Palo Alto Networks, Inc. — Q2 FY2014 Form 10-Q
Reporting period: Three and six months ended January 31, 2014; balance-sheet figures are as of January 31, 2014, compared with July 31, 2013. The company sells network-security products and related subscriptions and support, primarily through channel partners.
Financial performance
| Metric | Q2 FY2014 | Q2 FY2013 | Six months FY2014 | Six months FY2013 |
|---|---|---|---|---|
| Revenue | $141.1 million | $96.5 million | $269.2 million | $182.4 million |
| Gross profit / margin | $103.6 million / 73.4% | $68.9 million / 71.4% | $197.9 million / 73.5% | $130.6 million / 71.6% |
| Operating loss | $37.2 million | $2.2 million | $44.2 million | $5.3 million |
| Net loss | $39.9 million | $2.6 million | $47.8 million | $6.1 million |
| Net loss per share, diluted | $0.55 | $0.04 | $0.66 | $0.09 |
- Q2 product revenue was $80.8 million, up 30.5%; services revenue was $60.2 million, up 74.3%. Subscription and support-and-maintenance growth drove services expansion. For the six-month period, product and services revenue rose 33.1% and 73.8%, respectively.
- Q2 operating expenses increased 98.1% to $140.7 million. General and administrative expense rose sharply, including a one-time $20.0 million payment for a mutual release and extension of a covenant not to sue. Share-based compensation was $24.4 million for the quarter and $38.8 million for six months.
- Operating cash flow was $80.3 million for six months, versus $57.6 million a year earlier. Capital expenditure and other asset purchases were $25.5 million; reported non-GAAP free cash flow was $54.8 million, versus $47.3 million.
- Non-GAAP billings were $186.7 million for Q2, up from $124.3 million, and $344.6 million for six months, up from $234.8 million. Deferred revenue totaled $324.6 million, versus $249.2 million at July 31, 2013.
Financial position and liquidity
- Cash, cash equivalents, and investments totaled $501.3 million, up from $436.9 million at July 31, 2013; working capital was $292.5 million, down from $323.6 million. Cash and cash equivalents alone were $261.9 million.
- Total assets were $689.0 million and total liabilities were $404.6 million. The balance sheet presents no borrowings or debt balance.
- Investing activities used $149.7 million, including investment purchases and maturities, capital spending, and the Morta acquisition. The company reported a $48.7 million decrease in cash and cash equivalents over the six months.
- About $60.1 million of cash, cash equivalents, and investments was held outside the United States and not then available for domestic operations without potential tax consequences.
Changes, outlook, and risks
- Revenue growth remained strong, but losses widened as operating costs grew faster than revenue. Gross margin improved by 2.0 percentage points in Q2, reflecting product-cost reductions and improved services margins.
- Management said it expects operating expenses to rise in absolute dollars as it invests in product development, sales and marketing, international expansion, and support capacity. It believed operating cash flow and existing cash and cash equivalents would meet anticipated needs for the foreseeable future. The filing provides no specific numerical earnings or revenue guidance.
- The company acquired Morta Security in December 2013 for $10.3 million in cash consideration; the preliminary allocation included $10.1 million of goodwill and $2.2 million of identified intangible assets.
- Juniper Networks’ patent litigation is a material contingency. A trial began February 24, 2014; the company said it did not believe a loss was probable and could not estimate a possible loss or range. Juniper seeks, among other remedies, damages and injunctions.
- Other key risks include rapid growth and execution demands, intense competition, reliance on channel partners and third-party manufacturers, customer and channel-partner concentration, service renewals, product defects or security vulnerabilities, and macroeconomic and government-spending uncertainty. Three channel partners accounted for 69% of six-month revenue and 72% of gross accounts receivable at period end.
Important facts for investors to verify
- Whether service growth, renewals, deferred revenue, and billings continue to support reported revenue momentum.
- How operating expenses, particularly sales and marketing and share-based compensation, affect the path toward profitability.
- Developments and potential financial exposure in the Juniper litigation, including outcomes after the February 2014 trial.
- Cash availability, including overseas funds, and the use of cash for investments, acquisitions, and capital spending.
- Exposure to major channel partners and the ability of manufacturers and suppliers to meet product demand.