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Palo Alto Networks, Inc. Delivers a Deceivingly Good Quarter

IMAGE SOURCE: PALO ALTO NETWORKS.

Palo Alto Networks (NYSE: PANW) reported fiscal first-quarter 2017 results Monday after the market close. And though the next-gen security specialist technically beat earnings expectations for the 10th straight quarter, shares plunged more than 12% on Tuesday. Let's take a closer look at what happened.

Palo Alto Networks results: The raw numbers

Metric

Fiscal Q1 2017

Fiscal Q1 2016

Year-Over-Year Change

Revenue

$398.1 million

$297.2 million

34%

Adjusted net income

$51.2 million

$30.8 million

66.2%

Adjusted EPS

$0.55

$0.34

61.8%

DATA SOURCE: PALO ALTO NETWORKS. 

What happened with Palo Alto Networks this quarter?

  • The top line arrived within Palo Alto's guidance (albeit below the midpoint), which called for revenue of $396 million to $402 million. The bottom line was well above guidance for adjusted earnings per share in the range of $0.51 to $0.53.
  • Revenue growth was driven by a 10.9% year-over-year increase in product revenue, to $163.8 million, and 56.7% growth in services revenue, to $234.3 million.
  • Billings grew 33.2% year over year, to $516.9 million.
  • Based on generally accepted accounting principles (GAAP), Palo Alto Networks incurred a net loss of $61.8 million, or $0.69 per diluted share, widened from a GAAP net loss of $39.9 million, or $0.47 per share in last year's fiscal first quarter. Keep in mind in these early stages of its long-term story, the company forsakes bottom-line profitability in favor of investing to pursue top-line growth and taking market share.
  • Palo Alto generated cash flow from operations of $203.3 million (up 39% year over year), and free cash flow of $182.4 million (up 43% year over year).
  • The company signed agreements with multiple service providers in the Asia-Pacific region, including:
    • Singapore Telecommunications Ltd., whose new Managed Advanced Threat Prevention Service uses Palo Alto's Next-Gen Security Platform to protect large enterprise organizations against cyberthreats.
    • M1 Limited, which is offering Palo Alto Networks' Next-Gen Firewall as part of its Cyber Security Solution to enterprise customers.
  • Palo Alto Networks' Traps advanced endpoint protection product received verification that it meets cybersecurity requirements outlined by both Health Insurance Profitability and Accountability Act and the Payment Card Industry Data Security Standard, opening the door for healthcare and financial sector organizations to replace legacy antivirus products with Traps.
  • The company repurchased around 340,000 shares of common stock at a cost of roughly $146 per share, leaving $450 million remaining under its current repurchase authorization.
  • Palo Alto ended October with roughly $2.9 billion in cash, cash equivalents, and investments.

What management had to say

Initially, Palo Alto CEO Mark McLaughlin focused on the success of the company's security platform:

Our first quarter 2017 results underscore that our Next-Generation Security Platform uniquely solves customers' most complex security challenges. Our platform's ability to provide high degrees of prevention, automation, leverage and consistent security, regardless of wherever data may be, is becoming increasingly important in the face of today's important macro technology changes. As a result, customers and prospects globally are adopting our platform at high rates.

During the subsequent conference call, however, McLaughlin acknowledged that the quarter's results "were not as robust as we expected," then elaborated:

We are seeing purchasing decisions have to go through additional approvals, particularly in larger companies on the increasingly larger opportunities we are winning. As a result, we saw some deals push. Our win rates remain as high as ever, a good number of the pushed deals have closed, and we are benefiting long-term as the security provider of choice. In the short-term, we have taken the longer sales cycle into account in our guide.

Looking forward

For the current quarter, Palo Alto Networks expects revenue of $426 million to $432 million, good for approximate year-over-year growth between 27% and 29%. That should translate to adjusted earnings per share of $0.61 to $0.63. It's worth mentioning -- though we don't pay close attention to Wall Street's near-term expectations -- that, in contrast, analysts' consensus estimates predicted fiscal Q2 revenue of $438.9 million, and adjusted earnings per share near the high end of Palo Alto's guidance range.

But considering the root cause of Palo Alto's underwhelming guidance isn't related to competition, but rather a longer approval process for increasingly larger deals as it continues to take market share from those competitors, I think Palo Alto Networks investors have no reason to be worried for the company's position today.

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Steve Symington has no position in any stocks mentioned. The Motley Fool recommends Palo Alto Networks. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.