Palo Alto Networks, Inc. — Q1 FY2023 Form 10-Q
Reporting period: Three months ended October 31, 2022, compared with the three months ended October 31, 2021, unless otherwise noted. Amounts are in U.S. dollars.
Business context
Palo Alto Networks provides cybersecurity products and services across network security, secure access, cloud security, security operations, and threat intelligence and consulting. Subscription and support services generated 78.9% of quarterly revenue. The company reported a three-for-one stock split effective September 13, 2022; share and per-share data were retroactively adjusted.
Financial performance
| Metric | Q1 FY2023 | Q1 FY2022 | Change / context |
|---|---|---|---|
| Total revenue | $1.563 billion | $1.247 billion | Up 25.3% |
| Product revenue | $330.0 million | $295.5 million | Up 11.7% |
| Subscription and support revenue | $1.233 billion | $951.9 million | Up 29.6% |
| Gross profit / gross margin | $1.102 billion / 70.5% | $866.8 million / 69.5% | Margin up 1.0 percentage point |
| Operating income (loss) / margin | $15.2 million / 1.0% | $(82.7) million / (6.6)% | Returned to GAAP operating income |
| Net income (loss) | $20.0 million | $(103.6) million | Diluted EPS of $0.06 versus $(0.35) |
| Operating cash flow | $1.237 billion | $588.9 million | Up $647.8 million |
| Free cash flow (non-GAAP) | $1.197 billion | $554.3 million | Operating cash flow less $39.6 million of capital purchases |
Subscription revenue grew 32.0% and support revenue grew 25.8%. Product gross margin declined to 63.6% from 69.9%, primarily reflecting supply-chain-related costs; subscription and support gross margin rose to 72.3% from 69.4%. Overall gross margin improved as subscription and support revenue growth outpaced related costs. Operating expenses were $1.086 billion, up 14.4%; sales and marketing rose 21.6%, while general and administrative expense fell 4.4%.
Net income included $26.0 million of other income, principally reflecting higher interest income; the prior-year period had $1.6 million of other expense. Share-based compensation was $266.0 million for the quarter, and $2.0 billion of unrecognized compensation cost was expected to be recognized over approximately 2.5 years.
Liquidity, debt, and cash flows
- Cash, cash equivalents, and investments totaled $5.898 billion at October 31, 2022, versus $4.686 billion at July 31, 2022. Cash and cash equivalents were $2.067 billion; investments were $3.831 billion.
- Working capital was negative $2.462 billion, compared with negative $1.891 billion at July 31. Current liabilities included $3.679 billion of convertible notes classified as current and $3.741 billion of deferred revenue.
- Net cash provided by operating activities was $1.237 billion; the filing attributes the year-over-year increase primarily to business growth and higher collections, partly offset by higher cash spending. Investing activities used $1.320 billion, largely reflecting purchases of investments; financing activities provided $31.1 million.
- The company had $3.691 billion principal amount of unsecured convertible notes outstanding: $1.692 billion due July 2023 and $1.999 billion due June 2025. Both series were eligible for conversion from November 1, 2022 through January 31, 2023 after the conversion price condition was met. If all holders converted, the company would owe $3.7 billion of principal in cash; it stated it believed available liquidity and financing sources would suffice.
- No borrowings were outstanding under the $400 million revolving credit facility, and the company reported compliance with its covenants. Operating lease obligations were $346.1 million. Purchase commitments for products, components, cloud, and other services totaled approximately $2.3 billion.
Outlook, risks, and unusual items
- The filing provides no specific numerical revenue or earnings guidance. Management expects subscription and support revenue to grow over the long term as offerings and the customer base expand; it also expects operating expenses to rise in absolute dollars, while potentially declining as a share of revenue over time.
- Management cited inflation, higher interest rates, economic and geopolitical uncertainty, customer purchase delays and lengthening sales cycles, and continued semiconductor and component shortages. Supply constraints had increased costs and delivery lead times; some customers delayed hardware refreshes and larger transactions required additional approvals.
- Remaining performance obligations were $8.3 billion, with approximately $4.2 billion expected to be recognized as revenue over the next 12 months. Total deferred revenue was $7.180 billion.
- On November 17, 2022, the company agreed to acquire Cider Security for approximately $250 million, including about $194.6 million in cash and $55.4 million in replacement equity awards, subject to adjustment and customary closing conditions.
- Available-for-sale debt securities had $51.6 million of gross unrealized losses at October 31, primarily attributed to interest-rate movements rather than credit quality. Management said it did not intend to sell the securities and did not expect to be forced to sell before recovery or maturity.
- The company reported ordinary-course litigation but no significant accrual for loss contingencies and no loss it considered probable or reasonably possible with a reasonably estimable amount. Its risk disclosures highlight competition, cybersecurity incidents, channel and customer concentration, supply-chain dependence, macroeconomic conditions, and convertible-note cash settlement and dilution risks.
Key facts for investors to verify
- Whether growth in billings, deferred revenue, and remaining performance obligations continues to support reported revenue growth; billings were $1.749 billion, up 26.6% year over year.
- How the January 31, 2023 conversion window for both note series affects cash, debt classification, and potential share dilution; note hedges and warrants may affect the conversion economics.
- Whether supply constraints and product costs continue to pressure product gross margin, and whether subscription and support margin gains persist.
- How much of the unusually strong operating cash flow reflects durable operating performance versus collections and working-capital timing.
- Execution and funding of the Cider Security acquisition, and the company’s ability to meet approximately $2.3 billion of purchase commitments and other obligations while maintaining liquidity.