Palo Alto Networks, Inc.

Good day, everyone, and welcome to Palo Alto Network's fiscal fourth quarter 2022 earnings conference call. I am Clay Bilby, head of Palo Alto Network's investor relations. Please note that this call is being recorded today, Monday, August 22nd, 2022, at 1.30 p.m. Pacific time. With me on today's call are Nikesh Arora, our chairman and chief executive officer, Lee Klarich, our chief product officer, and Deepak Gulecha, our chief You can find the press release and information to supplement today's discussion on our website at investors.paloantanetworks.com. While there, please click on the link for events and presentations where you will find the investor presentation and supplemental information. In the course of today's conference call, we will make forward-looking statements and projections that involve risk and uncertainty that could cause actual results to differ materially from the forward-looking statements made in this presentation. These forward-looking statements are based on our current beliefs and information available to management as of today. Risks, uncertainties, and other factors that could cause actual results to differ are identified in the safe harbor statements provided in our earnings release and presentation and in our SEC filings. Palo Alto Networks assumes no obligation to update the information provided as a part of today's presentation. We will also discuss non-GAAP financial measures. These non-GAAP financial measures are not prepared in accordance with GAAP and should not be considered as a substitute for or superior to measures of financial performance prepared in accordance with GAAP. We have included the tables that provide reconciliations between the non-GAAP and GAAP financial measures in the appendix to the presentation and in our earnings release, which we have filed with the SEC and which can also be found in the investor section of our website. Please also note that all comparisons are on a year-over-year basis unless specifically noted otherwise. We would like to note management is scheduled to participate in the Citibank Global Technology Conference and Goldman Sachs Cornucopia and Technology Conference in September. I will now turn the call over to Nikesh.

Thank you, Clay. Good afternoon and thank you for joining us today for our earnings call. As you can see from the video, we were excited to celebrate the 10th anniversary of our IPO in early July. Our employees are engaged and excited as we continue confidently on our mission to be the cybersecurity partner of choice. Moving to Q4, I'm pleased to report that we again saw very strong results starting at the top line results that were well ahead of the guidance we initially outlined for the fiscal year 22. We delivered this growth while balancing our profitability commitments We also made significant investments to continue to transform our company and take advantage of the large and rapidly growing market opportunity we see in cybersecurity. On the top line, Billings' growth of 44% was the highest we've reported in four years. We also grew RPO ahead of our revenue growth rate. The key focus of our team has been rapidly positioning us as a constant cybersecurity innovator. And one way we measure our progress is how our NGS ARR develops. A delighted report this metric grew 60%, reaching $1.9 billion exiting the year. We are expecting it to reach $2.6 billion in FY23. If this was an independent startup, it would be amongst the fastest-growing cybersecurity businesses to achieve scale. Within our core network security business, firewall as a platform billings grew 26%. When we started reporting this metric, the intent was always to show that we continue to take share in the network security market. At the same time, transform the business to a software business. Today, close to 50% of that comes from software form factors. Operating income grew 52% in Q4, and our operating margin for the year finished at the high end of the guidance range, with adjusted free cash flow margin coming in above the high end of the range we provided. We achieved a major internal goal we've had on the profitability front, delivering GAAP profitability this quarter. Looking forward, we're guiding the full year GAAP profitability in fiscal 2023. We've had many of you ask us about the macro environment and how is it impacting our business and the markets we serve. In the last year, we arguably saw the most challenging supply chain conditions the technology industry has ever seen. We executed through this well during the year with modest impacts to our gross margins. We expect conditions will eventually ease. For our planning, we're assuming a material improvement won't be seen prior to the end of fiscal year 23. However, as the supply challenges fade, we expect this will start to have a favorable impact on our product growth markets. There's a continuing debate on inflation, its nature and duration. We saw some labor and other inflationary pressures in the second half of fiscal year. We do not anticipate these pressures going away in the next fiscal year, and we have planned for it to persist through fiscal year 23. And hence, it is included in our plan as reflected in our guidance. With respect to the macro impact and demand, we've just come out of Q4 with exceptional 44% billing growth. In enterprise sales, as most of you know, there is Q4 magic. We did, however, see some marginal changes in the macro environment in Q4. Whilst early, it is important to see how the overall macroeconomic conditions develop over the next year. First, we saw more longer duration deals as customers increasingly have the confidence to make large long-term commitments with us. This is important to the transformation objectives we set out for Palo Alto Networks. It confirms and validates our view that customers will consolidate if we give them constant best-of-breed products and ensure that they are integrated to deliver better security outcomes. Second, we saw some isolated instances of customers extending the life of hardware potentially driven by macro forces. We expect that on the margin. This could continue into FY23. It is counterbalanced by some customers refreshing their state and our continued share gains in the hardware form factor. Third, in transformational projects, the vast majority of our customers continue on their investments here, despite the expected short-term macro impacts. Security spending is tied into our customers' desires to move to the cloud, drive more direct relationship with their customers, modernize their IT infrastructure, as well as drive efficiencies while adapting to a new way of working. Those efforts continue. Coupled with the heightened awareness and need to do something on cybersecurity, we expect secular tailwinds to persist in cybersecurity, and we are best positioned to deliver against our customer needs. Another trend I would like to highlight is the return to Palo Alto Networks by employees who had left for seemingly greener pastures. Over a six-month period, as part of our Welcome Home program, we have engaged with many former employees to date. Dozens of top performers have been rehired, with many more in the funnel. Over 70% of people who reached out to have expressed a desire to come back to us, and a significant number already have. 50% are returning from startups, and the next largest percentage coming from peer companies. We're happy to welcome these employees back to Palo Alto Networks. As you embark on a new fiscal year, my fifth at Palo Alto Network CEO is worth reflecting where we came from. Our transformation strategy has not been easy, but we are unwavering in our resolve to build the most comprehensive and relevant offerings for our customers, taking away their complexity and delivering a better security outcome for them. We see a path to being the largest cybersecurity company backed by constant innovation and excellent execution, becoming our customer cybersecurity partner of choice while delivering increasing value to our shareholders. Just four years ago, we were a different company. We had reinvented the firewall market and captured the market share leadership position. There were glimmers of our next generation security strategy, but it made up just 8% of our billings. Our software story and network and security was early, with some traction in our virtual firewalls and a fledgling precursor to SASE called Global Protect Cloud Services. We made our first acquisition in cloud native security and had early point products that would become part of Cortex. When we stepped back and took stock in the industry, we had a key hypothesis, which we then tested, proved to ourselves and have reproduced across the business today. There has not previously been a cybersecurity company with a leadership position in multiple categories. None of the customers believed that a cybersecurity platform could anchor their architecture. We set out on this ambitious journey as we stood up Prisma Cloud and Cortex, as well as innovated significantly in our network security capabilities. Fast forward to today, our transformation has taken us far. We are a recognized leader in 11 cybersecurity categories across our three platforms. Next generation security contributed more than 38% of our billings, helping to accelerate our growth. In network security, we now have the most comprehensive solution across three form factors that share a common architecture and also offer a suite of market leading security subscriptions. We have built, assembled, and integrated capabilities in nine modules that make up Prisma Cloud, which is now the leader in cloud native security. Lastly, we have three anchor products in Cortex, which with our new XIM product showing promise in their revolutionary security operations is going to hold us in good stead. The proof that this transformation is working is in the momentum we are seeing in our customers. The number of customers that spend over $1 million annually with us continues to grow, with the millionaire count now in excess of 1,200. And the number of global 2,000 customers that have purchased products on all three of our platforms is now 50%. While we've had many large customer wins recently, I want to highlight a theme in three transactions. The first is a technology company that purchased products in all three of our platforms in a transaction over $75 million in value. The second is a financial services company that standardized its network security in our platform, including adding VMs and deploying Prisma Cloud, spending north of $40 million. And the third is a professional services company that spent over $75 million across Strata, Prisma, and Cortex. One of the outcomes from our transformation of the past four years is a steady increase in our subscription and support mix. primarily driven by the growth of our next-generation security business. Subscription and support now exceed 80% of our billings. This has resulted in greater predictability in our revenues. We have seen growing commitments from our customers represent a greater portion of our next year's revenue. As we enter fiscal year 23, that number is 59% at the midpoint of our guidance. Increasing revenue visibility gives us further confidence in our ability to invest and drive future growth. This number is over 70% for the revenue we expect in Q1. All of this has occurred while our revenue growth has accelerated from FY20 to FY22, in part due to the accelerated growth in our next-generation security offerings, while we have also taken share in traditional network security appliance form factors, as reported by third parties. Despite the success so far in our transformation, we still see significant potential ahead of us. We estimate our large addressable market to be growing at a rate of 14%. At 29%, our fiscal year 2022 revenue growth more than doubled this market growth rate. As we have transformed the business, we have seen our revenue growth reaccelerate. Even with this significant growth over the last four years, we still only represent approximately 6% of our TAM. We last presented our analysts in September 2021. 6% share of the market, low for the market leader as compared to other categories in technology. So we see there is ample room to grow. There are numerous trends that excite us around our ability to drive this growth and continue our share gains. You may soon see a day where there will be a trillion dollars in public cloud consumed. Our observation thus far in this early market is that companies allocate 2 to 5% of their cloud budget to security, creating a significant Prisma Cloud opportunity. There are 3.5 million worldwide cybersecurity jobs that are unfulfilled. Our view is that more training and hiring alone will not effectively and efficiently counter the growing use of automation employed in attacks and the volume of alerts that is overwhelming the security operations center. We believe a new paradigm in security ops is needed that heavily leverages AI and automation. We are targeting this opportunity with our Cortex products and XIM products specifically. Lastly, hybrid work is here to stay. There are more than 1 billion knowledge workers globally. We believe we have a strong position in SASE with our coverage of users and branch offices today, just caching the surface of the last opportunity. We have a clear mission in front of us in each of our security platforms to harness the opportunity that we have outlined. As this is Q4, I figured rather than having me outline all the accomplishments from our product team, I would invite Lee Klarich, who patiently listens and sits in our calls, to give you a more detailed update to help you understand how we will continue to build on our success we had in FY22.

Thank you, Nikesh. As Nikesh highlighted, across cybersecurity, one of the biggest challenges has always been the overwhelming number of point products that customers must deploy, integrate, and operationalize to achieve the security they need. In most cases, this is never fully achieved, leading to expensive yet suboptimal security outcomes. We are bringing a new approach, one that delivers market-leading capabilities tightly integrated in three platforms. FY22 has been a significant year for us in network security, where we have furthered our position delivering a consistent security architecture across hardware, software, and SASE. We neared completion of our Gen 4 hardware rollout, which on some models delivers close to 10x performance over Gen 3. As a result, we saw over 50% of NGFW hardware sales in Q4 on Gen 4. Also in FY22, we introduced the Cloud NGFW across three of the major clouds, enabling our customers to adopt best-in-class network security in a cloud-native service. And Prisma SASE had three major launches in FY22, including the most recent ZTNA 2.0 launch, firmly establishing our next-gen approach to zero trust. Across our hardware, software, and SASE form factors, we are able to deliver a consistent set of core security capabilities as ML-powered cloud services. In FY22, we saw the rapid adoption of advanced URL filtering, and we now see nearly all URL filtering sales on this advanced ML-based service. Advanced threat prevention, which was introduced in fiscal Q3, is also now off to a strong start. And perhaps most importantly, customers can manage all form factors and security subscriptions from a single management console to deliver consistent user experience and tremendous operational leverage. While we believe the full platform is where customers will end up, we want to ensure customers can start their adoption with any form factor and receive a truly best-in-class solution. The number of $1 million lifetime value SASE customers that are also customers of our two other network security form factors ended FY22 at 210. This is up eightfold since FY19. We have seven customers that have purchased all three of our form factors with $100 million in lifetime value in network security. More broadly, when we look at our network security customer base, customers that have bought all three platforms from us spend 10x more than those who are customers of only one form factor. This showcases the true value of our network security platform. In Q4, we introduced ZTNA 2.0, which redefines state of the art in zero trust network access to bring uncompromised security and deliver zero trust with zero exceptions. We have seen significant momentum at our customer traction on SASE and FY22 on a number of fronts. Our overall active SASE customer base grew by 51% in Q4, and our million-dollar SASE deals also accelerated this year, up 83% with over 50 $1 million deals in Q4 alone. While many of these large deals are coming from our install base as they see the value across reform factors, It is equally important that over 30% of our new SASE customers in Q4 were new to Palo Alto Networks. This highlights the competitiveness of our SASE solution and enables us to reach net new customers. Additionally, once we land with a new SASE customer, we are seeing customers look to standardize on our hardware and software appliances. In the cloud, we see that most customers are still relatively early in their journey. They are migrating workloads to the cloud and building new applications, growing their footprints, consuming more sophisticated services, and adopting multiple clouds. With this has come an expansion in their cloud security needs. Our approach with Prisma Cloud delivers a comprehensive platform with a growing set of capabilities to stay ahead of our customers' needs. Increasingly, cloud security needs to start at the moment developers write their first lines of code through to deploying and running this code in public cloud. The acquisition of BridgeCrew brought us infrastructure as code, a way of detecting and fixing security issues during development. IAC became our ninth integrated module of Prisma Cloud at the end of January. And in the first six months of availability, we already have over 200 customers, making it our fastest growing new module. We designed an incredibly easy way for our customers to activate any of the nine modules and have grown the number of customers that use more than three modules to over a third, and those using four modules to nearly 20%. This frictionless module adoption has helped to fuel our 55% growth in credits consumed on the platform. We are also closing in on 2,000 customers for Prisma Cloud. It's great to see all the third party recognition like the SC award as best cloud workload protection solution that we announced today. But we're not done yet. We see several opportunities for new modules and will continue to look at both organic development and external technology to drive continued expansion of the Prisma Cloud platform. We are earlier in a Cortex platform journey. executing well across our three core product categories of XDR, security orchestration and automation, and attack surface management. We saw significant progress in FY22 as we drove sales of our key products and increased traction, combining offerings and larger cross-cortex transactions. Our customer count surpassed 4,000, and we also signed 52 transactions greater than $1 million in Q4. Combined with this customer success, we also continued the rapid innovation that we believe will be required to be a leader in security operations more holistically. When we envision the future of cybersecurity, I don't see a path to success that is not heavily driven by AI and automation. Attackers are too well funded and determined, while customer networks, clouds, applications, and users are too complex to manually defend. The only way to deliver meaningful security outcomes is by collecting rich, useful data, normalizing all data sources to a single source of truth, and then applying AI models to detect attacks and automate responses in real time. We are now taking this to the next level. Earlier this year, we announced XIM, a fully integrated AI-driven SOC platform, and kicked off a program with a limited number of design partners to ensure we had strong product market fit. The results of this design partner program are incredibly encouraging, proving our assumptions about the value of good quality data powering AI-based attack detection and native automation simplifying and speeding response. And I'm happy to say our first paid customer was a seven-figure purchase, and most of the other design partners are likely to purchase in the coming months. We are on track to launch the product into a broader set of our customers in the first half of fiscal 23. We could not have accomplished all we have in the last several years in advancing our lead in network security, standing up our cloud native security platform, and progressing toward the autonomous SOC without our investments in innovation. Over the last several years, our R&D spending has grown in order to enable our ambition to lead with the three platforms. You see this in major product releases, which reached nearly 50 in FY22. As we move into FY23, We are more committed than ever to leading in cybersecurity innovation. My team went through a rigorous process of prioritizing our most important investment areas across our three platforms. With the continued investment in R&D, I'm confident we're set up to deliver a great set of innovations in the coming year with focus on the most important areas for our success. With that, I'll pass it back to Nikesh.