Palo Alto Networks, Inc. — FY2016 Form 10-K Summary
Business context and reporting period
Fiscal year ended July 31, 2016; the filing also reports the quarter ended July 31, 2016. Palo Alto Networks provides cybersecurity products and services spanning next-generation firewalls, endpoint protection, and cloud-based threat intelligence. It reported approximately 34,000 end-customers in more than 140 countries and operates as one reportable segment.
Key financial metrics
Amounts in U.S. dollars; millions except per-share data and percentages.
| Metric | FY2016 | FY2015 |
|---|---|---|
| Revenue | $1,378.5 | $928.1 |
| Product revenue | $670.8 | $492.7 |
| Services revenue | $707.7 | $435.4 |
| Gross profit / margin | $1,008.5 / 73.2% | $676.6 / 72.9% |
| Operating loss / margin | $(190.1) / (13.8)% | $(133.5) / (14.4)% |
| Net loss | $(225.9) | $(165.0) |
| Net loss per share, diluted | $(2.59) | $(2.02) |
| Operating cash flow | $658.1 | $350.3 |
| Free cash flow (non-GAAP) | $585.6 | $316.5 |
| Billings | $1,905.6 | $1,219.1 |
| Cash, cash equivalents and investments | $1,938.4 | $1,327.8 |
| Deferred revenue | $1,240.8 | $713.7 |
| Working capital | $872.3 | $41.8 |
- Revenue increased 48.5% year over year. Services, 51.3% of revenue, grew 62.5%; subscription revenue rose 67.8% to $357.0 million and support and maintenance revenue rose 57.5% to $350.7 million. Product revenue grew 36.2%.
- FY2016 fourth-quarter revenue was $400.8 million, compared with $283.9 million in the prior-year quarter; fourth-quarter net loss was $54.5 million, versus $46.0 million.
- Operating expenses rose to $1,198.6 million from $810.1 million, led by sales and marketing ($776.0 million) and research and development ($284.2 million). Share-based compensation totaled $392.9 million, up from $221.4 million.
- Operating cash flow increased substantially, with management citing business growth and higher deferred revenue, partly offset by increased receivables. Free cash flow is a non-GAAP measure defined as operating cash flow less purchases of property, equipment and other assets.
- At year-end, cash and cash equivalents were $734.4 million; investments were $1,204.0 million. The $575.0 million, 0% convertible notes due 2019 had a net carrying value of $508.2 million and were classified as long-term. FY2016 interest expense of $23.4 million was primarily non-cash amortization of debt discount and issuance costs.
Material changes versus the prior comparable period
- Revenue growth remained strong but decelerated to 48.5% from 55.1%. Services increased as a share of revenue from 46.9% to 51.3%, reflecting subscription adoption and renewals.
- Gross margin edged up to 73.2% from 72.9%; operating loss widened in dollars, although operating margin improved to (13.8)% from (14.4)%. Net loss increased to $225.9 million from $165.0 million.
- Operating cash flow rose to $658.1 million from $350.3 million. Deferred revenue increased $527.1 million during FY2016, compared with $291.0 million in FY2015.
- Working capital increased from $41.8 million to $872.3 million, substantially reflecting the reclassification of the convertible notes from current to long-term liabilities after the notes were no longer convertible under the applicable share-price condition at July 31, 2016.
Outlook, commentary, risks and unusual items
- Management expects continued investment in research and development, sales and marketing, customer support, international expansion and facilities. It expects operating expenses to rise in absolute dollars and indicated that services revenue may grow over time with new offerings, renewals and customer-base expansion. The filing does not provide a clear numerical forecast for FY2017 revenue, earnings or margins.
- Management stated that existing cash and operating cash flow should be sufficient for anticipated needs for the foreseeable future. In August 2016, the board authorized a share repurchase program of up to $500.0 million, funded from available working capital, through August 31, 2018; the authorization does not require repurchases.
- On August 30, 2016, the company entered into euro forward contracts with a notional amount of €66.9 million to hedge FY2017 euro-denominated expenditures.
- Key risks include intense competition and price pressure; reliance on channel sales; concentration in two distributors, which generated 58.2% of FY2016 revenue, and four distributors, which represented 74.1% of gross accounts receivable; dependence on contract manufacturing and limited-source components; quarter-end sales timing and seasonality; and the possibility of product defects or security incidents.
- The company reported a history of GAAP losses and an accumulated deficit of $726.6 million. It also disclosed $822.9 million of unrecognized share-based compensation cost expected to be recognized over a weighted-average 2.4 years, excluding future grants.
- Contractual commitments included $575.0 million principal on the notes, $509.3 million of operating lease obligations and $54.2 million of purchase obligations. The company reported approximately $48.4 million of recorded liabilities for uncertain tax positions. It reported no significant accrual for ordinary-course litigation contingencies and no loss considered probable or reasonably possible and estimable.
- FY2014 included a $141.2 million legal settlement expense related to Juniper and Fortinet; no comparable settlement expense was recorded in FY2015 or FY2016. The FY2016 financial statements received an unqualified audit opinion, and management and the auditor concluded internal control over financial reporting was effective.
Important facts for investors to verify
- Whether recurring-services growth, renewals and deferred-revenue expansion persist, and how billings compare with recognized revenue.
- Whether operating-expense growth and substantial share-based compensation translate into improving GAAP operating margins and profitability.
- The sustainability and drivers of operating cash flow, including the contribution from deferred revenue and working-capital movements.
- Distributor concentration, accounts-receivable collection, and manufacturing or component-supply exposure.
- The potential dilution, cash-settlement requirements and conversion terms of the 2019 convertible notes, and the actual pace and amount of share repurchases.
- Developments in uncertain tax positions, litigation, currency exposure and the company’s planned facility commitments.