Palo Alto Networks, Inc. — FY2019 Form 10-K
Reporting period: Fiscal year ended July 31, 2019. The filing also reports the quarter ended July 31, 2019 (FY2019 Q4). Financial amounts below are in U.S. dollars.
Business context
Palo Alto Networks sells cybersecurity products, subscriptions and support to enterprises, service providers and government customers. Its offerings span network security, endpoint protection, cloud security and security operations. Sales are primarily indirect through distributors and resellers; four distributors generated 74.6% of FY2019 revenue. Subscription and support revenue, generally recognized over contract terms of one to five years, represented 62.2% of annual revenue.
Financial performance
| Metric | FY2019 | FY2018 |
|---|---|---|
| Revenue | $2,899.6 million | $2,273.6 million |
| Gross profit / gross margin | $2,091.2 million / 72.1% | $1,628.5 million / 71.6% |
| Operating loss / margin | $(54.1) million / (1.9)% | $(104.2) million / (4.6)% |
| Net loss | $(81.9) million | $(122.2) million |
| Operating cash flow | $1,055.6 million | $1,038.1 million |
| Free cash flow (non-GAAP) | $924.4 million | $926.1 million |
| Billings | $3,489.8 million | $2,856.2 million |
| Deferred revenue | $2,888.7 million | $2,279.3 million |
FY2019 revenue grew 27.5%: product revenue increased 24.6% to $1,096.2 million, while subscription and support revenue rose 29.4% to $1,803.4 million. Annual subscription revenue grew 36.2%; support revenue grew 21.2%. Q4 revenue was $805.8 million, gross profit $588.4 million (about 73.0% margin), operating loss $9.9 million and net loss $20.8 million. Q4 revenue was up 22.4% from $658.5 million in the prior-year quarter.
At July 31, 2019, cash and cash equivalents were $961.4 million and investments totaled $2,417.1 million, or $3,378.5 million combined, versus $3,950.9 million a year earlier. Working capital was $1,611.5 million. Convertible notes, net, totaled $1,430.0 million; the $575.0 million 0% notes due 2019 were repaid at maturity, and $1,693.0 million principal of 0.75% convertible notes due 2023 remained outstanding. The $400 million revolving credit facility was undrawn. Management said operating cash flow and existing cash were expected to cover anticipated needs for the foreseeable future.
Changes, outlook and notable items
- Revenue growth moderated to 27.5% from 29.5%; billings growth slowed to 22.2% from 26.8%. Operating and net losses narrowed, while gross margin improved by 0.5 percentage points.
- Operating expenses rose 23.8% to $2,145.3 million, including R&D growth of 34.6% and sales and marketing growth of 25.1%. Share-based compensation was $587.7 million, and the company expected about $1.5 billion of unrecognized compensation cost to be expensed over a weighted-average 2.7 years.
- Management expects continued investment in R&D, sales, support and cloud infrastructure, and expects operating expenses to rise in absolute dollars. It described subscription and support revenue as likely to grow over the long term; the filing does not provide a clear numerical forecast for FY2020 revenue or earnings.
- FY2019 acquisitions included RedLock, Demisto, PureSec and Twistlock. Their combined net consideration, as disclosed for Demisto, RedLock and Twistlock in the audit discussion, was substantial; purchase-price allocations included significant goodwill and intangible assets. In September 2019, the company agreed to acquire Zingbox for approximately $75 million, subject to adjustment, with closing expected in FY2020 Q1.
- Cash used in investing was $1,825.9 million, chiefly reflecting investment purchases and $773.7 million of net cash paid for acquisitions. Cash used in financing was $773.9 million, including repayment of the 2019 notes and $330.0 million of share repurchases. A new $1.0 billion repurchase authorization had no purchases through July 31, 2019.
- Other notable items include a $7.0 million additional cease-use loss for former headquarters space, following a $39.2 million charge in FY2018; adoption of the new revenue standard using the full retrospective method; and expected recognition of right-of-use lease assets and liabilities upon lease-standard adoption in FY2020.
Principal risks and contingencies
The filing highlights intense competition, execution and integration risks from acquisitions, product defects or security incidents, dependence on channel partners and concentrated distributors, and reliance on manufacturing partners and limited-source components. Results may fluctuate with seasonality, customer spending, sales timing and revenue recognition. Other risks include rapid growth and hiring needs, privacy and regulatory compliance, international and currency exposure, intellectual-property claims, and the possibility that losses continue. The company reported no significant accrued legal contingencies and no off-balance-sheet arrangements. Contractual obligations included $1,693.0 million of 2023 notes, $491.8 million of gross operating lease obligations and $427.6 million of purchase obligations. Auditors issued unqualified opinions on the financial statements and internal controls.
Investor facts to verify
- Whether billings and deferred revenue growth translate into sustained recognized revenue growth and renewal performance.
- Whether the company can improve GAAP profitability, given operating losses, high share-based compensation and ongoing investment needs.
- Cash deployment and obligations: acquisition spending, repurchases, lease commitments, and repayment or conversion terms of the 2023 notes.
- Distributor concentration and credit exposure: four distributors generated 74.6% of revenue, and three represented 63.0% of gross receivables.
- Integration progress and realized returns from recent acquisitions, including the subsequent Zingbox agreement.