Palo Alto Networks Inc Q1 FY2022 Earnings Call

Thanks for listening. boosting. That one. Just platform given me the ability to experience to all of these different uses. Incredible innovation across our Network Security platform and again, all of which complemented by spread intelligence and security consulting to our previous cybersecurity partner of choice.

Good day and welcome to Palo Alto Network's First Quarter 2022 Earnings Conference Call. I'm Clay Bilby, head of Palo Alto Network's Investor Relations. Please note that this call is being recorded today, November 18th, at 1:30 PM Pacific Time. With me on today's call are Nikesh Arora, our Chairman and Chief Executive Officer, who will join us in the Q&A session following his prepared remarks. You can find the press release and information to supplement today's discussion on our website at investors.PaloAltoNetworks.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 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 on today's call. 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 tables which 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 be found in the Investors section of our website. We would like to note several upcoming events. Management is scheduled to participate in upcoming virtual investor conferences in December, hosted by Craig's List and Barclays. And now I would like to turn the call over to Nikesh.

Thank you, Clay. And good afternoon, everybody. As you can see, that was a video showing you some snippets from Ignite, our user and customer conference, which is just wrapping up. It has been a bit of a busy week at Palo Alto Networks, where we've had 27,000 customers and partners registered to engage with us virtually. Moving on to where we are at the end of Q1. Q1 was quite a familiar story from a demand perspective. We saw strength across major geographies and industries driven by heightened cybersecurity awareness. We've seen people at the top of organizations across government and private sector understand that it's their responsibility to ensure they are securing their environments against an increasingly malicious threat landscape. This quarter, we saw a fair amount of press out of Washington, DC, as Cyber Security funding was included in the recent infrastructure bill and executive orders are mandating focus from federal agencies. In the private sector, corporate boards are forming Cyber Security committees and directing their teams to raise the bar in terms of Cyber Security posture. We powered the networks institute our security committee as well this quarter. Early in the year, Gartner updated its forecast for spending in information security and risk management technology and services, calling for growth of 12% year-over-year in 2021. We see this backdrop as sustainable beyond this year, as customers grapple with familiar events like ransomware and data breaches, but also new threats coming to light as they adopt cloud services and also try to hire enough qualified security professionals to keep their environments safe. All in all, I think demand is strong, attention for cybersecurity is high, and there's a long-term positive secular trend in place, which gives us great comfort towards the three-year plan we highlighted for you. Diving into our results for the quarter. At our Analyst Day in September, we updated you on our Company's strategy and outlined our three-year financial targets. The last three months have bolstered our confidence in this strategy in the numbers that we shared with you. We were extremely happy with our Q1 performance, which was ahead of our guidance on all measures. We saw revenues grow 32% year-over-year, our fastest Q1 in five years. Coming on the back of a strong Q4, our billings grew 28% year-over-year. Q1 strength was broad-based with exceptional performance from our hardware business, but also strength in our Prisma, both SASE and Cloud. Hardware strength fueled 25% product growth in Q1, a result of strong orders that we talked about on our Q4 call, but also a continuation of this trend in Q1 with our ability to ship those orders to our customers. Based on our strong performance in Q1 and visibility into our hardware pipeline in the second quarter, we're going to be raising our hardware forecast for the year in subsequent quarters. Within our business, we continue to drive transformation towards a higher mix of software solutions as we continue to bring new innovations to market. You see this in our next-generation security ARR, which continues to increase with our business mix. Growth in our NGS solutions was driven by Prisma, SASE and Cloud. We balanced profitability well, with non-GAAP operating income growing 9% year-over-year and non-GAAP EPS was $0.07 ahead of the midpoint of our guidance. The $554 million in adjusted free cash flow is the largest we have ever reported in a quarter as a company. Beyond our financial results, we continued to see industry accolades highlighting the strong position of our best-of-breed products across ASCI platforms. I will always maintain that to be a leader in cybersecurity, we have to be the leader in innovation in cybersecurity, something I personally believe has not been practiced in past decades by cybersecurity companies. I'm delighted to see that we came out of FY 21 with a recognized strong position in six product areas. In Q1, we continued our position as a leader in the Gartner WAN Edge Magic Quadrant where again, we were named the leader for the 10th straight year in the Gartner Network Firewall Magic Quadrant. Additionally, we added two new awards being named a leader in Forrester's Zero-Trust Network Access, New Wave, and also a Strong Performer in Forrester's XDR New Wave. We look forward to earning further industry recognition driven by our strong innovation pipeline, as well as the efforts of our product teams across the world. Diving deeper into our three platforms. Starting first with our Network Security business. We're benefitting from having the industry's most comprehensive platform across hardware appliance, virtual appliance, and as-a-service form factor. Supported by a consistent set of security subscriptions and world-class customer support. We continue to innovate rapidly in network security, with announcements we made this week at Ignite, that I encourage you to review, if you haven't already done so. Appliance demand was strong as our team capitalized on the broad opportunity across network security. As the pandemic conditions eased and offices started to open up, we saw an uptick in refresh activity. Our new appliances, with improved price performance, saw strong demand from both new and existing customers. We saw strong competitive win activity as customers looked to standardize on our broad network security platform. Lastly, we did see some impact from pricing actions and customers that were ordering product based on concerns around lead times and availability. These forces combined drove 25% growth in product revenue in Q1, a significant re-acceleration as strong demand continues into Q2 as well. Let me comment a bit more on the supply chain challenges that the entire industry is dealing with. As you have seen, despite the challenges, we have managed to deliver against our orders. There have been some longer lead times for some of our customers, but overall, I think our teams have done a phenomenal job managing in this environment. We will continue to do our best effort to manage over the next few quarters. I expect these challenges to dissipate over the next six to nine months and we will do our best to continue to navigate. During this period the industry will probably end up having lead times, which are two to four weeks more than normal. The scarcity of some components and needs to expedite our causing some short-term cost increases, which we are managing within the overall budget envelope at Palo Alto Networks. We expect to be able to manage our expenses within our guidance outlined to you for the full year. We do expect, though, that given the vagaries of supply chain, we will not be able to beat them as aggressively as we have been in the past. Our focus is on making it easy for our customers to consume firewall technology across public cloud and on-prem deployment. We introduced firewall Flex late last year. On the back of this, have nearly 1000 customers that have taken advantage of this license agreement. We continue to take share in the firewall industry. But even as our various form factors, firewall as a platform, billings grew 29%, the fastest growth we have seen in almost two years as customers consolidated on network security spend with us on account of the breadth of our product line and our leadership position in each area. Software was 37% of our F5 billings Q1, continuing to transition to a higher mix of software. Switching to SASE. Prisma SASE continues to be a source of strength in our business as our customers proceed on their journey towards a permanent state of hybrid work. We see many customers in the very early stages, as this journey involves network transformation to enable access to all apps from any location. Only Palo Alto Networks can provide a comprehensive solution with our consistent network security platform across all form factors. We see many customers in our installed base recognizing this. So far, they have 1400 of our over 57000 next-generation firewall customers that have adopted our SASE technology, our Network Security sellers, and channel partners are becoming increasingly proficient in this natural extension of our core firewall offering. And we see this as a continuation of our growth in this SASE space, allowing us to gain share in firewall as a platform, as a category, as well as in SASE. Overall, we saw our SASE customers grow 61% year-over-year at over 1700. We're happy with our progress selling SASE into our installed base. What is also interesting is over the last 12 months, we have seen more than 25% of our SASE customers come from outside of our installed base, which is not just exciting to see because customers are choosing our Network Security stack, despite having other firewalls. It is also a sign showing that in the future you can expect to share our innovation in hardware and software firewalls through SASE customers, allowing us once again to expand our installed base. We believe this is an important indicator, not just on the competitiveness of our SASE offering, but also an opportunity for us to provide a comprehensive Zero Trust architecture to our customers. Switching to Prisma Cloud. Our Prisma Cloud business continues to benefit from the dual drivers of customer adoption of hyper-scale public cloud technology, as well as the growing awareness and need for security in cloud environments, as I've noted earlier. They introduced significant new enhancements to our Prisma Cloud offering this week at Ignite. And again, I encourage you to check out the highlights from the session that Lee and our CMO, Zeynep hosted on Tuesday. Total Prisma Cloud customers grew 26% year-over-year. Beyond customer adds, we remain very focused on customers consuming credits across our platforms. Credit consumption increased to 2.21 million in Q1, including strengths from some of our new modules. Credits being consumed are validation of customers deriving value from our products. Beyond this broadening of consumption, we are also seeing an uptick in expansion as renewal volumes grow and greater participation in Prisma Cloud from our channel partners. This is all important as we grow the business and focus on SaaS economics. We have continued to see strong results from Bridgecrew. As a reminder, Bridgecrew has a sales motion where they target developers and combined with this popular open-source offering Checkov, we have seen strong traction in the market. On a standalone basis, a five-figure opportunity is a large deal for Bridgecrew. As Palo Alto Networks, we're seeing these deals get substantially larger as customers understand how to leverage Bridgecrew in our comprehensive Prisma Cloud roadmap. This quarter Bridgecrew was an important driver of a $1 million deal in the insurance vertical. Overall, Prisma Cloud is leading this important trend towards securing the cloud-native environment. It's clear that the market has caught onto this trend that we identified early and has been aggressively funding companies in cloud-native security, as you might have noticed. I believe we do more ARR in one quarter than pretty much the annual ARR of most of these companies that are being funded at extremely lofty levels. We are growing quickly and executing well across the Cloud where we believe we have a long-term ability to win. Switching to our security automation capabilities. Our Cortex platform continues to deliver innovative integrated capabilities, unifying our market-leading technologies across XDR XSOAR in Expanse. Total customers across XDR Pro and XSOAR reached almost 2800, increasing over 75% year-over-year. Beyond new customer transactions, we also saw an increase in expansion on the back of increased general activity in Q1. Our Cortex products again received strong industry recognition. XDR was identified as a strong performer in the 2021 Forrester XDR new tech wave. This was based on our 2.9 version in early Q1. We just released XDR 3.0. 3.0 significantly enhances XDR's capability in the Cloud, and also includes a built-in forensics response capability to help SOC teams automate the full lifecycle of threat detection, investigation, and response. XSOAR continues its leadership position, being named a leader in the GigaOm store evaluation. We also continue to see traction on the partnering front as well across Cortex. We saw strong partner activity continuing around the XSOAR marketplace, with over 80% growth in bookings influenced by our systems integrators and MSP partners around Cortex. At Ignite, we have just launched an XMDR partner specialization with our partner program, with launch alliance partners including PwC, Orange Cyberdefense, Critical Start, and Trustwave. On the back of very strong large deal performance in Q4, we followed this up with strength in Q1. Driving a broad, repeatable, and efficient large deal motion is a key initiative for our sales organization in FY 22. Amit Singh, our Chief Business Officer is focused in partnership with our President, BJ Jenkins to drive deeper multi-platform relationships with a wider cohort of our customers. While Q1 is seasonally our lightest quarter of the year, we closed 160 seven-figure deals within the quarter. Furthermore, the total dollar value of the seven-figure deals signed in the quarter was up 36% year-over-year. Our millionaire customers were 1,025 in Q1, approximately 29% year-over-year. This is our 4th consecutive quarter where year-over-year growth in millionaire customers was north of 30% or close to. Turning to some of our larger wins in the quarter, there are several trends that should be evident in these large deals. First, we're seeing success with multi-product adoption. Second, customer commitments are increasing in size, reflecting both the growing importance of cybersecurity, as well as our leadership position across our platforms. The value of our large deals is up materially year-over-year, and growing faster than our business overall. This is becoming a more repeatable process for us, and is also an area for us to continue to mature and drive efficiency in our sales organization. Third, there are a few areas of success emerging where you see trends. These include an uptake in proxy replacement, significant expansion in SASE deployments in the back of initial purchases driven by work-from-home. Standardization of Prisma Cloud across customers' cloud footprints and consolidation across customers' network security architecture. We highlight these deals because they are in line with our strategy to lead in each of our platform areas, and also to drive cross-platform success. Bringing it all together. As I said, I think we're on a much stronger, long-term secular trend for cybersecurity, and Palo Alto Networks is uniquely positioned in that trend to be able to leverage all of our investments and innovations that we've made in last year across all three of our platforms. We've had a strong Q1. I'm delighted by the innovation and execution of our teams. We laid out our strategy for the year and our medium-term vision in mid-September at Analyst Day, and we remain focused on these areas. We aspire to build a durable business and lead the industry through this unprecedented period of growth. Our focus is on driving innovation, embedding in all three platforms, embedding AI or machine learning across our platforms to shift the balance between our customers and cyber adversaries. We leverage our scale to grow our business and drive efficiencies across the company in order to be the trusted security partner for our customers. Our revised guidance for the year reflects broad-based strength across our portfolio, resulting in higher revenue and billings for FY 22. We're holding our EPS guidance for the year to make sure we can deliver on strong demand with the current supply chain backdrop. With that, let me turn the call over to Dipak to go into more detail on the Q1 performance and our guidance.

Thank you very much, Nikesh, and good afternoon, everyone. Please note that all comparisons are on a year-over-year basis and financial figures are non-GAAP, unless specifically noted otherwise. We delivered ahead of our guidance provided in August across all metrics as we continue to grow and transform our business. In Q1, the acceleration of our topline continued driven by strength in our broad portfolio, including both our appliance offerings and our next-generation security offerings. For Q1, revenue of $1.25 billion grew 32% and was above the high end of the guidance range. Growth was driven by product revenue in all geographies and all three platforms. Total deferred revenue in Q1 was $5.16 billion, an increase of 31%. By geography, Q1 revenue growth was strong across all regions. The Americas grew 30%, EMEA was up 35% and JPAC grew 38%. Next-generation security or NGS ARR finished the quarter at $1.27 billion, continuing a steady growth trajectory. Within NGS, we saw exceptional strength in our Prisma platform, as well as XSOAR and XDR. In the first quarter of 22, we delivered billings of $1.38 billion, up 28% and above the high end of our guidance range. As a reminder, billings is total revenue plus the change in total deferred revenue. NGS billings of $366 million grew 38% year-over-year. Remaining performance obligation, or RPO, was $6 billion, increasing 37% with current RPO growing in line with total RPO. As I mentioned at our Analyst Day, we believe RPO adds meaningful insight into our future revenue, as it includes both prepaid and contractual commitments from our customers. As we also forecasted during our recent Analyst Day in September, our appliance business accelerated in Q1 as we achieved 25% year-on-year product growth, the fastest product growth in ten quarters. This was ahead of our guidance of low double-digit growth, as we saw both fulfillment of strong Q4 orders and also follow-through in demand in our Q1 orders. Customer reaction to the new appliance launch in late fiscal year '21 has been positive. As Nikesh noted, strength in our appliance business was broad-based. And while refresh was a positive driver, we also see signs that demand is sustainable beyond this refresh activity, as customers returned to pre-COVID patterns of purchasing. Subscription revenue of $579 million increased 35%. Support revenue of $373 million increased 33%. In total, subscription and support revenue of $952 million increased 34% and accounted for 76% of our total revenue. Gross margin of 74.4% was down 140 basis points year-over-year as we incurred additional costs related to appliances. We will continue to ensure that we are focused on enabling shipments to our customers in the current environment. Operating margin is 18% which was up sequentially and down year-over-year, as we absorbed the strong rate of hiring we had in the second half of fiscal 2021. Our operating expenses came in below our forecasted levels, as we focused on driving operating efficiencies to offset higher input costs on our products. Net income for the first quarter grew 8% to $170 million or $1.64 per diluted share. Our non-GAAP effective tax rate was 22% and our GAAP net loss was $104 million or $1.06 per basic and diluted share. Turning now to the Balance Sheet and Cash Flow Statement. We finished October with cash equivalents and investments of $4.4 billion. Days outstanding on sales was 74 days, a decrease of 7 days from a year ago, driven by a combination of strong collections and improved billings linearity. Cash flow from operations was $589 million and we generated record free cash flow of $554 million with a free cash flow margin of 44.4%. It's also worth noting that in Q1 we moved our customer count methodology to active customers from our historical method of sold-to customers. As we continue to transform our business with the growth in software form factors and ARR-based solutions in next-generation security, it's important for us to mature our customer acquisition, retention, and expansion framework. As we are increasingly focused on active customers internally, we believe it makes sense to align our external reporting in this way. In the appendix of our presentation, we've adjusted the customer counts provided over the last five quarters in our investor slides to conform to the active customer methodology. Our capital allocation priorities as outlined in our September Analyst Day are unchanged and aligned with the optimization of long-term shareholder returns. The pillars of our total shareholder return framework were in action in Q1. We delivered industry-leading growth for our revenue scale, highlighted by 32% revenue growth and the highest Q1 growth rate Palo Alto Networks has reported in five years. We're focused on investments that will continue to sustain this growth, while delivering EPS ahead of our guidance and the street for Q1. We did this with a bias towards making sure we can fulfill customer demand while driving operating efficiencies, to help offset higher product related costs. We believe this additional expense is a good investment for us as accrued value in our long-term customer relationships. Our free cash flow margin of 44% for this quarter was strong and puts us on track for our annual and multi-year goals. We remain focused on share repurchases as the largest use of our free cash flow generation. However, there were several material events in the quarter that made it challenging to buy back stock, including our mid-quarter Analyst Day and the transfer of our stock listings to NASDAQ. We will continue to be opportunistic buyers of our stock as you have seen over the last 12 months. We have a billion dollars remaining on our share repurchase authorization, expiring at December 31st, 2022. Lastly, regarding TSR, as many of you may have noticed in our 2021 proxy statements, our compensation committee updated the executive compensation program at Palo Alto Networks to include a TSR multiplier in our fiscal year 22 plan, aiming to better align executive pay with shareholder interests. We made a minor acquisition in Q1, Gamma Networks, which adds technology in the DLP area and was part of our next-gen product announcements this week at Ignite. As we have established the essential components needed for our platform strategy, we anticipate only incremental M&A activity in fiscal year '22 compared to the recent past. Now, turning to guidance and modeling points. As Nikesh mentioned, and you are likely aware, there are disruptions in global supply chains. Our teams have handled these challenges very well, although we did experience some additional costs related to product revenue in Q1. The guidance we're giving today considers the latest inputs we have around the supply chain and other factors. We do expect that we will incur additional costs of product in Q2 and the fiscal year, which we have factored in. At the same time, we're focused on driving operational efficiencies in our overall business to help offset this. In that context, we're pleased in our ability to hold our operating margin, EPS, and free cash flow margin guidance for fiscal year 2022. We note that at the high end of our guidance range, we would achieve the rule of 60, which was our aspiration at our Analyst Day, adding together our revenue growth and free cash flow margin. For the second fiscal quarter of 2022, we expect billings to be in the range of $1.51 billion to $1.53 billion, an increase of 24% to 26%. We expect revenue to be in the range of $1.265 billion to $1.285 billion, an increase of 24% to 26%. Non-GAAP EPS is expected to be in the range of $1.63 to $1.66 based on a weighted average dilution count of approximately 105 to 107 million shares. For the full fiscal year 2022, we expect billings to be in the range of $6.675 billion to $6.725 billion, an increase of 22% to 23%. We expect revenue to be in the range of $5.3 billion to $5.4 billion, an increase of 26% to 27%. We expect our next-gen security ARR to be $1.65 to $1.7 billion, an increase of 40% to 44%. We expect our product revenue growth percentage to be in the mid-teens year-over-year. We expect our operating margins to be in the range of 18.5% to 19%. And our non-GAAP EPS is expected to be in the range of $7.15 to $7.25 based on an average diluted count of approximately 106 million to 108 million shares. Adjusted free cash flow margin is expected to be in the range of 32% to 33%. Additionally, please consider the following additional modeling points. Based on the seasonality of spending we discussed last quarter, as well as progress during the year so far, we're forecasting we will deliver slightly more operating income in the first half of the year than we noted on our Q4 call. To help you further calibrate your modeling of our seasonality, we expect approximately 33% to 34% of our annual operating income to come in Q4, we expect our Non-GAAP tax rate to remain at 22% for Q2 '22 and fiscal year '22, subject to the outcome of future tax legislation. We expect net interest and other expenses of $6 to $6.5 million per quarter, and for Q2 '22 we expect capital expenditures of $80 to $85 million. For fiscal year '22 we expect capital expenditures of $205 to $215 million, which includes approximately $39 million related to our Santa Clara headquarters. With that, I will turn the call back over to Clay for the Q&A portion of the call.

Great. Thank you, Dipak. And to allow for broad participation, I would ask that each person only ask one question. And our first question will be from Brent Thill of Jefferies with Patrick Colville of Deutsche Bank to follow. Brent, you may ask your question.

Thanks. Good afternoon. Nikesh, when you think about some of the supply chain issues you're going through, are you seeing clients being willing to trade off for Cloud or are they accelerating their workloads faster to the Cloud and therefore, just substituting your solution there? Can you give us just the color of what you're seeing in customer behavior based on what's happening right now? Thanks.

Thank you for the question. Look, I think as Dipak highlighted and I said, we are seeing some customers get very sensitized around lead times and hence we are seeing them order ahead. We're also seeing customers think longer-term about what they want for capacity for the full year, hence we're seeing more visibility in terms of their needs on the hardware front. I am also sure that there is some substitution going on because we know that not every player in the industry has consistently delivered what we're offering to our customers. So there is some substitution going on in the market from other vendors to us, where they're already in the infrastructure as a first or second provider, or we have become a new provider for them. And outside of that? Yes, to some degree, we are seeing Cloud adoption continue to accelerate across the market. I think it's partly a function of the fact that people have made the shift to Cloud faster given the pandemic. I think there may be a marginal impact if people are running into the hardware issues, but it's not as widespread and broad-based as enough yet to call it a trend, but I'm sure on the margin that affects us there.

All right. Great. And our next question comes from Patrick Colville of Deutsche Bank with Sterling up to follow. Patrick, you may ask your question.

All right. Thank you so much for taking my question. Can I actually switch on to the NGS ARR? Very impressive as always, growing to $1.27 billion. I guess the sequential delta was maybe slightly less than we've seen with the recent trends. If my math's correct, about $90 million increase sequentially, which is about 8% sequential growth, which is a little bit below the trends we were seeing last year and before that. So can you just help me understand the puts and takes there of momentum around NGS, please?

There's a lot of momentum on NGS, Patrick, as we highlighted both in the Prisma Cloud side and the Prisma SASE side. As you experienced last year, NGS business is very heavily back-end loaded in terms of Q3 and Q4, because the teams spend a lot of time getting the customer to a place where most of the products are either a part of their Cloud transformation journey or their network transformation journey. The key word in all three is a transformation aspect. And transformational aspects require longer PLCs, longer discussions with our customers. We have ample confidence that we will handily meet our expectations for the full-year NGS ARR. We actually don't sweat the quarterly evolution because we look at it as annual pipeline, and as I said, we feel it's well in hand and I couldn't be more enthusiastic about it.

Great. And our next question comes from Sterling Auty of JPMorgan with Phil Winslow up next after that. Sterling you may ask your question.

Thank you. Hi everyone. I want to revisit the supply chain topic, which I know many of us are interested in. When you're speaking with your customers, do you have an idea of how much of the timing of these orders is related to lead time? For instance, if they’re just starting to engage in the first half of the year, could some of these orders have typically come in Q3 and Q4? Additionally, how much of this could be attributed to increased ordering as they explore more applications of the solution, like micro-segmentation and other Zero Trust architecture use cases?

That's a great question, Sterling. Honestly, if I were to rank the impacts we've seen, the 25% product growth is significant. We've recently updated part of our hardware portfolio, and traditionally, a hardware refresh leads to customers wanting the latest equipment and learning to anticipate these updates. This has clearly been the primary effect this quarter. The second impact, as you mentioned, is increased consumption and deployment requirements we're observing. You can distinguish whether a customer is pre-ordering or is a new customer. A new customer, who has never used Palo Alto before, is not pre-ordering; instead, they are transitioning to Palo Alto. This brings me to the third impact. Lastly, the fourth impact, which I estimate to be around 10%, relates to the ordering ahead trend.

Thank you. Our next question is from Phil Winslow of Credit Suisse with Saket Kalia up after that. Please proceed, Philip.

Great. Thanks, guys. Nikesh, just a question for you on Prisma Cloud. Obviously, you continue to put up good customer metrics as well as those consumption numbers. There's obviously been a lot of focus from investors on the lifecycle and Shift Left Security. Two questions here. Where do you think customers, in terms of their adoption of these technologies, what inning are we in? And then second, when you are winning these deals, what are customers telling you about why, what's the differentiation?

I have the pleasure of having Mr. Lee Klarich, our Chief Product Officer, and I want him to feel comfortable answering anything on these calls, so I'll ask him to chime in here. My brief comment is that when customers are partway through their journey and realize their homegrown tools or point solutions aren't the right fit for their infrastructure, that’s typically when we see significant engagements with Prisma Cloud. I’m not suggesting they don’t use us for specific cases—they do—but eventually, they recognize the need for a comprehensive product suite. Now, I'll let Lee discuss some of the Shift Left initiatives we're observing, including the recent announcement about Bridgecrew offering capabilities similar to Wiz, which involves over 18 types of scanning. We're also integrating our Shift Left Enable Prisma collateral into our enterprise platform for consistency.

Thank you, Nikesh. Many customers are still in their journey to fully operationalize cloud security, and they are also in the process of shifting to the cloud and understanding the various dynamics that need to change in order to fully leverage cloud architectures compared to traditional data centers. As we navigate these transitions, we are helping to facilitate these changes. I would like to highlight a few points. Firstly, we strongly believe that for cloud security to be effective, it must be integrated into the development and DevOps processes. This is why the recent announcement regarding the Bridgecrew integration into Prisma Cloud is significant. It allows the Prisma Cloud security capabilities to be incorporated into the CI/CD pipelines that developers and DevOps teams use to create their cloud applications, which is essential. Secondly, we have introduced agent-less security to simplify initial customer adoption, as well as maintaining support for a hybrid model that includes both agent-based and agent-less scanning, making us the only ones in the industry offering that flexibility. We are also focusing on cloud identity, permissions, and entitlements, and how these aspects impact cloud security, an area that has often been neglected. These features represent advanced capabilities that our customers are preparing to adopt. As with our personal cloud strategy, our objective is to remain ahead of these evolving needs.

Great. Thanks, Lee. Our next question comes from Saket Kalia of Barclays with Brian Essex. After that, Saket, please proceed.

Hey, thanks for taking my question here. Nikesh, I thought it was interesting to see on the Prisma SASE side, that roughly 1400 of the 1800 customers there are also next-gen firewall customers. And so the question was asked earlier about the short-term impact of substitution from one to the other. I'm kind of curious about how do you think about that long-term. Do you find the Prisma SASE is additive to customer spending or do you find that more often it is substituting or replacing what they are doing with Firewall? Does that make sense?

Sure. A few quarters back, my colleague, Mr. Lee Klarich, effectively pointed out that Prisma SASE customers provide us with greater lifetime value on a like-for-like basis and also present a lower total cost of ownership for them. With traditional hardware, if you have 1400 locations, you need to place a hardware device at each site and upgrade them for every new software release, which can be cumbersome. However, with Prisma SASE, we can upgrade all 1400 customers within just two weeks, enabling us to roll out multiple software updates each quarter. In contrast, our firewalls require a year to develop each significant release, and customers often take four months to deploy due to the discomfort with major changes. When we look back five years from now, we may consider it unwise to rely on physical upgrades. Additionally, I recently discussed this with a friend who owns an electric vehicle; my Tesla receives over-the-air software updates, while he has to go to a dealership for upgrades. In the long run, clearly, SASE is akin to the more efficient model of my Tesla versus driving to a dealership for updates. I believe SASE offers superior technical and security outcomes for customers, as well as better value for both us and the customers in the long term.

All right. Great. Thanks, Nikesh. Our next question comes from Brian Essex of Goldman Sachs with Ty Liani up after that. Go ahead, Brian.

Thank you, and thank you for taking a question.

Please give me a moment, Brian. Because it's his car, I forgot.

I’d like to direct this question to Nikesh or Dipak. We’ve noted some comments about increased costs associated with product revenue. In this inflationary environment, people are accustomed to higher prices. What strategies do you have to mitigate these increased costs, such as vendor consolidation or pricing adjustments? How are you planning to address these challenges?

Certainly. As Dipak mentioned, from a product revenue and cost perspective, some of our chip suppliers are requesting higher prices for the limited chips they provide. Currently, there’s no way to offset this; if you want a chip, you pay for it. However, at Palo Alto, we can manage it with other cost containment strategies that Dipak is overseeing. You might share some insights about the supply chain initiatives your team is implementing. It's quite interesting to note that this is one of our highest product growth quarters in recent memory despite the supply chain challenges. As you know, we can’t record sales until products are shipped, yet we have managed to do both. Clearly, Dipak's team is making significant progress.

Let's go back to your overall question. We consider all the different options, including the price increase we implemented in September in the U.S. and on November 1st internationally. We view that as a potential strategy. Fundamentally, one of the advantages of having strong demand is the visibility it provides. With that strong demand and longer lead times, we have indeed extended our lead times by a couple of weeks, as Nikesh mentioned. This extension gives us greater visibility, and our world-class team uses that to try to close the gap as much as possible. Additionally, the strategies we are exploring include evaluating all our vendors to identify cost reduction opportunities, leveraging our scale, examining our payment terms to lower costs, and reassessing all our suppliers. Overall, I would describe our approach as very balanced within the framework of considering total shareholder value.

And our shift to software helps.

Okay. I was muted as well. Next question coming from Hamza Fodderwala of Morgan Stanley, with Adam Tindle to follow. Hamza, you may proceed.

Hey guys. Thank you for taking my question. Maybe just a quick one for Dipak, in case he's getting lonely there. Dipak, you gave a really strong total RPO number. I'm wondering if you can tell us what the current RPO was. And do you think that these CRPO metrics are going to be a cleaner metric to gauge parallel to those underlying bookings growth as you shift more from hardware to software?

Thanks. So in my prepared remarks I actually did say that current RPO grew at the same rate as total RPO. So I do think that both are important. The reality is, I think total RPO is critically important because that's all of our future obligations. I think current RPO is what I spent a lot of time looking at because that really gives you a good understanding of your predictability of revenue over the next 12 months. I think both are important. I think the macro comment is RPO is important. You have to look at both. You have to look at your contract lines, you have to look at everything and anything around RPO and candidly, I'm surprised that more companies don't spend more time on it.

Great. Thank you. And our next question comes from Adam Tindle of Raymond James, with Rob Owens up next. Adam, you may proceed.

Great. Thanks for taking the question, Nikesh. I wanted to ask on go-to-market, and maybe you could tie in some feedback from new management members like Ahmed and BJ since joining. But kind of a two-parter. First, on the core sales team. On the last call you talked about them driving the majority of Cortex revenue, and I'm wondering if that's something that you could continue to drive that motion and apply to areas beyond Cortex. And then in channel, you had an inflection in partner-led deals this quarter in Cortex. If you could maybe double-click on the drivers of that and what the team can do to push further into other areas beyond Cortex. Thank you.

Thank you for the question. Having BJ here has been fantastic. Amit is in a room elsewhere during a CIO meeting, BJ is in Europe, and I’m here on the earnings call. This arrangement allows us to reach more customers. On the topic of Cortex, we’ve been on a journey, recognizing the potential of the Cloud early on. We’re fine-tuning our approach and have started enabling channel partners, which has increased our capacity to engage with customers regarding Cloud solutions. This market is still emerging, but I believe it will grow significantly in the next five to seven years. This explains the high valuations of startups in the space. I am confident that we are 18 to 24 months ahead in terms of our comprehensive platform. We are actively engaged; Palo Alto has more engineers focused on Cloud security than many startups combined. We're not concerned about our capabilities. We need to remain flexible and enhance our go-to-market strategies. Therefore, you will see us continue to strengthen our Cloud and Cortex go-to-market efforts. We are also developing some exciting product upgrades in our XDR and Cortex areas, which we'll discuss in future calls. This gives us confidence that by continuing to penetrate the market with XDR, we will create a substantial total addressable market for the future, reinforcing our third pillar. Additionally, in the last 90 days, I have met more CIOs personally than I did in my first three years at Palo Alto. This is not due to past inaction, but rather the opportunity to engage with them, as we now have a comprehensive cybersecurity platform. Many CIOs are expressing that point solutions aren’t effective, and they are transitioning to the Cloud, seeking a single vendor for their entire stack. That’s the update on our go-to-market strategy.

All right. Great. Thanks, Nikesh. Our next question comes from Rob Owens of Piper Sandler, followed by Irvin Lu. Rob, you may take your question.

Great. Good evening and thanks for taking my question. Curious on the federal fronts, given your end of quarter did span the end of the federal fiscal year, how things came in. But I think more importantly, what you're seeing in terms of pipeline for the ensuing quarters, given it feels like a more linear federal spend coming. Thanks.

Thank you for your question. As we mentioned at the end of the last quarter, the new administration is still in the early stages of organizing their processes. We experienced significant Fed business at the conclusion of their fiscal year, coinciding with the midpoint of our quarter, which was strong. What is even more encouraging is that I had the opportunity to speak with Ginny Easterly at our Ignite event, where it was evident that the U.S. government is making a serious commitment to cybersecurity. This commitment is reflected in various infrastructure bills that allocate specific funding for cybersecurity initiatives. It’s clear that the federal budget is increasingly considering cybersecurity expenditures. However, as is typical with government actions, these decisions are carefully considered and progress may be slower than what analysts and CEOs would prefer.

All right, thank you. Great. Next question is from Irvin Liu of Evercore with Matthew Hedberg followed by Urban, You may ask.

Hi, thanks for taking the question. You highlighted the completeness of your current platform, in that any acquisition in the near term would be incremental versus large scale. But I wanted to better understand how do you weigh build versus buy decisions looking ahead? And which areas of the market do you see yourselves potentially having a product gap?

We have been very clear about certain market areas where we've found success through API or connectivity. For instance, in identity access management, we see plenty of strong competitors, and entering that space wouldn’t add value. Similarly, we’ve avoided email security because we think that many will eventually move to platforms like Google, Microsoft, and Proofpoint. We've identified some market areas that are worth pursuing. Three years ago, we recognized the significant opportunity in Cloud and acted early on it, anticipating the creation of numerous new security products for that environment. We integrated with about six or seven companies in that space, which has led to promising results. We recently announced a significant new technology for Prisma Cloud, which has shown growth this quarter. Many startups in this sector are being valued at around $6 billion to $8 billion, a price I’m not willing to pay for that annual recurring revenue, especially since I already possess similar revenue multiples. Our focus is on the Cloud Security area and any disruptive technology that could lead customers to replace their current solutions. This trend is evident in the XDR market, which is transforming the endpoint space. Our firewall teams are also able to upsell new capabilities. For instance, we just launched a next-generation CASB product, which I believe will outpace existing solutions in the market. Over the past three years, we’ve identified the need for improvements and have shifted toward building rather than acquiring, as we already possess a significant portion of the necessary capabilities. However, we haven't yet seen a compelling new area that excites us enough to pursue urgently. Nonetheless, we continue to review around five to twenty companies each quarter, not with the intent to acquire but to gauge their relevance and contributions to the industry.

Our next question from Matthew Hedberg of RBC followed by Keith Bachman. Matt, go ahead.

Hey, thanks guys. The question for Nikesh or Lee. I think what stood out to me is you said 25% of SASE customers are from outside your core, which was great to hear. And I think really to the point of some of the earlier questions on Palo Alto is not only a consolidator, but also best-of-breed in these cases. Can you talk to how that trend has progressed, are you seeing other things like that in other segments like Cortex, XDR, Prisma Cloud?

Yes. First, your comment on being best-of-breed, not just consolidators, that is a 100% spot on. Our focus from a product perspective is everything we do. We strive to be best-in-class in that specific area, such that when we bring it together and integrate it for our customer, it truly adds value and not just reduces the number of vendors they have to do business with. And so along those lines, that's what fuels the number that you saw in terms of SASE adoption from net new customers to Palo Alto Networks. And it's a great starting point and it's an opportunity for us then to expand into other areas of network security, Prisma Cloud, Cortex after that. We've also shared similar numbers for Cortex in the past where we see a similar level of adoption of customers that come in for the very first time into XSOAR, into XDR, into Expanse. And quite frankly, Prisma Cloud is right up there as well in terms of net new adoptions. All of that has been made possible by being best-in-class in these different product areas and then affords the opportunity to expand in some cases fairly rapidly once they get in successful with the first product.

Great. Thank you, Lee. Our next question comes from Keith Bachman of BMO with Michael Turits next. Keith, go ahead.

Thank you very much. I’d like to return to the supply chain if I could and direct to this to you, Dipak, sir. Can you help us understand what the price increases have been for your products thus far in the anticipation going forward? Just trying to understand what the impact to the topline may have been from price increases. And then the corollary question is, can you give us any quantification associated with the margin impact? You mentioned it was negatively impacted for the quarter and would likely be for the year. Just wondering if you could flush that out. I know you're offsetting with the OpEx line and doing a good job of holding the margins, but I'm just wondering if you could quantify the costs associated with it in terms of the supply chain impact. Thank you.

Let me just start off with your comment about pricing. We took pricing on September 15th in the U.S., November 1st, internationally. The amount that you really see in Q1 is quite minimal in terms of that, because you'll see the majority of that come through in Q2 and beyond. I wouldn't say there's much there in our results to date. Obviously, it has been factored in our guidance. When it comes to the actual cost, that's been a couple of million dollars. Like for Q1, we expect that will continue in Q2, Q3, and beyond. And as I mentioned before, we're looking at everything on the table from OpEx to other things that we can do with our suppliers to offset, to the best of our ability. That's why we've really held off guidance where it is, just to give us enough flexibility to manage the next few quarters.

Well, we had a soft microphone on Dipak. We'll try to get that into the transcript if you didn't catch that. Our next question comes from Michael Turits of KeyBanc, followed by Jonathan Ho, who will be our last question for today. Michael, go ahead.

Thanks. Nikesh, a few quarters ago you noted that there were some go-to-market challenges for both Cortex and Prisma Cloud in relation to competitors. Can you provide an update on the discussions you've had? Do you now feel that you need to address these challenges? Are these product lines generating enough to support next-gen ARR as you expected for this quarter?

Michael I want to leave you with a historical perspective. Three years ago we were not in these businesses; 18 months ago is when we launched many of these products. So today, am I delighted with where we are? A 100%. Are we ahead of my expectations? For sure. Do I have high expectations going forward? Yes. Have we cleaned out some of the stuff? That's my job. Every day, every week, we clean out stuff in our processes to make sure our go-to-market capabilities, our product capabilities get better and better. As to the specific issues we were dealing with in Prisma Cloud and Cortex, we've hired some new people, they are doing a phenomenal job. This past quarter, we expect them to continue that job. Based on the visibility we have on Prisma Cloud front, similarly in the Cortex front, we're in a highly competitive market, yet we continue to deliver on our expectation and exceed them. Like I said, XDR is strategic in the context that I believe, overtime, there will be a convergence between what we do in XDR XSOAR and our teams are working hard towards making that happen. Also, I would highlight that we do in Expanse, so we think we have critical mass in that Cortex space to really, really continue to build product capability over time, bring them to build that into a very large business. Similarly, on Prisma Cloud again, I think you can see from all the valuations people are getting or not. If it's not value, then we'd say it's a validation that everybody has identified that as a big area. And I honestly believe that, I'm not just saying, I believe that our teams have worked hard towards building an early lead, and our job is to keep, sustain that lead, strengthen our product continually, and make sure that capabilities are made apparent to our customers.

Great. And our last question for today comes from Jonathan Ho of William Blair. Jonathan, please ask your question.

Thank you for squeezing me in. Just wanted to get a sense of where we are in terms of the return to work and refresh cycle uptake. And what is giving you the confidence that these trends will sustain longer-term? Thank you.

Thank you for the question, Jonathan. In the past 90 days, I've had the opportunity to meet significantly more CIOs than I have in my three years here. Each discussion has focused on how they are adapting their information security and IT infrastructure to the changing market conditions. The new reality is that most companies do not anticipate everyone returning to the office, and they are seeking consistent architectures. We've observed an increase in cyber attacks over the past year and a half, particularly related to remote work and VPNs, as organizations had to rely on their older VPN technologies to function globally. This situation is recognized as a new threat. CIOs are considering how to develop sustainable network architectures long-term. In addition, their Cloud transitions have evolved; three years ago, many were hesitant about cloud adoption, but now nearly all are utilizing multiple cloud services. There is a significant trend supporting both SASE and Cloud opportunities. If I were to use a sports analogy, I would say we are still in the early stages of the game.

I understand that one. Thank you.

It's alright. I don't understand the first one either. So, it's all good.

Fantastic. Well, with that we're going to conclude the Q&A portion of our call today, and I will turn it back over to Nikesh for his closing remarks.

Thank you everybody for joining. And I just want to reiterate in my three and a half years of being here, I haven't felt more bullish in the business as I feel today, given the visibility into the pipeline and the results our teams have been able to deliver in Q4, as well as the visibility we have going into our three-year plan following the first quarter. I want to thank you for attending. I look forward to seeing you in upcoming investor events, as well as I want to thank all of our customers, our partners, and most of all our employees around the world for putting in the hard work to get us where we are. For that see you next time.