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Palo Alto Networks (NASDAQ:PANW) Reports Q1 In Line With Expectations, Gross Margin Improves


Full Report / November 17, 2022
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Cybersecurity provider Palo Alto Networks (NASDAQ:PANW) reported results in line with analyst expectations in Q1 FY2023 quarter, with revenue up 25.3% year on year to $1.56 billion. The company expects that next quarter's revenue would be around $1.64 billion, which is the midpoint of the guidance range. That was in roughly line with analyst expectations. Palo Alto Networks made a GAAP profit of $20 million, improving on its loss of $103.6 million, in the same quarter last year.

Palo Alto Networks (PANW) Q1 FY2023 Highlights:

  • Revenue: $1.56 billion vs analyst estimates of $1.55 billion (small beat)
  • EPS (non-GAAP): $0.83 vs analyst estimates of $0.69 (20.3% beat)
  • Revenue guidance for Q2 2023 is $1.64 billion at the midpoint, roughly in line with what analysts were expecting
  • The company reconfirmed revenue guidance for the full year, at $6.88 billion at the midpoint
  • Gross Margin (GAAP): 70.4%, up from 69.4% same quarter last year

Founded in 2005 by a cybersecurity engineer Nir Zuk, Palo Alto Networks makes hardware and software cybersecurity products that protect companies from cyberattacks, breaches and malware threats.

The company started by offering traditional on-premise hardware firewalls and while that is still a big part of their business, it has in the last couple of years been successfully transitioning into offering cloud-based software-as-a-service products.

What makes the software as a service business so attractive is that once the software is developed, it typically shouldn't cost much to provide it as an ongoing service to customers. While the majority of Palo Alto’s revenue these days comes from selling software, a significant part of their business is still manufacturing hardware firewalls, and that type of business has higher costs than pure software.

Almost every company is slowly finding itself becoming a technology company and facing cybersecurity risks. The migration of businesses to the cloud and employees working remotely in insecure environments is increasing demand modern cloud-based network security software, which offers better performance at lower cost than maintaining the traditional on-premise solutions, such as expensive specialized firewall hardware.

Palo Alto is a well known brand in the network security space which includes competitors such as Fortinet (NASDAQ:FTNT), Check Point Software (NASDAQ:CHKP), and Cisco (NASDAQ:CSCO).

Sales Growth

As you can see below, Palo Alto Networks's revenue growth has been strong over the last two years, growing from quarterly revenue of $946 million in Q1 FY2021, to $1.56 billion.

Palo Alto Networks Total Revenue

This quarter, Palo Alto Networks's quarterly revenue was once again up a very solid 25.3% year on year. But the growth did slow down compared to last quarter, as the revenue increased by just $12.9 million in Q1, compared to $163.8 million in Q4 2022. We'd like to see revenue increase by a greater amount each quarter, but a one-off fluctuation is usually not concerning.

Guidance for the next quarter indicates Palo Alto Networks is expecting revenue to grow 24.9% year on year to $1.64 billion, slowing down from the 29.5% year-over-year increase in revenue the company had recorded in the same quarter last year. Ahead of the earnings results the analysts covering the company were estimating sales to grow 24.4% over the next twelve months.

Profitability

What makes the software as a service business so attractive is that once the software is developed, it typically shouldn't cost much to provide it as an ongoing service to customers. Palo Alto Networks's gross profit margin, an important metric measuring how much money there is left after paying for servers, licenses, technical support and other necessary running expenses was at 70.4% in Q1.

Palo Alto Networks Gross Margin (GAAP)

That means that for every $1 in revenue the company had $0.70 left to spend on developing new products, marketing & sales and the general administrative overhead. Significantly up from the last quarter, this is around the lower average of what we typically see in SaaS businesses. Gross margin has a major impact on a company’s ability to invest in developing new products and sales & marketing, which may ultimately determine the winner in a competitive market so it is important to track.

Key Takeaways from Palo Alto Networks's Q1 Results

With a market capitalization of $47.7 billion, more than $3.8 billion in cash and with free cash flow over the last twelve months being positive, the company is in a very strong position to invest in growth.

We enjoyed seeing Palo Alto Networks’s improve their gross margin materially this quarter. And we were also glad to still see good revenue growth. On the other hand, revenue growth has been slowing down a little and guidance is conservative. Zooming out, we think this was still a decent quarter, showing the company is staying on target. The company is flat on the results and currently trades at $155.98 per share.

Is Now The Time?

When considering Palo Alto Networks, investors should take into account its valuation and business qualities, as well as what happened in the latest quarter. Although we have other favorites, we understand the arguments that Palo Alto Networks is not a bad business. We would expect growth rates to moderate from here, but its revenue growth has been solid, over the last two years. And while its gross margins aren't as good as other tech businesses we look at, the good news is its bountiful generation of free cash flow empowers it to invest in growth initiatives.

The market is certainly expecting long term growth from Palo Alto Networks given its price to sales ratio based on the next twelve months is 7.3x. We don't really see a big opportunity in the stock at the moment, but in the end beauty is in the eye of the beholder. And if you like the company, it seems that Palo Alto Networks doesn't trade at a completely unreasonable price point.

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