Palo Alto Networks, Inc. — Q3 FY2018 Form 10-Q
Reporting period: Three and nine months ended April 30, 2018; comparative periods ended April 30, 2017. The company provides cybersecurity products and subscription and support services. Figures are in millions of dollars except per-share data.
Financial performance
| Metric | Q3 FY2018 | Q3 FY2017 | Nine months FY2018 | Nine months FY2017 |
|---|---|---|---|---|
| Revenue | $567.1 | $431.8 | $1,615.0 | $1,252.5 |
| Gross profit / margin | $407.2 / 71.8% | $308.1 / 71.4% | $1,154.4 / 71.5% | $914.4 / 73.0% |
| Operating loss / margin | $(51.6) / (9.1)% | $(49.1) / (11.4)% | $(137.7) / (8.5)% | $(152.5) / (12.2)% |
| Net loss | $(46.7) | $(60.9) | $(145.6) | $(178.4) |
| Net loss per share, diluted | $(0.51) | $(0.67) | $(1.59) | $(1.97) |
- Q3 revenue rose 31.3% year over year; nine-month revenue rose 28.9%. Subscription and support represented 62.1% of Q3 revenue and grew 31.5%; product revenue grew 31.1%.
- Q3 gross margin improved slightly, while nine-month gross margin declined, mainly reflecting lower product margins on newer appliances and higher cloud hosting costs.
- Operating losses narrowed for the nine-month period but increased slightly in Q3. Higher sales and marketing and R&D spending supported growth; general and administrative expense included substantial headquarters cease-use losses and acquisition-related costs.
- Nine-month operating cash flow was $759.1, versus $629.0; non-GAAP free cash flow was $672.5, versus $514.8. Cash and cash equivalents were $949.0 at April 30.
Liquidity, debt and balance sheet
- Cash, cash equivalents and investments totaled $2,214.1 at April 30, 2018, compared with $2,164.3 at July 31, 2017. Current and long-term deferred revenue totaled $2,154.9, up from $1,773.5.
- Working capital was $262.4 versus $775.0; the filing attributes much of the change to reclassifying the convertible notes as current liabilities.
- The company had $575.0 principal amount of 0% convertible notes due July 2019, with a net carrying amount of $543.8 classified as current. A conversion condition was met, allowing holders to convert during the quarter ending July 31, 2018. Cash payment is required for principal upon conversion; excess conversion value may be paid in cash and/or shares at the company’s election.
- Nine-month investing cash use was $313.6, including $370.1 net cash paid for acquisitions; financing cash use was $240.8, including $259.1 of share repurchases and related activity.
Material changes and unusual items
- Acquired cloud-security company Evident.io in March for $292.9 and endpoint-detection company Secdo in April for $82.7, both for cash. Purchase accounting was preliminary; acquired goodwill increased to $522.2 from $238.8.
- Recorded a $39.2 nine-month cease-use loss on vacated headquarters facilities, including an additional $23.8 in Q3 following revised sublease assumptions. The remaining cease-use liability was $31.8.
- Q3 income tax benefit included one-time benefits related to Evident.io valuation allowance release and an Israeli judicial ruling. Nine-month results also included a provisional $5.8 benefit related to U.S. tax legislation; final tax effects remained under evaluation.
- Share-based compensation was $380.2 for nine months, and $920.0 of unrecognized compensation cost was expected to be expensed over a weighted-average 2.6 years.
Outlook, commentary and risks
- The filing provides no specific numerical forward guidance. Management expects operating expenses to rise in absolute dollars, while aiming for them to decline as a percentage of revenue over the longer term. It expects subscription and support revenue to grow over time, while noting quarterly seasonality and margin variability.
- Management stated existing cash and operating cash flow should meet anticipated needs for the foreseeable future. Capital requirements may depend on growth, product development, cloud infrastructure, acquisitions and headquarters investment.
- Key disclosed risks include intense competition, dependence on channel partners and a small number of distributors, customer renewal and subscription demand, rapid growth and execution, product or service vulnerabilities, reliance on manufacturing and component suppliers, acquisition integration, foreign exchange exposure, and volatility in quarterly results.
- Three distributors generated 66.9% of nine-month revenue, and four distributors represented 77.1% of gross accounts receivable at period-end. The company also cited seasonal purchasing patterns and substantial quarter-end sales activity.
- Revenue recognition guidance was scheduled for adoption in Q1 FY2019 using the full retrospective method. Management expected changes in accounting for certain virtual-firewall term licenses and other contract arrangements, but had not determined the overall impact.
Important facts for investors to verify
- Progress and economics of integrating Evident.io and Secdo, including final purchase-price allocations and realized synergies.
- Timing and cash-versus-share settlement outcomes for convertible notes eligible for conversion in the quarter ending July 31, 2018.
- Whether subscription growth and deferred revenue convert into sustained revenue, cash generation and improved margins.
- Changes to the headquarters cease-use estimate and sublease proceeds, and the final effects of tax legislation and revenue-standard adoption.
- Distributor concentration, renewal trends, share-based compensation expense, and the company’s ability to sustain growth while controlling operating costs.