Palo Alto Networks, Inc. — Form 10-Q Summary
Business context and period: The company provides network, endpoint, and cloud cybersecurity products and services. This filing covers the second quarter and first six months of fiscal 2018, ended January 31, 2018; comparisons are with the same periods of fiscal 2017. Amounts are in U.S. dollars.
Financial performance and liquidity
| Metric | Q2 FY2018 | Q2 FY2017 | Six months FY2018 | Six months FY2017 |
|---|---|---|---|---|
| Revenue | $542.4 million | $422.6 million | $1,047.9 million | $820.7 million |
| Gross margin | 70.6% | 73.2% | 71.3% | 73.9% |
| Operating loss | $31.8 million | $54.4 million | $86.1 million | $103.4 million |
| Net loss | $34.9 million | $60.6 million | $98.9 million | $117.5 million |
| Net loss per share, diluted | $0.38 | $0.67 | $1.09 | $1.30 |
| Billings | $674.6 million | $561.6 million | $1,271.1 million | $1,078.5 million |
- Q2 revenue grew 28.3% year over year; six-month revenue grew 27.7%. Subscription and support made up 62.7% of Q2 revenue and grew 34.0%; product revenue grew 19.8%.
- Q2 gross margin declined 2.6 percentage points year over year. Management attributed lower product margin to costs of new appliances and lower margins on those models, and lower subscription and support margin to investment in cloud infrastructure.
- Operating losses narrowed, but the company remained GAAP loss-making. Six-month operating expenses rose to $833.3 million from $709.7 million, including $256.5 million of share-based compensation, versus $240.6 million.
- Six-month operating cash flow was $517.8 million, compared with $417.8 million; non-GAAP free cash flow was $460.0 million, versus $352.2 million. Cash flow benefited from growth in billings and collections, deferred revenue, and a $38.2 million landlord reimbursement. Share-based compensation and deferred revenue are significant factors in interpreting operating cash flow.
- At January 31, cash and cash equivalents were $915.0 million and investments were $1,443.0 million, totaling $2.358 billion. Working capital was $353.8 million, down from $775.0 million at July 31, 2017, partly because convertible notes were reclassified as current liabilities.
- The company had $575.0 million principal amount of 0.0% convertible notes due July 2019. A conversion condition was met, making the notes convertible through April 30, 2018; the company said conversion requires cash equal to principal and may require additional cash and/or shares. The notes’ net carrying amount was classified as current.
Material changes, outlook, and notable items
- Billings growth was 20.1% in Q2, versus 22.4% a year earlier; six-month growth was 17.9%, versus 27.3%. Revenue growth remained strong, but billings growth slowed.
- Deferred revenue increased to $1,996.7 million from $1,773.5 million at July 31, 2017, supporting future revenue recognition. The filing reports approximately 48,000 end-customers across more than 150 countries.
- The company recorded a $15.4 million cease-use loss after vacating its former headquarters; the remaining related liability was $10.8 million. It also received a $38.2 million upfront landlord reimbursement to apply against future rent. Net operating lease obligations were $533.5 million after expected sublease proceeds.
- The Tax Cuts and Jobs Act resulted in a provisional $6.2 million tax benefit related to refundable alternative minimum tax credits. The filing says the tax impact remains subject to uncertainty and further evaluation.
- Management expects operating expenses to increase in absolute dollars as the company invests in product development, sales and marketing, infrastructure, and support; it expects expenses to decline over time as a percentage of revenue. It expects subscription and support to increase over the long term, but revenue may vary seasonally and cyclically. The filing provides no specific numerical guidance for future revenue or earnings.
- Management believes operating cash flow and existing cash and investments will meet anticipated cash needs for the foreseeable future. Future capital needs depend on growth, product investment, facilities, manufacturing capacity, and other factors.
- Key risks include intense competition, execution and scaling challenges, customer renewal and sales variability, reliance on channel partners and manufacturing suppliers, cybersecurity and product-defect risks, international and regulatory exposure, and possible volatility in margins and results. Three distributors represented 67.1% of six-month revenue and 72.3% of gross receivables at period end. Purchase commitments were $121.5 million; the company disclosed no significant accrued litigation loss contingencies.
Important facts for investors to verify
- Whether billings growth and deferred-revenue trends support continued revenue growth, particularly as subscription and support revenue becomes a larger share of sales.
- Whether gross margins stabilize as new appliance costs and cloud-service infrastructure costs evolve.
- The cash and dilution consequences if holders convert the $575.0 million notes, and the effect of the notes’ current classification on reported working capital.
- How much operating cash flow reflects sustainable operations versus non-cash share-based compensation, deferred-revenue timing, and the one-time lease reimbursement.
- Potential future costs from share-based compensation, long-term leases, manufacturing commitments, distributor concentration, and the still-provisional tax accounting effects of the Tax Cuts and Jobs Act.