Drill Down Earnings, Ep. 474: Palo Alto Networks Q4 earnings – ($PANW) – A Deep Dive with Cory Johnson

Cory Johnson (0:00)

Welcome to Drill Down Earnings, we have quarterly results on Palo Alto Networks, and Cory Johnson, Chief Market Strategist for Epistrophy Capital Research. We're looking at the 50 most important companies in technology. One could make the argument that Palo Alto Networks is the most important company in cybersecurity. Certainly, they think so.

But it's an important company that's growing in importance, and they're making some big changes in their business. And in an era of AI, where large-language models are being used by hackers to find incredible vulnerabilities, incredible mounts of vulnerabilities in systems, at the same time as it's been used for the defense of companies, and indeed, Palo Alto Networks is trying to help use those models to create those defenses. The company has traditionally sold firewalls, cloud security, but now AI-driven security operations as well, especially since buying a company called CyberArk, and that fits into these results.

CyberArk is an identity management system that guards roughly 70,000 enterprises out there. So using autonomous AI agents, increasingly Palo Alto Networks is trying to outnumber human employees, both in defense, and they also see that with adversaries using agents a lot. So it's a huge deal, what's happening in cybersecurity right now. Now, Wall Street can't figure this out. The knuckleheads on TV talk about beats and misses, and it was a beat, I guess, 3.41 billion in revenues and $1.2 in adjusted earnings per share. But we can understand this business a little bit better when we dig a little bit deeper here. Now, that CyberArk merger really boosted the sales growth at 34% on a year-over-year basis, but also sequentially saw an important increase in revenues here, and indeed much better than their guidance, which was sitting at about $3.35 billion. They did $3.41 billion product revenues in particular, not just services, but products of 29% on a year-over-year basis. Now, Idira, the CyberArk identity platform, saw their growth accelerated 27% on a year-over-year basis, up from 20% a year or two quarters earlier. So under the Palo Alto umbrella, if you will, CyberArk is now growing faster. That's good news. That's exactly what they'd want to have happen in there. And the cross-sell is a huge thing with them able to take CyberArk's products out there with their existing sales team and seeing real growth there. And while sales and marketing hurt margins, specifically last quarter, operating margins, gap operating margins of 5%, nothing to write home about here. These guys are clearly investing on growing right now, as well as in R&D to make sure they've got the best products for a very rapidly changing threat environment.

And of course, the acquisition is expensive. Now, when you think about this company historically, you can dig a little bit deeper. And what they used to call next generation, which was getting away from firewalls, getting away from hardware, and a business they want to continue to serve because it's done quite well for them. But the other stuff growing faster in their next generation security, that business when measured on an annual basis is just growing fantastically, and is the bulk of revenues. This next gen security ARR reigns in terms of the dominance of their business here. Next gen is kind of the thing, but it's their term for like modern software and subscription. So they call it SASE, a software security as a service, cloud-delivered services, specifically the Prisma Air's Cortex, and I mentioned Adira as well, which was acquired in the last six months or so.

Now, these are also interesting because they're measured on recurring revenue. They don't have to go out there and make a sale and wait for that product to get old to get replaced to make a new sale here. The legacy firewall business, not so much. So, just growing wonderfully. There's different ways to look at it. If you just chart the two as I have, and you look at the old gen revenues and the next gen revenues, next gen revenues are just growing wonderfully. And you can see that reigning in terms of what's selling most there. Now, how did the market react? Well, the market loved these numbers and hated these numbers and loved these numbers. And after I was trading, the stock down, actually up a little bit, and after I was trading, I'm going to call that mostly flat. But look, that's after a 90% gain in the last year. So the change in what's happened in the world of cybersecurity because of AI has been very good to the shareholders of Palo Alto Networks. Now, as customers try to figure this out, you've seen the big growth in revenues at 34%. Orders for the future RPOs, remaining performance obligations, growing at exactly the same pace as revenues at 34%, hitting $21.2 billion in an annual basis here. And again, that growth in the next gen is driving that. Management framed as a background of what they say is ultimately $1 trillion of legacy security infrastructure that they think they're going to replace with their more modern offerings here that are addressing these threats from AI. Here's what CEO Nikesh Arora had to say about the quarter.