Attached files

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EX-32.2 - CERTIFICATION OF THE CHIEF FINANCIAL OFFICER PURSUANT TO SECTION 906 - Palo Alto Networks Incpanwex322q118.htm
EX-32.1 - CERTIFICATION OF THE CHIEF EXECUTIVE OFFICER PURSUANT TO SECTION 906 - Palo Alto Networks Incpanwex321q118.htm
EX-31.2 - CERTIFICATION OF THE CHIEF FINANCIAL OFFICER PURSUANT TO SECTION 302 - Palo Alto Networks Incpanwex312q118.htm
EX-31.1 - CERTIFICATION OF THE CHIEF EXECUTIVE OFFICER PURSUANT TO SECTION 302 - Palo Alto Networks Incpanwex311q118.htm
EX-10.7 - AMENDMENT TO LEASE BETWEEN THE COMPANY AND SANTA CLARA PHASE III EFH - Palo Alto Networks Incpanwex107q118_amendmentno5.htm
EX-10.6 - AMENDMENT TO LEASE BETWEEN THE COMPANY AND SANTA CLARA PHASE III G - Palo Alto Networks Incpanwex106q118_amendmentno4.htm
EX-10.5 - AMENDMENT TO LEASE BETWEEN THE COMPANY AND SANTA CLARA PHASE III EFH - Palo Alto Networks Incpanwex105q118_amendmentno4.htm
EX-10.3 - CLAWBACK POLICY - Palo Alto Networks Incpanwex103q118_clawbackpoli.htm
EX-10.2 - 2012 EQUITY INCENTIVE PLAN, AS AMENDED, AND RELATED FORM AGREEMENTS - Palo Alto Networks Incpanwex102q118_2012eip.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 October 31, 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.)
3000 Tannery Way
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 November 10, 2017 was 91,888,958.
 




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)

 
October 31, 2017
 
July 31, 2017
Assets
 
 
 
Current assets:
 
 
 
Cash and cash equivalents
$
842.6

 
$
744.3

Short-term investments
660.6

 
630.7

Accounts receivable, net of allowance for doubtful accounts of $1.0 and $0.7 at October 31, 2017 and July 31, 2017, respectively
350.8

 
432.1

Prepaid expenses and other current assets
185.5

 
169.2

Total current assets
2,039.5

 
1,976.3

Property and equipment, net
256.9

 
211.1

Long-term investments
777.4

 
789.3

Goodwill
238.8

 
238.8

Intangible assets, net
51.0

 
53.7

Other assets
122.9

 
169.1

Total assets
$
3,486.5

 
$
3,438.3

Liabilities, temporary equity, and stockholders’ equity
 
 
 
Current liabilities:
 
 
 
Accounts payable
$
38.8

 
$
35.5

Accrued compensation
74.5

 
117.5

Accrued and other liabilities
80.8

 
79.9

Deferred revenue
1,017.9

 
968.4

Convertible senior notes, net
531.0

 

Total current liabilities
1,743.0

 
1,201.3

Convertible senior notes, net

 
524.7

Long-term deferred revenue
846.6

 
805.1

Other long-term liabilities
192.2

 
147.6

Commitments and contingencies (Note 6)


 


Temporary equity
39.2

 

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

 

Common stock and additional paid-in capital; $0.0001 par value; 1,000.0 shares authorized; 91.9 and 91.5 shares issued and outstanding at October 31, 2017 and July 31, 2017, respectively
1,573.2

 
1,599.7

Accumulated other comprehensive loss
(7.0
)
 
(3.4
)
Accumulated deficit
(900.7
)
 
(836.7
)
Total stockholders’ equity
665.5

 
759.6

Total liabilities, temporary equity, and stockholders’ equity
$
3,486.5

 
$
3,438.3

 
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
 
October 31,
 
2017
 
2016
Revenue:
 
 
 
Product
$
186.5

 
$
163.8

Subscription and support
319.0

 
234.3

Total revenue
505.5

 
398.1

Cost of revenue:
 
 
 
Product
57.6

 
42.2

Subscription and support
83.8

 
59.0

Total cost of revenue
141.4

 
101.2

Total gross profit
364.1

 
296.9

Operating expenses:
 
 
 
Research and development
94.2

 
84.2

Sales and marketing
258.5

 
220.1

General and administrative
65.7

 
41.6

Total operating expenses
418.4

 
345.9

Operating loss
(54.3
)
 
(49.0
)
Interest expense
(6.3
)
 
(6.0
)
Other income, net
4.8

 
2.5

Loss before income taxes
(55.8
)
 
(52.5
)
Provision for income taxes
8.2

 
4.4

Net loss
$
(64.0
)
 
$
(56.9
)
Net loss per share, basic and diluted
$
(0.70
)
 
$
(0.63
)
Weighted-average shares used to compute net loss per share, basic and diluted
90.9

 
89.8


See notes to condensed consolidated financial statements.


- 4 -


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

 
Three Months Ended
 
October 31,
 
2017
 
2016
Net loss
$
(64.0
)
 
$
(56.9
)
Other comprehensive loss, net of tax:
 
 
 
Change in unrealized gains (losses) on investments
(1.9
)
 
(1.8
)
Change in unrealized gains (losses) on cash flow hedges
(1.7
)
 
(1.1
)
Other comprehensive loss
(3.6
)

(2.9
)
Comprehensive loss
$
(67.6
)
 
$
(59.8
)

See notes to condensed consolidated financial statements.

- 5 -


PALO ALTO NETWORKS, INC.

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

 
Three Months Ended
 
October 31,
 
2017
 
2016
Cash flows from operating activities
 
 
 
Net loss
$
(64.0
)
 
$
(56.9
)
Adjustments to reconcile net loss to net cash provided by operating activities:
 
 
 
Share-based compensation for equity based awards
125.7

 
113.3

Depreciation and amortization
21.3

 
13.6

Cease-use loss related to facility exit
15.4

 

Amortization of debt discount and debt issuance costs
6.3

 
6.0

Amortization of investment premiums, net of accretion of purchase discounts
0.5

 
0.7

Changes in operating assets and liabilities:
 
 
 
Accounts receivable, net
81.3

 
2.2

Prepaid expenses and other assets
(6.4
)
 
10.1

Accounts payable
4.2

 
1.8

Accrued compensation
(43.0
)
 
(14.5
)
Accrued and other liabilities
41.8

 
8.4

Deferred revenue
91.0

 
118.8

Net cash provided by operating activities
274.1

 
203.5

Cash flows from investing activities
 
 
 
Purchases of investments
(226.8
)
 
(285.7
)
Proceeds from maturities of investments
206.6

 
235.4

Purchases of property, equipment, and other assets
(32.2
)
 
(20.9
)
Net cash used in investing activities
(52.4
)
 
(71.2
)
Cash flows from financing activities
 
 
 
Repurchases of common stock
(134.1
)
 
(50.0
)
Proceeds from sales of shares through employee equity incentive plans
22.1

 
22.7

Payments for taxes related to net share settlement of equity awards
(11.4
)
 

Net cash used in financing activities
(123.4
)
 
(27.3
)
Net increase in cash and cash equivalents
98.3

 
105.0

Cash and cash equivalents—beginning of period
744.3

 
734.4

Cash and cash equivalents—end of period
$
842.6

 
$
839.4

Non-cash investing and financing activities
 
 
 
Property and equipment acquired through lease incentives
$
37.8

 
$


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 cyberattacks.
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 (“GAAP”), consistent in all material respects with those applied in our Annual Report on Form 10-K for the fiscal year ended July 31, 2017, filed with the Securities and Exchange Commission (“SEC”) on September 7, 2017. 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 due to our early adoption of new accounting guidance related to share-based payments in our second quarter of fiscal 2017. For more information, refer to “Recently Adopted Accounting Pronouncements” in Note 1. Description of Business and Summary of Significant Accounting Policies included in Part II, Item 8 of our Annual Report on Form 10-K for the fiscal year ended July 31, 2017.
Our condensed consolidated financial statements should be read in conjunction with the audited consolidated financial statements and related notes in our Annual Report on Form 10-K for the fiscal year ended July 31, 2017.
Summary of Significant Accounting Policies
There have been no material changes to our significant accounting policies as of and for the three months ended October 31, 2017, as compared to the significant accounting policies described in our Annual Report on Form 10-K for the fiscal year ended July 31, 2017.
Recently Issued Accounting Pronouncements
Derivatives and Hedging
In August 2017, the Financial Accounting Standards Board (“FASB”) issued new authoritative guidance on derivatives and hedging to better align an entity’s risk management activities and financial reporting for hedging relationships through changes to both the designation and measurement guidance for qualifying hedging relationships, and the presentation of hedge results. The standard is effective for us in our first quarter of fiscal 2020 and will be applied on a modified retrospective basis. Early adoption is permitted. We plan to early adopt the standard in our second quarter of fiscal 2018. We do not expect the adoption of the standard will have a material impact on our condensed consolidated financial statements.
Business Combinations - Definition of a Business
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 in our first quarter of fiscal 2019 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.
Statement of Cash Flows - Restricted Cash
In November 2016, the FASB issued authoritative guidance on the presentation of restricted cash or restricted cash equivalents in the statement of cash flows. Under the new standard, restricted cash or restricted cash equivalents should be included with cash and cash equivalents when reconciling the beginning-of-period and end-of-period total amounts shown on the statement of cash flows. The standard is effective for us in our first quarter of fiscal 2019 and will be applied on a retrospective 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 because our restricted cash balance has not been material.

- 7 -


Income Taxes - Intra-Entity Asset Transfers
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 in our first quarter of fiscal 2019 and will be applied on a modified retrospective basis. Early adoption is permitted. We plan to adopt the standard in our first quarter of fiscal 2019. The adoption of this standard may have a material impact on our condensed consolidated financial statements, subject to any potential intra-entity transfers of assets (excluding inventory).
Statement of Cash Flows - Classification of Certain Cash Receipts and Cash Payments
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 in our first quarter of fiscal 2019 and will be applied on a retrospective 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.
Financial Instruments - Credit Losses
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 in 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.
Leases
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 in 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.
Revenue Recognition
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, as well as guidance on the recognition of costs related to obtaining and fulfilling customer contracts. The standard also requires expanded disclosures about the nature, amount, timing, and uncertainty of revenues and cash flows arising from customer contracts, including significant judgments and changes in judgments, and assets recognized from costs incurred to obtain or fulfill a contract. The standard is effective for us in 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 (“full retrospective method”); 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 (“modified retrospective method”).
We will adopt the standard in our first quarter of fiscal 2019 using the full retrospective method. However, our ability to apply the full retrospective method is dependent on system readiness and the completion of our analysis of information necessary to restate prior period financial statements.
We are continuing to evaluate the impact of the new standard on our accounting policies, processes, internal controls over financial reporting, 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 the impact the standard will have on our condensed consolidated financial statements, including reviewing the provisions of our customer contracts and identifying performance obligations under the requirements of the new standard, and comparing to our current accounting policies and practices. Although we have not yet determined whether the effect will be material, we believe the 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

- 8 -


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.
2. Fair Value Measurements
We categorize assets and liabilities recorded or disclosed 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.
The following table presents the fair value of our financial assets and liabilities measured at fair value on a recurring basis using the above input categories as of October 31, 2017 and July 31, 2017 (in millions):
 
 
October 31, 2017
 
July 31, 2017
 
 
Level 1
 
Level 2
 
Level 3
 
Total
 
Level 1
 
Level 2
 
Level 3
 
Total
Cash equivalents:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Money market funds
 
$
250.1

 
$

 
$

 
$
250.1

 
$

 
$

 
$

 
$

U.S. government and agency securities
 

 
5.0

 

 
5.0

 

 

 

 

Total cash equivalents
 
250.1

 
5.0

 

 
255.1

 

 

 

 

Short-term investments:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Corporate debt securities
 

 
170.3

 

 
170.3

 

 
159.4

 

 
159.4

U.S. government and agency securities
 

 
490.3

 

 
490.3

 

 
471.3

 

 
471.3

Total short-term investments
 

 
660.6

 

 
660.6

 

 
630.7

 

 
630.7

Prepaid expenses and other current assets:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Foreign currency forward contracts
 

 
0.2

 

 
0.2

 

 

 

 

Total prepaid expenses and other current assets
 

 
0.2

 

 
0.2

 

 

 

 

Long-term investments:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Certificates of deposit
 

 
5.4

 

 
5.4

 

 
5.4

 

 
5.4

Corporate debt securities
 

 
184.1

 

 
184.1

 

 
186.5

 

 
186.5

U.S. government and agency securities
 

 
587.9

 

 
587.9

 

 
597.4

 

 
597.4

Total long-term investments
 

 
777.4

 

 
777.4

 

 
789.3

 

 
789.3

Total assets measured at fair value
 
$
250.1

 
$
1,443.2

 
$

 
$
1,693.3

 
$

 
$
1,420.0

 
$

 
$
1,420.0

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Accrued and other liabilities:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Foreign currency forward contracts
 
$

 
$
1.8

 
$

 
$
1.8

 
$

 
$

 
$

 
$

Total accrued and other liabilities
 

 
1.8

 

 
1.8

 

 

 

 

Total liabilities measured at fair value
 
$

 
$
1.8

 
$

 
$
1.8

 
$

 
$

 
$

 
$

As of October 31, 2017, we did not have any assets required to be measured at fair value on a nonrecurring basis. As of July 31, 2017, we determined that certain property and equipment related to our prior corporate headquarters were impaired. In connection with our planned relocation to our new corporate headquarters, we assessed the recoverability of certain leasehold improvements and other long-lived assets associated with our previous headquarter facilities and determined that the carrying amount of these assets

- 9 -


exceeded their fair value of $4.2 million. The resulting impairment loss of $20.9 million was recorded as general and administrative expense in our consolidated statements of operations during the year ended July 31, 2017. We calculated the fair value of the leasehold improvements and other long-lived assets based on estimated future discounted cash flows and classified the fair value as a Level 3 measurement due to the significance of unobservable inputs, which included the amount and timing of estimated sublease rental receipts that we could reasonably obtain over the remaining lease term and the discount rate. As of October 31, 2017 and July 31, 2017, we did not have any liabilities required to be measured at fair value on a nonrecurring basis.
Refer to Note 5. Convertible Senior Notes for the carrying amount and estimated fair value of our convertible senior notes as of October 31, 2017 and July 31, 2017.
3. Cash Equivalents and Investments
The following tables summarize the amortized cost, unrealized gains and losses, and fair value of our available-for-sale securities as of October 31, 2017 and July 31, 2017 (in millions):
 
October 31, 2017
 
Amortized Cost 
 
Unrealized Gains
 
Unrealized Losses
 
Estimated Fair Value
Cash equivalents:
 
 
 
 
 
 
 
Money market funds
$
250.1

 
$

 
$

 
$
250.1

U.S. government and agency securities
5.0

 

 

 
5.0

Total cash equivalents
$
255.1

 
$

 
$

 
$
255.1

 
 
 
 
 
 
 
 
Investments:
 
 
 
 
 
 
 
Certificates of deposit
$
5.4

 
$

 
$

 
$
5.4

Corporate debt securities
355.0

 
0.2

 
(0.8
)
 
354.4

U.S. government and agency securities
1,082.2

 

 
(4.0
)
 
1,078.2

Total investments
$
1,442.6

 
$
0.2

 
$
(4.8
)
 
$
1,438.0

 
July 31, 2017
 
Amortized Cost 
 
Unrealized Gains
 
Unrealized Losses
 
Estimated Fair Value
Investments:
 
 
 
 
 
 
 
Certificates of deposit
$
5.4

 
$

 
$

 
$
5.4

Corporate debt securities
346.1

 
0.3

 
(0.5
)
 
345.9

U.S. government and agency securities
1,071.2

 
0.1

 
(2.6
)
 
1,068.7

Total investments
$
1,422.7

 
$
0.4

 
$
(3.1
)
 
$
1,420.0

Unrealized losses related to these securities 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 securities before recovery of their amortized cost basis, which may be at maturity. As a result, there were no other-than-temporary impairments for these securities at October 31, 2017 and July 31, 2017.
The following table summarizes the amortized cost and fair value of our available-for-sale securities as of October 31, 2017, by contractual years-to-maturity (in millions):
 
Amortized Cost
 
Fair Value
Due within one year
$
917.0

 
$
915.7

Due between one and three years
780.7

 
777.4

Total
$
1,697.7

 
$
1,693.1

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

- 10 -


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 (loss) (“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.
As of October 31, 2017, the total notional amount of our outstanding foreign currency forward contracts was $164.4 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 October 31, 2017.
During the three months ended October 31, 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 October 31, 2017 were also not material.
5. 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:
during any fiscal quarter commencing after the fiscal quarter ending on October 31, 2014 (and only during such fiscal quarter), 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.
The sale price condition was met during the fiscal quarter ended October 31, 2017, and as a result, holders may convert their Notes at any time during the fiscal quarter ending January 31, 2018. Accordingly, the net carrying amount of the Notes was reclassified into current liabilities and the portion of the equity component representing the conversion option was reclassified into temporary equity in our condensed consolidated balance sheets as of October 31, 2017. The portion of the equity component classified as temporary equity is measured as the difference between the principal and net carrying amount of the Notes, excluding debt issuance costs. The sale price condition was not met during the fiscal quarter ended July 31, 2017. Since the Notes were not convertible, the net

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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 July 31, 2017.
The following table sets forth the components of the Notes as of October 31, 2017 and July 31, 2017 (in millions):
 
October 31, 2017
 
July 31, 2017
Liability:
 
 
 
Principal
$
575.0

 
$
575.0

Less: debt discount and debt issuance costs, net of amortization
44.0

 
50.3

Net carrying amount
$
531.0

 
$
524.7

 
 
 
 
Equity (including temporary equity)
$
109.8

 
$
109.8

The total estimated fair value of the Notes was $806.2 million and $747.5 million at October 31, 2017 and July 31, 2017, 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 October 31, 2017 and July 31, 2017 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 October 31, 2017, the if-converted value of the Notes exceeded its principal amount by $185.7 million.
The following table sets forth interest expense recognized related to the Notes (dollars in millions):
 
Three Months Ended
 
October 31,
 
2017
 
2016
Amortization of debt discount
$
5.6

 
$
5.4

Amortization of debt issuance costs
0.7

 
0.6

Total interest expense recognized
$
6.3

 
$
6.0

 
 
 
 
Effective interest rate of the liability component
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 at a strike price per share that corresponds to the initial conversion price of the Notes, which are also subject to adjustment, 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 8. Convertible Senior Notes included in Part II, Item 8 of our Annual Report on Form 10-K for the fiscal year ended July 31, 2017.
6. Commitments and Contingencies
Leases
We lease our facilities under various non-cancelable operating leases, which expire through the year ending July 31, 2028.
In May 2015 and October 2015, we entered into a total of three lease agreements for approximately 941,000 square feet of corporate office space in Santa Clara, California, which serves as our new corporate headquarters. The leases contain rent holiday

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periods, scheduled rent increases, lease incentives, and renewal options which allow the lease terms to be extended beyond their expiration dates of July 2028 through July 2046. In September 2017, per the terms of the lease agreements, the landlords exercised their option to amend our lease payment schedules and eliminate our rent holiday periods, which increased our rental payments by $24.4 million, $11.8 million, and $2.0 million for fiscal 2018, 2019, and 2020, respectively. In exchange, we received an upfront cash reimbursement of $38.2 million, which we will apply against the future additional rental payments when due. As amended, rental payments under the three lease agreements are approximately $412.0 million over the lease term.
In May 2015, we also entered into a lease agreement for approximately 122,000 square feet of space in Santa Clara, California, to serve as an extension of our previous corporate headquarters. The lease contains scheduled rent increases, lease incentives, and renewal options which allow the lease term to be extended beyond the expiration date of April 2021 through July 2046. Rental payments under the lease agreement are approximately $23.1 million over the lease term.
In September 2012, we entered into two lease agreements for a total of approximately 300,000 square feet of space in Santa Clara, California, which served as our previous corporate headquarters through August 2017, when we relocated to our new corporate campus. The leases contain rent holiday periods and two separate five-year options to extend the lease terms beyond their expiration dates of July 2023. Rental payments under these lease agreements are approximately $94.3 million over the lease term. In August 2017, we exited our previous headquarter facilities and relocated to our new corporate campus. As a result, we recognized a cease-use loss of $15.4 million as general administrative expense in our condensed consolidated statements of operations during the three months ended October 31, 2017 and a corresponding liability in our condensed consolidated balance sheets. The cease-use loss of $15.4 million was calculated as the present value of the excess of the remaining lease obligation for the vacated facilities, adjusted for the effects of any deferred items recognized under the leases and related costs, over the estimated sublease rentals that could be reasonably obtained. The amount of the cease-use loss may vary if the timing or amount of estimated cash flows change. During the three months ended October 31, 2017, $1.9 million of the cease-use liability was released through rental payments. As of October 31, 2017, the remaining balance of the cease-use liability was $13.5 million, which is expected to be paid through the end of the lease term in July 2023.
The following table presents details of the aggregate future non-cancelable minimum rental payments under our operating leases as of October 31, 2017 (in millions):
 
Amount
Fiscal years ending July 31:
 
Remaining 2018
$
46.3

2019
65.5

2020
65.8

2021
60.1

2022
56.7

2023 and thereafter
267.8

Committed gross lease payments
562.2

Less: proceeds from sublease rental
1.3

Net operating lease obligation
$
560.9

Manufacturing Purchase Commitments
Our electronics manufacturing service provider (“EMS provider”) 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 management 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 products and components to our manufacturing partners or component suppliers. As of October 31, 2017, our purchase commitments under such orders were $95.3 million, of which $2.8 million represent commitments through the year ending July 31, 2019, 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

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made. As of October 31, 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.
7. Stockholders’ Equity
Share Repurchase
In August 2016, our board of directors authorized a $500.0 million share repurchase which is funded from available working capital. In February 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 months ended October 31, 2017, we repurchased and retired 0.9 million shares of our common stock under the authorization for an aggregate purchase price of $125.0 million, including transaction costs. 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 October 31, 2017, $455.0 million remained available for future share repurchases under the repurchase authorization.
8. Equity Award Plans
2012 Employee Stock Purchase Plan
Our 2012 Employee Stock Purchase Plan was adopted by our board of directors and approved by the stockholders on June 5, 2012, and was effective upon completion of our initial public offering (“IPO”). On August 29, 2017, we amended and restated our 2012 Employee Stock Purchase Plan (our “2012 ESPP”) to extend the length of our offering periods from six to 24 months. Under our 2012 ESPP, each 24-month offering period consists of four consecutive six-month purchase periods, with purchase dates on the first trading day on or after February 28 and August 31 of each year. Our 2012 ESPP permits eligible employees to acquire shares of our common stock at 85% of the lower of the fair market value of our common stock on the first trading day of each offering period or on the purchase date. If the fair market value of our common stock on the purchase date is lower than the first trading day of the offering period, the current offering period will be cancelled after purchase and a new 24-month offering period will begin. Participants may purchase shares of common stock through payroll deductions of up to 15% of their eligible compensation, subject to purchase limits of 625 shares per six-month purchase period or $25,000 worth of stock for each calendar year. 
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, 2017
1.6

 
$
13.11

 
4.2
 
$
190.6

Options granted

 
$

 
 
 
 
Options forfeited

 
$

 
 
 
 
Options exercised
(0.1
)
 
$
10.09

 
 
 
 
Balance—October 31, 2017
1.5

 
$
13.30

 
4.0
 
$
202.3

Options exercisable—October 31, 2017
1.5

 
$
13.30

 
4.0
 
$
202.3

Restricted Stock Award (“RSA”), Performance-Based Stock Award (“PSA”), Restricted Stock Unit (“RSU”), and Performance-Based Stock Unit (“PSU”) Activities
Our PSAs and PSUs vest over a period of four years from the date of grant. The actual number of PSAs and PSUs earned and eligible to vest are determined based on level of achievement against a pre-established billings target for the fiscal year in which the awards are granted. We recognize share-based compensation expense for our PSAs and PSUs 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.

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The following table summarizes the RSA, PSA, RSU, and PSU activity under our stock plans during the reporting period (in millions, except per share amounts):
 
RSAs and PSAs Outstanding
 
RSUs and PSUs 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, 2017
1.0

 
$
163.55

 
6.5

 
$
141.16

 
1.3
 
$
854.1

Granted(1)

 
$

 
2.1

 
$
146.87

 
 
 
 
Vested
(0.1
)
 
$
166.03

 
(1.1
)
 
$
136.53

 
 
 
 
Forfeited
(0.1
)
 
$
148.54

 
(0.2
)
 
$
137.21

 
 
 
 
Balance—October 31, 2017
0.8

 
$
165.04

 
7.3

 
$
143.54

 
1.5
 
$
1,074.4

______________
(1)
For PSAs and PSUs, shares granted represents the aggregate maximum number of shares that may be earned and issued with respect to these awards over their full terms.
Share-Based Compensation
The following table summarizes share-based compensation included in costs and expenses (in millions):
 
Three Months Ended
 
October 31,
 
2017
 
2016
Cost of product revenue
$
1.9

 
$
1.7

Cost of subscription and support revenue
15.9

 
12.3

Research and development
37.5

 
38.0

Sales and marketing
51.2

 
43.8

General and administrative
19.2

 
17.5

Total share-based compensation
$
125.7

 
$
113.3

As of October 31, 2017, total compensation cost related to unvested share-based awards not yet recognized was $1.1 billion. This cost is expected to be amortized on a straight-line basis over a weighted-average period of approximately 2.6 years.
9. Income Taxes
Our provision for income taxes for the three months ended October 31, 2017 reflects an effective tax rate of (14.7)%. Our effective tax rate for this period was 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 period 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 months ended October 31, 2016 reflects an effective tax rate of (8.4)%. Our effective tax rate for this period was 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, U.S. state income taxes, and amortization of our deferred tax charges.
10. Net Loss Per Share
Basic net loss per share is computed by dividing net loss by basic weighted-average shares outstanding during the period. Diluted net loss per share is computed by dividing net 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
 
October 31,
 
2017
 
2016
Net loss
$
(64.0
)
 
$
(56.9
)
Weighted-average shares used to compute net loss per share, basic and diluted
90.9

 
89.8

Net loss per share, basic and diluted
$
(0.70
)
 
$
(0.63
)
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 Months Ended
 
October 31,
 
2017
 
2016
RSUs and PSUs
7.3

 
7.7

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
1.5

 
1.8

RSAs and PSAs
0.8

 
1.4

ESPP shares
0.1

 

Total
20.1

 
21.3

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; our plans to use the upfront cash reimbursement received from our landlords against future rental payments; 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.

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Results of Operations. A discussion of the nature and trends in our financial results and an analysis of our financial results comparing the three months ended October 31, 2017 to the three months ended October 31, 2016.
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.
Contractual Obligations and Commitments. An overview of our contractual obligations, contingent liabilities, commitments, and off-balance sheet arrangements outstanding as of October 31, 2017, including expected payment schedules.
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 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 cyberattacks. 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 operations and 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 comes in several physical and cloud-based software form-factors and delivers application, user, and content visibility and control as well as protection against network-based cyberthreats integrated within the firewall through our proprietary hardware and software architecture. Our Advanced Endpoint Protection software prevents cyberattacks that aim to run malicious code or exploit software vulnerabilities on a broad variety of fixed, mobile, 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 cyberattacks.
For the first quarter of fiscal 2018 and 2017, total revenue was $505.5 million and $398.1 million, respectively, representing year-over-year growth of 27.0%. Our growth reflects the increased adoption of our hybrid SaaS revenue model, which consists of product, subscriptions, 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 October 31, 2017, we had more than 45,000 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, subscriptions, and support to our distributors, which, in turn, sell to our resellers, which then sell to our end-customers.
Our product revenue was $186.5 million, or 36.9% of total revenue, for the first quarter of fiscal 2018, representing year-over-year growth of 13.9%. 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 $319.0 million, or 63.1% of total revenue, for the first quarter of fiscal 2018, representing year-over-year growth of 36.2%. 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 support in order to receive ongoing security updates, upgrades, bug fixes, and repairs. In addition to the subscriptions purchased with our firewall appliances, end-customers may also purchase other subscriptions on a per-user, per-endpoint, or capacity-based basis.
We continue to invest in and extend our platform, and in September 2017, we released two new cloud-based subscription offerings: our GlobalProtect cloud service subscription, which provides our Next Generation Security Platform as a cloud-based

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service for remote offices and mobile users; and our Logging Service subscription, which functions as the central cloud-based repository for application data and logs generated by our security offerings, including those of our firewalls and GlobalProtect cloud service subscription, and allows end-customers to collect data without needing to plan for local processing power and storage.
We plan to continue our investment in innovation as we evolve and further extend the capabilities of our platform, as we believe that innovation and timely development of new features and products is essential to meeting the needs of our end-customers and improving our competitive position. For example, in June 2017, we announced the next phase in the evolution of our Next-Generation Security Platform: our Palo Alto Networks Application Framework. Our cloud-based Application Framework will introduce a new SaaS consumption model under which our end-customers will be able to rapidly implement cloud-based security applications developed by us, third-party developers, or other security vendors, without having to deploy or manage additional products. We expect our Application Framework to become generally available in the first half of calendar year 2018, with continuous and ongoing introduction of new security applications.
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.” Certain prior period amounts in the tables and discussion that follow have been adjusted due to our early adoption of new share-based payment accounting guidance in our second quarter of fiscal 2017. For more information, refer to “Recently Adopted Accounting Pronouncements” in Note 1. Description of Business and Summary of Significant Accounting Policies included in Part II, Item 8 of our Annual Report on Form 10-K for the fiscal year ended July 31, 2017.
 
October 31, 2017
 
July 31, 2017
 
(in millions)
Total deferred revenue
$
1,864.5

 
$
1,773.5

Cash, cash equivalents, and investments
$
2,280.6

 
$
2,164.3

 
Three Months Ended October 31,
 
2017
 
2016
 
(dollars in millions)
Total revenue
$
505.5

 
$
398.1

Total revenue year-over-year percentage increase
27.0
 %
 
34.0
 %
Gross margin
72.0
 %
 
74.6
 %
Operating loss
$
(54.3
)
 
$
(49.0
)
Operating margin
(10.7
)%
 
(12.3
)%
Billings
$
596.5

 
$
516.9

Billings year-over-year percentage increase
15.4
 %
 
33.2
 %
Cash flow provided by operating activities
$
274.1

 
$
203.5

Free cash flow (non-GAAP)
$
241.9

 
$
182.6

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

- 18 -


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 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 October 31,
 
2017
 
2016
 
(in millions)
Billings:
 
 
 
Total revenue
$
505.5

 
$
398.1

Add: change in total deferred revenue, net of acquired deferred revenue
91.0

 
118.8

Billings
$
596.5

 
$
516.9

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:
 
Three Months Ended October 31,
 
2017
 
2016
 
(in millions)
Free cash flow (non-GAAP):
 
 
 
Net cash provided by operating activities
$
274.1

 
$
203.5

Less: purchases of property, equipment, and other assets
32.2

 
20.9

Free cash flow (non-GAAP)
$
241.9

 
$
182.6

Net cash used in investing activities
$
(52.4
)
 
$
(71.2
)
Net cash used in financing activities
$
(123.4
)
 
$
(27.3
)

- 19 -


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.
 
Three Months Ended October 31,
 
2017
 
2016
 
Amount
 
% of Revenue
 
Amount
 
% of Revenue
 
(dollars in millions)
Revenue:
 
 
 
 
 
 
 
Product
$
186.5

 
36.9
 %
 
$
163.8

 
41.1
 %
Subscription and support
319.0

 
63.1
 %
 
234.3

 
58.9
 %
Total revenue
505.5

 
100.0
 %
 
398.1

 
100.0
 %
Cost of revenue:
 
 
 
 
 
 
 
Product
57.6

 
11.4
 %
 
42.2

 
10.6
 %
Subscription and support
83.8

 
16.6
 %
 
59.0

 
14.8
 %
Total cost of revenue(1)
141.4

 
28.0
 %
 
101.2

 
25.4
 %
Total gross profit
364.1

 
72.0
 %
 
296.9

 
74.6
 %
Operating expenses:
 
 
 
 
 
 
 
Research and development
94.2

 
18.6
 %
 
84.2

 
21.2
 %
Sales and marketing
258.5

 
51.1
 %
 
220.1

 
55.3
 %
General and administrative
65.7

 
13.0
 %
 
41.6

 
10.4
 %
Total operating expenses(1)
418.4

 
82.7
 %
 
345.9

 
86.9
 %
Operating loss
(54.3
)
 
(10.7
)%
 
(49.0
)
 
(12.3
)%
Interest expense
(6.3
)
 
(1.2
)%
 
(6.0
)
 
(1.5
)%
Other income, net
4.8

 
0.9
 %
 
2.5

 
0.6
 %
Loss before income taxes
(55.8
)
 
(11.0
)%
 
(52.5
)
 
(13.2
)%
Provision for income taxes
8.2

 
1.7
 %
 
4.4

 
1.1
 %
Net loss
$
(64.0
)
 
(12.7
)%
 
$
(56.9
)
 
(14.3
)%
______________
(1)
Includes share-based compensation as follows:
 
Three Months Ended October 31,
 
2017
 
2016
Cost of product revenue
$
1.9

 
$
1.7

Cost of subscription and support revenue
15.9

 
12.3

Research and development
37.5

 
38.0

Sales and marketing
51.2

 
43.8

General and administrative
19.2

 
17.5

Total share-based compensation
$
125.7

 
$
113.3


- 20 -


Revenue
Our revenue consists of product revenue and subscription and support revenue. Revenue is recognized when persuasive evidence of an arrangement exists, delivery has occurred, the fee is fixed or determinable, and collectability is reasonably assured. We expect our revenue to vary from quarter to quarter based on seasonal and cyclical factors.
Product Revenue
Product revenue is derived primarily from sales of our appliances. Product revenue also includes revenue derived from software licenses of Panorama and the VM-Series. We recognize product revenue at the time of shipment, provided that all other revenue recognition criteria have been met.
 
Three Months Ended October 31,
 
 
 
 
 
2017
 
2016
 
Change
 
Amount
 
Amount
 
Amount
 
%
 
(dollars in millions)
Product
$
186.5

 
$
163.8

 
$
22.7

 
13.9
%
Product revenue increased for the three months ended October 31, 2017 compared to the three months ended October 31, 2016. The increase was primarily driven by demand for our newly introduced appliances. The change in product revenue due to pricing was not significant for either period.
Subscription and Support Revenue
Subscription and support revenue is derived primarily from sales of our subscription and support offerings. Our contractual subscription and support terms are typically one to five years. We recognize revenue from subscriptions and support over the contractual service period. As a percentage of total revenue, we expect our subscription and support revenue to vary from quarter to quarter and increase over the long term as we introduce new subscriptions, renew existing subscription and support contracts, and expand our installed end-customer base.
 
Three Months Ended October 31,
 
 
 
 
 
2017
 
2016
 
Change
 
Amount
 
Amount
 
Amount
 
%
 
(dollars in millions)
Subscription
$
169.3

 
$
121.2

 
$
48.1

 
39.7
%
Support
149.7

 
113.1

 
36.6

 
32.4
%
Total subscription and support
$
319.0

 
$
234.3

 
$
84.7

 
36.2
%
Subscription and support revenue increased for the three months ended October 31, 2017 compared to the three months ended October 31, 2016. The increase was due to increased demand for our subscription and support offerings from both new and existing end-customers. The mix between subscription revenue and support revenue will fluctuate over time, depending on the introduction of new subscription offerings, renewals of support services, and our ability to increase sales to new and existing customers. The change in subscription and support revenue due to changes in pricing was not significant for either period.
Revenue by Geographic Theater
 
Three Months Ended October 31,
 
 
 
 
 
2017
 
2016
 
Change
 
Amount
 
Amount
 
Amount
 
%
 
(dollars in millions)
Americas
$
351.3

 
$
280.2

 
$
71.1

 
25.4
%
EMEA
95.4

 
70.7

 
24.7

 
34.9
%
APAC
58.8

 
47.2

 
11.6

 
24.6
%
Total revenue
$
505.5

 
$
398.1

 
$
107.4

 
27.0
%

- 21 -


With respect to geographic theaters, the Americas contributed the largest portion of the increase in revenue for the three months ended October 31, 2017 compared to the three months ended October 31, 2016, due to its larger and more established sales force compared to our other theaters. Revenue from both Europe, the Middle East, and Africa (“EMEA”) and Asia Pacific and Japan (“APAC”) increased for the three months ended October 31, 2017 compared to the three months ended October 31, 2016, due to our investment in increasing the size of our sales force and number of channel partners in these theaters.
Cost of Revenue
Our cost of revenue consists of cost of product revenue and cost of subscription and support revenue.
Cost of Product Revenue
Cost of product revenue primarily includes costs paid to our manufacturing partners. Our cost of product revenue also includes personnel costs, which consist of salaries, benefits, bonuses, share-based compensation, and travel and entertainment associated with our operations organization, amortization of intellectual property licenses, product testing costs, shipping costs, and allocated costs. Allocated costs consist of certain facilities, depreciation, benefits, recruiting, and information technology costs that we allocate based on headcount. We expect our cost of product revenue to increase as our product revenue increases.
 
Three Months Ended October 31,
 
 
 
 
 
2017
 
2016
 
Change
 
Amount
 
Amount
 
Amount
 
%
 
(dollars in millions)
Cost of product revenue
$
57.6

 
$
42.2

 
$
15.4

 
36.5
%
Number of employees at period end
98

 
92

 
6

 
6.5
%
Cost of product revenue increased for the three months ended October 31, 2017 compared to the three months ended October 31, 2016. The increase was primarily due to higher product costs related to our newly introduced appliances.
Cost of Subscription and Support Revenue
Cost of subscription and support revenue includes personnel costs for our global customer support and technical operations organizations, customer support costs, third-party professional services costs, data center and hosting costs, amortization of acquired intangible assets, and allocated costs. We expect our cost of subscription and support revenue to increase as our installed end-customer base grows and adoption of our cloud-based subscription offerings increases.
 
Three Months Ended October 31,
 
 
 
 
 
2017
 
2016
 
Change
 
Amount
 
Amount
 
Amount
 
%
 
(dollars in millions)
Cost of subscription and support revenue
$
83.8

 
$
59.0

 
$
24.8

 
42.0
%
Number of employees at period end
778

 
575

 
203

 
35.3
%
Cost of subscription and support revenue increased for the three months ended October 31, 2017 compared to the three months ended October 31, 2016, driven by an increase in personnel costs, which grew $12.5 million to $47.1 million for the three months ended October 31, 2017 compared to the three months ended October 31, 2016. The increase in personnel costs was primarily due to headcount growth. The remaining increase was primarily due to costs to expand our customer service capabilities and infrastructure, customer support costs, and allocated costs. The increase in allocated costs was primarily due to our expansion of facilities to support the growth of our business.
Gross Margin
Gross margin, or gross profit as a percentage of revenue, has been and will continue to be affected by a variety of factors, including the introduction of new products, manufacturing costs, the average sales price of our products, the mix of products sold, and the mix of revenue between product and subscription and support offerings. For sales of our products, our higher-end firewall products generally have higher gross margins than our lower-end firewall products within each product series. For sales of our subscription and support offerings, our subscription offerings typically have higher gross margins than our support offerings. We expect our gross margins to fluctuate over time depending on the factors described above.

- 22 -


 
Three Months Ended October 31,
 
2017
 
2016
 
Amount
 
Gross Margin
 
Amount
 
Gross Margin
 
(dollars in millions)
Product
$
128.9

 
69.1
%
 
$
121.6

 
74.2
%
Subscription and support
235.2

 
73.7
%
 
175.3

 
74.8
%
Total gross profit
$
364.1

 
72.0
%
 
$
296.9

 
74.6
%
Product gross margin decreased for the three months ended October 31, 2017 compared to the three months ended October 31, 2016, driven by higher product costs related to our newly introduced appliances, which will have lower product margins.
Subscription and support gross margin decreased for the three months ended October 31, 2017 compared to the three months ended October 31, 2016, primarily due to higher costs related to the expansion of our infrastructure to support the adoption of our cloud-based subscription offerings.
Operating Expenses
Our operating expenses consist of research and development, sales and marketing, and general and administrative expense. Personnel costs are the most significant component of operating expenses and consist of salaries, benefits, bonuses, share-based compensation, travel and entertainment, and with regard to sales and marketing expense, sales commissions. Our operating expenses also include allocated costs, which consist of certain facilities, depreciation, benefits, recruiting, and information technology costs that we allocate based on headcount. We expect operating expenses to increase in absolute dollars and decrease over the long term as a percentage of revenue as we continue to scale our business. As of October 31, 2017, we expect to recognize approximately $1.1 billion of share-based compensation expense over a weighted-average period of approximately 2.6 years, excluding additional share-based compensation expense related to any future grants of share-based awards. Share-based compensation expense is generally recognized on a straight-line basis over the requisite service periods of the awards.
Research and Development
Research and development expense consists primarily of personnel costs. Research and development expense also includes prototype related expenses and allocated costs. We expect research and development expense to increase in absolute dollars as we continue to invest in our future products and services, although our research and development expense may fluctuate as a percentage of total revenue.
 
Three Months Ended October 31,
 
 
 
 
 
2017
 
2016
 
Change
 
Amount
 
Amount
 
Amount
 
%
 
(dollars in millions)
Research and development
$
94.2

 
$
84.2

 
$
10.0

 
11.9
%
Number of employees at period end
787

 
648

 
139

 
21.5
%
Research and development expense increased for the three months ended October 31, 2017 compared to the three months ended October 31, 2016, primarily due to an increase in personnel costs, which grew $5.8 million to $77.7 million, largely due to headcount growth, and allocated costs due to our expansion of facilities to support the growth of our business.
Sales and Marketing
Sales and marketing expense consists primarily of personnel costs, including commission expense. Sales and marketing expense also includes costs for market development programs, promotional and other marketing costs, professional services, and allocated costs. We continue to thoughtfully invest in headcount and have substantially grown our sales presence internationally. We expect sales and marketing expense to continue to increase in absolute dollars as we increase the size of our sales and marketing organizations to increase touch points with end-customers and to expand our international presence, although our sales and marketing expense may fluctuate as a percentage of total revenue.

- 23 -


 
Three Months Ended October 31,
 
 
 
 
 
2017
 
2016
 
Change
 
Amount
 
Amount
 
Amount
 
%
 
(dollars in millions)
Sales and marketing
$
258.5

 
$
220.1

 
$
38.4

 
17.4
%
Number of employees at period end
2,466

 
2,181

 
285

 
13.1
%
Sales and marketing expense increased for the three months ended October 31, 2017 compared to the three months ended October 31, 2016, primarily due to an increase in personnel costs, which grew $31.8 million to $196.9 million, largely due to headcount growth. The remaining increase was primarily driven by an increase in allocated costs due to our expansion of facilities to support the growth of our business.
General and Administrative
General and administrative expense consists primarily of personnel costs for our executive, finance, human resources, legal, and information technology organizations, professional services costs, which consist primarily of legal, auditing, accounting, and other consulting costs, and certain non-recurring general expenses. Certain facilities, depreciation, benefits, recruiting, and information technology costs are allocated to other organizations based on headcount. We expect general and administrative expense to increase in absolute dollars due to additional costs associated with accounting, compliance, and insurance, although our general and administrative expense may fluctuate as a percentage of total revenue.
 
Three Months Ended October 31,
 
 
 
 
 
2017
 
2016
 
Change
 
Amount
 
Amount
 
Amount
 
%
 
(dollars in millions)
General and administrative
$
65.7

 
$
41.6

 
$
24.1

 
57.9
%
Number of employees at period end
578

 
464

 
114

 
24.6
%
General and administrative expense increased for the three months ended October 31, 2017 compared to the three months ended October 31, 2016, primarily due to a loss of $15.4 million recognized on the lease of our previous headquarter facilities in August 2017, when we officially ceased use of such facilities. Refer to Note 6. Commitments and Contingencies in Part I, Item 1 of this Quarterly Report on Form 10-Q for more information on our cease-use loss. The remaining increase was primarily driven by an increase in personnel costs, which grew $3.9 million to $34.9 million for the three months ended October 31, 2017 compared to the three months ended October 31, 2016, due to headcount growth, and an increase in allocated costs due to our expansion of facilities to support the growth of our business.
Provision for Income Taxes
Provision for income taxes consists primarily of income taxes in foreign jurisdictions in which we conduct business, withholding taxes, U.S. state income taxes, and amortization of our deferred tax charges. We maintain a full valuation allowance for domestic and certain foreign deferred tax assets, including net operating loss carryforwards and tax credits.
 
Three Months Ended October 31,
 
Change 
 
2017
 
2016
 
Amount
 
%
 
(dollars in millions)
Provision for income taxes
$
8.2

 
$
4.4

 
$
3.8

 
86.4
%
Effective tax rate
(14.7
)%
 
(8.4
)%
 


 
 
We recorded an income tax provision for the three months ended October 31, 2017, due to foreign income taxes, withholding taxes, and amortization of our deferred tax charges. The provision for income taxes increased for the three months ended October 31, 2017 compared to the three months ended October 31, 2016, primarily due to an increase in amortization of our deferred tax charges from intercompany transactions and an increase in foreign taxes due to growth in non-U.S. operations.

- 24 -


Liquidity and Capital Resources
 
October 31, 2017
 
July 31, 2017
 
(in millions)
Working capital(1)
$
296.5

 
$
775.0

Cash, cash equivalents, and investments:
 
 
 
Cash and cash equivalents
$
842.6

 
$
744.3

Investments
1,438.0

 
1,420.0

Total cash, cash equivalents, and investments
$
2,280.6

 
$
2,164.3

______________
(1)
The net carrying amount of the 0.0% Convertible Senior Notes due 2019 (the “Notes”) was classified in current liabilities in our condensed consolidated balance sheets as of October 31, 2017. Refer to Note 5. Convertible Senior Notes in Part I, Item 1 of this Quarterly Report on Form 10-Q for more information.
At October 31, 2017, our total cash, cash equivalents, and investments of $2.3 billion were held for general corporate purposes, of which approximately $296.4 million was held outside of the United States. As of October 31, 2017, we had no unremitted earnings when evaluating our outside basis differences relating to our investment in foreign subsidiaries; accordingly, there is no restriction on the use of these funds.
As of October 31, 2017, all of the Notes remained outstanding. The Notes mature on July 1, 2019, however, prior to January 1, 2019, holders may surrender their Notes for early conversion under certain circumstances. During the fiscal quarter ended October 31, 2017, one of the early conversion conditions was met, and as a result, holders may convert their Notes at any time during the fiscal quarter ending January 31, 2018. Upon conversion, we will pay cash equal to the aggregate principal amount of the Notes to be converted, and, at our election, will pay or deliver cash and/or shares of our common stock for the amount of our conversion obligation in excess of the aggregate principal amount of the Notes being converted. Refer to Note 5. Convertible Senior Notes in Part I, Item 1 of this Quarterly Report on Form 10-Q for information on the Notes.
In August 2016, our board of directors authorized a $500.0 million share repurchase and, in February 2017, authorized a $500.0 million increase to our repurchase program, bringing the total authorization to $1.0 billion. Repurchases are funded from available working capital and may be made at management’s discretion from time to time. The repurchase authorization will expire on December 31, 2018, and may be suspended or discontinued at any time. As of October 31, 2017, $455.0 million remained available for future share repurchases under the repurchase authorization. Refer to Note 7. Stockholders’ Equity in Part I, Item 1 of this Quarterly Report on Form 10-Q for information on the repurchase authorization.
The following table summarizes our cash flows for the three months ended October 31, 2017 and 2016:
 
Three Months Ended October 31,
2017
 
2016
 
(in millions)
Net cash provided by operating activities
$
274.1

 
$
203.5

Net cash used in investing activities
(52.4
)
 
(71.2
)
Net cash used in financing activities
(123.4
)
 
(27.3
)
Net increase in cash and cash equivalents
$
98.3

 
$
105.0

We believe that our cash flow from operations with existing cash and cash equivalents will be sufficient to meet our anticipated cash needs for the foreseeable future. Our future capital requirements will depend on many factors including our growth rate, the timing and extent of spending to support development efforts, the expansion of sales and marketing activities, the introduction of new and enhanced products and subscription and support offerings, the costs to acquire or invest in complementary businesses and technologies, the costs to ensure access to adequate manufacturing capacity, the investments in our new corporate headquarters, and the continuing market acceptance of our products and subscription and support offerings. In addition, from time to time we may incur additional tax liability in connection with certain corporate structuring decisions.
We may also choose 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, our business, operating results, and financial condition may be adversely affected.

- 25 -


Operating Activities
Our operating activities have consisted of net losses adjusted for certain non-cash items and changes in assets and liabilities.
Cash provided by operating activities during the three months ended October 31, 2017 was $274.1 million, an increase of $70.6 million compared to the three months ended October 31, 2016. The increase was due to growth of our business, as reflected by increases in billings and collections on accounts receivable, and the receipt of an upfront cash reimbursement of $38.2 million related to certain of our lease agreements during the three months ended October 31, 2017. The upfront cash reimbursement was received from our landlords in connection with the amendment of our lease agreements and will be applied against rental payments due in fiscal years 2018 through 2020. Refer to Note 6. Commitments and Contingencies in Part I, Item 1 of this Quarterly Report on Form 10-Q for more information.
Investing Activities
Our investing activities have consisted of capital expenditures, net investment purchases, sales, and maturities, and business acquisitions. We expect to continue such activities as our business grows.
Cash used in investing activities during the three months ended October 31, 2017 was $52.4 million, a decrease of $18.8 million compared to the three months ended October 31, 2016, due to lower net purchases of available-for-sale investments, partially offset by increased investment in facilities to support the growth of our business during the three months ended October 31, 2017.
Financing Activities
Our financing activities have consisted of proceeds from sales of shares through employee equity incentive plans, cash used to repurchase shares of our common stock, and payments for tax withholding obligations of certain employees related to the net share settlement of equity awards.
Cash used in financing activities during the three months ended October 31, 2017 was $123.4 million, an increase of $96.1 million compared to the three months ended October 31, 2016, primarily due to an increase in repurchases of our common stock and payments for tax withholding obligations of certain employees related to the net share settlement of equity awards during the three months ended October 31, 2017.
Contractual Obligations and Commitments
The following table summarizes our contractual obligations and commitments as of October 31, 2017:
 
Payments Due by Period 
 
Total 
 
Less Than 
1 Year
 
1-3 Years
 
3-5 Years
 
More Than 
5 Years
 
 
 
(in millions)
 
 
0.0% Convertible Senior Notes due 2019(1)
$
575.0

 
$

 
$
575.0

 
$

 
$

Operating lease obligations(2) 
562.2

 
63.1

 
129.7

 
115.7

 
253.7

Purchase obligations(3)
95.3

 
92.5

 
2.8

 

 

Total(4)
$
1,232.5

 
$
155.6

 
$
707.5

 
$
115.7

 
$
253.7

______________
(1)
As of October 31, 2017, holders may convert their Notes at any time during the fiscal quarter ending January 31, 2018. Refer to Note 5. Convertible Senior Notes in Part I, Item 1 of this Quarterly Report on Form 10-Q for more information.
(2)
Consists of contractual obligations from our non-cancelable operating leases. Excludes contractual sublease proceeds of $1.3 million, which will be received in less than one year. Refer to Note 6. Commitments and Contingencies in Part I, Item 1 of this Quarterly Report on Form 10-Q for more information on our operating leases.
(3)
Consists of minimum purchase commitments of products and components with our manufacturing partners and component suppliers. Obligations under contracts that we can cancel without a significant penalty are not included in the table above.
(4)
No amounts related to income taxes are included. As of October 31, 2017, we had approximately $65.3 million of tax liabilities recorded related to uncertainty in income tax positions.

- 26 -


Off-Balance Sheet Arrangements
As of October 31, 2017, we did not have any relationships with unconsolidated organizations or financial partnerships, such as structured finance or special purpose entities that would have been established for the purpose of facilitating off-balance sheet arrangements or other contractually narrow or limited purposes.
Critical Accounting Estimates
Our condensed consolidated financial statements have been prepared in accordance with U.S. GAAP. The preparation of these condensed consolidated financial statements requires us to make estimates and assumptions that affect the reported amounts of assets, liabilities, revenue, expenses, and related disclosures. We base our estimates on historical experience and on various other assumptions that we believe are reasonable under the circumstances. We evaluate our estimates and assumptions on an ongoing basis. Actual results may differ from these estimates. To the extent that there are material differences between these estimates and our actual results, our future financial statements will be affected.
We believe the critical accounting estimates discussed under Item 7, “Management’s Discussion and Analysis of Financial Condition and Results of Operations” in our Annual Report on Form 10-K for the fiscal year ended July 31, 2017, reflect our more significant judgments and estimates used in the preparation of our condensed consolidated financial statements. There have been no significant changes to our critical accounting estimates as filed in such report.
Recent Accounting Pronouncements
Refer to “Recently Issued Accounting Pronouncements” in Note 1. Description of Business and Summary of Significant Accounting Policies in Part I, Item 1 of this Quarterly Report on Form 10-Q.
ITEM 3.
QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Our assessment of our exposures to market risk have not changed materially since the presentation set forth in Part II, Item 7A of our Annual Report on Form 10-K for the fiscal year ended July 31, 2017.
ITEM 4.
CONTROLS AND PROCEDURES
Evaluation of Disclosure Controls and Procedures
Our management, with the participation of our chief executive officer and chief financial officer, evaluated the effectiveness of our disclosure controls and procedures pursuant to Rule 13a-15 under the Securities Exchange Act of 1934, as amended (the “Exchange Act”), as of the end of the period covered by this report. Based on our evaluation, our chief executive officer and chief financial officer concluded that, as of October 31, 2017, our disclosure controls and procedures are designed at a reasonable assurance level and are effective to provide reasonable assurance that information we are required to disclose in reports that we file or submit under the Exchange Act is recorded, processed, summarized, and reported within the time periods specified in SEC rules and forms, and that such information is accumulated and communicated to our management, including our chief executive officer and chief financial officer, as appropriate, to allow timely decisions regarding required disclosure.
Changes in Internal Control over Financial Reporting
There were no changes in our internal control over financial reporting identified in connection with the evaluation required by Rule 13a-15(d) and 15d-15(d) of the Exchange Act that occurred during the quarter ended October 31, 2017 that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.
Limitations on Controls
In designing and evaluating the disclosure controls and procedures, management recognizes that any controls and procedures, no matter how well designed and operated, can provide only reasonable assurance of achieving the desired control objectives. In addition, the design of disclosure controls and procedures must reflect the fact that there are resource constraints and that management is required to apply its judgment in evaluating the benefits of possible controls and procedures relative to their costs. Further, no evaluation of controls can provide absolute assurance that misstatements due to error or fraud will not occur or that all control issues and instances of fraud, if any, within the Company have been detected.

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PART II
ITEM 1.
LEGAL PROCEEDINGS
The information set forth under the “Litigation” subheading in Note 6. Commitments and Contingencies in Part I, Item 1 of this Quarterly Report on Form 10-Q is incorporated herein by reference.
ITEM 1A.
RISK FACTORS
Our operations and financial results are subject to various risks and uncertainties including those described below. The risks and uncertainties described below are not the only ones we face. Additional risks and uncertainties that we are unaware of, or that we currently believe are not material, also may become important factors that affect us. If any of the following risks or others not specified below materialize, our business, financial condition, and operating results could be materially adversely affected and the market price of our common stock could decline.
Risks Related to Our Business and Our Industry
Our business and operations have experienced rapid growth in recent periods, and if we do not effectively manage any future growth or are unable to improve our systems, processes, and controls, our operating results could be adversely affected.
We have experienced rapid growth and increased demand for our products and subscriptions over the last few years. As a result, our employee headcount and number of end-customers have increased significantly, and we expect both to continue to grow over the next year. For example, from the end of fiscal 2017 to the end of the first quarter of fiscal 2018, our headcount increased from 4,562 to 4,707 employees, and our number of end-customers increased from more than 42,500 to more than 45,000. In addition, as we have grown, we have increasingly managed more complex deployments of our products and subscriptions with larger end-customers. The growth and expansion of our business and product, subscription, and support offerings places a significant strain on our management, operational, and financial resources. 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 our ability to manage headcount, capital, and processes in an efficient manner.
We may not be able to successfully implement or scale improvements to our systems, processes, and controls in an efficient or timely manner. In addition, our existing systems, processes, and controls may not prevent or detect all errors, omissions, or fraud. We may also experience difficulties in managing improvements to our systems, processes, and controls or in connection with third-party software licensed to help us with such improvements. Any future growth would add complexity to our organization and require effective coordination throughout our organization. Failure to manage any future growth effectively could result in increased costs, disrupt our existing end-customer relationships, reduce demand for or limit us to smaller deployments of our platform, or harm our business performance and operating results.
Our operating results may vary significantly from period to period and be unpredictable, which could cause the market price of our common stock to decline.
Our operating results, in particular, our revenues, gross margins, operating margins, and operating expenses, have historically varied from period to period, and even though we have experienced growth, we expect variation to continue as a result of a number of factors, many of which are outside of our control and may be difficult to predict, including:
our ability to attract and retain new end-customers or sell additional products and subscriptions to our existing end-customers;
the budgeting cycles, seasonal buying patterns, and purchasing practices of end-customers;
changes in end-customer, distributor or reseller requirements, or market needs;
price competition;
the timing and success of new product and service introductions by us or our competitors or any other change in the competitive landscape of our industry, including consolidation among our competitors or end-customers and strategic partnerships entered into by and between our competitors;
changes in the mix of our products, subscriptions, and support, including changes in multi-year subscriptions and support;
our ability to successfully and continuously expand our business domestically and internationally;
changes in the growth rate of the enterprise security market;

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deferral of orders from end-customers in anticipation of new products or product enhancements announced by us or our competitors;
the timing and costs related to the development or acquisition of technologies or businesses or strategic partnerships;
lack of synergy or the inability to realize expected synergies, resulting from acquisitions or strategic partnerships;
our inability to execute, complete or integrate efficiently any acquisitions that we may undertake;
increased expenses, unforeseen liabilities, or write-downs and any impact on our operating results from any acquisitions we consummate;
our ability to increase the size and productivity of our distribution channel;
decisions by potential end-customers to purchase security solutions from larger, more established security vendors or from their primary network equipment vendors;
changes in end-customer penetration, attach, and renewal rates for our subscriptions;
timing of revenue recognition and revenue deferrals;
our ability to manage production and manufacturing related costs, global customer service organization costs, inventory excess and obsolescence costs, and warranty costs;
insolvency or credit difficulties confronting our end-customers, which could adversely affect their ability to purchase or pay for our products and subscription and support offerings, or confronting our key suppliers, including our sole source suppliers, which could disrupt our supply chain;
any disruption in our channel or termination of our relationships with important channel partners, including as a result of consolidation among distributors and resellers of security solutions;
our inability to fulfill our end-customers’ orders due to supply chain delays or events that impact our manufacturers or their suppliers;
the cost and potential outcomes of litigation, which could have a material adverse effect on our business;
seasonality or cyclical fluctuations in our markets;
future accounting pronouncements or changes in our accounting policies, including the potential impact of the adoption and implementation of the Financial Accounting Standards Board’s new standard regarding revenue recognition;
increases or decreases in our expenses caused by fluctuations in foreign currency exchange rates, as an increasing amount of our expenses is incurred and paid in currencies other than the U.S. dollar;
political, economic and social instability, such as those caused by the upcoming elections in Europe, the referendum on June 23, 2016 in which voters in the United Kingdom (the “U.K.”) approved an exit from the European Union (the “E.U.”), which is commonly referred to as “Brexit,” continued hostilities in the Middle East, terrorist activities, and any disruption these events may cause to the broader global industrial economy; and
general macroeconomic conditions, both domestically and in our foreign markets that could impact some or all regions where we operate.
Any one of the factors above, or the cumulative effect of some of the factors referred to above, may result in significant fluctuations in our financial and other operating results. This variability and unpredictability could result in our failure to meet our revenue, margin, or other operating result expectations or those of securities analysts or investors for a particular period. If we fail to meet or exceed such expectations for these or any other reasons, the market price of our common stock could fall substantially, and we could face costly lawsuits, including securities class action suits.
Uncertain or weakened global economic conditions could have an adverse effect on our business and operating results.
We operate globally and as a result our business and revenues are impacted by global macroeconomic conditions. The global macroeconomic environment has been and may continue to be inconsistent and challenging due to instability in the global credit markets, the current economic challenges in China, falling demand for oil and other commodities, uncertainties regarding the effects of “Brexit,” uncertainties related to changes in public policies such as domestic and international regulations, taxes, or international trade agreements, geopolitical turmoil and other disruptions to global and regional economies and markets. As a result, any continued or further uncertainty, weakness or deterioration in global macroeconomic and market conditions may cause our end-customers to modify spending priorities or delay purchasing decisions, and result in lengthened sales cycles, all of which could harm our business and operating results.

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Our revenue growth rate in recent periods may not be indicative of our future performance.
We have experienced revenue growth rates of 27.0% and 34.0% in the first quarter of fiscal 2018 and fiscal 2017, respectively. Our revenue for any prior quarterly or annual period should not be relied upon as an indication of our future revenue or revenue growth for any future period. If we are unable to maintain consistent revenue or revenue growth, the market price of our common stock could be volatile, and it may be difficult for us to achieve and maintain profitability or maintain or increase cash flow on a consistent basis.
We have a history of losses, anticipate increasing our operating expenses in the future, and may not be able to achieve or maintain profitability or maintain or increase cash flow on a consistent basis, which could cause our business, financial condition, and operating results to suffer.
Other than fiscal 2012, we have incurred losses in all fiscal years since our inception. As a result, we had an accumulated deficit of $900.7 million at October 31, 2017. We anticipate that our operating expenses will continue to increase in the foreseeable future as we continue to grow our business. Our growth efforts may prove more expensive than we currently anticipate, and we may not succeed in increasing our revenues sufficiently, or at all, to offset increasing expenses. Revenue growth may slow or revenue may decline for a number of possible reasons, including slowing demand for our products or subscriptions, increasing competition, a decrease in the growth of our overall market, or a failure to capitalize on growth opportunities. Any failure to increase our revenue as we grow our business could prevent us from achieving or maintaining profitability or maintaining or increasing cash flow on a consistent basis. In addition, we may have difficulty achieving profitability under U.S. GAAP due to share-based compensation expense and other non-cash charges. If we are unable to navigate these challenges as we encounter them, our business, financial condition, and operating results may suffer.
If we are unable to sell additional product, subscription, and support offerings to our end-customers, our future revenue and operating results will be harmed.
Our future success depends, in part, on our ability to expand the deployment of our platform with existing end-customers. This may require increasingly sophisticated and costly sales efforts that may not result in additional sales. The rate at which our end-customers purchase additional products, subscriptions, and support depends on a number of factors, including the perceived need for additional security products, including subscription and support offerings, as well as general economic conditions. Further, existing end-customers have no contractual obligation to and may not renew their subscription and support contracts after the completion of their initial contract period. Our end-customers’ renewal rates may decline or fluctuate as a result of a number of factors, including their satisfaction with our subscriptions and our support offerings, the frequency and severity of subscription outages, our product uptime or latency, and the pricing of our, or competing, subscriptions. Additionally, our end-customers may renew their subscription and support agreements for shorter contract lengths or on other terms that are less economically beneficial to us. We also cannot be certain that our end-customers will renew their subscription and support agreements. If our efforts to sell additional products and subscriptions to our end-customers are not successful or our end-customers do not renew their subscription and support agreements or renew on less favorable terms, our revenues may grow more slowly than expected or decline.
We face intense competition in our market, especially from larger, well-established companies, and we may lack sufficient financial or other resources to maintain or improve our competitive position.
The market for enterprise security products is intensely competitive, and we expect competition to increase in the future from established competitors and new market entrants. Our main competitors fall into three categories:
large companies that incorporate security features in their products, such as Cisco Systems, Inc. (“Cisco”) and Juniper Networks, Inc. (“Juniper”), or those that have acquired, or may acquire, large network and endpoint security vendors and have the technical and financial resources to bring competitive solutions to the market;
independent security vendors, such as Symantec Corporation, Check Point Software Technologies Ltd. (“Check Point”), Fortinet, Inc., and FireEye, Inc., that offer a mix of network and endpoint security products; and
small and large companies that offer point solutions and/or cloud security services that compete with some of the features present in our platform.
Many of our existing competitors have, and some of our potential competitors could have, substantial competitive advantages such as:
greater name recognition and longer operating histories;
larger sales and marketing budgets and resources;
broader distribution and established relationships with distribution partners and end-customers;
greater customer support resources;

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greater resources to make strategic acquisitions or enter into strategic partnerships;
lower labor and development costs;
larger and more mature intellectual property portfolios; and
substantially greater financial, technical, and other resources.
In addition, some of our larger competitors have substantially broader and more diverse product and services offerings, which may make them less susceptible to downturns in a particular market and allow them to leverage their relationships based on other products or incorporate functionality into existing products to gain business in a manner that discourages users from purchasing our products and subscriptions, including through selling at zero or negative margins, offering concessions, product bundling, or closed technology platforms. Many of our smaller competitors that specialize in providing protection from a single type of security threat are often able to deliver these specialized security products to the market more quickly than we can.
Organizations that use legacy products and services may believe that these products and services are sufficient to meet their security needs or that our platform only serves the needs of a portion of the enterprise security market. Accordingly, these organizations may continue allocating their information technology budgets for legacy products and services and may not adopt our security platform. Further, many organizations have invested substantial personnel and financial resources to design and operate their networks and have established deep relationships with other providers of networking and security products. As a result, these organizations may prefer to purchase from their existing suppliers rather than add or switch to a new supplier such as us regardless of product performance, features, or greater services offerings or may be more willing to incrementally add solutions to their existing security infrastructure from existing suppliers than to replace it wholesale with our solutions.
Conditions in our market could change rapidly and significantly as a result of technological advancements, partnering or acquisitions by our competitors, or continuing market consolidation. New start-up companies that innovate and large competitors that are making significant investments in research and development may invent similar or superior products and technologies that compete with our products and subscriptions. Some of our competitors have made or could make acquisitions of businesses that may allow them to offer more directly competitive and comprehensive solutions than they had previously offered and adapt more quickly to new technologies and end-customer needs. Our current and potential competitors may also establish cooperative relationships among themselves or with third parties that may further enhance their resources.
These competitive pressures in our market or our failure to compete effectively may result in price reductions, fewer orders, reduced revenue and gross margins, and loss of market share. Any failure to meet and address these factors could seriously harm our business and operating results.
A network or data security incident may allow unauthorized access to our network or data, harm our reputation, create additional liability and adversely impact our financial results.
Increasingly, companies are subject to a wide variety of attacks on their networks on an ongoing basis. In addition to traditional computer “hackers,” malicious code (such as viruses and worms), phishing attempts, employee theft or misuse, and denial of service attacks, sophisticated nation-state and nation-state supported actors now engage in intrusions and attacks (including advanced persistent threat intrusions) and add to the risks to our internal networks and the information they store and process. Despite significant efforts to create security barriers to such threats, it is virtually impossible for us to entirely mitigate these risks. Furthermore, as a well-known provider of security solutions, we may be a more attractive target for such attacks. A breach in our data security could compromise our networks or networks secured by our products and subscriptions, creating system disruptions or slowdowns and exploiting security vulnerabilities of our products, and the information stored on our networks could be accessed, publicly disclosed, altered, lost, or stolen, which could subject us to liability and cause us financial harm. Although we have not yet experienced significant damages from unauthorized access by a third party of our internal network, any actual or perceived breach of network security in our internal systems could result in damage to our reputation, negative publicity, loss of channel partners, end-customers and sales, loss of competitive advantages over our competitors, increased costs to remedy any problems, and costly litigation. Any of these negative outcomes could adversely impact the market perception of our products and subscriptions and investor confidence in our company and could seriously harm our business or operating results.
Reliance on shipments at the end of the quarter could cause our revenue for the applicable period to fall below expected levels.
As a result of end-customer buying patterns and the efforts of our sales force and channel partners to meet or exceed their sales objectives, we have historically received a substantial portion of sales orders and generated a substantial portion of revenue during the last few weeks of each fiscal quarter. If expected revenue at the end of any fiscal quarter is delayed for any reason, including the failure of anticipated purchase orders to materialize (particularly for large enterprise end-customers with lengthy sales cycles), our logistics partners’ inability to ship products prior to fiscal quarter-end to fulfill purchase orders received near the end of the fiscal quarter, our failure to manage inventory to meet demand, any failure of our systems related to order review and processing, or any delays in shipments based on trade compliance requirements (including new compliance requirements imposed by new or renegotiated

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trade agreements), revenue could fall below our expectations and the estimates of analysts for that quarter, which could adversely impact our business and operating results and cause a decline in the market price of our common stock.
Seasonality may cause fluctuations in our revenue.
We believe there are significant seasonal factors that may cause our second and fourth fiscal quarters to record greater revenue sequentially than our first and third fiscal quarters. We believe that this seasonality results from a number of factors, including:
end-customers with a December 31 fiscal year-end choosing to spend remaining unused portions of their discretionary budgets before their fiscal year-end, which potentially results in a positive impact on our revenue in our second fiscal quarter;
our sales compensation plans, which are typically structured around annual quotas and commission rate accelerators, which potentially results in a positive impact on our revenue in our fourth fiscal quarter;
seasonal reductions in business activity during August in the United States, Europe and certain other regions, which potentially results in a negative impact on our first fiscal quarter revenue; and
the timing of end-customer budget planning at the beginning of the calendar year, which can result in a delay in spending at the beginning of the calendar year potentially resulting in a negative impact on our revenue in our third fiscal quarter.
As we continue to grow, seasonal or cyclical variations in our operations may become more pronounced, and our business, operating results and financial position may be adversely affected.
If we are unable to hire, integrate, train, retain, and motivate qualified personnel and senior management, our business could suffer.
Our future success depends, in part, on our ability to continue to attract, integrate, train, and retain qualified and highly skilled personnel. We are substantially dependent on the continued service of our existing engineering personnel because of the complexity of our platform. Additionally, any failure to hire, train, and adequately incentivize our sales personnel or the inability of our recently hired sales personnel to effectively ramp to target productivity levels could negatively impact our growth and operating margins. Competition for highly skilled personnel, particularly in engineering, is often intense, especially in the San Francisco Bay Area, where we have a substantial presence and need for such personnel. Additionally, potential changes in U.S. immigration policy may make it difficult to renew or obtain visas for any highly skilled personnel that we have hired or are actively recruiting.
In addition, the industry in which we operate generally experiences high employee attrition. Although we have entered into employment offer letters with our key personnel, these agreements have no specific duration and constitute at-will employment. We do not maintain key person life insurance policies on any of our employees. The loss of one or more of our key employees could seriously harm our business. If we are unable to attract, integrate, train, or retain the qualified and highly skilled personnel required to fulfill our current or future needs, our business, financial condition, and operating results could be harmed.
Our future performance also depends on the continued services and continuing contributions of our senior management to execute on our business plan and to identify and pursue new opportunities and product innovations. The loss of services of senior management or the ineffective management of any leadership transitions, especially within our sales organization, could significantly delay or prevent the achievement of our development and strategic objectives, which could adversely affect our business, financial condition, and operating results.
Further, we believe that a critical contributor to our success and our ability to retain highly skilled personnel has been our corporate culture, which we believe fosters innovation, teamwork, passion for end-customers, focus on execution, and the facilitation of critical knowledge transfer and knowledge sharing. As we grow and change, we may find it difficult to maintain these important aspects of our corporate culture. Any failure to preserve our culture as we grow could limit our ability to innovate and could negatively affect our ability to retain and recruit personnel, continue to perform at current levels or execute on our business strategy.
If we are not successful in executing our strategy to increase sales of our products and subscriptions to new and existing medium and large enterprise end-customers, our operating results may suffer.
Our growth strategy is dependent, in part, upon increasing sales of our products to new and existing medium and large enterprise end-customers. Sales to these end-customers involve risks that may not be present, or that are present to a lesser extent, with sales to smaller entities. These risks include:
competition from larger competitors, such as Cisco, Check Point, and Juniper, that traditionally target larger enterprises, service providers, and government entities and that may have pre-existing relationships or purchase commitments from those end-customers;
increased purchasing power and leverage held by large end-customers in negotiating contractual arrangements with us;

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more stringent requirements in our worldwide support contracts, including stricter support response times and penalties for any failure to meet support requirements; and
longer sales cycles, in some cases over 12 months, and the associated risk that substantial time and resources may be spent on a potential end-customer that elects not to purchase our products and subscriptions.
At the beginning of fiscal 2017, we experienced execution challenges with respect to certain elements of our go-to-market strategy. While we have and will continue to implement changes to our go-to-market strategy that are designed to address these challenges, such changes may be difficult to implement and result in further disruptions to our sales organization or, once implemented, fail to resolve these challenges, which could impact our results of operations. In addition, product purchases by large enterprises are frequently subject to budget constraints, multiple approvals, and unplanned administrative, processing, and other delays. Finally, large enterprises typically have longer implementation cycles, require greater product functionality and scalability and a broader range of services, demand that vendors take on a larger share of risks, sometimes require acceptance provisions that can lead to a delay in revenue recognition, and expect greater payment flexibility from vendors. All of these factors can add further risk to business conducted with these end-customers. If we fail to realize an expected sale from a large end-customer in a particular quarter or at all, our business, operating results, and financial condition could be materially and adversely affected.
We rely on revenue from subscription and support offerings, and because we recognize revenue from subscription and support over the term of the relevant service period, downturns or upturns in sales of these subscription and support offerings are not immediately reflected in full in our operating results.
Subscription and support revenue accounts for a significant portion of our revenue, comprising 63.1% of total revenue i