Palo Alto Networks, Inc. — Q2 FY2022 Form 10-Q
Reporting period: Three and six months ended January 31, 2022. Unless otherwise noted, amounts are in millions of dollars. Financial statements are unaudited and prepared under U.S. GAAP.
Business context and performance
Palo Alto Networks provides cybersecurity products and services, including network security, cloud security, SASE, security analytics and consulting. Subscription and support revenue accounted for 76.6% of Q2 revenue. Management attributed growth to increased demand and adoption across its portfolio.
| Metric | Q2 FY2022 | Q2 FY2021 | Six months FY2022 | Six months FY2021 |
|---|---|---|---|---|
| Revenue | $1,316.9 | $1,016.9 | $2,564.3 | $1,962.9 |
| Revenue growth, year over year | 29.5% | 24.5% | 30.6% | 23.6% |
| Product revenue | $308.0 | $254.7 | $603.5 | $492.0 |
| Subscription and support revenue | $1,008.9 | $762.2 | $1,960.8 | $1,470.9 |
| Gross margin | 69.2% | 69.8% | 69.4% | 70.2% |
| Operating loss | $(73.9) | $(88.8) | $(156.6) | $(133.3) |
| Net loss | $(93.5) | $(142.3) | $(197.1) | $(234.5) |
| Net loss per share, diluted | $(0.95) | $(1.48) | $(2.01) | $(2.45) |
Cash flow, liquidity and debt
- For the six months, operating cash flow was $1,071.5, compared with $899.4 a year earlier. Non-GAAP free cash flow was $956.2, versus $837.7.
- Cash, cash equivalents and investments totaled $4,191.3 at January 31, 2022, up from $3,789.4 at July 31, 2021. Cash and cash equivalents alone were $1,922.7.
- Working capital was negative $2,537.8, versus negative $469.4 at July 31, 2021. The company attributed the change principally to classifying convertible notes as current liabilities.
- Convertible notes had a $3,692.0 million principal balance, with a $3,673.9 net carrying amount, classified as current. Holders could convert during the quarter ending April 30, 2022; if all converted, the company would owe $3.7 billion in cash principal. Management said available cash, investments, operating cash flow and financing sources would be sufficient to meet anticipated needs.
- The $400 million revolving credit facility had no borrowings outstanding. Total deferred revenue was $5,449.2, compared with $5,024.0 at July 31, 2021. Remaining performance obligations were $6.3 billion, with approximately $3.4 billion expected to be recognized within 12 months.
Material changes and unusual items
- Q2 revenue rose 29.5% year over year; subscription and support revenue grew 32.4%, while product revenue grew 20.9%. Billings increased 32.4% to $1,607.9 in Q2 and 30.1% to $2,989.5 for the six months.
- Gross margin declined 0.6 percentage points in Q2 and 0.8 points for the six-month period. Management cited product mix and higher product costs, particularly supply-chain-related costs; subscription and support gross margin was broadly flat.
- Operating expenses rose 23.5% in Q2 and 28.1% for the six months, including growth in research and development and sales and marketing. Share-based compensation was $265.1 in Q2 and $525.4 for the six months.
- Interest expense fell to $6.8 in Q2 and $13.7 for the six months, from $40.7 and $80.9, respectively. The decrease primarily reflects adoption of new convertible-debt accounting guidance, which eliminated separate amortization of the debt discount; prior periods were not adjusted.
- The company repurchased $550.0 of stock, or approximately 1.0 million shares, during the six months. $450.0 remained authorized for repurchase at period end.
- In August 2021, the company acquired Gamma Networks for total consideration of $20.4, primarily cash; $21.2 of goodwill was recorded. It also purchased adjacent Santa Clara property for $39.5 during the six months.
Outlook, risks and contingencies
The filing provides no specific numerical revenue or earnings guidance. Management expects operating expenses to generally increase in absolute dollars, while potentially declining as a percentage of revenue over the long term. It expects subscription and support revenue to increase over time, with quarterly variation. Management stated that operating cash flow and existing liquidity should meet anticipated cash needs for at least the next 12 months and the foreseeable future.
- Management reported increasing semiconductor and component shortages, delivery delays, and higher product, freight and shipping costs. These pressures could affect product availability, revenue timing and gross margin.
- COVID-19 and broader economic uncertainty could affect customer spending, sales cycles, collections, suppliers and channel partners. The full financial impact was not reasonably estimable in the filing.
- Three distributors represented 54.4% of revenue for the six months; four distributors represented 53.9% of gross accounts receivable at January 31, 2022.
- Non-cancelable purchase commitments totaled approximately $2.6 billion, including manufacturing and service-provider commitments. Operating lease obligations were $344.5.
- The company reported ordinary-course litigation but no significant accrual for legal loss contingencies, and had not determined that an unfavorable outcome was probable or reasonably possible or that a possible loss could be reasonably estimated.
- The 2023 and 2025 notes’ conversion status creates a substantial near-term cash settlement exposure. The filing also identifies risks from competition, cybersecurity incidents, supply-chain concentration, customer credit, privacy regulation and the company’s history of GAAP losses.
Most important facts for investors to verify
- Whether noteholders converted any 2023 or 2025 notes during the period through April 30, 2022, and the resulting cash settlement and share effects.
- Whether supply constraints, component costs and product delivery lead times improved or continued to weigh on product margins and sales.
- Whether revenue growth, billings and deferred revenue continued to develop in subsequent quarters, including the durability of subscription and support demand.
- How operating expenses and share-based compensation affect progress toward profitability and cash generation.
- Whether distributor concentration, purchase commitments and customer financing create material changes in collection, liquidity or supply risk.