Palo Alto Networks, Inc.

Good afternoon, and thank you for joining us on today's conference call to discuss Palo Alto Network's fiscal fourth quarter and fiscal year 2020 financial results. I'm David Niederman, Vice President, Investor Relations. This call is being broadcast live over the web and can be accessed on the Investors section of our website at investors.palatonetworks.com. With me on today's call are Nikesh Arora, our Chairman and Chief Executive Officer, Luis De Soto, our Chief Financial Officer, and Luke Claridge, our Chief Product Officer. This afternoon, we issued a press release announcing our results for the fiscal fourth quarter and the July 31st, 2020. If you would like a copy of the release, you can access it online on our website. We would like to remind you that during the course of this conference call, management will make forward-looking statements, including statements regarding the duration and impacts of COVID-19 on our business, our customers, the enterprise and cybersecurity industry and global economic conditions, our financial guidance and modeling points for the fiscal first quarter of 2021, our expectations with regard to certain financial results and operating metrics for fiscal year 2021, our competitive position, and the demand and market opportunity for our products and subscriptions benefits and timing of new products, features, and subscription offerings, including those from our proposed acquisition of the Christmas Group, ARR, and various billing runs rates, as well as other financial and operating trends. These forward-looking statements involve a number of risks and uncertainties, some of which are beyond our control, which could cause actual results to differ materially from those anticipated by these statements. These forward-looking statements apply as of today. We should not rely on them as representing our views in the future, and we undertake no obligation to update these statements after this call. For a more detailed description of factors that could cause actual results to differ, please refer to our quarterly report in 410Q. filed with the SEC on May 22, 2020, and our earnings release posted a few minutes ago on our website and filed with the SEC on Form 8K. Also, please note that certain financial measures we use on this call are expressed on a non-GAAP basis and have been adjusted to exclude certain charges. For historical periods, we have provided reconciliations of these non-GAAP financial measures to GAAP financial measures in the supplemental financial information that can be found in the Investors section of our website, located at investors.palitonetworks.com. And finally, once we've completed our formal remarks, we will be posting them to our investor relations website under the quarterly results section. We'd also like to inform you that we will be virtually participating in the Citi 2020 Global Technology Conference on September 8th and the Deutsche Bank Technology Conference on September 14th. And with that, I will turn the call over to Nikesh.

Thank you, David. Good afternoon, everyone, and thank you for joining us today for our fiscal fourth quarter and full year 2020 results. I hope you enjoyed the video we showed you before. Our employees made that to celebrate how Palo Alto Networks has responded over the course of the year. I thought it would be a fitting start to everything we're talking about today. As you can probably tell, we're delighted with our results this quarter and extremely thankful for the resilience that the team at Palo Alto Networks has shown in navigating the current environment. I cannot appreciate their efforts enough. I also want to acknowledge the challenges that people are experiencing globally as a result of COVID-19. This is a difficult time, and we need to pull our strength and find empathy to get through it. Before we talk about the quarter, I wanted to go back and remind you of the journey over the last two years. Two years ago, in my first and subsequent earnings calls, I shared my observations about the cybersecurity industry. I talked about the need for an integrated platform, need for setting platform with industry-leading solutions. I also talked about the need for us to become more relevant in emerging cloud security industries and the need to focus on AI, ML, and automation. Two years later, we are well on our way to transforming from a single product category company to a three-platform company, a company that secures the network with Strata, secures the cloud with Prisma, and a platform for AI, ML applications and automation with Cortex. We have been building products and acquiring new businesses to make progress towards our vision of providing integrated solutions. We are in early stages of our journey, but excited by the progress we've been able to achieve so far. The success of our transformation has strengthened our resolve to double down on the growth areas in cybersecurity and aspire to be the cybersecurity partner of choice, the partner providing integrated, comprehensive, and industry-leading solutions to our customers. We've had several conversations over the last two years around our M&A approach. As you've seen, successful M&A is an integral part of our approach. We have honed a disciplined framework to ensure that the companies require our productive investment and that they fit well within our long-term strategy. We look for industry-leading solutions that prepare us for tomorrow, and we focus on integration and retaining key talent, talent that has beat all odds and built solutions designed for tomorrow. We have been able to unlock value by activating our go-to-market and customer success machines with incremental technologies to accelerate the acquired businesses. When we analyze the performance of our acquired companies, we see that we are achieving our stated goal of increasing a given target company's internal business plan by 30% to 40% in the first 12 months of bringing them into the Palo Alto Networks family. We recently reviewed the M&A history of Palo Alto Networks with our board and delighted to report that the aggregate annual run rate of all businesses that we have acquired is four times what it was pre-acquisition. Just as important, we've also been able to retain the key talent that has helped build the acquired company. Let's look at some of the financial highlights from this quarter. starting with NGS. Two years ago, these collective offerings made up approximately 8% of our total billings. We closed FY 2020 with $928 million in NGS billings, representing approximately 20% of the total. Additionally, NGS ARR was approximately $650 million in Q4 2020. Two years ago, we didn't have products that addressed the automation of cloud security markets. Today, holding multi-million dollar deals in these areas creating a strong foundation for our future growth. This is one of my favorite slides. NGS is going faster than any of the single product, new or public companies in the space. Let's take a deeper look in the piece parts of NGS. Turning to Cortex, we drove incredible innovation during 2020. We established a new category by transforming EDR to XDR, delivering detection and response across not just endpoints, but also firewalls and cloud assets. In November, we introduced XDR 2.0, which featured a unified management UI, powerful new endpoint features, and ingestion of third-party data and alerts. XDR is rapidly gaining traction and is the fastest-growing product within NGS to win 1,000 customers. We recently added Managed Threat Hunting, the industry's first threat hunting service, operating across integrated endpoint networking cloud data. Cortex XDR's momentum continues to accelerate, including a seven-figure deal with a major energy company that chose Fallout Networks as a key partner in the digital transformation journey. Cortex XDR helped them drive down the complexity of security operations by standardizing independent detection response tools onto one superior platform. Through Cortex XDR, they were able to significantly reduce the number of alerts that needed to be triaged and investigated by the security analysts, all while gaining holistic visibility across the enterprise. As security products get more real time, it becomes more important to manage outcomes and respond rapidly. To aid our customers, we believe it is important to have a team of trained expert professionals to support them. To that end, we announced earlier today our intention to acquire the Crypsis Group, a fast-growing cyber consulting and incident response company. This acquisition allows us to serve current and new customers across a border-order set of their cybersecurity needs. Once the transaction closes, Crypsis will bring strong incident response, forensics, and consulting capabilities to our XTR portfolio. They have served more than 1,700 organizations across the healthcare, financial services, retail, e-commerce, and energy industry. In addition to being able to predict and prevent cyber attacks, Cortex will also now be able to mitigate the impact of any breach that our customers may face, thus strengthening Palo Alto Network's position as a cybersecurity partner of choice for its customers. The Cryptos team, including the CEO, will join the Cortex feedlot. Let's turn to Cortex XTR, XOR. XOR is the industry's first extended sole platform with native-set intelligence management, XOR more than doubled their customers and billing in the last year, making it one of two leading solutions in the market. With the most recent launch of the XOR marketplace, they're opening up the platform to both our partners and customers to enable automation for their security solutions. One of the key wins I'm most proud to highlight for Q4 was an eight-figure Cortex XOR deal with the United States government agency. Cortex XOR was chosen as the cornerstone of their global stock transformation initiative, resulting in a 75% reduction in their mean-time response by automating key security processes across the organization. COVID further put XO's real-time collaboration capabilities into focus, allowing the agency to rapidly shift their security operations to an entirely remote model, enabling them to defend the organization without any on-site personnel. Let's shift gears to Prisma. Prisma Cloud has come a long way this past year. We started with cloud security posture management and expanded our capabilities into cloud workload protection with container security and serverless security. Prisma Cloud has by now acquired over 1,800 customers and boasts 14% of the global 2,000 list. Our integrated platform approach in cloud security is working. We signed a seven-figure deal with a Fortune 10 company who will be using Prisma Cloud for both cloud security posture management and cloud workload protection. Several Prisma Cloud customers are consolidating multiple solutions with our unified cloud security platform. Today, a third of our customers are using both these modules. We will shortly launch new cloud security modules in data security, network security, and IAM security. These modules will allow us to continue to execute on our vision of creating a fully integrated cloud security platform. Prisma Cloud continues to benefit from the overall global shift to cloud computing and the customer preference for platforms. We intend to work with our customers to continue to evolve this platform to serve their cloud security needs. Let's talk about Prisma Access. Prisma Access has been through an amazing journey in the last year. Combined with our recent CloudGenics acquisition, this is the most comprehensive SASE solution in the market. Prisma Access has become a powerful security tool as our customers go through a network transformation and create robust solutions for work from home for the long term. This is showing up in our numbers, with a combination of Prisma Access and CloudGenics nearly doubling their customer accounts over the past two years and achieving $19 million in buildings in our fiscal fourth quarter. We were very excited to sign a nearly eight-figure deal with a major healthcare provider for Prisma Access in the fourth quarter, winning against the competitor by providing clear evidence that our solution provides the most effective security for their needs. Additionally, we saw a very strong conversion of Prisma Access trials that were launched in response to COVID and work from home. A notable example is a major enterprise that called us on the first Friday of COVID lockdown because their data center lacked sufficient bandwidth for all of their remote employees. By Monday, they had 1,000 users up and running, and by Wednesday, they had shifted enough users that pressure on the data center was released. This quickly became their secure work-from-home solution, and they are now looking to extend Prisma Access out to all branch offices, replacing their existing provider. We have many more similar examples of customers converting from Prisma Access trials, and we're delighted to have been able to help companies and their people remaining productive during these challenging times. While NGS is an important part of our go-forward strategy, we are equally proud of our progress and success of our firewall business. Recognized as an eight-time Gartner Magic Quadrant leader, we continue to relentlessly innovate to stay ahead of the pack. We continue to believe that firewall capability is essential and needs to evolve to deliver capability across all customer needs. Hence, we've been offering a consistent approach in our hardware, software, and now containerized firewalls, and are also able to deliver them in the cloud with Prisma Access. We introduced our new Pan OS 10.0 that featured the industry's first machine learning-based powered next-generation firewall With advanced telemetry capabilities, the ability to secure containers, simplified decryption, and many more groundbreaking features. To truly enable the firewall platform, we have worked on services that work seamlessly as part of our platform. The launch of IoT security subscription is our most recent example. In the last 18 months, we have doubled our subscription offerings from four to eight. DNS security, which was launched in Q3 2019, has been our fastest growing subscription with over a 15% cash rate and now over 3,000 customers. Our software and next generation firewalls continue to shine. VM Series continues to capture new customers at a rapid rate with over 9,000 customers now using VM Series, many of which are consumed through cloud marketplaces. And with the introduction of CM Series, we can now apply next generation firewall capabilities to containerize environments on-prem or in the cloud with consistent security and policy. Turning to the topic of COVID-19 and its impact on both the global economy and our business, when we met with you to review our fiscal Q3 results in May, the pandemic was still in early stages. As we speak with our customers, we hear and see a range of impact and feedback. Many companies are becoming more cost and cash conscious. Companies are also adapting to the new environment by accelerating investment in technologies to ensure the more dispersed work is secured. I believe that we are in the very early stages of this acceleration and that the next several years present significant opportunities for cybersecurity as an industry and Palo Alto Networks in particular. For our own employees, The second half of our fiscal 2020 was indelibly marked by COVID-19. We responded quickly, taking rapid action to ensure the safety of our employees by establishing protocols and tools to work from home. We quickly gathered our early efforts and named it FlexWork, recognizing that we were in the early stages. Today, I'm delighted to announce that we're launching the next phase of FlexWork to help our employees maintain health, well-being, and productivity during COVID-19. The FlexWork program includes a broad range of initiatives, including FlexBenefits and FlexLearn. These initiatives will ensure that our people can choose benefits that make most sense for their working family environments and follow personalized learning paths designed to help them do their jobs and manage teams remotely. We plan to give our employees an additional allowance of $1,000 for the choice of various flexible benefits, and over time, we intend to individualize benefits, making them an employee choice. Even with all the challenges presented by COVID, the Palo Alto Network's teams have been able to adapt and maintain focus, allowing us to post some great results. I know we cannot sit on the progress achieved so far and need to focus on what is ahead. As I mentioned, we are pleased with our progress so far, yet we have a lot of work ahead of us. The macro environment, while better than we anticipated, is still uncertain. Here's what you can expect from us in 2021. We will continue to invest in our next-generation security and security subscriptions, both through organic and inorganic means to continue our transformation journey. We will do so in a financially prudent manner, as we have been able to demonstrate. You can expect us to manage our organic operating margin in line with what is achieved this year. The work-from-home transition has created a challenge in the industry around hardware, and we expect this trend to continue. We have been shifting our customers to software-delivered security, and we plan to continue to do so. We expect most of our goods to come from software and services. While there are some cost savings due to COVID, we are planning to reinvest those savings towards our employees. You'll be more generous over the coming years to drive this transition to a flex work environment. In the words of my friend Mark Benioff, we will be responsive to and support all of our stakeholders, not just our shareholders, because we believe that is how true value is created in the long term. I want to thank our amazing employees and partners for their contributions. Our success is only possible through our combined efforts. Now, I want to take the opportunity to welcome Louise to Powered Networks. Louise joined us almost two months ago from Amazon's AWS division, and has been rapidly learning all things cybersecurity. We're extremely fortunate to have an executive, Luis Excalibur, to lead our CFO organization. With that, I will turn the call over to Luis.

Thank you, Nikesh, for the warm welcome. While I wasn't here for the first two years of the transformation, I can clearly see that it is working, and we're only getting started. I'm encouraged by the value that Palo Alto Networks can create going forward, and I look forward to meeting you in the upcoming events. Moving on to our results, I'd like to note that except for revenue and billings, our financial figures are non-GAAP and growth rates are compared to the prior year periods unless stated otherwise. As Nikesh indicated, we had an extremely strong finish to our fiscal year, with fiscal Q4 billings of $1.39 billion, an increase of 32% year-over-year. Our next-generation security business is performing strongly. with NGN billings of $357 million, which grew 86% year-over-year. Firewall as a platform billings, which includes physical firewalls, VMs, Prisma Access, and CloudGenics grew 19%. In the fourth quarter, we beat our guidance across all guided metrics. Total revenue grew 18% to $950.4 million. For the fiscal year, we reported total revenue of $3.4 billion and 18% increase year-over-year. Looking at growth by geography, Q4 revenue in the Americas grew 18%, EMEA grew 20%, and APAC grew 16%. Q4 product revenue of $305.6 million was flat compared to the prior year. Q4 subscription revenue of $389.8 million increased 33%. Support revenue of $255 million increased 23%. In total, subscriptions and support revenue of $644.8 million increased 29% and accounted for 68% of total revenue. Turning to billings. Q4 total billings of $1.39 billion net of acquired deferred revenue increased 32%, driven by strong execution across a company, work-from-home tailwinds, and continued success in next-generation security. The dollar-weighted contract duration for new subscriptions and support billings in the quarter remained at approximately three years, flat year-over-years. We closed five additional Palo Alto Networks financial services deals, enabling our business by offering greater flexibility to customers. Our fiscal 2020 total billings were $4.3 billion, up 23% year-over-year. Product billings were $1.07 billion, a decrease of 3% year-over-year, and represent 25% of total billings. Support billings were $1.21 billion of 28% and represented 28% of total billings. Unsubscription billings were $2.02 billion, an increase of 40% year-over-year and represented 47% of total billings. Total deferred revenue at the end of Q4 was $3.8 billion, an increase of 32% year-over-year. In the fourth quarter, we continue to add new customers at a healthy clip, adding approximately 2,400 new customers in the quarter. We also continue to increase our share of wallet of existing customers. Our top 25 customers, all of which made a purchase this quarter, spend a minimum of $55.3 million in lifetime value through the end of fiscal Q4 2020, a 35% increase over the $40.9 million in the comparable prior year period. Q4 gross margin was 74.3%, which was down 320 basis points compared to last year, as some of our fastest growing products are still gaining the scale required to have the right cost structure and higher freight costs associated with COVID. We expect these headwinds to continue into fiscal year 2021. Q4 operating margin was 19.8%, a decline of 180 basis points year-over-year and includes the impact of approximately $14 million of net expense associated with our recent acquisitions. For the full fiscal year 2020, operating margin was 17.6%, a decrease of 440 basis points year-over-year compared to fiscal year 2019 operating margin of 22%. and includes the impact of approximately $23 million of net expense associated with our recent acquisitions. We ended the fourth quarter with 8,014 employees. On a gap basis, for the fourth quarter, net loss increased 183% year-over-year to $58.9 million, or 61 cents per basic and diluted share. For the full fiscal year 2020, GAAP net loss increased 226% year over year to $267 million, or $2.76 per basic and diluted share. Non-GAAP net income for the fourth quarter decreased 1% year over year to $144.9 million, or $1.48 per diluted share. For the full fiscal year 2020, non-GAAP net income decreased 10% year over year to $484.6 million, or $4.88 per diluted share. Our non-GAAP effective tax rate for Q4 was 22%. Turning to cash flow and balance sheet items, we finished July with cash, cash equivalents, and investments of $4.3 billion. This includes net cash of approximately $2 billion raised through the June 2020 offering of convertible senior notes during 2025. Q4 cash flow from operations of $333.7 million increased by 44% year-over-year. Free cash flow was $301.9 million of 69% at a margin of 31.8%. Capital expenditure in the quarter was $31.8 million. DSO was 81 days an increase of 26 days from the prior year period, reflecting strong billings at the end of the quarter that will be collected in 2021. Lastly, in fiscal Q4, we completed the $1 billion accelerated share repurchase transaction announced in February, where we retired a total of 5.2 million shares. For the first fiscal quarter of 2021, we expect billings to be in the range of 1.03 to $1.05 billion, an increase of 15 to 17% year-over-year. We expect revenue to be in the range of $915 to $925 million, an increase of 19 to 20% year-over-year. We expect non-cash EPS in the range of $132 to $135 using 99 to 101 million shares. We do not expect CRIPSIS to have a material impact to Q1 results. Additionally, I would like to provide some additional modeling points. We expect non-GAAP effective tax rate to remain at 22%. CAPEX will be approximately $35 to $40 million. Turning to the full fiscal year 2021, I would like to provide a few markers on how we expect to perform. We expect billings to grow in the mid-teens and revenue to grow in the high-teens, with product revenue flat to slightly down year-over-year. As Nikesh mentioned, we expect flat organic operating margins as we continue to invest in NGS and our employees during COVID times. EPS is expected to grow in the low-to-mid-teens as we face headwinds from lower interest income. Lastly, we expect our annual free cash flow margin to be consistent with 2020 margins. To note, we expect Q1 free cash flow margin to be higher than the year due to strong Q4 2020 billings. With that, I'd like to open the call for questions. David, please call for questions.