Palo Alto Networks Inc Q2 FY2025 Earnings Call

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Good day, everyone, and welcome to Palo Alto Networks, Inc.'s second quarter 2025 earnings conference call. I'm Walter Pritchard, senior vice president of investor relations and corporate development. Please note that this call is being recorded today, Thursday, February 13, 2025, at 1:30 PM Pacific time. With me on today's call to discuss second quarter results are Nikesh Arora, our chairman and chief executive officer, and Dipak Golechha, our chief financial officer. Following our prepared remarks, Lee Klarich, our chief product officer, will join us for the question and answer portion. You can find the press release and other information to supplement today's discussion on our website at investors.paloaltonetworks.com. While there, please click on the link for quarterly results to find the Q2 2025 supplemental information and the Q2 2025 earnings presentation. 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 made today are subject to a number of risks and uncertainties that could cause our actual results to differ from those forward-looking statements. Please review our press release and recent SEC filings for a description of these risks and uncertainties. We assume no obligation to update any forward-looking statements made in the present. This presentation today contains non-GAAP financial measures and key metrics related to the company's past and expected future performance. Non-GAAP financial measures should not be considered a substitute for financial measures prepared in accordance with GAAP. The most directly comparable GAAP financial metrics and reconciliations are in the press release and the appendix of the investor presentation. Unless specifically noted otherwise, all results and comparisons are on a fiscal year-over-year basis. All per-share figures have been adjusted for the two-for-one stock split that we announced on November 20, 2024, and effective after the close of trading on December 12, 2024. We also note that management is scheduled to attend the Morgan Stanley Technology Media and Telecom Conference this quarter. I will now turn the call over to Nikesh. Thank you, Walter. Good afternoon, everyone.

And thank you for joining us today for our earnings call. I'm excited about our Q2 results. Our teams did a phenomenal job of executing at scale. We've made considerable progress in platformization, allowing us to outperform both our top and bottom line expectations for this quarter. We delivered on our high RPU expectations towards the top of the range. This gave us strength in our NGS ARR and also allowed us to outperform our revenue expectations. In Q2, growth was pretty broad across the entire portfolio, with strength across all three geographies and platforms. In particular, we saw strong performance from large deals internationally and also strong contribution from SaaS, software firewalls, and XIM. On the profitability front, we delivered operating margins ahead of our internal target despite some one-time events. Our efficiency initiatives continue to bear fruit, including some promising early contributions from AI. These results allow us to raise our operating margin and EPS guidance for the year. We're also very happy with our free cash flow performance and continue to be confident in managing our free cash flow guidance over the next few years as outlined. More from Dipak on this later. From our vantage point, the outlook for cybersecurity seems to have been robust in Q2, and is likely to stay so over the rest of this year. Despite the settling in process of the new administration, we see signs that we are going to be able to see reasonable growth through the rest of the year. As the conversation around AI continues to get omnipresent, and companies race to evaluate, experiment, and deploy AI, they're discovering that some of the legacy architectures come in the way of their aspirations. Interestingly, this is resulting in a resurgence of cloud transformation projects and consequently demand for network security and network transformation. While cybersecurity's derivative effect is clear, the longer-term trend towards AI is going to continue to underpin technology transformation, and hence, continue to drive demand for security. The transformations are all geared to embedding AI capabilities across infrastructure. Additionally, many of them involve changing strategies towards data and a growing understanding that data security will be more and more important in the future. We see that from the heightened interest in data security posture management where our acquisition of DIG seems to be proving prescient. To fully harness the power of AI, customers must unshackle their data from disparate legacy systems and providers and open up broader access and lean into the cloud. Cloud infrastructure is much more dynamic than on-prem IT, creating risk. As cloud data volumes grow and customers utilize new services from the cloud service providers, such as modern data repositories, and doubling down in ensuring they're protecting their cloud environments from development to runtime. Understanding who's accessing what data in the cloud and putting controls around these new services. In other words, the cloud is becoming an integral part of the enterprise, and the same level of security must be delivered. A constantly changing attack backdrop is also compounding this inflection we've seen. There are tangible signs that bad actors use AI to accelerate attacks. Google recently found that adversaries can use generative AI to more rapidly create attacks including custom payloads, iterate on malicious scripts, and use evasion techniques. Additionally, bad actors using generative AI do reconnaissance of target organizations, including their infrastructure and hosting providers, which are often exploited in attacks. We have a new technological revolution that requires us to secure AI. As customers leverage the cloud, transform on-prem infrastructure, and respond to the escalating threat environment driven by AI, they're transforming how they manage security operations. Legacy offerings cannot unify SecOps across cloud and on-prem, across multiple vendors, and also take advantage of AI. AI is key for providing automation to help stitch together overwhelming volumes of data and generate the near real-time analysis of remediation needed to keep pace. As I said, security is a data problem. The data has to be all in one place for AI to have context and stop threats in their tracks. Our industry has to change the paradigm by shifting from fragmentation to platformization to enable the best security outcomes. In a recent study we did with IBM, platformized organizations take 72 days less to detect and 84 days less to contain a security incident. Our teams are busy helping customers as they accelerate cloud adoption and transformation across their environments. They need integrated security products and platforms for AI to be most effective in staying ahead of the active cybersecurity landscape. Herein, we're pleased with our progress in driving our platformization strategy and the adoption and endorsement of platformization broadly across the industry. As I mentioned a few quarters ago, I wish we had made this move earlier. We're seeing some interesting behavior that reinforces our conviction that the future state of cybersecurity will have to be AI-enabled platforms that can markedly improve the speed of response. We delivered approximately 75 new platformizations in Q2, up from approximately 45 in the year-ago period. We now have a total of over 1,150 platformizations within our top 5,000 customers. As you might expect, many of our platformizations start with network security and are from customers that have platformized in one area. However, our number of two-platform customers grew over 50% in Q2, and we're seeing a number of three-platform customers up three times year over year. Also, the number of customers platformized in Cortex is up more than three times, reflecting strong excitement. We're excited to see the number of parts we have had success driving strategy so far, and our Q2 performance keeps us on track to achieve our stated target of 2,500 to 3,500 platformizations by fiscal year 2030. Investors have always asked me what platformization deals look like. I want to provide a few examples based on deals we signed this quarter. A bank in Asia signed a transaction worth over $65 million in Q2 platformizing with us for the first time in Cortex, with a significant XIM deployment. They have been leveraging XDR and other Cortex capabilities several years ago also a network security customer and a QRadar customer. They had many point products in their SOC and were not getting the outcomes they needed. With limitations in the time to discover and remediate security incidents resulting in compliance issues. In platformizing on Cortex, our LGS AR with this customer increased by five times over $12 million. Here we are. We look forward to driving a successful deployment here, which can be an avenue to platformizing a network or cloud security in the future for this customer. A US municipality signed a transaction over $60 million which included renewal of its network security estate and expansion across our portfolio. The customer leverages all three of our four form factors within network security and is already platformized there. The deal also included Cortex and Prisma Cloud, which positions us well for future platformization in these areas. GSA are here. Increased over 40% in the last twelve months. Over $11 million. European automated automotive manufacturers signed a $25 million transaction in Q2 that already platformized with us in network security and cloud security. That includes several capabilities as they renewed their firewalls, and support footprints, including IoT, virtual firewall, and SASE. This is a complex customer, and we also secured business with them in Cortex, with XTR, XO, and Expanse, as well as Prisma Cloud. In doing so, we're now well-positioned in the future to consolidate the SOC opportunity with XIM. For this customer, the NGSA IR grew 50% to $9 million. More broadly than these anecdotes, the growth in our large deals tells a story. We had 74 accounts that had transactions over $500 in Q2, up 25% year over year, and 32 accounts added transactions over $10 million, up over 50%. Now moving on to an update about our first security platform network secure NetSec. Our Q2 net segment was driven by strong software demand. We continue to lead the market in network security, which is approximately 80% of our bookings. Our Zero Trust platform combines three best-of-breed form factors built on a consistent architecture. This is fast becoming a requirement as applications proliferate across data centers, hyperscalers, and SaaS. Meanwhile, users are increasingly distributed across headquarters, remote locations at home, and other places. And also there are now soon to be nonhuman users in the form of AI agents, where interactions with applications must be secured. Disjointed network security offerings require significant resources to be applied to integration, creating the possibility of gaps in security policies given the disparity of control panes and more importantly, unless we can harmonize the data across the network, it'll be challenging for customers to adopt AI-enabled security capability in the future. We have to believe that in the future, all solutions will need to integrate harmonize data, and use that to train AI agents to solve security. Looking deeper into firewall as a platform, our bookings accelerated and grew by 21%. Within this, we continue to see stable demand in the appliance market. That stability, coupled with us continuing to take market share, allowed us to grow our appliance bookings in the mid-single digits. There's a refresh cycle coming from many players in the industry, and we believe we are well-positioned to benefit from it. Software and SaaS make up approximately two-thirds of our firewall and platform bookings and grew one and a half times faster than the rate of the total firewall as a platform business. We have been on a multiyear journey to reinvent our security subscriptions, which we use consistently across all three form factors. Each of these advanced subscriptions are cloud-delivered, and at least significantly differentiate with what's in the market. Delivering these incremental innovations into our platform, like advanced subscriptions in the network security, makes our customers' adoption seamless. This is core to our strategy of staying ahead of our customer security needs with future-proof innovation. There's also a win-win for Palo Alto Networks, Inc. and the customer. Next, let's dive deeper into SaaS in a software firewall business. As customers transform their networks to keep pace with delivering first-class security capabilities for remote users and branch offices, we continue to see demand for SASE. Many SaaS projects are large and comprehensive, which is well suited to our rich offering. SASE continues to be our fastest-growing form factor in network security and a strong contributor to our growth. We grew SaaS customers by over 20%, we grew bookings well north of 50% and increased deals over $1 million in value by two and a half times. We now have over 5,600 SASE customers and over 23 million individual seats. Across our SaaS base as well as our GP customers that have been chosen to help protect the base of over 100 million users. Meanwhile, the drivers of our SaaS momentum are broadening. Bookings of newer modules of the SASE platform such as Autonomous Digital Experience Management or ADEM, Cloud Access Security Broker or CASB, Prisma access browser, which you just saw an ad for, NAI Access grew nearly fourfold this year. Customers are happy with their initial SaaS deployments, so adding these to derive a more modern security environment and streamline their vendor landscape. I'm particularly excited about the momentum we're seeing with Prisma Access Browser. Roughly one-third of the new Prisma Access seats we sold in the quarter work for our secure browser. We signed a transaction in Q2 for over $10 million with one customer. With a total of over $30 million in Prisma Access Browser bookings in Q2, and growing seats by 95% quarter over quarter. We also continued to innovate in SaaS, releasing the mobile version of our integrated secure browser. This browser, integrated with Prisma Access, offers mobile phone and tablet users the same robust security and access to private applications. We added capabilities to AI access, ensuring organizations can apply controls to how their users interact with AI-based applications. We can now provide real-time visibility into over 1,800 applications, up from 500 six months ago. AI access comes with out-of-the-box policies to manage functions such as uploads, downloads, and sharing capabilities. In a short period of time, this quarter, we crossed 300 customers who use the AI access capability. We can also provide comprehensive data protection to secure sensitive data secrets and intellectual property. Now turning to software firewalls. This has been a strong area of growth. We saw 50% bookings growth in our software firewall business with AI and public cloud adoption continuing to be the strongest driver. Approximately 70% of our VM deployments are now in the public cloud. We continue to see customers adopt our software firewalls alongside our hardware appliances. As a testament to this, about two-thirds of our software firewall customers are also hardware customers, showing the hybrid nature of the solution and the need for platformization. We also continue to innovate in this business. Early in Q2, we released our API-based AI runtime security capability, adding the ability of our product directly to secure applications without being in the traffic path. Later in Q2, we leveraged this capability to secure AI agents many of our customers look forward toward the value propositions of agents but need to secure them as they would need to secure any other user or application. This capability helped drive our first seven-figure software firewall transaction for AI in the quarter, and we have a healthy eight-figure pipeline for AI firewalls for the future. Now moving on to Cortex. This morning, we had an exciting announcement. We took our industry-leading Prisma Cloud platform and evolved it with more capability, merged it with our CDR capability, and our Cortex platform, to announce the introduction of Cortex Cloud. Cortex Cloud is now the industry's first end-to-end cloud security platform which deeply integrates into the SOC. As we have been delivering cloud security over time, we've learned that customers are keen to ensure that they can trace the cloud security capability all the way into runtime and production and do real-time security against that. We're also delivering a powerful data security DSP experience and real-time security capability with our cloud agent. Again, this is now natively connected to the Cortex platform. This is where cloud security is going. We have anticipated the market change in cloud security, as one reason for our momentum and leadership in the space. Recall that in our early days, we entered the cloud security market in 2018 with two acquisitions and continued to build up these capabilities, pioneering the category and leading with our initial cloud posture capabilities. Soon after, it became apparent that too many security issues were reaching production, and organizations could not keep up with remediating them once applications were deployed. We led the trend to shift left, connecting this to the cloud posture to address security that should be in place before deployment. Attackers took note as customer deployment of mission-critical applications and sensitive data accelerated into the cloud. Our own Unit 42 research shows that 80% of security exposures are found in cloud attack surfaces, with a 66% increase in threats targeting cloud environments. With these evolutions of the attack backdrop, we believe cloud security operations must be an integrated part of the organization's security strategy. Existing Prisma Cloud customers will have a seamless upgrade to Cortex Cloud to benefit from AI-powered prioritization, automated remediation, and a new simplified powerful user experience. Additionally, they can also adopt Cortex's best-in-class CDR capability to gain real-time cloud security capability. So the unification of enterprise to cloud can further drive the adoption of XIM in the customer's cloud environment. Cortex Cloud natively integrates with cloud data, context, and workflows within Cortex XIM, significantly reducing the mean time to respond to modern threats with a single unified SecOps solution. More importantly, because we are natively integrating cloud solutions into the SOC, XIM has now transformed into both a cloud and enterprise SIEM. We're excited about the prospects for us to maintain or accelerate our strong momentum. As I mentioned, we are making this announcement in the back of strong momentum in our cloud security and security business. I want to give you some highlights. We drove bookings growth of approximately 50% in both Cortex and Prisma Cloud in Q2, with healthy momentum in customer growth of approximately 20%. Fueling this customer growth, we again signed hundreds of new XDR customers in Q2, which become opportunities for transformation on the broader Cortex platform in the future. Our XDR momentum continues to be fueled by the efficacy of our product. This quarter, we achieved further external recognition, achieving leadership results in the most recent MITRE ATT&CK evaluations. XIM, our AI-driven SecOps platform surpassed the $1 billion cumulative bookings milestone in Q2. While we know we have a winning product with XIM, we're also starting to see external validation of our leadership with Frost and Sullivan and OMDA recognizing us as leaders in the same category. Contributing to our Cortex strength in Q2 was over $100 million in QRadar-related bookings. Our pipeline on QRadar is equally strong, leaving us optimistic about our IBM partnership as a driver of Cortex. On the cloud side, we saw the adoption of our capabilities continue to broaden. With DSP integrated with Prisma Cloud, we see early adoption to be one of the strongest among any of our new cloud security capabilities. We're excited to see the success continue with DSP as part of the Cortex Cloud product we announced this morning. We're also seeing particular success among some of the largest companies in strategic industries. For example, several SaaS companies signed significant cloud security deals with us in Q2. In this industry, XIM is the top ten SaaS companies outside of the cybersecurity market, leveraging their cloud security capabilities to secure the customer's environment. As you can see, we saw strong momentum across the business in Q2. We're seeing customer imperatives around AI driving accelerated cloud adoption and infrastructure investment, which is supporting strong cybersecurity demand. This healthy spending backdrop along with strong execution from our team and platformization helped drive the healthy top line trend we saw in Q2 across RPO, GSARR, and revenue. We remain optimistic about sustaining this momentum as our sales teams leverage our ecosystem and continue to become more adept at aligning our many capabilities into a unique platformization journey for each customer. We remain confident in our long-term NGS ARR forecast. Supporting this is a steady innovation stream and momentum across our portfolio. Leading early mover into new market categories like enterprise browser, secure AI by design, the AI-powered SOC, are making it easy for our customers to adopt key new innovations with our platform approach. Lastly, we're driving profitable growth, balancing operating margin improvements with strong cash flow. We continue to make progress in driving a culture of efficiency at all levels of Palo Alto Networks. You've seen the results of this over the last few years. This focus on efficiency and some early success in AI-based initiatives gives us the confidence to continue delivering profitable growth. I will now pass on to Dipak for his remarks.

Thank you, Nikesh, and good afternoon, everyone.

To maximize our time spent on Q&A, I will provide you with highlights of Q2. You can review the results in our press release and the supplemental financial information on our website. In Q2, total revenue was $2.26 billion and grew 14%, above the high end of our guidance. Within revenue, product revenue grew 8% while total services revenue grew 16%. Drilling into total services revenue, subscription revenue grew 20%, and support revenue rose 8%. Our product revenue is approaching 40% software on a trailing twelve-month basis. We expect healthy software contribution to product revenue in the second half of this year, which we expect will increase our product revenue into the double-digit growth range. We also saw stable demand for firewall appliances in Q2, which we expect to continue through fiscal 2025. The appliance market grows 0 to 5%, as we have previously discussed. Moving on to geographies. We saw double-digit revenue growth across all regions, with the Americas growing 13%, EMEA up 18%, and JPAC growing 17%. We were particularly encouraged by the volume of large deals we closed, with some notable large deals in EMEA and JPAC. For example, we had our largest deals ever in both EMEA and JPAC this quarter, each in excess of $50 million. As Nikesh noted, these deals demonstrate the broadening of our large deals success from North America to our international regions. Also, many investors have had questions about the US federal market. We have had prudent expectations in this market this year, and we saw stable federal business in Q2. Much of our federal business is tied to renewals and existing programs with long-standing funding. During the quarter, we also received FedRAMP high authorization across our network, cloud, and security operations platforms. We now have the most comprehensive suite of AI-powered cybersecurity solutions authorized for use in federal networks at the high impact level. Total RPO grew 21% to $13 billion at the high end of our guided range. Our current RPO grew 17% to $6.1 billion. The average duration of new contracts remained at approximately three years. It did trend towards the high end of our historical range in Q2, based on our performance in large platformization deals, particularly customers making longer-term commitments to XI App. Our NGS ARR again delivered strong growth, growing 37% finishing Q2 at $4.78 billion, and was driven by the strength across our advanced subscriptions, SaaSII, and Cortex. Moving down the income statement, gross margin of 76.6% was down slightly as we continue to see the impact to some of our newer SaaS offerings that are growing quickly but have yet to achieve scale. Also, we had some costs in Q2 related to inventory and product transitions that were higher than typical, and we don't expect that will recur in the second half of the year. It is worth noting we have been transitioning our contract manufacturing facility in Texas as our primary manufacturing and fulfillment center. Not only to enable scale and innovation in our appliances, but also to take advantage of our foreign trade zone that can help mitigate tariffs on products we ship to international destinations as we assemble and manufacture all of our firewall appliance products in the US. More broadly, we continue to see efficiencies across the company as we focus on driving profitable growth. We saw operating expenses as a percentage of revenue decrease by 120 basis points as we benefited from scale in our business model and initiatives as a part of continuing to build our culture of efficiency. We delivered $0.81 of diluted non-GAAP EPS and a diluted GAAP EPS of $0.38, continuing to grow along with our overall profitability. As a reminder, in the year-ago period, we had a significantly positive impact to GAAP EPS from the large $1.5 billion release of tax valuation allowance that happened only in fiscal 2024. We generated adjusted free cash flow of over $509 million in Q2. On our balance sheet, you will see that our debt balance came down by over $100 million as we continue to see early conversions of our convertible debts, which occurred at the discretion of the debt holders and was settled by us in cash and equity. In 2025, our remaining debt of just over $500 million matures in June, continuing to see some early conversions. We did not repurchase any shares in Q2, and our buyback strategy remains opportunistic. We have $1 billion in authorization remaining through December 2025. As Nikesh mentioned, we are pleased with the momentum we are seeing in our platformization strategy and the outcome in driving our financial results. I wanted to update you on what we are seeing a year into this strategy. As you all no doubt remember, we announced our optimization strategy a year ago. Over the last twelve months, we've learned from our success and adapted where it made sense. We launched a number of structured sales programs to jump-start this initiative. Our goal was to remove friction related to technology risk and budget challenges for the customer. We have now embedded these practices into how we do this. A year in, we have seen both the industry rally around this approach as well as some of our key ecosystem partners put significant resources behind platformization. This has helped leverage our own investments on the sales and marketing side and brings us closer to enterprise accounts where ecosystem partners have strong relationships. Many of our large platformization deals have been pursued and closed with global system integrators. With these joint successes, partners collectively are putting more resources behind platformization. When we initially announced platformization, we had piloted the program, helping us build conviction in our aggressive launch. Predating our broad announcement, some of our top reps were driving deals with the principles that embody platformization. A year in, we have seen rapid participation significantly increase, with approximately a third of our sales reps having already participated in a new platformization deal win in the last twelve months since we launched our accelerated strategy. Lastly, when we launched the program, we had assumed the platformization would enable us to increase our ARR per customer. As you can see in some of the large deal highlights that Nikesh covered, we have seen success signing larger deals and further expanding our ARR among platformized customers. As you can tell from both the tone and some of the details that we provided, we are very happy with our progress here. I'll reiterate what Nikesh noted last quarter and earlier: our biggest learning is that we should have made this move earlier. Now turning to the bottom line. Our confidence in future operating margin expansion is rooted in our visibility to continued leverage across our P&L. As Nikesh mentioned, we've seen some encouraging results from our AI-based initiatives across multiple areas of the company that give me greater confidence in our ability to drive leverage. I wanted to provide you with an update on some of these AI-based initiatives on what we're seeing so far. In the areas that we have focused on, we've seen meaningful efficiencies that manifest as lower spending, enabling us to drive incremental innovation, or absorb expected increases in volume without additional spending. One of our first AI-based initiatives was focused on our employee-facing processes. In the past, we have leveraged contractors in various business processes in IT. We are on track to reduce this contract labor by about 50% as we close out fiscal 2025, which will result directly in operating expense savings. In our global customer support business, we've leveraged an internally developed Copilot to assist in case resolution. So far, we have seen our support Copilot used in about 85% of cases in network security, which is where we first rolled out this technology. We're seeing approximately a 50% reduction in the time to resolve cases. This results in a better experience for our customers and also our team is being able to absorb more case volume while adding less headcount than in the past. Lastly, we are deploying Copilot tools for our developers early and are seeing some exciting results. We've recently deployed the technology to all of our engineers. These and other initiatives that are still in their early stages give us consistent outcomes and that gives me more confidence in our tangible benefits to our business, including our cost structure. Before I turn to guidance, we have had a lot of questions about how we get comfortable with the sustainability of our cash generation given some of the transitions happening in our business. We began to see an increase in deals with deferred payments in fiscal year 2022 and have seen a significant increase driven by larger transactions, particularly in our SaaS offerings over the last three and a half years. As we have absorbed an increase in deferred payments, our visibility into our free cash flow each year has increased. In fiscal year 2024, when we entered the year with $1 billion in deferred payments scheduled for the year, that was 32% of our fiscal year 2024 adjusted free cash flow. This year, that amount increased to $1.4 billion and our visibility increased to 41% of our expected adjusted free cash flow. Looking forward, we expect to enter fiscal 2026 with $2 billion in deferred payments scheduled for the year, further increasing our visibility into free cash flow in fiscal year 2026. We've progressed substantially over the last several years through the transition of deferred payments. We've also spent significant time ensuring that we're balancing this transition with other uses of cash and opportunities for cash flow optimization. Because our appliance bookings and smaller bookings predominantly are paid upfront, and many of our large transactions already utilize deferred payments, we believe we can manage the trend towards more of our larger transaction bookings utilizing deferred payments as we have done over the last several years. Consequently, our expected increasing profitability as we scale and these financial dynamics give us improved confidence in our free cash flow generation. Our confidence holds for fiscal year 2025 where we continue to expect 37 to 38% adjusted free cash flow margin as well as our cash generation beyond this year. We are comfortable that we can generate adjusted free cash flow margins for fiscal year 2026 and fiscal year 2027 of greater than 37%. As a reminder, we do not guide free cash flow on a quarterly basis, and we do see year-to-year fluctuations in our cash flow. In fiscal year 2025, relative to prior years, we expect to see fluctuations in seasonality driven by the timing of deferred payments from customers, the timing of bookings within the year, and the timing of cash tax payments. But this year, we expect relative to the market that more of our free cash flow will come in Q4. With that, let me turn to guidance. For fiscal year 2025, we expect NGS ARR to be in the range of $5.52 to $5.57 billion, an increase of 31 to 32%. Remaining performance obligation of $15.2 to $15.3 billion, an increase of 19 to 20%. Revenue to be in the range of $9.14 to $9.19 billion, an increase of 14%, operating margins to be in the range of 28 to 28.5%, diluted non-GAAP EPS to be in the range of $3.18 to $3.24, an increase of 12 to 14%. And adjusted free cash flow margin in the range of 37 to 38%. For the third fiscal quarter of 2025, we expect NGS ARR to be in the range of $5.03 to $5.08 billion, an increase of 33 to 34%. Remaining performance obligation of $13.5 to $13.6 billion, an increase of 19 to 20%. Revenue to be in the range of $2.26 to $2.29 billion, an increase of 14 to 15%, and diluted non-GAAP EPS to be in the range of $0.76 to $0.77, an increase of 15 to 17%. We've included our typical modeling points in the presentation for you to review. Before I turn back to Walter for Q&A, we will roll one more video.

When I think about the relationship between Palo Alto Networks, Inc. and our clients, we are a $20 billion global technical services firm that employs over 340,000 associates worldwide. We had disparate technologies across the environment. Our data was also very disjointed. How do we optimize our entire technology strategy through platformization and create a level of consistency across our entire enterprise? So our ability to protect and defend goes up. And the complexity to manage and maintain this technology, but we've improved. We look at the promise of what we're seeking for XIM and where we're seeing the benefit as the ability to more effectively consolidate the visibility through all that data. And the ability to then rapidly accelerate creating runbooks and use cases out of that data in order to drive our response and our decision. And the relationship between Palo Alto Networks, Inc. and Cognizant is one that I get to see come into real life in terms of how we're going to transform and how we're reenvisioning our entire security program.

We ask in the Q&A that each analyst only ask one question. Our first question will come from Saket Kalia from Barclays followed by Hamza Fodderwala from Morgan Stanley. Saket, go ahead.

Maybe a question for Nikesh and Dipak together. You know, it's great to see free cash flow margins at 37% plus expected now through fiscal 2027. Nikesh, can you just maybe talk about some of the success you're seeing driving better profitability and Dipak you just maybe go one level deeper into other drivers of that free cash flow like the deferred payments.

Yeah. No problem. First of all, thank you for the question. As Dipak highlighted, we are beginning to hit scale. As you see, platform deals are actually a lot more efficient from a sales perspective because larger deals—if you look at the cybersecurity landscape, we're now clearly a large deal company compared to most of our competitors. So that definitely drives efficiencies for us from a scale perspective. If you look at any P&L in any enterprise business, 50 to 60% of the P&L is sales, marketing, and customer support. If you can find efficiencies in that process, that's where leverage lies. You've seen we've been improving our operating margins consistently now for over two and a half years. That's being driven from that efficiency lens. If you couple that with some of the early experiments we've shared on the AI front, we think this has tremendous potential in the future. Where enterprise companies should operate at a much higher operating margin in the future from now. I'm not going to put a forecast just yet, but think the trend is our friend. And that gives us tremendous comfort that we can underpin our performance with strong operating margins over the course of the next few years. Couple that with the way Dipak and his team have been able to balance the deferred payment parts, which you can talk about, which they said gives us tremendous amounts of visibility. We feel confident that the range the next few years is there and possibly higher after.

If I can just build on that, Saket, a lot of this is is in the prepared remarks, but we've had a lot more visibility with the growing balance of deferred payments already in the past few years. There are parts of our business that are really never going to go to deferred payments. The smaller transactions that have multi-tiered distribution networks where everybody wants to get paid upfront, the appliance business, where it's industry standard to pay upfront. Then you're left over with everything else, and we've already made a significant transition. So there's not as much left to actually do. We're quite far along the journey, and that's what gives us confidence, and that’s what I was meaning to convey in the prepared remarks.

Very helpful. Thank you.

Thank you, Saket. Next question from Hamzah Fodderwala from Morgan Stanley followed by Brian Essex from JPMorgan. Hamzah, go ahead.

A bigger picture question for you. You know, Palo Alto Networks, Inc. has been at the forefront of AI, whether it's AI for security operations when it comes to Cortex, or securing AI now with DIG and Prisma Cloud.

It's a very good question coming from you, Hamzah. Not that I wouldn't expect that from you, but it's a great question. Like, I think deep seek is a phenomenal pivotal moment for AI. Not just for us, but across the industry. If you look at it across three parameters. Right? There's the question around quality. Is it as good as the models that people are using out there, like OpenAI, Gemini, or Llama, etc.? At least if you read the ratings out there, it seems like it's equally good if not better for technical answers. It does better coding, better math, better physics. So it looks like it has a better reasoning engine out there. So interesting. Then the next question becomes great. If it's so good at what it does, is it economically viable? Whether it can be done for a lot cheaper? Now we can debate that. I don't know if you'll ever get to the bottom of it. But what's interesting is today, you pay 14 cents for about a million words? And you pay $7.50 for every other model. So it's 2% of the cost to every other model. Now that's driving experimentation. I've talked to many SaaS CEOs recently, and everybody's experimenting. So we need to see if Deepseek can deliver that degree of performance. The third question comes: this may come from a nation state, maybe from somewhere where we don't want to trust the model. We got to figure out how to secure it. Now look, any AI model that is going to be used by enterprises will be used in a sequestered fashion. Either on-prem or in your own cloud instance, will require AI firewalls around it. If you can guarantee that your data doesn't get out of that sequestered kind of space, if you can guarantee that you can put guardrails around the model, I think you'll see a lot more experimentation. So from that perspective, I just got to pivot my only recommendation to every enterprise out there is to make sure you don't deploy AI without running firewalls around it. Make sure you don't deploy in a multi-tenant environment. But I think this is great for AI. And like any technology, it's great for security because any technology requires you to put more security around it.

Great. Thank you, Hamza.

Next question is coming from Brian Essex at JPMorgan followed by Gabriela Borges at Goldman Sachs. Brian, go ahead.

I have a bit of a different AI question. And, you know, it comes from leveraging AI across the platform to provide better security outcomes. And maybe if you could talk about what you're seeing in cloud security as an example, and win rates as you're able to provide know, code to cloud to SOC security across your entire platform, how does that affect your ability to compete against point solution providers in that space? And you know, how is that enabling you to leverage the platform maybe as an example in that cloud security space?

Hey, Brian. Is any point solution business left? Every security company seems to claim their platform now, so I don't think there's I don't think this, but anyway.

Was it different between calling yourself a platform and actually being a platform?

That's what they say about us too. That’s those guys. But that notwithstanding, like, I was I was telling Lee last night and I said, you know what? I found a new raison d'etre for platformization. Our earlier narrative was that you need a platform so you get a single pane of glass, you can run zero trust networks. You can be harmonized across policies. There are no security gaps. But as we go down this journey, we're discovering and we're talking about deploying agents, and why do we need human beings trying to do these complex tasks and trying to understand how security should be deployed? Why can't we have agentic personas that say, I'm your network configurator. I'm your phishing remediator. Can't we design security agents? When you realize you can't design an agent unless you have the data? You can't you can have the data across seventeen disparate products and make sense of it. So what we're discovering is this strategy that we deployed about two years ago, and really sort of put our weight behind a year ago is yielding harmonious data. These 1,150 customers who are platformized have data that is harmonized. We can run and build agents on top of that. So from that perspective, the more platforms we sell, it creates tremendous opportunities for us. I want to talk to let Lee talk about how this is helping us in the cloud security front.

Yes, you've seen what we've done in other places. Right, Brian? So in XIM, using AI for the SOC and reducing meantime remediation from days down to hours to minutes. You've seen us do this with in NetSec and across network security and SaaS and other places. In Cloud, what you can see is a couple of things. First is in the individual areas, such as AppSec, how we use AI in order to have better detection and prevention of misconfigurations before they reach production. In production, how we use AI in order to better remediate detect and remediate, prioritize, etc. And then with Cortex Cloud, which we announced earlier this morning, what that allows us to do is now not only apply AI on automation within each of these areas but now connect that across the full end to end—from AppSec into cloud, into runtime, into SOC. And that is incredibly powerful when you think about trying to become much more proactive in security.

Is that translating into a better win rate? So, like, if you look against a point solution, vendor like Wiz in the cloud security space, are you starting to see the improvement in win rates?

Yes.

Yes. Because it not only had it achieved better security outcomes, but it also translates to more efficient security operations for those that are responsible for managing all this on a day-to-day basis.

What I was going to say, Brian, is that I think cloud security is going to go through one more evolution. That evolution will be as it sort of started in the center, shifted left to go to code. Now it's doing a hard shift right. A hardship right is you need to be in the sensor in production environments understanding what's going on, protecting the production environment, and using that to prioritize cloud security. I think you know, the bigger cloud security action is going to be in runtime with agents, and that's where more—it's actually not the CNAP players who have had who won the last round. That makes any sense.

Alright. Thanks, Brian, for those two questions. We'll go next with Gabriela Borges from Goldman Sachs, followed by Jonathan Ho from William Blair. Gabriela, go ahead.

Hey. Good afternoon. Thanks for taking my question. Dipak, you mentioned earlier there are some deals that are always gonna be upfront. Maybe just elaborate for us. What are the guardrails or what is the framework for your salespeople that determines when they go to multiyear versus one-year billings? And when they can offer financing versus when you don't want to offer financing.

Yeah. So I think it's all part of the actual sales motion and negotiation. So really, really where you see the majority of the requests for deferred payments is in the higher end. Distributors don't really want to have to deal with lots of back and forth with customers at the lower end, therefore that's typically all upfront. Right. So it's really the higher-end deals. And on firewall, typically get the money upfront because that's being budgeted. On a refresh cycle. So those cases apart, it then becomes a negotiation. Our sales team will explain that there is value in the cost of money, and we expect to be paid upfront. Then it becomes part of the negotiation based on what is required and what's not required. We do have guardrails in place—everything from sales comp to approvals that are in place to make sure that we manage that tightly but it really is with a view of enabling platformization at scale, which is why we've been working on this for a while, and managed to transition pretty well so far.

Great. Thanks, Gabriela, for that question. Next, we’ll go with Jonathan Ho from William Blair followed by Peter Wheat from Bernstein. Jonathan, go ahead.

Can you talk a little bit about the ability to accelerate adoption or accelerate platformization as you take on the stock tick?

Yeah. Look. As Nikesh was mentioning, a lot of the action in cloud is shifting towards real-time, which means shifting toward runtime and even SOC. It’s really critical, though from our perspective that we bring in as much context as possible in order to be able to make those automated actions. Right? And that context often comes from CNAP and even code security. That's the first critical reason. Second is the cleaner your cloud environment can be from preventing issues from ever making it into production or cloud posture where we're detecting and remediating those issues. The cleaner your cloud environment, the better that security posture is. The easier it is for runtime and SOC capabilities to fire in real-time because it’s easier to pick out the attacks using machine learning AI and other types of capabilities like that. So ultimately, we believe that the best outcome for customers is achieved when they connect all of the aspects of the cloud together, and so you see that show up in terms of how we package the offering as well.

Great. Thanks for that question, Jonathan. Next, we’ll hear from Peter Wheat from Bernstein followed by Shaul Eyal from Cowen. Peter, go ahead.

Alright. Thank you, and congrats on the continued success on the platform. Maybe I ask the unsexy question. Which is, you know, on the product side. You know, I think we saw some nice strength this quarter, and I know the guidance is that's gonna remain a less exciting growth portion of the business. But that strength was important for delivering on the revenue. And if we look forward is that type of strength something that we should be able to look at as support rather than maybe a drag on overall growth, or is this kind of a one-time quarter? How will that evolve looking forward?

So, Peter, I think it's probably one—like, I sound like a broken record. I've always been saying that the hardware industry for us, at least our end, is going to deliver somewhere between 5% to 8%. And sometimes it's been flat in the post-pandemic. There was a sort of splurge, surge, and it went back down. I think we're back to steady state. So I think easily, you can expect us to be going low to mid-single digits on the appliance side. But I think the real action for us is, I think, you understand, there's a series of transformations going on underneath. Like, Dipak highlighted cash flow transition. We've been transitioning our network security business as you saw from hardware to software. This is why you see that we're growing that category 21%. Between hardware and software. So that just, over time, reduces our reliance on hardware because I think, you know, that cloud transformation is underway. More and more cloud volume. But that's the good news. The cloud volume is going up faster than the data center volume is declining. So if we can manage this transition in a way, we can drive more and more software firewalling capability and not just recompense for the hardware business being slow growth compared to that. We can also, over time, drive higher growth across the entire network security category for ourselves.

Thank you. Great. Thanks for the question. Next up is Shaul Eyal from Cowen followed by Taliani from BofA. Go ahead, Shaul.

I wanted to ask about the margins. Can you go over kind of what happened to margins this quarter? I saw a little bit of pressure, and then what's the outlook for the year? What are the puts and takes for margins?

So tell us the clarifying question you told me in gross margins? Is that what you're saying?

Gross, yes. So really it's mainly on the gross margin, and it was all in my prepared remarks. The main parts were on the services gross margin. It was driven by, you know, like faster growth on the newer SaaS offerings. Which just have more time to mature and scale. And on the hardware, we did have some one-time inventory write-off and CNOs. It will not repeat in the second half.

Thanks.

Alright. Thanks, Tal. Next, we'll go with Andy Nowinski, and our final question will be from Matt Hedberg from RBC. Andy, go ahead.

Good afternoon. Thank you. I thought your quarter overall was very good as well. I want to ask maybe a more difficult question on the Net New ARR side. You know, if you pull out the $74 million from QRadar in Q1, it looks like your net new ARR declined on a year-over-year basis for the last two consecutive quarters. You have so many positive trends in these large platformization deals. Why aren't those translating into net new ARR growth over the last two quarters?

Yeah. So, Andy, we talked about this a little bit last quarter. I mean, we're very happy with the net new ARR growth. We did have some transitions of, you know, old attaches to cloud-delivered advanced subscriptions that led to a significant increase in net new ARR a year ago. As we lap that, we don't have the same step-up. But the net new ARR on some of our newer products, what's driving a lot of the platformizations continues to go from strength to strength.

Yeah, and yes, just after that, like, you know, the software firewall strengths we talked about, the SASE strengths we talked about, the cloud security strength, the XIM strength—all these things contribute to net new ARR. That's what's allowing us to get it, to the— I still remember six years ago, this was zero. So we're very happy that it's driving up a whole lot of $5 billion, and know, we still believe we're on track to get to $15 billion on NGS ARR.

Great. Thanks, Andy. Our last question is from Matt Hedberg. Matt, go ahead.

Thanks for taking my question, guys. Congrats on the results. Not an easy environment here. I had kind of a high-level question, maybe Lee for you. I think we've all been talking about agentic frameworks, and I think, you know, Akash, you mentioned on the call. I guess, Lee, from your perspective, a lot of people look at identity as sort of maybe the tip of the spear for agentic security. What what's your perspective on the security foundation for a broader agent rollout?

Oh, I think it's a lot more complicated than that, Matt. Not necessarily in a bad way. But I think sometimes the industry can be quick to jump on a single magic bullet of identity, which is important, but there's a lot of other aspects to how these agentic platforms work. And I would actually start with how do you secure the AI portion of the agentic platform and making sure that it's providing. If you're going to give it the authority to take independent actions, which effectively what agentic AI will do, you better make sure that that AI environment is fully secured from attackers and you have proper guardrails enforced and everything else. Yes, that has to be combined with identity. All of it has to be combined with, it's going to ramp up even just machine to machine level communication, how we secure it. So there will be multiple facets to how agentic AI is secured as it matures. Just to add to that, Matt, I think one of the things which is from our perspective fascinating is that we have now sold XIM more than 200 times in the last 24 months, making it one of the fastest-growing products in cybersecurity. And in XIM, we see all the data. So we expect to start seeing agentic activity in XIM. So, you know, identity is two parts. Identity is validating your credentials to make sure you are who you are, whether you're an agent or human being, which is what typically MFA does a service accounts to SaaS applications. But watching the activity and being able to control the activity and stop the activity and change permissions will have to happen in some sort of AI-enabled SOC. So we think there's an opportunity for us in the future that we will be able to build as the definition of agents and the deployment agents starts to settle in. Agentic detection, remediation, and management within the XIM capabilities that we have.

Alright. With that question, Matt, thanks for wrapping it up for us. I will turn the call back over to Nikesh for his closing remarks.

I just want to say thank you very much to all of our customers, employees, and our ecosystem partners for all their hard work, and thank you for all of you for taking the time to listen in on our earnings call. We'll see you guys next quarter.