Palo Alto : Q3 FY2021 Earnings Call Transcript

Corrected Transcript

20-May-2021

Palo Alto Networks, Inc. (PANW )

Q3 2021 Earnings Call

	Total Pages: 22
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Palo Alto Networks, Inc. (PANW)	Corrected Transcript
Q3 2021 Earnings Call	20-May-2021

CORPORATE PARTICIPANTS

Walter Pritchard	Dipak Golechha
Senior Vice President-Investor Relations & Corporate Development,	Chief Financial Officer & Executive Vice President, Palo Alto Networks,
Palo Alto Networks, Inc.	Inc.
Nikesh Arora	Lee Klarich
Chairman & Chief Executive Officer, Palo Alto Networks, Inc.	Chief Product Officer, Palo Alto Networks, Inc.

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OTHER PARTICIPANTS

Brian Essex	Tal Liani
Analyst, Goldman Sachs & Co. LLC	Analyst, BofA Securities, Inc.
Fatima Boolani	Keith Bachman
Analyst, UBS Securities LLC	Analyst, BMO Capital Markets Corp.
Keith Eric Weiss	Gray Powell
Analyst, Morgan Stanley & Co. LLC	Analyst, BTIG LLC
Sterling Auty	Adam Tindle
Analyst, JPMorgan Securities LLC	Analyst, Raymond James & Associates, Inc.
Saket Kalia	Michael Turits
Analyst, Barclays Capital, Inc.	Analyst, KeyBanc Capital Markets, Inc.
Matthew Hedberg	Patrick Colville
Analyst, RBC Capital Markets LLC	Analyst, Deutsche Bank

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Palo Alto Networks, Inc. (PANW)	Corrected Transcript
Q3 2021 Earnings Call	20-May-2021

MANAGEMENT DISCUSSION SECTION

Walter Pritchard

Senior Vice President-Investor Relations & Corporate Development, Palo Alto Networks, Inc.

Good afternoon and thank you for joining us for today's conference call to discuss Palo Alto Networks' Fiscal Third Quarter 2021 Financial Results. I am Walter Pritchard, Senior Vice President of Investor Relations and Corporate Development. This call is being broadcast live over the web and can be accessed on the Investors section of our website at investors.paloaltonetworks.com.

With me on today's call are Nikesh Arora, our Chairman and Chief Executive Officer; Dipak Golechha, our Chief Financial Officer; and Lee Klarich, our Chief Product Officer.

This afternoon we issued a press release announcing our results for the fiscal third quarter ended April 30, 2021. If you'd 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 impact of COVID-19, the SolarWinds attack on our business, our customers, the enterprise and cybersecurity industry, and global economic conditions; our beliefs that cyber- attacks will continue to escalate; our expectations regarding a single equity structure; our expectations related to financial guidance, operating metrics and modeling points for the fiscal fourth quarter and fiscal year 2021; our expectations regarding our business strategy, our competitive position and the demand and market opportunity for our products and subscriptions, benefits and timing of new products, features, subscription offerings 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. You 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 these factors that could cause actual results to differ, please refer to our quarterly report on Form 10 Q filed with the SEC on February 23, 2021 and our earnings release posted a few minutes ago on our website and filed with the SEC on Form 8-K.

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 our GAAP financial measures in the supplementary financial information that can be found in the Investors section of our website located at investors.paloaltonetworks.com.

And finally, once we have completed our formal remarks, we'll be posting them to our Investor Relations website under the Quarterly Results section. We'd also like to inform you that we'll be virtually participating in the JPMorgan 49th Annual Global Technology, Media and Telecommunications Conference on May 24 and the BofA Securities 2021 Global Technology Conference on June 8. Please also see the Investors section of our website for additional information about conferences that we may be participating in.

And with that, I'd like to turn the call over to Nikesh.
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Palo Alto Networks, Inc. (PANW)	Corrected Transcript
Q3 2021 Earnings Call	20-May-2021

Nikesh Arora

Chairman & Chief Executive Officer, Palo Alto Networks, Inc.

Thank you, Walter. Good afternoon and thank you for joining us today for our earnings call. Let me being with the current cybersecurity landscape. After the December SolarStorm attack, we saw an acceleration in attacks throughout our third quarter and after the quarter closed. These range from software supply chain attacks like SolarWinds and Codecov to ransomware attacks like Colonial Pipeline. Ransomware especially has been in the spotlight recently and data from our own Unit 42 shows that the average ransom paid in 2020 tripled from 2019 and in 2021 it's more than doubled again. The highest demand we've seen is $50 million, up from $30 million in 2020, with organized groups with near nation state discipline perpetrating coordinated attacks.

The targets are not only corporations where healthcare and pharma is a focus with the pandemic, but also government organizations and shared infrastructure. The reason for this is vulnerability is deep seeded. Organizations run their operations on technology that is decades old, sometimes predating the Internet. They continually bolt on new technologies to automate facilities and make them compatible with the modern Internet, but those platforms are inherently insecure. At the same time, cyber defenses are fragmented, making it very challenging to block sophisticated attacks and lengthening mean time to discovery and repair. Lastly, more and more businesses and consumers are coming online without a baseline of protection.

In such a scenario, it is imperative that customers focus on securing their most critical assets while also focusing on reducing the fragmentation and leveraging newer technologies like artificial intelligence and machine learning and using those approaches.

With that backdrop, let's focus on our results. Overall, we saw a continued strong demand environment and our own continued execution drove Q3 billings, revenue and EPS ahead of guidance. We saw billings growth accelerate to 27% in Q3, ahead of our 24% revenue growth forecast, with growing ratable revenue contribution. I want to highlight one dynamic regarding our billings to help you better understand the drivers. During COVID, some customers are asking for annual billing plans to meet their needs. We noted to you that we saw success with larger, more strategic transactions in Q3. Along with these deals, we saw an uptick in annual billings plans. Normalizing for this, our billings would have grown greater than 28%, nearly 2 points higher than we reported, which is the highest billing growth we have seen in the third quarter since Q3 of fiscal year 2018. Last year, we saw billings plan have an approximate 1 point impact. Along with billings, we also saw 38% growth in our remaining performance obligations. This metric is growing faster than both revenue and deferred revenue, and will be a source of consistent revenue growth in the future.

Within the strong performance, we also saw 71% growth in ARR, or annualized recurring revenue, from our next- generation security offerings where we finished our third quarter at $970 million, up from $840 million in Q2. These ARR, billing and RPO trends drove 24% year-over-year growth in our reported revenue.

It's worth noting, given your attention to NGS ARR that in the very first week and the first day of Q4, we transacted one of our largest next-generation security deals in the history of Palo Alto Networks with a Fortune 30 manufacturer, which brought in $7 million in NGS ARR. So, we're already at $980 million on the first day of this quarter. With the acceleration and incremental NGS ARR in Q3 and trends we see in the business, we continue to have confidence in our Q4 target of $1.15 billion in ending NGS ARR.

As part of this strong Q3 performance, we saw a notable momentum in large transactions, with 901 customers having spent $1 million in Palo Alto Networks in the last four quarters. This cohort of customers was up 29% year- over-year, growing ahead of our overall revenue and billings growth. This growth in active millionaire customers has accelerated in recent quarters. As part of this large new performance, our business is benefiting from growing

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Palo Alto Networks, Inc. (PANW)	Corrected Transcript
Q3 2021 Earnings Call	20-May-2021

adoption of multiple Palo Alto Networks security platforms across Strata, Prisma and Cortex. In Q3, 70% of our Global 2000 customers had purchased products from more than one of these platforms and 41% have purchased all three platforms. This is up from 58% and 25% two years ago.

Turning to our product areas, earlier this year we started the dialogue around network security and cloud and AI and shared additional financial metrics to give you more transparency. Having these two product areas under the common umbrella of our world-class R&D and go-to-market organization is key to our strategy being the largest cybersecurity company in the world.

Starting with the network security side of our business. We are the leader in this business. Our strategy of selling customers leading firewall platform delivered through a hardware, software or as a service form factor underpins our success in this market. This has resulted in a business that is 28% larger than our next peer on a revenue basis in Q3. Also, if you look at leading indicators that include deferred revenue and RPO, our scale comes through even further, we are 40% to 50% larger. On these leading balance sheet metrics, we are growing faster than our next peer.

Three years ago when I joined Palo Alto Networks, we were hardware-based firewall company. We had a vision of a hybrid world where the enterprise and data centers would remain predominantly hardware-oriented with growing adoption of software form factors like our VM Series firewall. Meanwhile, in the remote access and remote office world, this opportunity has been transformed by cloud adoption and work-from-home trends to fuel secure access service edge or SASE adoption. The reception to our strategy of delivering a firewall in multiple form factors has enabled the accelerating Firewall as a Platform growth rate we just showed you.

Within our Firewall as a Platform billings, we are seeing a distinct mix shift towards software. This software mix, which includes our VMs and SASE business now makes up 40% of Firewall as a Platform, up 21 percentage points from a year ago. We saw seven-figure transactions for our software firewall capability, including VM and CN Series with a US Government agency, a Fortune 30 manufacturer and a diversified financial services company.

While we have seen the significant transition in form factors, one driver of growth in value in our business, our attached subscription and support, have grown at a steady rate over the last several quarters on a revenue basis. We expect the software mix to continue to increase in the medium term, although, along with this, we expect to continue to see attached subscription as a key growth driver.

We are showing you for the first time here the NetSec annualized recurring revenue, which was $2.66 billion at the end of Q3 and grew 25%. As a reminder, this does not include our hardware business, which continues to be significant. This recurring revenue business is a key driver to strong cash generation, which we've guided to 42% for NetSec in FY 2021. We believe this high degree of recurring revenue and strong cash flow generated by NetSec is something that should be more clear now given this incremental disclosure over the last two quarters.

Now turning to innovation and focusing first on Prisma SaaS. Back at the beginning of the pandemic, we saw customers look to significantly expand remote access capability while not compromising security or user experience. We've met that demand with free remote access trials and broad proof of concepts, enabling customers to see that value in Prisma Access as well as supporting the network transformation as they move to the cloud. We are seeing these efforts as well as momentum generated from the 2.0 launch, driving strong initial purchase and footprint expansion. This quarter we saw a number of large Prisma Access transactions, including a global technology company, a large manufacturer and a Fortune 10 healthcare company, all eight figures or greater. Additionally, over 25% of our Prisma Access new customers in Q3 were net new to Palo Alto Networks.

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