Palo Alto Networks, Inc. — Form 10-Q Summary
Reporting period: Quarter and six months ended January 31, 2020; fiscal second quarter 2020. Amounts are in millions unless otherwise noted. Comparisons are with the corresponding periods in 2019.
Business context
Palo Alto Networks provides cybersecurity products and services across network, cloud, endpoint, and security operations. Its hybrid model combines product sales with subscription and support revenue. Management attributed growth to increased adoption of subscriptions and support; the company operated in more than 150 countries.
Financial performance and liquidity
| Metric | Q2 FY2020 | Q2 FY2019 | Six months FY2020 | Six months FY2019 |
|---|---|---|---|---|
| Revenue | $816.7 | $711.2 | $1,588.6 | $1,367.2 |
| Gross profit / margin | $583.6 / 71.5% | $508.6 / 71.5% | $1,137.8 / 71.6% | $981.1 / 71.8% |
| Operating income (loss) | $(52.9) | $6.6 | $(104.7) | $(25.5) |
| Net income (loss) | $(73.7) | $(2.6) | $(133.3) | $(40.9) |
| Operating cash flow | Not presented quarterly | Not presented quarterly | $532.1 | $527.7 |
| Free cash flow, non-GAAP | Not presented quarterly | Not presented quarterly | $435.8 | $469.9 |
- Q2 revenue increased 14.8% year over year. Product revenue fell 9.2% to $246.5, while subscription and support revenue rose 29.7% to $570.2 and reached 69.8% of revenue. Within that category, subscription revenue grew 37.2% and support revenue grew 19.9%.
- Q2 operating expenses increased to $636.5 from $502.0. Research and development rose 44.5%, sales and marketing 17.2%, and general and administrative 41.9%. Management cited headcount growth, investment in cloud offerings, and related operating costs.
- Billings were $998.9 in Q2, up 17.2%; for the six months, $1,896.3, up 17.7%. Total deferred revenue was $3,198.5 at January 31, versus $2,888.7 at July 31, 2019. Remaining performance obligations were $3.3 billion, with about $1.8 billion expected to be recognized within 12 months.
- At January 31, cash and cash equivalents were $2,000.0 and investments were $1,451.8, totaling $3,451.8. Working capital was $1,738.7. Six-month cash flow from investing activities was $680.9, including substantial investment maturities; financing used $173.2.
- Convertible senior notes had $1.693 billion principal outstanding, with a $1,461.2 net carrying amount, and mature July 1, 2023. The $400 million revolving credit facility was undrawn; the company reported covenant compliance.
- Operating lease liabilities totaled $408.3, including $353.5 long-term. Adoption of lease accounting guidance in August 2019 recognized right-of-use assets and lease liabilities; it did not affect reported earnings or cash flows.
Material changes and unusual items
- Revenue growth slowed: Q2 year-over-year growth was 14.8% versus 30.4% in the prior-year quarter; six-month growth was 16.2% versus 30.5%.
- Product revenue declined primarily because of lower unit volume; management said pricing changes were not significant. Subscription and support growth reflected demand from new and existing customers.
- Operating losses widened, and Q2 net loss increased to $73.7 from $2.6. Share-based compensation was $172.9 in Q2 and $324.1 for the six months; $1.5 billion of unrecognized compensation cost remained, expected to be recognized over about 2.7 years.
- Acquisitions included Zingbox, completed in September 2019 for $66.4, and Aporeto, completed in December for $144.1. Their results were included from acquisition dates; pro forma results were not presented because the effects were not material. Goodwill increased by $159.4 during the six months.
- A December 2019 headquarters lease termination generated a $3.1 gain, net of related fees, in general and administrative expense. A separate $50.0 mutual covenant not to sue and release agreement was recorded as an asset and liability and is to be amortized to product cost over seven years.
- During the six months, the company repurchased $198.1 of shares under its existing authorization, with $801.9 remaining at January 31. After quarter-end, the board approved an additional $1.0 billion accelerated share repurchase, subject to market conditions, and agreed to buy adjacent land for $51.0.
Outlook, risks, and contingencies
- No quantified financial guidance for future periods is provided in the supplied filing text. Management said it expects operating expenses to rise in absolute dollars, while expecting them to decline over the long term as a percentage of revenue; gross margins may fluctuate.
- Management believed cash, investments, and operating cash flow would be sufficient for anticipated needs for the foreseeable future. Capital needs could vary with growth, product development, cloud infrastructure, acquisitions, headquarters investment, and repurchases.
- Risks highlighted include intense competition; the ability to sustain subscription renewals and growth; execution and integration of acquisitions; dependence on channel partners and a concentrated distributor base; product defects or cyber incidents; manufacturing and component supply constraints; and economic, foreign-exchange, regulatory, privacy, and geopolitical uncertainty. The filing specifically identified coronavirus-related disruption as a possible supply-chain and demand risk at that time.
- Four distributors represented 77% of six-month revenue and 61% of gross accounts receivable at January 31, increasing channel and credit concentration exposure.
- The company reported no significant accrued litigation losses and had not determined an unfavorable outcome to be probable or reasonably possible, or a loss range reasonably estimable. Purchase commitments included $106.0 for manufacturing and $299.6 for other services.
Important facts for investors to verify
- Whether subscription and support growth, billings, and deferred revenue continue to offset declining product revenue and slower overall growth.
- Whether operating expense growth, losses, and substantial share-based compensation improve relative to revenue over time.
- Cash generation after capital expenditures, acquisition spending, share repurchases, and the proposed additional $1.0 billion accelerated repurchase.
- Terms and potential cash or dilution effects of the 2023 convertible notes, related warrants, and note-hedge arrangements.
- Acquisition integration and performance, distributor concentration, and any supply-chain or other risks that affect customer demand or delivery.