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Operator
Good day, everyone, and welcome to Palo Alto Network's Fiscal Fourth Quarter 2023 Earnings Conference Call. I'm Walter Pritchard, Senior Vice President of Investor Relations and Corporate Development. Please note that this call is being recorded today, Friday, August 18, 2023, at 1.30 Pacific Time. With me on today's call to discuss fourth quarter results are Nikesh Arora, our Chairman and Chief Executive Officer, and Deepak Galecha, our Chief Financial Officer. Following the Q4 session, we will take questions on our results in the 2024 guidance, with Lee Klarich, our Chief Product Officer, also joining us. We will then continue with the forward-looking portion of our program. For this, Lee, along with several of his product leaders, and BJ Jenkins, our President, will present along with Deepak and Nikesh, with additional Q&A session to follow. You can find the press release and other information to supplement today's discussion on our website at investors.paloaltonetworks.com. While there, please click on the link for events and presentations to find the fourth quarter 2023 earnings presentation and supplemental information. Following the event, we will post the full set of slides, including the forward-looking portion of our program. During the course of today's call, we will make forward looking statements and projections regarding the company's business operations and financial performance. These statements made today are subject to a number of risks and uncertainties that could cause our actual results to differ from these forward looking statements. Please review our press release and recent SEC filings for a description of these risks and uncertainties. We assume no obligation to update any forward looking statements made in the presentations today. We will also refer to non-GAAP financial measures. These measures should not be considered a substitute for financial measures prepared in accordance with GAAP. The most directly comparable GAAP financial metrics and reconciliations are in the press release and the appendix of the investor presentation. And less specifically noted otherwise, all results and comparisons are on a fiscal year over year basis. We also note that management is participating in the Goldman Sachs Conference on September 7th. With that, I'll now turn the call over to Nikesh.
Walter Pritchard
Thank you, Walter, and good afternoon, everyone. Thank you for spending your Friday afternoon or perhaps some part of your Friday evening with us. Our choice of Friday has definitely made us the topic du jour these past two weeks and has made for some very interesting reading of all the analyst notes. We apologize to people who are inconvenienced, but as we had mentioned, in our press release. We wanted to give ample time to analysts to have one-on-one calls with us over the weekend. And we have a sales conference that kicks off on Sunday. We want to make sure all of our information was disclosed out there. So again, we apologize for the unique Friday afternoon earnings call, but clearly we've enjoyed the attention. Well, let me go and just straight away dive into our Q4 results. We start off the year focusing on excellence and execution. We stayed true to that. and delivered strong results in Q4, capping off a strong fiscal year 2023, where we met or exceeded our original top line guidance and significantly exceeded our profitability and cashflow guidance. This year indeed required clear focus across our company, and we're all proud that our treatment was delivered throughout the year, and especially in Q4. Our Q4 revenue grew 26%, marking our 12th consecutive quarter of revenue growth north of 20%. Our billings grew 18% of a very strong 44% growth in Q4 a year ago, and our RPO grew 30% ahead of our revenue growth. Our Q4 operating margins expanded by 760 basis points, driving $1.44 in non-gap earnings per share, and we achieved 39% adjusted free cash flow margins for the year. Our performance in Q4 did not come as a surprise to us. We've been investing in our next-generation security portfolio for some time now to position ourselves in a leadership position for the future of the cybersecurity market. It is this next-gen portfolio driving that is our growth transformation and enabling our leverage. Lee and his team will expand on this in the forward-looking portion of our program. We achieved several important milestones in this quarter, especially in our software and cloud-based businesses this year. Our combined SASE, Cortex, and cloud bookings were north of $1 billion in Q4. Our Cortex platform surpassed $1 billion in annual bookings last quarter, and we achieved the same milestone with SASE this quarter. We also exceeded $500 million in Prisma Cloud ARR. These product performances are all contributed to the strong goals we continue to enjoy in NGS ARR. Remember that our NGS business is largely a capability new to us in the last five years and is primarily cloud delivered. This quarter, we added more net new ARR than any other pure play cybersecurity company. Our platformization is continuing to drive large deal momentum. One way to illustrate the traction of our next generation security capability across network security, cloud security, and SOC automation is to look at the makeup of some of our largest deals. When we deliver best-of-breed products that are also integrated into platforms, we help customers simplify their architectures, lower their cost of ownership, and benefit from differentiated cross-platform capabilities. This is a win-win scenario. Eight out of our top 10 deals saw significant contribution from our next generation security capabilities. Five are essentially next generation security deals. Here are some examples. One, a large industrial manufacturer signed a transaction with a total value of $45 million. A Prisma Access expansion led the transaction, but the deal also included significant commitments to Prisma Cloud, XOR, and our IoT security offerings. The customer's success with Prisma Access and our executive-level engagement were keys to winning this additional opportunity. A large professional services firm standardized Prisma Access in a transaction exceeding $40 million, securing their hundreds of thousands of users. The completeness of our offering, particularly our strong capabilities in private access, differentiated us from the competition. By standardizing Prisma Access, the customer consolidated legacy security offerings from many competitors to a single solution. A large retailer also signed a landmark transaction for more than $40 million led by XIM. In this deal, we displaced the incumbent SIM offering and also added our threat intelligence and attack surface management capabilities. Rounding out the examples, a large technology service provider chose our XDR and XIM capabilities in a transaction worth over $30 million. This deal started as an independent evaluation of replacement for both endpoint security and their SIM. This is the second quarter in a row where we have signed an eight-figure deal that was driven by a unique capability to provide both XDR and XIM competing against separate competitors in each of these categories. This sample represents the success we see across industries and regions. As I mentioned, a critical part of our profitable growth formula is selling more to our largest customers. In Q4, we saw larger deals grow faster than our overall business. Notably, we saw the number of deals greater than 20 million grow faster than our deals over 10 million as our go-to-market motion becomes more and more increasingly successful in selling the platform and building the sort of trusted relationships required to close this quantum of business. Now for the surprise of this quarter. starting with Cortex. There are a number of things I'm excited about in this business as we ended this year. We launched XIM to general availability last October and set an aggressive goal of booking north of $100 million in our first year. The year is not over yet. We have closed out the year achieving $200 million in XIM. This is strong validation that our outcome-based value proposition exam is resonating well with security organizations and also a sign that interest in applying AI to transform security operations is very high. Lee will talk extensively about this in our forward-looking section. Our customers have told us loud and clear that the legacy products powering their SOCs are no longer working and they need to reduce their mean time remediation by an order of magnitude. This becomes increasingly important with the new SEC rules detailing that all public companies will be required to report material breaches within four business days. XIM is shaping up to be our fastest-growing offering outside our original next-generation firewall releases. XIM transactions are large and long-term, which help to further our goal of evolving our customer relationships from vendor to partner. As excited as we are about the early success of XIM, we are also seeing strong growth across the entire family of Cortex products, namely XDR, XOR, and Xpans. We crossed the 5,000-customer milestone in Cortex as we continue to gain share in the market and seed opportunities for upsell to the platform. Our average Cortex deal size grew over 50% a year, reflecting our success in cross-Cortex adoption. Moving on to the next star of the quarter, SASE. SASE continues to become our standout offering. We're seeing strong customer awareness and momentum following our new leadership position in the Gartner SSE Magic Quadrant last quarter. We recognize this quarter with a leadership position in the Forrester Zero Trust Edge wave that was published earlier in the week, establishing Palo Alto Networks as a clear industry leader in SASE. We also have some breaking news on industry recognition. Very excited that Palo Alto Networks has been recognized as the only, I repeat, the only leader in Gartner's first single vendor SASE Magic Quadrant just published on Wednesday. Our recent acceleration in external industry recognition has contributed to customer momentum, and we saw many new customer and large expansion transactions in Q4. This included four transactions over $10 million and many seven-figure deals that span numerous industries and regions. Not to be left behind, Prisma Cloud went past $500 million in ARR. Our cloud security platform, where we believe all companies will eventually lead to manage security across multiple cloud applications and providers through a single platform, continue to show strength. Ensuring customers consume our capabilities after committing to the platform is vital. In Q4, we saw steady consumption growth with credits consumed up by 45%. We're also seeing strong growth in customer adoption of multiple modules. This quarter, we are showing our growth in customers with five modules more as this is starting to become a meaningful trend with customers up 179% year-over-year. We continue to make significant organic investments in Prisma Cloud and grow the platform through acquisitions. We launched the CI-CD security module last week based on technology from the CIDR security acquisition. This is our 11th module, and we continue to have the broadest cloud native application protection platform in the industry, with capabilities spanning our customers' entire code to cloud needs. Later in our call, you will get a chance to see our exciting developments and glimpse into our plans for the future. Finishing where I started, I couldn't be more proud of our performance in Q4 and the year. Our teams helped drive steady performance, enabling us to maintain a strong outlook through macro challenges by focusing on crisply executing our differentiated strategy. We continue to drive platformization and capitalize on the opportunity the changing landscape presents through products like XIM. We continue with our go-to-market transformation. For example, he consolidated our SASE sales team into our core a year ago, and he has seen a strong outcome, as you saw, with some large transactions and opportunities across the pipeline. We have continued to not hold back on investing in innovation to ensure we can capture share in a market that constantly presents new opportunities. Lastly, he successfully accelerated some of our efficiency initiatives in fiscal year as we saw the environment change. I'll now pass the floor to Deepak to cover the detailed financial results and our 2024 guidance.
Walter
Thank you, Nikesh, and good afternoon, everyone.
spk08
Beyond providing the detailed results this quarter, I also wanted to highlight some additional business insights through the Q4 numbers to help you understand our results and provide context for our go-forward plans. As Nikesh mentioned, we saw strength across our various metrics, starting with the top line. This was especially true in our NGS ARR and RPO. NGS ARR grew 56% driven by strength across our portfolio. our PO grew 30% well ahead of our revenue growth. Broadly, the industry has experienced an increase in deal scrutiny as well as deal push-outs. The environment has become more challenging this year, and we started telling you about that at the beginning of our fiscal year. We got ahead of this changing environment by front-loading our sales hiring for the year, training our teams to address the tougher procurement processes, and by having our sales management teams apply additional scrutiny to the pipeline earlier in the quarter. As a result of these efforts, we did not see a significant impact in Q4 from unexpected deal delays. We did see, however, see two impacts on the top line from the changing environment. First, the rising cost of money has caused customers to hold onto their cash and more frequently seek deferred payments, payment terms. These deferred payment terms are delivered in the form of annual billing plans and through our PanaFest financing capability. the percent of bookings that included deferred payments increased approximately 45% year over year. Additionally, the proportion of our bookings that included billing plans more than doubled from Q3 to Q4. This quarter-to-quarter increase negatively impacted our billings as compared to what we forecasted 90 days ago in our guidance. As we see the shift in billing terms, RPO is becoming a more important leading indicator for our business, as it's not impacted by billing terms. As a reminder, RPO represents the book business we expect to recognize as revenue in future periods. Also, all customers' purchases, including an RPO, are non-cancelable. Second, we have seen the market return to a more normalized growth rate in hardware-based firewalls, and I wanted to help further the collective understanding of this. As many of you are aware, there have been several factors that have impacted industry hardware revenue. These include the COVID pandemic, the reopening related hardware demand catch-up, post-COVID supply chain challenges, price changes, and backlog release following supply chain easing. Despite these positive and negative fluctuations, there's a relatively consistent level of underlying hardware growth that is in the low to mid single digits, and we see the industry returning to those levels. This return to normalized appliance growth is also happening on the backdrop of on the backdrop of a broader transition from hardware to software in network security and growth in new security markets. We are unique in being recognized as a leader across different network security form factors, including our software-based VMs and our cloud-delivered SASE. Our firewalls of platform billings growth captures our business across these form factors and grew north of 20% in the last three years. Within this business, we've seen the mix of software increase substantially. Over the medium term, this mixed transition to software and cloud and network security, as well as the growth we are seeing in the rest of our next generation security portfolio, are driving an increase in our recurring revenue mix. Our platform business model and our focus on efficiency drove significant improvements in operating margin in fiscal year 23, including 760 basis points of margin expansion in Q4. This higher operating profitability Strong bookings growth and interest income formed the baseline for our free cash flow at higher levels as we achieved 39% adjusted free cash flow margins in fiscal year 23. The same dynamic of higher deferred payments plans not only had an impact on our top line, but also on our free cash flow. As I mentioned in my discussion of RPO, it is noteworthy that we absorbed the impact of the higher mix of bookings with deferred payment terms in Q4 and fiscal year 23. And we were still able to exceed our cash flow margin target for the year. If you look on a multi-year basis, we've seen the proportion of our bookings that occur with deferred payment plans increase over four times in the last three years, while we grew our free cash flow margins over the same period. As I will talk about when I come back in the second half of the program, this gives us confidence we can maintain our free cash flow margins at a high baseline. Moving on to the rest of the results. Product revenue grew 24% in Q4, driven by the impacts we noted last quarter from new go-to-market motions and SKUs that contributed more renewable software revenue to product than in the past. Total subscription and support revenue grew 27%, with subscription revenue of $918 million growing 31%, and support revenue of $528 million growing 20%. We saw consistent revenue growth across all our theaters with the Americas growing 26%, EMEA was also up 26% and JPAC growing 24%. Gross margin for Q4 of 77.3% increased over 400 basis points year over year. This caps off a year where gross margins expanded by 230 basis points as we saw a benefit from higher software mix and some scale synergies on our customer support spending. Our operating margin expanded well over 700 basis points in Q4 and over 500 basis points for the year. We saw the higher gross margins and efficiency across our three operating expense lines as we accelerated some of our efficiency initiatives. As happy as we are about the outcomes here, we're only part of the way through executing on these multi-year efforts. The result of all of this is that we continue to see strong non-GAAP EPS growth due to substantial operating leverage, which also translated to strength in GAAP EPS, which more than doubled quarter to quarter. We are now firmly GAAP profitable with GAAP net income of over $200 million in the quarter. Turning to the balance sheet and cash flow statement. We ended Q4 with cash equivalents and investments of $5.4 billion. We had our 2023 convertible note mature on July 1st, 2023, and we settled the principal obligation with cash of $1.7 billion. We settled the accessing shares and had previously accounted for these in our non-GAAP diluted shares outstanding. Q4 cash flow from operations was $414 million, with total adjusted free cash flow of $388 million this quarter. Stock-based compensation expense declined by 310 basis points as a percent of revenue sequentially. On a year-over-year basis, stock-based compensation expense was down 220 basis points as a percent of revenue. I'd like to provide the details of our fiscal year 2024 guidance, as well as guidance for Q1, before we move on to the broader forward-looking section of the presentation, where we will provide context for this guidance and talk about our medium-term targets. Overall, we are pleased we capped a strong year of growth and margins and look forward for more to come. For the fiscal year 2024, we expect billings to be in the range of $10.9 to $11 billion, an increase of 19% to 20%. We expect NGS ARR to be in the range of $3.95 to $4 billion, an increase of 34 to 36%. We expect revenue to be in the range of $8.15 to $8.2 billion, an increase of 18 to 19%. For fiscal 24, we expect operating margins to be in the range of 25 to 25.5%. We expect non-GAAP EPS to be in the range of 527 to 540, an increase of 19 to 22%. And we expect adjusted free cash flow margin to be 37 to 38%. For the first fiscal quarter of 2024, we expect billings to be in the range of 2.05 to 2.08 billion dollars, an increase of 17 to 19%. We expect revenue to be in the range of $1.82 to $1.85 billion, an increase of 16% to 18%. We expect non-GAAP EPS to be in the range of $1.15 to $1.17, an increase of 39% to 41%. Additionally, please consider the following modeling points. First, we expect our non-GAAP tax rate to remain at 22% for the first quarter and fiscal year 2024, subject to the outcome of future tax legislation. We also expect cash taxes in the range of $230 to $280 million. This is an increase as compared to the $150 million in cash taxes in fiscal year 2023. For the first quarter, we expect net interest and other income of $50 to $55 million. We expect first quarter diluted shares outstanding of 336 to 339 million shares. We expect fiscal year 2024 diluted shares outstanding of 338 to 343 million shares. And we expect fiscal year 2024 capital expenditures of $160 to $170 million. With that, I'd pass it back to Walter to start a short Q&A covering what we had discussed up to this point.
Operator
Walter? Thanks, Deepak. We'll take about 15 minutes now, and we'll have a few questions. We ask that each analyst only ask one question, and we ask that we cover the topics that we've focused on thus far. For the first question, we'll go to Matt Hedberg from RBC with Rob Owens from Piper Sandler on deck. Please go ahead, Matt.
Walter
Great, guys. Thanks for taking my questions. Maybe, Nikesh, with you, the macro, good results in the quarter. I wonder if you could just talk a bit more broadly about some of the broader trends that you're seeing. There's been some other, obviously, some comments from some competitors that are maybe a little bit different, but just broad brushstrokes on high-level demand trends.
Walter Pritchard
I think, as I said, and as Deepak elaborated, look, its interest rates are higher. CFOs are scrutinizing deals, which means you have to be better prepared to answer the question and show the business value that you bring to them with your cybersecurity product. uh we are we are lucky that we've been focusing on a platform strategy so we can usually walk in and say here you consolidate the following five it doesn't cost you anymore but you get a better outcome and you get a modernized security infrastructure so from that perspective that strategy of ours is resonating but there is more scrutiny there are deals that go through multiple levels there are some that get pushed there are some that get cancelled and again you just have to get more on the top of the funnel and as uh deepak very clearly highlighted that you know eventually end up and there's a conversation about saying wait i used to pay you up front and i need to understand the cost of money and is there a way either my cost has to be lower from you so i can sort of account for the cost of money or you gotta allow me to pay you later uh from a deferred plan perspective those are really the two effects and i think the biggest and if i if i summarize q4 for us great execution there's a lot of demand out there and uh The two things which are sort of were different is one, we saw the hardware cycle start to normalize much faster and not like we told you so, but we've been very consistent. I think one of you guys actually was kind enough to cut and paste every time we talked about hardware into their node. We've been very consistent that we think underlying hardware grows at single digits, low single, low to mid single digits. So we've seen that mean reversion. Other than that, Honestly, we just got to go out there and get more stricter on execution. That's the outcome from a macro perspective.
Operator
Great. Thanks, Matt. Next question will be from Socket Kalia of Barclays with Brad Zelnick from Deutsche Bank on deck. Go ahead, Socket.
Matt
Okay, great. Thanks for taking my question here. Nice end to the year to the team. Deepak, maybe for you, great to see the free cash flow margin for next year. I think a couple things that we were all thinking about as we model next year were cash taxes and the deferred payment plans that you referenced in your prepared commentary. Of course, the profitability here is well ahead also, but maybe you could just talk us through some of the puts and takes you thought about within that free cash flow margin guide for next year.
spk08
Yeah, so I think, thanks for the question, Saket. I think the primary driver really is the stronger profitability, right? That's really what underpins a lot of the cash flow confidence. We've also seen benefits of higher interest rates on the cash that we have, right? And that also helps. That's another put and take. But I would say you're right. We've absorbed the additional headwinds from deferred payment terms. We've modeled in the cash taxes. And when you put all the different puts and takes, we feel pretty confident of where we are.
Operator
Thank you. Sorry to skip the order there. We're going to go back to Rob Owens and Piper Sandler and then go to Brad Zalmick at Deutsche Bank. Go ahead, Rob.
Rob Owens
Thanks, Walter. You know Socket's much more interesting than I am. But I wanted to build on that question just a little bit relative to deferred payments. Is there discounting when you're doing these multi-year deals? And will we actually see a longer term economic benefit as people start to move towards annual payments? And I guess given the shift in the portfolio and what you guys are selling, this should be no surprise. So if you could just comment on if there is a broader economic benefit to kind of moving to annual terms and understand that we'll probably address the midterm guidance on the next portion of the call.
Walter Pritchard
Rob, I'm going to give you a little macro flavor and then Deepak can jump in as well. First of all, your shirts are way better than Saket's, so don't worry about that. Look, on the macro front, the part I'm really excited about that Deepak and his team have basically navigated a significant part of our business into annual billings effectively through these deferred payment plans, right? And we're able to hold our free cash flow in spite of those downward sort of pressure. And we think we're going to keep absorbing some of that as it goes.
Rob
In the end, it's an economic argument. It's like, there's a cost of money. I can take the money up front and let the customer
Walter Pritchard
get a discount and I can go try and get a return on that cash, or I can let them pay when they're ready to pay and I can extract a better economic outcome in that context.
spk02
And I think it's important to understand, given our portfolio-based approach, you know, our
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