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EX-31.1 - CERTIFICATION OF THE CHIEF EXECUTIVE OFFICER PURSUANT TO SECTION 302 - Palo Alto Networks Incpanwex311q119.htm
EX-32.2 - CERTIFICATION OF THE CHIEF FINANCIAL OFFICER PURSUANT TO SECTION 906 - Palo Alto Networks Incpanwex322q119.htm
EX-32.1 - CERTIFICATION OF THE CHIEF EXECUTIVE OFFICER PURSUANT TO SECTION 906 - Palo Alto Networks Incpanwex321q119.htm
EX-31.2 - CERTIFICATION OF THE CHIEF FINANCIAL OFFICER PURSUANT TO SECTION 302 - Palo Alto Networks Incpanwex312q119.htm
EX-10.5 - EX-10.5 - Palo Alto Networks Incpanwex105q119.htm
EX-10.4 - EX-10.4 - Palo Alto Networks Incpanwex104q119.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, 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 every Interactive Data File required to be submitted 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 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
¨
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 20, 2018 was 94,880,870.
 




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, 2018
 
July 31, 2018
 
 
 
(As Adjusted)
Assets
 
 
 
Current assets:
 
 
 
Cash and cash equivalents
$
1,784.4

 
$
2,506.9

Short-term investments
1,419.4

 
896.5

Accounts receivable, net of allowance for doubtful accounts of $1.2 at October 31, 2018 and July 31, 2018
382.3

 
467.0

Prepaid expenses and other current assets
229.1

 
268.1

Total current assets
3,815.2

 
4,138.5

Property and equipment, net
276.5

 
273.1

Long-term investments
565.5

 
547.5

Goodwill
636.4

 
522.8

Intangible assets, net
186.2

 
140.8

Other assets
321.7

 
326.2

Total assets
$
5,801.5

 
$
5,948.9

Liabilities, temporary equity, and stockholders’ equity
 
 
 
Current liabilities:
 
 
 
Accounts payable
$
43.0

 
$
49.4

Accrued compensation
99.4

 
163.7

Accrued and other liabilities
163.6

 
124.6

Deferred revenue
1,269.8

 
1,213.6

Convertible senior notes, net
239.9

 
550.4

Total current liabilities
1,815.7

 
2,101.7

Convertible senior notes, net
1,384.5

 
1,369.7

Long-term deferred revenue
1,114.6

 
1,065.7

Other long-term liabilities
226.8

 
229.6

Commitments and contingencies (Note 10)


 


Temporary equity
6.9

 
21.9

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

 

Common stock and additional paid-in capital; $0.0001 par value; 1,000.0 shares authorized; 94.7 and 93.6 shares issued and outstanding at October 31, 2018 and July 31, 2018, respectively
2,129.3

 
1,967.4

Accumulated other comprehensive loss
(19.0
)
 
(16.4
)
Accumulated deficit
(857.3
)
 
(790.7
)
Total stockholders’ equity
1,253.0

 
1,160.3

Total liabilities, temporary equity, and stockholders’ equity
$
5,801.5

 
$
5,948.9

 
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,
 
2018
 
2017
 
 
 
(As Adjusted)
Revenue:
 
 
 
Product
$
240.5

 
$
184.8

Subscription and support
415.5

 
317.0

Total revenue
656.0

 
501.8

Cost of revenue:
 
 
 
Product
73.2

 
57.6

Subscription and support
110.3

 
83.7

Total cost of revenue
183.5

 
141.3

Total gross profit
472.5

 
360.5

Operating expenses:
 
 
 
Research and development
113.4

 
94.2

Sales and marketing
314.6

 
254.1

General and administrative
76.6

 
65.7

Total operating expenses
504.6

 
414.0

Operating loss
(32.1
)
 
(53.5
)
Interest expense
(22.7
)
 
(6.3
)
Other income, net
13.0

 
4.8

Loss before income taxes
(41.8
)
 
(55.0
)
Provision for (benefit from) income taxes
(3.5
)
 
8.2

Net loss
$
(38.3
)
 
$
(63.2
)
Net loss per share, basic and diluted
$
(0.41
)
 
$
(0.70
)
Weighted-average shares used to compute net loss per share, basic and diluted
93.8

 
90.9


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,
 
2018
 
2017
 
 
 
(As Adjusted)
Net loss
$
(38.3
)
 
$
(63.2
)
Other comprehensive income (loss), net of tax:
 
 
 
Change in unrealized gains (losses) on investments
0.9

 
(1.9
)
Change in unrealized gains (losses) on cash flow hedges
(3.5
)
 
(1.7
)
Other comprehensive loss
(2.6
)

(3.6
)
Comprehensive loss
$
(40.9
)
 
$
(66.8
)

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,
 
2018
 
2017
 
 
 
(As Adjusted)
Cash flows from operating activities
 
 
 
Net loss
$
(38.3
)
 
$
(63.2
)
Adjustments to reconcile net loss to net cash provided by operating activities:
 
 
 
Share-based compensation for equity-based awards
136.9

 
125.7

Depreciation and amortization
32.5

 
21.3

Cease-use loss related to facility exit

 
15.4

Amortization of deferred contract costs
41.1

 
28.1

Amortization of debt discount and debt issuance costs
19.4

 
6.3

Amortization of investment premiums, net of accretion of purchase discounts
(2.4
)
 
0.5

Loss on conversions of convertible senior notes
2.2

 

Repayments of convertible senior notes attributable to debt discount
(52.3
)
 

Changes in operating assets and liabilities, net of effects of acquisitions:
 
 
 
Accounts receivable, net
86.6

 
80.3

Prepaid expenses and other assets
(22.6
)
 
(39.0
)
Accounts payable
(0.8
)
 
4.2

Accrued compensation
(65.0
)
 
(43.0
)
Accrued and other liabilities
12.5

 
43.8

Deferred revenue
102.5

 
93.6

Net cash provided by operating activities
252.3

 
274.0

Cash flows from investing activities
 
 
 
Purchases of investments
(741.0
)
 
(226.8
)
Proceeds from sales of investments
2.5

 

Proceeds from maturities of investments
214.5

 
206.6

Business acquisitions, net of cash acquired
(154.8
)
 

Purchases of property, equipment, and other assets
(34.3
)
 
(32.2
)
Net cash used in investing activities
(713.1
)
 
(52.4
)
Cash flows from financing activities
 
 
 
Repayments of convertible senior notes attributable to principal and equity component
(275.0
)
 

Payments for debt issuance costs
(3.6
)
 

Repurchases of common stock

 
(134.1
)
Proceeds from sales of shares through employee equity incentive plans
30.7

 
22.1

Payments for taxes related to net share settlement of equity awards
(13.9
)
 
(11.4
)
Net cash used in financing activities
(261.8
)
 
(123.4
)
Net increase (decrease) in cash, cash equivalents, and restricted cash
(722.6
)
 
98.2

Cash, cash equivalents, and restricted cash—beginning of period
2,509.2

 
745.5

Cash, cash equivalents, and restricted cash—end of period
$
1,786.6

 
$
843.7

 
 
 
 
Reconciliation of cash, cash equivalents, and restricted cash to the condensed consolidated balance sheets
 
 
 
Cash and cash equivalents
$
1,784.4

 
$
842.6

Restricted cash included in prepaid expenses and other current assets
1.0

 
0.5

Restricted cash included in other assets
1.2

 
0.6

Total cash, cash equivalents, and restricted cash
$
1,786.6

 
$
843.7

 
 
 
 
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 and data 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, 2018, filed with the Securities and Exchange Commission (“SEC”) on September 13, 2018. 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 retrospective adoption of new accounting guidance related to revenue from contracts with customers and new accounting guidance related to the presentation of restricted cash and cash equivalents in the statement of cash flows. Refer to “Recently Adopted Accounting Pronouncements” below for more information.
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, 2018.
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, 2018, as compared to the significant accounting policies described in our Annual Report on Form 10-K for the fiscal year ended July 31, 2018, except for the change in our accounting policies for revenue recognition and deferred contract costs due to our adoption of new accounting guidance related to revenue from contracts with customers. Refer to “Recently Adopted Accounting Pronouncements” below, Note 2. Revenue, and Note 8. Deferred Contract Costs for more information.
Recently Adopted Accounting Pronouncements
Business Combinations - Definition of a Business
In January 2017, the Financial Accounting Standards Board (“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. We adopted this standard in our first quarter of fiscal 2019 on a prospective basis. The adoption of the standard did not have an 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. We adopted this standard in our first quarter of fiscal 2019 on a retrospective basis. The adoption of the standard did not have a material impact on our condensed consolidated financial statements because our restricted cash balance has not been material.
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. We adopted the standard in our first quarter of fiscal 2019 on a modified retrospective basis. As a result, we recorded the cumulative effect of the change as an increase to accumulated deficit of $28.4 million, with a corresponding decrease to prepaid expenses and other current assets and other assets in our condensed

- 7 -


consolidated balance sheets as of August 1, 2018, the date of adoption. The cumulative effect adjustment represents the reclassification of unrecognized income tax effects from intra-entity transfers of assets other than inventory that occurred prior to the date of adoption.
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. We adopted this standard in our first quarter of fiscal 2019 on a retrospective basis. The adoption of the standard did not have an impact on our condensed consolidated financial statements.
Financial Instruments - Recognition and Measurement
In January 2016, the FASB issued authoritative guidance requiring equity instruments to be measured at fair value with changes in fair value recognized through net income. We adopted this standard in our first quarter of fiscal 2019 on a prospective basis for non-marketable equity securities and a modified retrospective basis for marketable equity investments. The adoption of the standard did not have an 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 when control of promised goods or services is transferred to customers with the expected consideration 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. We adopted the standard in our first quarter of fiscal 2019 using the full retrospective method.
The adoption of the new standard did not have a material impact on our condensed consolidated financial statements for the fiscal years ended July 31, 2018 and 2017, with the exception of the accounting for incremental costs to obtain customer contracts, which primarily consist of sales commissions, due to the longer period of amortization. Under the previous accounting guidance, we deferred and amortized these costs over the term of the related contract. Under the new standard, we defer and amortize these costs for initial contracts that are not commensurate with renewal commissions over a benefit period of five years, which is typically longer than the initial contract term.
The adoption of the standard using the full retrospective method required us to restate the prior periods presented in this Quarterly Report on Form 10-Q, with the cumulative effect of the change of $168.2 million reflected in accumulated deficit as of August 1, 2017. In adopting the new standard, we have also applied a transition practical expedient and have not disclosed revenue expected to be recognized from remaining performance obligations for periods prior to August 1, 2018.
The following tables present the impact of the adoption of the standard on our previously reported results (in millions, except per share data):
 
Three Months Ended October 31, 2017
 
As Previously Reported
 
Impact of Adoption
 
As Adjusted
Condensed Consolidated Statements of Operations
 
 
 
 
 
Product revenue
$
186.5

 
$
(1.7
)
 
$
184.8

Subscription and support revenue
319.0

 
(2.0
)
 
317.0

Total revenue
505.5

 
(3.7
)
 
501.8

Total cost of revenue
141.4

 
(0.1
)
 
141.3

Total operating expenses
418.4

 
(4.4
)
 
414.0

Operating loss
(54.3
)
 
0.8

 
(53.5
)
Net loss
(64.0
)
 
0.8

 
(63.2
)
Net loss per share, basic and diluted
$
(0.70
)
 
$

 
$
(0.70
)

- 8 -


 
July 31, 2018
 
As Previously Reported
 
Impact of Adoption
 
As Adjusted
Condensed Consolidated Balance Sheet
 
 
 
 
 
Accounts receivable, net
$
467.3

 
$
(0.3
)
 
$
467.0

Prepaid expenses and other current assets
261.3

 
6.8

 
268.1

Other assets
206.8

 
119.4

 
326.2

Accrued and other liabilities
107.0

 
17.6

 
124.6

Deferred revenue
1,268.9

 
(55.3
)
 
1,213.6

Long-term deferred revenue
1,096.0

 
(30.3
)
 
1,065.7

Accumulated deficit
$
(984.6
)
 
$
193.9

 
$
(790.7
)
The adoption of the standard did not impact net cash flows from operating, investing, or financing activities in our condensed consolidated statements of cash flows.
Recently Issued Accounting Pronouncements
Implementation Costs Incurred in a Cloud Computing Arrangement
In August 2018, the FASB issued new authoritative guidance on customer’s accounting for implementation costs incurred in a cloud computing arrangement that is a service contract, which will require customers to apply internal-use software guidance to determine the implementation costs that are able to be capitalized. Capitalized implementation costs will be required to be amortized over the term of the arrangement, beginning when the module or component of the hosting arrangement is ready for its intended use. The standard is effective for us in our first quarter of fiscal 2021 and will be applied on either a prospective or retrospective basis. Early adoption is permitted. We are currently evaluating adoption timing and whether this 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 adoption timing and 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; however, we plan to adopt the new standard in our first quarter of fiscal 2020. Upon adoption, we will recognize right-of-use assets and operating lease liabilities on our condensed consolidated balance sheets, which will increase our total assets and total liabilities. We are currently evaluating the accounting, transition, and disclosure requirements of this standard, including its impact on our accounting policies and processes.
2. Revenue
Revenue Recognition
Our revenue consists of product revenue and subscription and support revenue. Revenue is recognized when control of promised products, subscriptions and support services are transferred to customers with the expected consideration in exchange for those products and services. Depending on who the contract is with, our customers are either our channel partners or our end-customers.
We determine revenue recognition through the following steps:
Identification of the contract, or contracts, with a customer.
Identification of the performance obligations in the contract.

- 9 -


Determination of the transaction price.
Allocation of the transaction price to the performance obligations in the contract.
Recognition of revenue when, or as, we satisfy a performance obligation.
Revenues are reported net of sales taxes. Shipping charges billed to channel partners are included in revenues and related costs are included in cost of revenue.
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 hardware shipment or delivery of software license.
Subscription and Support Revenue
Subscription and support revenue is derived primarily from sales of our subscription and support offerings. We recognize subscription and support revenue over time as the services are performed. Our contractual subscription and support contracts are typically one to five years.
Contracts with Multiple Performance Obligations
The majority of our contracts with our customers include various combinations of our products and subscriptions and support which are distinct and accounted for as separate performance obligations. We account for multiple agreements with a single customer as a single contract if the contractual terms and/or substance of those agreements indicate that they may be so closely related that they are, in effect, parts of a single contract. The amount of consideration we expect to receive in exchange for delivering on the contract is allocated to each performance obligation based on its relative standalone selling price. If a contract contains a single performance obligation, no allocation is required.
We establish standalone selling price using the prices charged for a deliverable when sold separately. If the standalone selling price is not observable through past transactions, we estimate the standalone selling price based on our pricing model and our go-to-market strategy, which include factors such as type of sales channel (reseller, distributor, or end-customer), the geographies in which our offerings were sold (domestic or international), and offering type (products, subscriptions, or support).
Deferred Revenue
We record deferred revenue when cash payments are received or due in advance of our performance. Our payment terms typically require payment within 30 to 45 days of the date we issue an invoice. The current portion of deferred revenue represents the amounts that are expected to be recognized as revenue within one year of the condensed consolidated balance sheet date. During the three months ended October 31, 2018, we recognized approximately $370.0 million of revenue pertaining to amounts that were deferred as of July 31, 2018.
Remaining Performance Obligations
Revenue expected to be recognized from remaining performance obligations was $2.5 billion as of October 31, 2018, of which we expect to recognize approximately $1.3 billion over the next 12 months and the remainder thereafter.

- 10 -


Disaggregation of Revenue
The following table presents revenue by geographic theater (in millions):
 
Three Months Ended October 31,
 
2018
 
2017
 
 
 
(As Adjusted)
Revenue:
 
 
 
Americas
 
 
 
United States
$
415.9

 
$
326.0

Other Americas
34.3

 
23.3

Total Americas
450.2

 
349.3

Europe, the Middle East, and Africa (“EMEA”)
127.7

 
94.7

Asia Pacific and Japan (“APAC”)
78.1

 
57.8

Total revenue
$
656.0

 
$
501.8

The following table presents revenue for groups of similar products and services (in millions):
 
Three Months Ended October 31,
 
2018
 
2017
 
 
 
(As Adjusted)
Revenue:
 
 
 
Product
$
240.5

 
$
184.8

Subscription and support
 
 
 
Subscription
231.3

 
169.0

Support
184.2

 
148.0

Total subscription and support
415.5

 
317.0

Total revenue
$
656.0

 
$
501.8

3. 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.

- 11 -


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, 2018 and July 31, 2018 (in millions):
 
 
October 31, 2018
 
July 31, 2018
 
 
Level 1
 
Level 2
 
Level 3
 
Total
 
Level 1
 
Level 2
 
Level 3
 
Total
Cash equivalents:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Money market funds
 
$
904.4

 
$

 
$

 
$
904.4

 
$
1,512.3

 
$

 
$

 
$
1,512.3

Commercial paper
 

 
5.0

 

 
5.0

 

 
52.0

 

 
52.0

Corporate debt securities
 

 
2.5

 

 
2.5

 

 

 

 

U.S. government and agency securities
 

 
210.3

 

 
210.3

 

 
397.3

 

 
397.3

Total cash equivalents
 
904.4

 
217.8

 

 
1,122.2

 
1,512.3

 
449.3

 

 
1,961.6

Short-term investments:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Certificates of deposit
 

 
5.4

 

 
5.4

 

 
5.4

 

 
5.4

Non-U.S. government securities
 

 
20.0

 

 
20.0

 

 
20.0

 

 
20.0

Commercial paper
 

 
97.3

 

 
97.3

 

 
22.3

 

 
22.3

Corporate debt securities
 

 
188.9

 

 
188.9

 

 
139.8

 

 
139.8

U.S. government and agency securities
 

 
1,107.8

 

 
1,107.8

 

 
709.0

 

 
709.0

Total short-term investments
 

 
1,419.4

 

 
1,419.4

 

 
896.5

 

 
896.5

Long-term investments:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Corporate debt securities
 

 
191.2

 

 
191.2

 

 
153.6

 

 
153.6

U.S. government and agency securities
 

 
374.3

 

 
374.3

 

 
393.9

 

 
393.9

Total long-term investments
 

 
565.5

 

 
565.5

 

 
547.5

 

 
547.5

Total assets measured at fair value
 
$
904.4

 
$
2,202.7

 
$

 
$
3,107.1

 
$
1,512.3

 
$
1,893.3

 
$

 
$
3,405.6

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Accrued and other liabilities:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Foreign currency forward contracts
 
$

 
$
11.4

 
$

 
$
11.4

 
$

 
$
6.9

 
$

 
$
6.9

Total accrued and other liabilities
 

 
11.4




11.4

 


6.9




6.9

Total liabilities measured at fair value
 
$

 
$
11.4

 
$

 
$
11.4

 
$

 
$
6.9

 
$

 
$
6.9

Refer to Note 9. Debt for the carrying amount and estimated fair value of our convertible senior notes as of October 31, 2018 and July 31, 2018.

- 12 -


4. Cash Equivalents and Investments
Available-for-sale Securities
The following tables summarize the amortized cost, unrealized gains and losses, and fair value of our available-for-sale securities as of October 31, 2018 and July 31, 2018 (in millions):
 
October 31, 2018
 
Amortized Cost 
 
Unrealized Gains
 
Unrealized Losses
 
Fair Value
Cash equivalents:
 
 
 
 
 
 
 
Commercial paper
$
5.0

 
$

 
$

 
$
5.0

Corporate debt securities
2.5

 

 

 
2.5

U.S. government and agency securities
210.3

 

 

 
210.3

Total available-for-sale cash equivalents
$
217.8

 
$

 
$

 
$
217.8

Investments:
 
 
 
 
 
 
 
Certificates of deposit
$
5.4

 
$

 
$

 
$
5.4

Non-U.S. government securities
20.0

 

 

 
20.0

Commercial paper
97.3

 

 

 
97.3

Corporate debt securities
382.5

 

 
(2.4
)
 
380.1

U.S. government and agency securities
1,489.0

 

 
(6.9
)
 
1,482.1

Total available-for-sale investments
$
1,994.2

 
$

 
$
(9.3
)
 
$
1,984.9

 
July 31, 2018
 
Amortized Cost 
 
Unrealized Gains
 
Unrealized Losses
 
Fair Value
Cash equivalents:
 
 
 
 
 
 
 
Commercial paper
$
52.0

 
$

 
$

 
$
52.0

U.S. government and agency securities
397.3

 

 

 
397.3

Total available-for-sale cash equivalents
$
449.3

 
$

 
$

 
$
449.3

Investments:
 
 
 
 
 
 
 
Certificates of deposit
$
5.4

 
$

 
$

 
$
5.4

Non-U.S. government securities
20.0

 

 

 
20.0

Commercial paper
22.3

 

 

 
22.3

Corporate debt securities
295.9

 

 
(2.5
)
 
293.4

U.S. government and agency securities
1,110.6

 

 
(7.7
)
 
1,102.9

Total available-for-sale investments
$
1,454.2

 
$

 
$
(10.2
)
 
$
1,444.0

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, 2018 and July 31, 2018.
The following table summarizes the amortized cost and fair value of our available-for-sale securities as of October 31, 2018, by contractual years-to-maturity (in millions):
 
Amortized Cost
 
Fair Value
Due within one year
$
1,640.9

 
$
1,637.2

Due between one and three years
571.1

 
565.5

Total
$
2,212.0

 
$
2,202.7

Marketable Equity Securities
Marketable equity securities consist of money market funds and are included in cash and cash equivalents in our condensed consolidated balance sheets. As of October 31, 2018 and July 31, 2018, the carrying value of our marketable equity securities were

- 13 -


$904.4 million and $1.5 billion, respectively. During the three months ended October 31, 2018 and 2017, there were no unrealized gains or losses recognized for these securities.
5. Derivative Instruments
As a global business, we are exposed to currency exchange rate risk. Substantially all of our revenue is transacted in U.S. dollars, however, a portion of our operating expenditures are incurred outside of the United States and are denominated in foreign currencies, making them subject to fluctuations in foreign currency exchange rates. We enter into foreign currency derivative contracts with maturities of 12 months or less which we designate as cash flow hedges to manage the foreign currency exchange rate risk associated with these expenditures.
These derivative contracts expose us to credit risk to the extent that the counterparties may be unable to meet the terms of the arrangement. We mitigate this credit risk by transacting with major financial institutions with high credit ratings and also enter into master netting arrangements, which permit net settlement of transactions with the same counterparty. We are not required to pledge, and are not entitled to receive, cash collateral related to these derivative instruments. We do not enter into derivative contracts for trading or speculative purposes.
Our derivative financial instruments are recorded at fair value, on a gross basis, as either assets or liabilities in our condensed consolidated balance sheets. Gains or losses related to 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 October 31, 2018 and July 31, 2018, the total notional amount of our outstanding foreign currency forward contracts was $238.0 million and $288.5 million, respectively. Refer to Note 3. Fair Value Measurements for the fair value of our derivative instruments as reported in our condensed consolidated balance sheets as of October 31, 2018.
During the three months ended October 31, 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 October 31, 2018 and 2017 were not material.
6. Acquisitions
RedLock Inc.
On October 12, 2018, we completed our acquisition of 100% of the voting equity interest of RedLock Inc. (“RedLock”), a privately-held cloud security company. The acquisition expands our security capabilities for the public cloud with the addition of RedLock’s cloud security analytics technology. Total purchase consideration for the acquisition of RedLock was $158.2 million, which consisted of $155.0 million in cash paid upon closing and $3.2 million in fair value of unvested equity awards attributable to services performed prior to the acquisition date.
As part of the acquisition, we assumed RedLock equity awards with a total fair value of $57.4 million. Of the total fair value, a portion was allocated to the purchase consideration and the remainder was allocated to future services and will be expensed over the remaining service periods as share-based compensation.
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
$
113.6

Identified intangible assets
54.8

Net liabilities assumed
(10.2
)
Total
$
158.2

Goodwill generated from this business combination is primarily attributable to the assembled workforce and expected post-acquisition synergies from integrating RedLock’s technology into our platform. The goodwill is not deductible for income tax purposes.

- 14 -


The following table presents details of the identified intangible assets acquired (in millions, except years):
 
Fair Value
 
Estimated Useful Life
Developed technology
$
48.6

 
4 years
Customer relationships
5.3

 
8 years
Trade name and trademarks
0.9

 
6 months
Total
$
54.8

 
 
RedLock’s operating results are included in our condensed consolidated statements of operations from the date of acquisition. Pro forma results of operations have not been presented because the effect of the acquisition was 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 acquisition date, which may result in changes to the amounts and allocations recorded.
7. Goodwill and Intangible Assets
Goodwill
The following table presents details of our goodwill during the three months ended October 31, 2018 (in millions):
 
Amount
Balance as of July 31, 2018
$
522.8

Goodwill acquired
113.6

Balance as of October 31, 2018
$
636.4

Purchased Intangible Assets
The following table presents details of our purchased intangible assets as of October 31, 2018 and July 31, 2018 (in millions):
 
October 31, 2018
 
July 31, 2018
 
Gross Carrying Amount
 
Accumulated Amortization
 
Net Carrying Amount
 
Gross Carrying Amount
 
Accumulated Amortization
 
Net Carrying Amount
Intangible assets subject to amortization:
 
 
 
 
 
 
 
 
 
 
 
Developed technology
$
203.3

 
$
(45.3
)
 
$
158.0

 
$
154.7

 
$
(38.2
)
 
$
116.5

Customer relationships
17.5

 
(1.7
)
 
15.8

 
12.2

 
(1.2
)
 
11.0

Acquired intellectual property
8.9

 
(4.7
)
 
4.2

 
8.9

 
(4.5
)
 
4.4

Trade name and trademarks
9.4

 
(2.0
)
 
7.4

 
8.5

 
(0.4
)
 
8.1

Other
2.2

 
(2.2
)
 

 
2.2

 
(2.2
)
 

Total intangible assets subject to amortization
241.3

 
(55.9
)
 
185.4

 
186.5

 
(46.5
)
 
140.0

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

 

 
0.8

 
0.8

 

 
0.8

Total purchased intangible assets
$
242.1

 
$
(55.9
)
 
$
186.2

 
$
187.3

 
$
(46.5
)
 
$
140.8

We recognized amortization expense of $9.4 million and $2.7 million for the three months ended October 31, 2018 and 2017, respectively.

- 15 -


The following table summarizes estimated future amortization expense of our intangible assets as of October 31, 2018 (in millions):
 
Amount
Fiscal years ending July 31:
 
Remaining 2019
$
37.1

2020
39.4

2021
37.4

2022
32.9

2023
20.4

2024 and thereafter
18.2

Total future amortization expense
$
185.4

8. Deferred Contract Costs
We defer contract costs that are recoverable and incremental to obtaining customer sales contracts. Contract costs, which primarily consist of sales commissions, are amortized on a systematic basis that is consistent with the transfer to the customer of the goods or services to which the asset relates. Sales commissions paid for initial contracts are generally not commensurate with the commissions paid for renewal contracts, given the substantive difference in commission rates in proportion to their respective contract values. Sales commissions for initial contracts that are not commensurate are amortized over a benefit period of five years, consistent with the revenue recognition pattern of the performance obligations in the related contracts including expected renewals. The benefit period is determined by taking into consideration contract length, technology life, and other quantitative and qualitative factors. The expected renewals are estimated based on historical renewal trends. Sales commissions for initial contracts that are commensurate and sales commissions for renewal contracts are amortized over the related contractual period in proportion to the revenue recognized.
We classify deferred contract costs as short-term or long-term based on when we expect to recognize the expense. Short-term deferred contract costs are included in prepaid expenses and other current assets and long-term deferred contract costs are included in other assets in our condensed consolidated balance sheets. Deferred contract costs are periodically reviewed for impairment. The amortization of deferred contract costs is included in sales and marketing expense in our condensed consolidated statements of operations.
The following table presents details of our short-term and long-term deferred contract costs as of October 31, 2018 and July 31, 2018 (in millions):
 
October 31, 2018
 
July 31, 2018
Short-term deferred contract costs
$
112.1

 
$
113.2

Long-term deferred contract costs
223.1

 
224.8

Total deferred contract costs
$
335.2

 
$
338.0

We recognized amortization expense for our deferred contract costs of $41.1 million and $28.1 million during the three months ended October 31, 2018 and 2017, respectively. We did not recognize any impairment losses on our deferred contract costs during the three months ended October 31, 2018 or 2017.
9. Debt
Convertible Senior Notes
In June 2014, we issued $575.0 million aggregate principal amount of 0.0% Convertible Senior Notes due 2019 (the “2019 Notes”) and in July 2018, we issued $1.7 billion aggregate principal amount of 0.75% Convertible Senior Notes due 2023 (the “2023 Notes” and, together with the 2019 Notes, the “Notes”). The 2023 Notes bear interest at a fixed rate of 0.75% per year, payable semi-annually in arrears on January 1 and July 1 of each year, beginning on January 1, 2019. Each series of Notes is governed by an indenture between us, as the issuer, and U.S. Bank National Association, as Trustee (individually, each an “Indenture,” and together, the “Indentures”). The Notes of each series are unsecured, unsubordinated obligations and the applicable Indenture governing each series of Notes does not contain any financial covenants or restrictions on the payments of dividends, the incurrence of indebtedness, or the issuance or repurchase of securities by us or any of our subsidiaries. The 2019 Notes and 2023 Notes mature on July 1, 2019 and July 1, 2023, respectively. We cannot redeem either series of Notes prior to the applicable maturity date.

- 16 -


The following table presents details of the Notes (number of shares in millions):
 
Conversion Rate per $1,000 Principal
 
Initial Conversion Price
 
Convertible Date
 
Initial Number of Shares
2019 Notes
9.0680

 
$
110.28

 
January 1, 2019
 
5.2

2023 Notes
3.7545

 
$
266.35

 
April 1, 2023
 
6.4

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 their respective convertible dates only under the following circumstances:
during any fiscal quarter commencing after the fiscal quarters ending on October 31, 2014 and October 31, 2018, for the 2019 Notes and 2023 Notes, respectively (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 applicable conversion price for the respective Notes on each applicable trading day (the “sale price condition”);
during the five business day period after any five consecutive trading day period (the “measurement period”) in which the trading price per $1,000 principal amount of the applicable series 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 applicable conversion rate for the respective Notes on each such trading day; or
upon the occurrence of specified corporate events.
On or after the respective convertible date, 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 applicable maturity date regardless of the foregoing conditions. Upon conversion, holders of the Notes of a series will receive cash equal to the aggregate principal amount of the Notes of such series 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 of such series being converted.
The conversion price will be subject to adjustment in some events. Holders of the Notes of a series who convert their Notes of such series in connection with certain corporate events that constitute a “make-whole fundamental change” under the applicable Indenture are, under certain circumstances, entitled to an increase in the conversion rate for such series of Notes. Additionally, upon the occurrence of a corporate event that constitutes a “fundamental change” under the applicable Indenture, holders of the Notes of such series may require us to repurchase for cash all or a portion of the Notes of such series at a repurchase price equal to 100% of the principal amount of the Notes of such series plus accrued and unpaid interest to, but excluding, the fundamental change repurchase date.
The sale price condition was met for the 2019 Notes during the fiscal quarter ended July 31, 2018, and, as a result, holders were able to convert their 2019 Notes at any time during the fiscal quarter ended October 31, 2018. During the three months ended October 31, 2018, holders converted $327.3 million in aggregate principal amount of the 2019 Notes, which we repaid in cash. We also issued 1.4 million shares of our common stock to the holders for the conversion value in excess of the principal amount. These shares were fully offset by shares received from the corresponding exercise of the associated note hedges. We allocated $317.1 million of the cash consideration to the liability component of the converted 2019 Notes, which was calculated by measuring the fair value of a similar liability that did not have an associated convertible feature. We recorded a loss of $2.2 million related to the settlement of the 2019 Notes converted, which represented the difference between the cash consideration allocated to the liability component and the net carrying amount of the liability component on the respective settlement dates. The loss was included in other income, net in our condensed consolidated statement of operations for the three months ended October 31, 2018. During the three months ended October 31, 2018, we also recorded a $10.2 million net reduction to additional paid-in capital in our condensed consolidated balance sheets, reflecting the portion of the cash consideration allocated to the equity component.
The sale price condition continued to be met through the fiscal quarter ended October 31, 2018, and, as a result, holders may convert their 2019 Notes at any time prior to January 1, 2019 (the “2019 Notes Convertible Date”). On or after the 2019 Notes Convertible Date, holders may convert their 2019 Notes at any time prior to maturity, in accordance with the terms described above, regardless of the sale price condition. Accordingly, the net carrying amount of the 2019 Notes was classified as a current liability and the portion of the equity component representing the conversion option was classified as temporary equity in our condensed consolidated balance sheets as of October 31, 2018.
The sale price condition was not met for the 2023 Notes during the fiscal quarters ended October 31, 2018 and July 31, 2018. Since the 2023 Notes were not convertible, the net carrying amount of the 2023 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 October 31, 2018.
As of October 31, 2018, $247.7 million in aggregate principal amount of the 2019 Notes remained outstanding and all of the 2023 Notes remained outstanding. Subsequent to October 31, 2018, through the filing date of this Quarterly Report on Form 10-Q,

- 17 -


$88.3 million in principal amount of the 2019 Notes was converted or had been submitted by the holders for conversion and will settle during the fiscal quarter ending January 31, 2019.
The following table sets forth the components of the Notes as of October 31, 2018 and July 31, 2018 (in millions):
 
October 31, 2018
 
July 31, 2018
 
2019 Notes
 
2023 Notes
 
Total
 
2019 Notes
 
2023 Notes
 
Total
Liability component:
 
 
 
 
 
 
 
 
 
 
 
Principal
$
247.7

 
$
1,693.0

 
$
1,940.7

 
$
575.0

 
$
1,693.0

 
$
2,268.0

Less: debt discount and debt issuance costs, net of amortization
7.8

 
308.5

 
316.3

 
24.6

 
323.3

 
347.9

Net carrying amount
$
239.9

 
$
1,384.5

 
$
1,624.4

 
$
550.4

 
$
1,369.7

 
$
1,920.1

 
 
 
 
 
 
 
 
 
 
 
 
Equity component (including amounts classified as temporary equity)
$
47.3

 
$
315.0

 
$
362.3

 
$
109.8

 
$
315.0

 
$
424.8

The total estimated fair value of the Notes was $2.1 billion and $2.7 billion at October 31, 2018 and July 31, 2018, 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, 2018 and July 31, 2018 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, 2018, the if-converted value of the 2019 Notes exceeded its principal amount by $220.2 million. Based on the closing price of our common stock on October 31, 2018, the if-converted value of the 2023 Notes was less than its principal amount.
The following table sets forth interest expense recognized related to the Notes (dollars in millions):
 
Three Months Ended
 
Three Months Ended
 
October 31, 2018
 
October 31, 2017
 
2019 Notes
 
2023 Notes
 
Total
 
2019 Notes
 
2023 Notes
 
Total
Contractual interest expense
$

 
$
3.2

 
$
3.2

 
$

 
$

 
$

Amortization of debt discount
4.0

 
14.4

 
18.4

 
5.6

 

 
5.6

Amortization of debt issuance costs
0.5

 
0.5

 
1.0

 
0.7

 

 
0.7

Total interest expense recognized
$
4.5

 
$
18.1

 
$
22.6

 
$
6.3

 
$

 
$
6.3

 
 
 
 
 
 
 
 
 
 
 
 
Effective interest rate of the liability component
4.8
%
 
5.2
%
 
 
 
4.8
%
 
%
 
 
Note Hedges
To minimize the impact of potential economic dilution upon conversion of the Notes, we entered into separate convertible note hedge transactions (the “2019 Note Hedges,” with respect to the 2019 Notes, and the “2023 Note Hedges,” with respect to the 2023 Notes, and collectively, the “Note Hedges”) with respect to our common stock concurrent with the issuance of each series of Notes.
The following table presents details of the Note Hedges (in millions):
 
Initial Number of Shares
 
Aggregate Purchase
2019 Note Hedges
5.2

 
$
111.0

2023 Note Hedges
6.4

 
$
332.0

The Note Hedges cover shares of our common stock at a strike price per share that corresponds to the initial applicable conversion price of the applicable series of Notes, which are also subject to adjustment, and are exercisable upon conversion of the applicable series of Notes. The Note Hedges will expire upon maturity of the applicable series of Notes. The Note Hedges are separate transactions and are not part of the terms of the applicable series of the Notes. Holders of the Notes of either series will not have any rights with respect to the Note Hedges. Any shares of our common stock receivable by us under the Note Hedges are excluded from the calculation of diluted earnings per share as they are antidilutive. The aggregate amounts paid for the Note Hedges are included in additional paid-in capital in our consolidated balance sheets.
As a result of the conversions of the 2019 Notes settled during the fiscal quarter ended October 31, 2018, we exercised the corresponding portion of our 2019 Note Hedges and received 1.4 million shares of common stock during the period.

- 18 -


Warrants
Separately, but concurrently with the issuance of each series of Notes, we entered into transactions whereby we sold warrants (the “2019 Warrants,” with respect to the 2019 Notes, and the “2023 Warrants,” with respect to the 2023 Notes, and collectively, the “Warrants”) to acquire shares of our common stock, subject to anti-dilution adjustments. The 2019 Warrants and 2023 Warrants are exercisable beginning October 2019 and October 2023, respectively.
The following table presents details of the Warrants (in millions, except per share data):
 
Initial Number of Shares
 
Strike Price per Share
 
Aggregate Proceeds
2019 Warrants
5.2

 
$
137.85

 
$
78.3

2023 Warrants
6.4

 
$
417.80

 
$
145.4

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 applicable strike price for such series of Warrants. The Warrants are separate transactions and are not part of either series of Notes or Note Hedges and are not remeasured through earnings each reporting period. Holders of the Notes of either series will not have any rights with respect to the Warrants. The aggregate proceeds received from the sale of the Warrants are included in additional paid-in capital in our consolidated balance sheets.
Revolving Credit Facility
On September 4, 2018, we entered into a credit agreement (the “Credit Agreement”) with certain institutional lenders that provides for a $400.0 million unsecured revolving credit facility (the “Credit Facility”), with an option to increase the amount of the Credit Facility by up to an additional $350.0 million, subject to certain conditions. The Credit Facility matures on the earlier of (i) September 4, 2023 and (ii) the date that is 91 days prior to the stated maturity of our 2023 Notes if (a) any of the 2023 Notes are still outstanding and (b) our unrestricted cash and cash equivalents are less than the then outstanding principal amount of our 2023 Notes plus $400.0 million.

The borrowings under the Credit Facility bear interest, at our option, at a base rate plus a spread of 0.00% to 0.75%, or an adjusted LIBO rate plus a spread of 1.00% to 1.75%, in each case with such spread being determined based on our leverage ratio. We are obligated to pay an ongoing commitment fee on undrawn amounts at a rate of 0.125% to 0.250%, depending on our leverage ratio. As of October 31, 2018, there were no amounts outstanding and we were in compliance with all covenants under the Credit Agreement.
10. 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 have applied and 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 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.

- 19 -


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 term 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 $39.2 million as general and administrative expense in our consolidated statements of operations during the year ended July 31, 2018, and a corresponding liability in our consolidated balance sheets. During the three months ended October 31, 2018, we released $2.5 million of the cease-use liability through rental payments. As of October 31, 2018, the remaining balance of the cease-use liability was $26.6 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, 2018 (in millions):
 
Amount
Fiscal years ending July 31:
 
Remaining 2019
$
50.4

2020
68.9

2021
64.1

2022
59.8

2023
58.5

2024 and thereafter
224.1

Committed gross lease payments
525.8

Less: proceeds from sublease rentals
12.8

Net operating lease obligation
$
513.0

Purchase Commitments
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, 2018, our purchase commitments under such orders were $155.6 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 October 31, 2018, our purchase commitment under the addendum was $8.0 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 October 31, 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.

- 20 -


11. Stockholders’ Equity
Share Repurchase Program
In August 2016, our board of directors authorized a $500.0 million share repurchase program 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.
There were no shares repurchased under the authorization during the three months ended October 31, 2018. As of October 31, 2018, $330.0 million remained available for future share repurchases under the repurchase authorization.
12. Equity Award Plans
Share-Based Compensation Plans
RedLock Inc. 2015 Stock Plan
In connection with our acquisition of RedLock on October 12, 2018, we assumed RedLock’s 2015 Stock Plan, as amended (the “RedLock Plan”), under which the assumed RedLock equity awards were granted. The assumed equity awards will be settled in shares of our common stock and will retain the terms and conditions under which they were originally granted; forfeited awards will not be returned to the RedLock Plan. No additional equity awards will be granted under the RedLock Plan. Refer to Note 6. Acquisitions for more information on the RedLock acquisition and the related equity awards assumed.
Stock Option Activities
The following table summarizes the stock option and performance stock option (“PSO”) activity under our stock plans during the reporting period (in millions, except per share amounts):
 
Stock Options Outstanding 
 
PSOs Outstanding 
 
Number of Shares
 
Weighted-Average Exercise Price Per Share 
 
Weighted-Average Remaining Contractual Term
(Years)
 
Aggregate Intrinsic Value
 
Number of Shares
 
Weighted-Average Exercise Price Per Share 
 
Weighted-Average Remaining Contractual Term
(Years)
 
Aggregate Intrinsic Value
Balance—July 31, 2018
1.1

 
$
13.29

 
3.1
 
$
199.8

 
1.1

 
$
198.50

 
7.0
 
$

Granted

 
$

 
 
 
 
 
2.2

 
$
193.51

 
 
 
 
Exercised
(0.2
)
 
$
13.51

 
 
 
 
 

 
$

 
 
 
 
Forfeited

 
$

 
 
 
 
 

 
$

 
 
 
 
Balance—October 31, 2018
0.9

 
$
13.23

 
2.9
 
$
150.7

 
3.3

 
$
195.24

 
7.0
 
$

Exercisable—October 31, 2018
0.9

 
$
13.23

 
2.9
 
$
150.7

 

 
$

 
0.0
 
$

In October 2018, we granted 2.2 million PSOs with both a market condition and a service condition to certain executives. The market condition requires the price of our common stock to equal or exceed $297.75, $397.00, $496.25, and $595.50 (the “stock price targets”) during the four-, five-, six-, and seven-year periods following the date of grant, respectively. To the extent that the stock price targets have been met, one-fourth of the PSOs will vest on the anniversary date of the grant date for such PSOs, subject to continued service.
The aggregate fair value of the PSOs granted in October 2018 was $130.0 million based on a weighted-average fair value of $59.64 per share, which was estimated on the grant date using a Monte Carlo simulation model and the following assumptions: expected volatility of 35.6%, based on a combination of implied volatility from traded options on our common stock and the historical volatility of our common stock; dividend yield of 0.0%, based on our current expectations about our anticipated dividend policy; risk-free interest rates ranging from 3.1% to 3.2%, based on the implied yield available on U.S. Treasury zero-coupon issues with terms equal to the contractual terms of each tranche; and an expected term which takes into consideration the vesting term and the contractual term of the PSOs. We recognize share-based compensation expense for our PSOs on a straight-line basis over the requisite service period for each separately vesting portion of the award.
In November 2018, we granted PSOs and restricted stock units with a total value of $34.5 million to our newly appointed president.

- 21 -


Restricted Stock Award (“RSA”), Performance-Based Stock Award (“PSA”), Restricted Stock Unit (“RSU”), and Performance-Based Stock Unit (“PSU”) Activities
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, 2018
0.3

 
$
160.85

 
6.7

 
$
160.20

 
1.6
 
$
1,335.2

Granted(1)(2)

 
$

 
1.6

 
$
198.48

 
 
 
 
Vested
(0.1
)
 
$
167.18

 
(0.6
)
 
$
149.95

 
 
 
 
Forfeited

 
$

 
(0.2
)
 
$
156.39

 
 
 
 
Balance—October 31, 2018
0.2

 
$
157.84

 
7.5

 
$
169.81

 
1.6
 
$
1,367.9

______________
(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.
(2)
Includes 0.2 million RSUs granted under the assumed RedLock Plan with a weighted-average grant-date fair value of $211.95 per share.
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.
Share-Based Compensation
The following table summarizes share-based compensation included in costs and expenses (in millions):
 
Three Months Ended
 
October 31,
 
2018
 
2017
Cost of product revenue
$
1.6

 
$
1.9

Cost of subscription and support revenue
17.5

 
15.9

Research and development
40.5

 
37.5

Sales and marketing
56.0

 
51.2

General and administrative
35.5

 
19.2

Total share-based compensation
$
151.1

 
$
125.7

In connection with our acquisition of RedLock, we accelerated the vesting of certain equity awards and as a result, we recorded $14.2 million of share-based compensation within general and administrative expense during the three months ended October 31, 2018.
As of October 31, 2018, total compensation cost related to unvested share-based awards not yet recognized was $1.4 billion. This cost is expected to be amortized over a weighted-average period of approximately 2.9 years. Future grants will increase the amount of compensation expense to be recorded in these periods.
13. Income Taxes
Our provision for income taxes for the three months ended October 31, 2018 reflects an effective tax rate of 8.4%. Our effective tax rate for the three months ended October 31, 2018 was positive as we recorded a benefit from income taxes on year to date losses. The key components of our income tax provision, excluding one-time items, primarily consist of foreign income taxes and withholding taxes. During the three months ended October 31, 2018, the effect of these key components were offset by a one-time tax benefit of $9.4 million from a partial release of our valuation allowance related to the acquisition of RedLock Inc. Our effective tax

- 22 -


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 months ended October 31, 2017 reflects an effective tax rate of (14.9)%. 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 consisted of foreign income taxes, withholding taxes, and amortization of our deferred tax charges. Our effective tax rate differed 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 charges in our valuation allowance.
In December 2017, the Tax Cuts and Jobs Act (“TCJA”) was enacted into law. The SEC staff and FASB previously 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. As of October 31, 2018, we did not have any significant adjustments to our assessment performed as of July 31, 2018. We continue to analyze the tax effects of the TCJA, which are still subject to change during the measurement period, and anticipate further guidance on accounting interpretations from the FASB and application of the TCJA from the U.S. federal and state tax authorities.
14. 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
 
October 31,
 
2018
 
2017
 
 
 
(As Adjusted)
Net loss
$
(38.3
)
 
$
(63.2
)
Weighted-average shares used to compute net loss per share, basic and diluted
93.8

 
90.9

Net loss per share, basic and diluted
$
(0.41
)
 
$
(0.70
)
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,
 
2018
 
2017
Convertible senior notes
8.6

 
5.2

Warrants related to the issuance of convertible senior notes
11.6

 
5.2

RSUs and PSUs
7.5

 
7.3

Options to purchase common stock, including PSOs
4.2

 
1.5

RSAs and PSAs
0.2

 
0.8

ESPP shares
0.1

 
0.1

Total
32.2

 
20.1


- 23 -


15. Other Income, Net
The following table sets forth the components of other income, net (in millions):
 
Three Months Ended
 
October 31,
 
2018
 
2017
Interest income
$
15.4

 
$
5.1

Foreign currency exchange gains (losses), net

 
(0.6
)
Other
(2.4
)
 
0.3

Total other income, net
$
13.0

 
$
4.8

ITEM 2.
MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
The following discussion and analysis of our financial condition and results of operations should be read in conjunction with our condensed consolidated financial statements and related notes appearing elsewhere in this Quarterly Report on Form 10-Q. The following discussion and analysis contains forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. These statements include, among other things: expectations regarding drivers of and factors affecting growth in our business; 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, including through deployment of new capabilities via security applications developed by third parties; 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 anticipated or implied by any 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 months ended October 31, 2018 to the three months ended October 31, 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 October 31, 2018, including expected payment schedules.
Critical Accounting Estimates. A discussion of our accounting policies that require critical estimates, assumptions, and judgments.

- 24 -


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 the architecture of 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 hardware and software security products, and consists of four primary security capabilities.
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.
Other 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 first quarter of fiscal 2019 and 2018, total revenue was $656.0 million and $501.8 million, respectively, representing year-over-year growth of 30.7%. 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, 2018, we had 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 grew to $240.5 million, or 36.7% of total revenue, for the first quarter of fiscal 2019, representing year-over-year growth of 30.1%. 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 grew to $415.5 million, or 63.3% of total revenue, for the first quarter of fiscal 2019, representing year-over-year growth of 31.1%. 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 to invest 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 October 2018, we acquired RedLock Inc. (“RedLock”), which expands our security capabilities for the public cloud with the addition of RedLock’s cloud security analytics technology.
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

- 25 -


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.”
 
October 31, 2018
 
July 31, 2018
 
 
 
 
 
(in millions)
Total deferred revenue(1)
$
2,384.4

 
$
2,279.3

Cash, cash equivalents, and investments
$
3,769.3

 
$
3,950.9

______________
(1)
The amount for fiscal 2018 has been adjusted due to our adoption of the new revenue recognition standard. Refer to Note 1. Description of Business and Summary of Significant Accounting Policies in Part I, Item 1 of this Quarterly Report on Form 10-Q for more information.
 
Three Months Ended October 31,
 
2018
 
2017(1)
 
 
 
 
 
(dollars in millions)
Total revenue
$
656.0

 
$
501.8

Total revenue year-over-year percentage increase
30.7
 %
 
26.0
 %
Gross margin
72.0
 %
 
71.8
 %
Operating loss
$
(32.1
)
 
$
(53.5
)
Operating margin
(4.9
)%
 
(10.7
)%
Billings
$
758.5

 
$
595.4

Billings year-over-year percentage increase
27.4
 %
 
24.6
 %
Cash flow provided by operating activities
$
252.3

 
$
274.0

Free cash flow (non-GAAP)
$
218.0

 
$
241.8

______________
(1)
These amounts have been adjusted due to our adoption of the new revenue recognition standard and new guidance related to the presentation of restricted cash and cash equivalents in the statement of cash flows. Refer to Note 1. Description of Business and Summary of Significant Accounting Policies in Part I, Item 1 of this Quarterly Report on Form 10-Q for more information.
Deferred Revenue. Our deferred revenue 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 conditions for revenue recognition 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,

- 26 -


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,
 
2018
 
2017(1)
 
 
 
 
 
(in millions)
Billings:
 
 
 
Total revenue
$
656.0

 
$
501.8

Add: change in total deferred revenue, net of acquired deferred revenue
102.5

 
93.6

Billings
$
758.5

 
$
595.4

______________
(1)
These amounts have been adjusted due to our adoption of the new revenue recognition standard. Refer to Note 1. Description of Business and Summary of Significant Accounting Policies in Part I, Item 1 of this Quarterly Report on Form 10-Q for more information.
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,
 
2018
 
2017
 
 
 
 
 
(in millions)
Free cash flow (non-GAAP):
 
 
 
Net cash provided by operating activities(1)
$
252.3

 
$
274.0

Less: purchases of property, equipment, and other assets
34.3

 
32.2

Free cash flow (non-GAAP)(1)
$
218.0

 
$
241.8

Net cash used in investing activities
$
(713.1
)
 
$
(52.4
)
Net cash used in financing activities
$
(261.8
)
 
$
(123.4
)
______________
(1)
The amount for fiscal 2018 has been adjusted due to our adoption of new guidance related to the presentation of restricted cash and cash equivalents in the statement of cash flows. Refer to Note 1. Description of Business and Summary of Significant Accounting Policies in Part I, Item 1 of this Quarterly Report on Form 10-Q for more information.

- 27 -


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,
 
2018
 
2017(1)
 
Amount
 
% of Revenue
 
Amount
 
% of Revenue
 
 
 
 
 
 
 
 
 
(dollars in millions)
Revenue:
 
 
 
 
 
 
 
Product
$
240.5

 
36.7
 %
 
$
184.8

 
36.8
 %
Subscription and support
415.5

 
63.3
 %
 
317.0

 
63.2
 %
Total revenue
656.0

 
100.0
 %
 
501.8

 
100.0
 %
Cost of revenue:
 
 
 
 
 
 
 
Product
73.2

 
11.2
 %
 
57.6

 
11.5
 %
Subscription and support
110.3

 
16.8
 %
 
83.7

 
16.7
 %
Total cost of revenue(2)
183.5

 
28.0
 %
 
141.3

 
28.2
 %
Total gross profit
472.5

 
72.0
 %
 
360.5

 
71.8
 %
Operating expenses:
 
 
 
 
 
 
 
Research and development
113.4

 
17.3
 %
 
94.2

 
18.8
 %
Sales and marketing
314.6

 
47.9
 %
 
254.1

 
50.6
 %
General and administrative