Good day, everyone, and welcome to Palo Alto Networks Fiscal First Quarter 2023 Earnings Conference Call. I am Clay Bilby, Head of Palo Alto Networks Investor Relations. Please note that this call is being recorded today, Thursday, November 17, 2022, at 1:30 p.m. Pacific Time. With me on today's call are Nikesh Arora, our Chairman and Chief Executive Officer; and Dipak Golechha, our Chief Financial Officer. Our Chief Product Officer, Lee Klarich, will join us in the Q&A session following the prepared remarks. You can find the press release and information to supplement today's discussion on our website at investors.paloaltonetworks.com. While there, please click on the link for Events and Presentations where you will find the investor presentation and supplemental information. During the course of today's call, we will make forward-looking statements and projections regarding the company's business operations and financial performance. These statements are subject to risks and uncertainties that are made as of today. We assume no obligation to update them. Please review the press release and our recent SEC filings for a discussion of these risks and uncertainties. We will also refer to non-GAAP financial measures. These measures should not be considered as a substitute for financial measures prepared in accordance with GAAP. The most directly comparable GAAP financial measures and reconciliations are included in the press release and the appendix of this investor presentation. All comparisons are on a year-over-year basis, unless specifically noted otherwise. Please also note that the 3-for-1 stock split announced during our Q4 was completed with share and per share numbers now reflecting this. I will now turn the call over to Nikesh.

Thank you, Clay. Good afternoon, and thank you, everyone, for joining us for our earnings call. As you can see, we had a solid first quarter where we showed balanced top line growth and a demonstrable focus on profitability. Early in the quarter, we saw some customer behavior changes and have adapted our operations to align with the changing market conditions. On the top line, billings grew 27% year-over-year, while RPO grew 38%. We have consistently maintained that cybersecurity is the most innovative sector of the technology industry. To demonstrate progress on our transformation, we have shared how our new cloud-delivered and cloud-enabled offerings are contributing to our business via our NGS ARR. In that context, this quarter, our NGS ARR hit a key milestone. It crossed the $2 billion mark and grew 67% year-over-year. As the macroeconomic environment changes, we are accelerating our efforts to drive incremental operating leverage in our business. Given that we're the largest independent cybersecurity business, we can meaningfully improve our margins over the next phase of our company's next cycle. Our focus on profitability in the quarter drove operating income growth of 44% year-over-year with operating margins up 260 basis points during the same period. We also generated over $1 billion in free cash flow in the quarter. For the second quarter in a row, we generated net income on a GAAP basis as we focus on GAAP profitability for the fiscal year. At the center of our strategy is the need to drive more consolidation to get customers to a better security posture. Towards that end, we continue to see large cross-platform buys and grow our millionaire customers at a steady clip. Our customers have been on a journey with us; initial deals that give them comfort with our products and help distinguish our abilities from our competition, over time, lead to customers seeing an opportunity to consolidate into one of our platforms. As they get comfortable with either Strata, Prisma, or Cortex, we see them looking at further consolidation across multiple platforms from us. This strategy has allowed us to continue to transition our deal sizes with satisfied customers, and we expect this to continue. Consistent with that approach, we have had some marquee deals this quarter. The U.S. federal government agency chose our Cortex technology. This transaction allows the total spend to grow into 9 figures with additional years in customer option. This selection highlights the unique capabilities and market leadership of our Expanse technology, which was at the center of this transaction. We received a purchase order for the first 3 years of the deal for over $60 million in Q1. A large U.S. utility signed a 7-figure deal for software firewalls, security subscription, and the Prisma Cloud. The customer has hundreds of appliance-based firewalls and chose our software firewalls because of our consistent architecture, and chose Prisma Cloud as a standardized security across 4 public clouds. A major European media company signed an 8-figure multiproduct deal, replacing several incumbent network security vendors and consolidating on Palo Alto Networks, including our full line of cloud-delivered security subscriptions. We closed a 7-figure deal with a U.S. technology company, spanning all 3 platforms. The customer did not have our physical firewalls in the environment but valued our consistency of software firewall deployment across on-premise and cloud. Our unique Expanse offering and the total cost of ownership benefits of consolidating on our platforms. You can see evidence of our broader success with large customer commitments in our active millionaire customer count, where we added over 230 year-over-year in the first quarter. We continue to innovate across our platforms and get recognized by the market for our abilities. This quarter saw us launch software composition analysis in Prisma Cloud, SaaS security posture management and SASE, and just this week, across our next-generation firewalls. Lastly, we announced the general availability of XSIAM in Cortex. External recognition of our innovation is important to us as many customers rely on this third-party validation as a part of their evaluation process. This quarter, we received leadership recognition in 2 new categories, adding cloud security posture management, or CSPM, and cloud-native application protection platform, or CNAPP, to our list. Let's take a deeper look at our 3 platforms. We have continued to see solid growth in our network security business. Our innovations in the appliance firewall form factor, including our Gen 4 refresh and our investments in the virtual form factor, have continued to drive our share gains. On a year-over-year basis, we have gained approximately 3 percentage points of market share in the appliance market and 7 percentage points in the VM market. Our customers see an opportunity to drive standardization and make decisions to move away from competitors that have not kept up with our pace of innovation. We also see many customers extending the standardization to SASE. Many are in the relatively early stages of executing SASE, given it involves changes to their security network architectures. Our Prisma SASE offering has gained industry recognition, and we've seen an increasing number of wins within our installed base, as well as with new customers. To put this into perspective, our firewall customer base is over 15 times larger than our SASE customer base. With our core sellers now enabled and executing and driving SASE into the installed base, SASE continues to represent our largest pipeline. Consolidation of network security capabilities by our customers is driving a significant subscription increase into our installed base across all firewall form factors. Our constant innovation and capability expansion in network security has been a hallmark of our platform since we entered the market over 15 years ago. While we have highlighted the number of new subscriptions we offer, we have also reimagined our existing capabilities. Our advanced URL filtering and threat prevention versions leverage deep learning to block evasive, zero-day unknown attacks in real-time. Yesterday, we introduced the advanced version WildFire to stop more zero-day cloud attacks as part of our PAN-OS 11.0 Nova release. The new subscriptions provide significant additional value to our installed base and have already seen promising adoption. Moving on to Prisma Cloud. Prisma Cloud continues to be the industry's leading CNAPP platform built from best-in-class acquisitions and organic innovation. We acquired Bridgecrew 18 months ago to shift left and introduced the cloud core security module with infrastructure as code scanning. Building on this, we released our SCA, or software composition analysis solution in Q1. The integration of SCA with the Prisma Cloud platform enables developers and security teams to prioritize known vulnerabilities that impact the application life cycle proactively. We have seen hundreds of Prisma Cloud customers use our IAC and SCA capabilities as part of our cloud core security module. We continue to see Prisma Cloud customers increase their credit consumption as they expand their hyperscaler footprint and adopt more of our 9 modules such as cloud code. Half of our Prisma Cloud customers are using 2 or more modules, and nearly 20% are using 4 or more modules. In Q1, our credit consumption grew 55% year-over-year. Building further upon our success, shifting left with IAC Security and ASC adoption, we're doubling down on investing in software supply chain security. Today, we announced our intent to acquire Cider Security, which is key to the strategy. Cider brings the ability to visualize customers' application development and deployment environment, analyze the tools, identify risks, and how to remediate them. This ability to secure the software supply chain is backed up by Cider's leading CICD security research team. With the integration of Cider's capabilities into Prisma Cloud after the closing of the acquisition, we will further our leadership in cloud security, helping enterprises secure applications from code to cloud. Across Cortex, we are focused on driving momentum in a number of areas. The first key is ensuring we are winning customers with our best-of-breed product capability. In Q1, we saw strong Cortex large deal performance. We had success not only with XDR, XSOAR and Expanse on a stand-alone basis, but a number of notable examples of multiproduct deals. This included a multimillion dollar transaction at a European construction company, which replaced their existing SIEM and SOAR with XDR Pro and XSOAR. One of the government customers adopted XDR Pro and XSOAR in a 7-figure deal as it formalized a new SoC for multiple agencies. These are in addition to the federal customer we already talked about. We continue to innovate across Cortex during Q1, delivering a new managed detection and response service built on our XDR capability and enriched by our Unit 42 world-class threat intelligence. I'm most excited about the general availability of XSIAM, our breakthrough autonomous security operations platform. Our launch event for XSIAM was oversubscribed, and we see a lot of resonance with our product and its future roadmap as customers reimagine the world of SOC management. Just a few months ago, we had launched a design partner program. Most recently, we've had 2 multimillion-dollar commitments from XSIAM design partners as they expanded into production deployments. At this point, the majority of our design customers have transitioned to paying customers. In fact, we are carefully managing how we onboard future XSIAM customers because we want to ensure fast customer time to value. Our interest list is north of 50 customers who would like us to deploy XSIAM. We're qualifying them and carefully onboarding them so that we can scale the business appropriately and give them value. In summary, I feel our teams did a good job in a seasonally tough quarter, where also the macroeconomic climate is fast-changing. I'm sure all of you are trying to figure out what all of this means for us over the next 3 quarters. As we all know, the Fed is working to tame inflation impacting growth. While cybersecurity is somewhat resilient, we do see some marginal signs of impact. Cybersecurity deals are getting more scrutiny, suggesting deeper and longer reviews of transformational projects. New conversations that include payment terms and discounts are causing deal cycles to elongate. On a positive front, while some deals have been sized down and broken into phases, we are experiencing few deal cancellations. We expect this behavior to become the norm over the next year. The impact is not uniform across all sectors, but those feeling the impact of interest rate increases are more likely to scrutinize their budgets than those prospering in the high-interest rate environment. Technology, CPG, and some parts of retail are feeling an impact, while utilities, oil and gas, defense, and public sector verticals continue to be on course of their plans. Coming off Q4, Q1 tends to be a seasonally more challenging quarter, but we were able to tame some of these early trends by doubling down on execution. FY '23 will require continued excellent execution to overcome some of these macro impacts. Towards that end, we have already taken concrete action. We have front-loaded hiring of our field teams to increase coverage across our customer base. We have also expanded our level of activity around both new accounts and existing customers to ensure faster time to value with our products. As we discussed last quarter, we have seen some customers delay hardware refresh plans. While they will ultimately need to refresh, some are choosing to defer and reassess at a later date. I continue to believe that hardware will have a long-term industry growth rate in the 5% to 8% range, and we might trend to the lower end of the range. However, coupled with an easing supply chain, I expect that near term, we'll continue to report a low double-digit growth rate for product revenue. Too many vendors lead to complexity and increased risk. Given the increased scrutiny and return requirements, the silver lining for Palo Alto Networks is that we are having more conversations around consolidating platforms than we've ever had before. We think customers are less likely to purchase newer security products. Instead, they will continue to consolidate towards like-for-like capabilities from fewer vendors. Cybersecurity is critical to IT transformation and hyperscaler adoption. We believe that whilst there may be short-term bumps to the pace of investment by some of the customers, these projects will continue for the medium and long term. We see cybersecurity spending as resilient but not immune to customers adjusting for the current environment. Having said that, I continue to believe that we can overcome these macroeconomic impacts with strong and focused execution, which is what we plan to do. It was just 6 to 9 months ago that we were talking about the challenges we face in the competition for talent. We're now finding it easier to recruit and hire top talent but also seeing lower attrition rates, which necessitates fewer overall new hires. We will closely monitor our hiring as well as our overall spending to further sharpen our focus on efficiency. As we proceed through the year and focus internally how we respond to the external landscape, sharp execution from our teams will be paramount. Before I turn the call over to Dipak, I want to provide some perspectives on how we're thinking about the forecast. We are adjusting the high end of our guidance ranges for revenue and billings for the year for the upside we saw in Q1. Within our revenue, we do expect slightly higher product revenue growth in the range of 10-plus percent as we are able to ship some orders that had previously been held back by the more challenging supply chain situation I mentioned earlier. We're also reflecting the strength we saw in NGS ARR during Q1, with higher NGS ARR guidance range for the year. This reflects not only the performance of our Cortex, Prisma Cloud, SASE, and software firewalls, but also the success we have seen in advanced cloud-delivered subscriptions that I noted. On a positive note, we're focusing more and more on execution and how our teams focus on driving incremental operating leverage. Towards that end, we were able to take steps to accelerate the profitability we previously outlined at our Analyst Day, which was reflected in our Q1 operating margin and EPS performance. We will remain focused here. And as a result, we're raising our operating margin guidance for the year by 50 basis points. This, as well as higher interest income, is driving the increase to our EPS and cash flow guidance as Dipak will cover. Over the last 3 years on a compounded basis, our EPS and adjusted free cash flow have grown below our revenue growth rate as we made significant investments. We are now targeting EPS and adjusted free cash flow to both grow north of 30% at our guidance midpoint, which is ahead of our revenue growth. We are confident in our strategy and wouldn't trade our position with any other cybersecurity company. We believe our broad portfolio focus is an advantage as we focus on emerging areas where customers are allocating new budget dollars while also capturing an increased portion of the customer's broader cybersecurity budget as they look to consolidate spending. We will continue to invest for the long term with our commitment to fund innovation, while we also pursue near-term opportunities to drive efficiencies in our business. With that, I will turn the call over to Dipak.

Thank you, Nikesh, and good afternoon, everyone. For Q1, revenue of $1.56 billion grew 25% and was above the high end of our guidance range. Product grew 12% and total services grew by 30%. By geography, we saw growth across all theaters, with EMEA up 32%, the Americas growing 24%, and JPAC growing 26%. Our next-generation security capabilities are increasingly driving our results, and our NGS ARR grew 67% and at $2.11 billion exceeded $2 billion for the first time. We continue to see strength driven by our broad portfolio within next-generation security. This includes Cortex, Prisma Cloud, Prisma SASE, software firewalls, and the advanced versions of cloud-delivered subscriptions. We delivered total billings of $1.75 billion, up 27%, which was above the high end of our guidance range. Total deferred revenue in Q1 was $7.2 billion, an increase of 39%. Remaining performance obligation, or RPO, was $8.3 billion, increasing 38%, with current RPO representing about half of our RPO similar to previous quarters. Moving beyond the top line metrics, I already highlighted non-GAAP gross margin of 74.3% was down 10 basis points year-over-year, with some incremental supply chain-related expenses being incurred for components and shipping. Operating margin was 20.6%, an increase of 260 basis points year-over-year. This strength in operating margin was the result of lower expenses as a percent of revenue across all 3 expense lines: R&D, sales and marketing, and G&A. We have already focused on aligning our investment plans to the areas of highest return. Thus, as we proceed through this environment, it is sharpening these efforts. Non-GAAP net income for the first quarter grew 56% to $266 million or $0.83 per diluted share. Our non-GAAP effective tax rate was 22%. GAAP net income was $20 million or $0.07 per basic share and $0.06 per diluted share. Now turning to the balance sheet and cash flow statement. Our balance sheet is strong, closing Q1 with the highest cash and investable balance ever with cash equivalents and investments of $5.9 billion. We have ample flexibility to repay debt coming due, invest in the business, do tuck-in acquisitions, and return capital to shareholders. We're in the enviable position to be able to do all of these at the same time. Q1 cash flow from operations was $1.24 billion. We generated more than $1 billion in free cash flow for the first time in our history, with total free cash flow of $1.2 billion this quarter. This puts us well on track to hit our annual guidance, which we are raising today. This cash flow performance was largely driven by strong collections in the quarter that we expected based on the strength of our business in Q4. During Q1, we did not repurchase any of our shares. As a reminder, our share repurchase program is opportunistic, and we're committed to this method of returning cash to shareholders over the medium term. As Nikesh discussed on the M&A front, we entered into a definitive agreement to purchase Cider Security for approximately $195 million in cash, excluding the value of replacement equity awards, subject to adjustments. We expect this deal to close in the fiscal second quarter. We expect the financial impact of the transaction to be immaterial to our fiscal '23 guidance. Stock-based compensation ticked up slightly as a percentage of revenue quarter-over-quarter as expected with the issuance of a portion of our fiscal year '23 grants. On a year-over-year basis, we continue to manage our down as a percent of revenue, in line with our long-term plans. As we've had a number of questions about the impact of foreign exchange volatility on our business, I wanted to remind investors that we price our products in dollars around the world and therefore not exposed to the direct translation impact to revenue that you may be hearing about from other companies. Now moving on to our guidance for Q2 and for the year. For the second fiscal quarter of 2023, we expect billings to be in the range of $1.94 billion to $1.99 billion, an increase of 21% to 24%. We expect revenue to be in the range of $1.63 billion to $1.66 billion, an increase of 24% to 26%. We expect non-GAAP EPS to be in the range of $0.76 to $0.78, an increase of 31% to 35%. For the fiscal year, we expect billings to be in the range of $8.95 billion to $9.1 billion, an increase of 20% to 22%. We expect NGS ARR to be in the range of $2.65 billion to $2.7 billion, an increase of 40% to 43%. We expect revenue to be in the range of $6.85 billion to $6.91 billion, an increase of 25% to 26%. We expect product revenue growth in the range of 10%, up slightly, as Nikesh outlined in his remarks. We expect fiscal '23 operating margins to be in the range of 19.5% to 20%, up 50 basis points versus the range we outlined coming into the year. We expect non-GAAP EPS to be in the range of $3.37 to $3.40, an increase of 34% to 37%. We expect adjusted free cash flow margin to be 34.5% to 35.5%, and we continue to expect to be GAAP profitable for fiscal year 2023. Additionally, please consider the following modeling points. We expect our non-GAAP tax rate to remain at 22% for Q2 and fiscal '23, subject to the outcome of future tax legislation. For Q2 '23, we expect net interest and other income of $18 million to $20 million. We expect Q2 '23 diluted shares outstanding of 320 million to 326 million shares. We expect fiscal year '23 diluted shares outstanding of $325 million to $331 million. We expect Q2 capital expenditures of $40 million to $45 million, and we expect fiscal year capital expenditures of $190 million to $200 million. As an additional modeling support based on our prior seasonality, we expect the quarter-over-quarter revenue and billings growth for Q3 '23 to be in line with last year. Also, we expect operating income in Q3 to be roughly flat with our Q2 levels. To wrap up, we are confident in our strategy and wouldn't trade our position with any other cybersecurity company. We're focused on sharp execution and sales intensity to stay ahead of the changing macroeconomic environment. At the same time, we're focused on taking steps to accelerate our profitability as I guided.

Our first question of the evening comes from Saket Kalia of Barclays.

Okay. Great. Nice set of results. Nikesh, maybe for you. You mentioned some early customer behavior changes. I was wondering if you could just expand on that a little bit and how that manifested in the business? It doesn't seem like there was much of an impact in the NGS business. In fact, that accelerated growth year-over-year. I wonder if you could just expand on where that customer behavior changed and how you've incorporated that into the full year guide?

Look, Saket, as I mentioned, we are seeing customers spend more time trying to understand what they're spending money on. There's more questions; the CFOs are getting involved. So larger deals are getting more scrutiny. We noticed that early in the quarter, so we accelerated our efforts in trying to get those deals in front of those CFOs much faster than earlier in the quarter as opposed to waiting towards the end. In certain cases, customers came back and said, 'I'd like this now. I'd like to hold off on this and buy it next quarter.' That just means we have to go far more pipeline much faster and much harder to make sure we can make up for those deals with other deals in our pipeline. At any point in time, our pipeline, as you would expect, is larger than what we expect to deliver in that quarter. So we have deals in the pipeline. We just have to work with our customers to solidify them. And what we have done is, because of that behavior, we have increased scrutiny internally; we've increased efforts with our sales teams to get ahead of this and we're just increasing the activity of execution. We front-loaded our hires. We hired 550 direct sales reps as quickly as we could in the quarter because this environment is going to continue. And the only way to fight this to get more coverage out of the field. Get work coverage, get more focus on getting deals done, get them across the line. There's not a demand problem, right? All that is happening is that people are pushing out some of their products, means you just need to get more active with our customer base to make sure we get more business into our pipeline. This is what we're doing.

Next question from Hamza Fodderwala of Morgan Stanley.

And a lot of great clarity in the prepared remarks. Nikesh, I wanted to talk a little bit about supply chain security and Cider. I think a few months ago, there was an executive order from the Biden administration around securing software supply chains. I know it's early days in the acquisition; the acquisition is not even dry yet, but what do you feel about sort of the pipeline, the opportunity Palo Alto Networks is seeing now as the largest cybersecurity vendor for the U.S. federal government? What are you seeing there? And is there interest already from that front?

Let me comment, and then I'm going to let our birthday boy, Lee Klarich, speak to this because we've got to give him work to do. It's his birthday and he came to work. As you know, Prisma Cloud continues to go from strength to strength. We see very large deals in the hopper in our pipeline, and we're beginning to see more and more seriousness on cloud security from our customers. I highlighted a customer which has 4 public clouds deployed. They can't do that. They can't secure it with four different native cloud CSP platform security. So we are seeing more interest. We are seeing more engagement. As I've always maintained, I don't believe all the cloud security products have been created. And as you start to see the customers move. So we saw the shift left movement. We went ahead, did Bridgecrew. It's fully integrated. We've seen 65% of our customers begin to use that. As we're talking to them, we're realizing they have some legacy, some new apps tech vendors in place, which they're deploying and they're trying to use that to take care of supply chain security. Some of that is older architectures, older ways of doing things. But we decided we want to do it differently. If I answer the question, Lee, answer the rest of those questions.

Thank you, Nikesh. Good question, Hamza. So let me make one thing very clear. It's not just a U.S. federal government challenge. Anyone who is developing and deploying applications into public cloud, which today is basically everybody, has a supply chain risk that they're dealing with. That supply chain risk can come in the form of software, in the form of open-source software that they're building into their applications, which brings a certain type of supply chain risk. And the second type is through all of the tools and applications that they need to use in order to actually build an application. We've seen that this can easily be hundreds of different third-party tools that they incorporate into the development process that have access to their source code. That is the second form of supply chain risk and sometimes referred to as CICD pipeline risk, and that is a key component of what Cider will add to the broader capabilities we have with Prisma Cloud.

That is not good to be on mute. Okay, Brad Zelnick with Deutsche Bank with Andy to follow.

Congrats on the strong execution. Nikesh, I wanted to circle back on your comments about the using supply chain and expectations for hardware growth to be above the long-term trend this year. I believe you said low double digit. Just making sure the uptick is solely your view on supply. And just relatedly, when we look at product gross margin, it still seems to be under pressure. Can you help us just reconcile how much of this is mix versus COGS and any other factors to appreciate and what to expect the hardware gross margin?

First of all, Brad, remind me to send you a painting for your office; it looks a bit sparse. But that notwithstanding, I've always maintained the underlying hardware growth in the industry is about 5% to 8%. And I'm not deviating. We've seen changed behavior; people have tried to order ahead because of supply chain constraints. You've seen pricing impacts to drive some of the growth. But I think the underlying growth continues to be the same. What has happened in the last, I'd say, 4 to 6 months, is slowly and steadily, we are seeing easing of some elements of the supply chain. There are some components that become easier to get. As you've seen some semiconductor companies are talking about cutting supply or cutting production in memory and NAND and DRAM. So you're already going to see easing in various certain amounts of components, which is allowing us to ship product faster. At the same time, some, I'd say, real and perhaps some artificial supply chain constraints are being maintained in the industry. I expect them to ease over time, which should also ease up somewhat pressure on gross margin. The gross margin impact is purely us having great expedite fees for certain parts. It's really not an underlying component cost issue. So we think those will ease over the next, it really depends on suppliers. I think the supply chain easing is happening as we speak, and we should be out of it in the 6 to 9-month time frame, at the far end 12. It all depends on when the suppliers stop extracting more from us to try and get us those parts.

Next is Andy Nowinski of Wells Fargo.

Congrats on a great quarter. One of the key metrics that stood out to us, I guess, was the next-gen ARR growth, particularly your net new ARR growth. And I think you mentioned you saw strength across all. I was just wondering if you could put a finer point on that and maybe a lot of now the largest component of next-gen security and whether that big deal was included in that ARR this quarter?

So go ahead, Dipak.

Yes. So I would say, look, we feel very good about all the elements of our NGS ARR. Like just to repeat, we've got SASE, we've got Cortex, we've got cloud, and we have some of the new cloud live services. The majority of the growth continues to be the SASE, cloud, and Cortex side of the house. So I think all of that is good. There are portions of deals we don't comment on deals like specifically, but if they have the appropriate products, then we contribute the appropriate amount of ARR on them.

Yes, to your direct question, yes, the Expanse deal is in the net new ARR that you've seen.

Next up is Phil Winslow of Credit Suisse, with Tal Liani to follow.

Congrats on another phenomenal quarter. I wanted to focus in on Prisma SASE and Prisma Access. You gave some interesting stats there in terms of penetration into your existing firewall base. But also wins in the cloud for customers who are not current on-premise firewall customers of yours. When you look at the momentum you're seeing, are you getting better at penetrating that existing base? And are customers starting to understand the value of on-premise off-premise one policy? Or are you seeing more momentum even in, call it, displacing competing vendors in the cloud now?

So Phil, first of all, thanks for the compliment and the great question. I have noticed more activity this past quarter among C-level executives, with some of our customers pursuing consolidation strategies or initiating cloud transformations. It’s interesting that our customers are beginning to engage more with global system integrators. These integrators are being included to help reduce costs and facilitate transformations. While I won't mention any specific ones, I can say we are seeing increased engagement with the SI community as well as our direct customers. In response to your question about whether we're seeing interest from existing and new customers, the answer is yes. Existing customers are stepping up and are on track with their transformations, including cloud adoption. Previously, we focused primarily on firewalls, but now CIOs and CSOs are leading transformation projects—not just in cloud, but also in networks and software. Until about two and a half years ago, we didn’t have the right portfolio to engage in such discussions. Now, we are developing a strong capability to connect with CIOs and CSOs. We have a lot of engagement across our team and customers. Although these are long-term strategies, it's encouraging that some of these deals materialize within the quarter, leading to significant eight-figure contracts. These large transformation discussions typically take between three to ten months to evolve into major deals. Activity remains high, and while there is scrutiny regarding budgets for big deals, we are not seeing a decrease in conversations or overall activity.

Next is Fatima Boolani from Citigroup, with Mike Turits next.

Happy birthday, Lee. My gift to you is I won't be asking you a question. Nikesh and Dipak for you, is a commentary on the payment concessions and flexibility in light of a more challenged macro. I want to get a better sense of how pervasive these conversations have been for you in the installed base and maybe more directly what are some of the impacts, due to perhaps you're seeing from a deferred revenue mix standpoint and how we should think about invoicing duration and billings duration when we think about our cash flow trajectory in the context of some of those comments.

So Fatima, let me give you context. I want to make sure I'm clear. So far, these are on the margin, okay? This is not mainstream. We do expect the activity to get more in that direction because you can see the Fed continuing to be on this mission to go steam growth, and we expect that's going to cause more customers to pay attention. But let's not... as I said in my remarks, there are some industries which are making money hand over fist, talk to oil and gas. They've never made so much money. So the public sector continues to spend with all the geopolitical issues that are out there. And financials, they're making more money, believe it or not. They're fine. So there are certain segments of the market where these conversations are happening. It's not across the board. We don't expect. I think 50% of the market is not feeling any pain with the interest rate increases. So take that aside, we take the rest of it; some of our budgets in place. They have transformation plans in place. So on the margin, yes, those conversations will increase. As you know, in anticipation of this, we built PANFS; we have a very good motion around providing financing. We're sitting at $5.9 billion of cash. So we are able to finance our customers if they so need to be able to facilitate their transformation project. So the conversation happens between us or our third-party vendors; they're able to go make this happen. I don't know, Dipak, if you want to comment on the deferred billing and deferred revenue comment.

I would say, Fatima, I think Nikesh explained it excellently. And I would just say everything is included in our guidance, in terms of what we think.

Couple of the flip side, as we've said, we have $5.9 billion in cash. Our entire interest income last year was $19 million. I think our Q1 interest income was twice that. So there's the flip side of that.

Okay. Next is Michael Turits of KeyBanc and followed by Jonathan Ho.

Congratulations on a strong quarter in a challenging environment. Last quarter, Nikesh mentioned that you could meet your billings guidance without reducing the product backlog. Could you provide some insights on the backlog this quarter, whether it has increased, decreased, or remained flat? Also, do you still expect the product backlog to remain flat by the end of the year to achieve the targets you have set?

Michael, we don't comment on backlog. As I have said and as Dipak has said, because of supply chain constraints having eased a bit, we have been able to ship product to our customers much faster, which has a positive impact on attached services that we're able to ship them. But remember, our billings grew at 27%. And as we've said in the past, backlog in the overall scheme of things is not as substantial as you might think.

Next to Jonathan Ho, William Blair, with Roger Boyd to follow.

Great. Let me echo my congratulations as well. And happy birthday, Lee. Can you talk a little bit about the XSIAM traction that you're seeing? And maybe help us understand what this means from an upsell potential standpoint when customers start to move in this direction?

Jonathan, that's an excellent question. I was pleasantly surprised by the interest from customers wanting to discuss XSIAM, both directly and through many of our system integration partners. It seems there is a strong desire to reimagine their Security Operations Centers. Many rely on outdated data ingestion platforms and old alert-based systems for optimization and prioritization. They realize that manually combating cyber threats is neither physically nor humanly feasible, and this is a shared understanding. However, for a long time, they haven’t had an effective solution presented to them. When we initially brought in 8 or 9 design partners, they soon expressed that they wanted to use the product commercially instead of remaining as design partners. As a result, we fast-tracked the general availability of the product to meet the needs of these 9 customers, who have all transitioned into full customers. Our sales teams are actively promoting this product, and we have even established a waitlist to ensure that we can handle implementation effectively. This is a significant change, as it involves replacing their data ingestion systems and existing Security Information and Event Management tools while maintaining the ability to operate their SOC during the transition. We are collaborating with Global System Integrators and third-party partners to develop the necessary capabilities for diverse clients. I’ve emphasized this before, but I still believe that four years ago, we committed to building a cloud security business, a Cortex business, and a SASE business, all of which are on track to reach $1 billion. I think XSIAM holds similar potential and could become our fourth business in that category within the same timeframe.

Is Roger Boyd of UBS, with John Deputy to follow.

Congrats on the nice results. Nikesh, you had talked last quarter about extending Prisma Access and Prisma SASE to the entire sales force and really becoming a SASE-first sales organization. I'm just wondering, relative to your expectations, any comments you can provide on what you're seeing from a sales productivity efficiency standpoint?

Well, we said that, and we are in the midst of that transition; we have trained all of our salespeople to become SASE-first. We have hired a bunch of people from SASE competitors to lead some of these areas for us. So we continue that field force transformation. At the same time, and as I said, we've hired 550 direct salespeople in the first quarter because we want to increase the coverage. At the same time, we've been able to do that without having to create a specialist sales force on top of that. So you can see we also said in our prepared remarks, we are accelerating our path to more profitability because we believe we are going to get those efficiencies we anticipated by making a SASE-first field force. But also doing some other things to drive more and more efficiency across the organization, not just in sales. So we feel pretty comfortable that not only will we get sales productivity, but we also believe we'll get overall productivity in the organization so we can accelerate our operating margin aspirations ahead of our 3-year plan, we shared about near a quarter ago.

Next, John DiFucci from Guggenheim with Josh Tilton to follow.

So really strong NGS ARR quarter, guys. My question is more on the product line. We heard just an insight into the quarter of any product refresh that might be happening, perhaps is getting extended. And perhaps, and I think it sounds like maybe because of the macro backdrop, some of the stuff you talked about, Nikesh. I guess, first of all, is this accurate? And if so, should we be thinking about perhaps a little like in this quarter, a little bit lower product growth than we saw over the last several quarters, but decent product growth nevertheless, for perhaps a longer period of time?

I'm trying to interpret your question. I'm going to let Lee answer it. I promise we got more than 1 question.

So John, one of the things I've said in the past in talking about product refresh, as it pertains to the new models that we release is these refreshes typically play out over a fairly long period of time. And so I would suggest not looking at it as a singular quarter when you think about the trend and how this evolves. Most of our customers are large enterprise customers. They make long-term decisions. These decisions take place over 1, 2, 3-plus years of refinements. So these harder refreshers play out over cycles like that as opposed to on specific quarters.

Well, it actually affected the results the last time you did it in 2017 for about 2 years. And it looks like you're about a year into it. And I was just wondering if perhaps it could last longer than 2 years this time. That's really the question.

The only thing I am seeing this time is we've seen a lot of extraneous factors which have muted the outcomes for the industry, with the supply chain crisis, with the pandemic, with the Poland supply chain. Now with the Fed increasing interest rates, I'll tell you, one of the easiest decisions for our customers to make is to sweat their assets a little longer. Because it's not like these firewalls suddenly blow up at the end of life. They can be extended. So laces and I don't know where to put the money in my cloud transformation and sweat the asset a little longer. So if you add all to the miss, that's why we went through this whole cybersecurity transformation of the company. We wanted to take away the impact of any one product line.

Next is Joshua Tilton of Wolfe Research, with Adam Borg to follow.

It's Patrick on for Josh. It's Patrick on for Josh. Over the last several second quarters, the sequential billings guides have been in the 9% to 10% range. But the guide for next quarter implies a 12% sequential growth. So how do we interpret that? Is it a little more aggressive than usual?

I wouldn't read too much into it. Ultimately, we have a pipeline filled with numerous large deals, and it really comes down to when those deals materialize. They can profoundly influence our billings. We're making an effort to be as clear as possible with the information we have available. There isn’t any complicated calculation behind the guidance.

Next is Adam Borg of Stifel, followed by Rob.

I really appreciate it. Maybe we could discuss OT cybersecurity, which is a topic we haven't covered today. We're starting to notice increased focus in that area during our checks. I would love to hear your thoughts, Nikesh, on the opportunity and what strategies you have in mind.

Yes, we have been very focused on ensuring that IoT capability is part of our integrated portfolio. This way, you won't need to acquire another sensor or engage another cybersecurity vendor. Can you discuss this further? Let's have Lee talk about it.

Look, OT environments have long been secured by keeping them disconnected from everything else. And there's OT environments that are still running Windows 95, Windows NT, for those who have been around for a while. That obviously has significant risk. And so the way to control that is simply segmented and walled off from the rest of the world. But what's been happening over the last couple of years is OT networks are increasingly being digitized; specific parts of them are having to be connected to the cloud, which also means the OT and the IoT are starting to merge together a little bit more. And so as that happens, there's a greater interest in thinking about what the next generation of security for an OT environment looks like. And so this is where our ability to come in with a next-gen firewall infrastructure that can provide the segmentation where it's needed. But layer on top of that, the IoT OT security capabilities designed to secure that transformation is starting to pay dividends. I still think this is early days in transformation, but there definitely is a strong interest in these types of organizations. And as Nikesh mentioned earlier, many of these are oil and gas utilities and others that actually are seeing some of the benefits of some of the recent macro environments. And so that's also part of an opportunity to leverage and make investments now.

Next, we've got Rob Owens of Piper Sandler with Matt Hedberg to follow up. Go ahead, Rob.

Could you drill down a little bit in terms of Fed and what you saw in period, obviously calling out a couple of large deals. But if I rewind, the thought process was that Fed was going to get more linear and less budget flushed typical to the September quarter. So are you seeing those trends play out? Or was this more of a budget flush type of quarter? And was it in line with your expectations?

No, it wasn't a budget flush quarter. We've been working the deal, which we announced for a very long time, as you can imagine. Those size deals don't happen overnight. It just happened to converge at the right time for us from a timing perspective. But we're beginning to see the Fed activity get stronger because we're at that point in time with this administration where they've gotten their stuff together across the various agencies, and they've actually started executing against the strategy. So we think, yes, the Fed spend will continue to stay strong and we continue to get linear as time passes, as we get through the rest of this administration's term. It's always dicey in the first year or first 1.5 years because it's a whole new set of characters, especially if you change institutions where they're still trying to figure out what they want to endorse and what they don't want to. So I think things are more stable and things are going to continue to stay strong in that space.

Next is Matt Hedberg from RBC, with Paula.

Congratulations on the quarter, Dipak. I have a question for you. Your pricing is in U.S. dollars, but I'm curious about how international markets are handling the recent significant currency movements. I understand that historically, partners have absorbed a lot of those price changes. How are those discussions going with customers, considering the dollar has appreciated quite a bit?

Yes. So I think, look, there's always going to be the isolated instances where it comes up in discussion. But for the most part, our sales reps will try to manage that through different tools that they have available to them and then that's pretty much it.

I think, Matt, that's a fair question. In addition to what Dipak said, there have been customers who have come back and said, 'Look, the currency has moved a lot. Our price has gone up in the last 2 weeks, and what can we do about it?' In that case, it becomes a conversation. In some cases, we had to adjust prices. But at the same time, like you said, some of them get absorbed by the channel, some of them will get absorbed by the customer, and some get absorbed by us.

Our last question for the evening will be from Gray Powell of BTIG.

Congratulations on the strong results. The NGS ARR really stood out to me. Can you remind us about the economics of selling SASE compared to traditional firewalls? Is there a one-year trade-off to consider? How should we think about the impact as SASE becomes a larger part of the offering?

I find it interesting that all of our SASE deals are significantly larger than our firewall deals, even when they involve the same customer. They can range from two to three times larger, and in some cases, even up to five times, depending on the extent of the requirements and the customer’s willingness to deploy. We have numerous eight-figure deals in the SASE sector, with two vendors competing for these opportunities. As you know, we weren't involved in this space 2.5 years ago, but now we're competing in nearly all large deals. We either win or lose these deals, but we're present in every one of them, typically at large sizes. The economics and the security posture are more favorable for customers; for example, if I sell 500 firewalls, it requires a considerable amount of time for customers to deploy them. Every time we issue a software upgrade, customers have to manage the upgrade process, which can create security vulnerabilities. With SASE, we manage the upgrades, allowing us to complete updates for the entire customer base within two weeks. We recently announced version 11.0, and many customers have yet to upgrade from version 10.2. This enhances security and reduces total ownership costs, resulting in larger deal sizes as we shift management costs from the customer to us and our partners. The economics of SASE are outstanding regarding deal size and consistent margins. As I mentioned before, there’s an $8 billion to $10 billion SASE market out there that is growing in double digits as an opportunity.

All right. And with that, we'll conclude the Q&A portion of our call, and I'll turn it back over to Nikesh for his closing remarks.

Thank you, Clay. Thank you, everyone, again, for joining us. We look forward to seeing many of you at upcoming investor events. I also want to thank our customers, partners, and employees around the world for helping us deliver these great results in such a tough environment. With that, have a great day.