Palo Alto Networks, Inc. — Form 10-Q Summary
Business context and reporting period
Quarter ended January 31, 2017 (fiscal 2017 Q2), with six-month results compared with the periods ended January 31, 2016. Palo Alto Networks sells network security products and subscription and support offerings through channel partners. The company reported more than 37,500 end-customers in over 150 countries.
Financial performance and liquidity
| Metric | Q2 FY2017 | Q2 FY2016 | Six months FY2017 | Six months FY2016 |
|---|---|---|---|---|
| Revenue | $422.6 million | $334.7 million | $820.7 million | $631.9 million |
| Gross margin | 73.2% | 71.9% | 73.9% | 72.6% |
| Operating loss | $(54.4) million | $(50.1) million | $(103.4) million | $(82.1) million |
| Net loss | $(60.6) million | $(57.3) million | $(117.5) million | $(97.2) million |
| Diluted loss per share | $(0.67) | $(0.66) | $(1.30) | $(1.13) |
- Q2 revenue rose 26.3% year over year. Product revenue was $168.8 million, down 0.6%; subscription and support revenue was $253.8 million, up 54.0%, and represented 60.1% of revenue.
- Six-month billings were $1.079 billion, up 27.3%; total deferred revenue was $1.499 billion at January 31, 2017, versus $1.241 billion at July 31, 2016.
- Six-month operating cash flow was $417.8 million, compared with $301.0 million. Non-GAAP free cash flow was $352.2 million, compared with $264.1 million. Investing activities used $244.3 million; financing activities used $146.5 million, including $170.1 million of share repurchases.
- Cash, cash equivalents, and investments totaled $2.145 billion; working capital was $886.8 million. Management said operating cash flow and existing cash were expected to meet anticipated needs for the foreseeable future.
- Convertible notes had $575.0 million principal and a $512.3 million net carrying amount; they bear 0% stated interest and mature July 1, 2019. The company reported $12.1 million of six-month interest expense, primarily debt discount and issuance-cost amortization.
Material changes versus the prior comparable period
- Q2 revenue growth was lower than the prior-year quarter’s 53.8%; six-month growth was 29.9%, versus 54.1%. Subscription and support drove growth, while Q2 product revenue was slightly lower.
- Gross margin improved, including subscription and support margin, which management attributed to higher-margin subscription offerings. Operating expenses grew 25.2% in Q2 to $363.8 million, with higher personnel and sales-related costs; the operating loss widened in dollars, although operating margin improved to negative 12.9% from negative 15.0%.
- Cash and investments increased from $1.938 billion at July 31, 2016. Working capital declined from $927.2 million. The company repurchased 1.3 million shares for $170.1 million during the six months.
- Comparability is affected by a retrospective change in sales-commission accounting, which defers and amortizes qualifying commissions over the related contract term, and early adoption of share-based-payment guidance. Prior periods were adjusted; the commission change did not affect cash flows.
Outlook, commentary, risks, and unusual items
- No numerical revenue or earnings guidance is provided in the filing. Management expects operating expenses to increase in absolute dollars and anticipates subscription and support revenue will grow over the long term. It notes seasonal and quarterly variability.
- Management disclosed recent execution challenges in elements of its go-to-market strategy and said changes were being implemented; these could disrupt the sales organization or affect results in the second half of fiscal 2017.
- Key risks include competition, customer renewal and sales-cycle uncertainty, reliance on channel partners and a small number of distributors, product or security defects, dependence on contract manufacturers and limited-source components, foreign-exchange exposure, and the ability to manage rapid growth. Two distributors accounted for 57.2% of six-month revenue; three represented 72.4% of gross receivables at period-end.
- Commitments included $506.8 million of net future operating lease payments and $77.6 million of contract-manufacturer purchase commitments. The company reported no significant litigation accruals and no determination that an unfavorable legal outcome was probable or reasonably possible.
- Unrecognized tax benefits were $265.4 million, up from $127.7 million at July 31, 2016; the increase related to current-year transfer-pricing positions. The filing says the ultimate amount and timing of any tax settlements cannot be predicted with reasonable certainty.
- After quarter-end, the company completed its LightCyber acquisition for approximately $105 million in cash. Its board also added $500 million to the repurchase authorization, bringing it to $1.0 billion, and extended the program through December 31, 2018.
Important facts for investors to verify
- Whether billings, deferred revenue, subscription renewals, and customer additions sustain growth as product revenue remains comparatively weak.
- Whether the go-to-market changes address execution challenges and support expected second-half performance.
- The trajectory and effect of substantial share-based compensation: $240.6 million for the six months, with $989.7 million of unrecognized compensation cost.
- How the LightCyber acquisition performs and how the expanded repurchase program affects cash, liquidity, and share count.
- Developments in transfer-pricing examinations and other tax exposures, as well as the company’s ability to meet lease and manufacturing commitments.