Item 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

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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: our expectation of achieving and maintaining profitability under U.S. GAAP; the effects of supply chain challenges and the global chip and component shortages and other factors affecting the manufacture, delivery and cost of certain of our products; expectations regarding drivers of and factors affecting growth in our business; the performance advantages of our products and subscription and support offerings and the potential benefits to our customers; statements regarding trends in billings, our mix of product and subscription and support revenue, cost of revenue, gross margin, cash flows, operating expenses, including future share-based compensation expense, income taxes, investment plans and liquidity; expectations regarding our revenues, including the seasonality and cyclicality from quarter to quarter; expectations and intentions with respect to the products, technologies and businesses that we acquire and introduce; our strategy of acquiring complementary businesses and our ability to successfully acquire and integrate businesses and technologies; expected recurring revenues resulting from expected growth in our installed base and increased adoption of our products and cloud-based subscription services; the sufficiency of our existing cash, investments and available financing instruments to meet our cash needs for the foreseeable future; our intentions to sell any of our available-for-sale debt instruments; capital expenditures and share repurchases; expectations to increase customer financing activities in the future; expectations regarding the potential impacts of the coronavirus disease discovered in 2019 (“COVID-19”) and related public health measures on our business, the business of our customers, suppliers and channel partners, and the economy; and other statements regarding our future operations, financial condition and prospects, and business strategies. Forward-looking statements generally can be identified by words such as “anticipates,” “believes,” “could,” “estimates,” “expects,” “intends,” “may,” “plans,” “predicts,” “projects,” “would,” “will be,” “will continue,” “will likely result,” and similar expressions. These forward-looking statements are based on current expectations and assumptions that are subject to risks and uncertainties, which could cause our actual results to differ materially from those anticipated or implied by any forward-looking statements. Factors that could cause or contribute to such differences include, but are not limited to, those discussed in this Quarterly Report on Form 10-Q and, in particular, the risks discussed under the caption “Risk Factors” in Part II, Item 1A of this report and those discussed in other documents we file with the Securities and Exchange Commission (“SEC”). We undertake no obligation to revise or publicly release the results of any revision to these forward-looking statements, except as required by law. Given these risks and uncertainties, readers are cautioned not to place undue reliance on such forward-looking statements.

Our Management’s Discussion and Analysis of Financial Condition and Results of Operations (“MD&A”) is organized as follows:

Overview.** A discussion of our business and overall analysis of financial and other highlights in order to provide context for the remainder of MD&A.
Key Financial Metrics.** A summary of our GAAP and non-GAAP key financial metrics, which management monitors to evaluate our performance.
Results of Operations.** A discussion of the nature and trends in our financial results and an analysis of our financial results comparing the three and six months ended January 31, 2023 to the three and six months ended January 31, 2022.
Liquidity and Capital Resources.** An analysis of changes in our balance sheets and cash flows, and a discussion of our financial condition and our ability to meet cash needs.
Critical Accounting Estimates. A discussion of our accounting policies that require critical estimates, assumptions, and judgments.
Recent Accounting Pronouncements. A discussion of expected impacts of impending accounting changes on financial information to be reported in the future.

Overview

We empower enterprises, organizations, service providers, and government entities to protect themselves against today’s most sophisticated cyber threats. Our cybersecurity platforms and services help secure enterprise users, networks, clouds, and endpoints by delivering comprehensive cybersecurity backed by industry-leading artificial intelligence and automation. We are a leading provider of zero trust solutions that start with the next-generation of zero trust network access to secure remote workforces and extend into securing all users, applications and infrastructure with zero trust principles. Our security solutions are designed to increase security while reducing our customers’ total cost of ownership by improving operational efficiency and eliminating the need for siloed point products. Our company focuses on delivering value in five fundamental areas:

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Network Security:

Our network security platform, which includes our ML-Powered Next-Generation Firewalls, available in a number of form factors, including physical, virtual, and containerized appliances, as well as a cloud-delivered service, has been a leader in the industry for eleven consecutive years. Our network security platform also includes our Cloud-Delivered Security Services, such as Advanced Threat Prevention, Advanced WildFire®, Advanced URL Filtering, DNS Security, IoT Security, GlobalProtect™, Enterprise Data Loss Prevention (“Enterprise DLP”), AIOps, and SaaS Security. Through these add-on security services, our customers are able to secure their applications, users, devices, and content across our network security platform as well as the Prisma® and Cortex® product lines. Panorama™, our network security management solution, available as hardware or virtual machine, can centrally manage our network security platform irrespective of form factor, location, or scale. Our software-defined wide-area network (“SD-WAN”) is integrated with PAN-OS, so that our end-customers can get the security features of our PAN-OS ML-Powered Next-Generation Firewall together with SD-WAN functionality.

Secure Access Service Edge:

Prisma Access is our next-generation cloud-delivered security platform that provides secure network access for employees across all locations with continuous threat inspection and unified policy management for information technology. We recently introduced Zero Trust Network Access (“ZTNA”) 2.0, which addresses major shortcomings in the first-generation ZTNA products in the industry (which we refer to as ZTNA 1.0). Prisma Access delivers granular least-privileged access to all applications and data across the enterprise, while continuously verifying trust and inspecting traffic for security. When combined with Prisma SD-WAN, Prisma Access provides a comprehensive single-vendor Secure Access Service Edge (“SASE”) offering that we call Prisma SASE, that is used to secure hybrid workforces and enable the cloud-delivered branch.

Cloud Security:

As a comprehensive Cloud Native Application Protection Platform (“CNAPP”), Prisma Cloud secures hybrid and multi-cloud environments with continuous visibility and threat prevention across the entire application lifecycle. With code to cloud security coverage that encompasses code, infrastructure, workloads, data, networks, web applications, and APIs, Prisma Cloud is the only platform that addresses security needs at every step in the cloud journey. For inline network security on multi and hybrid-cloud environments, we also offer our VM-Series and CN-Series Firewall offerings.

Security Operations:

We deliver the next generation of endpoint security, security analytics and security automation solutions through our Cortex portfolio. These include our industry-leading extended detection and response solution Cortex XDR® to prevent, detect, and respond to complex cybersecurity attacks, Cortex XSOAR® for security orchestration, automation, and response (“SOAR”), and Cortex Xpanse® for attack surface management (“ASM”). In October 2022, we released Cortex XSIAM®, our autonomous Security Operations Center (“SOC”) platform that delivers unified security operations functions including automated threat detection and response, user behavioral analytics, threat intelligence management, orchestration and workflow, endpoint protection, and cloud detection and response. These products are delivered as software or SaaS subscriptions.

Threat Intelligence and Security Consulting (Unit 42):

We enable security teams with up-to-date threat intelligence and deep cybersecurity expertise before, during and after attacks through our Unit 42 threat research and security consulting team. Unit 42 offers incident response, risk management, proactive cybersecurity assessment services, and managed detection and response and threat hunting services.

For the second quarter of fiscal 2023 and 2022, total revenue was $1.7 billion and $1.3 billion, respectively, representing year-over-year growth of 25.7%. Our growth reflects the increased adoption of our portfolio, which consists of product, subscriptions, and support. We believe our portfolio will enable us to benefit from recurring revenues and new revenues as we continue to grow our end-customer base. As of January 31, 2023, we had end-customers in over 180 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 almost all of the Fortune 100 companies and a majority of the Global 2000 companies. We maintain a field sales force that works closely with our channel partners in developing sales opportunities. We primarily use a two-tiered, indirect fulfillment model whereby we sell our products, subscriptions, and support to our distributors, which, in turn, sell to our resellers, which then sell to our end-customers.

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Our product revenue grew to $352.9 million, or 21.3% of total revenue, for the second quarter of fiscal 2023, representing year-over-year growth of 14.6%. Product revenue is primarily generated from sales of our appliances, primarily our ML-Powered Next-Generation Firewall. Product revenue also includes revenue derived from software licenses of Panaroma, SD-WAN, and the VM-Series. Our ML-Powered Next-Generation Firewall incorporates our PAN-OS operating system, which provides a consistent set of capabilities across our entire network security product line. Our appliances and software licenses include a broad set of built-in networking and security features and functionalities. Our products are designed for different performance requirements throughout an organization, ranging from our PA-410, which is designed for small organizations and remote or branch offices, to our top-of-the-line PA-7080, which is designed for large-scale data centers and service provider use. 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, and in our CN-Series container firewalls, which secure container environments and traffic.

Our subscription and support revenue grew to $1.3 billion, or 78.7% of total revenue, for the second quarter of fiscal 2023, representing year-over-year growth of 29.1%. Our subscriptions provide our end-customers with near real-time access to the latest antivirus, intrusion prevention, web filtering, modern malware prevention, data loss prevention, and cloud access security broker capabilities across the network, endpoints, and the cloud. When end-customers purchase our physical, virtual, or container firewall appliances, or certain cloud offerings, they typically purchase support in order to receive ongoing security updates, upgrades, bug fixes, and repairs. In addition to the subscriptions purchased with these appliances, end-customers may also purchase other subscriptions on a per-user, per-endpoint, or capacity-based basis. We also offer professional services, including incident response, risk management, and digital forensic services.

We continue to invest in innovation as we evolve and further extend the capabilities of our portfolio, as we believe that innovation and timely development of new features and products are essential to meeting the needs of our end-customers and improving our competitive position. For example, in November 2022, we launched PAN-OS® 11.0 Nova, which introduced 50 product updates and innovations. Among them were the new Advanced WildFire® cloud-delivered security service that brings unprecedented protection against evasive malware and the updated Advanced Threat Prevention service which now protects against zero-day injection attacks.

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 portfolio 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.

Impact of Macroeconomic Developments and Other Factors on Our Business

Our overall performance depends in part on worldwide economic and geopolitical conditions and their impact on customer behavior. Worsening economic conditions, including inflation, higher interest rates, slower growth, fluctuations in foreign exchange rates, and other changes in economic conditions, may adversely affect our results of operations and financial performance.

We continue to monitor and respond to developments relating to COVID-19, which has resulted in significant global, social, and business disruption. The extent of the continued impact of COVID-19 on our operational and financial performance will depend on developments, including the duration and spread of the virus and its variants, impact on our end-customers’ spending, volume of sales and length of our sales cycles, impact on our partners, suppliers, and employees, actions that may be taken by governmental authorities, and other factors identified in the “Risk Factors” section in Part II, Item 1A of this Quarterly Report on Form 10-Q. The global supply chain and the semiconductor industry continue to experience challenges. We have experienced supply chain challenges, including chip and component shortages, which have, in certain cases, caused delays for us in acquiring chips, components and inventory and have resulted in increased costs as compared to historic levels. While we incurred increased costs and experienced increased lead time for certain product deliveries to our end-customers, we continue to work to minimize the effects from supply chain challenges.

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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 income (loss) and margin below under “Results of Operations.”


	January 31, 2023		July 31, 2022

	(in millions)
Total deferred revenue	$	7,554.0	$	6,994.0
Cash, cash equivalents, and investments	$	6,167.5	$	4,686.4


	Three Months Ended January 31,						Six Months Ended January 31,
	2023			2022			2023			2022

	(dollars in millions)
Total revenue	$	1,655.1		$	1,316.9		$	3,218.5		$	2,564.3
Total revenue year-over-year percentage increase	25.7		%	29.5		%	25.5		%	30.6		%
Gross margin	71.8		%	69.2		%	71.2		%	69.4		%
Operating income (loss)	$	39.9		$	(73.9)		$	55.1		$	(156.6)
Operating margin	2.4		%	(5.6)		%	1.7		%	(6.1)		%
Billings	$	2,029.1		$	1,607.9		$	3,778.1		$	2,989.5
Billings year-over-year percentage increase	26.2		%	32.4		%	26.4		%	30.1		%
Cash flow provided by operating activities							$	1,931.3		$	1,071.5
Free cash flow (non-GAAP)							$	1,853.4		$	956.2

Deferred Revenue.** Our deferred revenue primarily consists of amounts that have been invoiced but have not been recognized as revenue as of the period end. The majority of our deferred revenue balance consists of subscription and support revenue that is recognized ratably over the contractual service period. We monitor our deferred revenue balance because it represents a significant portion of revenue to be recognized in future periods.
Billings.** We define billings as total revenue plus the change in total deferred revenue, net of acquired deferred revenue, during the period. We consider billings to be a key metric used by management to manage our business. We 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 hardware shipment or delivery of software license, provided that all other conditions for revenue recognition have been met. We consider billings to be a useful metric for management and investors, particularly if we continue to experience increased sales of subscriptions and strong renewal rates for subscription and support offerings, and as we monitor our near-term cash flows. While we believe that billings provides useful information to investors and others in understanding and evaluating our operating results in the same manner as our management, it is important to note that other companies, including companies in our industry, may not use billings, may calculate billings differently, 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 January 31,				Six Months Ended January 31,
	2023		2022		2023		2022

	(in millions)				(in millions)
Billings:
Total revenue	$	1,655.1	$	1,316.9	$	3,218.5	$	2,564.3
Add: change in total deferred revenue, net of acquired deferred revenue	374.0		291.0		559.6		425.2
Billings	$	2,029.1	$	1,607.9	$	3,778.1	$	2,989.5

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


	Six Months Ended January 31,
	2023		2022

	(in millions)
Free cash flow (non-GAAP):
Net cash provided by operating activities	$	1,931.3	$	1,071.5
Less: purchases of property, equipment, and other assets	77.9		115.3
Free cash flow (non-GAAP)	$	1,853.4	$	956.2
Net cash used in investing activities	$	(2,484.3)	$	(504.2)
Net cash used in financing activities	$	(219.7)	$	(519.8)

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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 January 31,								Six Months Ended January 31,
	2023				2022				2023				2022
	Amount		% of Revenue		Amount		% of Revenue		Amount		% of Revenue		Amount		% of Revenue

	(dollars in millions)
Revenue:
Product	$	352.9	21.3	%	$	308.0	23.4	%	$	682.9	21.2	%	$	603.5	23.5	%
Subscription and support	1,302.2		78.7	%	1,008.9		76.6	%	2,535.6		78.8	%	1,960.8		76.5	%
Total revenue	1,655.1		100.0	%	1,316.9		100.0	%	3,218.5		100.0	%	2,564.3		100.0	%
Cost of revenue:
Product	100.5		6.1	%	97.8		7.4	%	220.6		6.9	%	186.7		7.3	%
Subscription and support	365.7		22.1	%	307.5		23.4	%	707.5		21.9	%	599.2		23.3	%
Total cost of revenue(1)	466.2		28.2	%	405.3		30.8	%	928.1		28.8	%	785.9		30.6	%
Total gross profit	1,188.9		71.8	%	911.6		69.2	%	2,290.4		71.2	%	1,778.4		69.4	%
Operating expenses:
Research and development	404.1		24.4	%	359.0		27.3	%	775.9		24.1	%	698.5		27.2	%
Sales and marketing	625.5		37.8	%	528.8		40.1	%	1,240.5		38.6	%	1,034.7		40.4	%
General and administrative	119.4		7.2	%	97.7		7.4	%	218.9		6.8	%	201.8		7.9	%
Total operating expenses(1)	1,149.0		69.4	%	985.5		74.8	%	2,235.3		69.5	%	1,935.0		75.5	%
Operating income (loss)	39.9		2.4	%	(73.9)		(5.6)	%	55.1		1.7	%	(156.6)		(6.1)	%
Interest expense	(6.9)		(0.4)	%	(6.8)		(0.5)	%	(13.7)		(0.4)	%	(13.7)		(0.5)	%
Other income (expense), net	51.4		3.1	%	(0.1)		—	%	77.4		2.4	%	(1.7)		(0.1)	%
Income (loss) before income taxes	84.4		5.1	%	(80.8)		(6.1)	%	118.8		3.7	%	(172.0)		(6.7)	%
Provision for income taxes	0.2		—	%	12.7		1.0	%	14.6		0.5	%	25.1		1.0	%
Net income (loss)	$	84.2	5.1	%	$	(93.5)	(7.1)	%	$	104.2	3.2	%	$	(197.1)	(7.7)	%

(1)Includes share-based compensation as follows:


	Three Months Ended January 31,				Six Months Ended January 31,
	2023		2022		2023		2022

	(in millions)
Cost of product revenue	$	2.6	$	2.3	$	5.0	$	4.6
Cost of subscription and support revenue	30.7		27.7		59.5		54.4
Research and development	129.7		123.6		247.7		249.2
Sales and marketing	88.4		79.8		175.8		153.1
General and administrative	38.5		31.7		67.9		64.1
Total share-based compensation	$	289.9	$	265.1	$	555.9	$	525.4

Revenue

Our revenue consists of product revenue and subscription and support revenue. Revenue is recognized upon transfer of control of the corresponding promised products and subscriptions and support to our customers in an amount that reflects the consideration we expect to be entitled to in exchange for those products and subscriptions and support. We expect our revenue to vary from quarter to quarter based on seasonal and cyclical factors.

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Product Revenue

Product revenue is derived from sales of our appliances, primarily our ML-Powered Next-Generation Firewall, which is available in a number of form factors, including as physical, virtual, and containerized appliances. Product revenue also includes revenue derived from software licenses of Panorama and SD-WAN. Our appliances and software licenses include a broad set of built-in networking and security features and functionalities. We recognize product revenue at the time of hardware shipment or delivery of software license.


	Three Months Ended January 31,								Six Months Ended January 31,
	2023		2022		Change				2023		2022		Change
	Amount		Amount		Amount		%		Amount		Amount		Amount		%

	(dollars in millions)
Product	$	352.9	$	308.0	$	44.9	14.6	%	$	682.9	$	603.5	$	79.4	13.2	%

Product revenue for the three and six months ended January 31, 2023 increased compared to the same periods in 2022 driven by increased demand for our new generation of hardware products and increase in software revenue primarily due to a new go-to-market strategy for certain Network Security offerings, partially offset by a decrease in revenue from our prior generation of hardware products.

Subscription and Support Revenue

Subscription and support revenue is derived primarily from sales of our subscription and support offerings. Our contractual subscription and support contracts are typically one to five years. We recognize revenue from subscriptions and support over time as the services are performed. As a percentage of total revenue, we expect our subscription and support revenue to vary from quarter to quarter and increase over the long term as we introduce new subscriptions, renew existing subscription and support contracts, and expand our installed end-customer base.


	Three Months Ended January 31,								Six Months Ended January 31,
	2023		2022		Change				2023		2022		Change
	Amount		Amount		Amount		%		Amount		Amount		Amount		%

	(dollars in millions)
Subscription	$	815.4	$	618.0	$	197.4	31.9	%	$	1,579.4	$	1,196.8	$	382.6	32.0	%
Support	486.8		390.9		95.9		24.5	%	956.2		764.0		192.2		25.2	%
Total subscription and support	$	1,302.2	$	1,008.9	$	293.3	29.1	%	$	2,535.6	$	1,960.8	$	574.8	29.3	%

Subscription and support revenue increased for the three and six months ended January 31, 2023 compared to the same periods in 2022 due to increased demand for our subscription and support offerings from our 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 end-customers.

Revenue by Geographic Theater


	Three Months Ended January 31,								Six Months Ended January 31,
	2023		2022		Change				2023		2022		Change
	Amount		Amount		Amount		%		Amount		Amount		Amount		%

	(dollars in millions)
Americas	$	1,117.0	$	915.9	$	201.1	22.0	%	$	2,187.7	$	1,782.6	$	405.1	22.7	%
EMEA	341.5		252.2		89.3		35.4	%	649.4		486.0		163.4		33.6	%
APAC	196.6		148.8		47.8		32.1	%	381.4		295.7		85.7		29.0	%
Total revenue	$	1,655.1	$	1,316.9	$	338.2	25.7	%	$	3,218.5	$	2,564.3	$	654.2	25.5	%

With respect to geographic theaters, the increase in revenue for the three and six months ended January 31, 2023 compared to the same periods in 2022 was driven primarily by the Americas, due to its larger sales force and a larger percentage of our customers located in the Americas. Revenue from our other geographic theaters, both Europe, the Middle East, and Africa (“EMEA”) and Asia Pacific and Japan (“APAC”), increased for the three and six months ended January 31, 2023 compared to the same periods in 2022 due to continued investment in our global sales force to support our growth and increase our customer base in the regions.

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Cost of Revenue

Our cost of revenue consists of cost of product revenue and cost of subscription and support revenue.

Cost of Product Revenue

Cost of product revenue primarily includes costs paid to our manufacturing partners for procuring components and manufacturing our products. Our cost of product revenue also includes personnel costs, which consist of salaries, benefits, bonuses, share-based compensation and travel and entertainment associated with our operations organization, amortization of intellectual property licenses, product testing costs, shipping and tariff costs, and shared costs. Shared 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 fluctuate with our product revenue.


	Three Months Ended January 31,								Six Months Ended January 31,
	2023		2022		Change				2023		2022		Change
	Amount		Amount		Amount		%		Amount		Amount		Amount		%

	(dollars in millions)
Cost of product revenue	$	100.5	$	97.8	$	2.7	2.8	%	$	220.6	$	186.7	$	33.9	18.2	%
Number of employees at period end	142		134		8		6.0	%	142		134		8		6.0	%

Cost of product revenue increased for the three and six months ended January 31, 2023 compared to the same periods in 2022 due to an increase in product volume and higher costs related to our product offerings, primarily driven by supply chain challenges, partially offset by hardware product mix.

Cost of Subscription and Support Revenue

Cost of subscription and support revenue includes personnel costs for our global customer support and technical operations organizations, customer support and repair costs, third-party professional services costs, data center and cloud hosting service costs, amortization of acquired intangible assets and capitalized software development costs, and shared costs. We expect our cost of subscription and support revenue to increase as our installed end-customer base grows and adoption of our cloud-based subscription offerings increases.


	Three Months Ended January 31,								Six Months Ended January 31,
	2023		2022		Change				2023		2022		Change
	Amount		Amount		Amount		%		Amount		Amount		Amount		%

	(dollars in millions)
Cost of subscription and support revenue	$	365.7	$	307.5	$	58.2	18.9	%	$	707.5	$	599.2	$	108.3	18.1	%
Number of employees at period end	2,751		2,380		371		15.6	%	2,751		2,380		371		15.6	%

Cost of subscription and support revenue increased for the three and six months ended January 31, 2023 compared to the same periods in 2022, primarily due to increased costs to support the growth of our subscription and support offerings. Cloud hosting service costs, which support our cloud-based subscription offerings, increased $26.8 million for the three months ended January 31, 2023 compared to the same period in 2022, and increased $45.8 million for the six months ended January 31, 2023 compared to the same period in 2022. Personnel costs grew $22.6 million to $161.2 million for the three months ended January 31, 2023 compared to the same period in 2022, and grew $42.4 million to $303.8 million for the six months ended January 31, 2023 compared to the same period in 2022, primarily due to headcount growth.

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Gross Margin

Gross margin has been and will continue to be affected by a variety of factors, including the introduction of new products, manufacturing costs, the average sales price of our products, cloud hosting service costs, personnel costs, the mix of products sold, and the mix of revenue between product and subscription and support offerings. Our virtual and higher-end firewall products generally have higher gross margins than our lower-end firewall products within each product series. We expect our gross margins to vary over time depending on the factors described above.


	Three Months Ended January 31,								Six Months Ended January 31,
	2023				2022				2023				2022
	Amount		Gross Margin		Amount		Gross Margin		Amount		Gross Margin		Amount		Gross Margin

	(dollars in millions)
Product	$	252.4	71.5	%	$	210.2	68.2	%	$	462.3	67.7	%	$	416.8	69.1	%
Subscription and support	936.5		71.9	%	701.4		69.5	%	1,828.1		72.1	%	1,361.6		69.4	%
Total gross profit	$	1,188.9	71.8	%	$	911.6	69.2	%	$	2,290.4	71.2	%	$	1,778.4	69.4	%

Product gross margin increased for the three months ended January 31, 2023 compared to the same period in 2022, primarily due to increased software revenue and favorable hardware product mix, partially offset by higher costs related to our hardware product offerings driven by supply chain challenges. Product gross margin decreased for the six months ended January 31, 2023 compared to the same period in 2022, primarily due to higher costs related to our hardware product offerings driven by supply chain challenges, partially offset by increased software revenue and favorable hardware product mix.

Subscription and support gross margin increased for the three and six months ended January 31, 2023 compared to the same periods in 2022, primarily due to our growth in subscription and support revenue, which outpaced the subscription and support costs.

Operating Expenses

Our operating expenses consist of research and development, sales and marketing, and general and administrative expenses. 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 shared costs, which consist of certain facilities, depreciation, benefits, recruiting, and information technology costs that we allocate based on headcount to each department. We expect operating expenses generally 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 January 31, 2023, we expect to recognize approximately $2.3 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 is generally recognized on a straight-line basis over the requisite service periods of the awards.

Research and Development

Research and development expense consists primarily of personnel costs. Research and development expense also includes prototype-related expenses and shared 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 January 31,								Six Months Ended January 31,
	2023		2022		Change				2023		2022		Change
	Amount		Amount		Amount		%		Amount		Amount		Amount		%

	(dollars in millions)
Research and development	$	404.1	$	359.0	$	45.1	12.6	%	$	775.9	$	698.5	$	77.4	11.1	%
Number of employees at period end	3,649		2,880		769		26.7	%	3,649		2,880		769		26.7	%

Research and development expense increased for the three and six months ended January 31, 2023 compared to the same periods in 2022, primarily due to increase in personnel costs, which grew $34.5 million to $320.7 million for the three months ended January 31, 2023 compared to the same period in 2022, and grew $57.7 million to $610.8 million for the six months ended January 31, 2023 compared to the same period in 2022, largely due to headcount growth. The remaining increase in research and development expense was further driven by increased shared costs.

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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 shared costs. We continue to strategically invest in headcount and have grown our sales presence. 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 grow our customer base, increase touch points with end-customers, and expand our global presence, although our sales and marketing expense may fluctuate as a percentage of total revenue.


	Three Months Ended January 31,								Six Months Ended January 31,
	2023		2022		Change				2023		2022		Change
	Amount		Amount		Amount		%		Amount		Amount		Amount		%

	(dollars in millions)
Sales and marketing	$	625.5	$	528.8	$	96.7	18.3	%	$	1,240.5	$	1,034.7	$	205.8	19.9	%
Number of employees at period end	5,778		4,826		952		19.7	%	5,778		4,826		952		19.7	%

Sales and marketing expense increased for the three and six months ended January 31, 2023 compared to the same periods in 2022, primarily due to increase in personnel costs, which grew $78.8 million to $482.0 million for the three months ended January 31, 2023 compared to the same period in 2022, and grew $153.9 million to $938.1 million for the six months ended January 31, 2023 compared to the same period in 2022, largely due to headcount growth and increased travel and entertainment expenses. The increase in the six months ended January 31, 2023 was further driven by increased costs associated with in-person events and go-to-market initiatives.

General and Administrative

General and administrative expense consists primarily of personnel costs and shared costs for our executive, finance, human resources, information technology, and legal organizations, and professional services costs, which consist primarily of legal, auditing, accounting, and other consulting costs. We expect general and administrative expense to increase in absolute dollars over time as we increase the size of our general and administrative organizations and incur additional costs to support our business growth, although our general and administrative expense may fluctuate as a percentage of total revenue.


	Three Months Ended January 31,								Six Months Ended January 31,
	2023		2022		Change				2023		2022		Change
	Amount		Amount		Amount		%		Amount		Amount		Amount		%

	(dollars in millions)
General and administrative	$	119.4	$	97.7	$	21.7	22.2	%	$	218.9	$	201.8	$	17.1	8.5	%
Number of employees at period end	1,612		1307		305		23.3	%	1,612		1,307		305		23.3	%

General and administrative expense increased for the three and six months ended January 31, 2023 compared to the same periods in 2022 primarily due to increase in personnel costs, which grew $9.4 million to $78.7 million for the three months ended January 31, 2023 compared to the same period in 2022, and grew $8.6 million to $145.3 million for the six months ended January 31, 2023 compared to the same period in 2022. The increase in personnel costs for both periods was primarily due to share-based compensation related to our recent acquisition and headcount growth. The remaining increase in general and administrative expense in both periods was primarily due to increase in acquisition-related costs and slightly higher reserves as a result of increased financing receivables.

Interest Expense

Interest expense primarily consists of interest expense related to our 0.75% Convertible Senior Notes due 2023 (the “2023 Notes”) and the 0.375% Convertible Senior Notes due 2025 (the “2025 Notes,” and together with “2023 Notes,” the “Notes”).


	Three Months Ended January 31,								Six Months Ended January 31,
	2023		2022		Change				2023		2022		Change
	Amount		Amount		Amount		%		Amount		Amount		Amount		%

	(dollars in millions)
Interest expense	$	6.9	$	6.8	$	0.1	1.5	%	$	13.7	$	13.7	$	—	—	%

Interest expense was relatively flat for the three and six months ended January 31, 2023 compared to the same periods in 2022.

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Other Income (Expense), Net

Other income (expense), net includes interest income earned on our cash, cash equivalents, and investments, and gains and losses from foreign currency remeasurement and foreign currency transactions.


	Three Months Ended January 31,							Six Months Ended January 31,
	2023		2022		Change			2023		2022		Change
	Amount		Amount		Amount		%	Amount		Amount		Amount		%

	(dollars in millions)
Other income (expense), net	$	51.4	$	(0.1)	$	51.5	*	$	77.4	$	(1.7)	$	79.1	*

Not meaningful

The increase in other income (expense), net for the three and six months ended January 31, 2023 compared to the same periods in 2022 was primarily due to higher interest income earned on our cash, cash equivalent, and investment balances as a result of higher interest rates for the three and six months ended January 31, 2023 compared to 2022.

Provision for Income Taxes

Provision for income taxes consists primarily of U.S. taxes driven by capitalization of research and development expenditures, foreign income taxes, and withholding taxes. We maintain a full valuation allowance for domestic and certain foreign deferred tax assets, including net operating loss carryforwards and certain domestic tax credits. Our valuation allowance has caused, and may continue to cause, disproportionate relationships between our overall effective tax rate and other jurisdictional measures.


	Three Months Ended January 31,										Six Months Ended January 31,
							Change				2023			2022			Change
	2023			2022			Amount		%		Amount			Amount			Amount		%

	(dollars in millions)
Provision for income taxes	$	0.2		$	12.7		$	(12.5)	(98.4)	%	$	14.6		$	25.1		$	(10.5)	(41.8)	%
Effective tax rate	0.2		%	(15.7)		%					12.3		%	(14.6)		%

Our provision for income taxes for the three and six months ended January 31, 2023 was primarily due to U.S. federal and state income taxes, withholding taxes, and foreign income taxes. Our effective tax rate varied for the three and six months ended January 31, 2023 compared to the same periods in 2022, primarily due to an increase in current taxes driven by capitalization of research and development expenditures with no offsetting deferred benefit as a result of our valuation allowance. This increase was offset by a release of uncertain tax positions during the three months ended January 31, 2023 resulting from a tax settlement. Refer to Note 13. Income Taxes in Part I, Item 1 of this Quarterly Report on Form 10-Q for more information.

Liquidity and Capital Resources


	January 31, 2023		July 31, 2022

	(in millions)
Working capital(1)	$	(3,069.3)	$	(1,891.4)
Cash, cash equivalents, and investments:
Cash and cash equivalents	$	1,346.3	$	2,118.5
Investments	4,821.2		2,567.9
Total cash, cash equivalents, and investments	$	6,167.5	$	4,686.4

**(1)**Current liabilities included net carrying amounts of convertible senior notes of $3.7 billion as of both January 31, 2023 and July 31, 2022. Refer to Note 9. Debt in Part I, Item 1 of this Quarterly Report on Form 10-Q for information on the Notes.

As of January 31, 2023, our total cash, cash equivalents, and investments of $6.2 billion were held for general corporate purposes. As of January 31, 2023, we had no unremitted earnings when evaluating our outside basis difference relating to our U.S. investment in foreign subsidiaries. However, there could be local withholding taxes payable due to various foreign countries if certain lower tier earnings are distributed. Withholding taxes that would be payable upon remittance of these lower tier earnings are not expected to be material.

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Debt

In July 2018, we issued the 2023 Notes with an aggregate principal amount of $1.7 billion. In June 2020, we issued the 2025 Notes with an aggregate principal amount of $2.0 billion. The 2023 Notes mature on July 1, 2023 and the 2025 Notes mature on June 1, 2025; however, under certain circumstances, holders may surrender their Notes of a series for conversion prior to the applicable maturity date. Upon conversion of the Notes of a series, we will pay cash equal to the aggregate principal amount of the Notes of such series 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 of such series being converted. The sale price condition for the Notes was met during the fiscal quarter ended January 31, 2023, and as a result, holders may convert their Notes at any time during the fiscal quarter ending April 30, 2023. If all of the holders of the Notes converted their Notes during this period, we would be obligated to settle the $3.7 billion principal amount of the Notes in cash. We believe that our cash provided by operating activities, our existing cash, cash equivalents and investments, and existing sources of and access to financing will be sufficient to meet our anticipated cash needs should the holders choose to convert their Notes during the fiscal quarter ending April 30, 2023 or hold the 2023 Notes until maturity on July 1, 2023. As of January 31, 2023, substantially all of our Notes remained outstanding. Refer to Note 9. Debt in Part I, Item 1 of this Quarterly Report on Form 10-Q for more information on the Notes.

In September 2018, we entered into a credit agreement (the “Credit Agreement”) that provides for a $400.0 million unsecured revolving credit facility (the “Credit Facility”), with an option to increase the amount of the Credit Facility up to an additional $350.0 million, subject to certain conditions. As of January 31, 2023, there were no amounts outstanding and we were in compliance with all covenants under the Credit Agreement. Refer to Note 9. Debt in Part I, Item 1 of this Quarterly Report on Form 10-Q for more information on the Credit Agreement.

Capital Return

In February 2019, our board of directors authorized a $1.0 billion share repurchase program. In December 2020, August 2021, and August 2022, our board of directors authorized additional $700.0 million, $676.1 million, and $915.0 million increases to this share repurchase program, respectively, bringing the total authorization under this share repurchase program to $3.3 billion. Repurchases will be funded from available working capital and may be made at management’s discretion from time to time. The expiration date of this repurchase authorization was extended to December 31, 2023, and our repurchase program may be suspended or discontinued at any time. As of January 31, 2023, $750.0 million remained available for future share repurchases under this repurchase program. Refer to Note 11. Stockholders’ Equity in Part I, Item 1 of this Quarterly Report on Form 10-Q for more information on this repurchase program.

Leases and Other Material Cash Requirements

We have entered into various non-cancelable operating leases primarily for our facilities with original lease periods expiring through the year ending July 31, 2032, with the most significant leases relating to our corporate headquarters in Santa Clara, California. As of January 31, 2023, we have total operating lease obligations of $336.8 million recorded on our condensed consolidated balance sheet.

As of January 31, 2023, our commitments to purchase products, components, cloud and other services totaled $2.2 billion. Refer to Note 10. Commitments and Contingencies in Part I, Item 1 of this Quarterly Report on Form 10-Q for more information on these commitments.

Cash Flows

The following table summarizes our cash flows for the six months ended January 31, 2023 and 2022:


	Six Months Ended January 31,
	2023		2022

	(in millions)
Net cash provided by operating activities	$	1,931.3	$	1,071.5
Net cash used in investing activities	(2,484.3)		(504.2)
Net cash used in financing activities	(219.7)		(519.8)
Net increase (decrease) in cash, cash equivalents, and restricted cash	$	(772.7)	$	47.5

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Cash from operations could be affected by various risks and uncertainties, including, but not limited to, the effects of COVID-19 and other risks detailed in Part II, Item 1A “Risk Factors” in this Quarterly Report on Form 10-Q. We believe that our cash flow from operations with existing cash and cash equivalents will be sufficient to meet our anticipated cash needs for at least the next 12 months and thereafter 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 infrastructure to support the adoption of our cloud-based subscription offerings, the repayment obligations associated with our Notes, the continuing market acceptance of our products and subscription and support offerings and macroeconomic events such as COVID-19. 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 income (losses) adjusted for certain non-cash items and changes in assets and liabilities. Our largest source of cash provided by our operations is receipts from our product revenue and subscription and support revenue.

Cash provided by operating activities during the six months ended January 31, 2023 was $1.9 billion, an increase of $859.8 million compared to the same period in 2022. The increase was primarily due to growth of our business as reflected by increases in collections during the six months ended January 31, 2023, partially offset by higher cash expenditure to support our business growth.

Investing Activities

Our investing activities have consisted of capital expenditures, net investment purchases, sales, and maturities, and business acquisitions. We expect to continue such activities as our business grows.

Cash used in investing activities during the six months ended January 31, 2023 was $2.5 billion, an increase of $2.0 billion compared to the same period in 2022. The increase was primarily due to an increase in purchases of investments and increase in net cash payments for business acquisitions, offset by an increase in proceeds from sales and maturities of investments during the six months ended January 31, 2023.

Financing Activities

Our financing activities have consisted of cash used to repurchase shares of our common stock, proceeds from sales of shares through employee equity incentive plans, and payments for tax withholding obligations of certain employees related to the net share settlement of equity awards.

Cash used in financing activities during the six months ended January 31, 2023 was $219.7 million, a decrease of $300.1 million compared to the same period in 2022. The decrease was primarily due to decrease in repurchases of our common stock during the six months ended January 31, 2023.

Critical Accounting Estimates

Our condensed consolidated financial statements have been prepared in accordance with 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 could differ materially from those estimates due to risks and uncertainties, including uncertainty in the current economic environment. To the extent that there are material differences between these estimates and our actual results, our future consolidated financial statements will be affected.

We believe the critical accounting estimates discussed under Item 7, “Management’s Discussion and Analysis of Financial Condition and Results of Operations” in our Annual Report on Form 10-K for the fiscal year ended July 31, 2022 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.

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