Palo Alto Networks, Inc. — Q3 FY2022 Form 10-Q
Reporting period: Three and nine months ended April 30, 2022. Amounts are in U.S. dollars; financial statement figures are in millions unless stated otherwise. The statements are unaudited.
Business context and performance
Palo Alto Networks provides cybersecurity products and services spanning network security, SASE, cloud security, security analytics and automation, and threat intelligence and consulting. Revenue is generated from products and subscription and support offerings; the latter are generally recognized over one-to-five-year contract terms.
Q3 revenue increased 29.1% year over year to $1,386.7 million. Subscription and support represented 74.7% of Q3 revenue, up 31.9%; product revenue rose 21.7%. For the first nine months, revenue grew 30.1% to $3,951.0 million.
Key financial metrics
| Metric | Q3 FY2022 | Q3 FY2021 | Nine months FY2022 | Nine months FY2021 |
|---|---|---|---|---|
| Revenue | $1,386.7 | $1,073.9 | $3,951.0 | $3,036.8 |
| Gross profit / margin | $946.2 / 68.2% | $743.3 / 69.2% | $2,724.6 / 69.0% | $2,120.8 / 69.8% |
| Operating loss / margin | $(47.6) / (3.4)% | $(110.4) / (10.3)% | $(204.2) / (5.2)% | $(243.7) / (8.0)% |
| Net loss | $(73.2) | $(145.1) | $(270.3) | $(379.6) |
| Diluted net loss per share | $(0.74) | $(1.50) | $(2.75) | $(3.95) |
| Billings | $1,796.9 | $1,286.4 | $4,786.4 | $3,583.9 |
For the nine months, cash provided by operating activities was $1,461.0 million, compared with $1,177.2 million; non-GAAP free cash flow was $1,307.4 million, compared with $1,088.6 million. Cash, cash equivalents and investments totaled $4,589.3 million at April 30, 2022, versus $3,789.4 million at July 31, 2021. Working capital was negative $1,979.6 million, largely because $3,675.7 million of convertible notes was classified as current.
Total assets were $11,100.0 million and stockholders’ equity was $337.6 million at April 30, 2022. The company had $3,692.0 million principal amount of unsecured convertible notes outstanding: $1.692 billion due in 2023 and $2.0 billion due in 2025. No borrowings were outstanding under its $400 million revolving credit facility.
Changes versus comparable periods
- Q3 revenue growth accelerated to 29.1% from 23.5% a year earlier; nine-month growth was 30.1% versus 23.5%.
- Billings increased 39.7% in Q3 and 33.6% for the nine-month period. Deferred revenue reached $5,859.4 million, up from $5,024.0 million at July 31, 2021.
- Gross margin declined 1.0 percentage point in Q3 and 0.8 point for nine months. Management attributed lower product margin primarily to higher supply-chain-related costs; subscription and support margin improved in Q3 and was relatively flat for nine months.
- Operating losses narrowed, while the company remained GAAP unprofitable. Interest expense fell substantially year over year following adoption of new convertible-debt accounting guidance, which eliminated separate amortization of the conversion-option debt discount. The accounting change affects comparability with prior periods.
- Nine-month operating cash flow increased by $283.8 million, which management attributed primarily to business and billings growth and increased collections, partly offset by higher cash spending.
Outlook, risks and unusual items
- The filing does not provide a clear numerical revenue or earnings outlook. Management expects operating expenses to rise in absolute dollars as it invests in research and development and sales and marketing, while expecting expenses to decline over the long term as a percentage of revenue. Management states that cash flow from operations and existing cash and investments should cover anticipated needs for at least the next 12 months and thereafter for the foreseeable future.
- Remaining performance obligations were $6.9 billion at April 30, 2022; approximately $3.6 billion was expected to be recognized over the next 12 months.
- Both note series became convertible during the quarter ending July 31, 2022 after the stock-price conversion condition was met. If all holders converted, the company would owe $3.7 billion of principal in cash, with any excess conversion obligation settled in cash and/or shares at the company’s election. Management says available cash, investments, operating cash flow and financing sources should be sufficient, but conversion could materially affect liquidity.
- Supply-chain and semiconductor shortages had delayed some components and deliveries and increased costs, contributing to lower product gross margin. The company also cites COVID-19 and macroeconomic uncertainty, inflation, geopolitical events including Russia’s invasion of Ukraine, longer sales cycles, customer credit risks, competition, and cybersecurity and execution risks.
- Purchase obligations totaled approximately $2.5 billion, including manufacturing and component commitments and commitments for cloud and other services. Operating lease obligations recorded on the balance sheet totaled $337.4 million.
- Share-based compensation was $772.7 million for the nine months and unrecognized compensation cost was $2.0 billion, expected to be recognized over approximately 2.6 years. The company repurchased $550.0 million of shares during the nine months, made no program repurchases in Q3, and had $450.0 million remaining under its authorization.
- The company reported no significant litigation accruals and had not determined that an unfavorable litigation outcome was probable or reasonably possible or that a loss range was reasonably estimable. It acquired Gamma Networks for total consideration of $20.4 million in August 2021.
Important facts for investors to verify
- Whether noteholders convert during the July 31, 2022 quarter and the resulting cash, share issuance and liquidity effects.
- Whether supply constraints ease or worsen, and how component availability, delivery timing and costs affect product revenue and gross margin.
- Whether billings, deferred revenue and remaining performance obligations translate into sustained recognized revenue and cash collections.
- How operating expenses and substantial share-based compensation affect progress toward GAAP profitability and per-share results.
- Exposure to major distributors: three represented 53.9% of nine-month revenue, and four represented 57.1% of gross accounts receivable at April 30, 2022.
- Execution of the company’s $2.5 billion purchase commitments and its ability to meet other debt, lease and capital needs while maintaining liquidity.