After spooking Wall Street for weeks with its plans to report earnings after Friday’s closing bell, Palo Alto Networks Inc.’s mysterious move turned out to be much ado about nothing. 

Some analysts were fearing trouble at Palo Alto Networks PANW, -2.60%, especially after fellow cybersecurity company Fortinet Inc. FTNT, -0.12% delivered a downbeat report earlier in the cycle and Palo Alto teased that its own call would last about two hours. Wedbush analyst Daniel Ives didn’t mince words in his preview note, writing that the decision to post results late Friday was “one of the biggest PR disasters and black eyes we have seen in decades of covering tech.”

Palo Alto and the contractors who are building the city's new police headquarters near California Avenue are in a legal battle over more than $3.5 million in change orders — requests for additional compensation for work that the companies allege was caused by incomplete plans and unexpected requirements.

According to documents obtained by Palo Alto Online through a Public Records Act request, the dispute primarily involves the city's main contractor, Swinerton Builders, and its subcontractor, Pacific Structures, the two companies behind most of the change orders and claims. Other companies involved include Swinerton's subcontractors Commercial Controls Corporation, Walters & Wolf, WSA Compliance, Helix Construction Company, Broadway Mechanical Contractors, Sandis, and Northern Services, according to the city.

The 15 change orders and claims were for work ranging from the electric wire sleeves required for the new building to the installation of doors in the building.

The City Council, which designated the new public safety building as its top priority more than a decade ago, discussed the claims and the potential litigation in a closed session on Monday night and did not take any formal action.

The new building at 250 Sherman Ave. will house the Police Department, the Office of Emergency Services and the administration of the Fire Department and is slated to be completed later this year. Workers recently completed electrical installation and removed the exterior scaffolding, according to a report from City Manager Ed Shikada. The $118-million project is now about 90% complete, and staff is preparing to move into the building in 2024, the report states.

The legal skirmish has been going on since at least November, when the city notified the contractors that it would reject — either wholly or in part — some of the requests for additional compensation. This includes a change order for $1.49 million from Pacific Structures in connection with construction of pre-cast stairs at the new building.

The city denied the change order in early November, arguing that the contractor had failed to comply with a contract provision requiring it to submit change orders "within 10 days of the occurrence of the circumstances giving rise thereto," according to a letter that Pacific Structures General Counsel Steve Cvitanovic wrote to the city on Nov. 30.

Pacific Structures took issue with the rejection. It argued that the added work was caused by city requirements. In disputing the city's rejection, Cvitanovic cited a court case in which a contractor was allowed to recover damages on a public works project in which extra work "was necessitated by the incorrect plans and specifications," notwithstanding the notice provision in the contract.

Pacific Structures maintained that it was directed to perform work relating to seam alignments at concrete decks, columns and walls "well above the requirements in contract documents and Pacific Structures' standard of care," according to the formal claim that the city discussed in the closed session. The change had an impact on the amount of labor required to finish the job and on the company's stair installation sequence, according to the claim.

The company noted that the circumstance giving rise to the cost impact occurred upon the completion of the work, making it impossible for Pacific Structures to meet the 10-day requirement.

"The impact could not have been discovered until after work completion because the final as-built condition was required for specific identification of additional scope," Jarrod Haering, president of Pacific Structures, wrote in the claim.

The claim for $1.49 million is the largest of 15 claims, with each stemming from a rejected change order.

Another claim entailed Pacific Structures' need to keep its craftsmen on site for longer than was expected, which cost the company an additional $205,403, it stated.

The documents show contractors' increasing frustration. On April 26, Haering filed a claim after the city rejected its change order for $333,520. He complained that his company discovered many errors, omissions, conflicts or ambiguities on the city's part.

"Pacific Structures has processed and implemented over $3.6 million in change orders on this project," Haering wrote. "This is a 27% increase from our original contract value. The volume of change on this project is grossly inconsistent with the industry norms. No reasonable contractor would have assumed or included staffing needs for a 27% increase in scope."

Swinerton also took issue with costly changes to the city's plans. In late June, it filed a claim for $257,338 relating to work on the audiovisual systems. The installation of the system was complicated by the city's review process, which required numerous modifications to the plans and caused delays in approving and ordering the needed materials, Swinerton asserted.

"In addition, in each submittal iteration, new comments were added that were not included in the previous iterations due to different entities reviewing the package each time," Swinerton wrote in its June 30 claim.

Swinerton in another claim said its workers and contractors had to delay work by nine days because the city required testing of building components that the company said had already been tested and certified in Los Angeles. In its claim for $142,592, Swinerton asserted that the testing requirement delayed its plans to pour concrete, and when the company asked the city if it could proceed with pours as per schedule while the testing was being performed, it was told that the work can proceed at "contractor's risk," according to the claim.

It didn't get the real go-ahead to proceed with the pouring until days later, the claim stated, which created a "compensable impact."

James Devine, the attorney representing the subcontractor Commercial Controls Corporation (CCC), similarly noted that material costs that escalated due to city delays should not be borne by his client.

"CCC believes that … there is only one viable outcome — the City pay for the increased material prices and the City should not force Swinerton and/or CCC to bear the burden of the City's own breaches of its public works contract with Swinerton," Devine wrote.

State law provides for the city and its contractors to submit unresolved claims to a mediator or another process for resolving disputes. The new report from Shikada suggests that the legal process will not affect the city's plans to make the building fully operational in 2024.

"As is typical with large, complex capital projects, staff is working through bringing the project to completion, including following the contractual dispute resolution process for claims received in relation to work completed by the general contractor and sub-contractors," the report states.

Introduction

As a dividend growth investor, I seek new investment opportunities in income-producing assets. I often add to my existing positions when I find them attractive. I also use market volatility to my advantage by starting new positions to diversify my holdings and increase my dividend income for less capital. Sometimes I look at prospects that can turn into dividend-growth companies in the future. These companies offer strong cash generation and enjoy a strong position in their realm.

The information technology sector is attractive, and Palo Alto Networks (NASDAQ:PANW) in particular. 2022 was harsh for many IT companies as the interest rates increased and valuations decreased as a response. In 2023, we see recovery across the board as the Nasdaq is climbing. I always seek individual opportunities with high-quality companies that I try to acquire for a reasonable and fair price.

I will analyze Palo Alto Networks using my methodology for analyzing dividend growth stocks. I am using the same method to make it easier to compare researched companies. I will examine the company's fundamentals, valuation, growth opportunities, and risks. I will then try to determine if it's a good investment.

Seeking Alpha's company overview shows that:

Palo Alto Networks provides cybersecurity solutions worldwide. The company offers firewall appliances and software, Panorama, a security management solution for the control of firewall appliances and software deployed on a customer's network, as well as their instances in public or private cloud environments, as a virtual or a physical device, and virtual system upgrades, which are available as extensions to the virtual system capacity that ships with physical appliances. It also provides subscription services covering the areas of threat prevention, malware, and persistent threat, URL filtering, laptop and mobile device protection, firewall, and DNS security, Internet of Things security, SaaS security API, and SaaS security inline, as well as threat intelligence, and data loss prevention. In addition, the company offers cloud security, secure access, security operations, threat intelligence, and cyber security consulting, professional services, including architecture design and planning, implementation, configuration, and firewall migration, education services, such as certifications, as well as online and in-classroom training; and support services.

Fundamentals

The revenues of Palo Alto Networks have increased by 1380% over the last decade. The company grew its sales more than ten times over by improving its product, selling it to more clients, and gradually increasing prices. The company also engaged in M&A (mergers and acquisitions), which allowed it to grow its sales and offer a more comprehensive cybersecurity platform, thus increasing the value and price for the entire suite. In the future, as seen on Seeking Alpha, the analyst consensus expects Palo Alto Networks to keep growing sales at an annual rate of ~20% in the medium term.

The EPS (earnings per share) of Palo Alto Networks has grown at an even faster pace. The company's EPS increased by 1720%, and as the graph below shows, the growth was steady and consistent. The company is basing its offering on the cloud. Therefore, more clients using more services doesn't increase expenses much, thus allowing the company to grow its EPS even faster despite a higher number of shares. In the future, as seen on Seeking Alpha, the analyst consensus expects Palo Alto Networks to keep growing EPS at an annual rate of ~16% in the medium term.

As the company, which bases its offering on the cloud, kept growing with limited growth in expenses, the margins have improved. The company has posted positive GAAP operating margins. As the company keeps expanding its client base and the services each client buys, its margins will improve. The company is already generating cash and has already generated over $2B in free cash flow over the last twelve months. The fact that the company generates cash and enjoys growing margins is positive for investors.

The number of shares has increased by 42%. Companies tend to return capital to shareholders via buybacks and dividends. When companies are still growing, these two methods are less popular. The increase in the number of shares has diluted existing shareholders significantly. The company doesn't need to issue shares to raise capital. It issues shares to reward its employees. SBC stock-based compensation has increased, and it now stands above $1B. Therefore, the current free cash flow and profitability may be skewed. At some point, the company will have to consider buybacks or limiting share issuance.

Valuation

The P/E (price to earnings) ratio of Palo Alto, when looking at the EPS estimates for the next fiscal year ending on July 2024, stands at 44. The valuation decreased as the projection for the current year is for strong EPS growth. However, 44 times forward earnings is still an extremely high valuation. The company didn't trade for a forward P/E ratio below 30 in the last twelve months. When considering the higher interest rates environment, shares of Palo Alto Networks are selling for a significant premium as investors see strong growth with high probabilities of success.

The graph below from Fast Graphs emphasizes the unique situation that Palo Alto Networks is in. The company's average P/E ratio since its IPO stands at 107. The current P/E ratio stands at 44. While it seems attractive, we need to look at the growth rate. The CAGR (compound annual growth rate) in the past was 40%, compared to the current 17%. Therefore, a lower valuation makes sense. Over time, the growth rate is unlikely to match the past growth rate. I believe that the current valuation still includes a significant premium.

Opportunities

Palo Alto Networks' shift towards a cybersecurity platform is a crucial growth opportunity. A platform allows clients to "plug and play" different security products using a single platform. They do not need to buy additional services, hardware, and products to protect the organization. Palo Alto Network can offer various services on its platform to cater to every need and enjoy a higher stickiness.

The combination of a platform capable of giving a variety of high-quality services, as today Palo Alto Networks leads in 10 Gartner Magic Quadrants and Forrester Waves, together with the trend of cloud migration, supports growth. Cloud migration means more businesses will need cyber protection, and corporations will need more services with higher usage. Therefore, we see an increase in the number of large accounts and these accounts buying more services.

Russia and China are a significant cyber threat to many governments and corporations. These countries are trying to hinder Western interests. Russia is doing this to hurt Western countries over the sanctions imposed after it invaded Ukraine. China is attempting to gain knowledge and information mostly. These risks increase the value of a solid cybersecurity platform Palo Alto Networks offers.

Risks

The first risk is competition concerns. Palo Alto's investment landscape is dealing with intense competition. The cybersecurity sector is full of startups aiming to disrupt the market, established peers like Check Point (CHKP) pose stiff competition, and even tech giants like Microsoft (MSFT) are entering the realm of software cybersecurity. This crowded and evolving competitive landscape could potentially erode Palo Alto's market share and force the company to invest heavily in innovation and marketing to maintain its current platform's edge.

In addition, the lack of margin of safety is even riskier. With a P/E ratio of 44, Palo Alto's stock appears to be priced for perfection. Such a high valuation leaves little room for error and raises concerns about an overvaluation bubble that could burst if the company fails to meet optimistic growth expectations. Investors should be cautious as this elevated valuation leaves little buffer for challenges or market downturns.

Investors should also consider reputation vulnerability. Palo Alto's reputation is a valuable asset, and any breach or penetration of its clients' systems could severely damage its standing in the cybersecurity industry. A significant security incident could erode customer trust, leading to client loss and investments in remediation efforts. The time required to restore the company's reputation might hinder growth and limit its ability to capitalize on opportunities during recovery.

Conclusions

To conclude, Palo Alto Networks is a fantastic company that grows across the board. Its sales and EPS are growing and generating cash. It leverages its business model to increase free cash flow as the margins improve. Investors in the company will capitalize on significant growth opportunities, including the superb platform it offers and the cloud migration trend.

While there are risks to Palo Alto, mainly regarding the competition and a dent in its reputation, these are manageable risks. However, the company valuation is a problem for me with an investment in the company. At 44 times earnings, that company leaves investors no margin of safety. If growth slows down, the valuation will decrease, which is a significant risk. Therefore, I believe the shares are a HOLD, and I'd consider buying them when the forward P/E is around 30 and the growth rate is still above 12%.

SANTA CLARA, Calif. (AP) — SANTA CLARA, Calif. (AP) — Palo Alto Networks Inc. (PANW) on Friday reported fiscal fourth-quarter…

Shares of Palo Alto Networks (PANW) jumped in after-hours trading. The cybersecurity company reported fiscal fourth adjusted quarter earnings that handily beat Wall Street estimates, while revenue was just shy of expectations. The company also issued upbeat full-year guidance. Constellation Research Founder Ray Wang says the company is "doing well" but "the challenge is the macro-environment. Budgets are being re-directed from cybersecurity to AI." Wong says Palo Alto is benefiting from putting "the best portfolio in the marketplace for customers to buy so that they don't have to go to all these different point solutions." However, Wong thinks the stock is going to be "challenged for the rest of the year" due to companies shifting their spending to AI.

Video Transcript

SEANA SMITH: Shares of Palo Alto Networks trading up just about 5% right now after reporting Q4 earnings. Now, lots of hype going into this report. Let's first get to the numbers, then I'll tell you why.

So when you take a look at this report, it was mixed on the top and bottom line. You're looking at sales coming in at just around $2 billion that beat the Street's expectations, I believe. When you take a look at your sales-- excuse me. Missing here just by a bit. $1.95 billion estimate. There was for $1.96 billion.

EPS, though, coming in better than expected $1.44. Estimate was for $1.28. But the guidance here is really what's critical. And I think it's almost a sigh of relief that we're seeing from the Street because they were bracing themselves for a disastrous report. But 2024 billings forecast, $10.9 billion to $11 billion, that beat the Street's expectations of $10.77 billion.

When it comes to Q1 revenue outlook, though, that coming in just a bit light here. When you take a look at what they are expecting there, they see Q1 revenue at $1.82 billion to $1.85 billion. The Street was looking for $1.92 billion.

So billings forecast topping expectations. We saw the stock sell off over the last 2 days or so because there was lots of concern about what we would be hearing in this report. So let's get analyst reaction to that. And we want to bring in Ray Wang, Constellation Research principal analyst and founder. Ray, your first take.

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RAY WANG: Yeah, they put out a Friday night special. Everybody got nervous. It felt like it was going to be some kind of political campaign where you make the announcements on a Friday and hope no one notices on the weekend.

But I think it was really a lot to do with Fortinet having bad forecasts going towards the future. And I think that spooked everyone on the market. But the good news is that they're doing well. They're definitely one of the leaders when you look at enterprise security and if you look at cybersecurity stocks.

The challenge is the macro environment. Budgets are being redirected from AI-- from cybersecurity to AI. And that's really the challenge in every single organization. Boards are going to AI first. And it's having an impact across the sector. They've managed to weather this AI onslaught much better than everyone else. And that's why their forecasts are where they are.

DIANE KING HALL: So, Ray, I know one of the concerns coming into this was, oh, there could possibly be an executive change, or. You know, it was just very dramatic coming into these results. I mean, you rarely see this what we usually call a Friday night data dump. So given that where it is, we kind of see a sigh of relief in the aftermarket. What do you-- what do you think about-- like, what are you expecting to hear on their earnings call? What are you looking for?

RAY WANG: Yeah, I think people want to understand if CISOs are still buying. I think they want to understand if there's an AI story that's going to be in place, which they do have, which is going to make it easier for CISOs and/or enterprises to manage their environments. They also want to know, you know, what they're doing to cut costs as well going forward.

So everyone's been on their cost posture. I think those are probably the three important things. The larger macro forecast in general is it's hard to beat the comps of the last 2 years. Everybody doubled down on cybersecurity like there was no tomorrow. And trying to match those comps aren't an easy thing to do.

SEANA SMITH: Ray, where do we stand in the broader space? Because when we talk about so much concern going into this report yesterday of reporting after the bell on Friday but also their competitor, the rival Fortinet also reported disappointing results. So what does this tell us just how Palo Alto is positioned among the broader industry?

RAY WANG: I think it's because Palo Alto has a broader portfolio. And when you look at what's happening inside every enterprise right now, they're trying to reduce the number of vendors they work with. They're trying to reduce the complexity, which means the integration cost of working with more than one vendor.

And so what Palo Alto has done is probably put the best portfolio in the marketplace for customers to buy so that they don't have to go to all these different point solutions. And I think that's really where their strength has been is managing that portfolio better than everyone else, managing M&A better than everyone else. And that's where the inherent advantage is.

DIANE KING HALL: And so, Ray, I want to ask you, in terms of where the stock stands, it's-- obviously, there was a lot of selling heading into this result. Do you think it's positioned for greater growth through the balance of the year?

RAY WANG: I think it's going to be challenged for the rest of the year. We do have a great dip at the moment. I think the rundown that was going on here, I think there were down 19% for the year. And the NASDAQ was down about, what, 7% to 8%. It's a good time if someone had got in, like, today. So they're a little bit late there.

But I would say that-- you know-- I mean, it's going to be flat for a while because the forecast going forward for Q3, Q4 are all impacted by everyone running to AI and spending the money in budgets in AI. And that's really the challenge. I think going forward, there's going to be other kind of security threats are going to be in place. And, of course, the spending on cybersecurity has always been pretty strong. It is the number one issue every CIO focused on last year. It is now the number two issue because of AI.

DIANE KING HALL: All right, Ray Wang of Constellation Research. Thanks so much for joining us for a Friday night special.

PALO ALTO, Calif, - Authorities are investigating the death of a man whose body was found on a downtown Palo Alto street Wednesday morning.

The discovery was made shortly before 6:30 a.m. on Waverley Street, close to Hamilton Avenue. The body was found between a parked green 2021 Dodge Challenge and the sidewalk. Authorities said the vehicle belonged to the victim.

Palo Alto police did not locate any obvious signs of foul play and have no evidence at this time that any crime occurred.

The man's identity is not being released at this time.

As a result of the ongoing investigation, the intersection has remained closed to traffic for several hours.