Palo Alto Networks, Inc. — FY2020 Form 10-K
Reporting period: Fiscal year ended July 31, 2020. The filing also reports quarterly results; FY2020 fourth-quarter revenue was $950.4 million. All amounts below are in U.S. dollars.
Business context
Palo Alto Networks provides cybersecurity products and subscriptions for network, cloud, and security operations. Its portfolio includes Next-Generation Firewalls, Prisma, and Cortex offerings. The company sells primarily through distributors and resellers; four distributors generated 68.8% of FY2020 revenue. Subscription and support contracts are generally one to five years.
Financial performance and liquidity
| Metric | FY2020 | FY2019 |
|---|---|---|
| Total revenue | $3,408.4 million | $2,899.6 million |
| Product revenue | $1,064.2 million | $1,096.2 million |
| Subscription and support revenue | $2,344.2 million | $1,803.4 million |
| Gross profit / gross margin | $2,408.9 million / 70.7% | $2,091.2 million / 72.1% |
| Operating loss / margin | $179.0 million / (5.3%) | $54.1 million / (1.9%) |
| Net loss | $267.0 million | $81.9 million |
| Operating cash flow | $1,035.7 million | $1,055.6 million |
| Free cash flow (non-GAAP) | $821.3 million | $924.4 million |
| Billings | $4,301.7 million | $3,489.8 million |
Revenue grew 17.5%, versus 27.5% in FY2019. Subscription and support revenue increased 30.0% and reached 68.8% of total revenue; product revenue declined 2.9%. Deferred revenue rose to $3,810.2 million from $2,888.7 million, and remaining performance obligations were $4.3 billion, with about $2.2 billion expected to be recognized within 12 months.
Higher operating expenses—especially research and development, up 42.4%—contributed to the wider operating loss. Subscription and support gross margin fell to 69.9% from 72.7%, reflecting higher cloud-hosting and acquired-intangible amortization costs; product gross margin improved to 72.3% from 71.2%. Share-based compensation was $664.5 million.
At July 31, 2020, cash, cash equivalents, and investments totaled $4,302.2 million, working capital was $2,437.5 million, and total assets were $9,065.4 million. Convertible notes had $3,693.0 million aggregate principal and $3,084.1 million net carrying value; the $400 million revolving facility was undrawn. Management said operating cash flow and existing cash were expected to meet anticipated needs for the foreseeable future.
Changes, transactions, and unusual items
- FY2020 revenue growth slowed from 27.5% to 17.5%, while GAAP net loss widened from $81.9 million to $267.0 million.
- The company issued $2.0 billion of 0.375% convertible notes due 2025 in June 2020. Together with the 0.75% notes due 2023, outstanding note principal was $3.693 billion at year-end.
- Completed acquisitions of CloudGenix for $402.7 million, Aporeto for $144.1 million, and Zingbox for $66.4 million, primarily to expand SASE, cloud-native, and IoT security capabilities.
- Repurchased $1.0 billion of shares through an accelerated repurchase and an additional $198.1 million under the existing program; total FY2020 repurchases were $1,198.1 million.
- Adopted lease accounting, recording operating lease right-of-use assets and liabilities. A $25 million fee was payable following termination of former headquarters leases; the company recorded a $3.1 million net gain related to the termination in FY2020.
FY2020 fourth-quarter revenue was $950.4 million, compared with $805.8 million in the prior-year quarter. Fourth-quarter net loss was $58.9 million, versus $20.8 million.
Outlook, risks, and contingencies
The filing provides no specific quantitative revenue or earnings guidance. Management expected to continue investing in research and development, sales, and international expansion; it also anticipated higher operating expenses in absolute dollars. A definitive agreement to acquire The Crypsis Group for $265 million in cash, subject to adjustments and closing conditions, was signed in August 2020 and was expected to close in FY2021 Q1.
Management said COVID-19 had not significantly disrupted FY2020 operations, but warned that it could reduce customer spending, delay purchases, lengthen sales cycles, extend payment terms, increase credit risk, and disrupt suppliers and logistics. Other notable risks include intense competition, dependence on channel partners and a concentrated distributor base, reliance on manufacturing and component suppliers, execution and integration of acquisitions, cybersecurity incidents, privacy regulation, and continued GAAP losses. The company reported no significant legal accruals and no probable or reasonably estimable material loss from disclosed litigation. The auditor issued unqualified opinions on the financial statements and internal control over financial reporting.
Most important facts for investors to verify
- Whether subscription growth, renewals, and deferred revenue convert into sustained revenue and cash flow, particularly amid COVID-19 uncertainty.
- Drivers of the lower overall gross margin and materially wider operating and net losses, including cloud-hosting costs, acquisition amortization, and share-based compensation.
- Debt repayment and potential dilution terms for the 2023 and 2025 convertible notes, and the impact of outstanding warrants and note hedges.
- Distributor concentration and the credit exposure represented by one distributor holding 31.5% of gross accounts receivable.
- Integration and expected returns from recent acquisitions, including the announced Crypsis transaction, and execution of planned investment and expense levels.
- Cash requirements for repurchases, leases, purchase commitments, and notes; contractual obligations totaled $4,568.2 million, including debt, leases, and purchase obligations.