Palo Alto Networks, Inc. — FY2018 Form 10-K Summary
Reporting period: Fiscal year ended July 31, 2018. The filing also reports fourth-quarter results for the three months ended July 31, 2018. Unless stated otherwise, amounts are in U.S. dollars.
Business context
Palo Alto Networks sells network, endpoint, and cloud security products and services, including next-generation firewalls, subscriptions, and support. It reported one operating segment, served more than 54,000 end-customers in over 150 countries, and conducted most sales through distributors and resellers. Subscription and support revenue is generally recognized over contract periods of one to five years.
Key financial metrics
| Metric | FY2018 | FY2017 |
|---|---|---|
| Revenue | $2,273.1 million | $1,761.6 million |
| Product revenue | $871.5 million | $709.1 million |
| Subscription and support revenue | $1,401.6 million | $1,052.5 million |
| Gross profit / gross margin | $1,627.8 million / 71.6% | $1,285.0 million / 72.9% |
| Operating loss / margin | $(129.1) million / (5.7)% | $(179.8) million / (10.2)% |
| Net loss | $(147.9) million | $(216.6) million |
| Billings | $2,860.2 million | $2,293.4 million |
| Cash from operating activities | $1,037.0 million | $868.5 million |
| Free cash flow (non-GAAP) | $925.0 million | $705.1 million |
FY2018 revenue grew 29.0%; subscription and support revenue grew 33.2% and represented 61.7% of revenue, versus 59.7% in FY2017. Product revenue grew 22.9%. Fourth-quarter revenue was $658.1 million, compared with $509.1 million a year earlier; the quarter recorded operating income of $8.6 million and a net loss of $2.3 million.
At July 31, 2018, cash and cash equivalents were $2,506.9 million, investments were $1,444.0 million, working capital was $1,992.6 million, and deferred revenue totaled $2,364.9 million. Convertible notes had $2,268.0 million of principal outstanding and a $1,920.1 million net carrying amount. The 2019 Notes were classified as current; $327.3 million principal was converted or submitted for conversion after year-end. A $400 million unsecured revolving credit facility was entered into on September 4, 2018, with an option to increase it by up to $350 million subject to conditions.
Material changes versus FY2017
- Revenue growth accelerated to 29.0% from 27.8%; billings growth rose to 24.7% from 20.4%.
- Gross margin declined 1.3 percentage points, primarily as new appliances carried lower product margins and cloud hosting and customer-service costs increased.
- Operating loss narrowed by $50.7 million and net loss narrowed by $68.7 million; operating expenses nevertheless rose 19.9% to $1,756.9 million.
- Cash and investments increased to $3,950.9 million from $2,164.3 million, reflecting operating cash generation and financing proceeds from the July 2018 Notes issuance.
- The company acquired Evident.io for $292.9 million and Secdo for $82.7 million in cash, adding public-cloud security and endpoint detection and response capabilities.
Outlook, risks, and unusual items
- Management expects continued investment in research and development, sales, customer support, and cloud infrastructure; operating expenses are expected to increase in absolute dollars. The filing gives no clear numerical FY2019 revenue or earnings guidance.
- A $39.2 million cease-use loss was recorded in FY2018 for vacated headquarters facilities; $29.1 million remained as a liability at year-end. FY2017 included a separate $20.9 million property impairment tied to the relocation.
- FY2018 share-based compensation was $503.9 million, and approximately $1.1 billion of unrecognized compensation cost was expected to be recognized over a weighted-average period of about three years.
- Key risks include intense competition, product or service security failures, dependence on channel partners and manufacturing suppliers, customer renewal and sales-cycle variability, and privacy, regulatory, foreign-exchange, and tax uncertainties. Three distributors generated 67.1% of FY2018 revenue; four distributors represented 71.9% of gross receivables at year-end.
- The company had $540.6 million of future operating lease payments and $146.3 million of purchase obligations. It reported no significant litigation accruals and no loss that it considered probable or reasonably estimable at year-end.
- The company planned to adopt the new revenue standard in FY2019 using the full retrospective method. Its estimated adjustments include earlier recognition for some contracts and a longer amortization period for certain sales commissions; actual adoption effects may vary.
Important facts for investors to verify
- Whether subscription growth, billings, and deferred revenue translate into sustained recognized revenue and renewals.
- Whether gross margins stabilize as product costs and cloud-service expenses change.
- The cash and share impact of 2019 Notes conversions and the repayment obligations for both convertible-note series.
- Distributor concentration, receivables exposure, and the resilience of manufacturing and component supply.
- The realized financial effects of acquisitions, the headquarters lease exit, the FY2019 revenue-standard adoption, and evolving tax rules.