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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, 2016
or
¨
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from             to             
Commission File Number 001-35594
Palo Alto Networks, Inc.
(Exact name of registrant as specified in its charter)
 
 
Delaware
20-2530195
(State or other jurisdiction of
incorporation or organization)
(I.R.S. Employer
Identification No.)
4401 Great America Parkway
Santa Clara, California 95054
(Address of principal executive office, including zip code)
(408) 753-4000
(Registrant’s telephone number, including area code)

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.    Yes  x    No  ¨
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).    Yes  x    No  ¨
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):
Large accelerated filer
x
Accelerated filer
¨
Non-accelerated filer
¨ (Do not check if a smaller reporting company)
Smaller reporting company
¨
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 11, 2016 was 91,686,431.
 



Table of Contents

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.
 

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

CONDENSED CONSOLIDATED BALANCE SHEETS
(Unaudited, in millions, except per share data)
 
October 31, 2016
 
July 31, 2016
 
 
 
(As Adjusted)
Assets
 
 
 
Current assets:
 
 
 
Cash and cash equivalents
$
839.4

 
$
734.4

Short-term investments
550.6

 
551.2

Accounts receivable, net of allowance for doubtful accounts of $2.5 and $2.4 at October 31, 2016 and July 31, 2016, respectively
346.5

 
348.7

Prepaid expenses and other current assets
129.4

 
139.7

Total current assets
1,865.9

 
1,774.0

Property and equipment, net
125.0

 
117.2

Long-term investments
708.4

 
652.8

Goodwill
163.5

 
163.5

Intangible assets, net
41.7

 
44.0

Other assets
102.0

 
106.7

Total assets
$
3,006.5

 
$
2,858.2

Liabilities, temporary equity, and stockholders’ equity
 
 
 
Current liabilities:
 
 
 
Accounts payable
$
29.2

 
$
30.2

Accrued compensation
59.0

 
73.5

Accrued and other liabilities
48.4

 
39.2

Deferred revenue
758.1

 
703.9

Convertible senior notes, net
506.2

 

Total current liabilities
1,400.9

 
846.8

Convertible senior notes, net

 
500.2

Long-term deferred revenue
601.5

 
536.9

Other long-term liabilities
85.8

 
79.4

Commitments and contingencies (Note 6)


 


Temporary equity
61.4

 

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

 

Common stock and additional paid-in capital; $0.0001 par value; 1,000.0 shares authorized; 91.7 and 90.5 shares issued and outstanding at October 31, 2016 and July 31, 2016, respectively
1,542.2

 
1,515.5

Accumulated other comprehensive income (loss)
(1.9
)
 
1.0

Accumulated deficit
(683.4
)
 
(621.6
)
Total stockholders’ equity
856.9

 
894.9

Total liabilities, temporary equity, and stockholders’ equity
$
3,006.5

 
$
2,858.2

 
See notes to condensed consolidated financial statements.

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PALO ALTO NETWORKS, INC.
 
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(Unaudited, in millions, except per share data)
 
 
Three Months Ended
 
October 31,
 
2016
 
2015
 
 
 
(As Adjusted)
Revenue:
 
 
 
Product
$
163.8

 
$
147.7

Subscription and support
234.3

 
149.5

Total revenue
398.1

 
297.2

Cost of revenue:
 
 
 
Product
42.2

 
38.8

Subscription and support
59.1

 
40.4

Total cost of revenue
101.3

 
79.2

Total gross profit
296.8

 
218.0

Operating expenses:
 
 
 
Research and development
84.6

 
59.7

Sales and marketing
220.3

 
159.5

General and administrative
41.8

 
30.8

Total operating expenses
346.7

 
250.0

Operating loss
(49.9
)
 
(32.0
)
Interest expense
(6.0
)
 
(5.8
)
Other income, net
2.5

 
2.2

Loss before income taxes
(53.4
)
 
(35.6
)
Provision for income taxes
8.4

 
4.3

Net loss
$
(61.8
)
 
$
(39.9
)
Net loss per share, basic and diluted
$
(0.69
)
 
$
(0.47
)
Weighted-average shares used to compute net loss per share, basic and diluted
89.8

 
85.1


See notes to condensed consolidated financial statements.


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

 
Three Months Ended
 
October 31,
 
2016
 
2015
 
 
 
(As Adjusted)
Net loss
$
(61.8
)
 
$
(39.9
)
Other comprehensive income (loss), net of tax:
 
 
 
Change in unrealized gains (losses) on investments
(1.8
)
 
(0.3
)
Change in unrealized gains (losses) on cash flow hedges
(1.1
)
 

Comprehensive loss
$
(64.7
)
 
$
(40.2
)

See notes to condensed consolidated financial statements.

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PALO ALTO NETWORKS, INC.

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited, in millions)
 
Three Months Ended
 
October 31,
 
2016
 
2015
 
 
 
(As Adjusted)
Cash flows from operating activities
 
 
 
Net loss
$
(61.8
)
 
$
(39.9
)
Adjustments to reconcile net loss to net cash provided by operating activities:
 
 
 
Share-based compensation for equity based awards
114.2

 
72.9

Depreciation and amortization
13.6

 
9.2

Amortization of investment premiums, net of accretion of purchase discounts
0.7

 
0.8

Amortization of debt discount and debt issuance costs
6.0

 
5.7

Excess tax benefit from share-based compensation arrangements
(0.2
)
 
(0.2
)
Changes in operating assets and liabilities:
 
 
 
Accounts receivable, net
2.2

 
16.0

Prepaid expenses and other assets
10.1

 
7.3

Accounts payable
1.8

 
5.2

Accrued compensation
(14.5
)
 
(27.0
)
Accrued and other liabilities
12.4

 
5.9

Deferred revenue
118.8

 
90.8

Net cash provided by operating activities
203.3

 
146.7

Cash flows from investing activities
 
 
 
Purchases of investments
(285.7
)
 
(512.5
)
Proceeds from sales of investments

 
124.4

Proceeds from maturities of investments
235.4

 
144.1

Purchases of property, equipment, and other assets
(20.9
)
 
(19.5
)
Net cash used in investing activities
(71.2
)
 
(263.5
)
Cash flows from financing activities
 
 
 
Repurchases of common stock
(50.0
)
 

Proceeds from sales of shares through employee equity incentive plans
22.7

 
16.6

Excess tax benefit from share-based compensation arrangements
0.2

 
0.2

Net cash provided by (used in) financing activities
(27.1
)
 
16.8

Net increase (decrease) in cash and cash equivalents
105.0

 
(100.0
)
Cash and cash equivalents—beginning of period
734.4

 
375.8

Cash and cash equivalents—end of period
$
839.4

 
$
275.8


See notes to condensed consolidated financial statements.

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

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The following tables present the changes to financial statement line items as a result of the accounting change for the periods presented in our condensed consolidated financial statements (in millions, except per share data):
 
October 31, 2016
 
July 31, 2016
 
Computed under Prior Method
 
Impact of Commission Adjustment
 
As Reported
 
As Previously Reported
 
Impact of Commission Adjustment
 
As Adjusted
Condensed Consolidated Balance Sheets
 
 
 
 
 
 
 
 
 
 
 
Prepaid expenses and other current assets
$
75.4

 
$
54.0

 
$
129.4

 
$
84.8

 
$
54.9

 
$
139.7

Other assets
53.6

 
48.4

 
102.0

 
64.6

 
50.1

 
114.7

Other long-term liabilities
85.0

 
0.8

 
85.8

 
79.4

 

 
79.4

Accumulated deficit
$
(785.0
)
 
$
101.6

 
$
(683.4
)
 
$
(726.6
)
 
$
105.0

 
$
(621.6
)
 
Three Months Ended October 31, 2016
 
Three Months Ended October 31, 2015
 
Computed under Prior Method
 
Impact of Commission Adjustment
 
As Reported
 
As Previously Reported
 
Impact of Commission Adjustment
 
As Adjusted
Condensed Consolidated Statements of Operations
 
 
 
 
 
 
 
 
 
 
 
Sales and marketing
$
217.7

 
$
2.6

 
$
220.3

 
$
158.3

 
$
1.2

 
$
159.5

Operating loss
(47.3
)
 
(2.6
)
 
(49.9
)
 
(30.8
)
 
(1.2
)
 
(32.0
)
Provision for income taxes
7.6

 
0.8

 
8.4

 
4.3

 

 
4.3

Net loss
$
(58.4
)
 
$
(3.4
)
 
$
(61.8
)
 
$
(38.7
)
 
$
(1.2
)
 
$
(39.9
)
Net loss per share, basic and diluted
$
(0.65
)
 
$
(0.04
)
 
$
(0.69
)
 
$
(0.45
)
 
$
(0.02
)
 
$
(0.47
)
Weighted-average shares used to compute net loss per share, basic and diluted
89.8

 

 
89.8

 
85.1

 

 
85.1

 
 
 
 
 
 
 
 
 
 
 
 
Condensed Consolidated Statements of Comprehensive Loss
 
 
 
 
 
 
 
 
 
 
 
Net loss
$
(58.4
)
 
$
(3.4
)
 
$
(61.8
)
 
$
(38.7
)
 
$
(1.2
)
 
$
(39.9
)
Comprehensive loss
$
(61.3
)
 
$
(3.4
)
 
$
(64.7
)
 
$
(39.0
)
 
$
(1.2
)
 
$
(40.2
)
This change in accounting policy does not affect our balance of cash and cash equivalents and, as a result, did not change net cash flows from operating, investing, or financing activities, or materially impact any individual line items presented in our condensed consolidated statement of cash flows for the three months ended October 31, 2015.
Recent Accounting Pronouncements
Recently Adopted Accounting Pronouncements
In April 2015, the Financial Accounting Standards Board (“FASB”) issued new authoritative guidance on fees paid in a cloud computing arrangement. The standard requires customers in a cloud computing arrangement to evaluate whether the arrangement includes a software license. If the arrangement includes a software license, the customer should account for the software license element of the arrangement consistent with the acquisition of other software licenses. If the arrangement does not include a software license, the customer should account for the arrangement as a service contract. We adopted the guidance in our first quarter of fiscal 2017 on a prospective basis. Our adoption of this guidance did not have a material impact on our condensed consolidated financial statements.
In April 2015, the FASB issued updated authoritative guidance to simplify the presentation of debt issuance costs. The amended standard requires that debt issuance costs related to a recognized debt liability be presented in the balance sheet as a direct deduction from the carrying amount of the related debt liability, consistent with the presentation of debt discounts, instead of being presented as an asset. We adopted the guidance in our first quarter of fiscal 2017 on a retrospective basis, and as a result, we reduced other assets and convertible senior notes, net by $8.0 million on our condensed consolidated balance sheets as of July 31, 2016.
Recently Issued Accounting Pronouncements
In October 2016, the FASB issued authoritative guidance requiring the recognition of income tax consequences of an intra-entity transfer of an asset, other than inventory, when the transfer occurs. The standard is effective for us for our first quarter of fiscal

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2019 and will be applied on a modified retrospective basis. Early adoption is permitted. We are currently evaluating whether this standard will have a material impact on our condensed consolidated financial statements.
In August 2016, the FASB issued new authoritative guidance addressing eight specific cash flow issues with the objective of reducing the existing diversity in practice in how certain transactions are presented and classified in the statement of cash flows. The standard is effective for us for our first quarter of fiscal 2019 and will be applied on a retrospective basis. Early adoption is permitted. We are currently evaluating whether this standard will have a material impact on our condensed consolidated financial statements.
In June 2016, the FASB issued new authoritative guidance on the accounting for credit losses on most financial assets and certain financial instruments. The standard replaces the existing incurred loss model with an expected credit loss model for financial assets measured at amortized cost, including trade receivables, and requires that credit losses on available-for-sale debt securities be presented as an allowance rather than as a write-down. The standard is effective for us for our first quarter of fiscal 2021 and will be applied on a modified retrospective basis. Early adoption is permitted beginning our first quarter of fiscal 2020. We are currently evaluating whether this standard will have a material impact on our condensed consolidated financial statements.
In March 2016, the FASB issued authoritative guidance simplifying several aspects of the accounting for employee share-based payment transactions, including the income tax consequences, accounting for forfeitures, and classification of excess tax benefits on the statement of cash flows. The standard is effective for us for our first quarter of fiscal 2018, however, early adoption is permitted. We are currently evaluating whether this standard will have a material impact on our condensed consolidated financial statements.
In February 2016, the FASB issued new authoritative guidance on lease accounting. Among its provisions, the standard requires lessees to recognize right-of-use assets and lease liabilities on the balance sheet for operating leases and also requires additional qualitative and quantitative disclosures about lease arrangements. The standard is effective for us for our first quarter of fiscal 2020 and will be applied on a modified retrospective basis, with the option to elect certain practical expedients. Early adoption is permitted. We are currently evaluating whether this standard will have a material impact on our condensed consolidated financial statements.
In May 2014, the FASB issued new authoritative guidance on revenue from contracts with customers. The new standard provides principles for recognizing revenue for the transfer of promised goods or services to customers with the consideration to which the entity expects to be entitled in exchange for those goods or services. The standard also requires significantly expanded disclosures about revenue recognition. The FASB subsequently delayed the effective date of the standard by one year and as a result, the standard is now effective for us for our first quarter of fiscal 2019 using either of two methods: (i) retrospective to each prior reporting period presented with the option to elect certain practical expedients as defined within the guidance; or (ii) retrospective with the cumulative effect of initially applying the guidance recognized at the date of initial application and providing certain additional disclosures as defined per the guidance. Early adoption as of the original effective date is permitted. We are currently evaluating adoption methods and whether this standard will have a material impact on our condensed consolidated financial statements.
2. Fair Value Measurements
We categorize assets and liabilities recorded at fair value on our condensed consolidated balance sheets based upon the level of judgment associated with inputs used to measure their fair value. The categories are as follows:
Level 1—Inputs are unadjusted quoted prices in active markets for identical assets or liabilities.
Level 2—Inputs are quoted prices for similar assets and liabilities in active markets or inputs that are observable for the assets or liabilities, either directly or indirectly through market corroboration, for substantially the full term of the financial instruments.
Level 3—Inputs are unobservable inputs based on our own assumptions used to measure assets and liabilities at fair value. The inputs require significant management judgment or estimation.

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The following table presents the fair value of our financial assets and liabilities using the above input categories as of October 31, 2016 and July 31, 2016 (in millions):
 
 
October 31, 2016
 
July 31, 2016
 
 
Level 1
 
Level 2
 
Level 3
 
Total
 
Level 1
 
Level 2
 
Level 3
 
Total
Short-term investments:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Commercial paper
 
$

 
$
17.9

 
$

 
$
17.9

 
$

 
$
3.0

 
$

 
$
3.0

Corporate debt securities
 

 
110.3

 

 
110.3

 

 
121.4

 

 
121.4

U.S. government and agency securities
 

 
422.4

 

 
422.4

 

 
426.8

 

 
426.8

Total short-term investments
 

 
550.6

 

 
550.6

 

 
551.2

 

 
551.2

Long-term investments:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Certificates of deposit
 

 
5.4

 

 
5.4

 

 
5.4

 

 
5.4

Corporate debt securities
 

 
188.7

 

 
188.7

 

 
166.1

 

 
166.1

U.S. government and agency securities
 

 
514.3

 

 
514.3

 

 
481.3

 

 
481.3

Total long-term investments
 

 
708.4

 

 
708.4

 

 
652.8

 

 
652.8

Total assets measured at fair value
 
$

 
$
1,259.0

 
$

 
$
1,259.0

 
$

 
$
1,204.0

 
$

 
$
1,204.0

Accrued and other liabilities:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Foreign currency forward contracts
 
$

 
$
1.2

 
$

 
$
1.2

 
$

 
$

 
$

 
$

Total accrued and other liabilities
 

 
1.2

 

 
1.2

 

 

 

 

Total liabilities measured at fair value
 
$

 
$
1.2

 
$

 
$
1.2

 
$

 
$

 
$

 
$

Refer to Note 5. Convertible Senior Notes for the carrying amount and estimated fair value of our convertible senior notes as of October 31, 2016 and July 31, 2016.
3. Investments
The following tables summarize the amortized cost, unrealized gains and losses, and fair value of our available-for-sale investments as of October 31, 2016 and July 31, 2016 (in millions):
 
October 31, 2016
 
Amortized Cost 
 
Unrealized Gains
 
Unrealized Losses
 
Estimated Fair Value
Certificates of deposit
$
5.4

 
$

 
$

 
$
5.4

Commercial paper
17.9

 

 

 
17.9

Corporate debt securities
298.9

 
0.4

 
(0.3
)
 
299.0

U.S. government and agency securities
937.0

 
0.3

 
(0.6
)
 
936.7

Total
$
1,259.2

 
$
0.7

 
$
(0.9
)
 
$
1,259.0

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

 
$

 
$

 
$
5.4

Commercial paper
3.0

 

 

 
3.0

Corporate debt securities
286.7

 
0.8

 

 
287.5

U.S. government and agency securities
907.3

 
0.9

 
(0.1
)
 
908.1

Total
$
1,202.4

 
$
1.7

 
$
(0.1
)
 
$
1,204.0

Unrealized losses related to these investments are due to interest rate fluctuations as opposed to credit quality. In addition, we do not intend to sell and it is not likely that we would be required to sell these investments before recovery of their amortized cost

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basis, which may be at maturity. As a result, there were no other-than-temporary impairments for these investments at October 31, 2016 and July 31, 2016.
The following table summarizes the amortized cost and fair value of our available-for-sale investments as of October 31, 2016, by contractual years-to-maturity (in millions):
 
Amortized Cost
 
Fair Value
Due within one year
$
550.5

 
$
550.6

Due between one and three years
708.7

 
708.4

Total
$
1,259.2

 
$
1,259.0

4. Derivative Instruments
As a global business, we are exposed to currency exchange rate risk. Substantially all of our revenue is transacted in U.S. dollars, however, a portion of our operating expenditures are incurred outside of the United States and are denominated in foreign currencies, making them subject to fluctuations in foreign currency exchange rates. We enter into foreign currency derivative contracts with maturities of 12 months or less which we designate as cash flow hedges to manage the foreign currency exchange rate risk associated with these expenditures.
These derivative contracts expose us to credit risk to the extent that the counterparties may be unable to meet the terms of the arrangement. We mitigate this credit risk by transacting with major financial institutions with high credit ratings and also enter into master netting arrangements, which permit net settlement of transactions with the same counterparty. We are not required to pledge, and are not entitled to receive, cash collateral related to these derivative instruments. We do not enter into derivative contracts for trading or speculative purposes.
Our derivative financial instruments are recorded at fair value, on a gross basis, as either assets or liabilities in our condensed consolidated balance sheets. Gains or losses related to the effective portion of our cash flow hedges are recorded as a component of accumulated other comprehensive income (“AOCI”) in our condensed consolidated balance sheets and are reclassified into the financial statement line item associated with the underlying hedged transaction in our condensed consolidated statements of operations when the underlying hedged transaction is recognized in earnings. Any gains or losses related to the ineffective portion of our cash flow hedges are recorded immediately in other income (expense), net in our condensed consolidated statements of operations. If it becomes probable that the hedged transaction will not occur, the cumulative unrealized gain or loss is reclassified immediately from AOCI into other income (expense), net. Gains or losses related to non-designated derivative instruments are recognized in other income (expense), net each period until the instrument matures, is terminated, is re-designated as a qualified cash flow hedge, or is sold. Derivatives designated as cash flow hedges are classified in our condensed consolidated statements of cash flows in the same manner as the underlying hedged transaction, primarily within cash flows from operating activities.
In August 2016, we entered into forward contracts to hedge the foreign currency exchange rate risk arising from our euro-denominated expenditures to be incurred during the fiscal year ending July 31, 2017. These forward contracts were designated as cash flow hedges. As of October 31, 2016, the total notional amount of our outstanding foreign currency forward contracts was $63.8 million. Refer to Note 2. Fair Value Measurements for the total estimated fair value of our derivative instruments as of October 31, 2016.
During the three months ended October 31, 2016, we accumulated unrealized losses of $1.1 million in AOCI related to the effective portion of our cash flow hedges, substantially all of which we expect to be reclassified into earnings within the next 12 months. The amounts reclassified into earnings related to our cash flow hedges were not significant for the three months ended October 31, 2016.
5. Convertible Senior Notes
Convertible Senior Notes
On June 30, 2014, we issued $575.0 million aggregate principal amount of 0.0% Convertible Senior Notes due 2019 (the “Notes”). The Notes mature on July 1, 2019, unless converted or repurchased in accordance with their terms prior to such date. The Notes do not contain any financial covenants and we cannot redeem the Notes prior to maturity.
The Notes are convertible for up to 5.2 million shares of our common stock at an initial conversion price of approximately $110.28 per share of common stock, subject to adjustment. Holders of the Notes may surrender their Notes for conversion at their option at any time prior to the close of business on the business day immediately preceding January 1, 2019, only under the following circumstances:

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if the last reported sale price of our common stock for at least 20 trading days (whether or not consecutive) during a period of 30 consecutive trading days ending on the last trading day of the immediately preceding fiscal quarter is greater than or equal to 130% of the conversion price for the Notes on each applicable trading day (the “sale price condition”);
during the five business day period after any five consecutive trading day period, in which the trading price per $1,000 principal amount of Notes for each trading day of the measurement period was less than 98% of the product of the last reported sale price of our common stock and the conversion rate for the Notes on each such trading day; or
upon the occurrence of specified corporate events.
On or after January 1, 2019, holders may convert all or any portion of their Notes at any time prior to the close of business on the second scheduled trading day immediately preceding the maturity date regardless of the foregoing conditions. Upon conversion, holders will receive cash equal to the aggregate principal amount of the Notes to be converted, and, at our election, cash and/or shares of our common stock for any amounts in excess of the aggregate principal amount of the Notes being converted.
The sale price condition was not met during the fiscal quarter ended July 31, 2016. Since the Notes were not convertible, the net carrying amount of the Notes and related debt issuance costs were classified as long-term liabilities and the equity component was included in additional paid-in capital in our condensed consolidated balance sheets as of July 31, 2016. The sale price condition was met during the fiscal quarter ended October 31, 2016, and as a result, holders may convert their Notes at any time during the fiscal quarter ending January 31, 2017. Accordingly, the net carrying amount of the Notes and related debt issuance costs were reclassified into current liabilities and the portion of the equity component representing the conversion option was reclassified into temporary equity in our condensed consolidated balance sheets as of October 31, 2016. 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 following table sets forth the components of the Notes as of October 31, 2016 and July 31, 2016 (in millions):
 
October 31, 2016
 
July 31, 2016
Liability:
 
 
 
Principal
$
575.0

 
$
575.0

Less: debt discount and debt issuance costs, net of amortization
68.8

 
74.8

Net carrying amount
$
506.2

 
$
500.2

 
 
 
 
Equity (including temporary equity)
$
109.8

 
$
109.8

The total estimated fair value of the Notes was $851.0 million and $761.9 million at October 31, 2016 and July 31, 2016, respectively. The fair value was determined based on the closing trading price per $100 of the Notes as of the last day of trading for the period. We consider the fair value of the Notes at October 31, 2016 and July 31, 2016 to be a Level 2 measurement. The fair value of the Notes is primarily affected by the trading price of our common stock and market interest rates. As of October 31, 2016, the if-converted value of the Notes exceeded its principal amount by $223.6 million.
The following table sets forth interest expense recognized related to the Notes (dollars in millions):
 
Three Months Ended October 31,
 
2016
 
2015
Amortization of debt discount
$
5.4

 
$
5.2

Amortization of debt issuance costs
0.6

 
0.5

Total interest expense recognized
$
6.0

 
$
5.7

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

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Warrants
Separately, but concurrently with our issuance of the Notes, we entered into transactions whereby we sold warrants (the “Warrants”) to acquire up to 5.2 million shares of our common stock at a strike price of approximately $137.85 per share, subject to adjustments. The shares issuable under the Warrants will be included in the calculation of diluted earnings per share when the average market value per share of our common stock for the reporting period exceeds the strike price of the Warrants. The Warrants are separate transactions and are not part of the Notes or Notes Hedges, and are not remeasured through earnings each reporting period. Holders of the Notes and Note Hedges will not have any rights with respect to the Warrants.
For more information on the Notes, the Note Hedges, and the Warrants, refer to Note 7. Convertible Senior Notes of Notes to Consolidated Financial Statements included in Part II, Item 8 of our Annual Report on Form 10-K for the fiscal year ended July 31, 2016.
6. Commitments and Contingencies
Leases
We lease our facilities under various non-cancelable operating leases, which expire through the year ending July 31, 2028.
The following table presents details of the aggregate future non-cancelable minimum rental payments under our operating leases as of October 31, 2016 (in millions):
 
Amount
Fiscal years ending July 31:
 
Remaining 2017
$
20.6

2018
27.2

2019
46.5

2020
50.2

2021
55.0

2022 and thereafter
316.6

Committed gross lease payments
516.1

Less: proceeds from sublease rental
4.4

Net operating lease obligation
$
511.7

Contract Manufacturer Commitments
Our independent contract manufacturer procures components and assembles our products based on our forecasts. These forecasts are based on estimates of demand for our products primarily for the next 12 months, which are in turn based on historical trends and an analysis from our sales and product marketing organizations, adjusted for overall market conditions. In order to reduce manufacturing lead times and plan for adequate supply, we may issue forecasts and orders for components and products that are non-cancelable. As of October 31, 2016, our purchase commitments under such orders were $63.9 million, excluding obligations under contracts that we can cancel without a significant penalty. 
Litigation
We are subject to legal proceedings, claims, and litigation arising in the ordinary course of business, including intellectual property litigation. Such matters are subject to many uncertainties and outcomes are not predictable with assurance. We accrue for contingencies when we believe that a loss is probable and that we can reasonably estimate the amount of any such loss.
To the extent there is a reasonable possibility that a loss exceeding amounts already recognized may be incurred and the amount of such additional loss would be material, we will either disclose the estimated additional loss or state that such an estimate cannot be made. As of October 31, 2016, we have not recorded any significant accruals for loss contingencies associated with such legal proceedings, determined that an unfavorable outcome is probable or reasonably possible, or determined that the amount or range of any possible loss is reasonably estimable.
7. Stockholders’ Equity
Share Repurchase
On August 26, 2016, our board of directors authorized a $500.0 million share repurchase which will be funded from available working capital. Repurchases may be made at management’s discretion from time to time on the open market, through privately

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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 August 31, 2018, and may be suspended or discontinued at any time. During the three months ended October 31, 2016, we repurchased and retired 0.3 million shares of our common stock under the authorization for an aggregate purchase price of $50.0 million. The total price of the shares repurchased and related transaction costs are reflected as a reduction to common stock and additional paid-in capital on our condensed consolidated balance sheets. As of October 31, 2016, $450.0 million remained available for future share repurchases under the repurchase authorization.
8. Equity Award Plans
Stock Option Activities
The following table summarizes the stock option activity under our stock plans during the reporting period (in millions, except per share amounts):
 
Options Outstanding 
 
Number
of
Shares
 
Weighted-
Average
Exercise
Price Per Share 
 
Weighted-
Average
Remaining
Contractual
Term
(Years)
 
Aggregate
Intrinsic
Value
Balance—July 31, 2016
2.1

 
$
13.42

 
5.2
 
$
244.9

Options granted

 

 
 
 
 
Options forfeited

 

 
 
 
 
Options exercised
(0.3
)
 
15.93

 
 
 
 
Balance—October 31, 2016
1.8

 
$
13.01

 
4.9
 
$
253.1

Options vested and expected to vest—October 31, 2016
1.8

 
$
13.01

 
4.9
 
$
253.1

Options exercisable—October 31, 2016
1.8

 
$
13.01

 
4.9
 
$
253.1

Restricted Stock Unit (“RSU”), Restricted Stock Award (“RSA”), and Performance-Based Stock Award (“PSA”) Activities
During the three months ended October 31, 2016, we granted PSAs to our employees, which will vest over a period of four years from the date of grant. The actual number of PSAs earned and eligible to vest will be determined based on level of achievement against a pre-established billings target for the fiscal year ending July 31, 2017, with a maximum of 0.2 million shares issuable at the end of the performance period. Share-based compensation expense for our PSAs is recognized, net of estimated forfeitures, 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 RSU, RSA, and PSA activity under our stock plans during the reporting period (in millions, except per share amounts):
 
RSAs and PSAs Outstanding
 
RSUs Outstanding
 
Number
of
Shares
 
Weighted-
Average
Grant-Date Fair Value Per Share
 
Number
of
Shares
 
Weighted-
Average
Grant-Date Fair Value Per Share
 
Weighted-
Average
Remaining
Contractual
Term
(Years)
 
Aggregate
Intrinsic
Value
Balance—July 31, 2016
1.1

 
$
170.97

 
6.5

 
$
130.14

 
1.1
 
$
852.7

Granted(1)
0.3

 
148.54

 
2.0

 
147.51

 
 
 
 
Vested

 

 
(0.7
)
 
98.49

 
 
 
 
Forfeited

 

 
(0.1
)
 
140.21

 
 
 
 
Balance—October 31, 2016
1.4

 
$
165.81

 
7.7

 
$
137.59

 
1.3
 
$
1,187.5

Expected to vest—October 31, 2016
1.4

 
$
166.55

 
7.3

 
$
137.19

 
1.3
 
$
1,119.0

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

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Share-Based Compensation
The following table summarizes share-based compensation included in costs and expenses (in millions):
 
Three Months Ended October 31,
 
2016
 
2015
Cost of product revenue
$
1.7

 
$
1.3

Cost of subscription and support revenue
12.4

 
7.0

Research and development
38.4

 
25.0

Sales and marketing
44.0

 
27.2

General and administrative
17.7

 
12.4

Total share-based compensation
$
114.2

 
$
72.9

At October 31, 2016, total compensation cost related to unvested share-based awards not yet recognized was $1.0 billion, net of estimated forfeitures. This cost is expected to be amortized on a straight-line basis over a weighted-average period of approximately 2.7 years.
9. Income Taxes
Our provision for income taxes for the three months ended October 31, 2016 reflects an effective tax rate of (15.7)%. Our effective tax rate for this period was negative as we recorded a provision for income taxes on year to date losses. The key components of our income tax provision primarily consist of foreign income taxes, withholding taxes, U.S. federal and state income taxes, and amortization of our deferred tax charges. Our effective tax rate differs from the U.S. statutory tax rate primarily due to non-deductible share-based compensation and changes in our valuation allowance. As compared to the same period last year, our effective tax rate changed primarily due to an increase in non-deductible share-based compensation and changes in our valuation allowance against deferred tax assets.
Our provision for income taxes for the three months ended October 31, 2015 reflects an effective tax rate of (12.1)%. 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, U.S. federal and state income taxes, and amortization of our deferred tax charges. Key components of our effective tax rate consisted of foreign tax losses which derive no benefit, non-deductible share-based compensation, and changes in our valuation allowance. 
10. Net Income (Loss) Per Share
Basic net income (loss) per share is computed by dividing net income (loss) by basic weighted-average shares outstanding during the period. Diluted net income (loss) per share is computed by dividing net income (loss) by diluted weighted-average shares outstanding, including potentially dilutive securities.
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,
 
2016
 
2015
Net loss
$
(61.8
)
 
$
(39.9
)
Weighted-average shares used to compute net loss per share, basic and diluted
89.8

 
85.1

Net loss per share, basic and diluted
$
(0.69
)
 
$
(0.47
)

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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,
 
2016
 
2015
RSUs
7.7

 
6.8

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
1.8

 
2.9

RSAs and PSAs
1.4

 

Total
21.3

 
20.1

ITEM 2.
MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
The following discussion and analysis of our financial condition and results of operations should be read in conjunction with our condensed consolidated financial statements and related notes appearing elsewhere in this Quarterly Report on Form 10-Q. The following discussion and analysis contains forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. These statements include, among other things: expectations regarding drivers of and factors affecting growth in our business; statements regarding trends in billings, our mix of product and subscription and support revenue, cost of revenue, gross margin, cash flows, operating expenses, including future share-based compensation expense, income taxes, investments and liquidity; expectations regarding the seasonality and cyclicality of our revenues from quarter to quarter; expected impact of the adoption of certain recent accounting pronouncements and the anticipated timing of adopting such standards; expected recurring revenues resulting from expected growth in our installed base; the sufficiency of our existing cash and investments to meet our cash needs for the foreseeable future; and other statements regarding our future operations, financial condition and prospects, and business strategies. Forward-looking statements generally can be identified by words such as “anticipates,” “believes,” “could,” “estimates,” “expects,” “intends,” “may,” “plans,” “predicts,” “projects,” “would,” “will be,” “will continue,” “will likely result,” and similar expressions. These forward-looking statements are based on current expectations and assumptions that are subject to risks and uncertainties, which could cause our actual results to differ materially from those reflected in the forward-looking statements. Factors that could cause or contribute to such differences include, but are not limited to, those discussed in this Quarterly Report on Form 10-Q, and in particular, the risks discussed under the caption “Risk Factors” in Part II, Item 1A of this report and those discussed in other documents we file with the Securities and Exchange Commission (“SEC”). We undertake no obligation to revise or publicly release the results of any revision to these forward-looking statements, except as required by law. Given these risks and uncertainties, readers are cautioned not to place undue reliance on such forward-looking statements.
Our Management’s Discussion and Analysis of Financial Condition and Results of Operations (“MD&A”) is organized as follows:
Overview. A discussion of our business and overall analysis of financial and other highlights in order to provide context for the remainder of MD&A.
Key Financial Metrics. A summary of our generally accepted accounting principles (“GAAP”) and non-GAAP key financial metrics, which management monitors to evaluate our performance.
Results of Operations. A discussion of the nature and trends in our financial results and an analysis of our financial results comparing the three months ended October 31, 2016 to the three months ended October 31, 2015.
Liquidity and Capital Resources. An analysis of changes in our balance sheets and cash flows, and a discussion of our financial condition and our ability to meet cash needs.
Critical Accounting Estimates. A discussion of our accounting policies that require critical estimates, assumptions, and judgments.
Recent Accounting Pronouncements. A discussion of expected impacts of impending accounting changes on financial information to be reported in the future.

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Overview
We have pioneered the next generation of security through our innovative platform that allows enterprises, service providers, and government entities to secure their organizations by safely enabling applications running on their networks and by preventing breaches that stem from targeted cyber attacks. Our platform uses an innovative traffic classification engine that identifies network traffic by application, user, and content and provides consistent security across the network, endpoint, and cloud. Accordingly, our platform enables our end-customers to maintain the visibility and control needed to protect their valued data and critical control systems while pursuing technology initiatives, like cloud and mobility, that grow their business. We believe our platform offers superior performance compared to legacy approaches and reduces the total cost of ownership for organizations by simplifying their security infrastructure and eliminating the need for multiple, stand-alone security appliances and software products.
Our Next-Generation Security Platform consists of three major elements: our Next-Generation Firewall, our Advanced Endpoint Protection, and our Threat Intelligence Cloud. Our Next-Generation Firewall delivers application, user, and content visibility and control as well as protection against network-based cyber threats integrated within the firewall through our proprietary hardware and software architecture. Our Advanced Endpoint Protection prevents cyber attacks that aim to run malicious code or exploit software vulnerabilities on a broad variety of fixed and virtual endpoints and servers. Our Threat Intelligence Cloud provides central intelligence capabilities, security for software as a service (“SaaS”) applications, and automated delivery of preventative measures against cyber attacks.
For the first quarter of fiscal 2017 and 2016, total revenue was $398.1 million and $297.2 million, respectively, representing year-over-year growth of 34.0%. Our growth reflects the increased adoption of our hybrid SaaS revenue model, which consists of product, subscription, and support. We believe this model will enable us to benefit from recurring revenues as we continue to grow our installed end-customer base. As of October 31, 2016, we had over 35,500 end-customers in over 150 countries. Our end-customers represent a broad range of industries including education, energy, financial services, government entities, healthcare, Internet and media, manufacturing, public sector, and telecommunications, and include some of the largest Fortune 100 and Global 2000 companies in the world. We maintain a field sales force that works closely with our channel partners in developing sales opportunities. We use a two-tiered, indirect fulfillment model whereby we sell our products and services to our distributors, which, in turn, sell to our resellers, which then sell to our end-customers.
Our product revenue grew to $163.8 million, or 41.1% of total revenue, for the first quarter of fiscal 2017, representing year-over-year growth of 10.9%. Product revenue is generated from sales of our appliances, primarily our Next-Generation Firewall, which is available in physical and virtualized form. Our Next-Generation Firewall incorporates our proprietary PAN-OS operating system, which provides a consistent set of capabilities across our entire product line. Our products are designed for different performance requirements throughout an organization, ranging from our PA-200, which is designed for enterprise remote offices, to our top-of-the-line PA-7080, which is especially suited for very large enterprise deployments and service provider customers. The same firewall functionality that is delivered in our physical appliances is also available in our VM-Series virtual firewalls, which secure virtualized and cloud-based computing environments.
Our subscription and support revenue grew to $234.3 million, or 58.9% of total revenue, for the first quarter of fiscal 2017, representing year-over-year growth of 56.7%. Our subscriptions provide our end-customers with real-time access to the latest antivirus, intrusion prevention, web filtering, and modern malware prevention capabilities across fixed and mobile devices. When end-customers purchase an appliance, they typically purchase one or more of our subscriptions for additional functionality, as well as support in order to receive ongoing security updates, upgrades, bug fixes, and repairs.
We 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.”

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October 31, 2016
 
July 31, 2016
 
(in millions)
Total deferred revenue
$
1,359.6

 
$
1,240.8

Cash, cash equivalents, and investments
$
2,098.4

 
$
1,938.4

 
Three Months Ended October 31,
 
2016
 
2015
 
(dollars in millions)
Total revenue
$
398.1

 
$
297.2

Total revenue year-over-year percentage increase
34.0
 %
 
54.5
 %
Gross margin percentage
74.6
 %
 
73.3
 %
Operating loss(1)
$
(49.9
)
 
$
(32.0
)
Operating margin percentage(1)
(12.5
)%
 
(10.8
)%
Billings
$
516.9

 
$
388.0

Billings year-over-year percentage increase
33.2
 %
 
61.4
 %
Cash flow provided by operating activities
$
203.3

 
$
146.7

Free cash flow (non-GAAP)
$
182.4

 
$
127.2

______________
(1)
Amounts have been adjusted for the three months ended October 31, 2015, as a result of our voluntary change in accounting policy for sales commissions. Refer to Note 1. Description of Business and Summary of Significant Accounting Policies of Notes to Condensed Consolidated Financial Statements included in Part I, Item 1 of this Quarterly Report on Form 10-Q for more information.
Deferred Revenue. Our deferred revenue consists of amounts that have been invoiced but have not been recognized as revenue as of the period end. The majority of our deferred revenue balance consists of subscription and support revenue that is recognized ratably over the contractual service period. We monitor our deferred revenue balance because it represents a significant portion of revenue to be recognized in future periods.
Billings. We define billings as total revenue plus the change in total deferred revenue during the period. We consider billings to be a key measure used by management to manage our business given our hybrid SaaS revenue model, and believe billings provides investors with an important indicator of the health and visibility of our business because it includes subscription and support revenue, which is recognized ratably over the contractual service period, and product revenue, which is recognized at the time of shipment, provided that all other revenue recognition criteria have been met. We consider billings to be a useful metric for management and investors, particularly if we continue to experience increased sales of subscriptions and strong renewal rates for subscription and support offerings, and as we monitor our near term cash flows. While we believe that billings provides useful information to investors and others in understanding and evaluating our operating results in the same manner as our management, it is important to note that other companies, including companies in our industry, may not use billings, may calculate billings differently, may have different billing frequencies, or may use other financial measures to evaluate their performance, all of which could reduce the usefulness of billings as a comparative measure. We calculate billings in the following manner:
 
Three Months Ended October 31,
 
2016
 
2015
 
(in millions)
Billings:
 
 
 
Total revenue
$
398.1

 
$
297.2

Add: change in total deferred revenue
118.8

 
90.8

Billings
$
516.9

 
$
388.0

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

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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,
 
2016
 
2015
 
(in millions)
Free cash flow (non-GAAP):
 
 
 
Net cash provided by operating activities
$
203.3

 
$
146.7

Less: purchases of property, equipment, and other assets
20.9

 
19.5

Free cash flow (non-GAAP)
$
182.4

 
$
127.2

Net cash used in investing activities
$
(71.2
)
 
$
(263.5
)
Net cash provided by (used in) financing activities
$
(27.1
)
 
$
16.8


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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,
 
2016
 
2015
 
Amount
 
% of Revenue
 
Amount(1)
 
% of Revenue(1)
 
(dollars in millions)
Revenue:
 
 
 
 
 
 
 
Product
$
163.8

 
41.1
 %
 
$
147.7

 
49.7
 %
Subscription and support
234.3

 
58.9
 %
 
149.5

 
50.3
 %
Total revenue
398.1

 
100.0
 %
 
297.2

 
100.0
 %
Cost of revenue:
 
 
 
 
 
 
 
Product
42.2

 
10.6
 %
 
38.8

 
13.0
 %
Subscription and support
59.1

 
14.8
 %
 
40.4

 
13.7
 %
Total cost of revenue(2)
101.3

 
25.4
 %
 
79.2

 
26.7
 %
Total gross profit
296.8

 
74.6
 %
 
218.0

 
73.3
 %
Operating expenses:
 
 
 
 
 
 
 
Research and development
84.6

 
21.3
 %
 
59.7

 
20.1
 %
Sales and marketing
220.3

 
55.3
 %
 
159.5

 
53.7
 %
General and administrative
41.8

 
10.5
 %
 
30.8

 
10.3
 %
Total operating expenses(2)
346.7

 
87.1
 %
 
250.0

 
84.1
 %
Operating loss
(49.9
)
 
(12.5
)%
 
(32.0
)
 
(10.8
)%
Interest expense
(6.0
)
 
(1.5
)%
 
(5.8
)
 
(1.9
)%
Other income, net
2.5

 
0.6
 %
 
2.2

 
0.7
 %
Loss before income taxes
(53.4
)
 
(13.4
)%
 
(35.6
)
 
(12.0
)%
Provision for income taxes
8.4

 
2.1
 %
 
4.3

 
1.4
 %
Net loss
$
(61.8
)
 
(15.5
)%
 
$
(39.9
)
 
(13.4
)%
______________
(1)
Certain prior period amounts have been adjusted as a result of our voluntary change in accounting policy for sales commissions. Refer to Note 1. Description of Business and Summary of Significant Accounting Policies of Notes to Condensed Consolidated Financial Statements included in Part I, Item 1 of this Quarterly Report on Form 10-Q for more information.
(2)
Includes share-based compensation as follows:
 
Three Months Ended October 31,
 
2016
 
2015
Cost of product revenue
$
1.7

 
$
1.3

Cost of subscription and support revenue
12.4

 
7.0

Research and development
38.4

 
25.0

Sales and marketing
44.0

 
27.2

General and administrative
17.7

 
12.4

Total share-based compensation
$
114.2

 
$
72.9


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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, to a lesser extent, the VM-Series. We recognize product revenue at the time of shipment, provided that all other revenue recognition criteria have been met.
 
Three Months Ended October 31,
 
 
 
 
 
2016
 
2015
 
Change
 
Amount
 
Amount
 
Amount
 
%
 
(dollars in millions)
Product
$
163.8

 
$
147.7

 
$
16.1

 
10.9
%
Product revenue increased for the three months ended October 31, 2016 compared to the three months ended October 31, 2015, driven by increased demand for our higher end appliances. The change in product revenue due to changes in pricing was not significant.
Subscription and Support Revenue
Subscription and support revenue is derived primarily from sales of our subscription and support offerings. Our contractual subscription and support terms are typically one to five years. We recognize revenue from subscriptions and support over the contractual service period. As a percentage of total revenue, we expect our subscription and support revenue to vary from quarter to quarter and increase over the long term as we introduce new subscriptions, renew existing subscription and support contracts, and expand our installed end-customer base. Prior to fiscal 2017, subscription and support revenue was referred to as services revenue, however, the composition of subscription and support revenue has not been modified.
 
Three Months Ended October 31,
 
 
 
 
 
2016
 
2015
 
Change
 
Amount
 
Amount
 
Amount
 
%
 
(dollars in millions)
Subscription
$
121.2

 
$
73.6

 
$
47.6

 
64.7
%
Support
113.1

 
75.9

 
37.2

 
49.0
%
Total subscription and support
$
234.3

 
$
149.5

 
$
84.8

 
56.7
%
Subscription and support revenue increased for the three months ended October 31, 2016 compared to the three months ended October 31, 2015, due to increased demand for our subscription and support offerings from both new and existing end-customers. The mix between subscription revenue and support revenue will fluctuate over time, depending on the introduction of new subscription offerings, renewals of support services, and our ability to increase sales to new and existing customers. The change in subscription and support revenue due to changes in pricing was not significant.
Revenue by Geographic Theater
 
Three Months Ended October 31,
 
 
 
 
 
2016
 
2015
 
Change
 
Amount
 
Amount
 
Amount
 
%
 
(dollars in millions)
Americas
$
280.2

 
$
211.3

 
$
68.9

 
32.6
%
EMEA
70.7

 
53.7

 
17.0

 
31.7
%
APAC
47.2

 
32.2

 
15.0

 
46.6
%
Total revenue
$
398.1

 
$
297.2

 
$
100.9

 
34.0
%

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With respect to geographic theaters, the Americas contributed the largest portion of the increase in revenue for the three months ended October 31, 2016 compared to the three months ended October 31, 2015, due to its larger and more established sales force compared to our other theaters. Revenue from both Europe, the Middle East, and Africa (“EMEA”) and Asia Pacific and Japan (“APAC”) increased for the three months ended October 31, 2016 compared to the three months ended October 31, 2015, due to our investment in increasing the size of our sales force and number of channel partners in these theaters.
Cost of Revenue
Our cost of revenue consists of cost of product revenue and cost of subscription and support revenue.
Cost of Product Revenue
Cost of product revenue primarily includes costs paid to our third-party contract manufacturer. Our cost of product revenue also includes amortization of intellectual property licenses, product testing costs, shipping costs, personnel costs, which consist of salaries, benefits, bonuses, share-based compensation, and travel and entertainment associated with our operations organization, and allocated costs. Allocated costs consist of certain facilities, depreciation, benefits, recruiting, and information technology costs that we allocate based on headcount. We expect our cost of product revenue to increase as our product revenue increases.
 
Three Months Ended October 31,
 
 
 
 
 
2016
 
2015
 
Change
 
Amount
 
Amount
 
Amount
 
%
 
(dollars in millions)
Cost of product revenue
$
42.2

 
$
38.8

 
$
3.4

 
8.8
%
Number of employees at period end
92

 
75

 
17

 
22.7
%
Cost of product revenue increased for the three months ended October 31, 2016 compared to the three months ended October 31, 2015 due to an increase in product unit volume for our higher end appliances.
Cost of Subscription and Support Revenue
Cost of subscription and support revenue includes personnel costs for our global customer support and technical operations organizations, amortization of acquired intangible assets, third-party professional services costs, and allocated costs. We expect our cost of subscription and support revenue to increase as our installed end-customer base grows.
 
Three Months Ended October 31,
 
 
 
 
 
2016
 
2015
 
Change
 
Amount
 
Amount
 
Amount
 
%
 
(dollars in millions)
Cost of subscription and support revenue
$
59.1

 
$
40.4

 
$
18.7

 
46.3
%
Number of employees at period end
575

 
406

 
169

 
41.6
%
Cost of subscription and support revenue increased for the three months ended October 31, 2016 compared to the three months ended October 31, 2015, driven by increases in personnel costs, which grew $12.8 million to $34.7 million for the three months ended October 31, 2016 compared to the three months ended October 31, 2015. The increase in personnel costs were due to headcount growth. The remaining increase was due to expansion of our customer service capabilities and infrastructure to support our growing installed end-customer base.
Gross Margin
Gross margin, or gross profit as a percentage of revenue, has been and will continue to be affected by a variety of factors, including the average sales price of our products, manufacturing costs, the mix of products sold, and the mix of revenue between product and subscription and support offerings. For sales of our products, our higher end firewall products generally have higher gross margins than our lower end firewall products within each product series. For sales of our subscription and support offerings, our subscription offerings typically have higher gross margins than our support offerings. We expect our gross margins to fluctuate over time depending on the factors described above.

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Three Months Ended October 31,
 
2016
 
2015
 
Amount
 
Gross Margin
 
Amount
 
Gross Margin
 
(dollars in millions)
Product
$
121.6

 
74.2
%
 
$
108.9

 
73.8
%
Subscription and support
175.2

 
74.8
%
 
109.1

 
72.9
%
Total gross profit
$
296.8

 
74.6
%
 
$
218.0

 
73.3
%
Product gross margin increased for the three months ended October 31, 2016 compared to the three months ended October 31, 2015, driven by our continued focus on material cost reductions. Subscription and support gross margin increased for the three months ended October 31, 2016 compared to the three months ended October 31, 2015 due to contributions from our higher margin subscription offerings.
Operating Expenses
Our operating expenses consist of research and development, sales and marketing, and general and administrative expense. Personnel costs are the most significant component of operating expenses and consist of salaries, benefits, bonuses, share-based compensation, travel and entertainment, and with regard to sales and marketing expense, sales commissions. Our operating expenses also include allocated costs, which consist of certain facilities, depreciation, benefits, recruiting, and information technology costs that we allocate based on headcount. We expect operating expenses to increase in absolute dollars and decrease over the long term as a percentage of revenue as we continue to scale our business. As of October 31, 2016, we expect to recognize approximately $1.0 billion of share-based compensation expense over a weighted-average period of approximately 2.7 years, excluding additional share-based compensation expense related to any future grants of share-based awards. Share-based compensation expense, net of forfeitures, is recognized on a straight-line basis over the requisite service periods of the awards.
Research and Development
Research and development expense consists primarily of personnel costs. Research and development expense also includes prototype related expenses and allocated costs. We expect research and development expense to increase in absolute dollars as we continue to invest in our future products and services, although our research and development expense may fluctuate as a percentage of total revenue.
 
Three Months Ended October 31,
 
 
 
 
 
2016
 
2015
 
Change
 
Amount
 
Amount
 
Amount
 
%
 
(dollars in millions)
Research and development
$
84.6

 
$
59.7

 
$
24.9

 
41.7
%
Number of employees at period end
648

 
520

 
128

 
24.6
%
Research and development expense increased for the three months ended October 31, 2016 compared to the three months ended October 31, 2015, driven by an increase in personnel costs, which grew $20.5 million to $70.3 million for the three months ended October 31, 2016 compared to the three months ended October 31, 2015. The increase in personnel costs was due to headcount growth.
Sales and Marketing
Sales and marketing expense consists primarily of personnel costs, including commission expense. Sales and marketing expense also includes costs for market development programs, promotional and other marketing costs, professional services, and allocated costs. We continue to thoughtfully invest in headcount and have substantially grown our sales presence internationally. We expect sales and marketing expense to continue to increase in absolute dollars as we increase the size of our sales and marketing organizations to increase touch points with end-customers and to expand our international presence, although our sales and marketing expense may fluctuate as a percentage of total revenue.

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Three Months Ended October 31,
 
 
 
 
 
2016
 
2015
 
Change
 
Amount
 
Amount
 
Amount
 
%
 
(dollars in millions)
Sales and marketing(1)
$
220.3

 
$
159.5

 
$
60.8

 
38.1
%
Number of employees at period end
2,181

 
1,642

 
539

 
32.8
%
______________
(1)
Prior period amount has been adjusted as a result of our voluntary change in accounting policy for sales commissions. Refer to Note 1. Description of Business and Summary of Significant Accounting Policies of Notes to Condensed Consolidated Financial Statements included in Part I, Item 1 of this Quarterly Report on Form 10-Q for more information.
Sales and marketing expense increased for the three months ended October 31, 2016 compared to the three months ended October 31, 2015. The increase was primarily driven by an increase in personnel costs, which grew $48.9 million to $165.5 million for the three months ended October 31, 2016 compared to the three months ended October 31, 2015, due to headcount growth. The remaining increase includes $6.7 million related to investments in demand generation activities and sales related events to support our revenue growth.
General and Administrative
General and administrative expense consists of personnel costs for our executive, finance, human resources, legal, and information technology organizations, professional services costs, which consist primarily of legal, auditing, accounting, and other consulting costs, and certain non-recurring general expenses. Certain facilities, depreciation, benefits, recruiting, and information technology costs are allocated to other organizations based on headcount. We expect general and administrative expense to increase in absolute dollars due to additional costs associated with accounting, compliance, insurance, and investor relations, although our general and administrative expense may fluctuate as a percentage of total revenue.
 
Three Months Ended October 31,
 
 
 
 
 
2016
 
2015
 
Change
 
Amount
 
Amount
 
Amount
 
%
 
(dollars in millions)
General and administrative
$
41.8

 
$
30.8

 
$
11.0

 
35.7
%
Number of employees at period end
464

 
355

 
109

 
30.7
%
General and administrative expense increased for the three months ended October 31, 2016 compared to the three months ended October 31, 2015, driven by an increase in personnel costs, which grew $10.3 million to $31.1 million for the three months ended October 31, 2016 compared to the three months ended October 31, 2015. The increase in personnel costs was due to headcount growth.
Provision for Income Taxes
Provision for income taxes consists primarily of income taxes in foreign jurisdictions in which we conduct business, withholding taxes, federal and state income taxes in the United States, and amortization of our deferred tax charges. We maintain a full valuation allowance for domestic deferred tax assets, including net operating loss carryforwards and tax credits.
 
Three Months Ended October 31,
 
Change 
 
2016
 
2015
 
Amount
 
%
 
(dollars in millions)
Provision for income taxes
$
8.4

 
$
4.3

 
$
4.1

 
95.3
%
Effective tax rate(1)
(15.7
)%
 
(12.1
)%
 
 
 
 
______________
(1)
Prior period effective tax rate has been adjusted as a result of our voluntary change in accounting policy for sales commissions. Refer to Note 1. Description of Business and Summary of Significant Accounting Policies of

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Notes to Condensed Consolidated Financial Statements included in Part I, Item 1 of this Quarterly Report on Form 10-Q for more information.
We recorded an income tax provision for the three months ended October 31, 2016, due to federal, state, and foreign income taxes, withholding taxes, and amortization of our deferred tax charges. The provision for income taxes increased for the three months ended October 31, 2016 compared to the three months ended October 31, 2015, primarily due to an increase in U.S. profits resulting in an increase in U.S. taxes.
Liquidity and Capital Resources
 
October 31, 2016
 
July 31, 2016
 
(in millions)
Working capital(1)(2)
$
465.0

 
$
927.2

Cash, cash equivalents, and investments:
 
 
 
Cash and cash equivalents
$
839.4

 
$
734.4

Investments
1,259.0

 
1,204.0

Total cash, cash equivalents, and investments
$
2,098.4

 
$
1,938.4

______________
(1)
Working capital as of July 31, 2016, has been adjusted as a result of our voluntary change in accounting policy for sales commissions. Refer to Note 1. Description of Business and Summary of Significant Accounting Policies of Notes to Condensed Consolidated Financial Statements included in Part I, Item 1 of this Quarterly Report on Form 10-Q for more information.
(2)
The net carrying amount of the Notes was classified in current liabilities in our condensed consolidated balance sheets as of October 31, 2016. Refer to Note 5. Convertible Senior Notes of Notes to Condensed Consolidated Financial Statements included in Part I, Item 1 of this Quarterly Report on Form 10-Q for more information.
At October 31, 2016, our total cash, cash equivalents, and investments of $2.1 billion were held for general corporate purposes, of which approximately $208.3 million was held outside of the United States. We do not provide for federal income taxes on the undistributed earnings of our foreign subsidiaries, all of which we expect to reinvest outside of the United States indefinitely. However, if these funds were needed for our domestic operations, we would be required to accrue and pay U.S. taxes on undistributed earnings of foreign subsidiaries. There are no other restrictions on the use of these funds. If we were to repatriate these earnings to the United States, any associated income tax liability would be insignificant.
As of October 31, 2016, all of our 0.0% Convertible Senior Notes due 2019 (the “Notes”) remained outstanding. The Notes mature on July 1, 2019, however, prior to January 1, 2019, holders may surrender their Notes for early conversion under certain circumstances. Upon conversion, we will pay cash equal to the aggregate principal amount of the Notes to be converted, and, at our election, will pay or deliver cash and/or shares of our common stock for the amount of our conversion obligation in excess of the aggregate principal amount of the Notes being converted. Refer to Note 5. Convertible Senior Notes of Notes to Condensed Consolidated Financial Statements included in Part I, Item 1 of this Quarterly Report on Form 10-Q for information on the Notes.
In August 2016, our board of directors authorized a $500.0 million share repurchase which will be funded from available working capital. Repurchases may be made at management’s discretion from time to time. The repurchase authorization will expire on August 31, 2018, and may be suspended or discontinued at any time. As of October 31, 2016, $450.0 million was available for future share repurchases under the repurchase authorization. Refer to Note 7. Stockholders’ Equity of Notes to Condensed Consolidated Financial Statements included in Part I, Item 1 of this Quarterly Report on Form 10-Q for information on the repurchase authorization.

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The following table summarizes our cash flows for the three months ended October 31, 2016 and 2015:
 
Three Months Ended October 31,
2016
 
2015
 
(in millions)
Net cash provided by operating activities
$
203.3

 
$
146.7

Net cash used in investing activities
(71.2
)
 
(263.5
)
Net cash provided by (used in) financing activities
(27.1
)
 
16.8

Net increase (decrease) in cash and cash equivalents
$
105.0

 
$
(100.0
)
We believe that our cash flow from operations with existing cash and cash equivalents will be sufficient to meet our anticipated cash needs for the foreseeable future. Our future capital requirements will depend on many factors including our growth rate, the timing and extent of spending to support development efforts, the expansion of sales and marketing activities, the introduction of new and enhanced products and subscription and support offerings, the costs to acquire or invest in complementary businesses and technologies, the costs to ensure access to adequate manufacturing capacity, the investments in our new corporate headquarters, and the continuing market acceptance of our products and subscription and support offerings. In addition, from time to time we may incur additional tax liability in connection with certain corporate structuring decisions.
We may also choose to seek additional equity or debt financing. In the event that additional financing is required from outside sources, we may not be able to raise it on terms acceptable to us or at all. If we are unable to raise additional capital when desired, our business, operating results, and financial condition may be adversely affected.
Operating Activities
Our operating activities have consisted of net loss adjusted for certain non-cash items and changes in assets and liabilities.
Cash provided by operating activities during the three months ended October 31, 2016 was $203.3 million, an increase of $56.6 million compared to the three months ended October 31, 2015. The increase was due to growth of our business and changes in our assets and liabilities during the three months ended October 31, 2016, which included an increase in sales of subscription and support contracts to new and existing customers as reflected by an increase in deferred revenue.
Investing Activities
Our investing activities have consisted of capital expenditures and net investment purchases, sales, and maturities. We expect to continue such activities as our business grows.
Cash used in investing activities during the three months ended October 31, 2016 was $71.2 million, a decrease of $192.3 million compared to the three months ended October 31, 2015, due to lower net purchases of available-for-sale investments.
Financing Activities
Our financing activities have consisted of proceeds from sales of shares through employee equity incentive plans and cash used in repurchases of shares of our common stock.
Cash used in financing activities during the three months ended October 31, 2016 was $27.1 million, a change of $43.9 million compared to the three months ended October 31, 2015, due to the repurchase of $50.0 million of common stock during the three months ended October 31, 2016.
Off-Balance Sheet Arrangements
As of October 31, 2016, we did not have any relationships with unconsolidated organizations or financial partnerships, such as structured finance or special purpose entities that would have been established for the purpose of facilitating off-balance sheet arrangements or other contractually narrow or limited purposes.
Critical Accounting Estimates
Our condensed consolidated financial statements have been prepared in accordance with U.S. GAAP. The preparation of these condensed consolidated financial statements requires us to make estimates and assumptions that affect the reported amounts of assets, liabilities, revenue, expenses, and related disclosures. We base our estimates on historical experience and on various other assumptions that we believe are reasonable under the circumstances. We evaluate our estimates and assumptions on an ongoing basis. Actual results may differ from these estimates. To the extent that there are material differences between these estimates and our actual results, our future financial statements will be affected.

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We believe the critical accounting estimates discussed under Item 7, “Management’s Discussion and Analysis of Financial Condition and Results of Operations” in our Annual Report on Form 10-K filed with the SEC on September 8, 2016, reflect our more significant judgments and estimates used in the preparation of our condensed consolidated financial statements. There have been no significant changes to our critical accounting estimates as filed in such report.
Recent Accounting Pronouncements
Refer to “Recent Accounting Pronouncements” in Note 1. Description of Business and Summary of Significant Accounting Policies of Notes to Condensed Consolidated Financial Statements included in Part I, Item 1 of this Quarterly Report on Form 10-Q.
ITEM 3.
QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Our exposures to market risk have not changed materially since July 31, 2016. For our quantitative and qualitative disclosures about market risk, see the disclosures in Part II, Item 7A in our Annual Report on Form 10-K filed with the SEC on September 8, 2016.
ITEM 4.
CONTROLS AND PROCEDURES
Evaluation of Disclosure Controls and Procedures
Our management, with the participation of our chief executive officer and chief financial officer, evaluated the effectiveness of our disclosure controls and procedures pursuant to Rule 13a-15 under the Securities Exchange Act of 1934, as amended (the “Exchange Act”), as of the end of the period covered by this report. Based on our evaluation, our chief executive officer and chief financial officer concluded that, as of October 31, 2016, our disclosure controls and procedures are designed at a reasonable assurance level and are effective to provide reasonable assurance that information we are required to disclose in reports that we file or submit under the Exchange Act is recorded, processed, summarized, and reported within the time periods specified in SEC rules and forms, and that such information is accumulated and communicated to our management, including our chief executive officer and chief financial officer, as appropriate, to allow timely decisions regarding required disclosure.
Changes in Internal Control over Financial Reporting
There were no changes in our internal control over financial reporting identified in connection with the evaluation required by Rule 13a-15(d) and 15d-15(d) of the Exchange Act that occurred during the quarter ended October 31, 2016 that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.
Limitations on Controls
In designing and evaluating the disclosure controls and procedures, management recognizes that any controls and procedures, no matter how well designed and operated, can provide only reasonable assurance of achieving the desired control objectives. In addition, the design of disclosure controls and procedures must reflect the fact that there are resource constraints and that management is required to apply its judgment in evaluating the benefits of possible controls and procedures relative to their costs. Further, no evaluation of controls can provide absolute assurance that misstatements due to error or fraud will not occur or that all control issues and instances of fraud, if any, within the Company have been detected.

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PART II
ITEM 1.
LEGAL PROCEEDINGS
The information set forth under the “Litigation” subheading in Note 6. Commitments and Contingencies of Notes to Condensed Consolidated Financial Statements in Part I, Item 1 of this Quarterly Report on Form 10-Q is incorporated herein by reference.
ITEM 1A.
RISK FACTORS
Our operations and financial results are subject to various risks and uncertainties including those described below. The risks and uncertainties described below are not the only ones we face. Additional risks and uncertainties that we are unaware of, or that we currently believe are not material, also may become important factors that affect us. If any of the following risks or others not specified below materialize, our business, financial condition, and operating results could be materially adversely affected and the market price of our common stock could decline.
Risks Related to Our Business and Our Industry
Our business and operations have experienced rapid growth in recent periods, and if we do not effectively manage any future growth or are unable to improve our systems, processes, and controls, our operating results could be adversely affected.
We have experienced rapid growth and increased demand for our products and subscriptions over the last few years. As a result, our employee headcount and number of end-customers have increased significantly, and we expect both to continue to grow over the next year. For example, from the end of fiscal 2016 to the end of the first quarter of fiscal 2017, our headcount increased from 3,795 to 3,960 employees, and our number of end-customers increased from approximately 34,000 to over 35,500. In addition, as we have grown, we have increasingly managed more complex deployments of our products and subscriptions with larger end-customers. The growth and expansion of our business and product and subscription and support offerings places a significant strain on our management, operational, and financial resources. To manage any future growth effectively, we must continue to improve and expand our information technology and financial infrastructure, our operating and administrative systems, and our ability to manage headcount, capital, and processes in an efficient manner.
We may not be able to successfully implement or scale improvements to our systems, processes, and controls in an efficient or timely manner. In addition, our existing systems, processes, and controls may not prevent or detect all errors, omissions, or fraud. We may also experience difficulties in managing improvements to our systems, processes, and controls or in connection with third-party software licensed to help us with such improvements. Any future growth would add complexity to our organization and require effective coordination throughout our organization. Failure to manage any future growth effectively could result in increased costs, disrupt our existing end-customer relationships, reduce demand for or limit us to smaller deployments of our platform, or harm our business performance and operating results.
Our operating results may vary significantly from period to period and be unpredictable, which could cause the market price of our common stock to decline.
Our operating results, in particular, our revenues, gross margins, operating margins, and operating expenses, have historically varied from period to period, and even though we have experienced growth, we expect variation to continue as a result of a number of factors, many of which are outside of our control and may be difficult to predict, including:
our ability to attract and retain new end-customers or sell additional products and subscriptions to our existing end-customers;
the budgeting cycles, seasonal buying patterns, and purchasing practices of end-customers;
changes in end-customer, distributor or reseller requirements, or market needs;
price competition;
the timing and success of new product and service introductions by us or our competitors or any other change in the competitive landscape of our industry, including consolidation among our competitors or end-customers and strategic partnerships entered into by and between our competitors;
changes in the mix of our products, subscriptions, and support, including changes in multi-year subscriptions and support;
our ability to successfully and continuously expand our business domestically and internationally;
changes in the growth rate of the enterprise security market;

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

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Our revenue growth rate in recent periods may not be indicative of our future performance.
We have experienced revenue growth rates of 34.0% and 54.5% in the first quarter of fiscal 2017 and fiscal 2016, respectively. Our revenue for any prior quarterly or annual period should not be relied upon as an indication of our future revenue or revenue growth for any future period. If we are unable to maintain consistent revenue or revenue growth, the market price of our common stock could be volatile, and it may be difficult for us to achieve and maintain profitability or maintain or increase cash flow on a consistent basis.
We have a history of losses, anticipate increasing our operating expenses in the future, and may not be able to achieve or maintain profitability or maintain or increase cash flow on a consistent basis, which could cause our business, financial condition, and operating results to suffer.
Other than fiscal 2012, we have incurred losses in all fiscal years since our inception. As a result, we had an accumulated deficit of $683.4 million at October 31, 2016. We anticipate that our operating expenses will continue to increase in the foreseeable future as we continue to grow our business. Our growth efforts may prove more expensive than we currently anticipate, and we may not succeed in increasing our revenues sufficiently, or at all, to offset increasing expenses. Revenue growth may slow or revenue may decline for a number of possible reasons, including slowing demand for our products or subscriptions, increasing competition, a decrease in the growth of our overall market, or a failure to capitalize on growth opportunities. Any failure to increase our revenue as we grow our business could prevent us from achieving or maintaining profitability or maintaining or increasing cash flow on a consistent basis. In addition, we may have difficulty achieving profitability under U.S. GAAP due to share-based compensation expense and other non-cash charges. If we are unable to navigate these challenges as we encounter them, our business, financial condition, and operating results may suffer.
If we are unable to sell additional product, subscription, and support offerings to our end-customers, our future revenue and operating results will be harmed.
Our future success depends, in part, on our ability to expand the deployment of our platform with existing end-customers. This may require increasingly sophisticated and costly sales efforts that may not result in additional sales. The rate at which our end-customers purchase additional products, subscriptions, and support depends on a number of factors, including the perceived need for additional security products, including subscription and support offerings, as well as general economic conditions. Further, existing end-customers have no contractual obligation to and may not renew their subscription and support contracts after the completion of their initial contract period. Our end-customers’ renewal rates may decline or fluctuate as a result of a number of factors, including their satisfaction with our subscriptions and our support offerings, the frequency and severity of subscription outages, our product uptime or latency, and the pricing of our, or competing, subscriptions. Additionally, our end-customers may renew their subscription and support agreements for shorter contract lengths or on other terms that are less economically beneficial to us. We also cannot be certain that our end-customers will renew their subscription and support agreements. If our efforts to sell additional products and subscriptions to our end-customers are not successful or our end-customers do not renew their subscription and support agreements or renew on less favorable terms, our revenues may grow more slowly than expected or decline.
We face intense competition in our market, especially from larger, well-established companies, and we may lack sufficient financial or other resources to maintain or improve our competitive position.
The market for enterprise security products is intensely competitive, and we expect competition to increase in the future from established competitors and new market entrants. Our main competitors fall into four categories:
large networking vendors such as Cisco and Juniper that incorporate security features in their products;
large companies such as Intel and IBM that have acquired large network and endpoint security specialist vendors in recent years and have the technical and financial resources to bring competitive solutions to the market;
independent security vendors such as Check Point, Fortinet, FireEye, and Symantec that offer a mix of network and endpoint security products; and
small and large companies that offer point solutions that compete with some of the features present in our platform.
Many of our existing competitors have, and some of our potential competitors could have, substantial competitive advantages such as:
greater name recognition and longer operating histories;
larger sales and marketing budgets and resources;
broader distribution and established relationships with distribution partners and end-customers;
greater customer support resources;
greater resources to make strategic acquisitions or enter into strategic partnerships;

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

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Seasonality may cause fluctuations in our revenue.
We believe there are significant seasonal factors that may cause our second and fourth fiscal quarters to record greater revenue sequentially than our first and third fiscal quarters. We believe that this seasonality results from a number of factors, including:
end-customers with a December 31 fiscal year-end choosing to spend remaining unused portions of their discretionary budgets before their year-end, which potentially results in a positive impact on our revenue in our second fiscal quarter;
our sales compensation plans, which are typically structured around annual quotas and commission rate accelerators, which potentially results in a positive impact on our revenue in our fourth fiscal quarter;
seasonal reductions in business activity during August in the United States, Europe and certain regions, which potentially results in a negative impact on our first fiscal quarter revenue; and
the timing of end-customer budget planning at the beginning of the calendar year, which can result in a delay in spending at the beginning of the calendar year potentially resulting in a negative impact on our revenue in our third fiscal quarter.
As we continue to grow, seasonal or cyclical variations in our operations may become more pronounced, and our business, operating results and financial position may be adversely affected.
If we are unable to hire, integrate, train, retain, and motivate qualified personnel and senior management, our business could suffer.
Our future success depends, in part, on our ability to continue to attract, integrate, and retain qualified and highly skilled personnel. We are substantially dependent on the continued service of our existing engineering personnel because of the complexity of our platform. Additionally, any failure to hire, train, and adequately incentivize our sales personnel or the inability of our recently hired sales personnel to effectively ramp to target productivity levels could negatively impact our growth and operating margins. Competition for highly skilled personnel, particularly in engineering, is often intense, especially in the San Francisco Bay Area, where we have a substantial presence and need for such personnel. In addition, the industry in which we operate generally experiences high employee attrition. Although we have entered into employment offer letters with our key personnel, these agreements have no specific duration and constitute at-will employment. We do not maintain key person life insurance policies on any of our employees. The loss of one or more of our key employees could seriously harm our business. If we are unable to attract, integrate, or retain the qualified and highly skilled personnel required to fulfill our current or future needs, our business, financial condition, and operating results could be harmed.
Our future performance also depends on the continued services and continuing contributions of our senior management to execute on our business plan and to identify and pursue new opportunities and product innovations. The loss of services of senior management or the ineffective management of any leadership transitions, especially within our sales organization, could significantly delay or prevent the achievement of our development and strategic objectives, which could adversely affect our business, financial condition, and operating results.
Further, we believe that a critical contributor to our success and our ability to retain highly skilled personnel has been our corporate culture, which we believe fosters innovation, teamwork, passion for end-customers, focus on execution, and the facilitation of critical knowledge transfer and knowledge sharing. As we grow and change, we may find it difficult to maintain these important aspects of our corporate culture. Any failure to preserve our culture as we grow could limit our ability to innovate and could negatively affect our ability to retain and recruit personnel, continue to perform at current levels or execute on our business strategy.
If we are not successful in executing our strategy to increase sales of our products and subscriptions to new and existing medium and large enterprise end-customers, our operating results may suffer.
Our growth strategy is dependent, in part, upon increasing sales of our products to new and existing medium and large enterprise end-customers. Sales to these types of end-customers involve risks that may not be present, or that are present to a lesser extent, with sales to smaller entities. These risks include:
competition from larger competitors, such as Cisco, Check Point, and Juniper, that traditionally target larger enterprises, service providers, and government entities and that may have pre-existing relationships or purchase commitments from those end-customers;
increased purchasing power and leverage held by large end-customers in negotiating contractual arrangements with us;
more stringent requirements in our worldwide support contracts, including stricter support response times and penalties for any failure to meet support requirements; and
longer sales cycles, in some cases over 12 months, and the associated risk that substantial time and resources may be spent on a potential end-customer that elects not to purchase our products and subscriptions.

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In addition, product purchases by large enterprises are frequently subject to budget constraints, multiple approvals, and unplanned administrative, processing, and other delays. Finally, large enterprises typically have longer implementation cycles, require greater product functionality and scalability and a broader range of services, demand that vendors take on a larger share of risks, sometimes require acceptance provisions that can lead to a delay in revenue recognition, and expect greater payment flexibility from vendors. All of these factors can add further risk to business conducted with these end-customers. If we fail to realize an expected sale from a large end-customer in a particular quarter or at all, our business, operating results, and financial condition could be materially and adversely affected.
We rely on revenue from subscription and support offerings, and because we recognize revenue from subscription and support over the term of the relevant service period, downturns or upturns in sales of these subscription and support offerings are not immediately reflected in full in our operating results.
Subscription and support revenue accounts for a significant portion of our revenue, comprising 58.9% of total revenue in the first quarter of fiscal 2017 and 50.3% of total revenue in the first quarter of fiscal 2016. Sales of new or renewal subscription and support contracts may decline and fluctuate as a result of a number of factors, including end-customers’ level of satisfaction with our products and subscriptions, the prices of our products and subscriptions, the prices of products and services offered by our competitors, and reductions in our end-customers’ spending levels. If our sales of new or renewal subscription and support contracts decline, our total revenue and revenue growth rate may decline and our business will suffer. In addition, we recognize subscription and support revenue monthly over the term of the relevant service period, which is typically one to five years. As a result, much of the subscription and support revenue we report each fiscal quarter is the recognition of deferred revenue from subscription and support contracts entered into during previous fiscal quarters. Consequently, a decline in new or renewed subscription or support contracts in any one fiscal quarter will not be fully or immediately reflected in revenue in that fiscal quarter but will negatively affect our revenue in future fiscal quarters. Also, it is difficult for us to rapidly increase our subscription and support revenue through additional subscription and support sales in any period, as revenue from new and renewal subscription and support contracts must be recognized over the applicable service period.
Defects, errors, or vulnerabilities in our products, subscriptions, or support, the failure of our products or subscriptions to block a virus or prevent a security breach, misuse of our products, or risks of product liability claims could harm our reputation and adversely impact our operating results.
Because our products and subscriptions are complex, they have contained and may contain design or manufacturing defects or errors that are not detected until after their commercial release and deployment by our end-customers. For example, from time to time, certain of our end-customers have reported defects in our products related to performance, scalability, and compatibility. Additionally, defects may cause our products or subscriptions to be vulnerable to security attacks, cause them to fail to help secure networks, or temporarily interrupt end-customers’ networking traffic. Because the techniques used by computer hackers to access or sabotage networks change frequently and generally are not recognized until launched against a target, we may be unable to anticipate these techniques and provide a solution in time to protect our end-customers’ networks. Furthermore, as a well-known provider of security solutions, our networks, products, including cloud-based technology, and subscriptions could be targeted by attacks specifically designed to disrupt our business and harm our reputation. In addition, defects or errors in our subscription updates or our products could result in a failure of our subscriptions to effectively update end-customers’ hardware and cloud-based products. Our data centers and networks may experience technical failures and downtime, may fail to distribute appropriate updates, or may fail to meet the increased requirements of a growing installed end-customer base, any of which could temporarily or permanently expose our end-customers’ networks, leaving their networks unprotected against the latest security threats. Moreover, our products must interoperate with our end-customers’ existing infrastructure, which often have different specifications, utilize multiple protocol standards, deploy products from multiple vendors, and contain multiple generations of products that have been added over time. As a result, when problems occur in a network, it may be difficult to identify the sources of these problems.
The occurrence of any such problem in our products and subscriptions, whether real or perceived, could result in:
expenditure of significant financial and product development resources in efforts to analyze, correct, eliminate, or work-around errors or defects or to address and eliminate vulnerabilities;
loss of existing or potential end-customers or channel partners;
delayed or lost revenue;
delay or failure to attain market acceptance;
an increase in warranty claims compared with our historical experience, or an increased cost of servicing warranty claims, either of which would adversely affect our gross margins; and
litigation, regulatory inquiries, or investigations that may be costly and harm our reputation.
Further, our products and subscriptions may be misused by end-customers or third parties that obtain access to our products and subscriptions. For example, our products and subscriptions could be used to censor private access to certain information on the

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Internet. Such use of our products and subscriptions for censorship could result in negative press coverage and negatively affect our reputation.
The limitation of liability provisions in our standard terms and conditions of sale may not fully or effectively protect us from claims as a result of federal, state, or local laws or ordinances, or unfavorable judicial decisions in the United States or other countries. The sale and support of our products and subscriptions also entails the risk of product liability claims. Although we may be indemnified by our third-party manufacturers for product liability claims arising out of manufacturing defects, because we control the design of our products and subscriptions, we may not be indemnified for product liability claims arising out of design defects. We maintain insurance to protect against certain claims associated with the use of our products and subscriptions, but our insurance coverage may not adequately cover any claim asserted against us. In addition, even claims that ultimately are unsuccessful could result in our expenditure of funds in litigation, divert management’s time and other resources, and harm our reputation.
False detection of applications, viruses, spyware, vulnerability exploits, data patterns, or URL categories could adversely affect our business.
Our classifications of application type, virus, spyware, vulnerability exploits, data, or URL categories may falsely detect applications, content, or threats that do not actually exist. This risk is heightened by the inclusion of a “heuristics” feature in our products and subscriptions, which attempts to identify applications and other threats not based on any known signatures but based on characteristics or anomalies which indicate that a particular item may be a threat. These false positives may impair the perceived reliability of our products and subscriptions and may therefore adversely impact market acceptance of our products and subscriptions. If our products and subscriptions restrict important files or applications based on falsely identifying them as malware or some other item that should be restricted, this could adversely affect end-customers’ systems and cause material system failures. Any such false identification of important files or applications could result in damage to our reputation, negative publicity, loss of channel partners, end-customers and sales, increased costs to remedy any problem, and costly litigation.
We rely on our channel partners to sell substantially all of our products, including subscriptions and support, and if these channel partners fail to perform, our ability to sell and distribute our products and subscriptions will be limited, and our operating results will be harmed.
Substantially all of our revenue is generated by sales through our channel partners, including distributors and resellers. We provide our channel partners with specific training and programs to assist them in selling our products, including subscriptions and support offerings, but there can be no assurance that these steps will be utilized or effective. In addition, our channel partners may be unsuccessful in marketing, selling, and supporting our products and subscriptions. We may not be able to incentivize these channel partners to sell our products and subscriptions to end-customers and, in particular, to large enterprises. These channel partners may also have incentives to promote our competitors’ products and may devote more resources to the marketing, sales, and support of competitive products. Our agreements with our channel partners may generally be terminated for any reason by either party with advance notice prior to each annual renewal date. We cannot be certain that we will retain these channel partners or that we will be able to secure additional or replacement channel partners. In addition, any new channel partner requires extensive training and may take several months or more to achieve productivity. Our channel partner sales structure could subject us to lawsuits, potential liability, and reputational harm if, for example, any of our channel partners misrepresent the functionality of our products or subscriptions to end-customers or violate laws or our corporate policies. If we fail to effectively manage our sales channels or channel partners, our ability to sell our products and subscriptions and operating results will be harmed.
If we do not accurately predict, prepare for, and respond promptly to the rapidly evolving technological and market developments and successfully manage product and subscription introductions and transitions to meet changing end-customer needs in the enterprise security market, our competitive position and prospects will be harmed.
The enterprise security market has grown quickly and is expected to continue to evolve rapidly. Moreover, many of our end-customers operate in markets characterized by rapidly changing technologies and business plans, which require them to add numerous network access points and adapt increasingly complex enterprise networks, incorporating a variety of hardware, software applications, operating systems, and networking protocols. If we fail to accurately predict end-customers’ changing needs and emerging technological trends in the enterprise security industry, including in the areas of mobility, virtualization, cloud computing, and software defined networks (“SDN”), our business could be harmed. The technology in our platform is especially complex because it needs to effectively identify and respond to new and increasingly sophisticated methods of attack, while minimizing the impact on network performance. Additionally, some of our new platform features and related platform enhancements may require us to develop new hardware architectures that involve complex, expensive, and time-consuming research and development processes. The development of our platform is difficult and the timetable for commercial release and availability is uncertain as there can be long time periods between releases and availability of new platform features. If we experience unanticipated delays in the availability of new products, platform features, and subscriptions, and fail to meet customer expectations for such availability, our competitive position and business prospects will be harmed.

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Additionally, we must commit significant resources to developing new platform features before knowing whether our investments will result in products, subscriptions, and platform features the market will accept. The success of new platform features depends on several factors, including appropriate new product definition, differentiation of new products, subscriptions, and platform features from those of our competitors, and market acceptance of these products, services and platform features. Moreover, successful new product introduction and transition depends on a number of factors including, our ability to manage the risks associated with new product production ramp-up issues, the availability of application software for new products, the effective management of purchase commitments and inventory, the availability of products in appropriate quantities and costs to meet anticipated demand, and the risk that new products may have quality or other defects or deficiencies in the early stages of introduction. There can be no assurance that we will successfully identify opportunities for new products and subscriptions, develop and bring new products and subscriptions to market in a timely manner, or achieve market acceptance of our products and subscriptions, or that products, subscriptions, and technologies developed by others will not render our products, subscriptions, or technologies obsolete or noncompetitive.
Our current research and development efforts may not produce successful products, subscriptions, or platform features that result in significant revenue, cost savings or other benefits in the near future, if at all.
Developing our products, subscriptions, platform features, and related enhancements is expensive. Our investments in research and development may not result in significant design improvements, marketable products, subscriptions, or platform features, or may result in products, subscriptions, or platform features that are more expensive than anticipated. Additionally, we may not achieve the cost savings or the anticipated performance improvements we expect, and we may take longer to generate revenue, or generate less revenue, than we anticipate. Our future plans include significant investments in research and development and related product and subscription opportunities. We believe that we must continue to dedicate a significant amount of resources to our research and development efforts to maintain our competitive position. However, we may not receive significant revenue from these investments in the near future, if at all, or these investments may not yield the expected benefits, either of which could adversely affect our business and operating results.
Because we depend on third-party manufacturers to build and ship our products, we are susceptible to manufacturing and logistics delays and pricing fluctuations that could prevent us from shipping customer orders on time, if at all, or on a cost-effective basis, which may result in the loss of sales and end-customers.
We depend on third-party manufacturers, primarily a subsidiary of Flex, our contract manufacturer, as sole source manufacturers for our product lines. Our reliance on these third-party manufacturers reduces our control over the manufacturing process and exposes us to risks, including reduced control over quality assurance, product costs, product supply, timing and transportation risk. Our products are primarily manufactured by our contract manufacturers at facilities located in the United States. Over time, a growing portion of our products may be manufactured outside the United States as we look for cost savings opportunities, which may subject us to additional logistical risks or risks associated with complying with local rules and regulations in foreign countries. Any manufacturing and logistics disruption by our third-party manufacturers could severely impair our ability to fulfill orders.
In addition, we are subject to requirements under the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010 to diligence, disclose, and report whether or not our products contain minerals originating from the Democratic Republic of the Congo and adjoining countries, or conflict minerals. We have incurred and expect to incur additional costs to comply with these disclosure requirements, including costs related to determining the source of any of the relevant minerals and metals used in our products. These requirements could adversely affect the sourcing, availability, and pricing of minerals used in the manufacture of semiconductor devices or other components used in our products. We may also encounter end-customers who require that all of the components of our products be certified as conflict free. If we are not able to meet this requirement, such end-customers may choose not to purchase our products.
Our third-party manufacturers typically fulfill our supply requirements on the basis of individual orders. We do not have long-term contracts with these manufacturers that guarantee capacity, the continuation of particular pricing terms, or the extension of credit limits. Accordingly, they are not obligated to continue to fulfill our supply requirements and the prices we pay for manufacturing services could be increased on short notice. Our contract with Flex permits them to terminate the agreement for their convenience, subject to prior notice requirements. If we are required to change contract manufacturers, our ability to meet our scheduled product deliveries to our end-customers could be adversely affected, which could cause the loss of sales to existing or potential end-customers, delayed revenue or an increase in our costs which could adversely affect our gross margins. Any production interruptions for any reason, such as a natural disaster, epidemic, capacity shortages, or quality problems, at one of our manufacturing partners would negatively affect sales of our product lines manufactured by that manufacturing partner and adversely affect our business and operating results.
Managing the supply of our products and product components is complex. Insufficient supply and inventory may result in lost sales opportunities or delayed revenue, while excess inventory may harm our gross margins.
Our third-party manufacturers procure components and build our products based on our forecasts, and we generally do not hold inventory for a prolonged period of time. These forecasts are based on estimates of future demand for our products, which are in turn

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based on historical trends and analyses from our sales and marketing organizations, adjusted for overall market conditions. In order to reduce manufacturing lead times and plan for adequate component supply, from time to time we may issue forecasts for components and products that are non-cancelable and non-returnable.
Our inventory management systems and related supply chain visibility tools may be inadequate to enable us to forecast accurately and effectively manage supply of our products and product components. If we ultimately determine that we have excess supply, we may have to reduce our prices and write-down inventory, which in turn could result in lower gross margins. If our actual component usage and product demand are lower than the forecast we provide to our third-party manufacturers, we accrue for losses on manufacturing commitments in excess of forecasted demand. Alternatively, insufficient supply levels may lead to shortages that result in delayed product revenue or loss of sales opportunities altogether as potential end-customers turn to competitors’ products that are readily available. If we are unable to effectively manage our supply and inventory, our operating results could be adversely affected.
Because some of the key components in our products come from limited sources of supply, we are susceptible to supply shortages or supply changes, which could disrupt or delay our scheduled product deliveries to our end-customers and may result in the loss of sales and end-customers.
Our products rely on key components, including integrated circuit components, which our contract manufacturers purchase on our behalf from a limited number of suppliers, including sole source providers. The manufacturing operations of some of our component suppliers are geographically concentrated in Asia and elsewhere, which makes our supply chain vulnerable to regional disruptions, such as natural disasters, fire, political instability, civil unrest, a power outage, or a localized health risk, and as a result could impair the volume of components that we are able to obtain.     
Further, we do not have volume purchase contracts with any of our component suppliers, and they could cease selling to us at any time. If we are unable to obtain a sufficient quantity of these components in a timely manner for any reason, sales of our products could be delayed or halted or we could be forced to expedite shipment of such components or our products at dramatically increased costs. Our component suppliers also change their selling prices frequently in response to market trends, including industry-wide increases in demand, and because we do not have volume purchase contracts with these suppliers, we are susceptible to price fluctuations related to raw materials and components and may not be able to adjust our prices accordingly. Additionally, poor quality in any of the sole-sourced components in our products could result in lost sales or sales opportunities.
If we are unable to obtain a sufficient volume of the necessary components for our products on commercially reasonable terms or the quality of the components do not meet our requirements, we could also be forced to redesign our products and qualify new components from alternate suppliers. The resulting stoppage or delay in selling our products and the expense of redesigning our products could result in lost sales opportunities and damage to customer relationships, which would adversely affect our business and operating results.
The sales prices of our products and subscriptions may decrease, which may reduce our gross profits and adversely impact our financial results.
The sales prices for our products and subscriptions may decline for a variety of reasons, including competitive pricing pressures, discounts, a change in our mix of products and subscriptions, anticipation of the introduction of new products or subscriptions, or promotional programs. Competition continues to increase in the market segments in which we participate, and we expect competition to further increase in the future, thereby leading to increased pricing pressures. Larger competitors with more diverse product and service offerings may reduce the price of products or subscriptions that compete with ours or may bundle them with other products and subscriptions. Additionally, although we price our products and subscriptions worldwide in U.S. dollars, currency fluctuations in certain countries and regions may negatively impact actual prices that channel partners and end-customers are willing to pay in those countries and regions. Furthermore, we anticipate that the sales prices and gross profits for our products will decrease over product life cycles. We cannot guarantee that we will be successful in developing and introducing new offerings with enhanced functionality on a timely basis, or that our product and subscription offerings, if introduced, will enable us to maintain our prices and gross profits at levels that will allow us to achieve and maintain profitability.
We generate a significant amount of revenue from sales to distributors, resellers, and end-customers outside of the United States, and we are therefore subject to a number of risks associated with international sales and operations.
We have a limited history of marketing, selling, and supporting our products and subscriptions internationally. We may experience difficulties in recruiting, training, managing, and retaining an international staff, and specifically staff related to sales management and sales personnel. We also may not be able to maintain successful strategic distributor relationships internationally or recruit additional companies to enter into strategic distributor relationships. Business practices in the international markets that we serve may differ from those in the United States and may require us in the future to include terms other than our standard terms related to payment, warranties, or performance obligations in end-customer contracts.
Additionally, our international sales and operations are subject to a number of risks, including the following:

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political, economic and social uncertainty around the world, in particular, those caused by the recent U.S. presidential election, macroeconomic challenges in Europe, terrorist activities, and continued hostilities in the Middle East;
greater difficulty in enforcing contracts and accounts receivable collection and longer collection periods;
the uncertainty of protection for intellectual property rights in some countries;
greater risk of unexpected changes in regulatory practices, tariffs, and tax laws and treaties;
risks associated with trade restrictions and foreign legal requirements, including the importation, certification, and localization of our products required in foreign countries;
greater risk of a failure of foreign employees, channel partners, distributors, and resellers to comply with both U.S. and foreign laws, including antitrust regulations, the U.S. Foreign Corrupt Practices Act, the U.K. Bribery Act, U.S. or foreign sanctions regimes and export or import control laws, and any trade regulations ensuring fair trade practices;
heightened risk of unfair or corrupt business practices in certain geographies and of improper or fraudulent sales arrangements;
increased expenses incurred in establishing and maintaining office space and equipment for our international operations;
management communication and integration problems resulting from cultural and geographic dispersion; and
fluctuations in exchange rates between the U.S. dollar and foreign currencies in markets where we do business and related impact on sales cycles.
These and other factors could harm our ability to gain future international revenues and, consequently, materially impact our business, operating results, and financial condition. The expansion of our existing international operations and entry into additional international markets will require significant management attention and financial resources. Our failure to successfully manage our international operations and the associated risks effectively could limit the future growth of our business.
Further, we are subject to risks associated with changes in economic and political conditions in countries in which we operate or sell our products and subscriptions. For instance, on June 23, 2016, the U.K. held a referendum in which voters approved an exit from the E.U., commonly referred to as “Brexit.” As a result of the referendum, it is expected that the British government will begin negotiating the terms of the U.K.’s withdrawal from the E.U. A withdrawal could, among other outcomes, disrupt the free movement of goods, services and people between the U.K. and the E.U., undermine bilateral cooperation in key policy areas and significantly disrupt trade between the U.K. and the E.U.; however, the full effects of Brexit are uncertain and will depend on any agreements the U.K. makes to retain access to E.U. markets either during a transitional period or more permanently. In addition, Brexit could lead to legal uncertainty and potentially divergent national laws and regulations as the U.K. determines which E.U. laws to replace or replicate. Given these possibilities and others we may not anticipate, as well as the lack of comparable precedent, the full extent to which our business, operating results and financial condition could be adversely affected by Brexit is uncertain.
The announcement of Brexit and the withdrawal of the U.K. from the E.U. may also create global economic uncertainty, which may cause our end-customers to closely monitor their costs and reduce their spending budgets. Any of these effects of Brexit, among others noted above, could adversely affect our business, financial condition, operating results and cash flows.
We are exposed to fluctuations in currency exchange rates, which could negatively affect our financial condition and operating results.
Our sales contracts are primarily denominated in U.S. dollars, and therefore, substantially all of our revenue is not subject to foreign currency risk. However, including the announcement of Brexit, there has been, and may continue to be, significant volatility in global stock markets and foreign currency exchange rates that resulted in the strengthening of the U.S. dollar against foreign currencies in which we conduct business. The strengthening of the U.S. dollar increases the real cost of our platform to our end-customers outside of the United States and may lead to delays in the purchase of our products, subscriptions, and support, and the lengthening of our sales cycle. If the U.S. dollar continues to strengthen, this could adversely affect our financial condition and operating results. In addition, increased international sales in the future, including through our channel partners and other partnerships, may result in greater foreign currency denominated sales, increasing our foreign currency risk.
Our operating expenses incurred outside the United States and denominated in foreign currencies are increasing and are subject to fluctuations due to changes in foreign currency exchange rates. If we are not able to successfully hedge against the risks associated with foreign currency fluctuations, our financial condition and operating results could be adversely affected. We have entered into forward contracts in an effort to reduce our foreign currency exchange exposure related to our euro-denominated expenditures for the fiscal year ending July 31, 2017. As of October 31, 2016, the total notional amount of our outstanding foreign currency forward contracts was $63.8 million. Refer to Note 4. Derivative Instruments of Notes to Condensed Consolidated Financial Statements included in Part I, Item 1 of this Quarterly Report on Form 10-Q for more information on our hedging transactions. The effectiveness of our existing hedging transactions and the availability and effectiveness of any hedging transactions we may decide to enter into in

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the future may be limited and we may not be able to successfully hedge our exposure, which could adversely affect our financial condition and operating results.
A small number of channel partners represent a large percentage of our revenue and gross accounts receivable. We are exposed to the credit and liquidity risk of some of our channel partners and to credit exposure in weakened markets, which could result in material losses.
For the first quarter of fiscal 2017, two distributors represented 57.0% of our total revenue, and as of October 31, 2016, three distributors represented 64.8% of our gross accounts receivable. Most of our sales to our channel partners are made on an open credit basis. Although we have programs in place that are designed to monitor and mitigate these risks, we cannot guarantee these programs will be effective in reducing our credit risks, especially as we expand our business internationally. If we are unable to adequately control these risks, our business, operating results, and financial condition could be harmed.
A portion of our revenue is generated by sales to government entities, which are subject to a number of challenges and risks.
Sales to government entities are subject to a