Palo Alto Networks, Inc. — Q3 FY2023 Form 10-Q
Reporting period: Fiscal third quarter and nine months ended April 30, 2023; comparisons are with the corresponding 2022 periods unless otherwise noted. Amounts are in U.S. dollars.
Business context and reporting period
Palo Alto Networks provides cybersecurity products and services spanning network security, SASE, cloud security, security operations, and threat intelligence. Subscription and support accounted for 77.4% of Q3 revenue. The company reported results under GAAP; the financial statements are unaudited.
Financial performance and liquidity
| Metric | Q3 FY2023 | Q3 FY2022 | Nine months FY2023 | Nine months FY2022 |
|---|---|---|---|---|
| Total revenue | $1,720.9m | $1,386.7m | $4,939.4m | $3,951.0m |
| Gross profit / margin | $1,246.1m / 72.4% | $946.2m / 68.2% | $3,536.5m / 71.6% | $2,724.6m / 69.0% |
| Operating income (loss) / margin | $78.7m / 4.6% | $(47.6)m / (3.4)% | $133.8m / 2.7% | $(204.2)m / (5.2)% |
| Net income (loss) | $107.8m | $(73.2)m | $212.0m | $(270.3)m |
| Diluted EPS | $0.31 | $(0.25) | $0.63 | $(0.92) |
| Billings | $2,256.2m | $1,796.9m | $6,034.3m | $4,786.4m |
Q3 revenue grew 24.1% year over year: product revenue rose 10.4% to $388.1m, while subscription and support revenue rose 28.7% to $1,332.8m. For the nine months, revenue grew 25.0%, below the prior-year 30.1% growth rate. Q3 billings increased 25.6%; nine-month billings increased 26.1%.
Cash flow: For the nine months, operating cash flow was $2,363.4m, versus $1,461.0m. Non-GAAP free cash flow was $2,254.3m, versus $1,307.4m, calculated as operating cash flow less $109.1m of purchases of property, equipment, and other assets. Investing activities used $2,396.4m, principally reflecting investment purchases and acquisitions; financing activities used $91.5m. Cash, cash equivalents, and restricted cash ended at $2,000.3m.
Liquidity and debt: Cash, cash equivalents, and investments totaled $6,668.0m at April 30, 2023, up from $4,686.4m at July 31, 2022. Working capital was negative $2,227.6m, reflecting in part $3.7bn of convertible notes classified as current liabilities. The $1.7bn 2023 Notes matured July 1, 2023; holders of the $2.0bn 2025 Notes could convert during the quarter ending July 31, 2023, potentially requiring cash repayment of principal. Management stated it expected available cash, operating cash flow, investments, and financing sources to cover these obligations. A new $400m revolving facility, expandable by up to $350m subject to conditions, had no borrowings at quarter-end.
Deferred revenue was $8,089.6m. Remaining performance obligations were $9.2bn, of which approximately $4.5bn was expected to be recognized over the next 12 months. These balances are not equivalent to current-period revenue or guaranteed future sales.
Material changes versus the prior comparable period
- Profitability improved from a GAAP operating and net loss to income in both the quarter and nine-month period.
- Gross margin rose 4.2 percentage points in Q3 and 2.6 points for the nine months. Management attributed improvement to revenue mix, software revenue, easing supply constraints in Q3, and subscription and support growth outpacing related costs.
- Other income, net increased to $60.1m in Q3 and $137.5m for the nine months, largely because of higher interest income from higher rates and investment balances. This contributed materially to the return to GAAP net income.
- Operating expenses continued to rise in dollars, reflecting personnel and investment growth. Q3 share-based compensation was $277.2m; nine-month expense was $833.1m. Unrecognized compensation cost was $2.1bn, expected to be recognized over a weighted-average 2.5 years.
- Operating cash flow improved, with management citing business growth and increased collections, partly offset by payment timing and higher spending. Investment purchases and acquisition spending drove substantially higher investing cash outflow.
Outlook, commentary, risks, and unusual items
- The 10-Q provides no specific numerical revenue or earnings guidance. Management said subscription and support revenue is expected to increase over the long term as offerings and the customer base expand; operating expenses are expected to rise in dollars, while declining over time as a percentage of revenue as the business scales.
- Management reported general improvement in chip and component availability during Q3, but continued higher costs and longer lead times for certain deliveries. It identified macroeconomic uncertainty, inflation, interest rates, foreign exchange, competition, customer spending, supply constraints, and seasonality as potential sources of volatility.
- Purchase commitments totaled approximately $2.0bn, in addition to $327.9m of recorded operating lease obligations. These commitments, along with growth investment and debt payments, are material cash requirements.
- The company completed the Cider Security acquisition for $198.3m of consideration and another acquisition for $18.9m in cash during the period. Goodwill increased by $179.1m.
- The company settled a tax audit with a non-U.S. tax authority for $28.9m during the nine months. Gross uncertain tax positions were $412.1m, with $7.2m of interest and penalties. Management said a valuation-allowance reversal in certain jurisdictions was reasonably possible in the foreseeable future.
- Management reported no significant litigation accruals and did not determine an unfavorable outcome was probable or reasonably possible, or that a possible loss was reasonably estimable. The filing identifies cybersecurity incidents, product defects, reliance on channel partners and suppliers, competition, acquisitions, and privacy and regulatory compliance among key risks.
- A hypothetical 100-basis-point increase in interest rates was estimated to reduce the investment portfolio’s fair value by $42.3m; the filing said the loss would be realized only if investments were sold before maturity.
Important facts for investors to verify
- How the July 2023 maturity of the 2023 Notes and potential conversion of the 2025 Notes were ultimately settled, and the resulting cash and share dilution.
- Whether revenue, billings, deferred revenue, and remaining performance obligations continue to grow, and how much future revenue is recognized from existing obligations.
- Whether gross-margin improvement persists as supply costs, cloud-hosting expenses, and product and subscription mix change.
- The impact of substantial share-based compensation on GAAP profitability, diluted share count, and future dilution.
- Whether customer and distributor credit exposure, purchase commitments, and supply-chain delivery risks change materially.
- Progress integrating acquisitions and the status of uncertain tax positions and any valuation-allowance changes.