Palo Alto Networks, Inc. — Form 10-Q Summary
Reporting period: First quarter of fiscal 2016, three months ended October 31, 2015; comparisons are with the three months ended October 31, 2014 unless noted. Amounts are in millions of dollars except per-share data.
Business context
Palo Alto Networks sells cybersecurity appliances and related subscription and support services through channel partners. The company reported more than 28,000 end-customers in over 140 countries. It introduced Aperture, a SaaS application security subscription, and AutoFocus, a cyber threat intelligence service, during the quarter.
Financial performance
| Metric | Q1 FY2016 | Q1 FY2015 |
|---|---|---|
| Product revenue | $147.7 | $101.5 |
| Services revenue | $149.5 | $90.8 |
| Total revenue | $297.2 | $192.3 |
| Gross profit / gross margin | $218.0 / 73.3% | $138.9 / 72.2% |
| Operating loss / margin | $(30.8) / (10.4)% | $(23.8) / (12.4)% |
| Net loss | $(38.7) | $(30.1) |
| Net loss per share, diluted | $(0.45) | $(0.38) |
| Operating cash flow | $146.7 | $74.9 |
| Free cash flow, non-GAAP | $127.2 | $69.0 |
| Billings, non-GAAP | $388.0 | $240.5 |
Revenue increased 54.5%. Subscription revenue grew 68.5% to $73.6; support and maintenance grew 60.9% to $75.9; product revenue grew 45.5%. Services were 50.3% of revenue, versus 47.2% a year earlier. Product gross margin rose 2.5 percentage points to 73.8%; services gross margin edged down 0.3 points to 72.9%.
Operating expenses increased 52.9% to $248.8, including research and development of $59.7, sales and marketing of $158.3, and general and administrative expense of $30.8. Share-based compensation was $72.9, up from $38.5. Headcount rose to 2,998 from 1,900 a year earlier. The company remained loss-making despite improved operating margin as a percentage of revenue.
Liquidity, debt and commitments
At October 31, cash and cash equivalents were $275.8 and investments were $1,180.0, totaling $1,455.8, compared with $1,327.8 at July 31, 2015. Cash itself declined by $100.0 during the quarter, largely reflecting investment purchases. Current assets were $1,039.9 and current liabilities $1,078.2; reported working capital was negative $38.3, partly because the convertible notes were classified as current.
Operating cash flow was $146.7; investing cash outflow was $263.5, including net investment purchases and $19.5 of purchases of property, equipment and other assets; financing cash inflow was $16.8. Deferred revenue increased to $804.5 from $713.7, supporting future revenue recognition.
The company had $575.0 principal amount of 0.0% convertible senior notes due July 2019, carried at $492.3 net. Holders could convert during the quarter ending January 31, 2016 because the stock-price conversion condition remained satisfied. Conversion requires cash payment at least equal to principal, with any excess payable in cash and/or shares at the company’s election. Management said existing cash, investments and operating cash flow should meet anticipated needs for the foreseeable future.
Contractual obligations included $508.5 of gross operating lease payments, or $501.1 net of expected sublease proceeds, and $46.3 of non-cancelable manufacturing purchase commitments. A new Santa Clara office lease covers approximately 310,000 square feet, with about $101.2 of rent over its initial term. The filing reports $41.8 of liabilities for uncertain tax positions. No significant loss-contingency accrual was recorded for litigation.
Changes, outlook and risks
- Revenue growth accelerated to 54.5% from 50.1% in the prior-year quarter. Billings and deferred revenue also increased substantially; billings is a non-GAAP measure defined as revenue plus the change in deferred revenue.
- Gross margin improved by 1.1 percentage points, while operating loss widened in dollars but improved as a share of revenue. Management attributed product-margin improvement to cost reductions and demand for higher-end appliances.
- Management expects operating expenses to rise in absolute dollars as it invests in product development, sales capacity, international expansion and infrastructure; it expects expenses to decline over time as a percentage of revenue. Gross margins may fluctuate with product and service mix, pricing and manufacturing costs. No specific forward revenue or earnings guidance is provided in the supplied filing text.
- Management cited growth opportunities from expanding its customer base and recurring services, while noting challenges in scaling systems and operations, competing effectively, and hiring and retaining personnel. It reported no material change in market-risk exposures and stated disclosure controls were effective; no material quarterly change in internal control over financial reporting was identified.
- Principal disclosed risks include intense competition, dependence on channel partners and third-party manufacturing, supply constraints, customer renewals, product defects or security incidents, rapid growth and execution demands, international and currency exposure, and potential volatility in results. Two channel partners accounted for 58.7% of quarterly revenue and 57.9% of gross accounts receivable.
Investor facts to verify
- Whether the convertible notes were converted, and the resulting cash, dilution and share-count effects.
- Whether rapid revenue, services, billings and deferred-revenue growth continued, and whether recurring-service renewals and margins remained strong.
- How much reported cash generation depends on deferred-revenue growth and non-cash share-based compensation, which was $72.9 for the quarter.
- Whether customer and receivable concentration among the two largest channel partners changed, and whether supply-chain capacity can support growth.
- The timing and total cost of the Santa Clara headquarters leases, manufacturing commitments and other planned growth investments.
- Whether the company can narrow operating losses while funding growth amid competitive, execution, product-security and customer-retention risks.