Q3 2023 Palo Alto Networks Inc Earnings Call
You all might remember at the beginning of this fiscal year as part of our scaling efforts, we combined our SaaS sales organization into our KOL score sales organization drivers here was that we saw sassy demand going mainstream and we saw encouraging signs that our core sellers could sell the more complex assay offering.
After three quarters of executing as a combined organization. We are delighted to report that over 80% of our core reps participated in the creation of Christmas assay pipelines as we enter Q4.
Q2 was a strong quarter of innovation highlighted by our AI powered chassis launch. This flagship release includes capabilities to enable organizations to automate their increasingly complex and.
And network operations center functions with the eye ops it improves monitoring for networks and after the branch office and significantly improve integrations with Iot secure.
Moving over to a firewall business rather than sassy the future of network security is clear to us. It is centered around software and while we have led and expect to continue to lead the hardware appliance market for many years software and cloud over form factors have been an increasing focus.
Since I joined as CEO . There are multiple reasons why the shift to software is accelerating and the changing macro environment customers are more challenged in their capex budgets, which often fund appliance purchases as a result their interest in software and cloud over form factors remain high.
Especially true when tied to strategic initiatives around cloud adoption illustrating this we saw significant uptick in customer requests to evaluate our virtual firewall offerings at the beginning of the pandemic customer interest in BMS has also sparked by supply chain challenges, where we saw evaluation sustain we continue to see primarily net new demand for software and cloud over form factors.
However, we are seeing more appliance replacements and planning for this trend to continue and possibly accelerate.
Beyond the strength I already covered and sassy the Soviet series deals over $1 million more than double in Q3, including an eight figure deal we signed with the government agency, where they moved from a primarily appliance centric model. The VM series of the fully leverage public cloud as their primary infrastructure. This year, so far <unk> bookings are up more than 40% year over ear and it.
Drew over 55% in Q3.
Most investors have equated our product revenue with hardware. However, given the drivers I have mentioned here. This has been rapidly shifting software now contribute 30% of our product revenue. This is up from about 10% two years ago. We expect this trend to continue and as Deepak could remind you bookings from our VM series and sassy transactions I recognize as revenue. Moreover.
<unk>, then an appliance booking.
Given the conversation about AI.
As I mentioned, there is a renaissance in artificial intelligence driven by significant advances in large language models the development of more powerful and efficient computing the broad availability of large volumes of training data as a result, we've all seen some of the fastest simulation cycles and the launches of unique application of last several months and Palo Alto networks, we have.
Been focused on this technology for many years and our efforts have been accelerating over the last two years.
The first introduced machine learning capabilities as part of a wildfire offering seven years ago and the ensuing years, we added AI and machine learning capabilities across our network security portfolio and has been a critical driver of our innovation and differentiation in the market in 2020, we introduced the industry's first machine learning powered next generation firewall where machine learn.
The detection and move in line to proven zero day attacks. Since then we have overhauled nearly all of our security subscriptions with advanced AI capabilities DNS.
DNS security advanced who all filtering advanced threat prevention, and thus wildfire all harness machine learning for inline detection and prevention of zero day attacks. This means even new attacks that have never been seen before are blocked at the very first attempted used by an attacker. Additionally, we applied AI to Iot security to discover.
If I and secure Iot devices and most recently it was expanded to cover both medical Iot and Ot security needs.
We had a signature released in SaaS fee that included AI powered autonomous digital experience management. In addition to leveraging AI for SD Wan as well as AI powered fishing profession in short we have really been accelerating the application of AI to our network security stack and is one of the most mature applications in the security industry today.
We are not only ahead in investments in AI and machine learning is a differentiator in our products, but these investments have driven tangible customer benefits.
In a typical day, we analyze nearly $750 million, yes, 750 million new unique tellement tree objects worldwide. This includes files Urls domains DNS connections and other signals.
<unk> analyzes data and every day, we see $1 5 million new attacks that have never been seen before we take these new insights and add them to all the other things we have already knew about and we use them to block eight 6 billion attacks across our customer base daily.
This forms the foundation, how do we do better security across our network security platforms and this is how we continue to get better and better at detecting zero day attacks and being in a position actually to prevent those attacks as well.
Moving onto Prisma cloud our early did in Prisma cloud continues to strengthen most of our competitors continue to provide only point products, while customer demand continues to shift towards the platform approach within this connecting the left side to the right side, otherwise known as core to cloud is becoming Paramount as an example of a platform success.
We continue to see strong usage of our cloud security posture management and cloud workload protection offerings custom.
Customers are increasingly standardizing on these foundational modules with 49% or if it's not cloud customers using both CSP MMC WP. This quarter Gartner noted that in 2022, only 25% of enterprises by these capabilities from a common vendor. They expect this will increase to 60% of enterprise by 2025 at the same time, we continue to stay ahead of.
The industry's need for new capabilities, which is core to our commitment to the platform. We are on track to launch our 11th module as we innovate cyber security.
So focus on driving industry certifications and Prisma cloud just last quarter. We were accepted by the joint Advisory Board and reached ready status for fed ramp high a first for our cloud security platform. This comes in addition to other certifications.
<unk>, including recently announced Prisma access achieving impact level, five or IL five provisional authorization.
<unk> is the highest unclassified authorization level for D O D agencies under the federal process.
We continue to see steady growth in consumption of Prisma cloud credits, which were up 44% year over year in Q3, our platform is key to the steady growth.
Continue to see customers increase their consumption of the deploy workloads and strategically leverage the public cloud at the core the Ikea business strategy. This includes migrating workloads to the Hyperscale cloud building new applications in the cloud and leveraging new cloud services. They are also deploying new prisma cloud modules of which we currently have 10, the number of customers using two or more prisma cloud modules grew.
37% area, while the number using photo more modules almost doubled.
We now have a one in five of our Prisma cloud customers using our cloud core module across our capabilities and infrastructure scope SCA or software composition analysis and secrets might've been as they leverage the more efficient approach to detect and remediate security issues as core decision for cloud applications before it reaches production.
Now moving onto cortex.
This has been a net new business with Palo Alto networks business, which is born in the belief that we need to bring next generation innovation to the salt and all the related activities. Just like we had brought the firewall business years ago will.
We're delighted to announce that cortex achieved a $1 billion booking milestone in the last 12 months.
Cortez was born in 2019, and since then their focus intensively on ensuring we have industry, leading capabilities across endpoints sock automation and tax up as many of them.
In the last four years, we have risen to a leading player in automation application of AI attack surface management continue to climb the chart. So they are industry as one of the most technically capable solutions.
We're particularly proud of the fact that <unk> has consistently led and security efficacy xdr delivered 100% prevention and 100% detection across the 19, Nevada steps conducted by Mitre and has had the highest quality detections of any part in the latest round of evaluation.
On the back of our hard work driving these capabilities, we have built cortex business to over $1 billion in bookings in the last 12 months as I mentioned is up from $150 million in annual bookings when we launched cortex of the business in 2019.
As we look forward. These three core capability and cortex are precursors to leading in next generation Autonomous security Operation Center, which pulls us all together. It was launched publicly a few months ago called X I am.
Our next generation <unk> platform X I am Bill totally on AI is on track to be our fastest growing new offering.
<unk> represents another significant opportunity within cortex, as we fulfill our vision autonomous security operations like network security to a decade ago security operations have evolved slowly X I am is now paving the way for us to drive AI driven security transformation outcomes.
After our <unk> launch in late Q1, our design partners made significant commercial commitments to Exxon.
We followed that up in Q2 by broadening our go to market and achieving early success with $30 million in bookings this quarter to establish momentum for X I am with quarterly bookings more than doubling sequentially as we signed our first eight figure deal.
And transactions across all three of our major geographic theaters with this product.
We remain optimistic about the prospects of <unk> with the product the centre of customer security Operation Center transformation, we're seeing exciting give us access to a broader swath of our customers' budgets based on what we have achieved this quarter and hope we've seen the pipeline. We're confident we can achieve our goal of honeymoon and bookings faster than we originally anticipated this would make it one of the fastest growing security plaque.
Problems from Palo Alto networks.
Only does X XI and bring together the core capability of the cortex. It also brings AI driven outcomes to customers.
This hurdle is a new approach to security and outcome based approach inspiration came to us from our own sock wherever we were woefully slow in our own meantime, remediate five years ago, IMTT hours and days, which in today's adversarial environment as an acceptable with that insight and mind you were able to collect billions of events and then using AI.
It is down to just over 100 alerts on a handful of incidents from here continuing to use AI and automation, we are able to investigate response, while detecting incidents a matter of seconds I'm disappointed the high priority ones that under a minute. This is one of the most compelling outcome stories in security so far and the early customers that are farthest along on the journey with US we are seeing there.
Benefits accrue in a similar way to process over three and a half petabytes of data a day across the customer state of xdr in exile from here, we apply approximately a thousand AI models to detect attacks. We then leveraged smart scoring these automation to accelerate investigation response, we are seeing early indications that customers are able to.
Reductions in meantime response from days or weeks down to hours or minutes, just like we did.
Stepping back.
We are fortunate to be focused on the part of the technology market that is more resilient.
Customers depend on their partnership with us to address challenges that are only becoming more sophisticated the market is tough and definitely more challenging than when we started the year I am proud that our team has executed through this environment.
Our strategy focused on having industry, leading capabilities, helping customers simplify their architectures and consolidating vendors is working given our diverse portfolio of products. Some of our products are growing faster in any given quarter others on moderating combined you see this portfolio of benefit in the top line results we reported today.
We also see significant opportunity as we begin to embed generative AI into our products and workflows.
Three ways that are considered investment is generative AI will benefit us first.
Generative AI will help us improve our core under the Hood detection and prevention efficacy by further advancing the state of the art yeah in ml in our products that I spoke of today second Joe manifests itself and how our customers engage with our products. They will leverage our large cybersecurity dataset and tell them that you to provide a more intuitive and natural language driven experience within our products.
Which should improve NPS and drive efficiency benefits for our customers and finally <unk>.
As our employees leverage generative AI, it will drive Cigna drive significant efficiency in our own processes and operations across the enterprise, we intend to deploy proprietary Palo Alto network security all of them in the coming years and are actively pursuing multiple efforts to realize these three outcomes.
Our portfolio approach companies oral scale and focus on efficiency has enabled us to drive significant leverage we are well ahead of schedule here and we're not done as we continue to execute our plans.
See additional opportunities for efficiency.
With our visibility into incremental leverage we continue to see the operating property levels and our fiscal year 2020 guidance as a baseline to build upon with that I will turn the call over to Deepak discussed the details of Q3 and our guidance.
Thank you and our cash and good afternoon, everyone.
For Q3 revenue was $1 $72 billion and grew 24% product revenue grew 10% total service revenue grew 29% with subscription revenue of 838 million growing 31% and support revenue of 495 million growing 25%.
Moving on to geographies, we saw revenue growth across all theaters with the Americas growing 24% EMEA up 23% and APAC growing 24%.
The strength of our next generation security capabilities continues to drive our results with Engie S. A L. A $2 6 billion growing 60%.
We saw strength across all three platforms network security cloud security our security operations.
We delivered total billings of $2 6 billion up 26% and above the high end of our guidance range.
Deferred revenue in Q3 was $8 $1 billion, an increase of 38%.
<unk> performance obligation or <unk> was $9 2 billion, increasing 35% with current IPO just under half of our appeal.
Our non-GAAP earnings per share was significantly ahead of our guidance growing 83% year over year.
We again delivered strong cash flow in Q3 with trailing 12 month adjusted free cash flow of $2 8 billion growing 68% year over year.
Moving on to the rest of the financial highlights.
non-GAAP gross margin of 76, 1% was up 320 basis points year over year, driven mainly by a higher software mix reduced supply chain costs and some efficiencies in customer support.
Our non-GAAP operating margin of 23, 6% increased 540 basis points year over year.
In addition to improving gross margins slow of head count additions contributed to our operating leverage.
Based on our performance in Q3, we are raising our fiscal year 'twenty three non-GAAP operating margin guidance.
non-GAAP net income for the third quarter grew 86% to $359 million or $1.10 per diluted share.
Our non-GAAP effective tax rate was 22%, we again delivered GAAP profitability in Q3 with GAAP net income was $108 million or <unk> 31 cents per diluted share.
Now turning to the balance sheet and cash flow statement.
We ended Q3 with cash equivalents and investments of $6 7 billion.
It is worth reminding investors that our 2023 convertible notes will mature on July 32023, and we expect to settle the principal obligation with cash on our balance sheet of $1 $7 billion.
Access will be settled in shares. This has previously been accounted for in our non-GAAP diluted shares outstanding.
Q3 cash flow from operations was $432 million with total adjusted free cash flow before and $1 million this quarter.
Stock based compensation declined by 90 basis points as a percentage of revenues sequentially on a year over year basis stock based compensation was down 220 basis points as a percent of revenue.
As we look forward, we remain focused on profitable growth.
At our analyst day in 2021, we outlined plans to drive 50 to 100 basis points of margin expansion annually in fiscal year, 2020, three and fiscal year 2024, and the <unk>.
Leading up to this profitability commitment we focused in depth on ultimately balancing investments in our business and opportunities to capture efficiencies and benefit from our growing scale.
As a result, we came out of this asset with significant conviction in meaningful operating leverage.
In fiscal 'twenty, two we started implementing these plans, let's say supply chain challenges that unexpectedly drove higher costs.
While the supply chain was uncertain as we enter fiscal year 2020. Three we also saw signs of changing macroeconomic environment.
It was the right time to accelerate our efficiency clients, we focused our head count additions in sales and R&D to fuel our medium term growth prospects.
Outside of these critical investment areas, we've leveraged our scale and employ technology to accommodate our growth in all the business areas.
Additionally, so quite chain challenges have continued to abate at an increasing pace, helping to improve our gross margin.
<unk> has been a significant acceleration in operating margin expansion through the first three quarters of fiscal year 2023, and also increasing increases to operating free cash flow margin guidance to the year.
As you as you see with our guidance for non-GAAP operating margin in fiscal year 2023 were nearly 300 basis points ahead of the midpoint of our fiscal year 2024 range, but we imply in back in 2021, we now see our fiscal year 2023, non-GAAP operating margin as a baseline to build on in the future.
Moving onto guidance for the fourth.
Fiscal quarter of 2023, we expect billings to be in the range of $3. One five to $3 two zero to $1 billion, an increase of 17% to 19%.
We expect revenue to be in the range of $1 97 to $1 96, 7 billion, an increase of 25% to 27%.
We expect non-GAAP EPS to be in the range of $1 96 to 130, an increase of 58% to 63%.
For the fiscal year 2023.
We expect billings to be in the range of $9, one eight to $9 to $3 billion, an increase of 23% to 24%, we expect <unk> to be in the range of $2 eight zero to 285 billion, an increase of 48% to 51%.
We expect revenues to be in the range of $6 eight eight to $6 $91 billion, an increase of 25% to 26%.
We expect product revenue growth in the range of 15% to 16% for fiscal year 'twenty three as we see supply chain challenges normalized as we exit fiscal year 'twenty three.
For fiscal year 'twenty, three we expect operating margins to be in the range of 23 to $23 two 5%.
We expect non-GAAP EPS to be in the range of $4 to four for $4 two nine an increase of 69% to 17%.
Adjusted free cash flow margin to be 37 five to $38.05.
And we expect to be GAAP profitable for fiscal year 2023, including in Q4.
Additionally, please consider the following model modeling points, we expect our non-GAAP tax rate to remain at 22% for Q4 2003 in fiscal year 'twenty three subject to the outcome of future tax legislation.
Q4, 'twenty three we expect net interest and other income of $15 $55 million, we expect Q4 diluted shares outstanding of $326 million to $332 million.
Fiscal year diluted shares outstanding of $322 million to $24 million, and we expect Q4 capital expenditures of $35 million to $40 million.
With that I will turn the call back over to Walter for the Q&A portion of the call.
Thank you Deepak to allow for broad participation I would ask that each person ask only one question. Our first question will come from socket Calia of Barclays with Honda Firewall left for Morgan Stanley on deck.
Second you're muted.
Yeah.
Okay.
Alright, why don't we go to Hamzah. Okay can you can you hear me go ahead.
Alright, it didn't didn't lend me on mute. Thanks, so much for taking the question here and nice job to the team executing in a very challenging environment.
The cash may be a lot of good things to talk about but I'd love to just double click on.
The operating margin improvement here that you've seen and really a new baseline that the team is creating going into next year. Maybe the question is Ken can you and Deepak maybe talk about what areas. The team is what areas. The team is finding efficiency.
And what are the opportunities for efficiency, maybe going forward as well thanks.
Yes.
Oh Oh.
Preface that as depot highlighted.
<unk> chain crisis, all but over and as you know there were some adverse impacts to gross margins by driven by hardware I think the product mixes in our favor as we go from hardware to software our gross margins are way better in software and they've generally our own hardware given a softer firewalls are much much more profitable for us.
Coupled with that I think what Deepak really has been driving for the last year as we flipped into the new macroeconomic environment has been a real focus on resource utilization ROI as well as making sure. We are focused our hiring only on stuff, where it's important we also talked about streamlining sales for.
Our survey if you remember second we have the conversation around making sure. Our SaaS team is integrated with our core which saved us hundreds of heads in terms of efficiency as well as driving more outcome and output from SaaS perspective, generally those are being some of the key drivers, but deeper did you want to add something not only some covenant all I think we've talked us a whole lot because yes.
Club, we scale well as a company right and I think that's across all the different elements of our P&L I think Mckesson has talked about the supply chain, we talked about the Opex I just also mentioned cloud.
Cloud hosting and cloud consumption as we get bigger and we can see more we have the ability to go back to our service providers and try and negotiate.
Better contracts, so I think across all the areas of the P&L, we scaled pretty well as a company and I think to your question in terms of where this goes as Deepak said. This is a new baseline. We think there is continued opportunity from here and we havent, even factored in the potential impact of generative AI.
As you've been hearing all the conversation in the industry, we're still working on it we're understanding it we're really looking at processes, but we believe there's a bear there. We think there will be an opportunity in the future to get more efficiency from generative AI as we go ahead and implement some of the capabilities to our organization. So I think theres upside both in the continued.
So what the book has been driving for the last nine months and there is the sort of the icing on the top is the potential application of guarantee of AI as we continue to grow our business over the next few years.
Got it thank.
Thank you.
Next question is from Hamzah <unk> from Morgan Stanley with Brian Essex from Jpmorgan on Dotcom. So go ahead.
Hey, guys. Good evening I Hope you can hear me okay.
Maybe a question for.
The cash and the players is around.
Okay.
AI.
You've clearly been thinking about this a lot based on what I can what I can tell from your Twitter.
But we.
We were at RSA last month, and while there is.
Got it.
While theres a lot of opportunity around AI did there seems to be a lot of risks around data security around sort of the data that these models are trained on <unk>. So I'm curious as you as you had that AI based conversation with your customers or are you getting them comfortable around that to really leverage the full capabilities of AI to automate their thoughts.
Yes, I think there's two different parts of it I think one part is.
US using our AI already in our products, where we have been using it for a while to get pattern recognition and look at what it's telling us from there.
In a real time analysis of data perspective, as I mentioned, we deployed over 1000 AI models to go look at what happened. The next time Theres all proprietary it's happening in our instance, it's not an L. M. That's going out and getting trained is a proprietary model used by Palo Alto networks built by Paulo networks being used for a specific use case in a dos four six.
Alrighty.
Now to the extent that we intend and will deploy conversational AI in our models. We are working with every public model and open source model out there to understand how can we build it using our own proprietary data I don't believe anyone can you elaborate on that please.
Yes of course.
<unk>.
It's very early in the large language model adoptions that we're seeing.
And as you point out there are a number of risks associated with them, particularly in enterprise use cases.
We've already seen some examples where.
Data has fed into large language models.
Without the understanding of how the data will be used in the data spend then.
Publicly made public available I mean, it was confidential so it's very clear that there is sensitivity there.
Also sensitive sensitivity from a security perspective things like prompt.
Injection attacks data poisoning and things like that that have to be taken into account.
The.
And so.
Think what we'll see is.
The enterprise use cases of <unk> will evolve a little bit more accurate they need to evolve a little bit more methodically and carefully to take these security challenges into account at.
At the same time, though it is also important to recognize that they offer tremendous promise as Nick has mentioned earlier in terms of being able to help guide product adoption product usage to help enhance security capabilities.
And to drive greater efficiencies.
The business, yes, I think to capital up I think.
No. There is no doubt we will continue to deploy our proprietary AI models for <unk> or for network security use case or the highlighted.
We believe in our preliminary analysis of the last three months and driving a lot of these work streams internally that there is a there there with generative AI. So we believe that we will be deploying generative AI over the course of the next few months and we'll talk more about at a later event.
But we think that has an opportunity both to significantly improve our customer efficiency and the efficacy of our products at the same time also to drive efficiencies within the way we run Palo Alto networks, I think last but not the least which is something you didn't ask but I'll say no separately Lee and his team have been working hard to see.
I look at the adverse impact that generally I could have in terms of adversaries using generative I to build new malware do you try and attack our customers and Theres a lot of work, we're doing as well to make sure we're able to protect our customers against any such activity that is conducted using generative yeah.
Thank you great. Thanks. Thanks for your question Hamzah next question is from Brian Essex with Jpmorgan, followed by Brad Zelnick from Deutsche Bank, Brian Go ahead.
Yeah, Hey, good afternoon. Thank you for taking the question and a follow up on <unk> comments nice progression in operating margin here.
Good to see cash flow margin guidance golf as well.
If I could kick down if you could maybe peel back a couple of layers on that core drivers of that cash flow margin improvement and how sustainable. It is we noticed that capex look like it looks like it's a little bit lower than you previously guided to so just wondering.
As you kind of look at that as a foundational metric to lean on for valuation how sustainable is that.
As we kind of forecast operating margins going forward should that I guess gap between operating margins and cash flow margins remained relatively consistent going forward.
Yes, so Brian Thanks for the question, let me just start off with like the biggest driver over the long term is really just strengthening of bookings at least your billings and then it comes down then the foundation really is your operating margin.
That makes up the base that you can do on your cash.
There are multiple other factors, but do recognize that when we came into the year.
The interest rates were at a different level, we have had the benefit of higher interest rates.
We've deployed a lot of our cash that we earn interest income.
We're not predictors of interest rates, but fundamentally we believe that that will continue to be a tailwind for our cash generation and then last but not least we do have a panel.
<unk>, we have a.
Certain amount of our business that way.
We can structure in financing.
Frankly, that's that's been broadly in line with what we assumed at the beginning.
But those are really the drivers and we feel pretty comfortable on.
What we're able to do with those different drivers and delivering on all of it.
Thank you.
Great. Thanks, Brian next question from Brad Zelnick of Deutsche Bank, followed by Andrew Nowinski at Wells Fargo go.
Go ahead Brad.
Great. Thanks, so much for the question and nice job.
Net cash Deepak and the entire team.
And of course my question is about M&A, which I feel like typically comes later in the call, but [laughter], it's such a great opportunity right now what's the hurdle to given the large deal and can you remind us how you think about transformative M&A and just related to that your competitors naturally knock you on having grown three required innovation just to set the record straight can you.
Talk about how much of a priority and our focus is to have a deeply integrated product.
Yeah, Ryan I think first of all I am amused that you're asking for a transformational M&A I think I feel like somehow we at Palo Alto networks have been going through a transformation already for the last five years.
Can you talk about instituting required one and I'd like to bus the myth.
The notion that we've grown our innovation through M&A, because pretty much the entire X I am product that we have built which is now going to be one of the fastest platform. The borrower is homegrown. It was built by our team internally. It was designed built and delivered by the cortex teams. So I think it's a dis service to them to say that some one of the fastest growing.
<unk> is being built with pilots and ours was was acquired similarly, our next generation firewall or a SaaS product or sassy product for the most part is entirely homegrown driven by the security capabilities that we've built using our firewalls as well as our virtual firewall business I think the majority of our M&A has been focused on building our to our security portfolio, where we felt where we needed to.
Be assertive and be out there in the front and I would say you know auxiliary capabilities, whether it's an automation with XOR are auxiliary capabilities around attack surface management. So.
Bottom line, we're very comfortable with the three platforms that we have and what we need to get done I think we've been very clear about from an acquisition perspective, we look for a product capability, where we can take product capability and attached that and make sure. We can solve more problems for our customers that they're looking at so from that perspective my.
My view on M&A is consistent that we find something interesting and industry trend which is.
Added incremental tech capability people do it I think from a transferal transformational M&A I think we can transform this company and have continued to transform it to where it is based.
Based on our innovation and a balance of execution I think.
We will continue to do that I don't think the market is particularly cheap yet if you were to try and look for a transformational M&A and I think it's kind of a dual double.
Ed situation, one I think we continue to get stronger as we get execution under our belt, I mean country growing value as Palo Alto networks.
If some of the large players out there ended up committing missteps and we will go take a look at it for now I feel very comfortable with our position, but it also has an industry I feel very very comfortable with the amount of cash we have on our balance sheet. I believe it is our job to keep our heads down and keep executing because it's a tough market and I think one of the things which are you know.
<unk> was brought up just a minute ago I think be opportunities from AI have not been fully comprehended by most enterprise businesses I think we are going to undergo a transformation.
The small auto networks as well as generally in enterprise software industry over the next 12 to 24 months as we embrace generative AI I think that's the real opportunity and challenge in front of us and I think half of the people out there who can get it wrong and hopefully we're on the right side of history.
He's doing a great job keep it up thank you.
Thanks for the question. Brad next question is from Andy Nowinski from Wells Fargo, followed by Matt Hedberg from RBC Andy go ahead.
Okay. Thank you and congrats on a great quarter.
So nearly every single vendor in nearly every single reseller, we talked to you says theyre seeing an elongation of sales cycles, yet you seem to defy those headwinds with massive growth in in large deals and customer spending $5 million to $10 million with your I guess would you view this as an inflect an important inflection point.
As it relates to sort of consolidation in that if you can drive large deals in this macro constrained environment, you could potentially see an acceleration of those consolidation trends.
When the macro improves are you predicting a macro improvement Andy I certainly hope so.
Well look I think first and foremost I don't want to leave you. The eve you with any impression that the macro is not hard it is hard out there I think everything youre hearing from resellers from other people in the industry is true.
Customers are spending more time paying attention to deals customers are.
Taking a longer summer right sizing deals some are focusing things that are important some are looking for financing. So I Wanna pay annually. So all the effects that you talked about are true in the industry.
And we see you recognize this towards the end of our first quarter and I'll tell you what we've been we've been working at double time like literally the day depot instead of shut the doors and us being able to book anything this quarter peer out there hunting for next quarter, if a big number to hit this quarter, but out there in the field. We're executing our teams are out there so yeah as you.
Probably appreciate Theres no magic.
In the world around the fact that our quarter end on July 31, there is no budget, Iran for any part of the World on July 31 is the date between created a volatile finishes ear Q4 on July 31st which means we have Ron has hard as we can to get business done by July 31, we know that at the end of our year we ended up.
At the end of our quarter, our customers know that so all we're doing is bringing getting ahead of it and we're hoping that us getting ahead of it and continuing to rigorously execute is going to allow us to be able to improve our conversion rates and our conversion rates on our pipeline are down I guess, what you've drawn up more pipeline. Therefore your conversion rate that's down still allows you to make the number that you've promised the street.
That's what we've been trying to do and as Ive said, the macro is hard and we're going to keep trying to keep our heads down and execute.
Thanks to cash keep up the good work great. Thanks, Andy next question for Matt Hedberg at RBC, followed by Gabriela Borges Goldman go ahead, Matt.
Thanks, a lot.
Mike Congrats again team outstanding results I guess, the cash or Lee on the success you've seen thus far with <unk> you noted.
You essentially have full access to Sim budgets right now Im curious with some of the large deals youre seeing or are these generally replacing legacy Sim vendors or are you actually generating new Tam.
That didn't exist previously.
So Matt I'll, let Lee jump in and talk about some of the specifics, but I'll tell you. What every one of these deals.
Is it a replacement of a legacy Sim or data store and.
Addition, we do not sell <unk> sign without our endpoint products. So you have to buy Palo Alto cortex, xdr to deploy axon, because we believe the only way to have normalized good source single source of truth data is deploy our endpoint products and then we use that as I showed in the AI funnel of how we can go cross correlate that and go drive great security outcome.
So in every case, we are replacing an existing window, but I will tell you. The sock industry is upside down. It was designed so far to go understand when a breach happens how did this happen and trying to figure out how to remediate it and those remediation times, a highlight or six days and now most modern attacks are in.
And out in under 12 hours. So if you've got a sock infrastructure, but it allows you to come up with what happened to you. After six days the bad actors have gone in and in and out in 12 hours you have a mismatch that is a problem, but Lee can you highlight some of the key a key use cases that we've seen in the first 30 plus customers that we have what's driven some of this.
Transformation.
Yeah.
But nearly.
So Exxon is replacing the centers also replacing other tools in the stock as well.
There's three core elements to how this is happening. The first is around data as you saw a three five petabytes of data is being adjusted and analyzed data.
Data is the key to driving good AI and <unk> as <unk>.
Specifically designed to be able to ingest large amounts of data across different data sources into an AI data Lake.
<unk> is how we drive AI based analytics on that data be able to detect attacks in real time.
This is something that the traditional sem industry was just not well designed to be able to do.
That is driving the meantime detection.
You are seeing and then three is the integration of automation natively into X I am.
It allows us to drive the meantime to remediation down from what in the past used to be in many cases days down to hours and even minutes and so in all of the <unk> deployments were seeing them. It's amazing how quickly we're seeing the outcomes that we saw in our.
One sock when redeployed and operationalize exane.
I think the last thing I'll add.
Sorry, Matt the only thing I'll add to that.
Over the last 15 years, what has happened is the cost and value equation in existing socs has diverse tremendously.
So people are spending a lot of money collecting data and large data stores and theyre not getting adequate value out of it and they're not getting adequate security outcomes out of it. So I think that is a big gap and that gap is something we've been we've built this problem trying to fill and now it really is very early days for US I think the fact that we will get to a $100 million in that time span.
Todd was aggressive and less than that I think tells US there is a huge potential out there, which means you have to keep our heads down again keep building keep executing and keep trying to solve the problems that our customers are presenting in front of us, but I have a good feeling about.
Certainly seems that way.
Great. Thanks, Matt next question Gabriela Borges Goldman Sachs with Adam Tindle from Raymond James on deck Gabrielli go ahead.
And I've seen thank you.
Firstly on the cash I want to ask about cloud security strategy and.
Specifically with respect to how you think about write downs and sometimes you get customers upfront to catalyze adoption and then also how you think about the balance top and grants.
Clint Greg given that that's not kind of step ups.
It would seem to be driven by product I'd quantify them. Thank you.
Please go.
Right.
To that question.
So.
One of the challenges that we've set out to address with Prisma cloud was this fundamental challenge in an enterprise cyber security sort of the proliferation of point products every time, there's a new security need there is a new product and then customers become the system integrator of all these different point solutions and they spend more.
Our time trying to be the system integrator than they are actually getting the value from the products.
And so with Prisma cloud, we've taken the unique approach of building a platform, where we can deliver many different capabilities pre integrated from the St location now at the same time, we did that on the technical side. We also approached it from a.
Sort of the adoption side and I'll call it the procurement side of.
Having a single Prisma cloud credit system that makes it really easy for customers to buy a level of capacity and then simply use it to adopt as much of the platform as they need and when they need and so it's allowed us to focus more of our attention in terms of how we engage with customers and how the product works.
And.
In product adoption guided adoption of additional capabilities.
And enabling them to easily use more and more the services as they need them as opposed to having to go back and turned every module into a new transaction with a customer.
And as you saw from from what Nick has showed the the new credit usage year over year growing up about 44% year over year, but then also the number of customers with two or more of three or more for more modules in the case of four more almost doubling year over year shows how all that is working.
Great. Thanks, Gabriel next up Adam Tindle, Raymond James followed by Gregg Moskowitz Mizuho Adam go ahead.
Okay. Thanks, good afternoon.
I'll start by just acknowledging the progression in operating margin is really impressive and commitment to that being a baseline is a really important point, if I'm thinking about tomorrow. Some of the distracting questions that might come up would be around product revenue. Thank you grew 10% year over year in Q3 than you had previously guided the fiscal year to 10%, but if I saw on the slides correct.
I think you are now raising that to 15% to 16%.
What's driving that increase in product revenue and the acceleration in Q4, despite the cautionary comments and anything we can think about in terms of puts and takes to product revenue as we think about fiscal 'twenty for us. So we don't get ahead of ourselves. Thanks.
Yeah, Adam I think there's two parts to it one is as you will appreciate we highlighted that software has become 30% of our product revenue.
So we you know whilst would you book a hardware firewall you've got a dollar for dollar for revenue and software you don't get a dollar for dollar for revenue. There is some part of an amortized value we get from our software firewalls and some part of our SD Wan, which becomes part of our product revenue. So we have to we have to run harder on billings to be able to deliver a product revenue.
In the context of software, but as I mentioned, our virtual firewall is through a 55% this quarter. They grew at 40% for the year. So far this is a tailwind we had not expected at the same time the hardware as I mentioned is not as strong as we'd expected so they balance each other out but in the balances in favor of sulfur for now.
Coming off a low base of last year. So as a result, we have been able to improve our product revenue guidance. Obviously it comes at the cost of services revenue because some of our software is now has to work triple a time to be able to deliver product revenue. So I think that's the context in which you should think about it overall or theres been a draw from one side and a partial gave on the.
The other side on the product revenue. However, given our RPM is growing way ahead of revenue. It just means we are saving up a lot of revenue for future rainy day.
That sounds about right financially.
Liberating data area.
The only other thing that I would maybe just add to that is is simply the supply chain dynamics that Mike has spoken about.
In his remarks, I mean that does have some some factors, but we really have been able to with a world class team got ahead of the supply chain reality and so that may explain.
Some of them.
The variability you're seeing Adam.
Great. Thank you Adam next up Gregg Moskowitz from Mizuho, followed by shallow layoff and talent.
Hi, Thank you can you hear me, yes, alright, Dan as a follow up for Lee or any cash on generate AIA. So your comments on ever lands were helpful. But do you think Jenny I will tilt the scales in favor of Palo Alto and perhaps some other security vendors over time, whereas it ultimately.
More likely to cause an even faster gained mccadden analysis between the vendors and the attackers headsets playing out.
Well it is.
But first and foremost.
The benefit of generative AI. So far is twofold. One is in its ability to summarize data and give you access to information much faster can I imagine a sales rep at Palo Alto, having access at their fingertips, where about all pollo to information of course, I can can I imagine by customer support people, having access to amazing amounts of innovation.
The tip of their fingers. So they can answer customer questions about faster can I imagine pork showcasing that information directly to my customers as you're seeing the industry now suddenly.
A plethora copilot start to emerge in every product. So I think that is going to become an obvious benefit of generative AI now don't forget it relies on one principal called having a lot of data but.
It's very important that whether you're using it for external sharing your own information from your customers too.
Do your customers you need all the data you have to clean all their data processes and have that secondly, if youre in the security business. It definitely helps if you have the largest data lake in the world while security data. So from that perspective, I think it favors the people who have a lot of data already as part of their strategy and they have built a business in the back of a data led strategy.
I think not just specific to security in any industry, especially consumer Internet if you've been a UI company you have something to worry about and if you're a travel booking operator or something that just takes other people's data and makes it better UI, yes, something to worry about so I think from that perspective, it favors companies, which have tremendous amounts of data and just secondly was also.
<unk> board and understand.
If I have 14000 people I've spent thousands of building a $1 billion in customer support or more.
There is leverage I can go spend $30 $40 million to $50 million of playing out of them and saving half my cost if you're running a small company in your entire cost of $50 million. It probably it doesn't behoove you to go out and create a Netherlands based generally I project to go out and pay and takeaway training and other costs I think they also benefits people of scale, we're able to drive efficiencies.
Using generative AI across the enterprise, allowing them to grow their business much faster.
With limited resources.
Does that help you guys. Thanks again.
Great. Thanks, Greg and Chevrolet all from Cowen our last question.
Yeah.
I'm pleased with that.
Good afternoon congrats team.
I guess I wanted to go back actually you know Brad was asking about M&A I want to ask about the competitive landscape, but specifically with a focus.
Maybe on the scene upfront. So my question is.
How do you think about it.
Any change do you think that the product right now as it stands.
Is comprehensive or <unk>.
Anything you might be thinking of maybe augmenting specifically on the scene upfront. Thank you for that.
Okay.
Sure.
And so.
Cloud Native application protection platform there is.
That doesn't mean that we do everything.
But we do far more than.
Any other solution out there.
There's tremendous amount of focus on.
Delivering capabilities.
Capabilities that we've been building internally organically amongst the team we've seen.
Most recent one we delivered with secret scanning just a few months ago, we're seeing very good early adoption of that.
At the same time, we're also delivering on the latest acquisition of cider security, where we expect that to become a new module in the next couple of months available to all of our Prisma cloud customers.
And so.
The Nic I talked about how we've leveraged M&A in the past to help build some of the key technology areas of Prisma cloud, which is absolutely true.
We have also shown an ability to deliver new cloud security capabilities organically and be very successful at that and and right now feel good about.
The balance of both of those capabilities and how we're bringing together and how we continue to deliver new Mexico new innovations.
Yeah.
Thank you.
Thank you for the question with that we'll conclude the Q&A portion of the call and I'd like to pass it back into cash for his closing remarks.
Well. Thank you very much again, everybody for joining us.
Look forward to seeing you many of you at the upcoming Investor events I also want to once again taken opportunity to thank all of our employees, who worked very hard and very dedicated fashion as you all know to help us achieve the results not only that but that big Thank you to all of our partners and our own.
Customers around the world have a wonderful day. Thank you.
Yeah.