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EX-31.2 - CERTIFICATION OF THE CHIEF FINANCIAL OFFICER PURSUANT TO SECTION 302 - Palo Alto Networks Incpanwex312q318.htm
EX-32.2 - CERTIFICATION OF THE CHIEF FINANCIAL OFFICER PURSUANT TO SECTION 906 - Palo Alto Networks Incpanwex322q318.htm
EX-32.1 - CERTIFICATION OF THE CHIEF EXECUTIVE OFFICER PURSUANT TO SECTION 906 - Palo Alto Networks Incpanwex321q318.htm
EX-31.1 - CERTIFICATION OF THE CHIEF EXECUTIVE OFFICER PURSUANT TO SECTION 302 - Palo Alto Networks Incpanwex311q318.htm



UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
_____________________ 
FORM 10-Q
 _____________________
(Mark One)
x
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended April 30, 2018
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 May 18, 2018 was 92,880,096.
 




TABLE OF CONTENTS

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

- 2 -


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

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

 
April 30, 2018
 
July 31, 2017
Assets
 
 
 
Current assets:
 
 
 
Cash and cash equivalents
$
949.0

 
$
744.3

Short-term investments
672.2

 
630.7

Accounts receivable, net of allowance for doubtful accounts of $1.1 and $0.7 at April 30, 2018 and July 31, 2017, respectively
361.8

 
432.1

Prepaid expenses and other current assets
222.5

 
169.2

Total current assets
2,205.5

 
1,976.3

Property and equipment, net
264.2

 
211.1

Long-term investments
592.9

 
789.3

Goodwill
522.2

 
238.8

Intangible assets, net
147.7

 
53.7

Other assets
175.8

 
169.1

Total assets
$
3,908.3

 
$
3,438.3

Liabilities, temporary equity, and stockholders’ equity
 
 
 
Current liabilities:
 
 
 
Accounts payable
$
32.7

 
$
35.5

Accrued compensation
95.1

 
117.5

Accrued and other liabilities
106.0

 
79.9

Deferred revenue
1,165.5

 
968.4

Convertible senior notes, net
543.8

 

Total current liabilities
1,943.1

 
1,201.3

Convertible senior notes, net

 
524.7

Long-term deferred revenue
989.4

 
805.1

Other long-term liabilities
226.0

 
147.6

Commitments and contingencies (Note 8)


 


Temporary equity
27.7

 

Stockholders’ equity:
 
 
 
Preferred stock; $0.0001 par value; 100.0 shares authorized; none issued and outstanding at April 30, 2018 and July 31, 2017

 

Common stock and additional paid-in capital; $0.0001 par value; 1,000.0 shares authorized; 92.9 and 91.5 shares issued and outstanding at April 30, 2018 and July 31, 2017, respectively
1,717.6

 
1,599.7

Accumulated other comprehensive loss
(13.2
)
 
(3.4
)
Accumulated deficit
(982.3
)
 
(836.7
)
Total stockholders’ equity
722.1

 
759.6

Total liabilities, temporary equity, and stockholders’ equity
$
3,908.3

 
$
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
 
Nine Months Ended
 
April 30,
 
April 30,
 
2018
 
2017
 
2018
 
2017
Revenue:
 
 
 
 
 
 
 
Product
$
215.2

 
$
164.2

 
$
603.9

 
$
496.8

Subscription and support
351.9

 
267.6

 
1,011.1

 
755.7

Total revenue
567.1

 
431.8

 
1,615.0

 
1,252.5

Cost of revenue:
 
 
 
 
 
 
 
Product
68.9

 
49.7

 
190.4

 
137.7

Subscription and support
91.0

 
74.0

 
270.2

 
200.4

Total cost of revenue
159.9

 
123.7

 
460.6

 
338.1

Total gross profit
407.2

 
308.1

 
1,154.4

 
914.4

Operating expenses:
 
 
 
 
 
 
 
Research and development
99.6

 
86.0

 
290.4

 
260.1

Sales and marketing
277.1

 
226.9

 
800.6

 
673.7

General and administrative
82.1

 
44.3

 
201.1

 
133.1

Total operating expenses
458.8

 
357.2

 
1,292.1

 
1,066.9

Operating loss
(51.6
)
 
(49.1
)
 
(137.7
)
 
(152.5
)
Interest expense
(6.5
)
 
(6.2
)
 
(19.2
)
 
(18.3
)
Other income, net
8.6

 
2.1

 
18.3

 
7.3

Loss before income taxes
(49.5
)
 
(53.2
)
 
(138.6
)
 
(163.5
)
Provision for (benefit from) income taxes
(2.8
)
 
7.7

 
7.0

 
14.9

Net loss
$
(46.7
)
 
$
(60.9
)
 
$
(145.6
)
 
$
(178.4
)
Net loss per share, basic and diluted
$
(0.51
)
 
$
(0.67
)
 
$
(1.59
)
 
$
(1.97
)
Weighted-average shares used to compute net loss per share, basic and diluted
91.9

 
91.0

 
91.3

 
90.5


See notes to condensed consolidated financial statements.


- 4 -


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

 
Three Months Ended
 
Nine Months Ended
 
April 30,
 
April 30,
 
2018
 
2017
 
2018
 
2017
Net loss
$
(46.7
)
 
$
(60.9
)
 
$
(145.6
)
 
$
(178.4
)
Other comprehensive income (loss), net of tax:
 
 
 
 
 
 
 
Change in unrealized gains (losses) on investments
(1.9
)
 

 
(9.1
)
 
(4.7
)
Change in unrealized gains (losses) on cash flow hedges
(4.1
)
 
0.9

 
(0.7
)
 
(0.5
)
Other comprehensive income (loss)
(6.0
)
 
0.9

 
(9.8
)

(5.2
)
Comprehensive loss
$
(52.7
)
 
$
(60.0
)
 
$
(155.4
)
 
$
(183.6
)

See notes to condensed consolidated financial statements.

- 5 -


PALO ALTO NETWORKS, INC.

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

 
Nine Months Ended
 
April 30,
 
2018
 
2017
Cash flows from operating activities
 
 
 
Net loss
$
(145.6
)
 
$
(178.4
)
Adjustments to reconcile net loss to net cash provided by operating activities:
 
 
 
Share-based compensation for equity based awards
373.1

 
356.8

Depreciation and amortization
68.0

 
43.1

Cease-use loss related to facility exit
41.1

 

Amortization of debt discount and debt issuance costs
19.2

 
18.3

Amortization of investment premiums, net of accretion of purchase discounts
0.6

 
2.1

Changes in operating assets and liabilities, net of effects of acquisitions:
 
 
 
Accounts receivable, net
72.5

 
(14.9
)
Prepaid expenses and other assets
(60.3
)
 
(11.8
)
Accounts payable
(4.6
)
 
2.8

Accrued compensation
(24.4
)
 
1.7

Accrued and other liabilities
42.4

 
39.2

Deferred revenue
377.1

 
370.1

Net cash provided by operating activities
759.1

 
629.0

Cash flows from investing activities
 
 
 
Purchases of investments
(387.9
)
 
(726.9
)
Proceeds from maturities of investments
531.0

 
520.7

Business acquisitions, net of cash acquired
(370.1
)
 
(90.7
)
Purchases of property, equipment, and other assets
(86.6
)
 
(114.2
)
Net cash used in investing activities
(313.6
)
 
(411.1
)
Cash flows from financing activities
 
 
 
Repurchases of common stock
(259.1
)
 
(295.1
)
Proceeds from sales of shares through employee equity incentive plans
52.6

 
45.8

Payments for taxes related to net share settlement of equity awards
(34.3
)
 
(11.0
)
Net cash used in financing activities
(240.8
)
 
(260.3
)
Net increase (decrease) in cash and cash equivalents
204.7

 
(42.4
)
Cash and cash equivalents—beginning of period
744.3

 
734.4

Cash and cash equivalents—end of period
$
949.0

 
$
692.0

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 security operating platform that empowers enterprises, service providers, and government entities to secure their organizations by safely enabling applications running in their networks, on their endpoints, and in the cloud, 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 reclassified to conform to current-period presentation.
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 nine months ended April 30, 2018, 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 Adopted 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. We early adopted the standard in our second quarter of fiscal 2018 on a modified retrospective basis. The adoption of this standard did not have a material impact on our condensed consolidated financial statements.
Recently Issued Accounting Pronouncements
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 through a cumulative-effect adjustment to accumulated deficit as of the date of adoption. 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) and additional guidance and interpretations issued by U.S. regulatory and standard-setting bodies related to the Tax Cuts and Jobs Act (“TCJA”) enacted into law on December 22, 2017. Refer to Note 11. Income Taxes for more information on the TCJA.
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 and are on schedule with the preparation of our relevant 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 and disclosures, 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;

- 8 -


term license revenue associated with our virtual firewalls will be recognized upfront;
allocation of revenue related to software due to the removal of the residual method of revenue recognition; and
amortization period for incremental costs to obtain or fulfill customer contracts.
The exact impact of the new standard will be dependent on facts and circumstances at adoption and could vary from quarter to quarter.
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.

- 9 -


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 April 30, 2018 and July 31, 2017 (in millions):
 
 
April 30, 2018
 
July 31, 2017
 
 
Level 1
 
Level 2
 
Level 3
 
Total
 
Level 1
 
Level 2
 
Level 3
 
Total
Cash equivalents:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Money market funds
 
$
361.8

 
$

 
$

 
$
361.8

 
$

 
$

 
$

 
$

Commercial paper
 

 
32.1

 

 
32.1

 

 

 

 

Corporate debt securities
 

 
1.0

 

 
1.0

 

 

 

 

U.S. government and agency securities
 

 
129.6

 

 
129.6

 

 

 

 

Total cash equivalents
 
361.8

 
162.7

 

 
524.5

 

 

 

 

Short-term investments:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Certificates of deposit
 

 
5.4

 

 
5.4

 

 

 

 

Corporate debt securities
 

 
145.6

 

 
145.6

 

 
159.4

 

 
159.4

U.S. government and agency securities
 

 
521.2

 

 
521.2

 

 
471.3

 

 
471.3

Total short-term investments
 

 
672.2

 

 
672.2

 

 
630.7

 

 
630.7

Prepaid expenses and other current assets:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Foreign currency forward contracts
 

 
1.0

 

 
1.0

 

 

 

 

Total prepaid expenses and other current assets
 

 
1.0

 

 
1.0

 

 

 

 

Long-term investments:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Certificates of deposit
 

 

 

 

 

 
5.4

 

 
5.4

Corporate debt securities
 

 
135.6

 

 
135.6

 

 
186.5

 

 
186.5

U.S. government and agency securities
 

 
457.3

 

 
457.3

 

 
597.4

 

 
597.4

Total long-term investments
 

 
592.9

 

 
592.9

 

 
789.3

 

 
789.3

Total assets measured at fair value
 
$
361.8

 
$
1,428.8

 
$

 
$
1,790.6

 
$

 
$
1,420.0

 
$

 
$
1,420.0

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Accrued and other liabilities:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Foreign currency forward contracts
 
$

 
$
2.3

 
$

 
$
2.3

 
$

 
$

 
$

 
$

Total accrued and other liabilities
 

 
2.3

 

 
2.3

 

 

 

 

Total liabilities measured at fair value
 
$

 
$
2.3

 
$

 
$
2.3

 
$

 
$

 
$

 
$

As of April 30, 2018, 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 previous 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 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 fiscal 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. We did not have any liabilities required to be measured at fair value on a nonrecurring basis as of April 30, 2018 and July 31, 2017.
Refer to Note 7. Convertible Senior Notes for the carrying amount and estimated fair value of our convertible senior notes as of April 30, 2018 and July 31, 2017.

- 10 -


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 April 30, 2018 and July 31, 2017 (in millions):
 
April 30, 2018
 
Amortized Cost 
 
Unrealized Gains
 
Unrealized Losses
 
Estimated Fair Value
Cash equivalents:
 
 
 
 
 
 
 
Money market funds
$
361.8

 
$

 
$

 
$
361.8

Commercial paper
32.1

 

 

 
32.1

Corporate debt securities
1.0

 

 

 
1.0

U.S. government and agency securities
129.6

 

 

 
129.6

Total cash equivalents
$
524.5

 
$

 
$

 
$
524.5

 
 
 
 
 
 
 
 
Investments:
 
 
 
 
 
 
 
Certificates of deposit
$
5.4

 
$

 
$

 
$
5.4

Corporate debt securities
283.9

 
0.1

 
(2.8
)
 
281.2

U.S. government and agency securities
987.6

 

 
(9.1
)
 
978.5

Total investments
$
1,276.9

 
$
0.1

 
$
(11.9
)
 
$
1,265.1

 
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 April 30, 2018 and July 31, 2017.
The following table summarizes the amortized cost and fair value of our available-for-sale securities as of April 30, 2018, by contractual years-to-maturity (in millions):
 
Amortized Cost
 
Fair Value
Due within one year
$
1,199.8

 
$
1,196.7

Due between one and three years
601.6

 
592.9

Total
$
1,801.4

 
$
1,789.6

4. Derivative Instruments
As a global business, we are exposed to currency exchange rate risk. Substantially all of our revenue is transacted in U.S. dollars, however, a portion of our operating expenditures are incurred outside of the United States and are denominated in foreign currencies, making them subject to fluctuations in foreign currency exchange rates. We enter into foreign currency derivative contracts with maturities of 13 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.

- 11 -


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 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. If it becomes probable that the hedged transaction will not occur, the cumulative unrealized gain or loss is reclassified immediately from AOCI into the financial statement line item associated with the underlying hedged transaction in our condensed consolidated statements of operations. Gains or losses related to non-designated derivative instruments are recognized in other income (expense), net in our condensed consolidated statements of operations for 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 April 30, 2018, the total notional amount of our outstanding foreign currency forward contracts was $154.6 million. We did not have any forward contracts outstanding as of July 31, 2017. Refer to Note 2. Fair Value Measurements for the fair value of our derivative instruments as reported in our condensed consolidated balance sheets as of April 30, 2018.
During the three and nine months ended April 30, 2018 and 2017, both unrealized gains and losses recognized in AOCI related to our cash flow hedges and amounts reclassified into earnings were not material. Unrealized losses in AOCI related to our cash flow hedges as of April 30, 2018 and 2017 were not material.
5. Acquisitions
Evident.io, Inc.
On March 26, 2018, we completed our acquisition of all outstanding shares of Evident.io, Inc. (“Evident.io”), a privately-held cloud security company. The acquisition expands our API-based security capabilities for the public cloud with the addition of Evident.io’s cloud services infrastructure protection technology. Total purchase consideration for the acquisition of Evident.io was $292.9 million in cash, of which $4.0 million was accrued and will be paid over a period of five months from the acquisition date.
We have accounted for this transaction as a business combination and allocated the purchase consideration to assets acquired and liabilities assumed based on preliminary estimated fair values, as presented in the following table (in millions):
 
Amount
Goodwill
$
209.8

Identified intangible assets
85.1

Net liabilities assumed
(2.0
)
Total
$
292.9

Goodwill generated from this business combination is primarily attributable to the assembled workforce and expected post-acquisition synergies from integrating Evident.io’s technology into our platform and sales opportunities of Evident.io’s software as a service (“SaaS”) offerings. The goodwill is not deductible for income tax purposes.
The following table presents details of the identified intangible assets acquired (in millions, except years):
 
Fair Value
 
Estimated Useful Life
Developed technology
$
68.4

 
6 years
Trade name and trademarks
8.5

 
8 years
Customer relationships
8.2

 
8 years
Total
$
85.1

 
 
In addition, we paid $6.6 million in cash to settle certain Evident.io stock options, for which vesting was accelerated in connection with the acquisition and the subsequent termination of the option holders’ services. This amount was recorded as post-acquisition share-based compensation included in general and administrative expenses in our condensed consolidated statements of operations.
Cyber Secdo Ltd.
On April 24, 2018, we completed our acquisition of all outstanding shares of Cyber Secdo Ltd. (“Secdo”), a privately-held company specializing in endpoint detection and response (“EDR”). The acquisition expands the functionality of our platform by adding EDR capabilities. Total purchase consideration for the acquisition of Secdo was $82.7 million in cash.

- 12 -


We have accounted for this transaction as a business combination and allocated the purchase consideration to assets acquired and liabilities assumed based on preliminary estimated fair values, as presented in the following table (in millions):
 
Amount
Goodwill
$
68.6

Identified intangible assets
17.3

Net liabilities assumed
(3.2
)
Total
$
82.7

Goodwill generated from this business combination is primarily attributable to the assembled workforce and expected post-acquisition synergies from integrating Secdo’s technology into our advanced endpoint protection offering and our platform. The goodwill is not deductible for income tax purposes.
The following table presents details of the identified intangible assets acquired (in millions, except years):
 
Fair Value
 
Estimated Useful Life
Developed technology
$
16.4

 
5 years
Customer relationships
0.9

 
2 years
Total
$
17.3

 
 
Additional Acquisition-Related Information
The operating results of the acquired companies are included in our condensed consolidated statements of operations from the respective dates of acquisition. Pro forma results of operations have not been presented because the effects of these acquisitions, individually and in the aggregate, were not material to our condensed consolidated statements of operations.
Additional information, such as that related to income tax and other contingencies, existing as of the acquisition date but unknown to us may become known during the remainder of the measurement period, not to exceed 12 months from the respective acquisition date, which may result in changes to the amounts and allocations recorded.
6. Goodwill and Intangible Assets
Goodwill
The following table presents details of our goodwill during the nine months ended April 30, 2018 (in millions):
 
Amount
Balance as of July 31, 2017
$
238.8

Goodwill acquired
283.4

Balance as of April 30, 2018
$
522.2


- 13 -


Purchased Intangible Assets
The following table presents details of our purchased intangible assets as of April 30, 2018 and July 31, 2017 (in millions):
 
April 30, 2018
 
July 31, 2017
 
Gross Carrying Amount
 
Accumulated Amortization
 
Net Carrying Amount
 
Gross Carrying Amount
 
Accumulated Amortization
 
Net Carrying Amount
Intangible assets subject to amortization:
 
 
 
 
 
 
 
 
 
 
 
Developed technology
$
154.5

 
$
(32.0
)
 
$
122.5

 
$
69.7

 
$
(23.8
)
 
$
45.9

Customer relationships
12.2

 
(0.7
)
 
11.5

 
3.1

 
(0.4
)
 
2.7

Acquired intellectual property
8.9

 
(4.4
)
 
4.5

 
8.9

 
(3.8
)
 
5.1

Trade name and trademarks
8.5

 
(0.1
)
 
8.4

 

 

 

Other
2.2

 
(2.2
)
 

 
2.2

 
(2.2
)
 

Total intangible assets subject to amortization
186.3

 
(39.4
)
 
146.9

 
83.9

 
(30.2
)
 
53.7

Intangible assets not subject to amortization:
 
 
 
 
 
 
 
 
 
 
 
In-process research and development
0.8

 

 
0.8

 

 

 

Total purchased intangible assets
$
187.1

 
$
(39.4
)
 
$
147.7

 
$
83.9

 
$
(30.2
)
 
$
53.7

We recognized amortization expense of $3.8 million and $9.2 million for the three and nine months ended April 30, 2018, respectively, and $2.5 million and $7.1 million for the three and nine months ended April 30, 2017, respectively.
The following table summarizes estimated future amortization expense of our intangible assets as of April 30, 2018 (in millions):
 
Amount
Fiscal years ending July 31:
 
Remaining 2018
$
7.0

2019
27.8

2020
27.7

2021
25.7

2022
21.2

2023 and thereafter
37.5

Total future amortization expense
$
146.9

7. Convertible Senior Notes
Convertible Senior Notes
On June 30, 2014, we issued $575.0 million aggregate principal amount of 0.0% Convertible Senior Notes due 2019 (the “Notes”). The Notes mature on July 1, 2019 unless converted or repurchased in accordance with their terms prior to such date. The Notes do not contain any financial covenants and we cannot redeem the Notes prior to maturity.
The Notes are convertible for up to 5.2 million shares of our common stock at an initial conversion price of approximately $110.28 per share of common stock, subject to adjustment. Holders of the Notes may surrender their Notes for conversion at their option at any time prior to the close of business on the business day immediately preceding January 1, 2019, only under the following circumstances:
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

- 14 -


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. As of April 30, 2018, all of the Notes remained outstanding.
The sale price condition was met during the fiscal quarter ended April 30, 2018, and as a result, holders may convert their Notes at any time during the fiscal quarter ending July 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 April 30, 2018. 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 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 April 30, 2018 and July 31, 2017 (in millions):
 
April 30, 2018
 
July 31, 2017
Liability:
 
 
 
Principal
$
575.0

 
$
575.0

Less: debt discount and debt issuance costs, net of amortization
31.2

 
50.3

Net carrying amount
$
543.8

 
$
524.7

 
 
 
 
Equity (including temporary equity)
$
109.8

 
$
109.8

The total estimated fair value of the Notes was $1.0 billion and $747.5 million at April 30, 2018 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 April 30, 2018 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 April 30, 2018, the if-converted value of the Notes exceeded its principal amount by $406.8 million.
The following table sets forth interest expense recognized related to the Notes (dollars in millions):
 
Three Months Ended
 
Nine Months Ended
 
April 30,
 
April 30,
 
2018
 
2017
 
2018
 
2017
Amortization of debt discount
$
5.7

 
$
5.5

 
$
17.1

 
$
16.4

Amortization of debt issuance costs
0.8

 
0.7

 
2.1

 
1.9

Total interest expense recognized
$
6.5

 
$
6.2

 
$
19.2

 
$
18.3

 
 
 
 
 
 
 
 
Effective interest rate of the liability component
4.8
%
 
4.8
%
 
4.8
%
 
4.8
%
Note Hedges
To minimize the impact of potential economic dilution upon conversion of the Notes, we entered into convertible note hedge transactions (the “Note Hedges”) with respect to our common stock concurrent with the issuance of the Notes. The Note Hedges cover up to 5.2 million shares of our common stock 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

- 15 -


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.
8. 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 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 during the three months ended October 31, 2017, 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 terms.
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 December 2017, we entered into an agreement to sublease this office space for the remaining lease term. Proceeds from this sublease will be approximately $16.3 million over the sublease 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, which resulted in the recognition of a cease-use loss of $15.4 million during the three months ended October 31, 2017. Due to the changes in market conditions in recent months, we recognized an additional cease-use loss of $23.8 million during the three months ended April 30, 2018, based on changes to the amount and timing of estimated cash flows from sublease rentals that could be reasonably obtained. The total cease-use loss of $39.2 million, recognized as general and administrative expense in our condensed consolidated statements of operations during the nine months ended April 30, 2018, and a corresponding liability in our condensed consolidated balance sheets, 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 and nine months ended April 30, 2018, we released $2.8 million and $7.4 million, respectively, of the cease-use liability through rental payments. As of April 30, 2018, the remaining balance of the cease-use liability was $31.8 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 April 30, 2018 (in millions):
 
Amount
Fiscal years ending July 31:
 
Remaining 2018
$
16.7

2019
65.9

2020
67.8

2021
63.3

2022
59.7

2023 and thereafter
281.3

Committed gross lease payments
554.7

Less: proceeds from sublease rentals
14.6

Net operating lease obligation
$
540.1


- 16 -


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 April 30, 2018, our purchase commitments under such orders were $142.7 million, excluding obligations under contracts that we can cancel without a significant penalty. 
Other Purchase Commitments
In March 2018, we amended an agreement with a third-party provider for our use of certain cloud services through June 2020. Under the non-cancelable addendum, we are committed to a minimum purchase of $14.0 million between April 2018 and March 2019 and $8.0 million between April 2019 and March 2020. As of April 30, 2018, our purchase commitment under the addendum was $22.0 million.
Litigation
We are subject to legal proceedings, claims, and litigation arising in the ordinary course of business, including intellectual property litigation. Such matters are subject to many uncertainties and outcomes are not predictable with assurance. We accrue for contingencies when we believe that a loss is probable and that we can reasonably estimate the amount of any such loss.
To the extent there is a reasonable possibility that a loss exceeding amounts already recognized may be incurred and the amount of such additional loss would be material, we will either disclose the estimated additional loss or state that such an estimate cannot be made. As of April 30, 2018, we have not recorded any significant accruals for loss contingencies associated with such legal proceedings, determined that an unfavorable outcome is probable or reasonably possible, or determined that the amount or range of any possible loss is reasonably estimable.
9. Stockholders’ Equity
Share Repurchase
In August 2016, our board of directors authorized a $500.0 million share repurchase that 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 nine months ended April 30, 2018, we repurchased and retired 1.7 million shares of our common stock under the authorization for an aggregate purchase price of $250.0 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 April 30, 2018, $330.0 million remained available for future share repurchases under the repurchase authorization.
10. 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 and $25,000 worth of stock for each calendar year. 

- 17 -


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
(0.4
)
 
$
11.77

 
 
 
 
Balance—April 30, 2018
1.2

 
$
13.54

 
3.5
 
$
217.0

Options exercisable—April 30, 2018
1.2

 
$
13.54

 
3.5
 
$
217.0

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.
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)

 
$

 
2.8

 
$
152.36

 
 
 
 
Vested
(0.3
)
 
$
168.33

 
(2.7
)
 
$
137.19

 
 
 
 
Forfeited
(0.3
)
 
$
157.49

 
(0.5
)
 
$
143.24

 
 
 
 
Balance—April 30, 2018
0.4

 
$
162.85

 
6.1

 
$
147.82

 
1.5
 
$
1,181.3

______________
(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.

- 18 -


Share-Based Compensation
The following table summarizes share-based compensation included in costs and expenses (in millions):
 
Three Months Ended
 
Nine Months Ended
 
April 30,
 
April 30,
 
2018
 
2017
 
2018
 
2017
Cost of product revenue
$
1.7

 
$
1.8

 
$
5.5

 
$
5.5

Cost of subscription and support revenue
15.1

 
14.0

 
50.9

 
41.3

Research and development
35.4

 
37.1

 
108.4

 
116.4

Sales and marketing
50.7

 
46.2

 
155.2

 
139.7

General and administrative
20.8

 
18.3

 
60.2

 
55.1

Total share-based compensation
$
123.7

 
$
117.4

 
$
380.2

 
$
358.0

As of April 30, 2018, total compensation cost related to unvested share-based awards not yet recognized was $920.0 million. This cost is expected to be amortized on a straight-line basis over a weighted-average period of approximately 2.6 years.
11. Income Taxes
Our provision for (benefit from) income taxes for the three and nine months ended April 30, 2018 reflects an effective tax rate of 5.7% and (5.1)%, respectively. Our effective tax rate for the nine months ended April 30, 2018 was negative as we recorded a provision for income taxes on year to date losses. The key components of our income tax provision primarily consisted of foreign income taxes, withholding taxes, and amortization of our deferred tax charges. In addition, we recorded the following one-time tax benefits during the nine months ended April 30, 2018: $5.8 million due to new tax legislation enacted during the fiscal quarter ended January 31, 2018; $4.6 million due to a partial release of our valuation allowance related to our acquisition of Evident.io during the fiscal quarter ended April 30, 2018; and $3.5 million due to an Israeli judicial ruling related to share-based compensation during the fiscal quarter ended April 30, 2018. Our effective tax rate differs from the U.S. statutory tax rate primarily due to deductibility of our share-based compensation, foreign income at other than U.S. tax rates, and changes in our valuation allowance.
Our provision for income taxes for the three and nine months ended April 30, 2017 reflects an effective tax rate of (14.5)% and (9.1)%, respectively. Our effective tax rates for these periods were negative as we recorded a provision for income taxes on year to date losses. The key components of our income tax provision primarily consisted of foreign income taxes, withholding taxes, and amortization of our deferred tax charges.
On December 22, 2017, the TCJA was enacted into law. The TCJA provides for significant tax law changes and modifications including, but not limited to, the reduction of the U.S. federal corporate statutory tax rate from 35% to 21% as of January 1, 2018, the requirement for companies to pay a one-time transition tax on earnings of certain foreign subsidiaries that were previously tax deferred, and the creation of new taxes on certain foreign-sourced earnings. As a fiscal year-end taxpayer, certain provisions of the TCJA began to impact us during the fiscal quarter ended January 31, 2018, while other provisions will impact us beginning in our fiscal year ending July 31, 2019.
As a result of the TCJA, we recorded a provisional benefit of $5.8 million for the nine months ended April 30, 2018, related to alternative minimum tax credits that will be refundable if not utilized. We expect adjustments to our deferred tax assets resulting from the TCJA to be offset by a corresponding adjustment to our valuation allowance. We have not recorded any amounts relating to the transition tax because we had no unremitted earnings as of the measurement date, based on our current estimate.
Accounting standards require companies to recognize the effect of tax law changes in the period of enactment. However, the SEC staff and FASB issued guidance that allows companies to record provisional amounts for the effects of the TCJA during a measurement period not to extend beyond one year from the enactment date. In accordance with this guidance, we have determined the amounts recorded and positions taken, as discussed, are provisional as of April 30, 2018. We continue to assess the impacts of the TCJA, and the final impact of the TCJA recorded by us may differ from the provisional amounts due to a number of uncertainties and factors, including information not available until the close of our fiscal year ending July 31, 2018, the need for further guidance and clarification of the new law by U.S. federal and state tax authorities, and the need for further guidance on the related income tax accounting.
In addition to the previously discussed impacts on our fiscal year ending July 31, 2018, the TCJA also establishes new tax laws that will be effective beginning with our fiscal year ending July 31, 2019, including a provision for low-taxed income of foreign subsidiaries. Due to its complexity, we are continuing to evaluate this provision of the TCJA. Based on recent FASB deliberations, we will be allowed to make an accounting policy election to either (i) treat taxes due on future U.S. inclusions in taxable income as a current-period expense when incurred or (ii) factor such amounts into our measurement of deferred taxes. Our selection of accounting policy will depend, in part, on analyzing our facts and circumstances to determine the expected impact under each method.

- 19 -


12. 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.
The following table presents the computation of basic and diluted net loss per share of common stock (in millions, except per share data):
 
Three Months Ended
 
Nine Months Ended
 
April 30,
 
April 30,
 
2018
 
2017
 
2018
 
2017
Net loss
$
(46.7
)
 
$
(60.9
)
 
$
(145.6
)
 
$
(178.4
)
Weighted-average shares used to compute net loss per share, basic and diluted
91.9

 
91.0

 
91.3

 
90.5

Net loss per share, basic and diluted
$
(0.51
)
 
$
(0.67
)
 
$
(1.59
)
 
$
(1.97
)
The following securities were excluded from the computation of diluted net loss per share of common stock for the periods presented as their effect would have been antidilutive (in millions):
 
Three and Nine Months Ended
 
April 30,
 
2018
 
2017
RSUs and PSUs
6.1

 
6.3

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
1.2

 
1.6

RSAs and PSAs
0.4

 
1.1

ESPP shares
0.1

 

Total
18.2

 
19.4


- 20 -


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; the performance advantages of our products and subscription and support offerings and the potential benefits to our customers; 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, including our ongoing assessment of the impact of the TCJA and any future adjustments, investment plans 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 and increased adoption of our products and cloud-based subscription services; 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.
Results of Operations. A discussion of the nature and trends in our financial results and an analysis of our financial results comparing the three and nine months ended April 30, 2018 to the three and nine months ended April 30, 2017.
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 April 30, 2018, 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 security operating platform that empowers enterprises, service providers, and government entities to secure their organizations by safely enabling applications and data running in their networks, on their endpoints, and in the cloud, 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 pursue transformative digital initiatives, like public cloud and mobility, that grow their business, while maintaining the visibility and control needed to protect their valued data and critical control systems. 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 hardware and software security products.

- 21 -


Our platform consists of four major elements:
Security for networks through our Next-Generation Firewalls, available as physical appliances, virtual appliances (called VM-Series), or a cloud-delivered service (called GlobalProtect cloud service) and Panorama management delivered as an appliance or as a virtual machine for the public or private cloud.
Security for endpoints through our Traps advanced endpoint protection software, delivered as a light-weight software agent with cloud or on-premise management capabilities.
Security for the cloud through our VM-Series for in-line protection of workloads in public and private clouds, Traps for host-based public cloud infrastructure protection, Evident for infrastructure monitoring and compliance in public clouds, and Aperture for protecting SaaS applications. These products are delivered as software or SaaS applications.
Cloud-delivered security services, such as WildFire, Threat Prevention, URL Filtering, and GlobalProtect subscriptions that are delivered as attached software services to our appliances, as well as applications delivered in connection with our Application Framework, such as AutoFocus, Magnifier, and Logging Service that are delivered as SaaS applications.
For the third quarter of fiscal 2018 and 2017, total revenue was $567.1 million and $431.8 million, respectively, representing year-over-year growth of 31.3%. 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 April 30, 2018, we had approximately 51,000 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 $215.2 million, or 37.9% of total revenue, for the third quarter of fiscal 2018, representing year-over-year growth of 31.1%. 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 $351.9 million, or 62.1% of total revenue, for the third quarter of fiscal 2018, representing year-over-year growth of 31.5%. Our subscriptions provide our end-customers with real-time access to the latest antivirus, intrusion prevention, web filtering, and modern malware prevention capabilities across the network, endpoints, and the cloud. When end-customers purchase our physical or virtual firewall appliances, they typically purchase support in order to receive ongoing security updates, upgrades, bug fixes, and repairs. In addition to the subscriptions purchased with these appliances, end-customers may also purchase other subscriptions on a per-user, per-endpoint, or capacity-based basis.
We 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. We introduced several new offerings during the first three quarters of fiscal 2018, including:
our GlobalProtect cloud service subscription, which provides our Security Operating Platform as a cloud-based service for remote offices and mobile users;
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;
Magnifier, a cloud-based subscription that enables organizations to identify and prevent behavior-based threats by applying machine learning to rich network, endpoint, and cloud data;
PAN-OS 8.1, with over 60 new features, and several new models of appliances, including the PA-3200 series, which increase SSL decryption throughput, bring higher performance and capacity for securing large data centers, and provide additional capabilities for managing large firewall deployments; and
Traps 5.0, which included a cloud-delivered management service and integration with our Logging Service to allow for the collection of detailed endpoint event data.
We also expanded the capabilities of our platform with extended protections to the Google Cloud Platform and enhanced capabilities for AWS and Azure environments to enable customers to easily integrate with their cloud infrastructure and workloads in

- 22 -


multi-cloud environments. Further, in March 2018, we acquired Evident.io, Inc. (“Evident.io”), which expands our API-based security capabilities for the public cloud with the addition of Evident.io’s cloud services infrastructure protection technology, and, in April 2018, we acquired Cyber Secdo Ltd. (“Secdo”), which expands the functionality of our platform by adding endpoint detection and response capabilities, including unique data collection and visualization.
We believe that the growth of our business and our short-term and long-term success are dependent upon many factors, including our ability to extend our technology leadership, grow our base of end-customers, expand deployment of our platform and support offerings within existing end-customers, and focus on end-customer satisfaction. To manage any future growth effectively, we must continue to improve and expand our information technology and financial infrastructure, our operating and administrative systems and controls, and our ability to manage headcount, capital, and processes in an efficient manner. While these areas present significant opportunities for us, they also pose challenges and risks that we must successfully address in order to sustain the growth of our business and improve our operating results. For additional information regarding the challenges and risks we face, see the “Risk Factors” section in Part II, Item 1A of this Quarterly Report on Form 10-Q.
Key Financial Metrics
We monitor the key financial metrics set forth in the tables below to help us evaluate growth trends, establish budgets, measure the effectiveness of our sales and marketing efforts, and assess operational efficiencies. We discuss revenue, gross margin, and the components of operating loss and margin below under “—Results of Operations.”
 
April 30, 2018
 
July 31, 2017
 
(in millions)
Total deferred revenue
$
2,154.9

 
$
1,773.5

Cash, cash equivalents, and investments
$
2,214.1

 
$
2,164.3

 
Three Months Ended April 30,
 
Nine Months Ended April 30,
 
2018
 
2017
 
2018
 
2017
 
(dollars in millions)
Total revenue
$
567.1

 
$
431.8

 
$
1,615.0

 
$
1,252.5

Total revenue year-over-year percentage increase
31.3
 %
 
24.9
 %
 
28.9
 %
 
28.1
 %
Gross margin
71.8
 %
 
71.4
 %
 
71.5
 %
 
73.0
 %
Operating loss
$
(51.6
)
 
$
(49.1
)
 
$
(137.7
)
 
$
(152.5
)
Operating margin
(9.1
)%
 
(11.4
)%
 
(8.5
)%
 
(12.2
)%
Billings
$
721.0

 
$
544.1

 
$
1,992.1

 
$
1,622.6

Billings year-over-year percentage increase
32.5
 %
 
11.9
 %
 
22.8
 %
 
21.7
 %
Cash flow provided by operating activities
 
 
 
 
$
759.1

 
$
629.0

Free cash flow (non-GAAP)
 
 
 
 
$
672.5

 
$
514.8

Deferred Revenue. Our deferred revenue primarily 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 metric used by management to manage our business given our hybrid SaaS revenue model, and believe billings provides investors with an important indicator of the health and visibility of our business because it includes subscription and support revenue, which is recognized ratably over the contractual service period, and product revenue, which is recognized at the time of shipment, provided that all other revenue recognition criteria have been met. We consider billings to be a useful metric for management and 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:

- 23 -


 
Three Months Ended April 30,
 
Nine Months Ended April 30,
 
2018
 
2017
 
2018
 
2017
 
(in millions)
Billings:
 
 
 
 
 
 
 
Total revenue
$
567.1

 
$
431.8

 
$
1,615.0

 
$
1,252.5

Add: change in total deferred revenue, net of acquired deferred revenue
153.9

 
112.3

 
377.1

 
370.1

Billings
$
721.0

 
$
544.1

 
$
1,992.1

 
$
1,622.6

Cash Flow Provided by Operating Activities. We monitor cash flow provided by operating activities as a measure of our overall business performance. Our cash flow provided by operating activities is driven in large part by sales of our products and from up-front payments for subscription and support offerings. Monitoring cash flow provided by operating activities enables us to analyze our financial performance without the non-cash effects of certain items such as depreciation, amortization, and share-based compensation costs, thereby allowing us to better understand and manage the cash needs of our business.
Free Cash Flow (non-GAAP). We define free cash flow, a non-GAAP financial measure, as cash provided by operating activities less purchases of property, equipment, and other assets. We consider free cash flow to be a profitability and liquidity measure that provides useful information to management and investors about the amount of cash generated by the business after necessary capital expenditures. A limitation of the utility of free cash flow as a measure of our financial performance and liquidity is that it does not represent the total increase or decrease in our cash balance for the period. In addition, it is important to note that other companies, including companies in our industry, may not use free cash flow, may calculate free cash flow in a different manner than we do, or may use other financial measures to evaluate their performance, all of which could reduce the usefulness of free cash flow as a comparative measure. A reconciliation of free cash flow to cash flow provided by operating activities, the most directly comparable financial measure calculated and presented in accordance with GAAP, is provided below:
 
Nine Months Ended April 30,
 
2018
 
2017
 
(in millions)
Free cash flow (non-GAAP):
 
 
 
Net cash provided by operating activities
$
759.1

 
$
629.0

Less: purchases of property, equipment, and other assets
86.6

 
114.2

Free cash flow (non-GAAP)
$
672.5

 
$
514.8

Net cash used in investing activities
$
(313.6
)
 
$
(411.1
)
Net cash used in financing activities
$
(240.8
)
 
$
(260.3
)

- 24 -


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 April 30,
 
Nine Months Ended April 30,
 
2018
 
2017
 
2018
 
2017
 
Amount
 
% of Revenue
 
Amount
 
% of Revenue
 
Amount
 
% of Revenue
 
Amount
 
% of Revenue
 
(dollars in millions)
Revenue:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Product
$
215.2

 
37.9
 %
 
$
164.2

 
38.0
 %
 
$
603.9

 
37.4
 %
 
$
496.8

 
39.7
 %
Subscription and support
351.9

 
62.1
 %
 
267.6

 
62.0
 %
 
1,011.1

 
62.6
 %
 
755.7

 
60.3
 %
Total revenue
567.1

 
100.0
 %
 
431.8

 
100.0
 %
 
1,615.0

 
100.0
 %
 
1,252.5

 
100.0
 %
Cost of revenue:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Product
68.9

 
12.1
 %
 
49.7

 
11.5
 %
 
190.4

 
11.8
 %
 
137.7

 
11.0
 %
Subscription and support
91.0

 
16.1
 %
 
74.0

 
17.1
 %
 
270.2

 
16.7
 %
 
200.4

 
16.0
 %
Total cost of revenue(1)
159.9

 
28.2
 %
 
123.7

 
28.6
 %
 
460.6

 
28.5
 %
 
338.1

 
27.0
 %
Total gross profit
407.2

 
71.8
 %
 
308.1

 
71.4
 %
 
1,154.4

 
71.5
 %
 
914.4

 
73.0
 %
Operating expenses:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Research and development
99.6

 
17.6
 %
 
86.0

 
19.9
 %
 
290.4

 
18.0
 %
 
260.1

 
20.8
 %
Sales and marketing
277.1

 
48.8
 %
 
226.9

 
52.5
 %
 
800.6

 
49.5
 %
 
673.7

 
53.8
 %
General and administrative
82.1

 
14.5
 %
 
44.3

 
10.4
 %
 
201.1

 
12.5
 %
 
133.1

 
10.6
 %
Total operating expenses(1)
458.8

 
80.9
 %
 
357.2

 
82.8
 %
 
1,292.1

 
80.0
 %
 
1,066.9

 
85.2
 %
Operating loss
(51.6
)
 
(9.1
)%
 
(49.1
)
 
(11.4
)%
 
(137.7
)
 
(8.5
)%
 
(152.5
)
 
(12.2
)%
Interest expense
(6.5
)
 
(1.1
)%
 
(6.2
)
 
(1.4
)%
 
(19.2
)
 
(1.2
)%
 
(18.3
)
 
(1.5
)%
Other income, net
8.6

 
1.5
 %
 
2.1

 
0.5
 %
 
18.3

 
1.1
 %
 
7.3

 
0.6
 %
Loss before income taxes
(49.5
)
 
(8.7
)%
 
(53.2
)
 
(12.3
)%
 
(138.6
)
 
(8.6
)%
 
(163.5
)
 
(13.1
)%
Provision for (benefit from) income taxes
(2.8
)
 
(0.5
)%
 
7.7

 
1.8
 %
 
7.0

 
0.4
 %
 
14.9

 
1.1
 %
Net loss
$
(46.7
)
 
(8.2
)%
 
$
(60.9
)
 
(14.1
)%
 
$
(145.6
)
 
(9.0
)%
 
$
(178.4
)
 
(14.2
)%
______________
(1)
Includes share-based compensation as follows:
 
Three Months Ended April 30,
 
Nine Months Ended April 30,
 
2018
 
2017
 
2018
 
2017
Cost of product revenue
$
1.7

 
$
1.8

 
$
5.5

 
$
5.5

Cost of subscription and support revenue
15.1

 
14.0

 
50.9

 
41.3

Research and development
35.4

 
37.1

 
108.4

 
116.4

Sales and marketing
50.7

 
46.2

 
155.2

 
139.7

General and administrative
20.8

 
18.3

 
60.2

 
55.1

Total share-based compensation
$
123.7

 
$
117.4

 
$
380.2

 
$
358.0


- 25 -


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 April 30,
 
 
 
 
 
Nine Months Ended April 30,
 
 
 
 
 
2018
 
2017
 
Change
 
2018
 
2017