Palo Alto Networks, Inc. — Q1 FY2019 Form 10-Q
Reporting period: Three months ended October 31, 2018. Palo Alto Networks sells cybersecurity products and related subscription and support services. The financial statements are unaudited; prior-period figures were retrospectively adjusted for the new revenue-recognition standard.
Financial results and liquidity
| Metric | Q1 FY2019 | Q1 FY2018 |
|---|---|---|
| Revenue | $656.0 million | $501.8 million |
| Gross profit / margin | $472.5 million / 72.0% | $360.5 million / 71.8% |
| Operating loss / margin | $(32.1) million / (4.9)% | $(53.5) million / (10.7)% |
| Net loss | $(38.3) million | $(63.2) million |
| Diluted loss per share | $(0.41) | $(0.70) |
| Operating cash flow | $252.3 million | $274.0 million |
| Free cash flow, non-GAAP | $218.0 million | $241.8 million |
| Billings | $758.5 million | $595.4 million |
- Revenue grew 30.7% year over year. Product revenue was $240.5 million, up 30.1%; subscription and support revenue was $415.5 million, up 31.1%, and represented 63.3% of revenue.
- Gross margin improved 0.2 percentage points. Operating loss narrowed, though operating expenses increased 21.9% to $504.6 million.
- Cash, cash equivalents, and investments totaled $3.769 billion at quarter-end, versus $3.951 billion at July 31, 2018. Working capital was $1.999 billion.
- Operating cash flow and free cash flow declined year over year. Investing activities used $713.1 million, mainly reflecting investment purchases and the RedLock acquisition; financing activities used $261.8 million, primarily due to convertible-note repayments.
- Convertible notes had $1.941 billion principal outstanding at quarter-end: $247.7 million of 0% notes due 2019 and $1.693 billion of 0.75% notes due 2023. The 2019 notes were classified as current. The company had repaid $327.3 million principal converted during the quarter and reported $88.3 million more converted or submitted for conversion after quarter-end. A $400 million revolving facility was undrawn.
- Total deferred revenue was $2.384 billion, up from $2.279 billion at July 31. Remaining performance obligations were $2.5 billion; approximately $1.3 billion was expected to be recognized over the next 12 months.
Changes, outlook, and notable items
- Revenue growth accelerated from the adjusted prior-year rate of 26.0% to 30.7%; billings growth was 27.4%, versus 24.6%. Management attributed growth to demand from new and existing customers and adoption of its hybrid subscription model.
- Operating margin improved as revenue grew faster than operating expenses. Management expects operating expenses to rise in absolute dollars, while declining as a percentage of revenue over the long term. It expects interest expense to increase in FY2019 due to the 2023 notes.
- Management said existing cash, investments, and operating cash flow should meet anticipated cash needs for the foreseeable future. The filing gives no specific numerical revenue or earnings guidance for upcoming quarters; it cautions that results may vary with seasonality, cyclicality, and other factors.
- RedLock was acquired on October 12 for $158.2 million of purchase consideration, principally cash. The acquisition added $113.6 million of goodwill and $54.8 million of identified intangible assets. RedLock-related accelerated vesting added $14.2 million to general and administrative expense.
- Share-based compensation was $151.1 million, compared with $125.7 million a year earlier. Unrecognized compensation cost was $1.4 billion, expected to be recognized over a weighted-average 2.9 years.
- A $9.4 million one-time tax benefit related to a partial valuation-allowance release connected with RedLock contributed to the quarter’s income-tax benefit. The company also adopted revenue-recognition guidance retrospectively; the primary effect was longer amortization of certain sales commissions.
- Contractual commitments included $525.8 million of gross operating lease payments and $163.6 million of purchase obligations. The company disclosed $81.7 million of uncertain-tax-position liabilities. It reported no significant litigation accruals and no determination that an unfavorable litigation outcome was probable or reasonably possible.
Key risks and investor verification points
- Verify the sustainability and cash conversion of reported growth, including billings, deferred revenue, renewals, and the mix of product versus subscription and support revenue.
- Assess the impact of high share-based compensation and future dilution, including convertible notes, warrants, equity awards, and the associated note hedges.
- Monitor liquidity and cash requirements from 2019-note conversions, the 2023 notes, leases, purchase commitments, acquisitions, and the share-repurchase authorization.
- Review acquisition integration and valuation risks, particularly preliminary RedLock purchase accounting and expected synergies.
- Consider revenue concentration: three distributors represented 65.4% of quarterly revenue and 65.9% of gross accounts receivable at quarter-end.
- Evaluate execution and industry risks cited by the company, including intense competition, customer renewal and spending patterns, cybersecurity incidents or product defects, reliance on channel and manufacturing partners, supply constraints, international and regulatory exposure, and rapid growth-management demands.