Amber Ossman - Director of Investor Relations Nikesh Arora - Chairman and Chief Executive Officer Kathy Bonanno - Chief Financial Officer Lee Klarich - Chief Credit Officer Dave Peranich - Executive Vice President of Worldwide Sales.

Ken Talanian - Evercore ISI Matt Hedberg - RBC Capital Markets Andrew Nowinski - Piper Jaffray Keith Weiss - Morgan Stanley Michael Turits - Raymond James Sterling Auty - JP Morgan Saket Kalia - Barclays Gregg Moskowitz - Cowen & Company Jonathan Ho - William Blair Patrick Colville - Arete Gabriela Borges - Goldman Sachs Erik Suppiger - JMP Securities Catharine Trebnick - Dougherty.

Good day. And welcome to the Palo Alto Networks Fiscal First Quarter 2019 Earning Conference Call. Today's conference is being recorded. At this time, I'd now like to turn the conference to Amber Ossman, Director of Investor Relations. Please go ahead, ma'am..

Good afternoon. And thank you for joining us on today's conference call to discuss Palo Alto Networks' fiscal first quarter 2019 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 Nikesh Arora, our Chairman and Chief Executive Officer; Kathy Bonanno, our Chief Financial Officer; Lee Klarich, our Chief Credit Officer; and Dave Peranich, our Executive Vice President of Worldwide Sales. This afternoon, we issued a press release announcing our results for the fiscal first quarter ended October 31, 2018.

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

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 2019, our competitive position and the demand and market opportunity for our products and subscriptions benefits, continued execution focus and timing of new products and subscription offerings.

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 13, 2019, and our earnings release posted a few minutes ago on our Web site and filed with the SEC on Form 8-K.

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

For historical periods, we've 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 Web site located at investors.paloaltonetworks.com.

We'd also like to inform you that will be participating in the 2018 Wells Fargo Tech Summit in Park City, Utah on Tuesday December 4th and the Barclays Global Technology Media and Telecom Conference in San Francisco on Wednesday, December 5th.

Lastly, once we have completed our formal remarks, we will be posting them to our Investor Relations Web site under Quarterly Results. With that, I'll turn the call over to Nikesh..

Thank you, Amber. Hello everyone and thank you everyone for joining us this afternoon for our fiscal first quarter 2019 results. As you know, it's been a busy few months for me at Palo Alto Networks, and I'm delighted to reports that we had another outstanding quarter.

And once again, we have been able to go our top line significantly faster than the market. I'm also happy to say that my cyber security education is progressing nicely as I continue to meet more customers, partners and employees.

Through this quarter, we held our first ever European Ignite, our user event in Amsterdam and our second annual Federal Ignite event in Washington, D.C. At these events for our customers and partners, we consistently heard from multinationals to governments, all the challenges that are associated with protecting data in a digital world.

Mobility, the movement of data to the cloud, data analytics and machine learning are some of the trends that we believe are forcing companies to evaluate the security posture in a more comprehensive manner looking for high levels of integration and automation.

In this way, we believe we are uniquely positioned to support our customers across all these three events; one, securing the enterprise; two, enabling them on their journey to the cloud; and three, helping with them with their desired display advanced AI and ML across their enterprise.

So, let's discuss some current examples of how we're solving customer problems and what we have in store. Service provider is a segment where we have traditionally done not done as well as we would like. We're about to change that.

We're excited to announce a new product for our service provider partners, and how we plan to focus on investing for future growth. Our service providers are facing a major mobile infrastructure transition from 4G to 5G. You want to be there with them to help them succeed.

They're announcing a new super scale next generation firewall, the K2C that has been developed specifically for service providers for their high throughput need, taking into account their prices innovations, their upcoming 5G and IoT transition. We expect it will be available shortly in early 2019.

And in segments where we've done well, the federal space, WildFire, our cloud delivered malware analysis service achieved fed ramp ready status during fiscal Q1. This extends our ability to provide Advanced Threat Prevention analysis capabilities to U.S. federal agencies. For our largest customers we introduced Panorama Interconnect.

The new Panorama Interconnect plugin gives customers the ability to manage the configurations of over 30,000 next generation firewalls from a single Panorama console, and they can push configuration changes or manage devices from one single location. This continues our quest simplifying large scale security management for our customers.

And lastly in cloud security, we closed our RedLock acquisitions this quarter. RedLock adds are already extensive set of could security offerings, which include Evident, Aperture, GlobalProtect cloud services and BMC.

By combining the Evident RedLock technologies we provide customers with cloud visibility and compliance, cloud security analytics and advanced threat detection in a single offering to be released very early next year.

Video offering will help security teams better understand their cloud deployments, detect or respond faster to the most critical threat and achieve automated remediation. I know there’s a lot of discussion around our philosophy and my philosophy on M&A. So I’d like to use the subject of RedLock to refine our point on the M&A philosophy.

The technology required is best in class. We have a clear opportunity to be a leader in this space, and we believe that we can significantly enhance the value of the assets required. We invested a product focused team and technology that we believe we can integrate quickly and effectively into our infrastructure.

I want to reiterate that as a shareholder and an investor my interests are aligned with yours to create long-term shareholder value.

To give you some guidance, any activities related to M&A are going to be disciplined, they’re going to be guided by aspiration to; one, participate in large markets; two, become number one or number two in that market; and three, bring the vast execution capabilities on Palo Alto networks to any acquisition so that we can instantly enhance value.

Moving forward, we will continue to stay strong in network security, adding capabilities to solve our customer problems. Additionally, we will lean forward into the trends of cloud, machine learning and AI in a big way.

These import technologies stayed with our vision of simplifying security and providing a platform with consistent protection across an enterprise environment is resonating with customers. The application framework and XDR are the next steps in our evolution towards this goal. We’re making good progress under the leadership of our founder Nir Zuk.

And while we’re still in the early days during Q1, seven partners launched applications of framework. The technologies of these partners bring to the framework, include analytics, MSSP, identity, threat intelligence, security for industrial control systems, IoT and network access control.

Before I move on, I’d like to add a little bit more color on my first 180 days. As we all know, execution has been a key variable in our success as a company and will continue to be so in the future. During last earnings call, I mentioned launching speedboats with focused leadership accountable for results in our more nascent market opportunity.

Once we have a great execution machine, we want to make sure our speedboats give us the flexibility to operate and execute effectively in some of the newer areas. Our first speedboat in cloud security has been launched and is also a good start.

We have product and sales leaders jointly driving our cloud performance, and we expect this focus will allow us to execute as well in new areas as we have done historically. We'll likely launch traditional speedboat in the future and we’ll keep you posted on our progress.

We have an excellent go-to-market engine that is running well and with our new president, Amit Singh, we have a leader in place who brings extensive experience, growing enterprise and small businesses to driving revenue scale. Amit joined us on the November 1st, and has been extremely busy in his first few weeks on the job.

He’s finished over 50 account reviews, met as many customers already this quarter to both share our commitment to them and learn from our customers and how we can best partner over there. He’s running hard and then excited that we found such a capable leader to fill this important role.

He joins a great team and together they will remain focused in executing against our significant market opportunity and momentum across the platform. In our fiscal Q1, team lived up to the reputation as we once again acquired new customers at a rapid rate and expand our wallet share with existing customers.

Our top 25 customers each spend a minimum of $33.6 million in lifetime value, which is 45% increase or the $23.2 billion that is in Q1 of fiscal ’18. Examples of customer wins and competitive displacement in fiscal Q1 that demonstrate the progress we’re making across the network and point to cloud are; we landed top three airlines in the U.S.

to secure their data centers; we also replaced the competitor in the data center and sold all of our cloud subscription at a U.S.

based investment management company; our cloud firewall VM-Series was selected as a security standard, one of the world's largest networking telecom companies in the world; our cloud monitoring compliance offering Evident was selected to secure the public cloud infrastructure on one of the world's largest banks based in Europe.

GlobalProtect cloud service was selected to secure remote factories, offices and stores, one of the world's leading manufacturers and marketers of quality skin care, makeup fragrance and hair care products. No points in guessing what that is.

And our advanced endpoint protection offering Trap was selected to protect 10,000 devices at a leading healthcare provider in Australia. To round-out the news in the quarter, we were happy to be positioned as a leader for the seventh consecutive year in Gartner’s 2018 Magic Quadrant for Enterprise Network firewall.

This positioning reflects our commitment to staying ahead of the landscape and providing our customers with best protection against the ever revolving credit cyber attack. I personally remain extremely excited about the opportunity ahead of us and plan to keep my head down and continue to execute with our leadership team.

I'd like to thank our customer and our partners for their support and of course the team at Palo Alto Network for their dedication to our mission. I really enjoyed becoming more established at Palo Alto Networks and learning about cybersecurity and working with this great team. I wake up every day excited to be part of a great Company.

With that, I am going to turn the call over to Kathy..

Thank you, Nikesh. Before I start, I'd like to note that except for revenue and billing, all financial figures are non-GAAP and growth rates are compared to the prior year periods unless stated otherwise. All current and prior period financial discussed are selected under ASC606 as we adopted the new standard as of August 1, 2018.

As Nikesh indicated, we had a great start to our fiscal year. We continue to see healthy security spending and strong demand across our platform. In the first quarter, total revenue grew 31% to $656 million. By geography, Q1 revenue grew 29% in the Americas, 35% in EMEA and 35% in APAC.

Q1 product revenue of $240.5 million grew 30% compared to the prior year. Q1 SaaS based subscription revenue of $231.3 million increased 37%. The support revenue of $184.2 million increased 24%. In total, subscription and support revenue of $415.5 million increased 31% year-over-year and accounted for 63% of total revenue.

Q1 total billings of $758.5 million increased 27% year-over-year. The dollar weighted contract duration for new subscription and support billings in the quarter was approximately three years consistent with what we have stated in prior periods. Total deferred revenue at the end of Q1 was $2.4 billion, an increase of 34%.

Q1 gross margin was 76.7%, relatively flat to last year. Q1 operating expenses were $366.5 million or 55.9% of revenue, which represents 140 basis point improvement year-over-year. Q1 operating margin was 20.8%, an increase of 150 basis points year-over-year. We ended the first quarter with 5,645 employees.

Non-GAAP net income for the first quarter grew 64% to $115.4 million or $1.17 per diluted share. On a GAAP basis for the first quarter, net loss decline 39% to $38.3 million or $0.41 per basic and diluted share. Turning to cash flow and balance sheet items, we finished October with cash, cash equivalents and investments of $3.8 billion.

Q1 cash flow from operations of $252.3 million declined by 8%. Free cash flow for the quarter was $218 million. During the quarter, we redeemed $327 million of the $575 million 2019 converge. For GAAP accounting, $52.3 million of the amount redeemed is categorized as cash flow from operations.

Adjusting for this and other cash charges, free cash flow in the quarter was $275.4 million, up 27% at a margin of 42%. Capital expenditures during the quarter were $34.3 million. DSO was 58 days, a decline of 12 days during the prior year period. Turning now to guidance and modeling points.

For fiscal Q2 '19, we expect revenue to be in the range of $675 million to $685 million on an ASC 606 basis, an increase of 24% to 26% year-over-year. We expect second quarter non-GAAP EPS to be in the range of $1.20 to $1.22 also under ASC 606 using approximately 99 million to 101 million shares.

Before I conclude, I'd like to provide some additional modeling points. Our non-GAAP EPS guidance includes expense of $10 million to $15 million associated with our recent acquisition. Also included is our expectation of $0.01 to $0.02 impact associated with U.S. tariffs on Chinese origin of goods.

As we continue to retire the 2019 convertible debt through maturity in July, we expect approximately $45 million of the remaining $248 million balance to be accounted for as cash flow from operations. We expect our non-GAAP effective tax rate to remain at 22%. CapEx in Q2 '19 will be approximately $25 million to $30 million.

With that, I'd like to open the call for questions. Operator, please poll for questions..

Thank you. At this time, we'd like to open the floor for questions [Operator Instructions]. Our first question will come from Ken Talanian with Evercore ISI..

So first off, could you give us a sense for what if any changes you have made to your go to market efforts on the firewall side, and I'm thinking of that inclusive of the channel?.

We haven't made any particularly major changes to our go to market on the firewall side that I think of, or including the channels and the efforts continue to be the same. Dave is there anything you….

Ken it’s really been business as normal on that front. The sales team is enthused and highly engaged. We’ve got the industry leading product. We’ve got great traction and great markets in front of us to grab and we feel great about that business..

And as a second question, could you give us an update on your traction with GlobalProtect cloud and how you characterize your win rates there?.

Ken, on the GlobalProtect cloud front we think we have a unique opportunity. As we see people trying to go ahead and automate and put security and some of the architecture for their remote branches and for the remote offices. We think GPCS is a unique product, which does really well. We’ve had some good successes with some very large players.

We’ll share more about the success in our next quarterly call.

But for now, again, it’s an interesting product, it’s unique in the way that allows our existing customers of Palo Alto Networks to be able to extend their network security which they already have in the data centers, all for their remote branches without having to change management control system, et cetera.

So really exciting, we’re seeing a lot of traction and hopefully, we’ll tell you more about it next quarter..

Our next question will be from Matt Hedberg with RBC Capital Markets..

Nikesh, in your prepared remarks, you talked about an increased focus on the service provider segment, which is great to hear. It sounds like there’s a new product coming early next year. There’s obviously a lot of drivers here you mentioned a couple of them, including 5G. I guess, I’m wondering.

Can you give us a little bit more detail on how this new product portfolio might accelerate the momentum there? And then is there anything else from a go-to-market perspective that needs to be also augmented?.

Let me give you a very high level point of view and then I have Lee jump in and give you some more insight into why we believe this product meets the needs for the future for our service provider customers. It’s a segment when I came here we realized we haven’t done as well as we’d like to do.

And there’s structural reasons for it, there's reasons on the service provider side for it. But that’s not enough of an answer. So we sat down and looked at what we should be doing, what we can do.

And the product team really rallied hard the last six months to be able to put this together, because we believe the only have the industry leading firewall from a security and networking perspective is that needed to make sure we were emphasizing some of the features that the service providers need in the future.

So from that perspective, I think the team has done a phenomenal job in getting us ready. Now, remember the sales cycles will serve further along. So you’re not going to be hearing us blow the top off from a sales perspective in three months, but this is a prerequisite for us to be strong in that sector.

We have a very dedicated go-to-market team in that space as one of our few spaces where we have a dedicated team around the world. And they’re very excited about this new product. And I'll let Lee jump in and talk about why this product development for 5G IoT and a next generation perspective for the service provider..

When we look at what’s happening in the transition from 4G to 5G, there’s some really significant changes that are taking place. The first is just the advent of IoT becoming really high scale on mobile networks with 5G offers.

Second is a lot of that is going to be high value IoT, it's going to be in medical device use cases, it’s going to be connected cars, it’s going to be things are really important. And the third is more and more applications are moving into these mobile environments.

So when we think about that, you can just imagine the need for the best security all the sudden become stay critical driver for this change from 4G to 5G. And so our timing of bringing out the new K2 series is aligned with the space shift in the SP space for this move to 5G..

Maybe one other for Lee on the product side, obviously, RedLock seems like a great acquisition really complementary. I think you’ve done I think specifically what I can tell from Evident.io. Maybe a bit more color there. I guess it shares -- it's an API framework, so it seems like it's going to be a nice integration.

But maybe just a little bit more detail on how that supplements what you guys have done there including continue to build out that side of the business?.

Matt, that’s a great question. I think as I walk around and talk to lot of customers, it was evident that no pun intended that everyone of our customers was undergoing some journey towards the cloud. And different shapes or forms, some people have a public cloud instance, some people are analyzing it, some people are trying to size.

And many of them talk of a hybrid environment or a multi cloud environment, because none of them is quite yet sure where they want to land in the long-term.

And as we went around understood that journey, we understood that they need a multi-cloud security platform that allows them to carry their security posture from their existing data centers, exiting infrastructure into the cloud.

And as we look to that, we thought we had a product in this space called Evident, which was leading in its own way in its own category. But we looked to the market and said RedLock also was nipping at our heels that was also doing really well in adjacent parts of the same market but a good offering would be the integration of the two.

And to the credit of our Evident RedLock team, they will integrate in the next month and be able to have integrated product in the market by the first week of January, which I think is phenomenal given the base of that market and given the opportunity in that market, we believe that’s the -- this is only product of its kind in the space.

But Lee, I’ll let you talk more about..

So one of the things we have seen and when we talk to our customers in their journey of the cloud is; one, they are all going through this journey; but two, they almost 100% don’t fully understand everything they have in the cloud already and so the combination of the Evident and RedLock really gives us a great window into -- and our customers a window into everything they have so visibility, asset inventory based on that I think is the next step, which is how to provide security analytics for that ultimately detects threats and respond to those threats.

And Evident brought a certain aspect to that, RedLock brought another component and as Nikesh said, we’ll be integrating those two quite shortly into a single integrated offering..

Thank you. Our next question will be from Andrew Nowinski with Piper Jaffray. .

You announced a new service provider product today, that’s definitely a market that you should be in. And you've also referred to your low hand in mid range firewalls. So I am wondering when can we expect to refresh of the large enterprise of 7000 series….

I'll let Dave to answer that question..

We don’t talk about product futures on these calls and don’t make public announcements. The 7000 Series is extremely competitive in the marketplace right now, it's doing great with our customers and we’re very happy with the performance on that box..

And then a question for Kathy, in talking your sales team and your channel partners, do you feel like the enterprise buying cycle is more -- perhaps more backend loaded this year than it was last year as it relates to the calendar year end enterprise budget flush?.

Well, our linearity has actually been pretty good the last couple of quarters. And so, I wouldn't say that we're really seeing more back end loaded nature of the business necessarily..

So not normal seasonality you're expecting this quarter?.

In Q2, we've guided to what 24% to 26% year-over-year revenue growth, seasonality there was pretty in line with what we've seen historically..

Thank you. Our next question will be from Keith Weiss with Morgan Stanley..

This is Tom on for Keith Weiss. Thank you for taking my questions. I wanted to just dig into the security demand environment more broadly heading into 2019. It seems like we've had good strong refresh activity this quarter.

Where do you think we are in terms of the -- we are in early innings still or middle innings, just want to get your thoughts on that?.

Yes, in terms of refresh opportunity, we've talked about the fact that it's an important variable for us as our cohort size increases every year over our history. It becomes a bigger and bigger opportunity for us as time goes on. While it's an important variable, it's not the most important driver of our growth.

As you see we continue to add customers at a very high cliff every quarter and our expansion opportunity within our existing customer base is quite significant.

So relative to the numbers in our customer cohort of five or six years ago, just the opportunity within our existing install base and the new customers that we're adding are really the primary driver of our growth..

And then just a follow-up question on that, so it seems like the RedLock acquisition was pretty good one for you, you've gotten some good feedback from the partner channel that we talked to you on that product.

What other functionality GAAP you see from a cloud security standpoint that you still have to fill in? And do you think it could be addressed organically or you're looking at all options?.

Look, public cloud security is obviously very important and we're putting a lot of our weight behind that with VM-Series, which continues to do very well for in line security with Evident RedLock combination, which we believe is the leading solution for API based security and public cloud.

And with some of the enhancements we made to Trap over the last many months to include support for Linux, which is obviously on our operating system behind application to run on the public cloud.

And so that combination of in line security, API based security and host security, we believe is the right approach and we feel very good about being in a position where we have leading solutions and all three of those..

Thank you. Our next question will be from Michael Turits with Raymond James..

This is Keith on for Michael. Nikesh, you indicated several times at Palo Alto to be focused on utilizing security data.

So does this mean that you want to enter the SIM market or -- and with the automation aspect what we call now the slow market? How should we think about that?.

So we have some very exciting products coming up early next year in XDR, which allows you to some degree of investigation, some degree of remediation. We are looking carefully at what this entails. Our application framework will allow for sync and source to run on top of it.

So we believe that we will be able to provide a comprehensive solution to our end customers as long as we can deploy our firewalls and our endpoint agents more ubiquitously across our entire base..

So I mean just to piggyback on that, so without a major investment whether organically inorganically.

Can you develop the intellectual capital and the culture around analytics and data science if you decide to go that way, needed to become a data focused company or?.

We have a significant effort around analytics with our product magnifier, which does a bunch of the analytics with some of the application framework.

We have embedded ML people and almost every one of our product teams albeit the small but our intention is to keep beefing thing that up, because we believe machine learning is not just about taking a lot of data and trying to train it, machine learning is about making every product of yours, understanding the data that it gives you, understanding how you use that data to be able to create a better product to start with and then leverage the ubiquity of that product to improve the outcome for every customer.

So we have many ML people across the board and across the company. We also have analytics apps on our platform. And as we see the deployment of the application framework, as we see the user's behaviors of customers we'll decide which way, which out of those needs we need to put mobile behind..

Our next question will be from Sterling Auty with JP Morgan..

Kathy, you mentioned I think $0.01 to $0.02 impact in terms of Chinese tariffs, has some discussion with [Technical Difficulty] some question as to if we see something go further in terms of trade war.

Is there any earn about supply of products coming out of China if you have alternative sourcing if necessary?.

Yes, it’s important for us to remind everyone that we do manufacture our products in the U.S. There are some components that we source that are only available in China. And we are looking at a number of options in terms of being able to mitigate the impact of tariffs or ensure that we have dual source opportunities.

And so our supply chain management is always very aggressive in terms of ensuring that we have a number of options available to us and we’re doing the same in the current environment..

And then just one follow-up just strategically, how should we think about the subscription -- the product subscription growth throughout year or subscriptions that are not attached to a physical appliance? So whether that’s a virtual firewall, et cetera, moving forward.

How should we think of the growth dynamic there versus some of the physical product sales as you talked about service provider and other strategies?.

Well, we’ve talked historically about the non-attached business being at $274 million run rate as of Q4 '18 growing at 68% year-over-year. And so we are -- these are newer markets for us where we’re seeing very nice growth in that.

And Nikesh mentioned launching speedboats that we believe will help us to execute very well in these newer markets where we think we have great products, particularly in the cloud space. We’ve talked about the Evident and RedLock combination. And so we’re very excited about the opportunity there.

But obviously, the business of the firewall growth and the product growth and our attach subscription growth is extremely important as well and we continue to focus there and those areas are also growing very nicely for us, which is why we continue to be able to grow at rates above the rate of the market..

Thank you. Our next question will be from Saket Kalia with Barclays. .

First, maybe for you, Nikesh. You talked about some of the early partners on application framework.

Can you just zoom out a little bit and can we talk about how customers are using Logging Service, and maybe some of the next couple milestones that you look forward to that can help drive the app Framework opportunity?.

Look I think part of the app Framework thesis has always been of trying to collect the data ones and use it many times across multiple applications, because today every cyber security solution that the customer sees require some degree of intrusive probes into their infrastructure, whether it’s the network, the endpoint, or even their cloud security in some cases.

So the notion is let’s collect all the data ones and then use it multiple times throughout multiple apps. Towards that end, for example, our Traps product is probably going to collects close to 100 megabytes of data per user per model, which I think is probably 15 or 20 times higher than any other end point product in the market.

So that’s what allows the customers to be able to collect that data ones and we can deploy multiple applications with the guest, because that’s probably going to be able to deploy XDR for them. And this is the reason why these customers need to have that data collection happened multiple times.

There are some customers who are running six to eight end points at the same time, because each end point is taking a slither of data for the deployment lifecycle of that end point is anywhere from three months to 12 months depending on the complexity of the customer and the locations of their employee base.

So in that context, we have seen good progress when we deployed Logging Service with Traps, or people who use Traps management services in the cloud to be able to manage their end points with other enterprises.

We’re probably going to be able to leverage the same thing without an incremental end point deployment for the same customer with XDR, which is offer that as a service on top of the one service.

Similarly, the products like Magnifier which use similar data to be able to deploy the application on top of data collection from firewalls and its future your endpoints. So we’re seeing the evolution of the application Framework as an integration point across multiple solutions. We’re starting with our own first.

We want to make sure that our stuff works so there is proof in the putting.

And for me the key milestones are, can we get multiple Palo Alto Networks apps to be useful without deploying multiple sensors into the customers' infrastructure and be able to turn them on extremely rapidly, because the speed of deployment is a key component in the future for the cyber security.

So as long as we believe we’re headed down that track, I am excited. As long as we can see other partners coming out say this is interesting, we like the fact that you have all those data. We don’t have people who deploy multiple sensors across our customer base or your customer base. They can just sit on top of those data.

And as long as there’s an economic model, which allows them to utilize that data and as customers can sent we're fine letting them use it..

Maybe my follow-up for you, Kathy, just a quick housekeeping question. Was there anything to note on the other income line, I guess this quarter and last? It feels just a little bit harder than we have seen historically.

Just wondering if you could talk about some drivers there?.

Well, there are probably a couple of drivers. Number one, interest rates have been increasing and then number two, we have a higher cash balance given the convert that we recently did..

But no other one time investment gains or anything like that?.

No, nothing like that..

Thank you. Our next question will be from Gregg Moskowitz with Cowen & Company..

First question is for Nikesh or Lee.

How did Traps do this quarter and can you perhaps provide an update on the integration of Secdo as part of your XDR approach?.

Traps continues to do well, we added a lot of new customers, of course.

As Nikesh mentions, the Traps managed service which is cloud based service, the majority of these new customers are deploying using that service, which is great because that ties into logging service and application framework and sets us up for some of the features around things like XDR.

And so on that topic, we continue to make good progress on the integration of Secdo. It would be as we've told you before we believe that EDR is not sufficient. So the idea of doing detection response based off of single data sources is not enough, we think that the endpoint data needs to be combined with network and cloud data as well.

And so we are actively working on that, we have been -- and some the endpoint data, we're getting more. We have network data, we have cloud data and then in parallel to that, we're making good products in the XDR application around on top of that to use that data. And we're on track for early calendar 2019 to have that available..

And then just for, Kathy, as you noted your operating margins were up about 150 basis points year-over-year. And so it seems that you're absorbing the incremental costs from Evident.io and Secdo quite well. And I know of course that you you're not providing fiscal '19 guidance.

I'm just wondering though if there are any unusually high investments that you're targeting at this time over the balance of the year, whether it'd be the K2 launch or anything else..

We're providing guidance, obviously, one quarter at a time, as you mentioned. We did referenced that $10 million to $15 million investments in M&A in Q2 in our modeling point. And aside from that, there's really nothing significant for us to report at this time..

Thank you. Our next question will be from Jonathan Ho with William Blair..

I just wanted to start out with the reference that you made to the speedboats.

Can you maybe give us a sense of what this entails and maybe contrast that with your traditional approach?.

What happens and we have very successful large team selling a large amount of revenue and you start a new product initiative. Typically, some of those efforts get burned across a very large team of functional organizations.

So what we've done is we've taken all the people who are focused on some of our new product areas, put them in the same floor, taken them across functions and effectively created two leaders, one on the product side, one on the go to market side. And they have caught large to move as fast as they'd like to move within certain guide rails.

And this has really increased our agility and our speed, both in terms of deployment of product but also decisions that they need to make on a customer by customer basis and from a go to market perspective. And the early results are promising on our cloud security space, is really helped us.

For example, the cloud security team is run by Varun Badhwar who we brought on board as part of the RedLock acquisition. He is a CEO there. He's very excited.

He's very motivated to keep driving the product strategy and Dean Darwin, who is a longstanding members of the Palo Alto Networks, go-to-market and business team they're both partnering really well. Dean brings the capability to be able to deploy that product across our very large sales forces as global distributed.

Varun doesn’t have to worry about that, Varun has to worry about continuing to build a market leading product and going in partnership with Dean and making sure that some of our best customers sign up for the part. So that’s like the model behind it, it's working really well so far for one of the bulk areas.

We’re working on carving out the next set of product areas. So we are almost on to our second.

We'll be able to carve out a team, which is going to focused on GPCS and Aperture as our second speedboat and really excited about being able to do that, which will be driven by out of our product side and running our CMO, so just trying to create speed and agility on the speedboat front..

Just wanted to also follow-up on some of the newer developments with AWS and maybe your early thoughts in terms of what outpost and some of the newer impacts could have on the business?.

The good thing is that what AWS and not just the AWS, GCP, VMware and other or Azure, all of them are trying to encourage customers to think hard about the cloud and get out of this model of let me control my destiny by my own data center. They're trying to convince people that we all need to go to cloud.

Now as people are going to the cloud, they’re realizing that, yes, the cloud is a fantastic platform, it gives you low latency, allows the availability, allows you to go scale globally very rapidly. But it’s very hard to think about cyber security in that context.

And there’s a whole set of organizations that come about by data integrity, how do I move my security posture from existing platforms to the future and that’s where we think none of these cloud transitions are going to happen in a meaningful way unless customers are able to think about as a secure transition.

So our job is to make sure that we partner with our enterprise customers today and help them in the journey as they make this cloud journey and transition. And there's a debate whether people are going to use AWS native security or GCP native security, or is there room for something like us.

And the answer is yes, there is, because there’s no -- there is very few that those never going to ask. But there’s very few dedicated single cloud only customers out there. Most customers are either hybrid customers, most customers are multi-cloud customers.

In which case, you need an independent cloud security partner, who can help you across this new end of platforms with a very hard for one native cloud provider to produce a multi cloud hybrid and public cloud environments security environment. So we believe that it's a huge space.

We believe as both us and AWS, and GCP, and Azure to partner in this journey, because it’s beneficial for them and beneficial for us. And honestly in the security the 2% or 2.5% spend across a cloud transition 83, so they’re not going to go try and compete with us in that 3% to 4% of spend.

I know I went from 2.5 before but it does in the customer, I like it to be more but because of the customers. So we think there’s going to be -- there’s enough room for a partnership in this space..

Our next question will be from Patrick Colville with Arete. .

Can I ask about the core next generation firewall? What continues to differentiate you guys, because you guys are crushing it, and doing great job.

And just from your perspective, what continues to differentiate Palo Alto versus the competition to produce these results?.

Look, in my six months that I’ve spent talking to customers and traveling around the world, trying to understand both why our customers buying us and what’s differentiating our product. I have to say at least the feedback I get from our customers is that there’s a very clear differentiation around security.

Palo Also Networks' firewalls were built with security first in line and that’s why you heard us launch the service provider K2 series just now, because they balance both the throughput need to service providers as well as this high security requirement for 5G and IoT. So we are a security first firewall and that resonates with all of our customers.

And it's the right time in the journey, because early cloud migrations, early data center migrations were a lot of about moving your data there. Now, it's a lot about opening up the internet.

And more people started opening up ingress or egress to the Internet on a large scale basis, you open the door for cyber security attacks or cyber attacks across their infrastructure. At that point in time every CIO, every CSO is concerned about making sure that their environment is protected.

So security is becoming a more and more relevant topic on the agenda of CSO, CEOs and CIOs. They turn around and say do we have the security or not, and that’s not a price sensitive conversation, it’s a security sensitive conversation. And from that perspective, I think -- and I can’t take credit for, this is the team here and the prior management.

They did a phenomenal job in making sure we have people around the world, we have customers we have gone ahead and worked with these customers earlier. Some of the deals coming crucial now are deals teams that have been working on for 12 months, 18 months, or 24 months. So this is a journey that we've started a while ago.

It is a security focused journey and it is the product that is clearly differentiated in the marketplace and we hope given the more sensitive around security, we will continue to take market share..

And can I ask -- and my follow-up, another high level question like that. So some investors are skeptical that appliance company can transition to be more of a software company at a time, because history and technology over the last 30 years shows us that that can be quite difficult.

Clearly, the number you guys are putting out and on top subscriptions are very healthy with the growth and momentum being very strong. So the indicators for now are that this transition is happening very effectively.

But what you gives confidence that that can continue and that you guys can continue for pivoting away from product and more towards subs?.

Look, I think whilst we look at it from an industry transition perspective, because some of us analyze the industry and look at it from afar. If you ask the customer, for them it is a continuous spectrum.

They see it as a continuous journey and they want to be able to take their existing partner with them through the journey, because security is a thing where your customers have to believe and trust in you that you’re going to protect them.

We have many instances, many, many incidents happen on daily basis where the customers we understand reaches they call us, we work with them, we show them how to protect themselves, we show them how to improve their security posture. So we built trust and reliability with over 50,000 customers around the world.

And I think as we come out with new products, when customers either buy the next-generation product from a small startup with 40 people or would they rather have the capability of a team that’s been working with them for three to five years up in the security posture, we believe the latter.

Look, I am sitting in the pit, working with the team for the last six months, 12 hour days, working hard on every product, every part of the transition. So I am convinced we can make the transition. And as far the skeptical investors is far us to know and for them to find out by the time they find out, it would be too late..

Thank you. Our next question will be from Gabriela Borges with Goldman Sachs. .

I was hoping you could characterize for us the level of sophistication education that you're seeing around cloud security awareness from your customers.

At this stage, how much of it is a push and Palo Alto where you're really need to educate around the virtual firewall and GlobalProtect and Aperture and some of the cloud products that you have versus customers may be reaching a consensus and realizing that in order to be secure in the cloud, they need more Palo Alto products. Thanks..

Nikesh Arora:.

, :.

And the follow-up is not specifically on the 7,000 series refresh. But I do want to ask how you are thinking about the cadence of appliance introductions at a higher level. If I think back 2017, there are number of product instructions on the appliance side.

So just maybe some high level thoughts and how you think about those instructions going forward and how much more Morris Law plays into that, if it all? Thanks..

I'm sorry, can you clarifying question appliance, what?.

How are you thinking about this cadence of new appliance introductions at a high level?.

Our desire as we build our hardware roadmaps and overall strategies, our large enterprise customers or search customers that in general they do not want to see hardware technology change too fast, because that necessitates need for them to then go through and do a whole bunch of work to swap out old hardware for new hardware and things like that.

And on the flip side, of course, we want to stay very up to date on latest and greatest technology in order to be able to find the best products. So we're always balancing between those two aspects.

And there's no single answer to it, it's just always looking for where the big technology inflections are on the hardware side and then looking at how we can swap those [Technical Difficult] into a development schedule that makes a lot of sense to both us and our customers.

What you've seen us do over the last couple years is obviously introduce a number of new hardware platforms that have been very well received. And then where we need to go we'll continue that process of bringing to market new hardware technologies where we get a lot of banks for the buck and really help our customers..

Thank you. Our next question will be from Erik Suppiger with JMP Securities..

Two questions. One, Nikesh, how do you feel your channel is currently prepared for moving into the cloud, what kind of evolution do you need to see from your channel partners? And then secondly, on the service provider front, one of your competitors does a lot of development with the hardware with ASICS.

Is that something that you would consider in order to achieve the performance that you need and any service provider requirements are 5G?.

I think if you look, the channel [Technical Difficult]. Erik, from a channel perspective, channel is not one in one entity, channel is the very large set of partners where we have people who are very cloud savvy and very cloud ready.

And we have people who are going through their own journey of transitioning to the cloud, because they’ve been very hardware centric. So they come in different shapes and sizes.

So we’re very excited about the partners who are stepping up and creating the cloud education focus within their own teams to be able to part of this journey and there are some others who are called BICS, called born in the cloud. So they are people who are focused exclusively on the SaaS space and working with us and other players in the SaaS space.

So there’s a transition going on in the channel as much as there’s a transition going on in our customer base. And the channel is getting ready to be able to provide these capabilities to our customers.

So we see a very, very healthy partnership going forward with the channel, or they’re going to end up wanting a lot of services to our customers getting a lot of education awareness. As the question Gabriela asked about how do we create the awareness across 50,000 plus customers off the top of the cloud companies and get them to see our product.

We can't do it alone with our smaller team on that scale we’re going to have to leverage a large distribution network, which is in place which is service provider network? So I think that’s the answer for the first part of your question.

And as it relates to the ASICS and the throughput partner, we believe in the cadence of these products we are going to match the price performance of everybody else out there from a throughput perspective. And we believe we’re going to be industry leading in security.

In fact, the only ones in the industry, who can deliver the security requirements for 5G and IoT.

So we feel very comfortable with the new K2 product As I said very early, the sales cycle and SP are long but as we’ve announced this today, we’re going to be launching efforts toward our teams and our go-to-market teams to start approaching some of the largest service providers around the world, working with them to make sure they understand the capabilities of the effectively the next generation firewalls now.

And make sure that they keep us in consideration as they go towards their own journey of going to 5G and IoT..

Our next question will be from Catharine Trebnick with Dougherty..

Did you provide the number of customers you added during the quarter? That’s my first question..

Yes, we didn’t talk about it in the prepared remarks, but we added over 2,500 customers this quarter..

And any particular service that stood out in driving your subscription services? Was there one that was stronger than the other during the quarter, and then any that underperformed? Thanks..

We had nice performance across our subscription portfolio and obviously, we’re very happy with the growth we saw there..

So none of them underperformed like Aperture, AutoFocus? I’m just trying to quantify….

No, we will break out -- we break out more details from time-to-time, but we haven’t provided details by product of how each one grow..

I’d now like to turn the call back over to Nikesh for closing remarks..

Yes. Well, thank you, operator. Look, in closing, I’d like to thank all of you for interest in Palo Alto Networks. I also would like to thank once again our customers, our partners and our employees for the tremendous amount of effort they put into making sure that we're able to deliver our results.

I have been reading many of your notes, and I know that some of you are still anxious to understand me. So before I wish you a happy holiday, I wanted to send out this invite to all of you who would like to come meet me. We’re going to try and schedule over the next three weeks for sales side analyst to come visit.

If you reach out to Amber and our Investor Relations team, she could schedule it. That way hopefully next time around when I read your notes, you won’t be as anxious about me. I am anxious enough about myself. I don’t know need you to be more anxious about me. So with that, thank you again for your interest in Palo Alto Networks and good bye..

Thank you, ladies and gentlemen. This concludes today’s teleconference. You may now disconnect..