The most surprising thing about Palo Alto Networks Inc (NYSE:PANW)’s recent results were that the market was surprised by them. In truth it has been a difficult first quarter for technology companies, and despite having defensive characteristics (IT security threats are definitely not going away) its sector hasn’t been oblivious to the difficulties. In summary Palo Alto Networks Inc (NYSE:PANW) missed estimates and guided lower than the market consensus with the usual concerns over Europe and Government coming to the fore.
Palo Alto gives little succor
Probably the most interesting aspect of these results was the timing. Its security rivals like Check Point Software Technologies Ltd. (NASDAQ:CHKP) and Fortinet Inc (NASDAQ:FTNT) had already given weaker than expected results amid talk of customer hesitancy (partly due to sequestration fears) and a faltering macro environment. If this was to prove temporary then we might have hoped that Palo Alto Networks Inc (NYSE:PANW) would report better conditions given that it is already June. Unfortunately it intimated that things got worse in April (the back end of its quarter), and performance in May was only ‘in line’ with its adjusted guidance.
Here is a chart of Palo Alto’s performance.
Note that product revenues saw a sequential decline in the quarter, and while the revenue guidance for Q4 of $106 million to $108 million implies a near 43% rise in revenues (at the mid-point), it is below the market estimates of $113.7 million. On such things do tech stocks soar and crash.
To put this into context, Fortinet Inc (NASDAQ:FTNT) had already warned, and as articulated in an article linked here, it will have to see a bounce back in the second half in order to hit even the lowered guidance. Palo Alto Networks Inc (NYSE:PANW)’s recent statements would not suggest that underlying conditions have improved much so I would suggest taking Fortinet’s word (that Q2 would be similar to Q1) at face value.
In addition Fortinet stated that its service provider revenues were weak in the quarter. This is a similar story to what F5 Networks, Inc. (NASDAQ:FFIV) outlined over its application delivery controller based revenues too. The good news for Palo Alto Networks Inc (NYSE:PANW) is that, although it did see some ‘softness on its service provider based revenues, they do not make up a significant part of its overall revenues.
What caused the miss?
It is really about sequestration effects and Europe, specifically Southern and Central Europe. Palo Alto saw a $3 million-$4 million shortfall in sales from this region. Overall EMEA sales declined 4% on a sequential basis. As for federal work the weakness seen was largely a consequence of sequestration effects. We can also see these effects on federal spending in a detailed look at F5 Networks’ recent results. With regards to F5 Networks, Inc. (NASDAQ:FFIV) specifically, I note that Citrix Systems, Inc. (NASDAQ:CTXS) had a pretty good quarter with its rival product, and since F5 is undergoing a product refresh there may be other factors at play here.
With regards to competition there were a couple of interesting points made in the conference call. Firstly, Palo Alto’s management doesn’t feel that ‘bundling’ will get the job done anymore. I suspect this is a reference to competitors like Cisco Systems, Inc. (NASDAQ:CSCO) or Juniper Networks, Inc. (NYSE:JNPR) who may well try to include security solutions as part of their networking offerings. Indeed, Cisco Systems, Inc. (NASDAQ:CSCO)’s security revenue growth turned negative in the last quarter.
Second, there were the usual references to beating out Check Point Software Technologies Ltd. (NASDAQ:CHKP) and others in the presentation. As a young and fast growing company we should expect Palo Alto to be replacing the installed base of competitors, but in retrospect Check Point Software Technologies Ltd. (NASDAQ:CHKP)’s recent results were relatively good, and there are some signs (average selling prices rising) that it is getting over the hump of convincing its customers to buy its upgraded products.
Where next?
It’s hard to be overly positive because it would have been useful if Palo Alto had reported better conditions in April/May but, the fact is that they did not. With that said the bullish case sees the sequestration effects as causing some short term reactions, much of which will be ironed out later in the year. Sequestration has its most obvious influence on public expenditure, but it will also affect the private sector because the former uses the latter. However, once the fear of the unknown recedes then companies like Palo Alto and Fortinet can hit their revised guidance.
The bearish case argues that these effects will continue to slowdown the IT market as the knock-on effects ripple through the economy and guidance will have to be lowered for many of these companies. Meanwhile the situation in Europe is hardly looking much better with sovereign debt issues remaining at the forefront of concerns.
Since we have never had sequestration before, it is hard to know which approach to take! My gut feeling is that things won’t get much worse. Unemployment is falling in the U.S., and growth is moderate but constant, while the housing market is picking up. F5 Networks has some uncertainty about it and Check Point Software Technologies Ltd. (NASDAQ:CHKP) needs to demonstrate it can get back to product revenue growth. However, if you are going to buy Palo Alto and Fortinet then this could be a decent time to start thinking about picking some of these names up.
Lee Samaha has a position in Fortinet. The Motley Fool recommends Check Point Software Technologies and F5 Networks. The Motley Fool owns shares of Check Point Software Technologies and F5 Networks.
The article Notes From the Latest Tech Crash originally appeared on Fool.com and is written by Lee Samaha.
Lee is a member of The Motley Fool Blog Network — entries represent the personal opinion of the blogger and are not formally edited.
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