Palo Alto Networks, Inc. — Q1 Fiscal 2020 Form 10-Q
Reporting period: Three months ended October 31, 2019; comparisons are with the three months ended October 31, 2018 unless noted. Amounts are in U.S. dollars; financial statement amounts are in millions.
Business context and key results
Palo Alto Networks provides cybersecurity products and subscriptions for networks, endpoints, and cloud environments. Management attributed growth to increased adoption of its hybrid product, subscription, and support model. Subscription and support represented 70% of revenue, up from 63.3% a year earlier.
| Metric | Q1 FY2020 | Prior comparable period |
|---|---|---|
| Total revenue | $771.9 | $656.0 |
| Product revenue | $231.2 | $240.5 |
| Subscription and support revenue | $540.7 | $415.5 |
| Gross profit / gross margin | $554.2 / 71.8% | $472.5 / 72.0% |
| Operating loss / operating margin | $(51.8) / (6.7)% | $(32.1) / (4.9)% |
| Net loss / diluted loss per share | $(59.6) / $(0.62) | $(38.3) / $(0.41) |
| Operating cash flow | $225.2 | $252.3 |
| Non-GAAP free cash flow | $178.0 | $218.0 |
| Billings | $897.4 | $758.5 |
Financial position and liquidity
- Cash, cash equivalents, and investments totaled $3,328.8 at October 31, 2019, versus $3,378.5 at July 31, 2019. Working capital was $1,598.2, compared with $1,611.5.
- The company reported $1,445.5 of convertible senior notes, net, against $1,693.0 principal outstanding on its 0.75% notes due July 2023. Its $400 million revolving credit facility had no borrowings, and the company reported covenant compliance.
- Operating lease liabilities totaled $433.4, including $61.8 current and $371.6 long-term. Adoption of lease accounting guidance on August 1, 2019 brought operating lease right-of-use assets and liabilities onto the balance sheet.
- Operating cash flow was $225.2; investing activities provided $244.5, and financing activities used $167.1. The investing inflow reflected investment maturities exceeding purchases. Financing included $198.1 of share repurchases.
- Of the $1.0 billion share-repurchase authorization, $801.9 remained available at quarter-end. The company held approximately $360.7 of cash and investments outside the United States.
Material changes versus the prior period
- Revenue increased 17.7%, a slower growth rate than 30.7% in the prior-year quarter. Billings grew 18.3%, compared with 27.4%.
- Subscription revenue rose 37.7% and support revenue rose 20.6%; product revenue declined 3.9%, primarily due to lower unit volume.
- Operating expenses increased 20.1% to $606.0. Research and development rose 50.4%, primarily on personnel and headcount growth; sales and marketing rose 16.2%. General and administrative expense fell 8.9%, partly because the prior-year quarter included $14.2 of accelerated equity-award expense associated with the RedLock acquisition.
- Gross margin edged down to 71.8% from 72.0%. Product gross margin improved, while subscription and support gross margin declined, reflecting cloud-service support costs and acquired-intangible amortization, partly offset by support-organization efficiencies.
- Net loss widened to $59.6 from $38.3. Total share-based compensation was $151.2, and unrecognized compensation cost on unvested awards was $1.6 billion, expected to be recognized over a weighted-average 2.8 years.
- Operating cash flow decreased $27.1, which management attributed mainly to the timing of payments and collections. The prior-year period also included convertible-note-related cash flow items.
Outlook, management commentary, and risks
- Management said existing cash, investments, and operating cash flow should meet anticipated cash needs for the foreseeable future. It expects operating expenses to rise in absolute dollars, while expressing an expectation that they will decline over the long term as a share of revenue. The filing provides no specific numerical revenue or earnings guidance.
- Management expects revenue to vary by quarter and identifies seasonal patterns, including potentially stronger second and fourth fiscal quarters. Subscription and support revenue is generally recognized over contract terms, typically one to five years.
- The company completed its $66.4 cash acquisition of IoT-security company Zingbox in September 2019. In November, it agreed to acquire Aporeto for approximately $150 million in cash, subject to adjustment; closing was expected in Q2 FY2020.
- Key disclosed risks include intense competition, dependence on channel partners and distributors, customer renewal and spending trends, execution and integration of acquisitions, rapid technology change, cybersecurity incidents, product defects, and supply-chain constraints. Four distributors represented 78% of quarterly revenue and 60.2% of gross accounts receivable at period-end.
- Other exposures include international and foreign-exchange risks, privacy and regulatory compliance, and potential dilution or cash obligations related to convertible notes and warrants. The company reported no significant legal-contingency accruals and no determination that an unfavorable litigation outcome was probable or reasonably possible and estimable.
- The income-tax provision was $5.1 despite a pretax loss; management cited taxes in profitable foreign jurisdictions, U.S. state taxes, and withholding taxes. The prior-year quarter included a $9.4 one-time tax benefit from a partial valuation-allowance release.
Important facts for investors to verify
- Whether subscription and support growth, renewals, and billings remain strong as product revenue declines and revenue growth moderates.
- Whether rising research and development and subscription-service costs can be absorbed without further pressure on operating and subscription margins.
- The impact of substantial share-based compensation on GAAP profitability and future share dilution.
- The timing, terms, and integration results of the Aporeto acquisition, alongside the integration and performance of recent acquisitions.
- Distributor concentration, receivable exposure, and the status of the 2023 convertible notes, related warrants, and remaining repurchase authorization.
- How operating cash flow and liquidity develop after acquisition spending, buybacks, and lease obligations.