Palo Alto Networks, Inc. — Q3 FY2015 Form 10-Q
Reporting period: Three and nine months ended April 30, 2015. Dollar amounts below are in millions unless otherwise stated. Comparisons are with the corresponding 2014 periods.
Business context and financial performance
Palo Alto Networks sells enterprise cybersecurity products, subscriptions, and support and maintenance services. Its hybrid model combines firewall products with recurring services revenue.
| Metric | Q3 FY2015 | Q3 FY2014 | Nine months FY2015 | Nine months FY2014 |
|---|---|---|---|---|
| Revenue | $234.2 (+55.4%) | $150.7 | $644.2 (+53.4%) | $419.9 |
| Product revenue | $121.5 (+44.5%) | $84.1 | $338.6 (+40.8%) | $240.4 |
| Services revenue | $112.6 (+69.2%) | $66.6 | $305.6 (+70.2%) | $179.5 |
| Gross profit / margin | $169.8 / 72.5% | $111.0 / 73.6% | $467.0 / 72.5% | $308.9 / 73.6% |
| Operating loss | $(36.7) | $(145.7) | $(99.0) | $(189.9) |
| Net loss | $(45.9) | $(146.6) | $(119.0) | $(194.4) |
| Basic and diluted loss per share | $(0.56) | $(1.96) | $(1.47) | $(2.66) |
Q3 subscription revenue was $54.8 million, up 71.3%; support and maintenance was $57.8 million, up 67.3%. Management attributed growth to demand for its firewall platform, customer expansion, and increasing subscription momentum. Gross margin declined 110 basis points year over year, primarily reflecting amortization of intellectual property licenses, partly offset by services mix.
Cash flow, liquidity, and debt
- At April 30, 2015, cash, cash equivalents, and investments totaled $1.231 billion, versus $974.4 million at July 31, 2014. Cash and cash equivalents were $454.1 million; investments were $777.3 million.
- Working capital was $96.5 million, down from $610.2 million at July 31, 2014. The filing reclassified the convertible notes as current because holders became eligible to convert during the quarter ending July 31, 2015.
- For the nine months, operating cash flow was $239.0 million (prior year $114.6 million); purchases of property and equipment and other assets were $21.9 million, yielding non-GAAP free cash flow of $217.1 million (prior year $83.2 million).
- Investing activities used $480.5 million, primarily reflecting net purchases of investments. Financing activities provided $41.9 million. Cash and cash equivalents decreased $199.7 million over the nine months.
- The company has $575 million principal amount of 0.0% convertible senior notes due July 2019; net carrying value was $482.0 million. Notes are unsecured and have no financial covenants. Q3 share-price conditions made them convertible in Q4 FY2015. The company reported $5.6 million Q3 and $16.6 million nine-month non-cash interest expense related to debt discount and issuance-cost amortization.
- Deferred revenue was $603.9 million, up from $422.6 million at July 31, 2014; Q3 billings, a non-GAAP measure, were $302.2 million, up from $193.9 million.
Material changes, outlook, and risks
- Net and operating losses narrowed substantially versus 2014, when the company recorded $121.2 million of Juniper settlement expense in Q3 and $141.2 million total legal settlement expense in the nine-month period. No legal settlement expense was recorded in the 2015 periods. The comparison is therefore affected by this prior-year unusual charge; operating expenses excluding settlement charges increased.
- Operating expenses for the nine months rose 13.5% to $566.0 million, including $138.6 million of share-based compensation. Total share-based compensation was $155.6 million for the nine months. The company expected to recognize $510.4 million of unrecognized compensation cost over approximately three years.
- Management said Traps, its Advanced Endpoint Protection offering, was expected to ramp billings through the end of FY2015, with a more meaningful revenue contribution in FY2016. The filing provides no numerical forward revenue or earnings guidance in the supplied text. Management believed operating cash flow and existing cash and investments would meet anticipated needs for the foreseeable future.
- Management identified continued growth, investment in product development and sales capacity, and scaling systems and processes as priorities and execution challenges. Headcount increased to 2,317 from 1,556 a year earlier.
- Three channel partners represented 71% of nine-month revenue and 77% of gross accounts receivable at period-end. The company also relies on third-party manufacturers and has $41.8 million of open purchase orders.
- Other items to note: the May 2015 CirroSecure acquisition cost approximately $18 million; the company recorded a $36.7 million deferred tax charge following a corporate restructuring and reported $57.6 million of unrecognized tax benefits; and no significant accruals were recorded for ordinary-course litigation contingencies. Juniper litigation was settled in 2014, while other legal outcomes remain uncertain.
Important facts for investors to verify
- Whether recurring services growth and deferred-revenue/billings trends continued, and how Traps contributed to revenue versus billings.
- The effect of the convertible notes’ Q4 FY2015 conversion eligibility on liquidity, reported current liabilities, and potential dilution or cash settlement.
- Whether gross margins stabilize as product mix, intellectual-property amortization, and subscription growth change.
- Whether customer and receivables concentration among the three largest channel partners changes.
- The financial impact and integration progress of the CirroSecure acquisition, along with developments in tax exposures and legal contingencies.