Palo Alto Networks, Inc. — Q3 FY2021 Form 10-Q
Reporting period: Three and nine months ended April 30, 2021. Figures are unaudited and in U.S. dollars; financial statement amounts are in millions unless otherwise noted.
Business context and performance
Palo Alto Networks provides cybersecurity products, subscriptions and support to enterprise, service-provider and government customers. Its offerings span network security, cloud security, security analytics and automation, and threat intelligence and consulting. Subscription and support represented 73.1% of Q3 revenue, continuing the shift toward recurring offerings.
Key financial metrics
| Metric | Q3 FY2021 | Q3 FY2020 | Nine months FY2021 | Nine months FY2020 |
|---|---|---|---|---|
| Revenue | $1,073.9 | $869.4 | $3,036.8 | $2,458.0 |
| Gross profit / margin | $743.3 / 69.2% | $611.1 / 70.3% | $2,120.8 / 69.8% | $1,748.9 / 71.2% |
| Operating loss / margin | $(110.4) / (10.3)% | $(56.5) / (6.5)% | $(243.7) / (8.0)% | $(161.2) / (6.6)% |
| Net loss | $(145.1) | $(74.8) | $(379.6) | $(208.1) |
| Basic and diluted loss per share | $(1.50) | $(0.77) | $(3.95) | $(2.14) |
- Revenue mix and growth: Q3 product revenue was $288.9, up 2.8%; subscription and support revenue was $785.0, up 33.4%. Nine-month subscription and support revenue increased 32.7% to $2,255.9. Q3 total revenue grew 23.5% year over year.
- Operating costs: Q3 operating expenses increased to $853.7 from $667.6, including R&D of $311.0, sales and marketing of $448.0, and G&A of $94.7. Nine-month share-based compensation expense was $696.9, versus $490.2 in the prior-year period.
- Cash generation: For the first nine months, operating cash flow was $1,177.2, compared with $702.0; company-defined non-GAAP free cash flow was $1,088.6, compared with $519.4. Capital purchases of property, equipment and other assets were $88.6.
- Billings and contracted revenue: Nine-month billings were $3,583.9, up 23.1%. Deferred revenue was $4,375.0 at April 30, 2021, versus $3,810.2 at July 31, 2020. Remaining performance obligations were $4.9 billion, with about $2.6 billion expected to be recognized within 12 months.
- Liquidity and debt: Cash, cash equivalents and investments totaled $3,830.8, down from $4,302.2 at July 31, 2020; working capital was $1,133.6. Convertible notes had $3,693.0 aggregate principal and a $3,190.6 net carrying value. The $400.0 million revolving facility was undrawn; the company reported covenant compliance.
- Cash deployment: Nine-month investing cash outflow was $1,478.2, including $777.3 of net cash paid for acquisitions. Financing cash outflow was $768.4, including $850.0 of share repurchases.
Material changes versus comparable periods
- Q3 revenue grew 23.5%, led by subscription and support; product revenue growth was modest at 2.8%.
- Q3 gross margin fell 1.1 percentage points to 69.2%; nine-month gross margin fell 1.4 points to 69.8%. Management cited product mix, higher fulfillment and intellectual-property amortization costs, and cloud-service costs in the respective periods.
- Operating loss widened to $110.4 in Q3 and $243.7 for nine months, as operating expenses grew faster than revenue. R&D expense rose 58.4% in Q3, primarily reflecting personnel costs and headcount growth.
- Interest expense more than doubled in both reported comparisons, primarily due to the 2025 convertible notes issued in June 2020. Other income declined, largely because of lower interest income.
- Cash from operations improved year over year, while cash and investments declined from fiscal year-end, reflecting acquisition spending, investment activity and repurchases. Goodwill rose to $2,713.1, largely following acquisitions.
Outlook, risks and unusual items
- The filing provides no specific numerical revenue or earnings guidance. Management expects operating expenses generally to increase in absolute dollars and states that gross margins may fluctuate. It expects subscription and support revenue to rise over the long term as offerings and the installed customer base expand.
- Management said existing cash flows, cash and cash equivalents should cover anticipated needs for at least the next 12 months and thereafter for the foreseeable future. Future capital needs remain dependent on growth, product development, cloud infrastructure, acquisitions and other factors.
- COVID-19 continued to create uncertainty around customer spending, sales-cycle length, collections, employee operations and supply chains. The company also cited semiconductor and component availability, manufacturing concentration, logistics costs and forecast risk.
- Four acquisitions were completed during the nine-month period: Crypsis, Sinefa, Expanse and Bridgecrew. Aggregate consideration disclosed for these transactions was approximately $1.2 billion; purchase-price allocations were preliminary. Acquisitions increased goodwill and intangible assets, and acquisition-related accelerated vesting contributed $32.4 of nine-month share-based compensation expense.
- Unrecognized compensation cost on unvested awards was $2.0 billion, expected to be recognized over a weighted-average period of about 2.7 years. This is a significant future expense commitment, excluding future grants.
- Manufacturing purchase commitments totaled $317.5 and other non-cancelable purchase commitments totaled $1,504.8 as of April 30, 2021. The company reported no significant litigation accruals and said it had not determined an unfavorable legal outcome to be probable or reasonably possible with a reasonably estimable loss.
- Other material risks include distributor concentration (three distributors accounted for 56.4% of nine-month revenue), intense competition, cybersecurity incidents, foreign-exchange exposure, acquisition integration, convertible-note repayment or conversion obligations, and the company’s history of GAAP losses.
Important facts for investors to verify
- Whether subscription and support growth, billings and remaining performance obligations translate into sustained recognized revenue and renewal performance.
- Whether gross-margin pressure and rapid operating-expense growth moderate, and how much reported losses reflect ongoing share-based compensation and acquisition-related costs.
- Cash and investment balances after acquisitions and repurchases, the timing and funding of the 2023 and 2025 notes, and potential dilution or cash settlement upon conversion.
- Progress integrating recent acquisitions and whether preliminary purchase-price allocations, goodwill and acquired intangibles remain supportable.
- Developments in COVID-19-related customer demand, semiconductor and component supply, distributor credit exposure and manufacturing commitments.