7

Sales and marketing
226.9

 
195.9

 
673.7

 
537.8

General and administrative
44.3

 
33.5

 
133.1

 
98.5

Total operating expenses
357.2

 
303.4

 
1,066.9

 
844.0

Operating loss
(49.1
)
 
(52.5
)
 
(152.5
)
 
(134.6
)
Interest expense
(6.2
)
 
(5.8
)
 
(18.3
)
 
(17.4
)
Other income, net
2.1

 
1.0

 
7.3

 
5.7

Loss before income taxes
(53.2
)
 
(57.3
)
 
(163.5
)
 
(146.3
)
Provision for income taxes
7.7

 
6.8

 
14.9

 
15.0

Net loss
$
(60.9
)
 
$
(64.1
)
 
$
(178.4
)
 
$
(161.3
)
Net loss per share, basic and diluted
$
(0.67
)
 
$
(0.73
)
 
$
(1.97
)
 
$
(1.86
)
Weighted-average shares used to compute net loss per share, basic and diluted
91.0

 
87.8

 
90.5

 
86.5


See notes to condensed consolidated financial statements.


- 4 -


PALO ALTO NETWORKS, INC.
 
CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE LOSS
(Unaudited, in millions)

 
Three Months Ended
 
Nine Months Ended
 
April 30,
 
April 30,
 
2017
 
2016
 
2017
 
2016
 
 
 
(As Adjusted)
 
 
 
(As Adjusted)
Net loss
$
(60.9
)
 
$
(64.1
)
 
$
(178.4
)
 
$
(161.3
)
Other comprehensive income (loss), net of tax:
 
 
 
 
 
 
 
Change in unrealized gains (losses) on investments

 
1.3

 
(4.7
)
 
0.7

Change in unrealized gains (losses) on cash flow hedges
0.9

 

 
(0.5
)
 

Other comprehensive income (loss)
$
0.9

 
$
1.3

 
$
(5.2
)

$
0.7

Comprehensive loss
$
(60.0
)
 
$
(62.8
)
 
$
(183.6
)
 
$
(160.6
)

See notes to condensed consolidated financial statements.

- 5 -


PALO ALTO NETWORKS, INC.

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited, in millions)

 
Nine Months Ended
 
April 30,
 
2017
 
2016
 
 
 
(As Adjusted)
Cash flows from operating activities
 
 
 
Net loss
$
(178.4
)
 
$
(161.3
)
Adjustments to reconcile net loss to net cash provided by operating activities:
 
 
 
Share-based compensation for equity based awards
356.8

 
283.2

Depreciation and amortization
43.1

 
30.7

Amortization of investment premiums, net of accretion of purchase discounts
2.1

 
2.4

Amortization of debt discount and debt issuance costs
18.3

 
17.4

Changes in operating assets and liabilities, net of effects of acquisitions:
 
 
 
Accounts receivable, net
(14.9
)
 
(55.3
)
Prepaid expenses and other assets
(49.6
)
 
(17.8
)
Accounts payable
2.8

 
11.7

Accrued compensation
1.7

 
(23.4
)
Accrued and other liabilities
77.0

 
28.2

Deferred revenue
370.1

 
355.5

Net cash provided by operating activities
629.0

 
471.3

Cash flows from investing activities
 
 
 
Purchases of investments
(726.9
)
 
(830.1
)
Proceeds from sales of investments

 
137.4

Proceeds from maturities of investments
520.7

 
409.6

Business acquisitions, net of cash acquired
(90.7
)
 

Purchases of property, equipment, and other assets
(114.2
)
 
(56.2
)
Net cash used in investing activities
(411.1
)
 
(339.3
)
Cash flows from financing activities
 
 
 
Repurchases of common stock
(295.1
)
 

Proceeds from sales of shares through employee equity incentive plans
45.8

 
42.2

Payments for taxes related to net share settlement of equity awards
(11.0
)
 

Net cash provided by (used in) financing activities
(260.3
)
 
42.2

Net increase (decrease) in cash and cash equivalents
(42.4
)
 
174.2

Cash and cash equivalents—beginning of period
734.4

 
375.8

Cash and cash equivalents—end of period
$
692.0

 
$
550.0


See notes to condensed consolidated financial statements.

- 6 -


 NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
1. Description of Business and Summary of Significant Accounting Policies
Description of Business
Palo Alto Networks, Inc. (the “Company,” “we,” “us,” or “our”), located in Santa Clara, California, was incorporated in March 2005 under the laws of the State of Delaware and commenced operations in April 2005. We offer a next-generation security platform that empowers enterprises, service providers, and government entities to secure their organizations by safely enabling applications running on their networks and by preventing breaches that stem from targeted cyber attacks.
Basis of Presentation and Principles of Consolidation
The accompanying condensed consolidated financial statements have been prepared in conformity with U.S. generally accepted accounting principles, consistent in all material respects with those applied in our Annual Report on Form 10-K for the fiscal year ended July 31, 2016, filed with the Securities and Exchange Commission on September 8, 2016. Our condensed consolidated financial statements include our accounts and our wholly owned subsidiaries. All significant intercompany balances and transactions have been eliminated in consolidation.
Our condensed consolidated financial statements are unaudited, but include all adjustments of a normal recurring nature necessary for a fair presentation of our quarterly results. We have made estimates and judgments affecting the amounts reported in our condensed consolidated financial statements and the accompanying notes. The actual results that we experience may differ materially from our estimates. Certain prior period amounts have been adjusted as a result of our voluntary change in accounting policy for sales commissions, our early adoption of new accounting guidance related to share-based payments, and our adoption of new accounting guidance related to debt issuance costs. Refer to “Summary of Significant Accounting Policies” and “Recent Accounting Pronouncements” below for more information.
Our condensed consolidated financial statements should be read in conjunction with the consolidated financial statements and related notes in our Annual Report on Form 10-K for the fiscal year ended July 31, 2016.
Summary of Significant Accounting Policies
There have been no material changes to our significant accounting policies as of and for the nine months ended April 30, 2017, as compared to the significant accounting policies described in our Annual Report on Form 10-K for the fiscal year ended July 31, 2016, except for our voluntary change in accounting policy related to sales commissions and our early adoption of the new share-based payment accounting guidance discussed below.
Change in Accounting Policy for Sales Commissions
Effective August 1, 2016, we voluntarily changed our accounting policy for sales commissions that are incremental and directly related to non-cancelable customer sales contracts from recording an expense when incurred to deferral and amortization of the sales commissions over the term of the related contract in proportion to the recognized revenue. We believe this change in accounting policy is preferable as the direct and incremental commission costs are closely related to the associated revenue, and therefore should be deferred and recognized as an expense over the same period that the related revenue is recognized.
Short-term deferred commissions are included in prepaid expenses and other current assets, while long-term deferred commissions are included in other assets in our condensed consolidated balance sheets. The amortization of deferred commissions is included in sales and marketing expense in our condensed consolidated statements of operations.
The adoption of this accounting policy change has been applied retrospectively to all prior periods presented in this Quarterly Report on Form 10-Q, in which the cumulative effect of the change of $71.8 million has been reflected in accumulated deficit as of August 1, 2015, the beginning of the earliest period presented.

- 7 -


The following tables present the changes to financial statement line items as a result of the accounting policy change for the periods presented in our condensed consolidated financial statements (in millions, except per share data):
 
April 30, 2017
 
July 31, 2016
 
Computed under Prior Method
 
Impact of Commission Adjustment
 
As Reported
 
As Previously Reported
 
Impact of Commission Adjustment
 
As Adjusted
Condensed Consolidated Balance Sheets
 
 
 
 
 
 
 
 
 
 
 
Prepaid expenses and other current assets
$
99.4

 
$
59.7

 
$
159.1

 
$
84.8

 
$
54.9

 
$
139.7

Other assets
91.7

 
56.5

 
148.2

 
64.6

 
50.1

 
114.7

Other long-term liabilities
136.7

 
0.4

 
137.1

 
79.4

 

 
79.4

Accumulated deficit
$
(914.3
)
 
$
115.8

 
$
(798.5
)
 
$
(726.6
)
 
$
105.0

 
$
(621.6
)
 
Three Months Ended April 30, 2017
 
Three Months Ended April 30, 2016
 
Computed under Prior Method
 
Impact of Commission Adjustment
 
As Reported
 
As Previously Reported
 
Impact of Commission Adjustment
 
As Adjusted
Condensed Consolidated Statements of Operations
 
 
 
 
 
 
 
 
 
 
 
Sales and marketing
$
234.6

 
$
(7.7
)
 
$
226.9

 
$
202.0

 
$
(6.1
)
 
$
195.9

Operating loss
(56.8
)
 
7.7

 
(49.1
)
 
(58.6
)
 
6.1

 
(52.5
)
Provision for income taxes
7.3

 
0.4

 
7.7

 
6.8

 

 
6.8

Net loss
$
(68.2
)
 
$
7.3

 
$
(60.9
)
 
$
(70.2
)
 
$
6.1

 
$
(64.1
)
Net loss per share, basic and diluted
$
(0.75
)
 
$
0.08

 
$
(0.67
)
 
$
(0.80
)
 
$
0.07

 
$
(0.73
)
Weighted-average shares used to compute net loss per share, basic and diluted
91.0

 

 
91.0

 
87.8

 

 
87.8

 
 
 
 
 
 
 
 
 
 
 
 
Condensed Consolidated Statements of Comprehensive Loss
 
 
 
 
 
 
 
 
 
 
 
Net loss
$
(68.2
)
 
$
7.3

 
$
(60.9
)
 
$
(70.2
)
 
$
6.1

 
$
(64.1
)
Comprehensive loss
$
(67.3
)
 
$
7.3

 
$
(60.0
)
 
$
(68.9
)
 
$
6.1

 
$
(62.8
)
 
Nine Months Ended April 30, 2017(1)
 
Nine Months Ended April 30, 2016
 
Computed under Prior Method
 
Impact of Commission Adjustment
 
As Reported
 
As Previously Reported
 
Impact of Commission Adjustment
 
As Adjusted
Condensed Consolidated Statements of Operations
 
 
 
 
 
 
 
 
 
 
 
Sales and marketing
$
684.8

 
$
(11.1
)
 
$
673.7

 
$
547.9

 
$
(10.1
)
 
$
537.8

Operating loss
(163.6
)
 
11.1

 
(152.5
)
 
(144.7
)
 
10.1

 
(134.6
)
Provision for income taxes
14.6

 
0.3

 
14.9

 
15.0

 

 
15.0

Net loss
$
(189.2
)
 
$
10.8

 
$
(178.4
)
 
$
(171.4
)
 
$
10.1

 
$
(161.3
)
Net loss per share, basic and diluted
$
(2.09
)
 
$
0.12

 
$
(1.97
)
 
$
(1.98
)
 
$
0.12

 
$
(1.86
)
Weighted-average shares used to compute net loss per share, basic and diluted
90.5

 

 
90.5

 
86.5

 

 
86.5

 
 
 
 
 
 
 
 
 
 
 
 
Condensed Consolidated Statements of Comprehensive Loss
 
 
 
 
 
 
 
 
 
 
 
Net loss
$
(189.2
)
 
$
10.8

 
$
(178.4
)
 
$
(171.4
)
 
$
10.1

 
$
(161.3
)
Comprehensive loss
$
(194.4
)
 
$
10.8

 
$
(183.6
)
 
$
(170.7
)
 
$
10.1

 
$
(160.6
)

- 8 -


______________
(1)
Amounts reflect an adjustment for the three months ended October 31, 2016, due to our early adoption of new share-based payment accounting guidance in our second quarter of fiscal 2017. Refer to “Recent Accounting Pronouncements” below for more information.
This change in accounting policy does not affect our balance of cash and cash equivalents and, as a result, did not change net cash flows from operating, investing, or financing activities, or materially impact any individual line items presented in our condensed consolidated statement of cash flows for the nine months ended April 30, 2016.
Recent Accounting Pronouncements
Recently Adopted Accounting Pronouncements
In March 2016, the Financial Accounting Standards Board (“FASB”) issued authoritative guidance simplifying several aspects of the accounting for employee share-based payment transactions. The new standard requires us to recognize excess tax benefits or deficiencies as income tax expense or benefit in the period in which they occur, rather than additional paid-in capital, and also requires us to recognize excess tax benefits regardless of whether the benefit reduces taxes payable in the current period. In addition, excess tax benefits should be classified as an operating activity, along with other income tax cash flows, instead of a financing activity in our condensed consolidated statements of cash flows. The standard also allows us to make an accounting policy election to account for forfeitures of share-based payment awards when they occur, rather than estimate expected forfeitures.
We elected to early adopt the standard in our second quarter of fiscal 2017, which required us to reflect any adjustments related to the adoption as of the beginning of the fiscal year. The impact of the adoption on our condensed consolidated financial statements was as follows:
Income tax accounting - We adopted the guidance related to the timing of when excess tax benefits are recognized on a modified retrospective basis. As a result, we recorded the cumulative effect of the change as a $3.5 million reduction to accumulated deficit as of August 1, 2016, to reflect the recognition of excess tax benefits in prior years, with a corresponding adjustment to deferred tax assets and long-term tax liabilities. We adopted the guidance related to the recognition of excess tax benefits and deficiencies as income tax expense or benefit on a prospective basis.
Cash flow presentation of excess tax benefits - We elected to adopt the guidance related to the presentation of excess tax benefits in our condensed consolidated statements of cash flows on a retrospective basis, which increased net cash provided by operating activities by $0.7 million for the nine months ended April 30, 2016, with a corresponding decrease to net cash provided by financing activities.
Forfeitures - We elected to account for forfeitures when they occur and adopted this change on a modified retrospective basis. As a result, we recorded the cumulative effect of the change as a $2.0 million increase to accumulated deficit as of August 1, 2016.
The adoption of the standard also impacted our previously reported results for the three months ended October 31, 2016, as presented in the following tables (in millions, except per share data):
 
October 31, 2016
 
As Previously Reported
 
Impact of Adoption
 
As Adjusted
Condensed Consolidated Balance Sheets
 
 
 
 
 
Other assets
$
102.0

 
$
1.7

 
$
103.7

Other long-term liabilities
85.8

 
(5.6
)
 
80.2

Common stock and additional paid-in capital
1,542.2

 
0.9

 
1,543.1

Accumulated deficit
$
(683.4
)
 
$
6.4

 
$
(677.0
)

- 9 -


 
Three Months Ended October 31, 2016
 
As Previously Reported
 
Impact of Adoption
 
As Adjusted
Condensed Consolidated Statements of Operations
 
 
 
 
 
Total cost of revenue(1)
$
101.3

 
$
(0.1
)
 
$
101.2

Total operating expenses(1)
346.7

 
(0.8
)
 
345.9

Provision for income taxes
8.4

 
(4.0
)
 
4.4

Net loss
$
(61.8
)
 
$
4.9

 
$
(56.9
)
Net loss per share, basic and diluted
$
(0.69
)
 
$
0.06

 
$
(0.63
)
Weighted-average shares used to compute net loss per share, basic and diluted
89.8

 

 
89.8

 
 
 
 
 
 
Condensed Consolidated Statements of Comprehensive Loss
 
 
 
 
 
Net loss
$
(61.8
)
 
$
4.9

 
$
(56.9
)
Comprehensive loss
$
(64.7
)
 
$
4.9

 
$
(59.8
)
 
 
 
 
 
 
Condensed Consolidated Statements of Cash Flows
 
 
 
 
 
Net cash provided by operating activities
$
203.3

 
$
0.2

 
$
203.5

Net cash used in financing activities
$
(27.1
)
 
$
(0.2
)
 
$
(27.3
)
______________
(1)
Adjustments consist of share-based compensation, which was impacted by our policy election to account for forfeitures when they occur. The impact of adoption on each cost and expense line item within these subtotals was not significant.
In April 2015, the FASB issued new authoritative guidance on fees paid in a cloud computing arrangement. The standard requires customers in a cloud computing arrangement to evaluate whether the arrangement includes a software license. If the arrangement includes a software license, the customer should account for the software license element of the arrangement consistent with the acquisition of other software licenses. If the arrangement does not include a software license, the customer should account for the arrangement as a service contract. We adopted the standard in our first quarter of fiscal 2017 on a prospective basis. Our adoption of this standard did not have a material impact on our condensed consolidated financial statements.
In April 2015, the FASB issued updated authoritative guidance to simplify the presentation of debt issuance costs. The amended standard requires that debt issuance costs related to a recognized debt liability be presented in the balance sheet as a direct deduction from the carrying amount of the related debt liability, consistent with the presentation of debt discounts, instead of being presented as an asset. We adopted the standard in our first quarter of fiscal 2017 on a retrospective basis, and as a result, we reduced other assets and convertible senior notes, net by $8.0 million on our condensed consolidated balance sheets as of July 31, 2016.
Recently Issued Accounting Pronouncements
In January 2017, the FASB issued authoritative guidance simplifying the subsequent measurement of goodwill. The standard eliminates Step 2 of the current goodwill impairment test, which requires companies to determine the implied fair value of goodwill when measuring the amount of impairment loss. Under the new standard, goodwill impairment will be measured as the amount by which a reporting unit’s carrying value exceeds its fair value, with the loss limited to the total amount of goodwill allocated to that reporting unit. The standard is effective for us for our first quarter of fiscal 2021 and will be applied on a prospective basis. Early adoption is permitted. We do not expect the adoption of the standard will have a material impact on our condensed consolidated financial statements.
In January 2017, the FASB issued authoritative guidance clarifying the definition of a business to assist companies with evaluating whether transactions should be accounted for as acquisitions (or disposals) of assets or businesses. The standard is effective for us for our first quarter of fiscal 2019 and will be applied on a prospective basis. Early adoption is permitted. We are currently evaluating whether this standard will have a material impact on our condensed consolidated financial statements.
In October 2016, the FASB issued authoritative guidance requiring the recognition of income tax consequences of an intra-entity transfer of an asset, other than inventory, when the transfer occurs. The standard is effective for us for our first quarter of fiscal 2019 and will be applied on a modified retrospective basis. Early adoption is permitted. We are currently evaluating whether this standard will have a material impact on our condensed consolidated financial statements.

- 10 -


In August 2016, the FASB issued new authoritative guidance addressing eight specific cash flow issues with the objective of reducing the existing diversity in practice in how certain transactions are presented and classified in the statement of cash flows. The standard is effective for us for our first quarter of fiscal 2019 and will be applied on a retrospective basis. Early adoption is permitted. We are currently evaluating whether this standard will have a material impact on our condensed consolidated financial statements.
In June 2016, the FASB issued new authoritative guidance on the accounting for credit losses on most financial assets and certain financial instruments. The standard replaces the existing incurred loss model with an expected credit loss model for financial assets measured at amortized cost, including trade receivables, and requires that credit losses on available-for-sale debt securities be presented as an allowance rather than as a write-down. The standard is effective for us for our first quarter of fiscal 2021 and will be applied on a modified retrospective basis. Early adoption is permitted beginning our first quarter of fiscal 2020. We are currently evaluating whether this standard will have a material impact on our condensed consolidated financial statements.
In February 2016, the FASB issued new authoritative guidance on lease accounting. Among its provisions, the standard requires lessees to recognize right-of-use assets and lease liabilities on the balance sheet for operating leases and also requires additional qualitative and quantitative disclosures about lease arrangements. The standard is effective for us for our first quarter of fiscal 2020 and will be applied on a modified retrospective basis, with the option to elect certain practical expedients. Early adoption is permitted. We are currently evaluating whether this standard will have a material impact on our condensed consolidated financial statements.
In May 2014, the FASB issued new authoritative guidance on revenue from contracts with customers. The new standard provides principles for recognizing revenue for the transfer of promised goods or services to customers with the consideration to which the entity expects to be entitled in exchange for those goods or services. The standard also requires significantly expanded disclosures about revenue recognition. The FASB subsequently delayed the effective date of the standard by one year and as a result, the standard is now effective for us for our first quarter of fiscal 2019 using either of two methods: (i) retrospective to each prior reporting period presented with the option to elect certain practical expedients as defined within the guidance; or (ii) retrospective with the cumulative effect of initially applying the guidance recognized at the date of initial application and providing certain additional disclosures as defined per the guidance. Early adoption as of the original effective date is permitted. We do not plan to early adopt, and accordingly, we will adopt the new standard in our first quarter of fiscal 2019. We are continuing to evaluate the impact of the new standard on our accounting policies, processes, and system requirements, and have assigned cross-functional internal resources and engaged third-party service providers to assist in our evaluation and system implementation. Furthermore, we have made and will continue to make investments in systems to enable timely and accurate reporting under the new standard. We are also continuing to evaluate adoption methods and the potential impact that the implementation of this standard will have on our condensed consolidated financial statements, but have not yet determined whether the effect will be material. However, we believe this new standard will impact our accounting for revenue arrangements in the following areas:
removal of the current limitation on contingent revenue may result in revenue being recognized earlier for certain contracts;
term license revenue associated with our virtual firewalls will be recognized upfront;
allocation of revenue related to software due to the removal of the residual method of revenue recognition; and
amortization period for deferred commissions.
We will continue to assess the new standard along with industry trends and additional interpretive guidance, and may adjust our implementation plan accordingly. We expect to finalize our adoption method and assessment of the impact that the implementation of this standard will have on our condensed consolidated financial statements by the end of fiscal 2017.
2. Fair Value Measurements
We categorize assets and liabilities recorded at fair value on our condensed consolidated balance sheets based upon the level of judgment associated with inputs used to measure their fair value. The categories are as follows:
Level 1—Inputs are unadjusted quoted prices in active markets for identical assets or liabilities.
Level 2—Inputs are quoted prices for similar assets and liabilities in active markets or inputs that are observable for the assets or liabilities, either directly or indirectly through market corroboration, for substantially the full term of the financial instruments.
Level 3—Inputs are unobservable inputs based on our own assumptions used to measure assets and liabilities at fair value. The inputs require significant management judgment or estimation.

- 11 -


The following table presents the fair value of our financial assets and liabilities using the above input categories as of April 30, 2017 and July 31, 2016 (in millions):
 
 
April 30, 2017
 
July 31, 2016
 
 
Level 1
 
Level 2
 
Level 3
 
Total
 
Level 1
 
Level 2
 
Level 3
 
Total
Cash equivalents:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
U.S. government and agency securities
 
$

 
$
19.0

 
$

 
$
19.0

 
$

 
$

 
$

 
$

Total cash equivalents
 

 
19.0

 

 
19.0

 

 

 

 

Short-term investments:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Commercial paper
 

 
15.0

 

 
15.0

 

 
3.0

 

 
3.0

Corporate debt securities
 

 
160.1

 

 
160.1

 

 
121.4

 

 
121.4

U.S. government and agency securities
 

 
504.9

 

 
504.9

 

 
426.8

 

 
426.8

Total short-term investments
 

 
680.0

 

 
680.0

 

 
551.2

 

 
551.2

Long-term investments:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Certificates of deposit
 

 
5.4

 

 
5.4

 

 
5.4

 

 
5.4

Corporate debt securities
 

 
176.1

 

 
176.1

 

 
166.1

 

 
166.1

U.S. government and agency securities
 

 
537.6

 

 
537.6

 

 
481.3

 

 
481.3

Total long-term investments
 

 
719.1

 

 
719.1

 

 
652.8

 

 
652.8

Total assets measured at fair value
 
$

 
$
1,418.1

 
$

 
$
1,418.1

 
$

 
$
1,204.0

 
$

 
$
1,204.0

Accrued and other liabilities:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Foreign currency forward contracts
 
$

 
$
1.2

 
$

 
$
1.2

 
$

 
$

 
$

 
$

Total accrued and other liabilities
 

 
1.2

 

 
1.2

 

 

 

 

Total liabilities measured at fair value
 
$

 
$
1.2

 
$

 
$
1.2

 
$

 
$

 
$

 
$

Refer to Note 7. Convertible Senior Notes for the carrying amount and estimated fair value of our convertible senior notes as of April 30, 2017 and July 31, 2016.
3. Investments
The following tables summarize the amortized cost, unrealized gains and losses, and fair value of our available-for-sale investments as of April 30, 2017 and July 31, 2016 (in millions):
 
April 30, 2017
 
Amortized Cost 
 
Unrealized Gains
 
Unrealized Losses
 
Estimated Fair Value
Certificates of deposit
$
5.4

 
$

 
$

 
$
5.4

Commercial paper
15.0

 

 

 
15.0

Corporate debt securities
336.6

 
0.2

 
(0.6
)
 
336.2

U.S. government and agency securities
1,064.2

 
0.1

 
(2.8
)
 
1,061.5

Total
$
1,421.2

 
$
0.3

 
$
(3.4
)
 
$
1,418.1


- 12 -


 
July 31, 2016
 
Amortized Cost 
 
Unrealized Gains
 
Unrealized Losses
 
Estimated Fair Value
Certificates of deposit
$
5.4

 
$

 
$

 
$
5.4

Commercial paper
3.0

 

 

 
3.0

Corporate debt securities
286.7

 
0.8

 

 
287.5

U.S. government and agency securities
907.3

 
0.9

 
(0.1
)
 
908.1

Total
$
1,202.4

 
$
1.7

 
$
(0.1
)
 
$
1,204.0

Unrealized losses related to these investments are due to interest rate fluctuations as opposed to credit quality. In addition, we do not intend to sell and it is not likely that we would be required to sell these investments before recovery of their amortized cost basis, which may be at maturity. As a result, there were no other-than-temporary impairments for these investments at April 30, 2017 and July 31, 2016.
The following table summarizes the amortized cost and fair value of our available-for-sale investments as of April 30, 2017, by contractual years-to-maturity (in millions):
 
Amortized Cost
 
Fair Value
Due within one year
$
699.7

 
$
699.0

Due between one and three years
721.5

 
719.1

Total
$
1,421.2

 
$
1,418.1

4. Derivative Instruments
As a global business, we are exposed to currency exchange rate risk. Substantially all of our revenue is transacted in U.S. dollars, however, a portion of our operating expenditures are incurred outside of the United States and are denominated in foreign currencies, making them subject to fluctuations in foreign currency exchange rates. We enter into foreign currency derivative contracts with maturities of 12 months or less which we designate as cash flow hedges to manage the foreign currency exchange rate risk associated with these expenditures.
These derivative contracts expose us to credit risk to the extent that the counterparties may be unable to meet the terms of the arrangement. We mitigate this credit risk by transacting with major financial institutions with high credit ratings and also enter into master netting arrangements, which permit net settlement of transactions with the same counterparty. We are not required to pledge, and are not entitled to receive, cash collateral related to these derivative instruments. We do not enter into derivative contracts for trading or speculative purposes.
Our derivative financial instruments are recorded at fair value, on a gross basis, as either assets or liabilities in our condensed consolidated balance sheets. Gains or losses related to the effective portion of our cash flow hedges are recorded as a component of accumulated other comprehensive income (“AOCI”) in our condensed consolidated balance sheets and are reclassified into the financial statement line item associated with the underlying hedged transaction in our condensed consolidated statements of operations when the underlying hedged transaction is recognized in earnings. Any gains or losses related to the ineffective portion of our cash flow hedges are recorded immediately in other income (expense), net in our condensed consolidated statements of operations. If it becomes probable that the hedged transaction will not occur, the cumulative unrealized gain or loss is reclassified immediately from AOCI into other income (expense), net. Gains or losses related to non-designated derivative instruments are recognized in other income (expense), net each period until the instrument matures, is terminated, is re-designated as a qualified cash flow hedge, or is sold. Derivatives designated as cash flow hedges are classified in our condensed consolidated statements of cash flows in the same manner as the underlying hedged transaction, primarily within cash flows from operating activities.
Beginning August 2016, we entered into forward contracts to hedge the foreign currency exchange rate risk arising from our euro-denominated expenditures to be incurred during the fiscal year ending July 31, 2017. As of April 30, 2017, the total notional amount of our outstanding foreign currency forward contracts was $37.5 million. Refer to Note 2. Fair Value Measurements for the fair value of our derivative instruments as reported in our condensed consolidated balance sheets as of April 30, 2017.
During the three and nine months ended April 30, 2017, both unrealized losses recognized in AOCI related to the effective portion of our cash flow hedges and amounts reclassified into earnings were not material. Total unrealized losses in AOCI related to the effective portion of our cash flow hedges as of April 30, 2017 were also not material.

- 13 -


5. Acquisitions
LightCyber Ltd.
On February 27, 2017, we completed our acquisition of all outstanding shares of LightCyber Ltd. (“LightCyber”), a privately-held cybersecurity company, for total consideration of $103.1 million in cash. The acquisition expands the functionality of our next-generation security platform with the addition of LightCyber’s behavioral analytics technology. 
We have accounted for this transaction as a business combination and allocated the purchase consideration to assets acquired and liabilities assumed based on their preliminary estimated fair values, as presented in the following table (in millions):
 
Amount
Cash
$
12.4

Goodwill
75.3

Identified intangible assets
19.5

Net liabilities assumed
(4.1
)
Total
$
103.1

Additional information, such as that related to income tax and other contingencies, existing as of the acquisition date but unknown to us may become known during the remainder of the measurement period, not to exceed 12 months from the acquisition date, which may result in changes to the amounts and allocations recorded.
The following table presents details of the identified intangible assets acquired (in millions, except years):
 
Fair Value
 
Estimated Useful Life
Developed technology
$
16.6

 
8 years
Customer relationships
2.9

 
8 years
Total
$
19.5

 
 
Goodwill generated from this business combination is primarily attributable to the assembled workforce and expected synergies from integrating the LightCyber technology into our platform. The goodwill is not deductible for income tax purposes.
LightCyber’s operating results are included in our condensed consolidated statements of operations from the date of acquisition. Pro forma results of operations have not been presented as the impact to our condensed consolidated statements of operations is not material.
6. Goodwill and Intangible Assets
Goodwill
The following table presents details of our goodwill during the nine months ended April 30, 2017 (in millions):
 
Amount
Balance as of July 31, 2016
$
163.5

Goodwill acquired
75.3

Balance as of April 30, 2017
$
238.8


- 14 -


Purchased Intangible Assets
The following table presents details of our purchased intangible assets as of April 30, 2017 and July 31, 2016 (in millions):
 
April 30, 2017
 
July 31, 2016
 
Gross Carrying Amount
 
Accumulated Amortization
 
Net Carrying Amount
 
Gross Carrying Amount
 
Accumulated Amortization
 
Net Carrying Amount
Developed technology
$
69.7

 
$
(21.3
)
 
$
48.4

 
$
53.1

 
$
(15.4
)
 
$
37.7

Acquired intellectual property
8.9

 
(3.6
)
 
5.3

 
8.9

 
(2.9
)
 
6.0

Customer relationships
2.9

 
(0.1
)
 
2.8

 

 

 

In-process research and development held for defensive purposes
1.9

 
(1.9
)
 

 
1.9

 
(1.6
)
 
0.3

Other
0.5

 
(0.5
)
 

 
0.5

 
(0.5
)
 

Total purchased intangible assets
$
83.9

 
$
(27.4
)
 
$
56.5

 
$
64.4

 
$
(20.4
)
 
$
44.0

We recognized amortization expense of $2.5 million and $7.1 million for the three and nine months ended April 30, 2017, respectively, and $2.3 million and $7.1 million for the three and nine months ended April 30, 2016, respectively.
The following table summarizes our estimated future amortization expense of intangible assets as of April 30, 2017 (in millions):
 
Amount
Fiscal years ending July 31:
 
Remaining 2017
$
2.7

2018
10.7

2019
10.6

2020
10.6

2021
8.9

2022 and thereafter
13.0

Total future amortization expense
$
56.5

7. Convertible Senior Notes
Convertible Senior Notes
On June 30, 2014, we issued $575.0 million aggregate principal amount of 0.0% Convertible Senior Notes due 2019 (the “Notes”). The Notes mature on July 1, 2019, unless converted or repurchased in accordance with their terms prior to such date. The Notes do not contain any financial covenants and we cannot redeem the Notes prior to maturity.
The Notes are convertible for up to 5.2 million shares of our common stock at an initial conversion price of approximately $110.28 per share of common stock, subject to adjustment. Holders of the Notes may surrender their Notes for conversion at their option at any time prior to the close of business on the business day immediately preceding January 1, 2019, only under the following circumstances:
if the last reported sale price of our common stock for at least 20 trading days (whether or not consecutive) during a period of 30 consecutive trading days ending on the last trading day of the immediately preceding fiscal quarter is greater than or equal to 130% of the conversion price for the Notes on each applicable trading day (the “sale price condition”);
during the five business day period after any five consecutive trading day period, in which the trading price per $1,000 principal amount of Notes for each trading day of the measurement period was less than 98% of the product of the last reported sale price of our common stock and the conversion rate for the Notes on each such trading day; or
upon the occurrence of specified corporate events.
On or after January 1, 2019, holders may convert all or any portion of their Notes at any time prior to the close of business on the second scheduled trading day immediately preceding the maturity date regardless of the foregoing conditions. Upon conversion, holders will receive cash equal to the aggregate principal amount of the Notes to be converted, and, at our election, cash and/or shares of our common stock for any amounts in excess of the aggregate principal amount of the Notes being converted.

- 15 -


The sale price condition was not met during the fiscal quarter ended April 30, 2017. Since the Notes were not convertible, the net carrying amount of the Notes was classified as a long-term liability and the equity component was included in additional paid-in capital in our condensed consolidated balance sheets as of April 30, 2017.
The following table sets forth the components of the Notes as of April 30, 2017 and July 31, 2016 (in millions):
 
April 30, 2017
 
July 31, 2016
Liability:
 
 
 
Principal
$
575.0

 
$
575.0

Less: debt discount and debt issuance costs, net of amortization
56.6

 
74.8

Net carrying amount
$
518.4

 
$
500.2

 
 
 
 
Equity
$
109.8

 
$
109.8

The total estimated fair value of the Notes was $671.3 million and $761.9 million at April 30, 2017 and July 31, 2016, respectively. The fair value was determined based on the closing trading price per $100 of the Notes as of the last day of trading for the period. We consider the fair value of the Notes at April 30, 2017 and July 31, 2016 to be a Level 2 measurement. The fair value of the Notes is primarily affected by the trading price of our common stock and market interest rates. As of April 30, 2017, the if-converted value of the Notes exceeded its principal amount by $7.7 million.
The following table sets forth interest expense recognized related to the Notes (dollars in millions):
 
Three Months Ended
 
Nine Months Ended
 
April 30,
 
April 30,
 
2017
 
2016
 
2017
 
2016
Amortization of debt discount
$
5.5

 
$
5.3

 
$
16.4

 
$
15.7

Amortization of debt issuance costs
0.7

 
0.6

 
1.9

 
1.7

Total interest expense recognized
$
6.2

 
$
5.9

 
$
18.3

 
$
17.4

 
 
 
 
 
 
 
 
Effective interest rate of the liability component
4.8
%
 
4.8
%
 
4.8
%
 
4.8
%
Note Hedges
To minimize the impact of potential economic dilution upon conversion of the Notes, we entered into convertible note hedge transactions (the “Note Hedges”) with respect to our common stock concurrent with the issuance of the Notes. The Note Hedges cover up to 5.2 million shares of our common stock and are exercisable upon conversion of the Notes. The Note Hedges will expire upon maturity of the Notes. The Note Hedges are separate transactions and are not part of the terms of the Notes. Holders of the Notes will not have any rights with respect to the Note Hedges. The shares receivable related to the Note Hedges are excluded from the calculation of diluted earnings per share as they are antidilutive.
Warrants
Separately, but concurrently with our issuance of the Notes, we entered into transactions whereby we sold warrants (the “Warrants”) to acquire up to 5.2 million shares of our common stock at a strike price of approximately $137.85 per share, subject to adjustments. The shares issuable under the Warrants will be included in the calculation of diluted earnings per share when the average market value per share of our common stock for the reporting period exceeds the strike price of the Warrants. The Warrants are separate transactions and are not part of the Notes or Note Hedges, and are not remeasured through earnings each reporting period. Holders of the Notes and Note Hedges will not have any rights with respect to the Warrants.
For more information on the Notes, the Note Hedges, and the Warrants, refer to Note 7. Convertible Senior Notes included in Part II, Item 8 of our Annual Report on Form 10-K for the fiscal year ended July 31, 2016.
8. Commitments and Contingencies
Leases
We lease our facilities under various non-cancelable operating leases, which expire through the year ending July 31, 2028.

- 16 -


The following table presents details of the aggregate future non-cancelable minimum rental payments under our operating leases as of April 30, 2017 (in millions):
 
Amount
Fiscal years ending July 31:
 
Remaining 2017
$
7.2

2018
29.7

2019
48.8

2020
52.2

2021
56.5

2022 and thereafter
318.5

Committed gross lease payments
512.9

Less: proceeds from sublease rental
2.9

Net operating lease obligation
$
510.0

Manufacturing Purchase Commitments
Our independent contract manufacturer procures components and assembles our products based on our forecasts. These forecasts are based on estimates of demand for our products primarily for the next 12 months, which are in turn based on historical trends and an analysis from our sales and product marketing organizations, adjusted for overall market conditions. In order to reduce manufacturing lead times and plan for adequate supply, we may issue non-cancelable orders for components and products to our independent contract manufacturer, original design manufacturers, or component suppliers. As of April 30, 2017, our purchase commitments under such orders were $104.3 million, excluding obligations under contracts that we can cancel without a significant penalty. 
Litigation
We are subject to legal proceedings, claims, and litigation arising in the ordinary course of business, including intellectual property litigation. Such matters are subject to many uncertainties and outcomes are not predictable with assurance. We accrue for contingencies when we believe that a loss is probable and that we can reasonably estimate the amount of any such loss.
To the extent there is a reasonable possibility that a loss exceeding amounts already recognized may be incurred and the amount of such additional loss would be material, we will either disclose the estimated additional loss or state that such an estimate cannot be made. As of April 30, 2017, we have not recorded any significant accruals for loss contingencies associated with such legal proceedings, determined that an unfavorable outcome is probable or reasonably possible, or determined that the amount or range of any possible loss is reasonably estimable.
9. Stockholders’ Equity
Share Repurchase
On August 26, 2016, our board of directors authorized a $500.0 million share repurchase which is funded from available working capital. On February 24, 2017, our board of directors authorized a $500.0 million increase to our repurchase program, bringing the total authorization to $1.0 billion. Repurchases may be made at management’s discretion from time to time on the open market, through privately negotiated transactions, transactions structured through investment banking institutions, block purchase techniques, 10b5-1 trading plans, or a combination of the foregoing. The repurchase authorization will expire on December 31, 2018, and may be suspended or discontinued at any time.
During the three and nine months ended April 30, 2017, we repurchased and retired 1.1 million and 2.4 million shares, respectively, of our common stock under the authorization for an aggregate purchase price of $125.0 million and $295.1 million, respectively. The total price of the shares repurchased and related transaction costs are reflected as a reduction to common stock and additional paid-in capital on our condensed consolidated balance sheets. As of April 30, 2017, $704.9 million remained available for future share repurchases under the repurchase authorization.

- 17 -


10. Equity Award Plans
Stock Option Activities
The following table summarizes the stock option activity under our stock plans during the reporting period (in millions, except per share amounts):
 
Options Outstanding 
 
Number of Shares
 
Weighted-Average Exercise Price Per Share 
 
Weighted-Average Remaining Contractual Term
(Years)
 
Aggregate Intrinsic Value
Balance—July 31, 2016
2.1

 
$
13.42

 
5.2
 
$
244.9

Options granted

 

 
 
 
 
Options forfeited

 

 
 
 
 
Options exercised
(0.5
)
 
14.23

 
 
 
 
Balance—April 30, 2017
1.6

 
$
13.20

 
4.5
 
$
156.7

Options exercisable—April 30, 2017
1.6

 
$
13.20

 
4.5
 
$
156.7

Restricted Stock Unit (“RSU”), Restricted Stock Award (“RSA”), and Performance-Based Stock Award (“PSA”) Activities
In October 2016, we granted PSAs to certain employees, which will vest over a period of four years from the date of grant. The actual number of PSAs earned and eligible to vest will be determined based on level of achievement against a pre-established billings target for the fiscal year ending July 31, 2017, with a maximum of 0.2 million shares issuable at the end of the performance period. Share-based compensation expense for our PSAs is recognized on a straight-line basis over the requisite service period for each separately vesting portion of the award when it is probable that the performance condition will be achieved.
In February 2017, we began to net-share settle equity awards held by certain employees by withholding shares upon vesting to satisfy tax withholding obligations. The shares withheld to satisfy employee tax withholding obligations are returned to our 2012 Equity Incentive Plan (our “2012 Plan”) and will be available for future issuance under our 2012 Plan. Payments for employees’ tax obligations to the tax authorities are reflected as financing activities in our condensed consolidated statements of cash flows.
The following table summarizes the RSU, RSA, and PSA activity under our stock plans during the reporting period (in millions, except per share amounts):
 
RSAs and PSAs Outstanding
 
RSUs Outstanding
 
Number of Shares
 
Weighted-Average Grant-Date Fair Value Per Share
 
Number of Shares
 
Weighted-Average Grant-Date Fair Value Per Share
 
Weighted-Average Remaining Contractual Term
(Years)
 
Aggregate Intrinsic Value
Balance—July 31, 2016
1.1

 
$
170.97

 
6.5

 
$
130.14

 
1.1
 
$
852.7

Granted(1)
0.3

 
148.54

 
2.8

 
143.28

 
 
 
 
Vested
(0.3
)
 
170.97

 
(2.6
)
 
118.53

 
 
 
 
Forfeited

 

 
(0.4
)
 
137.88

 
 
 
 
Balance—April 30, 2017
1.1

 
$
164.24

 
6.3

 
$
140.29

 
1.3
 
$
687.1

______________
(1)
The number of PSAs granted represents the aggregate maximum number of shares that may be earned and issued with respect to these awards over their full terms.

- 18 -


Share-Based Compensation
The following table summarizes share-based compensation included in costs and expenses (in millions):
 
Three Months Ended
 
Nine Months Ended
 
April 30,
 
April 30,
 
2017
 
2016
 
2017(1)
 
2016
Cost of product revenue
$
1.8

 
$
1.6

 
$
5.5

 
$
4.5

Cost of subscription and support revenue
14.0

 
11.5

 
41.3

 
29.0

Research and development
37.1

 
36.0

 
116.4

 
95.9

Sales and marketing
46.2

 
43.8

 
139.7

 
110.4

General and administrative
18.3

 
15.6

 
55.1

 
43.5

Total share-based compensation
$
117.4

 
$
108.5

 
$
358.0

 
$
283.3

______________
(1)
Amounts reflect an adjustment for the three months ended October 31, 2016, due to our early adoption of new share-based payment accounting guidance. Refer to Note 1. Description of Business and Summary of Significant Accounting Policies for more information.
As of April 30, 2017, total compensation cost related to unvested share-based awards not yet recognized was $913.0 million. This cost is expected to be amortized on a straight-line basis over a weighted-average period of approximately 2.5 years.
11. Income Taxes
Our provision for income taxes for the three and nine months ended April 30, 2017 reflects an effective tax rate of (14.5)% and (9.1)%, respectively. Our effective tax rates for these periods were negative as we recorded a provision for income taxes on year to date losses. The key components of our income tax provision primarily consist of foreign income taxes, withholding taxes, and amortization of our deferred tax charges. Our effective tax rate differs from the U.S. statutory tax rate primarily due to changes in non-deductible share-based compensation, foreign income at other than U.S. tax rates, and changes in our valuation allowance. As compared to the same periods last year, our effective tax rate changed primarily due to changes in our foreign income taxed at other than U.S. rates and our valuation allowance.
Our provision for income taxes for the three and nine months ended April 30, 2016 reflects an effective tax rate of (11.9)% and (10.3)%, respectively. Our effective tax rates for these periods were negative as we recorded a provision for income taxes on year to date losses. The key components of our income tax provision primarily consisted of foreign income taxes, withholding taxes, U.S. federal and state income taxes, and amortization of our deferred tax charges. Key components of our effective tax rate consisted of foreign tax losses which derive no benefit, non-deductible share-based compensation, and changes in our valuation allowance. 
As of April 30, 2017, we had $289.1 million of unrecognized tax benefits, $29.2 million of which would affect income tax expense if recognized, after consideration of our valuation allowance in the United States and other assets. As of July 31, 2016, we had $127.7 million of unrecognized tax benefits, $21.9 million of which would affect income tax expense if recognized, after consideration of our valuation allowance in the United States and other assets. The increase in unrecognized tax benefits since July 31, 2016 relates to positions taken relating to transfer pricing in the current year. As of April 30, 2017, our federal, state, and foreign returns for the tax years 2008 through the current period remain open to examination. Fiscal years outside the normal statute of limitation remain open to audit by tax authorities due to tax attributes generated in earlier years, which have been carried forward and may be audited in subsequent years when utilized. We do not expect our unrecognized tax benefits to change significantly over the next 12 months. We recognize both interest and penalties associated with uncertain tax positions as a component of income tax expense. The ultimate amount and timing of any future cash settlements cannot be predicted with reasonable certainty.
12. Net Income (Loss) Per Share
Basic net income (loss) per share is computed by dividing net income (loss) by basic weighted-average shares outstanding during the period. Diluted net income (loss) per share is computed by dividing net income (loss) by diluted weighted-average shares outstanding, including potentially dilutive securities.

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The following table presents the computation of basic and diluted net loss per share of common stock (in millions, except per share data):
 
Three Months Ended
 
Nine Months Ended
 
April 30,
 
April 30,
 
2017
 
2016
 
2017
 
2016
Net loss
$
(60.9
)
 
$
(64.1
)
 
$
(178.4
)
 
$
(161.3
)
Weighted-average shares used to compute net loss per share, basic and diluted
91.0

 
87.8

 
90.5

 
86.5

Net loss per share, basic and diluted
$
(0.67
)
 
$
(0.73
)
 
$
(1.97
)
 
$
(1.86
)
The following securities were excluded from the computation of diluted net loss per share of common stock for the periods presented as their effect would have been antidilutive (in millions):
 
Three and Nine Months Ended
 
April 30,
 
2017
 
2016
RSUs
6.3

 
7.0

Convertible senior notes
5.2

 
5.2

Warrants related to the issuance of convertible senior notes
5.2

 
5.2

Options to purchase common stock
1.6

 
2.3

RSAs and PSAs
1.1

 
1.1

Total
19.4

 
20.8

ITEM 2.
MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
The following discussion and analysis of our financial condition and results of operations should be read in conjunction with our condensed consolidated financial statements and related notes appearing elsewhere in this Quarterly Report on Form 10-Q. The following discussion and analysis contains forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. These statements include, among other things: expectations regarding drivers of and factors affecting growth in our business; statements regarding trends in billings, our mix of product and subscription and support revenue, cost of revenue, gross margin, cash flows, operating expenses, including future share-based compensation expense, income taxes, investments and liquidity; expectations regarding the seasonality and cyclicality of our revenues from quarter to quarter; expectations and intentions with respect to the products and technologies that we acquire and introduce; expected impact of the adoption of certain recent accounting pronouncements and the anticipated timing of adopting such standards; expected recurring revenues resulting from expected growth in our installed base; the sufficiency of our existing cash and investments to meet our cash needs for the foreseeable future; and other statements regarding our future operations, financial condition and prospects, and business strategies. Forward-looking statements generally can be identified by words such as “anticipates,” “believes,” “could,” “estimates,” “expects,” “intends,” “may,” “plans,” “predicts,” “projects,” “would,” “will be,” “will continue,” “will likely result,” and similar expressions. These forward-looking statements are based on current expectations and assumptions that are subject to risks and uncertainties, which could cause our actual results to differ materially from those reflected in the forward-looking statements. Factors that could cause or contribute to such differences include, but are not limited to, those discussed in this Quarterly Report on Form 10-Q, and in particular, the risks discussed under the caption “Risk Factors” in Part II, Item 1A of this report and those discussed in other documents we file with the Securities and Exchange Commission (“SEC”). We undertake no obligation to revise or publicly release the results of any revision to these forward-looking statements, except as required by law. Given these risks and uncertainties, readers are cautioned not to place undue reliance on such forward-looking statements.
Our Management’s Discussion and Analysis of Financial Condition and Results of Operations (“MD&A”) is organized as follows:
Overview. A discussion of our business and overall analysis of financial and other highlights in order to provide context for the remainder of MD&A.
Key Financial Metrics. A summary of our generally accepted accounting principles (“GAAP”) and non-GAAP key financial metrics, which management monitors to evaluate our performance.
Results of Operations. A discussion of the nature and trends in our financial results and an analysis of our financial results comparing the three and nine months ended April 30, 2017 to the three and nine months ended April 30, 2016.

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Liquidity and Capital Resources. An analysis of changes in our balance sheets and cash flows, and a discussion of our financial condition and our ability to meet cash needs.
Critical Accounting Estimates. A discussion of our accounting policies that require critical estimates, assumptions, and judgments.
Recent Accounting Pronouncements. A discussion of expected impacts of impending accounting changes on financial information to be reported in the future.
Overview
We have pioneered the next generation of security through our innovative platform that allows enterprises, service providers, and government entities to secure their organizations by safely enabling applications running on their networks and by preventing breaches that stem from targeted cyber attacks. Our platform uses an innovative traffic classification engine that identifies network traffic by application, user, and content and provides consistent security across the network, endpoint, and cloud. Accordingly, our platform enables our end-customers to maintain the visibility and control needed to protect their valued data and critical control systems while pursuing technology initiatives, like cloud and mobility, that grow their business. We believe our platform offers superior performance compared to legacy approaches and reduces the total cost of ownership for organizations by simplifying their security infrastructure and eliminating the need for multiple, stand-alone security appliances and software products.
Our Next-Generation Security Platform consists of three major elements: our Next-Generation Firewall, our Advanced Endpoint Protection, and our Threat Intelligence Cloud. Our Next-Generation Firewall delivers application, user, and content visibility and control as well as protection against network-based cyber threats integrated within the firewall through our proprietary hardware and software architecture. Our Advanced Endpoint Protection prevents cyber attacks that aim to run malicious code or exploit software vulnerabilities on a broad variety of fixed and virtual endpoints and servers. Our Threat Intelligence Cloud provides central intelligence capabilities, security for software as a service (“SaaS”) applications, and automated delivery of preventative measures against cyber attacks.
For the third quarter of fiscal 2017 and 2016, total revenue was $431.8 million and $345.8 million, respectively, representing year-over-year growth of 24.9%. Our growth reflects the increased adoption of our hybrid SaaS revenue model, which consists of product, subscription, and support. We believe this model will enable us to benefit from recurring revenues as we continue to grow our installed end-customer base. As of April 30, 2017, we had more than 39,500 end-customers in over 150 countries. Our end-customers represent a broad range of industries, including education, energy, financial services, government entities, healthcare, Internet and media, manufacturing, public sector, and telecommunications, and include some of the largest Fortune 100 and Global 2000 companies in the world. We maintain a field sales force that works closely with our channel partners in developing sales opportunities. We use a two-tiered, indirect fulfillment model whereby we sell our products and services to our distributors, which, in turn, sell to our resellers, which then sell to our end-customers.
Our product revenue was $164.2 million, or 38.0% of total revenue, for the third quarter of fiscal 2017, representing year-over-year growth of 1.3%. Product revenue is generated from sales of our appliances, primarily our Next-Generation Firewall, which is available in physical and virtualized form. Our Next-Generation Firewall incorporates our proprietary PAN-OS operating system, which provides a consistent set of capabilities across our entire product line. Our products are designed for different performance requirements throughout an organization, ranging from our PA-200, which is designed for enterprise remote offices, to our top-of-the-line PA-7080, which is especially suited for very large enterprise deployments and service provider customers. The same firewall functionality that is delivered in our physical appliances is also available in our VM-Series virtual firewalls, which secure virtualized and cloud-based computing environments.
Our subscription and support revenue was $267.6 million, or 62.0% of total revenue, for the third quarter of fiscal 2017, representing year-over-year growth of 45.7%. Our subscriptions provide our end-customers with real-time access to the latest antivirus, intrusion prevention, web filtering, and modern malware prevention capabilities across fixed and mobile devices. When end-customers purchase an appliance, they typically purchase one or more of our subscriptions for additional functionality, as well as support in order to receive ongoing security updates, upgrades, bug fixes, and repairs.
We continue to invest in innovation and extending our platform and, in February 2017, introduced several new products and features. First, we expanded our family of firewalls with the launch of several new appliances: our PA-220, which is designed for small branch offices and remote locations; our PA-800 series, which are ideal for medium-sized networks and branch and remote office environments; our PA-5200 series, which deliver security for high throughput environments in a compact form factor; and the addition of three new VM-Series virtual firewall models, which support cloud and virtualization initiatives ranging from virtualized branch offices to data center and service provider deployments. Additionally, we delivered PAN-OS 8.0, an important software release that expands security for public and private clouds, provides new SaaS application security functionality, and provides the capabilities to prevent the theft and abuse of stolen credentials. We also acquired LightCyber Ltd. (“LightCyber”) in

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February 2017. LightCyber’s technology further expands the functionality of our platform through the addition of behavioral analytics, and will be the foundation for a future subscription offering.
We believe that the growth of our business and our short-term and long-term success are dependent upon many factors, including our ability to extend our technology leadership, grow our base of end-customers, expand deployment of our platform and support offerings within existing end-customers, and focus on end-customer satisfaction. To manage any future growth effectively, we must continue to improve and expand our information technology and financial infrastructure, our operating and administrative systems and controls, and our ability to manage headcount, capital, and processes in an efficient manner. While these areas present significant opportunities for us, they also pose challenges and risks that we must successfully address in order to sustain the growth of our business and improve our operating results. For additional information regarding the challenges and risks we face, see the “Risk Factors” section in Part II, Item 1A of this Quarterly Report on Form 10-Q.
Key Financial Metrics
We monitor the key financial metrics set forth in the tables below to help us evaluate growth trends, establish budgets, measure the effectiveness of our sales and marketing efforts, and assess operational efficiencies. We discuss revenue, gross margin, and the components of operating loss and margin below under “—Results of Operations.”
 
April 30, 2017
 
July 31, 2016
 
(in millions)
Total deferred revenue
$
1,611.8

 
$
1,240.8

Cash, cash equivalents, and investments
$
2,091.1

 
$
1,938.4

 
Three Months Ended April 30,
 
Nine Months Ended April 30,
 
2017
 
2016
 
2017
 
2016
 
(dollars in millions)
Total revenue
$
431.8

 
$
345.8

 
$
1,252.5

 
$
977.7

Total revenue year-over-year percentage increase
24.9
 %
 
47.7
 %
 
28.1
 %
 
51.8
 %
Gross margin(2)
71.4
 %
 
72.6
 %
 
73.0
 %
 
72.6
 %
Operating loss(1)(2)
$
(49.1
)
 
$
(52.5
)
 
$
(152.5
)
 
$
(134.6
)
Operating margin(1)(2)
(11.4
)%
 
(15.2
)%
 
(12.2
)%
 
(13.8
)%
Billings
$
544.1

 
$
486.2

 
$
1,622.6

 
$
1,333.2

Billings year-over-year percentage increase
11.9
 %
 
60.8
 %
 
21.7
 %
 
61.5
 %
Cash flow provided by operating activities(2)
 
 
 
 
$
629.0

 
$
471.3

Free cash flow (non-GAAP)(2)
 
 
 
 
$
514.8

 
$
415.1

______________
(1)
Amounts have been adjusted for the three and nine months ended April 30, 2016, as a result of our voluntary change in accounting policy for sales commissions. Refer to Note 1. Description of Business and Summary of Significant Accounting Policies in Part I, Item 1 of this Quarterly Report on Form 10-Q for more information.
(2)
Certain amounts reflect adjustments as a result of our early adoption of new share-based payment accounting guidance. Refer to Note 1. Description of Business and Summary of Significant Accounting Policies in Part I, Item 1 of this Quarterly Report on Form 10-Q for more information.
Deferred Revenue. Our deferred revenue consists of amounts that have been invoiced but have not been recognized as revenue as of the period end. The majority of our deferred revenue balance consists of subscription and support revenue that is recognized ratably over the contractual service period. We monitor our deferred revenue balance because it represents a significant portion of revenue to be recognized in future periods.
Billings. We define billings as total revenue plus the change in total deferred revenue, net of acquired deferred revenue, during the period. We consider billings to be a key measure used by management to manage our business given our hybrid SaaS revenue model, and believe billings provides investors with an important indicator of the health and visibility of our business because it includes subscription and support revenue, which is recognized ratably over the contractual service period, and product revenue, which is recognized at the time of shipment, provided that all other revenue recognition criteria have been met. We consider billings to be a useful metric for management and

- 22 -


investors, particularly if we continue to experience increased sales of subscriptions and strong renewal rates for subscription and support offerings, and as we monitor our near term cash flows. While we believe that billings provides useful information to investors and others in understanding and evaluating our operating results in the same manner as our management, it is important to note that other companies, including companies in our industry, may not use billings, may calculate billings differently, may have different billing frequencies, or may use other financial measures to evaluate their performance, all of which could reduce the usefulness of billings as a comparative measure. We calculate billings in the following manner:
 
Three Months Ended April 30,
 
Nine Months Ended April 30,
 
2017
 
2016
 
2017
 
2016
 
(in millions)
Billings:
 
 
 
 
 
 
 
Total revenue
$
431.8

 
$
345.8

 
$
1,252.5

 
$
977.7

Add: change in total deferred revenue, net of acquired deferred revenue
112.3

 
140.4

 
370.1

 
355.5

Billings
$
544.1

 
$
486.2

 
$
1,622.6

 
$
1,333.2

Cash Flow Provided by Operating Activities. We monitor cash flow provided by operating activities as a measure of our overall business performance. Our cash flow provided by operating activities is driven in large part by sales of our products and from up-front payments for subscription and support offerings. Monitoring cash flow provided by operating activities enables us to analyze our financial performance without the non-cash effects of certain items such as depreciation, amortization, and share-based compensation costs, thereby allowing us to better understand and manage the cash needs of our business.
Free Cash Flow (non-GAAP). We define free cash flow, a non-GAAP financial measure, as cash provided by operating activities less purchases of property, equipment, and other assets. We consider free cash flow to be a profitability and liquidity measure that provides useful information to management and investors about the amount of cash generated by the business after necessary capital expenditures. A limitation of the utility of free cash flow as a measure of our financial performance and liquidity is that it does not represent the total increase or decrease in our cash balance for the period. In addition, it is important to note that other companies, including companies in our industry, may not use free cash flow, may calculate free cash flow in a different manner than we do, or may use other financial measures to evaluate their performance, all of which could reduce the usefulness of free cash flow as a comparative measure. A reconciliation of free cash flow to cash flow provided by operating activities, the most directly comparable financial measure calculated and presented in accordance with GAAP, is provided below:
 
Nine Months Ended April 30,
 
2017
 
2016
 
(in millions)
Free cash flow (non-GAAP):
 
 
 
Net cash provided by operating activities(1)
$
629.0

 
$
471.3

Less: purchases of property, equipment, and other assets
114.2

 
56.2

Free cash flow (non-GAAP)(1)
$
514.8

 
$
415.1

Net cash used in investing activities
$
(411.1
)
 
$
(339.3
)
Net cash provided by (used in) financing activities(1)
$
(260.3
)
 
$
42.2

______________
(1)
Amounts reflect adjustments as a result of our early adoption of new share-based payment accounting guidance. Refer to Note 1. Description of Business and Summary of Significant Accounting Policies in Part I, Item 1 of this Quarterly Report on Form 10-Q for more information.

- 23 -


Results of Operations
The following table summarizes our results of operations for the periods presented and as a percentage of our total revenue for those periods based on our condensed consolidated statements of operations data. The period to period comparison of results is not necessarily indicative of results for future periods.
Due to our early adoption of new share-based payment accounting guidance in the second quarter of fiscal 2017, certain amounts for the nine months ended April 30, 2017 in the tables and discussion that follow reflect an adjustment for the three months ended October 31, 2016. Refer to Note 1. Description of Business and Summary of Significant Accounting Policies in Part I, Item 1 of this Quarterly Report on Form 10-Q for more information.
 
Three Months Ended April 30,
 
Nine Months Ended April 30,
 
2017
 
2016
 
2017
 
2016
 
Amount
 
% of Revenue
 
Amount(1)
 
% of Revenue(1)
 
Amount
 
% of Revenue
 
Amount(1)
 
% of Revenue(1)
 
(dollars in millions)
Revenue:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Product
$
164.2

 
38.0
 %
 
$
162.1

 
46.9
 %
 
$
496.8

 
39.7
 %
 
$
479.7

 
49.1
 %
Subscription and support
267.6

 
62.0
 %
 
183.7

 
53.1
 %
 
755.7

 
60.3
 %
 
498.0

 
50.9
 %
Total revenue
431.8

 
100.0
 %
 
345.8

 
100.0
 %
 
1,252.5

 
100.0
 %
 
977.7

 
100.0
 %
Cost of revenue:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Product
49.7

 
11.5
 %
 
43.2

 
12.5
 %
 
137.7

 
11.0
 %
 
126.9

 
13.0
 %
Subscription and support
74.0

 
17.1
 %
 
51.7

 
14.9
 %
 
200.4

 
16.0
 %
 
141.4

 
14.4
 %
Total cost of revenue(2)
123.7

 
28.6
 %
 
94.9

 
27.4
 %
 
338.1

 
27.0
 %
 
268.3

 
27.4
 %
Total gross profit
308.1

 
71.4
 %
 
250.9

 
72.6
 %
 
914.4

 
73.0
 %
 
709.4

 
72.6
 %
Operating expenses:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Research and development
86.0

 
19.9
 %
 
74.0

 
21.4
 %
 
260.1

 
20.8
 %
 
207.7

 
21.2
 %
Sales and marketing
226.9

 
52.5
 %
 
195.9

 
56.7
 %
 
673.7

 
53.8
 %
 
537.8

 
55.0
 %