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Why Did Investors Shrug Off Palo Alto Networks' Impressive Quarter?

Danny Vena, The Motley Fool

Going into its quarterly financial report, Palo Alto Networks (NYSE: PANW) had been on an impressive run. The company's stock price has surged, driven by four consecutive quarters of better-than-expected results and rising demand for its flagship cybersecurity solutions. This had investors hoping that the company could add to its string of recent wins.

The company delivered solid results once again, as Palo Alto reported both top and bottom-line growth that exceeded its own forecasts as well as analyst expectations.

A padlock overlaid with illuminated images of computer circuits.

Image source: Getty Images.

Palo Alto Networks results: The raw numbers

Metric

Q3 2018

Q3 2017

Year-Over-Year Change

Revenue

$567.1 million

$431.8 million

31%

Operating income (loss)

($51.6 million)

($49.1 million)

N/A

Net income (loss)

($46.7 million)

($60.9 million)

N/A

Diluted earnings (loss) per share

($0.41)

($0.28)

N/A

Data source: Palo Alto Networks third-quarter 2018 financial release. Chart by author.

What happened at Palo Alto Networks this quarter?

For the just-completed third quarter, Palo Alto's reported revenue blew past the high end of its own forecast of $548 million, as well as analysts' consensus estimates of $546 million. Product revenue increased 31% year over year to $215 million, well above management forecasts for growth between 18% and 19%. Subscription and support revenue were up an impressive 32% year over year, too.

This led to adjusted net income of $95.1 million and adjusted earnings per share of $0.99, again topping both Wall Street and management guidance.

The results were broad-based, with revenue in the Americas up 29%. Sales in Europe, the Middle East, and Africa (EMEA) increased 35%, and Asia-Pacific revenue jumped 37%. The company reported billings that grew 33% to $721 million, and deferred revenue that climbed to $2.2 billion, up 34% year over year.

Palo Alto continued to build up its impressive list of client gains, adding about 3,000 customers during the quarter, increasing the running total to 51,000. The company also made progress with existing accounts -- its top 25 customers increased their lifetime spending by $28.7 million during the quarter, up 43% year over year.

And Palo Alto Networks recently welcomed Nikesh Arora as the new chairman and CEO. Arora previously served as chief business officer at Google and as president of SoftBank.

Current CEO Mark McLaughlin said: "We delivered strong fiscal third-quarter results with record revenue, deferred revenue and billings, while continuing to capture market share at rates that far outpace the competition. Our security operating platform utilizes software, the cloud, and analytics to deliver increasingly better prevention through automation and ecosystem leverage, while dramatically reducing the complexity of the consumption model for customers."

Looking ahead

For the upcoming fourth quarter, Palo Alto is expecting revenue in a range of $625 million to $635 million, which would represent year-over-year growth between 23% and 25%. The company also expects adjusted earnings per share in a range of $1.15 to $1.17, which would be an increase of between 25% and 27% compared to the same period last year.

So why did investors initially shrug off the respectable growth? At the time of the report, the stock was already up over 40% year to date, stretching the company's valuation. The stock sports a price-to-sales ratio of nearly 9x, when 2x or less would be considered "good". Then, there's the transition to a new CEO that introduces a level of uncertainty about the future -- and the market loathes uncertainty.

While these issues certainly bear watching, I think the results speak for themselves, and Palo Alto stock is a keeper.

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Suzanne Frey, an executive at Alphabet, is a member of The Motley Fool's board of directors. Danny Vena owns shares of Alphabet (A shares). The Motley Fool owns shares of and recommends Alphabet (A shares) and Alphabet (C shares). The Motley Fool recommends Palo Alto Networks. The Motley Fool has a disclosure policy.