Palo Alto Networks, Inc. Falls Short on Execution Issues

By Steve Symington Markets Fool.com

Palo Alto Networks(NYSE: PANW)reported mixed fiscal second-quarter 2017 results Tuesday after the market closed, falling short on revenue growth but exceeding expectations on the bottom line. With shares of the next-gen network security specialist down sharply in after-hours trading, it was clear the market wasn't pleased.

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Let's take a closer look, then, at how Palo Alto capped the first half of its fiscal year, and what investors should expect from the company going forward.

Image source: Palo Alto Networks, Inc.

Palo Alto Networks results: The raw numbers

Metric

Fiscal Q2 2017

Fiscal Q2 2016

Year-Over-Year Change

Revenue

$422.6 million

$334.7 million

26.3%

Adjusted net income

$59.6 million

$39.5 million

50.9%

Adjusted EPS

$0.63

$0.43

46.5%

Data source: Palo Alto Networks.

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What happened with Palo Alto Networks this quarter?

  • Adjusted earnings per share came in at the high end of Palo Alto Networks' guidance for EPS of $0.61 to $0.63. But revenue fell below guidance for $426 million to $432 million.
  • Based on generally accepted accounting principles (GAAP), Palo Alto Networks generated a net loss of $60.6 million, or $0.67 per diluted share, compared with a net loss of $57.3 million, or $0.66 per share, in last year's fiscal Q2. Palo Alto consciously forgoes GAAP profitability, as it invests for growth and taking market share in these early stages of its business.
  • Growth was driven by a 54% increase in subscription and support revenue, which was partially offset by a 0.6% decline in product revenue, to $168.8 million.
  • Billings increased 22.4% year over year, to $561.6 million.
  • Cash flow from operations increased 39% year over year, to $214.3 million, and free cash flow rose 24%, to $169.6 million.
  • The company announced a $500 million increase to Palo Alto Networks' existing share-repurchase program, bringing its total authorization to $1 billion. As of the end of January 2017, $330 million remained under the initial $500 million authorization.
  • January ended with roughly $2.1 billion in cash, cash equivalents, and investments.
  • The company acquired automated behavioral analytics company LightCyber for $105 million in cash.
    • Palo Alto will continue offering LightCyber products and support existing customer implementations while it engineers the technology into its own next-gen security platform. After that engineering work's planned completion (by the end of calendar 2017), it will offer LightCyber as a subscription to enhance the platform's automated threat-prevention capabilities.
  • New product launches included:
    • Six new hardware appliances to help customers deploy next-gen security from large data centers to small branches.
    • Three new VM-Series virtualized firewall appliance models, bringing Palo Alto Networks' portfolio to seven models for the series.
    • The first multi-method, scalable, and automated approach to preventing credential-based theft and abuse, including a policy-based multi-factor authentication capability at the network layer.
    • PAN-OS and Panorama 8.0, with over 70 new features.

What management had to say

Palo Alto CEO Mark McLaughlin elaborated:

"While fiscal second quarter revenue of$423 millionwas yet another record for the company, we were disappointed that we came in below top-line expectations due to some execution challenges, which we are moving quickly to address.Our customers rely on us to solve their most difficult cybersecurity challenges, and we have yet again widened the technology gap between our next-generation security platform and the competition with the largest product and features launch in our history, including expansion of our virtual and cloud capabilities. We are also extending our capabilities in data analytics and machine learning with today's announcement of our acquisition of LightCyber.

Looking forward

For the current fiscal third quarter, Palo Alto expects revenue in the range of $406 million to $416 million, good for year-over-year growth of 17% to 20%. Palo Alto also anticipates adjusted net income per share of $0.54 to $0.56, including the effects of a $0.04-per share investment in LightCyber using 93 million to 95 million shares. By comparison -- and though we don't typically pay much attention to Wall Street's demands -- analysts' consensus estimates predicted fiscal third-quarter 2017 revenue of $454.6 million, and adjusted earnings of $0.62 per diluted share.

For additional perspective, last quarter Palo Alto management noted that revenue was held back by longer approval processes for increasingly larger deals the company was winning -- an unconcerning issue, considering the implication that Palo Alto still wasn't losing share to competitors, but rather taking longer to secure those bigger deals. This quarter's execution issues, however, are something on which investors should keep a close eye to ensure the problem doesn't persist in the coming quarters.

In the end, given Palo Alto's lighter-than-expected revenue growth and underwhelming outlook, it's no surprise to see Palo Alto Networks stock pulling back right now.

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Steve Symington has no position in any stocks mentioned. The Motley Fool recommends Palo Alto Networks. The Motley Fool has a disclosure policy.