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Healthy Growth, but Palo Alto Networks Struggles to Post Profit

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Mar. 11 2016, Updated 12:05 a.m. ET

Palo Alto Networks’ top line growth

Previously in the series, we looked at Palo Alto Networks’ (PANW) recently announced fiscal 2Q16 results. Not only did the company’s revenues exceed analysts’ expectations, but so did its billings growth.

However, on a GAAP (generally accepted accounting principles) basis, Palo Alto Networks continued to post a loss. In fiscal 2Q16, PANW’s net loss stood at $62.5 million compared to $43 million in fiscal 2Q15. On a non-GAAP basis, in fiscal 2Q16, its net income stood at $36.3 million compared to $16.9 million in fiscal 2Q15. Non-GAAP excludes share-based compensation-related charges that increased from $60.6 million in 2Q15 to $106.9 million in 2Q16. The significant increase in share-based compensation charges explains the widening loss in fiscal 2Q16.

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Increasing operating expenses, especially S&M (sales and marketing) expenses as a percentage of revenue, have impacted PANW margins and, consequently, profitability. In fiscal 2Q16, PANW’s S&M expenses stood at 56% of its total revenues. In comparison, Fortinet (FTNT) and Check Point Software Technologies (CHKP) spent about 46% and 22%, respectively, of their revenues on S&M expenses. Jane Wright, a principal analyst at Technology Business Research, said that compared to its peers, PANW allocates far more toward S&M expenses as a percentage of revenues.

In its recent 2Q16 earnings release, the company reduced its fiscal 2016 operating margin guidance to 18%–19% from 22%–25%, primarily due to the expected increase in S&M expenses.

PANW’s cash, debt, and cash flow

In the midst of losses, Palo Alto Networks reported double-digit growth in fiscal 2Q16 cash flows. Its CFO (cash flow from operations) doubled to $153.8 million from $76.9 million in fiscal 2Q15. Its FCF (free cash flow) grew 93% to $136.4 million. In 2Q16, PANW cash and short-term investments stood at $964.6 million, and total debt stood at $497.5 million. Its entire debt is short-term.

Investors wanting to gain exposure to the cybersecurity space might consider investing in the PureFunds ISE Cyber Security ETF (HACK). HACK has a portfolio of 32 stocks made up of companies such as FireEye (FEYE), Qualys (QLYS), and Palo Alto Networks (PANW).

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