Q3 2022 Palo Alto Networks Inc Earnings Call
This call is being recorded today Thursday May 19, 2022 at 130 P M Pacific time.
With me on todays call are Nick <unk>, our chairman and Chief Executive Officer, and Deepak Galicia, Our Chief Financial Officer, Our Chief product Officer, Lee Klarich will join us in the Q&A session. Following the prepared remarks, you can find the press release and information to supplement today's discussion on our website at investors that Palo Alto networks Dot 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 or projections that involve risk and uncertainty that could cause actual results to differ materially from the forward looking statements made in this presentation. These forward looking statements are based on our current beliefs and information available to management as of today risks uncertainties and other factors that could cause actual results to differ are identified in the safe Harbor statements.
In our earnings release and presentation and in our SEC filings Palo Alto networks assumes no obligation to update the information provided as part of today's presentation.
He 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.
Filed with the SEC and can also be found in the investors section of our website. Please note that all comparisons are on a year over basis.
Specifically noted otherwise we.
We would also like to note management is scheduled to participate in the upcoming Jpmorgan Jefferies and Bank of America Investor conferences in the next several weeks I will now turn the call over to cash.
Thank you clay.
Good afternoon, everyone and thank you for joining us today for our earnings call.
And this time of increased macroeconomic volatility and geopolitical uncertainty we saw a combination of strong cyber security market demand and our team's execution in.
In line with our strategy to drive our Q3 financial results.
We reported strong top line metrics of both billings and our apio growing 40% year on year.
The highest billings growth, we have reported looking back over the past few years four years.
It's driven both by strong demand for our next generation security offerings and strong customer commitments to our network security business.
The network security, we saw product again grew over 20% as we continue the transition to software.
Customers continue to consolidate the network security to follow Up's network as a result of the significant expansion in our subscription capabilities over the last several years.
Our net security IRR ended Q3 at 161 billion up 65% year over year.
Our top line performance translated into non-GAAP operating income that grew ahead of revenue enabled strong cash flow conversion.
<unk> that we were able to achieve these bottom line results despite challenges in the supply chain.
Speaking of the global backdrop, whether it is supply chain geopolitical conflict of rising interest rates and inflation. This environment is creating challenges for our customers and testing our execution I am pleased our teams have risen to the occasion and showing strong execution across sales operations in all areas that support the business.
The trend that started with the pandemic and the widespread cyber attacks the trend of network transformation cloud transformation and fortifying one infrastructure continued to be strong.
Coupled with consolidation in cyber security, we expect this to continue to drive spend and growth both for the industry and us in particular, given our unique platform approach.
Of course, the events of Ukraine on everyone's mind, we stand with the people that Ukraine against Russian aggression, and I've been working to provide direct service to support do creating organizations.
This geography has not been significant event for us in terms of revenue on our overall growth expectations for this quarter and our most recent quarters, our combined Russia, and Ukraine revenue was well below 1%.
Halted new sales in Russia, and we're also complying with all government sanctions.
Since December we have deployed protection for over 3400, new indicators of attack the different organizations from disruptive and destructive Russian cyber attacks.
As you might expect we are seeing heightened interest from commercial and government customers in Europe around mitigating this nation state activity.
Challenging threat landscape is dialing broader and more strategic customer conversations we continue to see our customers look for an elevated level of partnership and this is expanding our market opportunity.
We continue to see success.
In consolidated share within the enterprise market and this has become a core tenant of our growth strategy.
We see evidence of this in our multi platform sales at 48% of our global 2000 customers, having transacted now with us on all three of our major platform of strata Prisma and cortex.
The number of million dollar deals transactions, we signed was up 65% in Q3 and the average size of our million dollar deals increase in the quarter.
We also saw the number of $5 million deals increased by 73% year over year.
These are important selling motion for us as we further penetrate in global 2000 customers with our second and third platforms.
Innovation is the engine that underpins our growth in the market, which Gartner estimates will total over $250 billion.
And end user spending by 2026.
With a trend towards vendor consolidation in the market customers appreciate our best of breed capabilities within each of our three platforms. This quarter. We added four additional categories to the recognition we received for our best of breed capabilities remember, they're all integrated drug free platforms, so customers get the benefit of our platform as well as the individual <unk>.
Best of breed capabilities, which compete effectively against independent vendors in our industry.
Forrester recognized our position in cloud workload security with the leader designation in the air.
Inaugural wave in this market the only company to have the recognition.
Early recognition of the importance of attack surface management, which we entered through the acquisition of expense in 2020 was validated as we were recognized as an outperforming leader by Google.
We received strong performer designation from Forrester in two categories incident response and Edr.
I'll next provide you an update on our platforms and what progress we've made in the last quarter, starting with Prisma cloud.
But could you just continue to see strong momentum driven by both new customers and notable for this quarter logic upsell and expansion commitments, which drove 25 deals north of a million dollars.
This growth in customers and existing customer expansion is evidenced in our credit consumption, which grew 50% year over year in Q3.
We continue to drive cloud secured leadership across the industry and as I've said before all prisma cloud customers on inherently customers of Hyperscale knows yet they choose us customers are looking for a scaled integrated cloud security platform that prisma cloud provider, enabling us to deliver high double digit growth.
Our customers are increasingly recognizing that operating security in the cloud means ensuring the software that is written for the cloud is secure.
It starts with the developer.
Early observation of this trend led us to acquire breached through in early 2021.
We have been focused on building out our portfolio of offerings targeted at developers.
This is our fifth pillar of Prisma cloud cloud code Leverages all of the existing capabilities of Prisma cloud, including its approach to credit consumption deployment to reporting.
One quarter from release, you've seen success in six figure commitments to Prisma cloud driven by cloud code and also this is amongst the fastest modules adopted in Prisma cloud in terms of private consumption.
Critical to our development strategy, we continue to see strong downloads of our check all open source offering which reached over $7 million in Q3.
Moving onto cortex.
We are helping customers re imagine how they operate their security operation centers with automation and AI ml at the core.
<unk> customers grew over 60% in Q3 supported by multi product cortex transactions in EMEA and the Americas.
We achieved an important milestone in Q3 with approximately $500 million and cortex <unk>.
In Q3, we saw strength in each of our established cortex product areas with a record number of transactions for STR and expense and nearly that level of business with XR.
Xdr continues to shine with industry Awards and benchmark this quarter <unk> was recognized for 100% sure prevention and detection and the recent mitral evaluation Forrester.
Forrester also recognize the significant progress we have made with STR and a series of releases over the last nine months, recognizing xdr as a strong performer in its edr way.
Our expense performance with transactions up well over 100% of last 12 months shows that attack surface management is now seeing an inflection in mainstream demand.
After our recent limited release of <unk>, we are making progress in our goal to initiate co designed work with 10 partners and expect to be on track at the end of this quarter with our plans.
<unk> will ultimately enable us to achieve our cortex vision around stock automation, delivering what we expect to be a very unique value to our customers and disrupting the multibillion dollar Sim category by offering a modern alternative that leverages AI and ml.
Moving on to SaaS fee.
Last week, we made a call to the industry to adopt <unk> ushers in a new era of hybrid workforce security based on key zero Trust principles like least privilege access continuous trust verification and continuous security inspection across all apps, our mantra for Prisma access is to provide zero trust with zero exception.
The pandemic has accelerated the adoption of staffing in addition to the significant traction from our installed base. We continue to see strong momentum from net new customers for whom Prisma SaaS is their first significant purchase from US. These customers then become opportunities for incremental engagements across our other platforms.
<unk> saw particular success with large transaction in Europe as you signed 11 large transaction EMEA further endorsing the global nature of that demand. The sassy is in the early innings, and we're making significant investments to ensure we continue our momentum in this category.
Moving on to startup.
Hardware and subscription services platform.
For the third consecutive quarter, we delivered north of 20% product revenue growth.
Strength across our portfolio of both hardware appliances and software form factor.
As you're all aware the industry is dealing with unprecedented supply chain issues, which are likely to persist for yet another year or.
Our team is definitely managing these with our partners, allowing us to maintain better lead times and some in the industry.
We have seen instances, where we are advantaged in having supply our competitors cannot timely deliver and we believe this has helped contribute to market share gains.
We saw our momentum validated by third party recognition and market share gains in both hardware and will be a form factors and hardware on <unk>.
I recognize volatile networks is being number one in market share for the appliance market with over 27% share up more than five points year over year in the VM market. According to delauro, we added six points of market share year over year and come on nearly 34% of the market.
We continue to execute on our generation three to generation four transition you have now released nearly all gen. Four appliance models, although customers are very early in the evaluation adoption of Gen. Four we expect this gen. Four adoption will help drive our appliance growth rates ahead of the market growth rate.
We're seeing strong uptake of advanced the oil subscriptions and strong early demand for our new advanced threat prevention subscription release next generation casualty last quarter and saw solid Q3 performance here.
Lastly, we announced our second partnership with Hyperscale or to embed our network security into the fabric of their cloud. This is differentiated innovation that leverages, our engineering scale, our market leadership position and relationships. The Hyperscale cloud next generation firewall on AWS brings a combination of Palo Alto networks industry, leading network security and our cloud native.
Form factor and married it with ease of use of Amazon Web services <unk>.
This relationship with AWS follows the launch of cloud ideas on Google Cloud platform last July the.
We expect cloud next generation firewall will drive further growth of our firewall as a platform and specifically a software form factors. It also gives customers. Another reason to standardize on our network security platform innovations like cloud next generation firewall on AWS cloud Ids, and Google cloud and our licensing of security subscriptions to SaaS providers.
To protect their cloud applications are differentiators for us versus competitors competitors that are primarily focused on the appliance form factor.
Bringing it altogether, we were very pleased with our Q2 results, where we saw exceptional top line growth at the same time, even while growing faster we are prioritizing investments in delivering on the profitably targets. We committed during our September 2021 analyst day. We believe this is an important discipline and we intend to maintain this focus on profitability.
The targets, while maximizing growth.
We continue to see broadening demand for cyber security, which is enabling us to grow and invest from a position of strength.
As we focus on our mission to be our customer's cyber security partner of choice for today and Tomorrow. We also aspire to deliver to our shareholders outstanding returns as a proxy for growth of the cyber security opportunity as well as world class execution.
We're very pleased with the first three quarters, we have delivered so far in fiscal year 2022, we look forward to updating you in three months on our plans to continue accelerated growth balanced profitability and look and look at how we intend to target GAAP profitability in the near future.
With that I will pass the call over to Deepak to talk about our results in more detail.
Thank you Kash and good afternoon, everyone.
Our strong results continued to be driven by solid demand across the breadth of our offerings with results again ahead of our guidance across all metrics in the midst of top line strength, we balanced profitability well with the strength of this momentum and our favorable outlook. We are again, raising our full year guidance.
Our Q3 revenue of $1 $39 billion grew 29% and was above the high end of our guidance range product grew 22% and total services grew by 32%.
By geography growth was balanced across all theaters with the Americas growing 30% EMEA up 28% and Jay Pat growing by 29%.
<unk> grew 65% to $1 six 1 billion supported by balanced strength across this portfolio.
Noted in our Q2 earnings going forward, we focused on <unk>. It was one of our core metrics as we believe its indicative of the returns we're seeing on our growth investments and also helps investors track the growing mix of this business within our revenue.
We saw strong double digit growth across all of our major NDS offerings with Prisma cloud Prisma and cortex as well as growing contributions from recently introduced NDS offerings.
We are pleased with this diversified portfolio driven growth.
Overall this performance as well as the continued maturity of our go to market organization and selling our NDS capabilities gives us confidence to raise our annual guidance for Ngls era again in Q3.
In the third quarter of 2022, we delivered total billings of $1 8 billion up 40% and also above the high end of our guidance range.
Deferred revenue in Q3 was $5 9 billion an increase of 34%.
Remaining performance obligation or <unk> was $6 $9 billion, increasing 40% with current <unk>, representing a similar percentage of the total as in recent quarters.
Teams executed very well again in Q3 and you see the result of the strength in these top line metrics, which lead revenue.
There were a few factors to call out that drove the strength that we saw this quarter. In addition to the significant strength in our NGL business, we saw strength in our attach subscriptions.
We've seen customers use their budget to make incremental commitments to our attach subscriptions as they anticipate firewall upgrades and overall network security capacity increases.
Well, they're seeing the value and newest subscriptions, we report to the market over the last 12 months to 18 months.
This gives us further conviction around sustained demand for appliances as well as our software based FY form factors as customers look to benefit from our consistent architecture, including the subscription capabilities.
Product revenue again was strong growing 22% in Q3 with demand exceeding our ability to ship to the supply.
Chain challenges.
We estimate customers refresh their products every four to seven years with many now evaluating our gen four hardware.
We're in the early days of this refresh cycle with only a small proportion having updated that products.
As I noted earlier, we are seeing signs of customers, making commitments to our hardware platform. Both based on strong subscription demand and also the beginning of our installed base refresh activity.
Our firewall as a platform billings grew 25% on top of the accelerated in Q.
Q3 growth in the year ago period.
We continue to see this performance well balanced across our Aqua form factors within our FY offerings, the strength of our product business held our QC software mix at approximately 39% in line with Q2 and the year ago quarter.
Turning to the details of our results product revenue was $352 million growing 22% subscription revenue was $640 million increasing by 35%.
<unk> revenue of $395 million increased 27%.
In total subscription and support revenue of 1.04 billion increased 32% and accounted for 75% of total revenue.
non-GAAP gross margin of 72, 9% was down 170 basis points. The driver continues to be supply chain related costs as we incurred additional expense to components and shipping.
Despite the pressure on our gross margins non-GAAP operating margin of 18, 2% was up 120 basis points year over year we.
We were able to offset higher supply chain costs with lower operating expenses as we drove efficiencies across the business.
non-GAAP net income for the third quarter grew 38% to $193 million or $1 79 per diluted share.
non-GAAP effective tax rate was 22% GAAP net losses were $73 million or <unk> 74 per basic and diluted share.
Turning now to the balance sheet and cash flow statement with.
We finished April with cash equivalents and investments of $4 6 billion.
Product and associated subscription shipments shifted towards three resulting in days sales outstanding of 71 days.
Cash flow from operations was $390 million, we generated adjusted free cash flow of $351 million a margin of 25, 3%.
With regard to capital allocation priorities, we did not repurchase stock. During Q3. However, we do expect share repurchase to be amazing use of cash flow as previously stated.
We currently have approximately $450 million remaining on our authorization for future share repurchases. This current authorization expires on December 31 2022.
On the M&A fronts, we did not close any acquisitions in Q3.
Managing stock based compensation remains a management focus this quarter, we reduced SBC as a percentage of revenue by approximately four points year over year and two points quarter over quarter. We will continue to apply discipline to this process, while balancing reductions against the marketing market dynamics, the cybersecurity dynamic town.
Key to our ongoing success is maintaining balanced top and bottom line growth, while continuing to acquire and retain top talent.
Lastly, moving to guidance and modeling points as Nick has highlighted we continue to see very balanced demand from customers across our portfolio. This includes demand for.
For our appliance form factors that outstrips, our ability fulfill to fulfill in the near term as well as strengthen our next generation security portfolio.
Our Q4 guidance takes into account the strong demand picture. The best information, we have today on supply chain and other factors recall that a year ago in the second half of fiscal year 'twenty. Two we were hiring aggressively as we move beyond that comparison investors should be considering the comments, we provided around medium term margin expansion goals.
<unk>.
Turning to our guidance for the fourth quarter of 2022, we expect billings to be in the range of $2 32 to $2 $35 billion, an increase of 24% to 26%.
We expect revenue to be in the range of $1 53 to 155 billion, an increase of 25% to 27%.
We expect non-GAAP EPS to be in the range of $2 two six to $2. Two nine based on a weighted average diluted count of approximately 106 to 108 million shares.
For fiscal year 2022, we expect billings to be in the range of 7106 to 713 6 billion, an increase of 30% to 31%. We expect revenue to be in the range of $5 four eight to $5 $501 billion, an increase of approximately 29%.
We expect next generation at <unk>.
<unk> to be $1 77 to five to $1 85 billion, an increase of 50% to 55% versus a very strong performance in the first fourth quarter of fiscal year 'twenty one.
We expect strength in product revenue to continue in Q4 with full year growth of 20%.
We expect non-GAAP operating margin to be 18, 5% to 19%.
We expect non-GAAP EPS to be in the range of 743% to $746 based on weighted average diluted count of approximately 106 million to 107 million shares.
We continue to expect an adjusted free cash flow margin for the year of 32% to 33%.
Achieving the rule of 60 was an aspiration, we called out in our September 21st Analyst day, the rule combined revenue growth and adjusted free cash flow margin based on our Q4 guidance. We're pleased to project that the combination will exceed 60% in fiscal year 'twenty, two which is ahead of our prior stated plan.
We've seen strong growth in fiscal year 'twenty two on our revenue on a revenue basis, our guidance for the year was $3 six higher.
At the midpoint than where we started and seven 5% higher at the midpoint for <unk>.
Along with this topline we've absorbed incremental supply chain costs and are happy to be able to continue to project. The same operating profitability range as at the beginning of the year.
Additionally, please consider the following additional modeling points, we expect non-GAAP tax rate to remain at 22% for Q4 and fiscal year 'twenty two subject to the outcome of future tax legislation for Q4 2002, we expect net interest and other expenses of $1 million to $2 million.
We expect capital expenditures in Q4 $36 million to $41 million and we expect capital expenditures for the full fiscal year of $190 million to $195 million, which includes $39 million outlaid in Q2, 'twenty two related to our Santa Clara headquarters.
Stepping back we're focused on balancing all drivers of total shareholder return.
Recognizing not only the importance of top line growth as we focus on executing strong market demand, but also profitability cash conversion and the capital structure.
<unk> profitability as a commitment we made at our analyst day, and we've been able to deliver on this in fiscal year 'twenty two despite increased costs related to our supply chain. We will continue to make progress on our commitment of 50 to 100 basis points operating margin expansion and 100 to 150 basis points of adjusted cash flow margin.
Pension beyond fiscal year 'twenty, two through 'twenty, four whilst balancing topline growth opportunity.
We're on track to achieving our fiscal year 'twenty four targets, we outlined that are outlined in our September 2021 analyst day, including $10 billion in billings and $8 billion in revenue.
We believe we can continue to deliver shareholders outstanding returns as a proxy for the growth upside of the cyber security opportunity as well as world class execution.
With that I will turn the call back over to clay for the Q&A portion of the call.
Great. Thank you Deepak to allow for broad participation I would ask that each person ask only one question.
Our first question will be from Phil Winslow of credit Suisse.
Hamzah firewall waterfall Gill you may ask your question.
Great. Thanks, guys for taking my question and congrats on another great quarter of execution now in a quarter, where a lot of numbers really jumped out.
173% growth in 5 million plus deals or the fact that nearly half the global 2000 purchase all three platforms free all really jumped out to US now if you put these numbers in the context of the upside with strider product revenue as well as a strong Christmas SaaS.
Customer counts.
What are customers, telling you about why they selected Palo Alto networks are registering an accelerated rate versus the traditional firewall vendors or the call. It the cloud Native zero Trust competitors, just increasingly understanding the value of the hybrid nature of the portfolio as a valuable three together et cetera, how do you see competitive dynamics playing out.
Phil I'm accused of speaking fast increasing.
Including peer beating me added so.
Thanks, a lot.
Thank you for the question Phil.
It's kind of everything you said.
And we've been saying this for a while that.
Cyber security is consolidating and the evidence we have been shown by people like yourself is look it's never happened before and I still submit that the reason it has never happened before because you didn't have a cyber security company, which would show you <unk> best of breed products in this portfolio.
Because customers are not suggesting they will buy.
Something you have because its senior platform. They are still demanding best of breed and were able to demonstrate to them. The best of breed, but not only that I think in the last three and a half years, we have been able to demonstrate our track record, saying is something as important these will make sure we deliver to you with best in class capabilities. So we're seeing that there is.
Allows us to go back into customers as you can imagine if all you've got is edr xdr to sell if the customers just bought it you've got to move on if all you've got SaaS, you've got to move on into customers bought chassis in our case.
Our sales teams have a very large bag of tricks. If you don't want SaaS, you've got cloud security going on let me talk to you about cloud security if youre on a cloud security going on yet do you want to talk about buy more firewalls or replacing somebody if you don't have that do you want me to help you automate yeosock. So just the ability for us to demonstrate that we can help them with their multi.
Due to their cyber security challenges and also show them that we're not trying to get them to make a very large commitment across all three of our platforms. They can work and then they can run they actually start by taking one of our platforms, allowing us to demonstrate our credibility and our security capabilities, thereby giving us the opportunity to bid for the <unk>.
Next business that they have and I think the $1 million deal of $5 million deals or just a way to look at it because 1 million. These are typically single platform deals and as you get into the fives and tens you certainly see that there is more of a portfolio approach.
It's what we said.
Awesome. Thanks, guys. Thank you for the good work thanks.
Sure.
Next from Hamzah <unk> of Morgan Stanley followed by a team of Lani Hamzah. Please proceed.
Okay.
Hey, guys. Thanks for taking my question I'll try to speak a little more slowly.
Maybe just on the consolidation theme sticking to that.
One just from a macro standpoint.
I'm wondering if you are.
Hearing anything different from customers around how they are thinking about the spending environment.
In relation to that given the macro pressures on it but just more broadly.
Are you seeing more of a willingness to want to consolidate to fewer vendors as opposed to multiple different point products yes.
It's a great question look interestingly, if you compare and contrast, what we're seeing today with what we saw about two and a half years ago three years ago. When the pandemic hit believe it or not there were more industries impacted by the pandemic. There are then are impacted right now by inflation concerns the oil industry is not stressing about it budgets.
The commodity industry is not stressing about it but the CBD industry is not stressing about it budgets. The tech industry is not worried about it but it's so it's funny. If you think about it the impact is yet to be felt in the companies and even when it is felt youll see it in some constrained industries because this services boom right now people conquered more Johnson.
We hired so we're not seeing the pressure from inflation or reduced economic activity perspective, I will tell you when the pandemic hit we were getting letters from CIO, saying listen our revenue has gone away. We're not sure when it's going to come back and I was going to come back oil prices were at zero for a few days. So at that point in time. They were all in in that scenario you described.
We haven't seen that scenario and.
I don't I don't want to.
Be way too optimistic, but the fact that we were able to tide over that pandemic moment as an industry to be fair to cyber security.
Im less worried about it right now given what's going on in the environment, because I think on the flip side as I said, you're seeing way more security awareness and concern more than I've ever seen them.
We don't hear about or until there is a bigger and some of our discussion publicly but trust me there going on right now as we speak.
Thank you.
Play.
Okay.
I don't know.
Yes next year between Laguardia from Athena. Please proceed.
Thank you for taking my questions I have.
Counting question and I'd like to ask him to be back.
On your billings performance just to unpack the strength there a little bit.
Can you contextualize any changes to contract duration.
Specifically reconciling some of the commentary on the negative volumes that you realized this quarter and also giving us maybe some flavors on.
Palo Alto financial services vehicle the financing arm that you introduced two years ago, and then thirdly, just around any discounts that we're peeling off from the Covid era, just against some of those dynamics that we should think about there really outside the billings performance. Thank you.
Couple of different questions ask Athena. Thanks for the question. So overall I would say I'll, let me just start off with the billings growth was really quite widespread or contract durations have remained roughly at around three years they've been around that.
That time at any one given quarter, they can change a little bit like a multiple to not not.
So.
It's possible that we get a little bit of which was the last year's fluctuation versus this year, but overall it was very broad based and we're not seeing really many issues related to that.
With respect to the Pan Fas.
The thing we had that in place for a while we're roughly at the same level of exposure that we've had before it's not massively growing.
It's really changing significantly on that so I don't think that and unpack like a reconciling item.
It really is like strength the overall business.
And sorry, just remind me the third part of your question.
Just in the Covid era. Thank you had been generous or flexible with your customers with respect to payment terms. It was me.
Maybe a point or two of impact of discounts are probably rolling option next year. Yes. There was has completely been flushed out of the <unk>.
Modestly trimmed back discounts, yes, that's how we track our discount is obviously very very closely we haven't really seen anything, particularly significant in our discount changes either.
So I would say that as you unpack the model it really becomes pretty clear that it's broad based growth.
Perfect. Thank you.
Okay next question from Brian Essex with Goldman Sachs, followed by Gray Powell, Brian . Please proceed.
Great. Thank you clay and congrats on some nice results for me as well I have a bit of a bean counting question as well.
Maybe for Deepak could.
Could you help us understand a little bit what's going on on the cost side of the equation really great job in this environment delivering on the operating me operating margin side. So I guess from a gross margin perspective impact of price increases and then from an opex perspective.
Where is it that youre getting better cost control measures and how sustainable are they.
So let me just start off with the cost pressures are really all within the supply chain.
Area.
We did take pricing, we took seven 5% pricing.
In September of last year, followed later internationally.
We monitor that all the time and we try to capture the <unk>.
Impacts, we will have a future inflation.
We've seen reasonably good realization of that pricing, which has been good.
But obviously the supply chain environment remains fluid.
I think when it comes to where we've been able to focus on our operating expenses to offset that it really is just a laser focus theres no magic silver bullet. It's just a laser focus on the execution, making sure that we're watching every single dollar acting like an owner.
Incredible intense scrutiny on travel because that was a concern of wood that come back with a vengeance, we focused a lot theyre looking at leveraging scale. When it comes to all the areas frankly, we've had good scale in R&D that scale in sales marketing good scale in G&A, but it's really just making sure that we're purposely looking at <unk>.
Every single head count.
And justify it.
And there's a lot of that sustainable I mean, <unk> I would imagine would be relatively flexible, but how much are you going back for sustainable cost measures.
I, but I think we're very comfortable with the sustainability.
As reflected in our guidance going forward, we just need to continue.
To act without that kind of diligence going forward.
Very helpful. Thank you great. Thanks, and next is gray Powell from BT.
All by cyclical Leah Brady. Please proceed okay. Thank you very much.
Congratulations on the great results.
So a question on the product side are 12 to 18 months ago, We're always taking a product revenue should be growing in lifestyle low single digit range and is.
Consistently been much better closer to 20% in the last few quarters.
So how should we think about the sustainability of product revenue growth going forward and then beyond the price increases that you called out earlier. This year is there anything helping product revenue growth in fiscal 'twenty, two that creates a tougher comp in fiscal 'twenty three.
Hello, Greg.
First of all we said this last quarter.
We have been positively surprised by the growth in product, obviously and Lee has a very interesting explanation.
Explanation on why people need more firewalls as an internet traffic goes and I'll, let him speak to it because otherwise you won't come to these calls along with that.
But before he does sabic we are seeing.
The Gen. Two gen four evolves, causing people to go through a refresh cycle is typically last 12 to 18 months. One is in full flow and it is not yet in full flow.
As we highlighted the market share changes.
But there are people in our industry, who are not able to keep up to 12 months to 18 weeks of supply chain sort of deliver firewalls, we have seen certain isolated incidences where.
Customers have drawn up deals for some of our competitors and chosen power networks, because we have product and others are not able to do that which the best way to measure that is through market share gains in these market share gains are some statistic, but they're not going to go away because you're buying something which has six to seven year life and are basically making a technology decision to switch to follow up on that one.
So I think the combination of market share gains a refresh cycle the increased volume and Lee do you want to give you. The explanation, yes, I think one of the.
Sort of misunderstanding, we could move to the cloud.
Everyone thought that that would be the death of hardware, but the.
Reality is you have all of these users that need to now reach applications running in the cloud in this.
Applications generally are higher bandwidth type applications, and so that triggers they need to upgrade the firewall infrastructure to be able to secure.
Higher bandwidth connectivity and so that that actually is a positive trend toward hardware sales and hardware requirements, especially as they come out of the pandemic and more and more companies are moving back towards a hybrid workforce, where more and more employers are showing up to the office as well for example.
Primarily in the cloud with our capabilities, but.
Yes, a few years ago, we had a pair of one gig links to the Internet at our main headquarters. We now have a pair of 10 gig links just to kind of give you an order of magnitude and I don't think thats, an unusual situation for for companies to be so despite us moving to the cloud we've had to upgrade our firewalls in our headquarter.
It makes a lot of sense.
Super helpful. Thank you very much thanks, Kurt <unk>.
Our next question from socket clear Barclays followed by Michael trips.
Please proceed.
Okay, great. Okay, guys. Thanks for taking my question here the cash maybe for you again going back to the billings great to see the acceleration maybe just to look at it from a different angle you've talked about some new attached subscriptions that some of them might be higher value of course, you've got the <unk>.
<unk> billings in there as well can you just talk to how much each of those are sort of driving that billings acceleration some of those newer attach subscriptions to the core firewall as well as debt NGF ceilings mine.
Well.
Thanks for the question you've seen we share our NGF spilling IRR with you. So it's quite transparent and you'll see that that number at that scale continues to grow in the 50%, 60% range, which is clearly.
Big contributor to our billings and <unk>.
Being a 20 person also contributes to the billings you've highlighted the cortex hit 500 million IRR in that number. So clearly it's reached a milestone for us in that entire mix and.
As you rightfully identified we have now 10 subscriptions that we run when I came two years ago yourself for so clearly you should expect that there is a significant attach.
That is going on which will persist as we continue to sell hardware and the <unk> and the current growth rates that we are so.
Higher growth in hardware drives.
More subscriptions and services, which are higher attach ends up giving us a nice lift on our billings.
Got it very helpful. Thanks, Super extra got Michael <unk> Keybanc, followed by Roger Boyd Michael Please.
Yeah.
Great. Thanks, very much for everybody. So I think Deepak I'll ask Hugh on the labor and wage front, we've seen given the given the shortages out there on that side, we've seen some large corporation some of them are.
Hiring freezes some are raising wages for.
The existing customers.
How are you doing in terms of hiring as many people that you need and then B what is.
Exactly are you doing in order to maintain cost net increasing wage environment around skilled labor.
Yes.
This is Michael.
We haven't hired as many people as we were expecting to in this market is a very tight labor market as current point as you see.
Having said that my personal view is the labor market is going to become easier in the next six to 12 months.
And anecdotally as you've seen we're seeing hiring freezes anecdotally. If you think about it six months ago, we were losing people to startups, we're losing people to competitors, whose stock prices were going up into the right. The market rationalization is causing people to take stock and say where do I really want to make this move.
I've already seen anecdotally startups start to stop hiring because they are trying to hold onto their cash because they don't expect to be able to raise money in the market for the next 12 to 18 months. So I think from that perspective, the labor market actually.
Our opinion is going to ease up a little bit we expect some degree of wage inflation, which is being cost because of the fact that we're in Silicon Valley and we're live around some very large tech companies, who are trying to get people to come work there.
So we have factored into our planning some degree of inflation on our wages, but I personally don't think it's going to be.
Off the charts.
Thanks for answering the question you on product, but Greg that you first thought.
Deepak thanks for answering.
I'll just add one comment may be to the overall is like wages is one factor that people look at when they when they choose.
A company we've recently.
Welcome Home program I think a couple of quarters.
So bill we actually showed you guys a video of it and Thats been remarkably successful and we find a lot of people.
We've realized that the culture of the company is equally as important as what was essentially a short term.
Gains when they leave.
A lot more important ultimately.
Then the gains and then the graph does not always greener, we've had remarkable success, bringing them back.
We will continue to do that.
Next to Roger <unk> of UBS, followed by Andrew Nowinski Roger.
Great. Thanks for taking my questions and congrats on the quarter, just going back to the macro conversation I think you've noted a couple of larger deals in EMEA. Just curious if you any commentary on what youre seeing around sales cycles, and any sense of whether maybe you're pulling forward some demand.
Given given the threat environment. Thanks.
Yes.
Look at every quarter, we have seen some deals get pulled forward, sometimes our salespeople because I'm trying to headquarters sometimes a customer because they are not compromised situation theyre trying to get something sorted quickly as possible sometimes has to do with budgets expiring in different parts of all December becomes one of those moments.
August becomes out for the federal government so.
I think the perhaps the best answer is that we have not seen any unusual activity around that topic, having said that as we said we are seeing heightened activity from nation states.
Specialty with proximity to where the war is where theyre trying to fortify their defenses and make sure they understand their attack surfaces as a nation better which they have not had to worry about in the past and they should have worried about it but they haven't focused on it but now.
As people are trying to petition to go become members of NATO.
They've got to make sure that their defenses are robust in case, they see retaliation.
Got it thanks for cash.
Alright, and next we've got Andy to Whiskey from Wells Fargo, followed by Rob Owens Andy. Please proceed.
Alright. Thank you congrats on a great quarter sign a question with regard to the Nextgen here are.
Obviously very strong quarter, but youre in Youre not only arm was also up about 32% yet your guidance.
Suggests that net new way or will decline about 7% in Q4 other than conservatism or are there any other factors that we should consider that might cause net new <unk> growth to significantly decelerate in your fiscal year end.
Andy I look at it from the other side of the lens.
The upside of let's say as we had a great quarter, we're upping guidance across the board for Q4, we're upping guidance across the board for the full fiscal year. We are ahead of what we had promised to the market and our analyst day in not too long ago, and that seems to be a wonderful story and a happy place to be.
Got it thank you.
Alright next we've got Rob Owens with Piper Sandler followed by Jonathan Ho Rob. Please proceed great. Thanks, and thanks for taking my question I was wondering if you could drill down a little bit into some of the supply chain advantages that you've alluded to both in your prepared script.
As well as Q&A here, where do you see an advantage how sustainable is it as well.
Well I think the real opportunity here is Deepak has a team of.
Experts, who spent a lot of time trying to understand the puts and takes in terms of being able to deliver firewalls in terms of ordering forward.
I don't.
I think.
That's worked out so far for us.
We have been able to deliver 20% growth, which is basically shipping as you've heard across the board in the industry that most hardware businesses are building backlog.
No different than most hardware businesses out there during the year, we have more backlog than we started with our it moves back and forth depending on what we can ship in different categories. So the teams already have.
So their marching orders in terms of what day to go out and find and I think I think the other way to think about it is that from a scale and scope perspective, if youre doing three plus $100 million of product.
<unk> semiconductor cost and that is probably $60 million 70 million Bucks. So here, we're looking for $300 semiconductors and a.
Hundreds of billions of dollar industry. So I joked at some of our other plays industry needs. The entire truck I just need the box that falls off the back of the truck. So we're doing a good job chasing trucks to find the boxes.
Alright, thank you.
Okay.
So if I can just add like me.
The only thing that I would add is like a lot of it just comes down to the people and the quality of the execution and discipline.
The people and that's really been I think across the board the execution across pretty much every part of our portfolio is is what we feel most proud of all of them what gives us confidence in our guidance going forward.
Next we've got Jonathan Ho with William Blair, followed by Matt Hedberg. Jonathan. Please proceed thank you.
One question for me to make sure we keep he keeps coming onto this call how should we think about the pace of adoption for Prisma cloud.
Specific drivers emerge there to tie some of this accelerated demand. Thank you.
Yeah.
Thanks, Jonathan for that.
I appreciate it thank you Jonathan.
There is some obvious drivers cloud consumption continues to rise and you have to secure that.
That consumption of workloads that companies are moving to the cloud that's probably the most obvious one but.
It goes hand in hand with that the recognition of all the different security capabilities that are actually needed to secure that cloud environment. If you look back even just three or four years ago.
A lot of cloud security was just maybe one or two simple capabilities and today.
<unk> businesses are being run out of the cloud and the understanding of <unk>.
How important to security is and what it takes to do that.
And in that then ends up leading to a choice for many customers do they try to patch together.
A whole bunch of different point products from different vendors and find ways to integrate them and get them to work in.
And operate them.
Or do they go with Prisma cloud, which is really unique in the industry as being a platform made up of best of breed capabilities that can secure their whole cloud environments, and that's really where we're seeing that.
Not only the driving new customer adoption, but driving the expansion within our existing installed base.
As they adopt these new modules and as <unk> said in his prepared remarks cloud code securities.
The fastest growing new module that we've introduced.
And that just shows.
The ability to deliver a high value new module to customers, but and then also the ease with which they can adopt those new capabilities into the platform. They are already using.
Alright, Thanks folks are sticking with one question. Our next question from Matt Hedberg of RBC, followed by <unk>.
Oh, Hey, thanks, Clay and hey, thanks, guys.
So I have another one for Lee actually we'll keep going here.
Obviously, there's a huge talent shortage out there for security experts and obviously the threat landscape is very challenging does that make your automation orchestration capabilities, even more important today and maybe how does that manifest itself in platform attach maybe even beyond sore.
Yeah great.
Great question Matt.
Oh actually.
Reverse what you said the first.
Key value that customers are realizing in that shortages being able to adopt security on top of platforms as a significant benefit toward the ease with which it can be operationalized.
And so that actually is the starting point automation, then becomes a layer on top of that where the remaining manual workflows then start to go through cycles of where the most repetitive tasks. How do we put those through and automation workflow engine, Mike XOR and build that.
Muscle of recognizing manual workflows automating and then finding the next Menno workflows and automating those I'll give you. An example, within our own IQ organization. We track. This we actually quantify every quarter.
A number of hours that we have been able to automate a typical quarter for us we can we will automate and incremental.
30000 hours of manual repetitive tasks.
And that's why it's not so much about savings, it's about being able to then reallocate that focus toward new high value tasks that people need to accomplish.
Helpful. Thanks, Congrats guys. Thanks.
Next have been bold in Cleveland research, followed by Adam Tindle. Please go Ben.
Good afternoon, thanks for taking the question.
Back into cash I was hoping you could quad.
Quantify the impact of supply chain, you think was left on the table in the quarter and how you think about that in guidance.
Any longer term thoughts you have on how your strategy around supply chain has evolved.
<unk> because of what we've seen over the last several quarters.
Well look as you can imagine the teams work hard every quarter with our suppliers and partners to see what the art of the possible is not just this quarter, but over the next four quarters and even longer and depending on the lead times with the items and again.
<unk> status as Deepak characterized it is a fluid environment things keep moving around in that timeframe. So we have robust plans with our partners. We look at the inventory we understand the inventory remember bill industry has gone from Gi to just in case, because he cannot stuff laying around for three months because the required part doesn't show up for three months, so you've got to integrate it.
So there's a whole bunch of stuff, that's moved and as Steve highlighted there's a phenomenal team focused on executing that in a way that we.
We can deliver our numbers.
In terms of the demand the backlog and what we have been promising we have reasonable line of sight. If all things work in terms of what we're likely to get on a quarterly basis and so our guidance is consistent with what our best guess on what will be available is and Thats why we keep telling you guys that.
This is not a demand problem. This is a supply challenge that we're trying to address is an industry. So I think from that perspective things are on track like at some point in time this has to abate.
At that point in time, we just want to make sure that we're not stuck with too much supply and we have the right keep bright stuff out there. So there's a lot of work that goes into into forecasting predicting understanding product roadmaps understanding the refresh cycles of our customers understanding which customers more likely to order a gen. Three gen. Four so a lot of planning a lot of.
Matt that's going into this stuff because.
My sense is.
There was a big pendulum shifted a lot of people are ordering a lot of stuff and there is definitely at some point in time, there will be more supply and you have to make sure that you don't get stuck with too much supply.
From a long term perspective, we're trying to balance that.
We have held the view that we're not going to do too many price increases because stuck with a lot of supply in a high price.
It doesn't take a genius to figure out what the consequences are so we have been very careful of our price increase of or keeping the moderated we watch our discounts and we're making sure that.
We don't order so much that there were going to have a hangover I think that works like that is it okay.
Okay.
They'll help you better.
It does thank you.
Sure.
Yeah.
Okay next we've got Adam Tindle of Raymond James followed by Brent Thill Adam. Please proceed.
Okay. Thanks, good afternoon, and the cash you alluded to GAAP profit in the near future in your prepared comments and I just wanted to challenge this but admitted to doubleclick since it's part of my thesis, but as that question myself why is now the time to show GAAP profit and leverage the flip side as youre seeing momentum across almost all metrics you could step on.
Gas, even further and go to market given the portfolio's winning you are having success in hiring yet human capital is scarce and your R&D engine has developed products that are clearly showing differentiation and Deepak. If you wanted to add any comments to that because there's some level of substituting this for increased cash margin in the future. So what to do with the incremental cash that has a better.
Roy than more aggressive internal investment strategy. Thank you.
It's kind of interesting if you look at <unk> been sharing with you in the past the amount of products, we introduced into our field force and we have actually asked us Lee and his great team to slowdown in product instruction in the fourth quarter, because I want to make sure that seems out there our focus on delivering a Q4, which clearly is one of the larger quarters.
We deliver so I don't think we need more fuel in the product pipeline, we need to make sure that the product pipeline gets to a lot of our customers, having said that as you see as we traverse to larger and larger deal sizes, we keep driving efficiency from a go to market capabilities and we.
We think we have been and I think I was counting depot, probably set at four times and he is ordering my script twice. So he's clearly sending a message we are managing growth with the right aspiration for profitability. So.
Trust me I am not shy if I feel there is an opportunity maybe to go Overinvest. We did that when you bought or north of 15 companies between $5 billion. When the time was right to be able to build a product portfolio. So if you feel that we're leaving money on the table. You'll go charge added, but I think we're striking the right balance.
And if we see better growth, we will make sure we got an invest but as of now we feel we have ample resources and our plan.
In line with our growth expectations and our key is to sustain those growth expectations over time to.
To generate most value for our shareholders.
What do you do with all that free cash.
Look I think I think it's a it's a world class problem to have but I think I'm just going to echo what Nick has said I think everything in balance.
And then we really let total shareholder return on the ROI determine what we do within the boundaries of what we've committed to.
Okay, Great last question for today from Brent Thill of Jefferies. Please proceed.
The cash and the G. Four refresh cycle you mentioned, it's early days is there a percentage through this you put on a 20% 30% as they're easy ballpark you can give us on where youre at through that right now.
Yes, it's a great question.
It's a low number remember the.
The biggest chunk of the Gen. Four hardware was just introduced about three months ago towards the end of February . So the first round was June of last year, but the the broader set of platforms actually was just a few months ago. So we're very much early innings on this one.
Good.
Very good early adoption and interest from customers and as <unk> said this these refreshes.
Our 12 18 24 months in nature.
Alright, great well that will conclude the Q&A portion of our call today I will now turn it back over to the cash for his closing remarks.
Hi, I just wanted to say, thank you to our employees our partners our customers for allowing us to be both their cyber security partner in some of our employees for doing a phenomenal job all around the world.
And I also want to thank you for taking the time. So you guys next quarter.
Yeah.