Palo Alto Networks, Inc. — Q2 FY2021 Form 10-Q
Reporting period: Three and six months ended January 31, 2021. Financial amounts are in millions of U.S. dollars unless stated otherwise.
Business context
Palo Alto Networks sells cybersecurity products, subscriptions and support through channel partners. Its offerings span network security, cloud security and security analytics and operations. The business is increasingly subscription- and support-led: those offerings accounted for 75% of Q2 revenue. The company reported operations in more than 170 countries.
Key financial metrics
| Metric | Q2 FY2021 | Q2 FY2020 | Six months FY2021 | Six months FY2020 |
|---|---|---|---|---|
| Revenue | $1,016.9 | $816.7 | $1,962.9 | $1,588.6 |
| Gross profit / gross margin | $709.3 / 69.8% | $583.6 / 71.5% | $1,377.5 / 70.2% | $1,137.8 / 71.6% |
| Operating loss / margin | $(88.8) / (8.7)% | $(52.9) / (6.5)% | $(133.3) / (6.8)% | $(104.7) / (6.6)% |
| Net loss | $(142.3) | $(73.7) | $(234.5) | $(133.3) |
| Basic and diluted loss per share | $(1.48) | $(0.75) | $(2.45) | $(1.37) |
- Revenue mix and growth: Q2 product revenue was $254.7, up 3.3% year over year; subscription and support revenue was $762.2, up 33.7%. Six-month revenue rose 23.6% year over year. Americas revenue grew 26.8% in Q2, compared with 23.8% in EMEA and 13.6% in APAC.
- Cash flow: Six-month operating cash flow was $899.4, versus $532.1 a year earlier. Non-GAAP free cash flow was $837.7, versus $435.8. Investing used $1,270.6, including investment purchases and acquisitions; financing used $469.9, including $500.0 of share repurchases.
- Liquidity: Cash, cash equivalents and investments totaled $4,028.3 at January 31, 2021, down from $4,302.2 at July 31, 2020. Working capital was negative $100.5, primarily because the 2023 convertible notes were classified as current after becoming convertible during the next quarter.
- Debt: Convertible notes had $3,693.0 aggregate principal and $3,154.7 net carrying value. The $1.7 billion 2023 notes became convertible at holders’ option during the quarter ending April 30, 2021; all notes remained outstanding at January 31. The $400 million revolving facility was undrawn, and the company reported covenant compliance.
- Deferred revenue and obligations: Deferred revenue was $4,162.4, up from $3,810.2 at July 31, 2020. Remaining performance obligations were $4.6 billion, with approximately $2.5 billion expected to be recognized over the next 12 months.
Material changes versus prior comparable periods
- Q2 revenue grew 24.5%, driven primarily by subscription and support, while product revenue growth was modest. Subscription and support’s share of revenue rose from 69.8% to 75.0%.
- Gross margin declined 1.7 percentage points in Q2. Management attributed product margin pressure to inventory reserves and higher intellectual-property amortization, and subscription and support margin pressure to cloud-hosting and other costs supporting growth.
- Operating expenses increased 25.4% in Q2 to $798.1, with R&D up 43.9%; the operating loss widened to $88.8. Higher interest expense, mainly associated with the 2025 notes issued in FY2020, also contributed to the larger net loss.
- Six-month operating cash flow increased by $367.3, which management attributed chiefly to business growth, higher billings and collections, partly offset by payment timing.
- Cash and investments declined despite stronger operating cash generation, reflecting investment purchases, acquisitions and repurchases. The company repurchased 2.1 million shares for $500.0 during the six months; $1.0 billion remained authorized.
Outlook, commentary, risks and unusual items
- Outlook: The filing provides no specific numeric revenue or earnings guidance. Management expects operating expenses to rise in absolute dollars, including continued investment in R&D and sales and marketing. It expects cash from operations and existing liquidity to cover anticipated needs for at least 12 months and the foreseeable future, including potential conversion of the 2023 notes.
- COVID-19: The company reported no significant work-operation disruption in Q2 but warned that the pandemic could constrain customer spending, lengthen sales cycles, delay purchases, affect collections and disrupt suppliers. The full financial impact could not be reasonably estimated.
- Acquisitions: During the six months, Palo Alto Networks acquired Crypsis for $227.7, Sinefa for $27.0 and Expanse for $797.2. Expanse consideration included $434.9 cash and $340.7 stock; preliminary purchase accounting included $601.2 goodwill. In February 2021, the company agreed to acquire Bridgecrew for approximately $200, subject to adjustment, with closing expected in Q3 FY2021.
- Share-based compensation: Q2 expense was $241.1, versus $172.9 a year earlier; six-month expense was $454.0, versus $324.1. The company disclosed $2.1 billion of unrecognized compensation cost expected to be recognized over a weighted-average 2.8 years. Acquisition-related accelerated vesting contributed to expense.
- Commitments and contingencies: Non-cancelable manufacturing purchase commitments were $157.7; other non-cancelable purchase commitments totaled $1,543.6 through FY2026 and thereafter. The company reported no significant litigation accruals and no probable or reasonably possible material litigation loss that it could estimate.
- Principal risks: Risks include competition, reliance on distributors and resellers and on manufacturing partners and limited component sources, cybersecurity and product vulnerabilities, customer and channel credit exposure, acquisition integration, foreign-exchange and regulatory risks, and uncertainty from COVID-19 and broader economic conditions.
Important facts for investors to verify
- Whether subscription and support growth can continue while cloud-hosting and support costs are pressuring gross margin.
- The liquidity and cash-settlement implications if holders convert the 2023 notes during the April 2021 conversion window; verify subsequent filings for the outcome.
- Whether acquisition integration, purchase accounting and continuing share-based compensation affect margins, dilution and cash generation as expected.
- Whether deferred revenue, billings and remaining performance obligations convert into recognized revenue at the pace management anticipates.
- Whether COVID-19, channel concentration, supply constraints or customer credit deterioration materially affect sales, collections or fulfillment.