Palo Alto Networks Inc. (PANW, Financial) disappointed investors in 2016 as the stock was down nearly 29%. Although the stock was off to a good start heading into 2017, it sank over 20% in a single day following weaker-than-expected second-quarter results and weak guidance. The stock, however, has successfully managed to find its way into the green as it is up almost 13% year to date.
Palo Alto reported robust third-quarter results on May 31. For the third quarter, the company posted earnings per share of 61 cents, surpassing the analysts' estimates by six cents. Revenue came in at $431.80 million, again surpassing the consensus by $19.88 million. That figure also represents a surge of 25% year over year.
While the top-line growth did drop again in the third quarter, the 25% surge was far better than the 19% initially guided for in the second quarter. On the other hand, investors should keep in mind Palo Alto is operating in the rapidly growing cybersecurity space, and it might face some problems as it tries to figure out the best business model to benefit from the long-term opportunity.
Furthermore, billings grew 12% year over year to $544 million, and deferred revenue surged 51% to $1.6 billion. Revenues of $432 million were still considerably lower than billings, suggesting higher billings volume could transform into escalating revenues in the coming quarters.
On the other hand, the company also detailed strong guidance for the current quarter with top-line and bottom-line growth in the range of 20% to 23% and 56% to 60%, respectively.
Although Palo Alto reported strong numbers, one significant thing to notice is the company still is not profitable on a GAAP basis. The cybersecurity company’s net earnings have been negative for a while, with no change in the recent quarter.
The company’s non-GAAP earnings and cash flow, however, continues to grow at a healthy rate. In the most recent quarter, operating cash flow was $211 million, representing an increase of 24% year over year. Free cash flow (FCF) surged to over $162 million.
With the increasing non-GAAP earnings and operating cash flow, the company’s capital expenditures are also growing with each passing quarter. In the third quarter, capital expenditures were $48.6 million, an increase from $19.3 million in the same quarter a year ago.
The Internet of Things (IoT) has been gaining more coverage over the past couple of  years. Security remains a major concern for this market. Therefore, Palo Alto formed a cybersecurity alliance with Internatioal Business Machines (IBM, Financial), Nokia (NOK, Financial), AT&T (T, Financial), Symantec (SYMC, Financial) and Trustonic to help customers address IoT cybersecurity challenges and elucidate IoT security.
Conclusion
Although Palo Alto has managed to turn itself around this year, it still faces several risks. First, the company’s revenue growth is slowing down and capital expenditures are increasing. Second, it is still not profitable on a GAAP basis and is not likely to be so anytime soon.
Overall, the company's third quarter was impressive. Despite ongoing challenges, the company continues to grow at a healthy rate. The stock is currently overvalued, but shares could climb sharply again as soon as it returns to hyper-growth mode.
Consequently, investors should continue holding the stock for long-term gains as its future looks good.
Disclosure: I do not hold a position in the stock mentioned in this article.
