Morningstar | Palo Alto Reports Another Record Quarter; Shows Operating Leverage; Maintaining FVE of $217. See Updated Analyst Note from 26 Feb 2019
No-moat Palo Alto Networks' second-quarter revenue of $711 million (30% year-over-year growth) considerably beat consensus expectations of $682 million. Compared with last year, deferred revenue increased by 32% to $2.5 billion. Lower than expected sales and marketing and G&A costs resulted in slightly positive GAAP operating margin for the quarter. While we applaud Palo Alto's ability to reel in operating expenses in the quarter, we do not expect durable operating margin expansion until fiscal 2020 and we are maintaining our fair value estimate of $217 per share.Product revenue grew by 17% and subscription and support sales increased by 22% compared with the prior year, including accounting update considerations. On a sequential basis, product gross margin stayed constant at 70% and subscription and support decreased to 72.7%. Operating expenses decreased sequentially, with sales and marketing dropping to 45% from 48% of revenue and G&A declining to 7.6% from 11.7% of sales. In our view, this quarter's results were stronger than what we should expect in next quarter, but a great indication, verifying our belief that Palo Alto will be able to produce positive operating margin in the coming quarters.
For next quarter, Palo Alto guided revenue of $697-$707 million (24% annual increase at midpoint) and non-GAAP EPS of $1.23-$1.25. We expect operating expenditures to pick back up as Palo Alto aggressively markets its newly announced public cloud-based Cortex platform and Traps 6.0 endpoint protection products, with the latter free to Cortex XDR subscribers. In our view, this sales strategy, and public cloud location, should give Palo Alto more threat intelligence data to analyze and grow its machine learning capabilities and possibly create switching costs. We like Palo Alto's plan on breaking down siloed security solutions into a more simplified and centrally managed product as IT teams look to consolidate security vendors.
In February, Palo Alto announced its intention to acquire the security orchestration, automation, and response company Demisto for $560 million. We believe this purchase fits with Palo Alto's plan to offer proactive security solutions through automation capabilities. Palo Alto projected Demisto billings of $50-$55 million for 2019, and the offering is already part of Cortex. Management announced that a new $1.0 billion share repurchase plan was authorized in February, which expires at the end of 2020. The company completed its existing $1.0 billion buyback program in the previous quarter.
Palo Alto Networks provides a platform that allows enterprises, service providers, and government entities to secure their organizations. The company's platform uses a traffic classification engine that identifies network traffic by application, user, and content and provides security across the network, endpoint, and cloud. The company's product, subscription, and support offerings include: firewall appliances and software; and Panorama, which is a centralized security management solution for global control of various firewall appliances and software deployed on an end-customer's network as well as in their instances in public or private cloud environments as a virtual appliance or a physical appliance.
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