Palo Alto deserves more credit for quarterly results only a year into its new strategy

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Club stock Palo Alto Networks dropped Thursday evening on a strong quarter and a solid full-year outlook that were not good enough to satisfy investors’ lofty expectations. Revenue for the cybersecurity company’s fiscal 2025 second quarter increased 14% year over year to $2.26 billion, exceeding the LSEG-complied Wall Street consensus estimate of $2.24 billion. Adjusted earnings per share (EPS) increased 11% to 81 cents in the three months ended Jan. 31, ahead of the 78-cent LSEG consensus estimate. Palo Alto Networks Why we own it: We believe cybersecurity is a secular growth market as bad actors are relentless and companies simply cannot afford to not invest in defense. It is a never-ending arms race. We believe Palo Alto Networks, in particular, is uniquely positioned to win due to its best-in-class tools and a broad product portfolio that allows it to provide an all-encompassing “platform” solution to cybersecurity. Competitors : CrowdStrike (also a Club stock), Fortinet , Cisco Systems Last buy : Aug. 2, 2024 Initiation : Feb. 15, 2023 Bottom line It’s been one year since Palo Alto Networks first announced its plan to accelerate the concept of platformization, which essentially is the consolidation of different products and services into a single platform, and the results show it has gained some steam and has started to scale, creating efficiencies from a sales perspective. The company had 75 net new platform clients in this year’s second quarter, up from 45 in Q2 in fiscal 2024. Palo Alto now has 1,150 platformizations, up from about 1,150 in the first quarter. Management continues to believe they’re on track to hit their target of 2,500 to 3,500 by fiscal year 2030. Palo Alto is pushing platformization because it means customers are using more of its products and services, leading to bigger deals and higher annual recurring revenue per customer. One of the big wins in the quarter was a $68 million deal with a bank in Asia that consolidated with Palo Alto for the first time. Another highlight was a $61 million transaction with a U.S. municipality. The deal included the renewal of its network security estate and expansion across Palo Alto’s portfolio. A third big win was a $25 million deal with an auto manufacturer. This customer had already converted to the platform in network and cloud security and made additional purchases across the company’s offerings. In total, Palo Alto Networks had 74 accounts add transactions of over $5 million each. That’s up 25% year over year. Additionally, 32 accounts had transactions over $10 million each, which was up 52% year over year. Another case for this umbrella strategy is better security outcomes. During the conference call, CEO Nikesh Arora shared the findings of a recent study the company did with IBM. It showed that platformed organizations take 72 fewer days to detect an incident and four fewer days to contain a security incident. Arora was also upbeat about the outlook for cybersecurity spending for the rest of the year, anticipating “reasonable growth.” He also sees advancements in creating tailwinds. “As the conversation around AI continues to get omnipresent and companies race to evaluate, experiment and deploy AI, they’re discovering that some of the legacy architectures come in the way of their aspirations” he explained. “Interestingly, this is resulting in a resurgence of cloud transformation projects and consequently, demand for network security and network transformation.” “Whilst cyber security is a derivative effect,” he continued, “it is clear that the longer-term trend towards AI is going to continue to underpin technology transformations that hence continue to drive demand for security.” So, why is the stock dropping more than 5.5% in after-hours trading? The consensus estimates for quarterly Palo Alto revenue and EPS at some other data providers, including Bloomberg, were higher, which may be adding to volatility. For our comparisons, however, we’re sticking with LSEG and FactSet since those are the ones we use for every earnings report. You could also ding the company for an in-line fiscal 2025 third-quarter guide and no material increase in the full-year outlook. PANW 1Y mountain Palo Alto Networks 1 year Still, this was a pretty good quarter. Palo Alto stock ran over the past two weeks alongside other cybersecurity stocks in anticipation of strong earnings, and this move lower represents a repeal of this week’s gains. It’s a little frustrating to see the stock trade back to the low $190s, essentially the same level it hovered around last quarter. But even with this drop, shares were still up more than 5% for the year, outpacing the broader S & P 500. Real progress has been made, but the market may need to see some more evidence that platformization is leading to faster growth to get the stock trending toward our $225 price target. We still think it can get there. We’re reiterating our 2 rating. We believe strongly that hackers are only going to keep getting more capable due to the proliferation of artificial intelligence. For that reason, we own a second cybersecurity stock, CrowdStrike , which is expected to report earnings next month. Commentary Palo Alto Networks has stopped providing billing guidance because management believes it is no longer as relevant in the current high-interest-rate environment, with customers increasingly seeking financing options. Instead, their focus is on growing its remaining performance obligation (RPO) because that metric represents the total value of contracted revenue yet to be delivered. The company’s RPO in its fiscal second quarter was at the high end of prior guidance, increasing about 21% year over year to $13 billion and slightly beating estimates of $12.96 billion. A second metric Palo Alto wants investors to focus on is its next-gen security (NGS) average recurring revenue, or ARR for short. This is another subscription business term that represents the annualized revenue of all active contracts on the final day of the reporting period. NGS ARR includes revenue for Palo Alto’s Prisma, Cortex, QRadar, and certain cloud-delivered security services. This metric increased 37% year over year to $4.78 billion, beating the consensus estimate of $4.73 billion and the high end of prior guidance. The company also pushed back on some of the bearish points against the stock. For example, Arora said on the call that there is a refresh cycle coming at many cybersecurity companies, and he expects to benefit from it. Another investor hesitation is about the pace of U.S. federal spending as President Donald Trump looks at agency budget cuts. CFO Dipak Golechha eased some of these concerns by explaining that the company has “prudent expectations” for the federal market this year, and most of the business is tied to renewals and existing programs with longstanding funding. Guidance For its fiscal 2025 third quarter, here’s what Palo Alto expects. All estimates are sourced from FactSet. Total revenue of $2.26 billion to $2.29 billion, which is in line with the $2.27 billion consensus estimate. Non-GAAP earnings per share (EPS) in the range of $0.76 to $0.77, which is in line with the $0.76 consensus estimate. Remaining Performance Obligation of $13.5 billion to $13.6 billion, which is also pretty much in line with the consensus estimate of $13.55 billion. Next-gen security ARR of $5.03 billion to $5.08 billion, in line with the $5.05 billion consensus estimate. For the full-year fiscal 2025, management expects the following. Total revenue of $9.14 billion to $9.19 billion, reflecting a slight raise from the prior guide of $9.12 billion to $9.17 billion and slightly above the $9.15 billion consensus estimate. Non-GAAP EPS in the range of $3.18 to $3.24, reflecting a solid raise from the prior guide of $3.13 to $3.20 and above the $3.17 billion consensus estimate. RPO in the range of $15.2 billion to $15.3 billion, unchanged from its prior outlook and in line with the $15.24 billion consensus estimate. NGS annual recurring revenue of $5.52 billion to $5.57 billion, unchanged from its prior outlook. Adjusted free cash flow margin of 37% to 38%, unchanged. (Jim Cramer’s Charitable Trust is long PANW, CRWD. See here for a full list of the stocks.) As a subscriber to the CNBC Investing Club with Jim Cramer, you will receive a trade alert before Jim makes a trade. 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Palo Alto Networks headquarters in Santa Clara, California, US, on Monday, Aug. 14, 2023.

David Paul Morris | Bloomberg | Getty Images

Club stock Palo Alto Networks dropped Thursday evening on a strong quarter and a solid full-year outlook that were not good enough to satisfy investors’ lofty expectations.

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Palo Alto deserves more credit for quarterly results only a year into its new strategy

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