Palo Alto Networks, Inc. — Q1 Fiscal 2018 Form 10-Q
Reporting period: Three months ended October 31, 2017; comparison is with the three months ended October 31, 2016 unless otherwise noted. Palo Alto Networks provides network, endpoint, and cloud cybersecurity products and services.
Financial performance and liquidity
| Metric | Q1 FY2018 | Q1 FY2017 | Change |
|---|---|---|---|
| Revenue | $505.5 million | $398.1 million | +27.0% |
| Product revenue | $186.5 million | $163.8 million | +13.9% |
| Subscription and support revenue | $319.0 million | $234.3 million | +36.2% |
| Gross profit / margin | $364.1 million / 72.0% | $296.9 million / 74.6% | Margin down 2.6 percentage points |
| Operating loss / margin | $54.3 million / (10.7%) | $49.0 million / (12.3%) | Loss increased; margin improved |
| Net loss | $64.0 million | $56.9 million | Loss increased |
| Operating cash flow | $274.1 million | $203.5 million | Increased $70.6 million |
| Free cash flow (non-GAAP) | $241.9 million | $182.6 million | Increased |
| Billings | $596.5 million | $516.9 million | +15.4% |
At October 31, 2017, cash and cash equivalents were $842.6 million and investments were $1.438 billion, totaling $2.281 billion. Current assets were $2.040 billion and current liabilities $1.743 billion; reported working capital was $296.5 million, including the current classification of the convertible notes.
The $575.0 million principal amount of 0% convertible notes is due July 2019. Because a conversion condition was met, holders could convert during the quarter ending January 31, 2018; the $531.0 million net carrying amount was therefore classified as current. The company reported $1.865 billion of deferred revenue. It generated $98.3 million of net cash in the quarter, after $123.4 million used in financing, including $134.1 million of cash repurchases of common stock.
Changes and notable items
- Revenue growth moderated to 27.0% from 34.0% in the prior-year quarter; billings growth slowed to 15.4% from 33.2%.
- Subscription and support grew faster than product revenue and rose to 63.1% of revenue from 58.9%, supporting a larger recurring-revenue mix.
- Gross margin fell to 72.0%, primarily due to lower margins on newly introduced appliances and increased infrastructure costs for cloud subscriptions.
- General and administrative expense included a $15.4 million cease-use loss after the company vacated its former headquarters. The balance of that liability was $13.5 million at quarter-end.
- Landlords provided a $38.2 million upfront reimbursement after lease amendments; it will offset future rent. Total committed gross operating lease payments were $562.2 million.
- Share-based compensation was $125.7 million, versus $113.3 million a year earlier. Approximately $1.1 billion of unrecognized compensation cost remained, expected to be recognized over about 2.6 years.
Outlook, risks, and contingencies
The filing gives no specific quantitative revenue or earnings guidance. Management expects operating expenses to increase in absolute dollars as it invests in research and development, sales and marketing, infrastructure, and international expansion; it expects gross margins to fluctuate with product and revenue mix, product costs, and cloud-service infrastructure needs. Management stated that cash, investments, and operating cash flow should meet anticipated needs for the foreseeable future.
Key risks identified include intense competition, variable quarterly results and seasonality, dependence on channel partners and a small number of distributors, renewal and customer-retention risk, reliance on manufacturing and component suppliers, cybersecurity and product-defect risks, and the challenges of managing rapid growth. The company noted that two distributors represented 56.3% of quarterly revenue and four distributors represented 75.8% of gross accounts receivable. It also cited foreign-exchange exposure, international regulatory and tax uncertainty, and risks tied to its convertible notes.
Manufacturing purchase commitments were $95.3 million. The company reported approximately $65.3 million of liabilities related to uncertain tax positions. It had not recorded significant litigation accruals or concluded that an unfavorable legal outcome was probable or reasonably possible with a reasonably estimable loss. Disclosure controls were assessed as effective at a reasonable-assurance level, with no material change in internal control over financial reporting reported for the quarter.
Most important facts for investors to verify
- Whether billings growth and revenue growth continue to moderate, and whether deferred revenue converts to recognized revenue as expected.
- Whether gross margins stabilize after the lower-margin appliance introductions and infrastructure expansion.
- The potential cash and dilution effects if the convertible notes are converted, and the company’s ability to meet conversion-related obligations.
- How much of operating cash flow reflects recurring business performance versus timing and the one-time $38.2 million landlord reimbursement.
- Distributor concentration, receivables exposure, and renewal performance for subscription and support contracts.
- The trajectory of share-based compensation, operating expenses, lease commitments, and share repurchases.