Palo Alto Networks, Inc. — Form 10-Q Summary
Reporting period: Third quarter and first nine months of fiscal 2020, ended April 30, 2020. Amounts are in U.S. dollars; financial statement figures are in millions unless noted.
Business context and performance
Palo Alto Networks sells network, cloud and endpoint security products, subscriptions and support. Its business mix continued shifting toward recurring subscription and support revenue. The company reported more than 150 countries served and cited adoption of its hybrid SaaS model as a growth driver.
| Metric | Q3 FY2020 | Q3 FY2019 | Nine months FY2020 | Nine months FY2019 |
|---|---|---|---|---|
| Total revenue | $869.4 | $726.6 | $2,458.0 | $2,093.8 |
| Revenue growth, year over year | 19.7% | 28.0% | 17.4% | 29.6% |
| Product revenue | $280.9 | $278.4 | $758.6 | $790.5 |
| Subscription and support revenue | $588.5 | $448.2 | $1,699.4 | $1,303.3 |
| Gross margin | 70.3% | 71.8% | 71.2% | 71.8% |
| Operating loss | $(56.5) | $(18.7) | $(161.2) | $(44.2) |
| Net loss | $(74.8) | $(20.2) | $(208.1) | $(61.1) |
| Basic and diluted loss per share | $(0.77) | $(0.21) | $(2.14) | $(0.65) |
Financial position, cash flow and debt
- Liquidity: At April 30, cash and cash equivalents were $1,484.7 and investments were $705.3, totaling $2,190.0, compared with $3,378.5 at July 31, 2019. Working capital was $678.3, down from $1,611.5.
- Cash flow, nine months: Operating cash flow was $702.0, versus $824.1 a year earlier. Free cash flow, a non-GAAP measure defined as operating cash flow less purchases of property, equipment and other assets, was $519.4, versus $746.0.
- Cash uses and investing: Investing activities provided $955.6, primarily reflecting investment maturities and sales, partly offset by $583.5 of acquisition spending and $182.6 of property, equipment and other asset purchases. Financing activities used $1,132.5, including $1,198.1 of share repurchases.
- Debt: The $1.693 billion principal amount of 0.75% convertible senior notes due July 2023 remained outstanding; their net carrying amount was $1,477.0. No amounts were drawn on the $400 million revolving credit facility, and the company reported covenant compliance.
- Deferred revenue and obligations: Total deferred revenue was $3,370.6, versus $2,888.7 at July 31, 2019. Remaining performance obligations were $3.5 billion; the company expected to recognize approximately $1.9 billion over the next 12 months.
Material changes versus comparable periods
- Q3 revenue increased 19.7%, but growth slowed from 28.0% in the prior-year quarter; nine-month growth slowed to 17.4% from 29.6%.
- Subscription and support revenue rose 31.3% in Q3 and 30.4% for the nine months. Product revenue was nearly flat in Q3 and fell 4.0% for the nine months.
- Q3 gross margin declined 1.5 percentage points year over year. Subscription and support gross margin fell to 68.6% from 71.7%, as cloud-hosting costs and acquired-intangible amortization increased; product gross margin improved to 73.9% from 72.0%.
- Operating expenses increased faster than revenue: Q3 expenses rose to $667.6 from $540.4, including higher research and development and sales and marketing costs. Operating loss widened to $56.5 from $18.7.
- Share-based compensation was $166.1 in Q3 and $490.2 for the nine months. The company estimated $1.6 billion of unrecognized compensation cost to be recognized over a weighted-average 2.6 years.
- The company adopted operating-lease accounting in fiscal 2020, recognizing right-of-use assets and lease liabilities. This accounting adoption did not affect reported operations or cash flows.
Outlook, commentary and risks
- Outlook: This 10-Q does not provide a numerical revenue or earnings forecast. Management said it expected subscription and support revenue to increase over the long term as offerings and the installed customer base grow; operating expenses were expected to rise in absolute dollars. It believed cash flow from operations and existing cash and cash equivalents would cover anticipated needs for at least 12 months and thereafter for the foreseeable future.
- COVID-19: The company reported no significant work-operation disruption during Q3 after moving most employees to remote work in March. It warned that customer spending delays, longer sales cycles, requests for extended payment terms, partner and customer credit constraints, and supply-chain disruption could materially affect results; the full impact could not be reasonably estimated. Hiring was slowed, travel restricted and in-person events canceled or moved online.
- Acquisitions: CloudGenix was acquired on April 21, 2020 for $402.7, primarily cash consideration, to strengthen the SASE platform. Aporeto and Zingbox were also acquired during the nine-month period. Preliminary purchase accounting added $460.6 of goodwill from acquisitions; goodwill is not tax-deductible for the CloudGenix acquisition.
- Unusual items and capital allocation: The company recorded a $3.1 gain, net of related fees, from terminating leases at its former headquarters. It paid $1.0 billion under an accelerated share repurchase and initially received 4.2 million shares; final settlement was expected in Q4 FY2020. Separately, $198.1 was spent under the existing repurchase authorization during the nine months.
- Contingencies: The company reported ordinary-course litigation, including intellectual-property matters, but had no significant loss-contingency accrual and had not determined an unfavorable outcome to be probable or reasonably possible. Manufacturing commitments were $124.3; other non-cancelable purchase commitments were $286.7.
- Key risks: Management highlighted COVID-19 and macroeconomic uncertainty, competition, reliance on channel partners and third-party manufacturing, component availability, customer and distributor credit risk, cybersecurity and product defects, acquisition integration, and potential dilution or cash requirements tied to the 2023 notes and equity awards. Disclosure controls were assessed as effective at a reasonable assurance level.
Important facts for investors to verify
- Whether subscription-led growth and deferred revenue convert into recognized revenue while product revenue remains comparatively weak.
- Whether cloud-hosting and support costs stabilize enough to protect subscription and overall gross margins.
- How COVID-19 affects customer purchasing, collections, sales-cycle duration, supply availability and subsequent reported results.
- Final CloudGenix purchase accounting and acquisition integration, including the expected contribution to SASE and future expenses.
- Final share count and settlement of the $1.0 billion accelerated repurchase, and remaining authorization under the separate repurchase program.
- Cash generation and liquidity after repurchases and acquisitions, alongside the $1.693 billion notes due in 2023 and substantial unrecognized share-based compensation.