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Broad Security Freeze: Palo Alto Demand Stalls; Q2 Views Lukewarm

Palo Alto Networks ( PANW ) stock tumbled Thursday after a Piper Jaffray analyst said that lackluster April demand and Q2 guidance from Check Point Software Technology ( CHKP ), FireEye ( FEYE ) and Imperva ( IMPV ) could signal a broad cybersecurity slowdown. IBD’s 26-company Computer Software-Security industry group is down 18.5% for the year after toppling 32% through Feb. 9, on bleak guidance for IT spending from firms like LinkedIn ( LNKD ) and Tableau Software ( DATA ). Barracuda Networks ( CUDA ), Check Point, FireEye and Fortinet ( FTNT ) recently missed full-year views. Imperva and Proofpoint ‘s ( PFPT ) Q2 outlooks lagged the consensus. Now, channel checks show April demand slowed, Piper Jaffray analyst Andrew Nowinski says. “The key takeaway from Q1 earnings season is that the security sector is starting to show signs of slowing based on the guidance that was provided for Q2 and fiscal 2016,” he wrote in a research report Thursday. Cybersecurity stocks toppled Thursday on Nowinski’s assessment. IBD’s security group was down 2% in morning trading on the stock market today , with Palo Alto Networks and FireEye stocks leading the deluge, down a respective 6% and 4%. Palo Alto Networks stock was at a two-month low, near 130. IBD’s Take: How does Palo Alto Networks stack up, and how does it compare to its rivals? Find out at IBD Stock Checkup But some analysts say Palo Alto Networks could beat guidance when it posts fiscal Q3 earnings on May 26. The company has topped the high-end of its outlook by an average 5.6% for the past 11 quarters. To do so again, Palo Alto would have to report $356 million in sales. The consensus of 43 analysts polled by Thomson Reuters models $339.4 million in April-quarter sales, which would be up 45% vs. the year-earlier quarter. But $549.5 million in July-quarter billings expectations, up 40%, might be too aggressive, Nowinski wrote. During the April quarter, some delays in large contracts likely hurt Palo Alto Networks, Nowinski wrote. “Most (resellers) thought it was simply due to a ‘digestion period’ where customers were still trying to integrate products they purchased in 2015,” he wrote. “The results definitely indicate demand slowed sequentially and also on a year-over-year basis.” Nowinski expects Palo Alto Networks to at least meet estimates, but he cut his price target on Palo Alto Networks stock to 180 from 208. He reiterated an outperform rating, but wrote that “this is the first quarter in at least two years where we picked up any sort of slowdown in Palo Alto’s demand trends.”

Amazon, Facebook Admit Stock Compensation Is A Normal Cost

For more than a decade, technology companies doled out heaps of stock to recruit top talent — then pretended this wasn’t a normal part of doing business by reporting profit numbers that subtracted the cost. That’s changing as the industry grows up and responds to pressure from regulators and investors. Amazon.com ( AMZN ) started breaking out stock-based compensation in the results of its different businesses in the first quarter. This is “the way we now evaluate our business performance and manage our operations,” Chief Financial Officer Brian Olsavsky told analysts after the earnings report last week. Facebook ( FB ) Chief Financial Officer David Wehner had a similar message. From now on, he said he’ll talk about the social network’s results and other metrics based on U.S. standards known as Generally Accepted Accounting Principles, or GAAP, which include equity-based pay costs, instead of a mix of GAAP and non-GAAP numbers. “We view it as a real expense,” he said. Some technology companies, such as Netflix ( NFLX ) and Intel ( INTC ), already take this approach, but many don’t. If the shift to focusing on the real bottom line catches on more broadly, it could slice billions of dollars off the reported profits and official forecasts that underpin the technology sector’s lofty market valuations. Facebook stock trades at about 35 times estimated earnings over the next 12 months. Add in equity compensation expense and that price-to-earnings ratio jumps to 50, according to a Sanford C. Bernstein & Co. analysis. Amazon would trade at 122 times projected profit, rather than a multiple of 63. Using GAAP numbers, Alphabet ( GOOGL ) would trade at 26 times forecast profit, versus 21 times, Bernstein estimates. The change also highlights the struggles of smaller Internet companies like Twitter ( TWTR ) and LinkedIn ( LNKD ) to generate GAAP earnings. Facebook, Amazon and Alphabet may have high stock valuations, but they are also very profitable by GAAP and non-GAAP measures. Twitter shares trade at about 36 times estimated profit, but including stock-based compensation analysts expect it to have a loss over the next 12 months, Bernstein research shows. “If you can act from a position of strength, which Amazon and Facebook clearly are, there’s no better time to change your behavior,” said Denny Fish, who helps oversee $2.5 billion in technology stocks at Janus Capital Group Inc. “They look more responsible and it makes them accountable for how they issue stock for compensation in the future.” New Disclosure Amazon in prior quarters disclosed overall stock-based compensation, but didn’t tell investors how much went to each business and didn’t allocate this expense to these divisions for its own management purposes. In the fourth quarter, the AWS cloud business generated $687 million in operating income, and investors were left to estimate how much of Amazon’s total equity-pay costs of $606 million went into that division. Last Thursday, the company said AWS had first-quarter operating profit of $604 million, including $112 million in stock-compensation expense. Alphabet may focus more on GAAP results in the future, while Twitter is unlikely to do so because that would make its numbers look a lot worse, Fish said. In February, Alphabet started reporting stock-based compensation for its Google business and a group of newer businesses known as Other Bets. The Google unit had $1.3 billion in equity pay expense in the final quarter of 2015, leaving an operating profit of $6.8 billion. Other Bets spent $498 million on equity awards for the whole of last year, contributing to a $3.6 billion annual operating loss. ‘Egregious’ Compensation Twitter reported 2015 non-GAAP profit of $277 million, or 40 cents a share. On a GAAP basis, including stock-based compensation, the company posted a loss of $521 million, or 79 cents. “Some companies have been egregious with stock compensation,” Fish said, citing LinkedIn, which has relatively high equity-based pay compared to its revenue and earnings. Analysts on average project that LinkedIn will have profit of $591 million, or $4.27 a share, in 2017 — a non-GAAP number that excludes stock-based compensation costs. When that expense is included, along with other items, the company is forecast to lose $36 million, or 29 cents, according to data compiled by Bloomberg. LinkedIn cut growth forecasts earlier this year, making it more important for investors to assess its long-term compensation costs. “When fundamentals deteriorate relative to high-growth expectations and stock-based comp is high as well, companies can be doubly penalized,” Fish said. LinkedIn shares have declined 44 percent this year, while rival social network Facebook is up 13 percent. “Non-GAAP results are the most accurate representation of our operating results,” LinkedIn spokesman Hani Durzy wrote in an e-mail. Still, he said the company aims to reduce stock-based compensation to about 10 percent of revenue from the current 17 percent, while still using equity as a hiring tool. “Talent is critical in this industry, and we want to make sure that we’re balancing the trade-offs appropriately,” Durzy said. Representatives at Facebook, Amazon and Alphabet declined to comment. A Twitter spokesman didn’t respond to an e-mail seeking comment. Mounting Criticism Facebook and Amazon’s new approach follows mounting criticism about many companies’ overuse of non-GAAP numbers, especially in technology, where big equity awards are common. In his latest shareholder letter, Warren Buffett disparaged the omission of pay as “the most egregious” example of non-GAAP accounting. “If compensation isn’t an expense, what is it? And, if real and recurring expenses don’t belong in the calculation of earnings, where in the world do they belong?” he wrote. Companies have taken note. The Society of Corporate Secretaries and Governance Professionals, which represents company executives and other managers, sent a memo to members last month highlighting comments on this issue by officials at the U.S. Securities and Exchange Commission and the Public Company Accounting Oversight Board. SEC Chief Accountant James Schnurr said executives and directors on boards’ audit committees should ask why non-GAAP numbers are an appropriate way to measure performance and probe whether they’re really useful to investors. Investor Pressure Shareholder pressure may also have had a big impact at Facebook and Amazon. The companies recently told one large technology investor that they made the change in response to investor requests and for competitive reasons. When large, profitable technology companies exclude stock-based compensation, they promote an accounting concept that lets smaller rivals appear more profitable than they actually are. This helps these same rivals compete better for talented employees, who are looking to work at the most successful firms, said this investor, who asked not to be identified because the conversations were private. If the tech industry keeps shifting toward treating share-based pay as a real expense, Twitter may be most exposed, according to Carlos Kirjner, an Internet analyst at Bernstein. The social-media company has to compete with Internet behemoths Facebook and Alphabet and venture-backed startups to hire talented product and engineering employees, and issuing stock as part of a job offer is a good way to lure candidates. Yet these expenses will eat up a “very large portion” of Twitter’s future free cash flow, and long-term investors should consider this when deciding whether to back the company, Kirjner said. “Some companies like Twitter that pay their employees generously with hundreds of millions of dollars in equity grants will say they are free-cash-flow positive before expensing stock-based comp,” the analyst wrote. “Maybe they should define free cash flow before any expenses, which would look even better,” he joked.  

How LinkedIn Turned A Bad Business Situation Into Good

It was a shocking day for LinkedIn ( LNKD ) when the business networking company reported fourth-quarter earnings on Feb. 4 that led to a 44% plunge in its stock price. In its Q4 earnings conference call, LinkedIn executives revealed a company reshuffling that had many observers scratching their heads. Analysts slashed price targets as LinkedIn announced it would shutter a unit worth about $50 million in revenue, a move one analyst called a “gigantic mistake.” Apparently it wasn’t. LinkedIn committed new resources toward newer products that cashed in when the company reported first-quarter earnings  after the close Thursday that walloped expectations. LinkedIn reported Q1 revenue of $860.7 million, up 35% year over year and beating the consensus of $828.5 million. Earnings per share minus items rose 30% to 74 cents, beating the consensus of 60 cents, as polled by Thomson Reuters. Its guidance also exceeded views. “We believe LinkedIn righted its ship with a solid first-quarter upside and raised guidance,” wrote Needham analyst Kerry Rice, who maintained a buy rating and price target of 200. Many of the issues LinkedIn revealed were not as severe as expected, Rice wrote in a research note. LinkedIn generates revenue from three business segments. Revenue from Talent Solutions, which gets fees from companies and headhunters seeking hires, rose 41% to $558 million. Revenue from Marketing Solutions, which sells ads, increased 29% to $154 million. Revenue from Premium Subscriptions increased 22% to $149 million. In its reshuffling, LinkedIn created products such as Referrals and Connectifier, online platforms that help customers drive a greater share of hiring through LinkedIn. In its Marketing Solutions unit, LinkedIn redoubled its focus on Sponsored Content. which provides targeted advertising that appears in the feeds of social platforms on LinkedIn. These new products and others were a significant contributor that helped LinkedIn beat expectations. Sponsored Content revenue rose 80% and is the fastest-growing segment of Marketing Solutions, LinkedIn said. “LinkedIn posted Q1 upside across every business unit,” wrote Pacific Crest analyst Evan Wilson in a report. “We are confident in LinkedIn’s uniquely valuable data set and think the company has set itself up for further upside over the balance of the year.” Wilson has a overweight rating on LinkedIn stock and a price target of 190. Jefferies has a buy rating and price target of 180. RBC Capital Markets has a market perform rating and price target of 160. Nomura has a buy rating and price target of 180. LinkedIn stock was up 3%, near 126.50, in afternoon trading in the stock market today . Since the 44% plunge three months ago, LinkedIn stock is up 15%. Image provided by Shutterstock .