Palo Alto Networks delivered a strong quarter, but the stock tumbled in after-hours trading due to a slight shortfall in billings and a disappointing reduction in its full-year outlook due to a change in strategy. The cybersecurity company's second-quarter fiscal 2024 revenue rose 19% year-over-year to $1.98 billion, beating the $1.97 billion consensus estimate prepared by LSEG, formerly known as Refinitiv. Adjusted earnings per share rose 39% to $1.46, beating estimates of $1.30. But total billings rose about 16% from a year ago to $2.35 billion, missing estimates of $2.36 billion and nearing the low end of management's expected range of 2.34 to 2 .39 billion US dollars. Bottom line: These results were not as clear-cut as we described in the previous quarter when the stock fell to $240 as a buy-the-selloff opportunity. But they weren't a complete thesis changer either. While the quarter went well for the most part, with margins and cash flow improving significantly, the problem lay with billings for the second quarter in a row. Last time we heard that the reduction in billings was due to the high cost of money, which was pushing customers into shorter term contracts and leading to more financing. This time we heard about a short-term weakness in a particular industry and a short-term change in strategy. In the short term, management pointed to a slowdown in the US federal government market. The company said it has several large projects in the pipeline but has not completed them. This trend began toward the end of the company's first fiscal quarter, increased in the second quarter and is expected to continue into the second half of the fiscal year. In the short term, CEO Nikesh Arora spent a lot of time on the conference call discussing accelerating its “platformization” and consolidation strategies. “Customers have adopted platforms in other markets across technologies,” explained Arora, using Salesforce, ServiceNow and Workday as examples. “This will inevitably happen in cybersecurity,” he added. “These industry trends create conditions that favor leaders who can drive consolidation. We want to meet this challenge.” Remember, the old way of doing things was for companies to shop around and select individual product providers à la carte. But the industry has changed in recent years because the old way was too inefficient. To achieve better security outcomes and increase value, customers focus their budgets on vendors that offer a broad range of solutions. Palo Alto Networks is at the forefront of this trend as it is the best of its kind in 21 categories. However, every transition has financial implications in advance. Essentially, a typical customer who completes a platformization transaction does not pay for the technology for a while as the company proves the benefits. As additional platformization programs begin over the next year, the company expects billing and revenue growth to be impacted over the next 12 to 18 months. It's a short-term pain as the company looks to crush the competition. As customers enter a period with contracts that include full billing and revenue contribution, the company's revenue metrics will accelerate. Consider it a short-term dip due to investments that will lead to an acceleration that management believes will result in higher growth rates for longer, more stable customer relationships that will help the company achieve its goal of $15 billion in next-generation security will bring closer in 2030. It's hard to argue against what Arora is doing because he has built this company into the market leader it is today with the most comprehensive range of solutions. We have little doubt that he will not be able to do this in the future. For him, it makes perfect sense to change the approach to accelerate the consolidation trend and weed out “unfaithful” competitors that have been too aggressive with discounting. “We have found that we have a higher win rate on platform deals, we have a higher win rate on consolidation plays as opposed to best-of-breed front-ons, which end up taking more time and energy,” Arora further explained Call. Arora reiterated in a “Mad Money” interview with Jim Cramer on Tuesday night: “There is no abyss in cybersecurity. “I think this is a reshaping of our demand curve so we can grow faster in the longer term.” It's important to take a step back and recognize that the factors surrounding Tuesday night's forecast have little to do with the overall demand that the statement said management remains healthy. It's hard to argue against that. The threat environment has never been more challenging as malicious actors become increasingly sophisticated. Rising geopolitical tensions have increased the pace of attacks. The Securities and Exchange Commission's (SEC) new rules for disclosing cybersecurity incidents have raised awareness of how devastating a breach can be. So where do we get to? Typically, you want to sell a stock when a company is talking about starting an investment year or transitioning its business model. These tend to have a negative impact on the figures and leave little room for positive corrections in the next few quarters. There is also the possibility of execution risk if the business model changes take effect. That's why Palo Alto sellers were out in full force Tuesday night, sending shares down 20% in after-hours trading. In fact, it's a return of most of the stock's year-to-date gains. The shares more than doubled in 2023. PANW 1Y Mountain Palo Alto Networks 1 Year However, we will not attempt to get in and out of Palo Alto. The change in platformization causes some short-term pain, but if Arora is right about the change – and we see no reason to doubt him – it will result in a faster-growing company that can make a lot more money than we thought it could could. That's why we're looking at the 20% post-earnings selloff from an opportunistic perspective and upgrading the stock back to our Buy equivalent of 1 for this leader in a secular growth industry. “Sometimes you have to consolidate to double down from there. I’m not worried about the stock price,” Arora told Jim. “Let's go back to basics: Our business is strong, demand is strong.” Forecast For the third quarter of fiscal 2024, the company expects: Total billings in the range of $2.3 billion to $2.35 billion, a big miss versus the estimates of $2.62 billion. Total sales are between 1.95 and 1.98 billion US dollars, estimates of around 2 billion US dollars are missing. Non-GAAP earnings per share are expected to be between $1.24 and $1.26, below consensus estimates of $1.29. For full-year 2024, management expects: total billings in the range of $10.1 billion to $10.2 billion, a cut from the previous guidance of $10.7 billion to $10.8 billion and below the consensus of $10 .74 billion US dollars. This is the second quarter in a row that management has lowered its billings guidance for the year. Total revenue is $7.95 billion to $8 billion, down slightly from previous guidance of $8.15 billion to $8.2 billion. The consensus was $8.19 billion. Non-GAAP earnings per share are expected in the range of $5.45 to $5.55, a slight increase from the previous forecast of $5.40 to $5.53. But at its midpoint of $5.50, it was below the consensus of $5.52. Adjusted free cash flow margin of 38% to 39%, an improvement from previous guidance of 37% to 38%. 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Nikesh Arora, Palo Alto Networks
Adam Galica | CNBC
Palo Alto Networks delivered a strong quarter, but the stock tumbled in after-hours trading due to a slight shortfall in billings and a disappointing reduction in its full-year outlook due to a change in strategy.