Palo Alto Networks, Inc. — Q2 FY2023 Form 10-Q
Reporting period: Three and six months ended January 31, 2023. Amounts are in millions of dollars unless stated otherwise. The filing is unaudited.
Business context
Palo Alto Networks provides cybersecurity products and services across network security, SASE, cloud security, security operations, and threat intelligence and consulting. Subscription and support represented 78.7% of Q2 revenue. The company sells primarily through distributors and resellers.
Financial performance
| Metric | Q2 FY2023 | Q2 FY2022 | Six months FY2023 | Six months FY2022 |
|---|---|---|---|---|
| Revenue | $1,655.1 | $1,316.9 | $3,218.5 | $2,564.3 |
| Gross margin | 71.8% | 69.2% | 71.2% | 69.4% |
| Operating income (loss) | $39.9 | $(73.9) | $55.1 | $(156.6) |
| Net income (loss) | $84.2 | $(93.5) | $104.2 | $(197.1) |
| Diluted EPS | $0.25 | $(0.32) | $0.31 | $(0.67) |
- Q2 revenue grew 25.7% year over year; product revenue grew 14.6% to $352.9, and subscription and support grew 29.1% to $1,302.2. Six-month revenue growth was 25.5%.
- Q2 operating margin was 2.4%, compared with (5.6)% a year earlier. Operating expenses increased 16.6% to $1,149.0; management cites headcount and growth investments.
- Six-month operating cash flow was $1,931.3, versus $1,071.5. Non-GAAP free cash flow was $1,853.4, versus $956.2. Operating cash flow benefited from business growth and increased collections.
- Billings were $2,029.1 for Q2, up 26.2%, and $3,778.1 for six months, up 26.4%. Deferred revenue was $7,554.0 at January 31, up from $6,994.0 at July 31, 2022. Remaining performance obligations were $8.8 billion; about $4.4 billion was expected to be recognized in the next 12 months.
- At January 31, cash, cash equivalents, and investments totaled $6,167.5, compared with $4,686.4 at July 31, 2022. Cash and cash equivalents alone were $1,346.3. Working capital was negative $3,069.3, largely reflecting convertible notes classified as current and deferred revenue.
- Convertible notes had $3,691.3 principal outstanding, with $3,680.3 net carrying value; the $400 million revolving facility was undrawn. The 2023 notes mature July 1, 2023, and the 2025 notes mature June 1, 2025.
Material changes and unusual items
- Results turned profitable under GAAP versus a loss in the comparable periods. Other income was $51.4 in Q2 and $77.4 for six months, primarily reflecting higher interest income ($56.6 and $86.0, respectively); this materially contributed to pretax income.
- Q2 income tax provision was $0.2; the six-month provision was $14.6. The tax rate was affected by R&D expense capitalization and a release of uncertain tax reserves following a $28.9 tax-audit settlement with a non-U.S. authority.
- The company acquired cloud-security company Cider Security in December 2022 for total consideration of $198.3, primarily cash. Preliminary purchase accounting included $164.6 of goodwill and $27.8 of acquired technology.
- The company repurchased $250.0 of stock during the quarter; $750.0 remained authorized at January 31, 2023. Six-month share-based compensation expense was $555.9, and $2.3 billion of unrecognized compensation cost was expected to be recognized over approximately 2.7 years.
Outlook, risks, and contingencies
- The filing provides no specific numerical revenue or earnings guidance in the supplied text. Management says it expects operating expenses generally to increase in dollars and decrease over the long term as a percentage of revenue; margins may vary with product mix, cloud hosting costs, supply costs, and other factors.
- Management believes operating cash flow, existing cash and investments, and financing access will meet anticipated cash needs for the foreseeable future, including potential note conversions. The notes’ conversion conditions were met: holders could convert during the quarter ending April 30, 2023. If all holders converted, the company said it would owe $3.7 billion of principal in cash.
- Key disclosed risks include macroeconomic and geopolitical uncertainty, supply-chain and semiconductor constraints, competition, reliance on channel partners and a small number of distributors, cybersecurity and product vulnerabilities, customer credit exposure, and execution and integration risks from acquisitions. Management reported higher supply-related costs and longer lead times for some products.
- Purchase commitments totaled approximately $2.2 billion, including manufacturing and other non-cancelable commitments; the filing separately notes a $159.6 million minimum service-provider commitment through September 2027. Operating lease obligations recorded on the balance sheet were $336.8 million.
- Management reported no significant accruals for litigation contingencies and no loss outcome assessed as probable or reasonably possible with a reasonably estimable amount. Disclosure controls were considered effective at period end; no material change in internal control was reported.
Important facts for investors to verify
- How the July 2023 maturity and potential conversions of the $3.7 billion notes are settled, and the effect on cash, dilution, and the share count.
- Whether recurring revenue, billings, deferred revenue, and remaining performance obligations continue to grow, and how much converts to recognized revenue and cash.
- How much reported profit and cash generation depends on interest income, working-capital movements, and non-cash share-based compensation.
- Whether supply constraints, cloud hosting costs, and purchase commitments affect product availability, gross margins, or cash needs.
- Distributor concentration: three distributors accounted for 50.6% of six-month revenue and 52.2% of gross receivables.