Kelsey Turcotte - VP, IR Mark McLaughlin - Chairman and CEO Steffan Tomlinson - CFO Mark Anderson - President Kathy Bonanno - New CFO.

Philip Winslow - Wells Fargo Securities Pierre Ferragu - Bernstein Rob Owens - KeyBanc Capital Markets Ken Talanian - Evercore ISI Sterling Auty - JP Morgan Matthew Hedberg - RBC Capital Markets Saket Kalia - Barclays Capital Gabriela Borges - Goldman Sachs Michael Turits - Raymond James Andrew Nowinski - Piper Jaffray.

Gur Talpaz - Stifel Gregg Moskowitz - Cowen and Company John DiFucci - Jefferies Fatima Boolani - UBS Walter Pritchard - Citi Keith Weiss - Morgan Stanley Karl Keirstead - Deutsche Bank Shaul Eyal - Oppenheimer Jonathan Ho - William Blair.

Good day and welcome to the Palo Alto Networks Fiscal First Quarter 2018 Earnings Conference Call. Today’s conference is being recorded. At this time, I would like to turn the conference over to Ms. Kelsey Turcotte, Vice President of Investor Relations. Please go ahead ma'am..

Thank you. Good afternoon, and thank you for joining us on today’s conference call to discuss Palo Alto Networks' fiscal first quarter 2018 financial results. This call is being broadcast live over the web and can be accessed on the Investors section of our website at investors.paloaltonetworks.com.

With me on today’s call are Mark McLaughlin, our Chairman and Chief Executive Officer; Steffan Tomlinson, our Chief Financial Officer; Mark Anderson, our President and Kathy Bonanno, our newly appointed CFO. This afternoon, we issued a press release announcing our results for the fiscal fourth quarter ended October 31, 2017.

If you would like a copy of the release, you can access it online on our website.

We would like to remind you that during the course of this conference call, management will make forward-looking statements, including statements regarding our financial guidance and modeling points for the fiscal second quarter and full-year fiscal 2018, our competitive position and the demand and market opportunity for our products and subscriptions, benefits and timing of new products and subscription offerings, our ability to drive outside growth rates, and trends in certain financial results, operating metrics, mix shift and seasonality.

These forward-looking statements involve a number of risks and uncertainties, some of which are beyond our control, 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 and we undertake no obligation to update these statements after this call.

For a more detailed description of factors that could cause actual results to differ, please refer to our Annual Report on Form 10-K, filed with the SEC on September 07, 2017 and our earnings release posted a few minutes ago on our website and filed with the SEC on Form 8-K.

Also, please note that certain financial measures we use on this call are expressed on a non-GAAP basis and have been adjusted to exclude certain charges.

For historical periods, we have provided reconciliations of these non-GAAP financial measures to GAAP financial measures in the supplemental financial information that can be found in the Investors section of our website located at investors.paloaltonetworks.com.

We’d also like to remind you that we will be participating in the Credit Suisse 21st Annual Technology Media and Telecom Conference in Scottsdale, Arizona on November 30, the Raymond James 2017 Technology Investors Conference in New York on December 4th, the 2017 Wells Fargo Tech Summit in Park City, Utah on December 6th, the Barclay's Global Technology Media and Telecom Conference in San Francisco on December 7th and the Cowen Networking and Cybersecurity Summit in New York on December 13th.

And finally, once we have completed our formal remarks, we will be posting them to our Investor Relations website under Quarterly Results. And with that, I’ll turn the call over to Mark..

Thank you, Kelsey and thank you everyone for joining us this afternoon for our fiscal first quarter 2018 results. I'm pleased to report that we delivered a strong start to the fiscal year. On a year-over-year basis Q1 revenue was $505 million up 27%. Billings were $596 million up 15% and non-GAAP earnings per share were $0.74 up 35%.

In the quarter we saw a healthy demand environment in all theaters as well as strong customer interest in all the extended capabilities of our next generation security platform from network, endpoint and cloud.

The go to market changes we made in midyear fiscal '17 which were designed to drive growth and leverage its scale are paying dividends for us in our channel as we start off our new fiscal year. In the quarter we added over 2500 new customers and are now privileged to serve over 45,000 customers globally.

In addition to strong new customer acquisition, we also continue to rapidly increase the wallet share of our existing customers. Our top 25 customers each spent a minimum of $23.2 million in lifetime value in Q1 which is a 53% increase over the $15.2 million in Q1 of fiscal '17.

The rapid growth and adoption of our platform, results from our relentless focus on innovation at our customers. Specific examples of customer wins and competitive displacements in the quarter included a seven-figure competitive win against Cisco in a virtualized data center deal with the U.S. military organization.

The Cisco displacement as the standard security vendor at one of the world's busiest airports based in EMEA, a Check Point displacement at one of the world's largest technology companies to become its global security platform, a Check Point displacement in the data center of one of the world's leading payment processors based in the United States and a Symantec displacement in an endpoint deal for 10,000 workstations at a U.S.

federal agency that also included AutoFocus. There are three Hallmarks to our platform that are increasingly well understood by customers and prospects.

The first is our ability to provide increased prevention through automation and orchestration; second, is our ability to deliver these security outcomes consistently across on-premise, endpoint, cloud in hybrid environments; and third, is our demonstrated ability to continually push the boundaries to simplify consumption models at a time when organizations are struggling to balance security needs with limited operational manpower and budgets.

To accomplish these objectives we continue to drive disruptive evolutions in the market that are designed to meet today's most challenging security requirements and they build on each other over time to establish significant competitive differentiation. To that end, we introduced two new offerings in September.

First, GlobalProtect cloud service which delivers the Palo Alto Networks next generation security infrastructure for remote offices and mobile users as a cloud based service. This offering opens up new use cases for us, help widely distribute organizations, improve their security and reduce complexity.

Also in late September we introduced the Palo Alto Networks Logging Service, a cloud-based offering that stores context rich logs generated by our security platform. Managed seamlessly with our existing panorama management product our Logging Service is the foundation of our Application Framework which is the next major evolution in security.

We expect our Application Framework to provide a new model for the delivery of security applications that it can apply advanced analytics to massive data sets and have automated workflow decisions enforced through already deployed capabilities in the network on the endpoint and in the cloud.

We have received great feedback from the hundreds of customers brief [ph] on the Application Framework which we are on track to deliver in the first half of calendar 2018. Initial reception to GlobalProtect cloud service and the Logging Services has been strong and we are very pleased to have closed several deals in the first quarter.

In addition to our new services we further enhanced the capabilities of Traps, our advanced endpoint protection offering with the introduction of Version 4.1. Among the many new features 4.1 added behavior-based ransomware protection, enhanced kernel exploit prevention and local analysis from Mac OS.

And just a few weeks ago Traps scored a 100% protection rate and earned the Approved Award in the Business Security Report published by AV-Comparatives, an independent organization that tests and assesses AV software. This is yet another third-party validation of our ability to replace traditional AV products.

And in October we expanded the capabilities of Aperture, our Cloud Access Security Broker offering.

As part of the migration to the cloud many organizations are adopting a multi-cloud strategy that includes storing large amounts of data within cloud environments and which requires advanced protection that complement basic native cloud offerings to achieve comprehensive and consistent security.

Aperture now provides application protections for several AWS solutions including Amazon EC2, AWS Identity and Access Management and Amazon S3. We also enhanced our support for Office 365 and Google applications to include cloud based email services and G3 marketplace applications.

We continue to see very good traction with customers as they look to us to help them work through the requirements of security in a hybrid world. Also we were recently honored to be named the Fortune Magazine's list of top 50 companies changing the world and to the Fortune Future 50 list.

These acknowledgements further underscore our commitment to innovation and our dedication to improving security outcomes for our customers. I also want to welcome Kathy Bonanno as our next Chief Financial Officer.

Kathy joined our team in 2014 and is currently Senior Vice President of Finance responsible for financial planning, treasury, enterprise risk management and facilities.

With more than three years at Palo Alto Networks, a decade in cyber security and 30 years business experience she has an intimate knowledge of our company, the industry and broad expertise across financial disciplines as well as a proven track record of building world-class organizations. Congratulations Kathy.

I look forward to continue to work with you..

Thanks Mark. I'm excited about this role and my work with the team. I believe we have a truly unique opportunity to continue to disrupt the security market, take share at scale and increase operating leverage. I will be at several of the upcoming investor conferences and look forward to meeting those of you I don't already know..

Congratulations again Kathy and I look forward to taking the reins from Steffan this coming Wednesday. And before I conclude, I want to thank our customers and partners for their support and our team for their dedication to our mission which is to protect our way of life in the digital age. And with that, I'm going to turn the call over to Steffan..

Thanks Mark. I'd like to add my congratulations to Kathy as well. I've really enjoyed working with you and I know you'll be successful in your new role. Now let's turn to the numbers and guidance.

I'd like to note that except for revenue and billings figures all financial figures are non-GAAP and growth rates are compared to the prior year periods unless stated otherwise. In the first quarter we delivered strong performance against our land-and-expand go to market model.

In addition, the power of our hybrid SaaS model was evident in record deferred revenue that continues to be driven by our ongoing mix shift to subscription and support year-over-year non-GAAP operating margin expansion which drove 35% growth in non-GAAP EPS and very healthy free cash flow generation.

As we look to the balance of the fiscal year we are pleased with our improving execution and widening competitive positioning which is further differentiated by our new offerings. In Q1 total revenue grew 27% to $505.5 million. Looking at the geographic growth of Q1 revenue the Americas grew 25%, EMEA grew 35% and APAC grew 25.

Q1 product revenue of $186.5 million grew 14% compared to the prior year. Sales of the new hardware which we launched in fiscal Q3 '17 continued to perform well as we land new customers and up-sell them into our existence customer base. Q1 SaaS based subscription revenue of $169.3 million increased 40%. Support revenue of $149.7 million increased 32%.

In total subscription and support revenue of $319 million increased 36% and accounted for 63% share of total revenue which was a 420 basis point increase compared to last year. Q1 total Billings of $596.5 million increased 15%. Total deferred revenue at the end of Q1 was $1.9 billion an increase of 37%.

Q1 gross margin was 76.8% a decrease of 260 basis points compared to last year and within our target range of 75% to 78%. The decline was primarily attributable to the ongoing traction we're seeing with the new products introduced in the third quarter of last fiscal year.

Q1 operating expenses were $292.4 million or 57.8% of revenue which is a 360 basis point improvement year-over-year driven primarily by ongoing increasing leverage in sales and marketing. Operating margin was 19% an increase of 100 basis points. We ended the first quarter with 4707 employees.

Net income for the first quarter grew 36% to $69.8 million or $0.74 per diluted share. On a GAAP basis for the first quarter net loss increased 12% to $64 million or $0.70 per basic and diluted share. Turning to cash flows and balance sheet items, we finished October with cash, cash equivalents and investments of $2.3 billion.

During the first quarter we repurchased approximately 861,000 shares of common stock at an average price of approximately $145 per share leaving a balance of approximately 455 million available for ongoing repurchases through December 2018.

Turning to cash flow, Q1 cash flow from operations of $274.1 million increased 35% and included the receipt of a $38.2 million upfront cash reimbursement related to certain of the company's lease agreements. Capital expenditures in the quarter were $32.2 million including $11.2 million of CapEx related to our new headquarters.

Free cash flow was $241.9 million up 32% at a margin of 47.9%. On an adjusted basis excluding the upfront cash reimbursement and investment in our new headquarters free cash flow was $214.9 million up 16% at a margin of 42.5%. DSO were 70 days at the low end of the target range of 70 to 80 days.

Turning now to guidance and modeling points, this guidance takes into account the type of forward-looking information that Kelsey referred to earlier.

For fiscal Q2 '18 we expect revenue to be in the range of $518 million to $528 million an increase of 23% to 25% year-over-year, product revenue to be in the range of $185 million to $188 million an increase of 10% to 11% year-over-year, billings to be in the range of $640 million to $655 million an increase of 14% to 17% year-over-year, non-GAAP EPS to be in the range of $0.78 to $0.80 using 94 to 96 million shares and we expect CapEx for Q2 fiscal '18 to be approximately $30 million.

For the full fiscal year '18 we are raising our guidance and now expect revenue to be in the range of $2.145 billion to $2.185 billion an increase of 22% to 24% year-over-year, product revenue to be in the range of $755 million to $770 million an increase of 6% to 9% year-over-year, billings to be in the range of $2.65 billion to $2.71 billion an increase of 16% to 18% year-over-year, non-GAAP EPS to be in the range of $3.35 to $3.41 using 96 to 98 million shares and we continue to expect extremity to be approximately $100 million.

Before I conclude, I'd like to provide some additional modeling points for the fiscal year. We continue to expect fiscal Q2 and fiscal Q4 to have the strongest sequential total revenue growth.

As reflected in consensus heading into this call our non-GAAP EPS guide continues to include approximately 150 basis points of organic operating margin expansion excluding first half fiscal year '18 investments associated with the LightCyber acquisition.

And we continue to expect fiscal year free cash flow margin to be in the range of 37% to 39% as the nonrecurring cash reimbursement received in Q1 will be mostly offset by rent payments throughout the balance of this fiscal year. With that, I'll turn the call back over to Mark..

Thanks Steffan. Before we head over to questions I want to take the opportunity to thank you again for all your contributions to Palo Alto Networks. You've been an inspiring leader, you've got a great organization and you've been a wonderful friend and a real pleasure to work with you. Thank you very much for that..

Thanks Mark, I appreciate the kind words..

And with that why don’t we head to questions.

Operator, would you please poll for questions?.

Absolutely. [Operator Instructions] And our first question will come from Philip Winslow of Wells Fargo..

Hey, thanks guys and congrats on a great quarter. Obviously the product number was strong again in the quarter and saw an acceleration from the prior two quarters.

Wonder if you can double click on just the sales practices that you all discussed following Q2 and just wondering how you feel in terms of just the go to market right now with the changes that you made last year? And then just one quick followup to that..

Sure Phil, so we saw a good strong environment every theatre so we really liked the health of the market out there and then with being able to go capitalize with some of the changes we made last year which have really taken us back and I think we’re seeing the dividends from that work we started mid last year we feel good about where we are with that process.

We're in the we call the base space before the relationship building phase which seems to be going very well, we'd expect that to keep paying dividends for us as we play out the year..

Got it and then I was hoping if you all could comment on just the pricing environment as well, are there sort of any changes that you've seen there as we exit through this calendar year versus maybe earlier in the year last year? Thanks guys..

Yes, it seems that, good question. Yes it seems the same it is a very competitive market. We've seen the competition price aggressively for quite some time and what we've seen us be able to do is continue to sell to the value of the platform. I think customers get that more and more.

Our team is trained to do that and we like the results of that and we've been able to continue to improve product discounting continuously, sequentially for example, as we like to see that as well and it does not seem like we have to succumb through all the pricing machinations that are going over at the competition here as the customers really adopt the entire platform..

And our next question will come from Pierre Ferragu of Bernstein..

Hi everybody, thanks for taking my question. So when I look at your guidance for next year, so you have 6% to 9% in product and 16% to 18% in billing. So if I make the difference you are growing your subscription billing 20% to 23% year-on-year which is first really impressive and are so way above your product growth.

So my question would be how does that split between attached and unattached product? How much of that is still driven by your expansion of your installed base of firewall and how much is really like subscriptions that are not attached anymore? And then my second question would be, if you keep growing like that subscriptions much faster than products, next year you are going to have less than a third of your billings coming from products and then in two to three years I wish it would be like 80% subscription and only 20% product business, am I right thinking it that way?.

Yes, Pierre, so obviously we don’t guide beyond the year, [Indiscernible] that, but I think this is a general matter. We've seen our business continue to move into the services category over time particularly in subscription services for a few reasons.

One is the platform is very powerful and the customers understand how the subscription services provide better security and reduce the complexity of their consumption models. Secondly we continue to introduce new services.

We just introduced two in September, the GlobalProtect cloud service and Logging Service and we are happy with the performance already with those.

So as we continue to bring new services to market as well we would see the business move in the subscription services direction as well and then on top of that the application framework which will come into market next year as well should also move things in those directions, so that's what we would imaging would occur over a period of time it would keep moving in that direction, but we – for the year we've guided about 65% split if you recall from Analyst Day is revenue as to what will come from the services side of the business..

Thank you..

Thank you..

Next question please?.

And our next question will come from Rob Owens of KeyBanc Capital Markets..

Great and thanks for taking my question.

Maybe you could give us a little more color on the success you are seeing on the products side of things and what's coming from preexisting customers that are within your renewal base versus maybe an increase in competitive wins?.

Yes Rob, well we're doing well in both cases. You can see like net new customer acquisitions continue to be very strong and obviously we're selling product into a lot of those customers, the vast majority of those as a matter of fact.

So we continue to bring in new customer wins and also in the expansion business has been strong for us for a very long time and is powering you know the majority of our business [Indiscernible] by math you know the size of the customer base, the expansion business continues to do well.

I feel like we're doing really great in white space opportunities and also convincing our customers to continue to grow their life time value with us..

And I guess along those lines with much of the upside in the quarter coming from product, the billings was at the high end but you over achieved on product and over achieved on total revenue.

So if I looked at billings relative to revenue yield or I guess the inverse product with the attach of subscriptions, is that product mainly coming then from preexisting customers, you don’t give us much of a subscription uplift or you have less attach or less duration to attach, maybe you could help provide some color there? Thanks..

Yes, sure, just a couple of observations, rounding out the quarter we are very happy with the product delivery obviously and total revenue delivery and also on the billings side, in the quarter we saw a couple of things going on [Indiscernible] ratio, one was as we continue to improve the product discounting the net would put more into the product revenue buckets so the mixes were a bit higher than we thought we would see in the quarter and also in some of our service provider businesses purchases some of those were a little more CapEx heavy than we had forecasted as well, so that would put some more into the product bucket as well so just really the mix is a little different than we expected coming into the quarter..

And our next question will come from Ken Talanian of Evercore ISI..

Hi, guys. Thanks for taking the question.

So another one on product, I was wondering if you could give us a sense for how much the VM-Series and Panorama contributed to the product revenue in the quarter and how we should think about that for the remainder of the fiscal year?.

Yes, this is Mark, very, very little. VM-Series is primarily almost all of it is heading into the subscription services line that’s how we recognize that and it performed very well by the way but very little that goes in the product..

And the same is true with Panorama..

Yes, same with panorama..

Okay and I guess you delivered double digit year-over-year product revenue growth in the quarter, expecting the same next quarter.

Is there anything that you see in the back half of the year that makes you a little bit cautious?.

No, we like the way the quarter played out, so we over delivered on product which is great.

Our forecast looks good in the second quarter and based on that we've increased the product revenue guide on a full year basis, but it's early in the year so we don't see it play out a little bit more?.

And our next question will come from Sterling Auty of JP Morgan..

Yes, thanks. Hi Guys. First of all Kathy, congratulations. Steffan, great job to finish off your tenure on such a strong note. But just wanted to take it to the high level with a guide out of the Check Point, out of Fortinet there was all of these concerns about what was happening in the firewall market.

Obviously you put up good results but Mark in your comments you specifically pointed out good demand in all theaters. That's what I want to point to.

Can you give us additional color as to just in general spending environment for network security more specifically firewalls and there's still this big question on everybody's minds, how much is the move to the cloud going to hamper, help or be a non-event to the firewall vendors?.

Yes, so I mean I think that there are two different levels, higher in our S market, talk about that we're just second which are just very strong, but the highest of all and so we've seen healthy demand in the market for security period right and I think what's happening is but are definitely moving in a real platform direction and then we feel like we have the best one of those and it continues to get better and better over time.

And if you remember Sterling at Analyst Day we talked about the three evolutions all that build on each other and drive continued competitive advantage in that second one in there which is we defined as consistency of security outcomes across not only the network but end points and also cloud environments whether they're public or hybrid cloud environments is very important.

And customers we think agree with that. So we are seeing a good adoption in our cloud offerings the M-Series and Aperture as well. But lots of folks are operating in hybrid environments and I expect them to continue to do that for some time.

So that drives strength and not only the cloud offering that drives strength and that data center, what’s happening in data centers from a hardware perspective and we see less and all this.

May be Mark can you talk about the theatre?.

Yes, you bet Mark. So hey Sterling, I think geographical standpoint no we have across the board we saw 25% in the Americas by far the biggest theatre and 25% in fact in Japan and 35% in EMEA, so really good strong execution across the board.

I think in all theatres we're getting tremendous set bats [ph] because we've got great geographic coverage in all the sub regions and really good partner traction as well. So we're getting a lot more bats we're winning the vast majority of those of bats because we have a much better solution.

I think with regards to cloud as we said pretty clearly at Analyst Day we really think that there’s major tailwinds coming with cloud.

We are hearing constantly from customers that they want as they move more and more off of-prim over the long term, they're going to want consistent delivery of security and that's kind of what we've been talking about for a long time and then we think were pretty unique in that..

And our next question will come from Matt Hedberg of RBC Capital Markets..

Hey guys thanks for taking my questions. Kathy I'll offer you my congratulations as well.

Mark, we continue to hear good things about GlobalProtect cloud services and you've highlighted in your prepared remarks, could you talk a little bit more about the competitive landscape there, what are some of the opportunities? And then I have a quick follow up..

Yes, sure. So I think the way to think about that Matt is and the way we certainly think about it is we want to make sure that our customers when they want to consume the platform, that those consumption models are broad and flexible as possible.

So we have for a long time we’ve offered those capabilities from an on-prem perspective as people mentioned themselves we’ve had with MSSP partners where it could be managed by third-party and now with GlobalProtect cloud service we’ve given the option of having that totally the cloud experience as well.

We've continued to evolve all the offerings based on what the customer needs will be into the future.

So if I step back and that if I say okay, what are we doing? We were bringing the full-on network security or the full-on enterprise security platform in that form factor to the market which means we’re going to be able to provide and we are providing the security outcomes we’ve been driving for some time across all applications consistently from endpoint to network and cloud as well and in ways that are just not be like traffic is leaving but also coming into the network and being able to bridge the multiple user.

So pretty distinct competitive advantage I think there and also flexibility on a new model that customers' reaction so far has been very positive..

That’s great.

And then maybe just a quick one, could you comment on the relative rate of sales capacity ads in Q1 relative to your 15% billings growth was it little less, more or about the same?.

Nothing other than - historically so very consistent what we’ve been doing for many years..

And our next question will come from Saket Kalia of Barclays..

Hi guys, thanks for taking my questions here and congrats Kathy for the promotion as well..

Thank you..

Hey Mark, maybe just to start with you, just part of level understanding it’s still early days on Application Framework, I’m just curious how Application Framework is maybe changing customer conversations if at all at this juncture?.

It’s been really dramatic Saket and positive way that when we are talking with customers and we start off are always with the very high level to say, Palo Alto for the last decade has been fundamentally bringing higher and higher rates of prevention to automation and orchestration and addition to doing that, we’ve also been massively simplifying the consumption model along the way, so that customers can have better security with a much simpler consumption model which drives better ROI, less manpower, all the things that we believe is important for long time and we are completely [indiscernible] now with the models the way they are, they’re really broken have to be fundamentally different.

And then to show them the way for the third evolution with the application framework to say imagine a world that looks like this that were you don’t have to give up getting lots of innovation from the security market because security has to be highly innovative but no one company can do that, but here is a way to get even more automation, more orchestration, better prevention rates and do it with the vastly simplified, our consumption model is well they really like that.

Now I think what that’s doing for us right, right now is very much showing what the future is going to look like as the thought leader. We have lots of demonstrated capabilities of making those real.

We have people writing applications for the Application Framework today and we always got to keep in mind that after that conversation they’re going to buy something this afternoon, it might be a firewall, it might be end point solution, it might be virtual machine and the cloud or something along those lines for a project and what I think we’re hearing them say is you've given us a very significant reason why we want to choose Palo Alto Networks as our operating platform for lack of a better term in all places in our architecture for our security capabilities..

And our next question will come from Gabriela Borges of Goldman Sachs..

Great, good afternoon, thanks for taking my question.

Maybe a follow up on the demand picture, but instead of geographically by verticals, so maybe if you could comment a little bit on federal carrier a bit Mark and I think there was a comment earlier on some of the mix being better towards products because of CapEx from the service provider, so if you could just talk a little bit more about the demand profile and the mix you’re seeing across the vertical that would be really helpful?.

Sure thanks. Yes, so first let me start with we’re very well diversified across our verticals and which is great and we like to see that.

I mean mostly it demonstrates that we are truly a platform because you see that horizontally played out across all verticals and from a Fed perspective at Fed year end we saw good wins there and continue to see increasing signs of spending getting back to normal which would be fantastic.

There has been a lot of ups and downs and anxiety in the Fed market due to type of leadership positions being filled or in continuing resolution right now. So any - can return to normalcy as a good thing there.

And also the Fed space fits very well within our mission for what we do which is to protect our way of life in the digital age and what the federal government is trying to do they find that to be very in line with their mission, so they like that a lot too which is great. On the service provider side that is a good market for us.

It continues to grow nicely.

We've continued to put more investment in there from a technology perspective of adding features and function and earlier to that, my comment earlier on the prepared remarks around service provider was that the product mix of the deal sets in the service provider is a bit heavier than we thought in the quarter that contributed some to the product mix in the quarter which of course we like to see..

And we'll hear next from Michael Turits of Raymond James..

Hey guys. I have two questions.

First one I think this is a continuation of Rob Owens question asking about the new risk existing, can you give us some sense of where you are and then refresh cycle coming off of your big build where you approached was really strong back in the 2012, 2013 era and where you might be if that's on track? And then I have a followup question about billings..

Yes, sure. So from a refresh perspective the refresh opportunity as we've said before is large and continues to grow we add this many customers and the cohorts grow over time that's been going well for us. We had to refresh in the quarter, we expect to continue that through the rest of the year.

We also mentioned likewise you may remember on Analyst Day that wallet [ph] the case we wouldn’t expect that to be the major driver of product growth in year.

We select that to be really the platform itself or new customers or new product introductions and increasing productivity in the sales team that we own, but the refresh is definitely a positive for us and we're doing very well..

And our next question will come from Patrick [indiscernible]..

Thanks for taking my questions.

He I wonder if you would tell us see, or give us indication of the product revenue blend from the new hardware launched in Feb ’17?.

Product revenue blend, I’m sorry Patrick, I'm not exactly sure I understand the question..

So of the quarter revenue sold in the quarter what kind of portion roughly was from the kind of new hardware you launched early this year?.

Yes, that the new products that we launched had a very healthy contributing factor to the mix of products. We don't give out specific percentages, but the traction has been very strong.

It's opened up new opportunities to sell to the new customers as well as selling into our installed base from an expansion standpoint and so it was a very strong contributor. We just don't give up the specific percentages..

And our next question will come from Andrew Nowinski of Piper Jaffray..

Great, thanks congratulations Kathy. So just may be a clarification I guess your product gross margin was a little bit lower than it has been historically which I think you said was due to the new products the new hardware.

But when do you expect to start see the cost efficiencies from the new products where they are no longer headwind to your gross margin?.

Yes, what we said earlier when we had new product launches that we would have some headwinds on product gross margins as we got to kind of the scale also that our providers people who supply us with components can also take those components into a broad base into the market.

When we look at the size of the product launch we just did back in February is the biggest one we've done by a long shot, so we don't have actually a perfect analogies on that but probably the closest one is the 5000 Series we did a number of years ago and that's about a year or so before we were able to get those economies of scale we expect that to be the case here..

And just follow-on point, with that being the dynamic we're still operating within our framework of 75% to 78% total gross margin and we've incorporated that dynamic into that guidance range, so we feel good about that structure..

And our next question will come from Gur Talpaz with Stifel..

Great. Thanks for taking my question. So a quick question on end point do you think we're at the point now where large enterprises are more willing to buy end point prevention and networking security from the same vendor and are you seeing more in the way of standardization projects thinking perhaps in the quarter..

Yes, this is Mark. Yes, I think that's the case and we believe just as a big picture matter that that's definitely going to be the case in the future we've been very heavily into the end point market as you know.

We think it is by matter of necessity and that you think about that second evolution the way we define it is consistency of the network end points that's going to be very important some capabilities from a security perspective or better done on network and some that are better done on end points and increasing the data in the cloud some will be a cloud.

So we have to get all of those right and very importantly they all have to work together.

We're seeing that the customers want, they want that consistency and I think they also want fewer vendors as a big picture matter as well so being able to have a platform that has consistency that allows to reduce the number of vendors and sprawl in the organization that might be devices in a network, that might be agents on an endpoint is a net positive for them..

And Gregg Moskowitz with Cowen and Company has our next question..

Okay, thank you. Congrats on a good quarter. Congrats Kathy, best of luck Steffan. So I'd like to go back to new customer acquisition because this was an impressive quarter on that basis and especially so for Q1.

We do attribute this to the product refresh earlier in the year or would you also say there is a more concerted go to market focus around reaching new accounts? Thanks..

I think we have a number of things that are going on Gregg. We had solid performance from all the theatres, you heard a little while ago across all the customer profiles. We've got our continued productivity improvements as well from the work we started last year.

The new products for sure are getting a positive reception in the market and then also with increasingly growing that of offerings so their new services. We have the ability to talk to customers about new opportunities and land new customers with not cash services as well.

So we have a whole bunch of stuff going on from as far as ability of the test customers new products definitely are contributing nicely to that..

Okay, thanks..

Thanks Greg..

And our next question will come from John DiFucci of Jefferies..

Thank you. I have a quick follow up question for Gurs question, I mean it has to do with Traps, because it looks like you're seeing some good traction and by the way this question I think is more for Mark Anderson. And that Symantec displacement is really interesting.

I assume when you have conversations with customers that first buy your firewall and everything that comes along with that and then they consider Traps.

But I guess is that accurate? And have you ever seen, I've seen when they look at Traps are they comparing Traps on its own merits against Symantec? Mark McLaughlin just talked about having both is you know has some advantages, but do they also consider on its own merit against its own merits against the competing product and has it ever been or do you think it will ever be the land product, like hey, I want to buy Traps and then maybe I'll consider the firewall?.

Yes, John. Thanks for the question. No, I think just first of all about a third of our customers for Traps or that first purchases Traps not traditional network security, so and we think on the merits of the solution with the focus that we have in the field that we are winning because we're delivering better outcomes.

And we're going after traditional anti-virus budget because customers have associated very little value with the money that they are spending on traditional anti-virus. I think down the road we won't really strategic space for us and as Mark mentioned earlier and we're going to continue to see success here..

Yes and I think one of the things John is well and this is important for our teams that are out there making these sales is the ability to be able to tell a customer to say this second evolution where we define it all is really important have consistency of the security outcomes regardless where the data is and sometime want to be on an endpoint right? So we definitely want that consistency and also be able to say on a head-to-head basis we're the best there right? So you should choose us on a competitive bake off which we know you're going to do and we feel very good about that.

And as you think about that bake off in addition to winning head-to-head you also get the consistency aspect that allows you to grow in the future into even more interesting things like the Application Framework over time right? So more reasons why you want to deploy off the networks everywhere that's important as a data collection point and an enforcement putting your architecture sometimes network, sometimes endpoint, sometimes in the cloud..

And it's really the trust and faith that we've earned from customers over the last decade where they know that we're going to provide a high quality product and then we're going to support it in a way in a more focused way than anybody out there can from a product support standpoint..

Great, thank you, guys..

Sure, thanks..

And our next question will come from Fatima Boolani of UBS..

Thank you for taking my questions. Mark a question for you around your dedicated efforts around building a public cloud practice and bringing your partners in there.

Just at a high level I'd love to see what sort of conversations you are having with the customers around their public cloud challenges and how you are positioned to sort of help them cross the cavern? And a quick follow up Steffan if I may..

Yes, you bet Fatima. So I think we've got a really broad spectrum of customers, some are leaning pretty aggressively into public cloud and we're putting preproduction deve ups new applications into the cloud.

Some are dipping their toes and I think what we represent for them is an opportunity to provide a real consistent look and feel for their security that we can impose there. This is going to take the place over the next five to ten years.

We're going to continue to see more and more migration as people become more and more comfortable for that and I think that comfort is going to come from the kind of security that we can help deliver to them. So I think were in a very good space there..

That's helpful and Steffan if I look back to your billings performance a couple of years ago where you may be signed some longer term contracts, as those come up for renewal in ‘18 and even ‘19 what sort of trends are you seeing in the earlier crop of these longer term deals, are they renewing at the same duration, that would be really helpful? Thank you..

Well, if you look back over the last several years, we've seen a modest gradual increase in duration and it seems to have leveled out at approximately three years. And so for the companies who are, who did a three-year deal three years ago, there's really a mix of renewals business right now.

We're seeing some re-op for a multi-year term we're seeing others renewing annually. So there's really a mix there, but what we said at our Analyst Day and what we still believe to be true is that for the rest of the fiscal year we don't really see any changes in overall duration that it should be roughly about three years..

And our next question will come from Walter Pritchard with Citi..

Hi, thank you.

I’m wondering just as I look at revenue per customer you highlighted your large I think $0.3 million to be a top 25 customer, can you talk about what's happening at the other end of your business? Are you with some of the lower end products are you released in the last six months, are you dipping down into smaller customers at all and what is your strategy around I know you're not a small office SMB player but kind of when do you look to potentially turn into that segment of the market which is probably some revenue opportunity for you?.

Hey Walter its Mark. Our focus has been and continues to be as you know is enterprise security market mostly because we find focus matters is delivering the best solution and have been support them in a high quality manner.

So that hasn't changed for us and we look at the customer acquisition and the mix of customers who are very consistent with what it has been for some time. So we haven't seen a change there as well either.

Though I think what we are seeing from some use cases and some of the larger customers is the ability to address interesting and new use cases around like a retail environment and plus some of the services just want to be able to do some more campus work, global user work and things along those lines, I would expect that to continue to be..

Then a question for Mark Anderson just around the European theatre that was to especially strong, was there anything specific, I mean sometimes good execution is the answer, but I'm curious is there anything specific you're seeing in certain countries or certain vertical markets that might explain the strong performance in Europe?.

Yes that was really good performance across the board in every sub region within in the year Walter.

I think just what we're seeing across the board in Europe is they're typically one to two years behind the Americas in terms of their IT culture if you will and we're seeing just a general awareness of the need for migration away from legacy disconnected products to a more of an architecture approach.

That’s coming at a time when bad things are happening around the world, focused on legislation with GPR and frankly the coverage that we have now in every major country and in Europe that's getting us in front of customers and showing them how we can be a much better provider for them..

Great, thank you..

Sure..

And our next question will come from Keith Weiss of Morgan Stanley..

Hi guys. Thanks for fitting me in and a very nice quarter.

I was wondering just on sort of go to market strategy, it seems like the differentiation in kind of this sales sort of what the service kind of selling to the customer base is changing in a big way, this isn't an appliance selling it was not a box selling where you guys are selling a platform, does this change sort of the partners strategy at all or change sort of the kinds of partners you're going to market with and in terms of who could actually get across that value proposition?.

That’s a good question Keith. Certainly we're always on the lookout for surgically frankly for new partners, not looking to cast a wide blanket, but really looking to improve the coverage we have around the world.

So it is just naturally as we've grown the kind of partners that we couldn't address the large global ones, the large systems integrators seven or eight years ago now we're at the scale where it's hard for them to avoid us frankly.

So we've actually worked really hard on that over the last five years and as I think we’ve discussed in each of the Analyst Days, we’re getting more and more attention there.

But I’d say nothing really dramatically different than the last Analyst Day other than just very much a focus on looking for large global distribution partners, large global systems integrators, service provider partners and national brands.

What we do want is we want a message that’s consistent with what our field team is talking to customers about that this platform or architecture delivery versus disconnected point products..

Got it.

And then just one follow up on the federal vertical in particular, any color you could give us on sort of strength of federal in Q1 and given sort of current machinations with budgeting and what not, expectations for potential to continue that strength further into the fiscal year?.

Yes Keith, Mark again. In the Fed space like I said we saw some good wins there in the quarter. I would say big picture on Fed it’s been a mixed bag for a number of quarters as there has been some consternation I think in the federal space on some senior leadership positions that still go unfilled.

And it is also just the budget we’re still working on the continued resolution right now that don’t think it’s for December timeframe, but the progression of seeing more normal spending and people understanding what their budgets will look like for the following year is very important to hopefully getting through the continuous solution would be a positive marker on the table and get people back to more normal spending patterns there..

Yes and then just I would add, it’s a really important space for us to be in, we’ve invested in the team over the last three years and we’ve got great coverage across the Intel, Pavilion and DoD segments and I think we feel really good about the team..

Excellent. Thank you very much guys..

Sure, thanks Keith..

And our next question will come from Karl Keirstead of Deutsche Bank..

Hi thanks for either Mark, I wouldn’t mind going back to the relative performance.

It feels like in this quarter and the one you’re guiding to the gap between yourselves and Check Point and Fortinet seems to be widening and I just want to ask if you can help us understand exactly where that wedge seems to be opening up? Is it simple as you've got a product cycle benefit that perhaps they don’t know maybe you could help us there? And then maybe as a follow up to Steffan to build on a prior question, you raised the revenue guidance, but the billings guidance is at least at the high end essentially the same, is that simply because most of the DR comes from maintenance and subscription and those line items were a little bit more in line versus the outperformance on product? Thank you..

So I will take the first part. What I think we are seeing in the market and have been for a while is the importance of the platform which I mentioned before where things work together in a highly automated fashion and there is really positive benefits in prevention outcomes plus the simplicity of the consumption models that result.

I think that’s really continues to distinguish itself in the market because anybody can make those statements but at the end of the day what really matters is the architecture on how it’s actually built.

And I think that what we’ve proven over time is we get a lot of credibility there because we’re a company that primarily is working on developing and building those things ourselves, we can make those statements at scale to customers and say no we really think this actually works together right and we have lots of references you can talk to where other companies might be cobbling things together and trying to do things that really don’t work out at the end of the day, when trying to get to the automated platforms.

So I think that’s one level, the second thing on the architecture is the elegance of the architecture matters is well where from a simplicity perspective having it work in that automated orchestrated way and kind of mostly in charge of the platform you build a lot of it yourself matters from a stability perspective.

So we increasingly as other vendors add more like acquisitions into the mix that stuff doesn’t really work well together and not only does it not try the security outcomes but it is increasing instability in networks as well.

but we will hear a lot of folks coming to Palo Alto Networks saying one of the primary reasons is not just technical it’s also stability my currently provide can’t run at these big scales any longer they just keep adding more stuff and starting to break things as well.

So if we -whole bunch of stuff in the mix of that but it all comes back to the architecture of the platform is the primary differentiator and as we try these revolutions and they build on each other we think that increases the moat and over time we'll continue to distinguish ourselves..

Yes and Karl on the second part of your question, as you mentioned we did raise billings for the full year by $10 million. The mechanics are such that when you look our deferred revenue balance and that what we're adding to it every quarter very robust and healthy growth in both attached and non-attached subscriptions and also maintenance.

But they're coming in line as expected and I think to the point that you raised, we are having more in-period more in-period revenue than we had originally planned for because product was so strong and so we also raised product for the full year.

And the last point, I'll leave you with is if you think about current billings, current billings was strong and that reflects product revenue in the period versus the change in short term deferred..

Got it, okay. Thanks a lot..

Thanks Karl..

And our next question will come from Shaul Eyal of Oppenheimer..

Thank you. Hi good afternoon guys, congrats on a good quarter, congrats Kathy on the recent promotion, Steffan, thank you for everything. Actually Steffan before we let you go just a quick housekeeping.

Number of customers relating to Traps and WildFire historically you have been providing that, any view, any update along these lines?.

Yes on that front, we release those on a semi-annual basis and we saw a very healthy growth in customer accounts for both of those product lines..

Fair enough. Mark, you mentioned in your prepared remarks an expansion of your cloud product.

I think you also mentioned including them an updated email version targeting Office 365 landscape among other things, just want to make sure does that products [indiscernible] successful partnership with Proofpoint? A - Mark McLaughlin Yes what I mentioned Shaul is the for our Aperture offering which is our Cloud Access Security Broker offering we continue to expand the applications APIs that it's worked with and we've expanded it into cloud based e-mail offerings like Gmail for example, so that we've done and so it's you can just think of them as we keep getting more application coverage through Aperture..

But there hasn’t been great number of proof point that would when we can make this discovery with Palo Alto Networks integration between Proofpoint can allow Proofpoint actually do something about it, so it really is an ad for Proofpoint..

Got it, that is helpful, thank you..

And our final question today will come from Jonathan Ho of William Blair..

Hi congratulations, just to make it quick, I will leave with one question, in your early data lake and application framework deals can you maybe give us a little bit of color in terms of what those deals look like and the potential for up sell and expansion over time?.

Yes sure, I will take that and Mark is very involved with some of these, he give some more color, but the big picture on the third evolution Jonathan of bringing the application framework to market maybe somewhat an obvious statement but we definitely are reinforcing that with customers is that if you're going to have capability sets that are really based on analytics and increasingly lots of interesting things and security will be driven on analytic capability, machine learning capability.

The data set against which it runs is very important not only in terms of its size but also in the diversity of the kind of data in there right, like for example you don't need machine learning to tell you information is bad, the only data set we put in every bad stuff right.

So you want to have very big data sets and you want the diversity of these dataset to have good, bad, unknowns in there and grow a lot of types of Logging Service is a capability set that we could go to customers and say for a very cost effective point of view, you can log all the information coming off of Palo Alto Networks capabilities because you want those really large datasets for all the analytic capabilities like LightCyber for example and things will bring to application framework to chew on and the bigger they are, the better they are and it doesn't have to be cost prohibitive a lot of that information.

So Mark was deeply involved in a couple of the sales this quarter, maybe you can add little color..

Yes I think you pretty much nailed it Mark. I think for – to be able to leverage machine learning like our average series are leveraging against our customers everyday in an increasing scale and velocity. You need to be able to log not just bad and suspected bad but also good to really let the machine crunch as Mark said.

So I think what makes us attractive beyond price is the fact that we're able to take the data from Logging Service and add that to the trillions of artifacts that we have in our threat intelligence data centers around the world to really drive the kind of automation that you need to be able to reduce the attack surface.

I think that’s the last question. Okay, well thanks. Before I close, I want to thank everybody again for joining us today and I wish you and your families a very safe and happy Thanksgiving. We look forward to seeing many of you in the coming weekly Summer Investor Conferences. I really appreciate your time. See you next time..

And ladies and gentlemen, this does conclude today's conference. We thank you for your participation, you may now disconnect..