Palo Alto Networks, Inc. (PANW) Earnings Call Transcript & Summary

Good day, and welcome to the Palo Alto Networks announces intent to acquire CloudGenix conference call. Today's conference is being recorded. At this time, I would like to turn the conference over to Mr. David Niederman, Vice President of Investor Relations. Please go ahead.

Good afternoon. As you've seen this morning, we announced the proposed acquisition of CloudGenix. Joining us today to discuss the transaction are Nikesh Arora, Chairman and CEO, Palo Alto Networks; and Lee Klarich, Chief Product Officer. Please note that we will not be commenting on our fiscal third quarter or fiscal 2020 guidance during today's call. We'd like to remind you that during the course of this conference call, management will make forward-looking statements including statements regarding our competitive position and the demand and market opportunity for our products and subscriptions, including our beliefs about the anticipated benefits of the proposed acquisition of CloudGenix, the anticipated timing of close and our phased integration approach, our continued execution and focus on providing new products to our customers and the overall impact from the COVID-19 crisis on our business. All statements, other than historical facts, including the statements regarding the expected benefits of the proposed transaction, are forward-looking statements. These statements are based on management's current expectations, assumptions, estimates and beliefs. While we believe these expectations, assumptions, estimates and beliefs are reasonable, such forward-looking statements are only predictions and are subject to a number of risks and uncertainties, which are beyond our control and which could cause actual results to differ materially from those anticipated by these statements. These forward-looking statements apply as of today and you should not rely on them as representing our views in the future. With that, I'll turn the call over to Nikesh.

Thank you, David, and welcome, everyone. Thank you for joining the call and making the time in such short notice. We're excited to announce the proposed acquisition of CloudGenix and explain how this complements our strategy. Before we get to CloudGenix, I would like to take a few minutes to address the COVID-19 situation. First and foremost, we have prioritized the health and safety of our employees. In addition to travel guidance of public health authorities, we restricted international and domestic travel for our teams. As of March 16, we made working from home mandatory for all employees with limited exceptions and optimized virtual meetings to help them do so. In this unique time, we also have shown a commitment to helping our employees. Yesterday, we committed to a no-layoff policy associated with the uncertainty caused by COVID-19. We have slowed down hiring to ensure that we manage the pace of our hires in line with the expectations of the economy. We also established a fund to assist our employees that may be in need, our hourly workers who may not be working during this period and also the communities we're in. The fund will be supported by donations from management, our Board of Directors, our employees and me. From a technology perspective, we're fully leveraging our remote secure working capabilities through Prisma Access for our employees to enable them to securely connect to the applications they need both in the cloud and in our data centers or offices. Additionally, we have transitioned our security operations center to a remote model in which all our analysts are working from home. Our partnership with Google allows us to scale our products in a linear fashion and ensure that we had no issues in meeting the high demand we're seeing for remote secure access. Let me talk about the business impacts of COVID-19. From a sales perspective, we have seen a few dynamics. One, the working from home phenomenon has prompted many organizations to purchase incremental firewalls to accommodate the new traffic from employees no longer working from their corporate offices. We are well positioned to help customers with GlobalProtect, our attached firewall subscription that allows organizations to secure remote workforces. We are also seeing an increase in conversations regarding Prisma Access from customers who are contemplating a new paradigm in terms of remote working as organizations around the globe are mandating their workforce where possible to work from home. We launched a free trial product in Prisma Access. We have seen over 1,000 trials initiated by customers in the last few weeks itself. In a little over a month, we have seen a significant increase in Prisma Access and GlobalProtect pipeline, and I have already seen wins in that time frame. The majority of this pipeline is from our installed base and speaks to its strength. With all that said, we're facing a situation without precedent. While we are working as hard as we can to continue to serve our existing and new customers, there may be impacts that as of today, we cannot yet determine. On the margin, we expect that some of our customers who are seeing a disproportionate economic impact are likely to be credit constrained, and we're already proactively working with them to adapt their payment terms to ensure continued service. Looking at supply, we're monitoring the situation extremely closely. As a reminder, we manufacture all of our appliances here in California. We do have a small number of components that are single-sourced in China that are used in our lower-end firewalls. We have worked through our supply chain to ensure that we're able to deal with the current demand and expected demand for the quarter. On most of our deals, we do not expect any supply chain interruptions. Now turning to CloudGenix. We're delighted to further our staffing capability with the proposed acquisition of CloudGenix. We've spoken quite a bit in recent months about how the digital transformation is accelerating the adoption of cloud and SaaS applications. Most organizations now have a digital transformation strategy to fuel using mobility. A recent study showed that 42.5% of the global workforce will be mobile by 2022. Although during this COVID-19 crisis, this number is clearly much higher. We expect that once the pandemic slows, we may see a permanent change in how organizations think about remote workforces. Cloud adoption is another macro level trend being fueled by digital transformation. For most field organizations, they use the cloud in some shape or form, whether that's SaaS, IaaS or PaaS. As applications move from corporate data centers to cloud, and users need secure access from anywhere, whether at headquarters, remote branch or on the road, organizations face challenges of traditional networking and security architectures that'd be costly and ineffective. With the acquisition of CloudGenix, we intend to maintain a dual SD-WAN strategy. Lee will talk about that in a minute. We believe with the inclusion of CloudGenix, Prisma Access, which is already the industry's most comprehensive SASE platform, will be enhanced to deliver global cloud network with cloud-delivered security for all users. In the proposed acquisition, we will integrate CloudGenix cloud-managed SD-WAN products to accelerate the intelligent onboarding of remote branches and retail stores into Prisma Access. This combination will extend the breadth of our solution, our platform, and address best-of-breed network as well as security transformation requirements. This will accelerate the shift from SD-WAN to SASE. As you've likely read in the press release, the agreed upon purchase price is $420 million. The co-founders, Kumar Ramachandran, Mani Ramasamy and Venkataraman Anand, have agreed to join Palo Alto Networks. I'm going to turn the call over to Lee to let him share his thoughts on how CloudGenix fits with our product strategy. Lee?

Thank you, Nikesh. As you can imagine, I'm excited about the opportunity to accelerate our SASE strategy with the proposed acquisition of CloudGenix. But first, a little context. Driven by digital transformation, we're seeing a significant increase in customers embarking on network transformation projects with SD-WAN as a core enabling technology. The most -- the way most SD-WAN architectures work, the customer deploys an SD-WAN device in every branch office, but they also need to deploy SD-WAN devices in regional data centers around the world and effectively build and operate their own global network. As you can imagine, this can be very challenging, and we think there's a better way. This is why we built Prisma Access, where both the network and security are cloud-delivered and offered as a service. Prisma Access provides customers world-class security as a service on a premium global network through our partnership with Google. And with this acquisition, we will further enhance our SASE platform by integrating the CloudGenix AI-based SD-WAN product with Prisma Access, providing a seamless end-to-end solution to our customers. This is referred to as a thin branch solution as the device in the branch is intelligent yet lightweight, with most of the complex processing happening in our cloud. We expect the first integration milestone within 3 months of closing, with deeper integration through the back half of the year. Importantly, for our customers, especially as work from home has become the new norm, Prisma Access also provides scalable secure access for remote users. This means one cloud-delivered security solution for branch offices, mobile users and partners for secure global connectivity to all applications. Please note, we do believe in giving our customers choice, and so we will continue to enhance both the existing CloudGenix SD-WAN product as well as our own next-gen firewall-based SD-WAN product. This ensures we meet the range of requirements from our customers and provide a great on-ramp to our full SASE solution. With that, let's open it up for questions.

[Operator Instructions] We will take our first question from Brian Essex with Goldman Sachs.

Congratulations, first of all, on the transaction. It's a really interesting technology. Maybe, Lee, I have a question for you. From what I understand, CloudGenix is kind of a hybrid hardware-software model. How do you anticipate integrating that with your platform? And then maybe part B of this, help us understand that they're a little bit differentiated with application routing technology as opposed to packet routing technology. How does that also marry with your platform? And where do you have the best synergy with those 2 aspects?

Yes. Thanks for the question, Brian. To the first part, the -- one of the things we really liked about CloudGenix is the cloud-based approach they took from a management, telemetry, visibility console they provide to customers. It's really unique and something that the customers value highly. The -- on the branch side, they have both a hardware option as well as a software virtual appliance option, and they give customers the choice between those. We think that in the branch, we really like the solution they have. What we will do is -- from an integration perspective is design as such that it connects customers directly up to Prisma Access, so our global network and Security as a Service. And then we will start to integrate the management consoles to give customers that unified experience over time.

Got it. Super helpful. Maybe one quick follow-up for Nikesh. I understand you guys have been partners for a while. From a sales perspective, how familiar is the sales force with CloudGenix? And is this something where you might be able to get a great amount of synergy through the sales force right away?

Yes, Brian. Look, we have already been pivoting our sales force to learn more and more about Prisma Access, loggable security and SD-WAN with the launch of our SD-WAN capability in our firewalls. Additionally, CloudGenix has a dedicated SD-WAN team, obviously. And we have a few customers where we have partnered together already, where customers are using the CloudGenix SD-WAN product with Prisma Access with it. We anticipate being able to cross-sell SD-WAN to our Prisma Access customers and upsell Prisma Access to CloudGenix SD-WAN customers. So we think there is huge opportunity of putting the sales teams together and leveraging both the SD-WAN and Prisma Access secure ability. As I said in my prepared remarks, we are seeing a bump up in the conversations around remote secure working from home. That usually translates into an SD-WAN conversation in the medium term. I think as it becomes a new norm, given the pandemic we're in, I think we're going to see more and more projects in the next few years. We're going to talk about MPLS replacement, backhauling some of the traffic straight to the cloud and haul all of it back to the data center. And right in the center of that trend, we think having a dual-pronged solution is great because for customers which are taking on large-scale network transformation projects, they do want a dedicated cloud-based SD-WAN solution which we think CloudGenix has.

[Operator Instructions] We'll take our next question from Keith Weiss with Morgan Stanley.

Nikesh, I guess, a question for you in terms of the timing. Why now from a kind of market perspective? Is this the right time for doing CloudGenix? Anything specific kind of forced the issue to making this acquisition now? And then second part of the question, any detail you could give us on the financials that -- at CloudGenix or any projected impacts to the Palo Alto Networks' financial model on a going-forward basis?

Great, Keith. Thank you for the question. Look, that's a great question. And we have been in conversation and been evaluating the SD-WAN market even prior to when COVID-19 came about. And we've looked at every player in the market. We looked at where the maximum benefit for us would be from an integration perspective. And as you heard Lee, he has outlined a very clear integration path. And honestly, the more we dug into the company, the better we liked it. The more we looked at it, the more we felt that the next sort of development should be together as opposed to separate. And the only question was, is this the right time or not? And if I take a long-term view to this, sooner is better than later because you want the teams to coalesce. You want the product to be aligned and integrated. And the team on Prisma Access has just come off a big release, where it was stable, it's working on GCP. We're turning on tens of thousands, if not hundreds of thousands, of customers. And rather than them launch off the next development path, trying to make it even stronger, we figured this was the right time to do it. And similarly, CloudGenix was going through its next transition of how do we go integrate LTE and 5G into their boxes. So we figured, if we do -- if we start working now, we're better off getting it done. Our Board made sure we looked at our capacity as a company to seek and reintegrate. They made sure we looked at our capacity from a cash perspective, we have lots and lots of cash on our balance sheet. We think we can ride out any economic scenario in the next few years. So from those perspectives, it's our -- there's nothing stopping us. And to be honest, I've seen the Palo Alto team really step-up in the last few weeks and really focused hard on getting it done. It has done remotely by doing diligence remotely over the last 30 days, and it's worked out. So I -- better sooner than later if you're going to deliver an integrated product. And we think this is the time in the market where -- or this market will shake out winners and losers more so than the prior market.

Got it. And then on any financial impacts?

Yes. I'm going to -- we're going to hold that one until the earnings call, Keith, because as you can imagine, we still have to go through regulatory approval to get the deal closed, and we'd rather have the certainty to close behind us when we share financial impacts with you.

Next question comes from Fatima Boolani with UBS.

Lee, maybe to start with you. So of course, you've been working on an organically developed SD-WAN solution. And maybe tying some of the earlier points together, can you help parse through sort of what is incremental to the homegrown SD-WAN capabilities and how the new capabilities from CloudGenix are going to be deployed, whether that's through an attached subscription or an unattached subscription? And then I have a follow-up for Nikesh.

Yes. Thanks for the question. The -- we've seen, and I described a little bit in the market is there's -- a lot of the SD-WAN market today is more of a sort of a do-it-yourself model where SD-WAN products are sold to customers and the customers deploy them. They build their own -- the hubs and regional data centers. They connect them together. They basically build their own network. And the -- and there will continue to be a market for that. But we really see the market shifting toward a SASE model, where that global network footprint and cloud-delivered security is delivered as a service for the customer. And so in that model, what -- the CloudGenix approach really fits nicely in that their SD-WAN device, whether hardware or virtual, is designed to be very lightweight yet intelligent, deployed into the branch office, and it's already optimized for connecting into a global cloud footprint like Prisma Access. They then provide the cloud-based telemetry, monitoring capabilities, the application performance routing. So it really completes the approach that we're taking with Prism Access in an optimized way. Now we will, again, as I said before, we will continue to enhance the stand-alone products. We think there are a set of customers out there for various reasons that will continue to go down that path. And so you'll see us enhance both the CloudGenix as well as the -- our next-gen firewall-based products. But we see that more as a -- in the future, becoming the on-ramp to Prisma Access and SASE solution.

That's super helpful. And Nikesh, for you, in our conversations at RSA, there were some considerations around potentially slowing down the M&A effort. So can you give us a sense of or some indication of how investors can feel confident that ongoing transaction activity like this won't dilute or divert your focus away from the efforts on rehabilitating the core firewall business and network security business? And that's it for me.

Thank you, Fatima. Look, from a revival of the firewall business, that's a sales execution issue we highlighted in Q1 and Q2. And we said we believe that we would improve that capability in Q3 and going forward into Q4. And we still stand behind our statement that we believe our revival will improve over Q3 and Q4, of course, notwithstanding any COVID impacts that are hard to determine the further out that you look. From an opportunity perspective, we -- as I've said, our Prisma Cloud team is heads up in all the integrations they have to do, and focused on getting them to deliver the integrations. And so is our Cortex team. And when you look at the firewall and the most secure access opportunity, to be honest, as we deliver the SD-WAN, you've clearly seen more activities in the SD-WAN space in the last 6 to 9 months, both competitively as well as from the established players. And we are beginning to see a convergence of security in SD-WAN. And we felt it was imperative for us to have a solution sooner than later. And we have an organic solution, as we described, that satisfies a certain number of use cases. If you want to have a fully integrated, onboarded, remote secure work SD-WAN use case, then this is the right answer for us. So I do still stand by the fact that we're not interested in going and spending money in an uncoordinated, undisciplined fashion. But this was an important acquisition from a product road map perspective and something we'd like to get done. I probably will have more ability to share how we think about it financially at our earnings call. And hopefully, that will give you some more comfort.

Next question comes from Saket Kalia with Barclays Capital.

First, maybe for you, Lee. Can certainly see the strategic overlap between CloudGenix and Prisma Access as well as the dual SD-WAN strategy you talked about, but could you just maybe talk about longer term, how perhaps CloudGenix could add to the SD-WAN capability on your core firewall appliances?

Yes. Good question. Yes, the integration with Prisma Access, certainly, we think it's an obvious one and one that will significantly benefit our customers in where we see the market moving. We are taking a look at where we can leverage either technology and/or simple know-how from CloudGenix into our next-gen firewalls. They've -- one thing I've learned, they've been working on this for the past close to 7 years. Obviously, they've built up a tremendous amount of knowledge and experience to that process, and there's no question we'll tap into that as we integrate the teams and leverage the knowledge and learning in both directions.

Got it. Maybe as my follow-up for you, Nikesh. Listen, obviously, still a lot to play for this quarter. And not looking for a comment on numbers to your point earlier, but you spend a lot of time with customers. And I'm curious, any preliminary things that you're hearing from them just on their view of security spending through this crisis? You talked about more infrastructure from work from home and other tidbits. But anything else that you're hearing from customers as they sort of maybe adjust to this crisis?

Saket, it feels like it's been a long time. But let me remind you, it's only been about 2.5 weeks since people have gone into this mode. And to be honest, most customers were caught unawares, as I'm sure, and everybody was busy making business continuity plans as well as making sure they can scale remote worker capability in a secure fashion. So yes, we've seen that spike in terms of people's interest on the margin in terms of making sure the remote work use cases are working. I honestly believe that -- and as I mentioned in my prepared remarks, clearly, there are some sectors of the economy which have been badly hit already [ by this outbreak ] and those people we're actively working with to make sure that we can work with them on credit terms. Beyond those 2 impacts, I think it will still take a few weeks before customers readjust their plans and rethink their plans if they have to. But for now, we haven't seen any major changes, which is not to suggest they will not. It's just I don't think they've had enough time to think stuff. And everybody's trying to see how this thing unfolds, whether it's going to be a quick one or a slightly longer one or a very long one.

We'll take our next question from Walter Pritchard with Citi.

Question either for Lee or Nikesh. Just around service provider relationships. How are you thinking about this product either being friendly for channel partners like telcos and others that provide network services? Do you think it will put you [ in ] more competition there? Or do you think you can help leverage those relationships with managed services and so forth?

Yes. It's a good question. Let me give you a quick overview and if Lee has something to add. Look, SD-WAN is an interesting market. A lot of the deals that CloudGenix has done have happened through network influencers and people who support large network transformations. Sometimes they come from the security side, sometimes they come from the network side. And we're well placed. We also have kind of started building an SP for Access. We hired a few people who are working with SPs directly. But Lee, do you want to add to that from the possibility of SP as a channel here?

Yes. Obviously, we view SP as this being a viable and a very interesting channel. One thing I'd add is, with Prisma Access, we already have a number of relationships around the world with service providers, using that as the footprint for providing both network and security as a service. And so I could see CloudGenix playing nicely as an extension of that.

We'll take our next question from Brent Thill with Jefferies.

I was curious if you could just expand on the pricing model and how you see that evolving going forward.

Lee, do you want to take that one?

Sure. The -- so maybe just to answer the first part. So the pricing model they have is largely based on -- it's a subscription model and priced by the size of the branch office essentially, which means the entire thing, including hardware, is part of the subscription. That's the current model. As we look forward, as I mentioned, the primary strategic focus will be on integrating CloudGenix with Prisma Access. And Prisma Access obviously is also designed as a subscription model. And so while we haven't finalized all the plans, we'll be going through refining integration planning. During the close process, I would anticipate that you would see us -- the pricing models fit seamlessly together.

And just a quick follow-up for Nikesh on Prisma Access. You mentioned a pickup in demand. There's a few financial services companies. We've seen that already and that we spoke to. And just when you think about how quickly customers are coming back to kind of get renewed on this, can you just walk through what that uptick looks like? And any other color that you have just to further cement that comment would be helpful.

Well, I only indicated that, look, we've had people call us up for more firewall capacity to make sure that GlobalProtect works for them. We currently have approximately over 25 million remote users we're supporting across multiple customers, over 10,000 customers. So some of them have called for increased capacity. Some of them have done quick POCs. Literally 48-hour POCs have gone live. And again, these are anecdotal. These are not a large base we're talking about. We've had customers who literally -- school districts or universities who wanted a more secure access instantly. So we are seeing a pickup in demand. And our view is that it takes 21 or more days to form a habit. We think remote work becomes more normal in corporations. It grows from 5% to 20%, and that becomes a need for every organization to ramp up their capacity in a more stable, scalable way over time. So we think every one of the leads we're seeing who are trialing this stuff out, hopefully, we should be able to convert over the medium term.

We'll take our next question from Sterling Auty with JPMorgan.

I'm curious, in the situation where the customer still wants to bring traffic back from the branch to the core data center, if they're using CloudGenix, would that actually require a separate CloudGenix box at the data center? Or will you be able to integrate that into the existing firewall platform? Or would that perhaps require a customer to upgrade their Palo Alto firewall to support?

Lee, do you want to take that?

Yes. Absolutely. So there's 2 ways in which we can address that. So for -- we can directly address that today with CloudGenix, both in the branch office as well as deploying a CloudGenix device in the data center. We anticipate that it won't take too long before we would be able to have the data center device via next-gen firewall simply running updated software. So that's one way in which we could address it. The other option that we would anticipate seeing a lot of customers do is actually connect CloudGenix up to the Prisma Access service, and from there, determine only the traffic that actually needs to go to the data centers routed back to the data center. Any traffic that's destined for a SaaS application, a cloud application or Internet is secured and then forwarded to the appropriate destination. So it basically does all the security in the cloud and only forwards the traffic to the data center that actually has to go there. But we'll be able to support both deployment options for customers.

Got you. And then one quick administrative follow-up. How many employees at CloudGenix and -- at this time?

Approximately 200.

That concludes today's question-and-answer session. Mr. Arora, I'd like to turn the conference back to you for any additional or closing remarks.

I just want to thank everybody for taking the time and joining us today. As I've said, we're extremely excited to bring our enhanced SASE solution to help our customers. I appreciate all your questions. I hope all of you are staying safe and healthy. I look forward to speaking with you all again. Thank you again. Bye-bye.

That concludes today's presentation. Thank you for your participation. You may now disconnect.