Palo Alto Networks, Inc. — Q1 Fiscal 2022 Form 10-Q
Reporting period: Three months ended October 31, 2021, compared with the three months ended October 31, 2020, unless otherwise noted. Amounts are in U.S. dollars; financial statement figures are in millions except per-share data.
Business context
Palo Alto Networks provides cybersecurity products and services spanning network security, secure access service edge, cloud security, security analytics and automation, and threat intelligence and consulting. Its sales are substantially made through distributors and resellers. Subscription and support offerings represented 76.3% of quarterly revenue.
Financial performance
| Metric | Q1 FY2022 | Q1 FY2021 | Change |
|---|---|---|---|
| Total revenue | $1,247.4 | $946.0 | +31.9% |
| Product revenue | $295.5 | $237.3 | +24.5% |
| Subscription and support revenue | $951.9 | $708.7 | +34.3% |
| Gross profit / gross margin | $866.8 / 69.5% | $668.2 / 70.6% | Margin down 1.1 percentage points |
| Operating loss / operating margin | $(82.7) / (6.6)% | $(44.5) / (4.7)% | Loss widened |
| Net loss | $(103.6) | $(92.2) | Loss widened |
| Net loss per share, diluted | $(1.06) | $(0.97) | — |
| Operating cash flow | $588.9 | $534.9 | +$54.0 |
| Free cash flow (non-GAAP) | $554.3 | $505.3 | +$49.0 |
| Billings | $1,381.6 | $1,082.8 | +27.6% |
Operating expenses rose to $949.5 million from $712.7 million, driven largely by hiring and personnel costs in research and development and sales and marketing. Share-based compensation was $260.3 million for the quarter; $2.3 billion of compensation cost for unvested awards remained to be recognized over a weighted-average period of approximately 2.8 years.
Cash, cash equivalents and investments totaled $4.36 billion at October 31, 2021, up from $3.79 billion at July 31, 2021. Cash and cash equivalents alone were $2.27 billion. Working capital was negative $2.31 billion, largely reflecting the classification of convertible notes as current liabilities. The company had $5.16 billion of deferred revenue and $6.0 billion of remaining performance obligations, of which approximately $3.2 billion was expected to be recognized over the next 12 months.
Net cash used in investing activities was $229.9 million, versus $886.2 million used a year earlier, primarily reflecting lower investment purchases and acquisition payments. Financing activities provided $38.7 million, compared with $464.5 million used a year earlier, when the company repurchased $500 million of stock.
Material changes and notable items
- Revenue growth was broad-based: Americas revenue increased 30.0%, EMEA 34.8%, and APAC 38.5% year over year. Subscription and support growth exceeded product growth.
- Gross margin declined, with product margin falling to 69.9% from 73.8%, primarily due to product mix and higher material costs associated with supply constraints. Subscription and support margin was 69.4%, compared with 69.6%.
- The company adopted new convertible-debt accounting guidance effective August 1, 2021. The change eliminated separate equity-component accounting and reduced reported interest expense; quarterly interest expense fell to $6.9 million from $40.2 million, primarily because prior-period debt-discount amortization was no longer recorded under the new method.
- The sale-price condition for the 2023 and 2025 convertible notes was met. Holders could convert during the quarter ending January 31, 2022; the $3.7 billion net carrying amount was consequently classified as current. If all holders converted, the company said it would owe $3.7 billion of principal in cash and believed available cash, investments, operating cash flow and financing sources would be sufficient.
- The company acquired Gamma Networks for total consideration of $20.4 million, primarily in cash, and recorded $22.2 million of goodwill. Gamma is expected to enhance data loss prevention offerings.
- No shares were repurchased during the quarter. $1.0 billion remained available under the $2.4 billion repurchase authorization, which runs through December 31, 2022 and may be suspended or discontinued.
Outlook, risks and contingencies
The filing does not provide specific numerical revenue or earnings guidance. Management said it expects subscription and support revenue to increase over the long term as new offerings are introduced, contracts renewed and the customer base expanded. It also expects operating expenses to rise in absolute dollars as the business scales, while potentially declining as a percentage of revenue over the long term. Management believed operating cash flow and existing cash and investments would cover anticipated needs for at least the next 12 months and the foreseeable future.
Management highlighted semiconductor and component shortages, longer product lead times, increased costs and supply-chain uncertainty. COVID-19 and broader economic uncertainty could also delay customer purchases, extend sales cycles, affect customer and partner credit, and make forecasting more difficult. Other material risks include intense competition, dependence on channel partners and manufacturing partners, customer and distributor concentration, cybersecurity incidents, product defects, and the ability to integrate acquisitions and manage rapid growth.
As of October 31, 2021, purchase commitments totaled approximately $1.9 billion, including manufacturing and component commitments and minimum or fixed commitments for services. Operating lease obligations recorded on the balance sheet totaled $363.9 million. The company had also agreed to buy adjacent land for $38.9 million, with closing expected in the quarter ending January 31, 2022. The filing reported no significant legal-contingency accruals and no litigation loss assessed as probable or reasonably possible and reasonably estimable.
The company reported a $400 million unsecured revolving credit facility with no borrowings outstanding and compliance with its covenants. It also reported an effective disclosure-controls evaluation and no material changes in internal control over financial reporting during the quarter.
Important facts for investors to verify
- Whether holders converted the notes during the January 31, 2022 quarter and how any cash settlement was funded.
- Whether semiconductor shortages, higher material costs and delivery delays persisted, and their effects on product revenue, gross margin and customer demand.
- Whether billings, deferred revenue and remaining performance obligations continued to support reported revenue growth.
- How operating expenses and substantial share-based compensation affected operating leverage and progress toward profitability.
- Whether the company completed the land purchase and met its significant service-provider and manufacturing purchase commitments.
- Any subsequent changes to customer or distributor concentration, litigation exposure, or other contingencies.