Palo Alto's AI Offering Statements Were 'Materially False,' Alleges Class Action

Palo Alto Networks made misleading statements and failed to disclose material facts in violation of securities laws from Aug. 18 through Feb. 20, alleged a class action Monday (docket 5:24-cv-01156) in U.S. District Court for Northern California in San Jose against the company and three executives. Palo Alto shares fell 28% Feb. 21 to $261.97 on the company's disclosure of worsening Q2 results.

Company executives failed to disclose that its consolidation and platformization initiatives “were not driving increased market share to a significant degree"; it would need to accelerate platformization and free product offerings to entice customers to adopt more of their platforms; its high growth in billings “was not sustainable”; new AI offerings weren’t creating greater platformization and consolidation; and they lacked a reasonable basis for their positive statements about customer demand, billings, and platformization, plus related financial results, growth, and prospects, the complaint said.

After market close on Feb. 20, Palo Alto Networks announced Q2 2024 results and lowered Q3 and full-year billings and revenue guidance of 2%-4% and 13%-15%, said the complaint. On its Feb. 20 earnings call that day, CEO Nikesh Arora said federal government deals for several large projects didn’t close and resulted in “a significant shortfall in our U.S. federal government business” that’s expected to continue into Q3 and Q4. He added that the situation that started at the end of Q1 “worsened in Q2.”

As a result of Palo Alto’s wrongful acts and omissions, and the “precipitous decline” in the value of its common stock, Martin Schlaegel and class members "suffered significant losses and damages," the complaint alleged. In addition to Arora, Schlaegel names Chief Financial Officer Dipak Golechha and Chief Product Officer Lee Klarich as individual defendants who had the power and authority to control the content of the company’s annual and quarterly reports, press releases and investor presentations provided to the SEC, financial analysts and investors, it said.

At the beginning of the class period, Arora promoted Cortex XSIAM, a Palo Alto Networks AI product, and the potential for AI in general to benefit the company, the complaint said. He referenced “'very strong’” interest from customers fueled by its AI technology and automation for the 'fastest sort of growth of a new product that we’ve ever seen.’”

The company represented during the class period that consolidation and platformization efforts were driving growth, said the complaint. Arora said in November that an AI-enabled cloud manager in network security could continue those efforts toward zero trust, an approach to cybersecurity that validates every stage of a digital interaction, said the complaint. Palo Alto was competing with Microsoft, CrowdStrike, Zscaler and Cloudflare on zero trust offerings, it said.

Despite representing to investors that there was “strong demand" in the market,” strong interest across its next-generation "security portfolio,” and that “platformization is continuing to drive large deal momentum,” Palo Alto Networks was “struggling to compete in a competitive environment,” the complaint said. As a result of those “misleading statements and omissions” about platformization efforts and customer demand, “investors were unaware that Palo Alto Networks was being pushed to ramp up customer incentives to the detriment of its own financial performance and that the Company’s high growth in its key billings metric was not sustainable,” it said.

The defendants acted with scienter in that they knew public statements made in the name of Palo Alto Networks were "materially false and misleading," the complaint said. They “knowingly and substantially participated or acquiesced in the issuance or dissemination of such statements or documents and in actions intended to manipulate the market price of Palo Alto Networks’ common stock as primary violations of the federal securities laws,” it alleged. The individual defendants “knew or were reckless in not knowing” of the facts detailed in the complaint, it said.

Schlaegel claims violations of the Securities Exchange Act and seeks compensatory and punitive damages for himself and class members, plus pre- and post-judgment interest, attorneys’ fees and costs. Palo Alto Networks didn’t comment Tuesday.