Hello. Welcome to the Q3 Fiscal Year 2020 Earnings Call for Palo Alto Networks. This call is being recorded and will be accessible on the Palo Alto Networks Investor Relations website. Now, I'd like to turn it over to David Niederman, Vice President of Investor Relations.

Good afternoon, and thank you for joining us on today's conference call to discuss Palo Alto Networks fiscal third quarter 2020 financial results. This call is being broadcast live over the web and can be accessed on the Investors section of our website at investors.paloaltonetworks.com. With me on today's call are Nikesh Arora, our Chairman and Chief Executive Officer; Kathy Bonanno, our Chief Financial Officer; and Lee Klarich, our Chief Product Officer. This afternoon, we issued a press release announcing our results for the fiscal third quarter ended April 30, 2020. If you'd like a copy of the release, you can access it online on our website. We would like to remind you that during the course of this conference call, management will make forward-looking statements, including statements regarding the duration and impacts of COVID-19 on our business, our customers, enterprise and cybersecurity industry and global economic conditions, our financial guidance and modeling points for the fiscal fourth quarter and full year, full fiscal year 2020, our competitive position, and the demand and market opportunity for our products and subscriptions, benefits and timing of new products features and subscription offerings, revenue, ARR and various billings run rates, as well as trends and certain financial results and operating metrics. These forward-looking statements involve a number of risks and uncertainties, some of which are beyond our control, which could cause actual results to differ materially from those anticipated by these statements. These forward-looking statements apply as of today. You should not rely on them as representing our views in the future, and we undertake no obligation to update these statements after the call. For a more detailed description of factors that could cause actual results to differ, please refer to our quarterly report on Form 10-Q filed with the SEC on February 25, 2020, and our earnings release posted a few minutes ago on our website and filed with the SEC on Form 8-K. Also please note that certain financial measures we use on this call are expressed on a non-GAAP basis and have been adjusted to exclude certain charges. For historical periods we have provided reconciliations of these non-GAAP financial measures to GAAP financial measures. The supplemental financial information can be found in the Investor section of our website located at investors.paloaltonetworks.com. And finally, once we have completed our formal remarks, we will be posting them to our Investor Relations website under the quarterly results section. We'd also like to inform you that we will be virtually presenting at the Baird Global Consumer Technology and Services Conference, the Bank of America Global Technology Conference, the Piper Sandler P.S., its Friday session on SASE versus SD-WAN, and the Morgan Stanley Zero Trust Architectures Virtual Thematic Conference. And with that, I will turn the call over to Nikesh.

Thank you, David. Good afternoon. Thank you to everyone joining our first video earnings call. I appreciate you being patient as we experiment with a Zoom earnings call. Before I comment on our results, I'd like to thank our employees, our partners, suppliers for the tremendous dedication and commitment they've shown over the last few months. I couldn't be prouder of our teams who’ve worked tirelessly to ensure the security needs of our customers were met in this uncertain environment. It is important to note, our last month of this quarter saw a majority of the world under lockdown. And to be able to deliver these results in these times is a testament to the strength of our teams and our partner ecosystem. As a company, we responded quickly, we've made the transition to nearly 100% remote workforce without a hitch. Focus on the well-being of our employees, we moved to work from home in early March, ahead of local ordinances. With the global team whose mission is enabling our customers to work securely, no matter where they are, we were well-equipped with the tools, technologies and security to work safely from home. Our teams have been hard at work in recent months, helping our customers adjust to entire organizations working from home. This change has prompted companies to rethink how they manage data and applications no longer protected by hardened corporate network parameters. As always, Palo Alto Networks has served as a trusted partner to our customers. Our teams rallied to help customers secure remote workers and provide expanded infrastructure security quickly, encompassing thousands of workers across multiple locations. We have over 1,500 customers just in the past six weeks, using our free trials for remote secure access, which we enabled in the middle of March. The feedback we…

Thank you, Nikesh. Before I start, I want to echo Nikesh's sentiments and thank our employees, partners and suppliers for their dedication and the incredible work done to support our customers during this global pandemic. A special call out to our operations team for managing through the global supply chain challenges associated with COVID-19. Our team and our manufacturing partner FLEX did a terrific job, working with our suppliers around the globe to ensure that we could meet the security needs of our customers during this time. Moving on to our results, I'd like to note that except for revenue and billings, all financial figures are non-GAAP, and growth rates are compared to the prior year periods unless stated otherwise. As Nikesh indicated we had a great third quarter, even in the wake of COVID-19. In the third quarter, we continue to add new customers at a healthy clip. We saw improvement in our product revenue, and our next-gen security sales continued to be strong. In Q3, total revenue grew 20% to $869.4 million. Looking at growth by geography, the Americas grew 19%, EMEA grew 24% and APAC grew 15%. Q3 product revenue of $280.9 million increased 1% compared to the prior year. Q3 SaaS based subscription revenue of $354.3 million increased 37%. Support revenue of $234.2 million increased 24%. In total, subscription and support revenue of $588.5 million increased 31%, and accounted for 68% of total revenue. Turning to billings, Q3 total billings of $1.015 billion net of acquired deferred revenue, increased 24%, the dollar weighted contract duration for new subscription and support billings in the quarter, remained at approximately three years, flat year-over-year. At the margin, we are seeing certain customers sign up for annual billing terms, given the dynamics of the COVID environment. Total deferred revenue at…

Our first question is from Keith Weiss with Morgan Stanley.

Excellent. Thank you guys. I hope everyone is well on your side of the fence. Nikesh, I was thinking can you give us a little bit more color into both in terms of the results that you guys saw in Q3, which were ahead of our expectation, I think ahead of most people's expectations. Can you help us parse out what of that came from better execution on your side of the equation? You had talked about a lot of initiatives that you guys put into place to get sort of the sales force more focused on selling firewalls, building up that pipeline. So how much of that was kind of better execution? How much came from perhaps a pull forward of spending or crisis spending, if you will, of people setting themselves up for work from home environments? And then secondarily, can you give us a little of a sense of what you've been seeing so far in May? You talked about difficult macro ahead. Has the positive trends -- how well have the positive trends you saw in Q3, how well is that actually sustained into May thus far?

Thanks Keith. Thanks for the question. I think it's fair to say as the pandemic hit, we saw a spurt of activity in the first few weeks, where customers wanted to rush and create more capacity to be able to support their remote workers; so people asking for more firewalls or chassis cards to expand capacity, people doing our GlobalProtect trials to see if they can fill in the remote work capability by using our free option that we've offered, because we want to support our customers. Some people accelerated their Prisma Access trials into full purchase orders, because they wanted to get it deployed quickly and we put in teams to go deploy. So definitely there was an early surge in the first few weeks. I'd say on the margin in the quarter, there were puts and takes. There were things that got slowed down because customers are not in the office, the federal government can't have half their people go in. So all those things cause puts and takes. So I'd say the puts and takes probably gave us a slight bump, but not a substantial bump in the last quarter. And to be fair, I think some of these trends are going to be here to stay. I suspect that most companies want to maintain their remote secure access capabilities coming out of the pandemic, we announced today a policy called FLEXWORK. We're allowing our employees to come into work as many times a week as they want when things open. We're not dictating everybody has to come to the office, which means we have to maintain a remote secure capacity across our entire employee base, because now they will split their time between our office as well as their homes. And I think that's going to be true for many companies. If you see the last week, multiple companies have announced that they don't expect all their employees to come back to work. So I think that extra remote secure capacity has to be created. I don't think every company has actually scaled up to that. I think that's going to be a sustainable trend for the next three, four quarters. So I don't think that's a onetime support, that's going to be systemic. In the industry, I think the cloud transformations are real, I think those are getting accelerated. I think it's just going to be the puts and takes in terms of people who can get business done in the next three months or not, versus people who are accelerating their spending.

Got it. Thanks a lot. And then the trends that you've seen so far in May?

Well, we have no reason to believe so far, as what we've seen in May, that our guidance is not achievable. Otherwise we would not have guided. I think that's the best answer I can give you.

Okay. Thank you very much.

Our next question is from Walter Pritchard with Citigroup.

Hi, thanks. And thanks for doing the call this way. Two questions. Just first on, Kathy, you mentioned the financing program. Could you just walk us through, is there any difference in how we see sales through that program hit the financial statements? And maybe some sense as to how widespread the uptake was on the using that? And what you expect over time?

Sure, Walter. The Palo Alto Networks Financial Services arm that we've -- the entity that we created this quarter is designed to allow us to offer some financial flexibility to our customers for larger deals, particularly in this time, when so many of our customers have been financially impacted. The goal for us is to help smooth the deal process and accelerate the timing of deals, getting to closure, offering some assistance to our customers. And then of course, ultimately, hopefully improving our margins by getting into the deal economics early enough to understand when they need financing. And so we do hope that this will be a win-win for both our customers and for us. The entity is very small. We've done one deal. We're not expecting this to be a significant portion of our billings. It should in fact, be pretty immaterial. And therefore the entity itself will not be broken out. The results will be combined in total on the financials.

And then just on hiring. I think you talked about on the call that you did CloudGenix and you were slowing your hiring to some degree. And you've taken away the long-term guidance. So maybe it'd be helpful which is proven it seems. But it would be helpful to understand how you're thinking about spending through this environment. If we do see some incremental weakness on the topline, do you expect to continue to be cautious on the OpEx? Or do you think you'll spend through to just drive the investment you'd planned on before?

So Walter, let me take that one. We announced as soon as we got out of the gate of the pandemic that we're not going to have any COVID-related layoffs. Because it's very important for our employee base to feel secure and comfortable during these times, as people having to work from home. We have been pretty ahead of the curve in making sure we had enough resources to cover our base on revenue and support our sales team. There are ample resources, both in acquisition and in our hiring processes to make sure that our product teams have enough runway to go build products. I think, it's only been two months, as we power through the pandemic, as we start seeing signs of economic recovery, you will see us continue to ramp up hiring again. At this point in time, we've just been prudent, and we're hiring very, very critical roles, which we believe are needed to continue to keep momentum on our projects, both on the go-to-market side, as well as our product side. So we're not anticipating any impact of our slowing down of hiring in our ability to produce results. We're just being cautious in these times to make sure we align that with how the market unfolds. So yes. In terms of -- the other part is your expense question. Look, I think people haven't realized the expense categories that have shifted when nobody travels, you don't have any face-to-face conferences, you don't have people in the office, a lot of certain spending goes away. You have to shift that spend to provide capability for employees. So as we announced this morning, our FLEXWORK program, we increased allowance for employees to be able to make their homes more comfortable, so that they can actually work more effectively and productively from home. And there's a longer note, which is in our blog post, you can go and take a look at it. But we expect when we come back out of this pandemic, the way people work is going to change. We've introduced this concept called FLEXWORK, where people we think will in the long-term work partly from home and partly from the office, which will eventually require us to rethink our workplaces. I've seen other companies offer people to move out of the state, or the city. I've seen other companies say don't come back to work ever again. We don't think it's going to be as extreme, but we do believe there'll be a shift in the way we think about employees. We think about travel, we think about meetings, and that is going to create a different cost structure.

Great, thank you.

Our next question is from Sterling Auty with JP Morgan.

Thanks. Hi, guys. And I echo, I like this format a lot. So I guess my question is, you mentioned the next six to nine months are going to be a bumpy ride for cybersecurity. I'm just wondering how that's going to manifest itself in your product revenue versus the rest of the subscription revenue?

Sterling, I think it's fair to say we're all very focused on how our Q3 happened and how we plan our Q4. And we're all sort of digging deep to understand what this means over the following 12 months. We have visibility into Q4, we obviously have some visibility in Q1. As we progress through Q4, we haven't really put our heads down in terms of what this actually translates into, which we will talk about more, at the end of Q4. All I'm talking about the bumpy ride is the macroeconomic environment is not coming back as most people expect. And we were experimenting one day in the office and it feels weird, having to wear a mask as you walk around, having to rub my hands six times in an hour, and the softest hands I've ever had. And all these things are going to take time for us to adapt to as our employees. They're cautious about coming back to work. I think that's going to have ripple-through impact to our customers and our capabilities. The good news is I think the worst is over. I think now we're slowly building back to an economic recovery, which means our customers are more relaxed and are more interesting to see how they create these technological transformations that need to happen in their business. So I feel that that's going to happen. All I'm saying is it may not fall neatly into quarters like it used to fall neatly into quarters. That's kind of the only way -- takeaway from my comment.

That makes sense. And then one follow-up, how does SD-WAN demand get impacted positively or negatively from increased work from home?

I think it's going to be huge. But since Lee Klarich is here, and I feel like he has to answer the question, and this is a perfect question for me to give my friend Lee.

Thank you, Nikesh. Look, I think we're not only seeing greater work from home, but we're seeing greater work from remote locations, branch offices, even retail environments will come back. And as that happens, in conjunction with a accelerated shift of applications to the cloud, SD-WAN becomes increasingly important. So it will obviously play out overtime. But I believe that we're going to see an acceleration of these network transformation projects, as a result of the shift to cloud, as a result of working from home. And SD-WAN in a cloud deliver format will be central in that.

Great. Thank you.

Our next question is from Fatima Boolani with UBS.

Thank you, for taking the questions. I hope you guys are doing okay. I appreciate this format as well. Maybe just to start, as I think about the adoption levels in the portfolio of NGS solutions, that seems to be seeing a continued healthy take up. So I'm wondering, if you can kind of talk through the concept of ELAs or EAAs and to what extent this type of transaction structuring is becoming more frequent in your sales engagements? And then I have a follow-up for Kathy.

Yes. Fatima, thank you for the question. I don't think we've seen much, we've changed much in our EAA and ELA activity. I think what's primarily happened is that, we've seen a healthy balance between new logos and existing customers buying into some of these products. Like Prisma Cloud has opened up a whole new set of customers to us, who are more cloud centric, cloud transformation focused, maybe cloud-only companies. And getting to 1,500 customers in any business from a standing start or 18 to 24 months is amazing for us. We're very excited about the progress our sales teams have made on the Prisma Cloud side. Take Cortex XDR, it used to be a product called Traps. Again, getting to the top of the charts, great execution by our product and sales teams to get us to be leading contender against some of the industry leaders. So I think what's happened over the last 18 to 24 months, our concerted efforts around both go-to-market, as well as product have led us to really target the market focus on acquiring customers. We've established these speed boats two years ago or 18 months ago when I came in, and the whole purpose was to go accelerate and not get bogged down by a lot of cross collaborative efforts, until we establish clear propositions, clear leadership. So probably in the next phase, we'll worry more about putting stuff together. Having said that, there are some cases customers who bought everything from us, as the retailer we mentioned has over time and established our platform across every category within their infrastructure, because they believe the integration across our platforms and products is key. So, I’d say this is less driven by EAA ELA activities, more driven by product excellence and go-to-market excellence in those categories. And as time evolves, as we get more robust and as we start cross-selling more and more into our existing customer base, hopefully that becomes an accelerator for EAAs and ELAs in the future.

That makes sense. I appreciate that. And Kathy for you, just with the conversation around FLEXWORK and potentially some structural changes with respect to the 8,000 employees at Palo Alto and how they work. Can you talk a little bit about the implications for CapEx here? I mean, there's been a huge effort to build out the headquarter footprint. So to what extent does that change or is reevaluated? And that's it for me. Thank you.

Hi. Fatima, thanks for the question. Yes, obviously the CapEx investments that we've made around headquarters were made in a pre-COVID environment, and we're going to have to wait and see how long this work from home phenomenon lasts, and to the extent with which our employees choose to work from home. We made a land purchase, which we talked about on the call. And that purchase, we've not yet started to develop. However, our plans were to start developing that somewhat quickly. In this current environment that will probably be pushed out a bit, but ultimately the land here is very valuable. The real estate here is very tight typically. And so we still think that that's going to present us with a good opportunity in the future.

Sounds good. Thank you. And nice to see you guys.

Our next question is from Brian Essex with Goldman Sachs.

Hi, thank you. Good afternoon, and thank you for taking the question. I guess, Nikesh I want to dig into product revenue if I could. Maybe could you give us a little bit of color in terms of how much visibility you had into improvement of sales force productivity, given the adjustment and incentives that you had? And maybe how much was from expansion with existing customers versus new logo wins? And how durable do you think the growth there will be?

Thanks Brian. Thanks for the question. As you know, the conversation last quarter was around our product revenues. And we had offered our insight that we had seen a slowing down of customer evaluation, across evals and POCs and there was a discussion on execution of our sales team. And we're in the high-single negative digits in product growth last quarter. So, our teams really rallied. Our team is really focused on the product issue, built tremendous execution. So I'm very proud of what they've been able to achieve going into Q3, especially as you see people having to work from home, get deals done from home, customers are at home, getting through their purchasing departments and being able to target a number and meet and beat the number is nontrivial in such environment. Not to mention, the incredible amount of supply chain effort it takes. I know many companies have slipped on supply chain this quarter. And our supply chain team did a phenomenal job working with our sales and go-to-market team. So I think the execution has been spectacular. I do believe there's probably a few 100 basis points off tailwind as Keith asked in the beginning from that. So maybe without COVID we'd been one or two percentage points lower. But there are some companies in our industry whose entire growth is that number in the COVID environment. So I think the teams did a great job. And don't forget, the reason I actually, I understand product is important because it's instant gratification. It flows through revenue and EPS. But going back, firewall as a platform, 13% growth, industry growing to 6% to 8%. We once again started taking share from people, because remember, I can sell a firewall with GlobalProtect to a customer, or I can sell Prisma Access delivered to the cloud. Now the beauty is PrismaAccess, the customer calls and says, I want to go from 25,000 to 80,000 remote secure workers now. I don't have to do anything. I just have to increase capacity, reconfigure things from remotely and allow them the capacity. On firewalls, I got to ship a firewall, I got to deploy the firewall, they’re going to enhance their subscription. So it's a lot higher friction in physical box firewall sales to remote secure access than it is to provide a cloud delivered firewall to our customer. So whilst I understand it's very important for financial modeling, how much revenue and cash flow Palo Alto drops in the same year from firewall, my team and I really look at the firewall as a platform number and watching that get back to double digit, high industry growth is more gratifying than just seeing the product number go up. So once again, kudos to the team out there. I am just delighted the way they stepped up with the challenge.

Great. Thank you for that. And maybe, Kathy to follow-up. Thank you, for ARR commentary, by the way that's very helpful. Maybe if I could ask, I get a lot of questions from investors around how to think about balancing the core appliance based business with a growth in next-gen. How should we think about how you manage those two businesses? One is the installed base and the core business still growing. It's generating obviously a lot of cash flow, we can see that in maintenance revenue. And then two, is next-gen generating cash flow or profitability? Is one funding the other? Is it self-funding? If we kind of split those businesses and think about those in a strategy to grow and leverage your installed base and cash flow to grow those businesses, what's the best way to frame that out?

Yes, it's a good question, Brian. And obviously, we're very focused on driving the newer products in our portfolio. Lots of times you see companies who make acquisitions or try to develop internally, and you just don't ever see the kind of momentum that you saw with their original core product. And so, we're really pleased. And Nikesh has done a great job building out these speedboats and driving the discipline and focus around allowing us to build out those businesses, so that they can be successful. Initially, they take investment, like all new businesses. And so it is kind of a company now with a multi-product strategy. We have a core product that's been very successful for us that we continue to innovate in. And we're adding new subscriptions. You've seen us add recently three, fourth to come soon, and still more to follow. So we're still investing in the core. We're still releasing a lot of new great technology there. But additionally, as Nikesh mentioned, we have lots of different options now for firewalls we have. The cloud delivered firewall, we have cloud version of the firewall, a software version of the firewall. So we can serve a much different breadth of product offerings to our customers today. And so really, you're just going to have to think about the lifecycle of the different stages of growth that our portfolio is in, which is why we've separated out next-gen security to give you some markers and show you that we are making progress in this group as a whole, that is our newest set of offerings, that granted is less mature, therefore the margin profile is not as strong. But overtime, we're definitely committed to profitability and improving overall operating margin performance, as we've said in the past.

Fair enough. Thank you.

And with consideration for time, our final question is from Jonathan Ho with William Blair.

Hi. Can you hear me okay?

Yes, we can hear you.

Fantastic. Can you talk a little bit about maybe what you're seeing with the trends around SASE and firewall as a service, and maybe the trajectory that you're seeing in terms of a shift away from the more traditional infrastructures over and the cloud?

Yes. Jonathan, thank you for the question. And as Lee mentioned, we are seeing customers evaluate the remote secure access posture even more aggressively now, of course, because of COVID. I think that's been an accelerator. I think people want capacity for all their employees to be able to do this remotely. Given the choice of adding more hardware into their datacenters and infrastructure they prefer the software solution. We can offer both. We see a predilection for people to go after the software use case more than the hardware use case. Unless you already have a lot of quality firewalls in there. I think as we see the cloud transformation accelerate, people will realize that they don't need to bring all the traffic back to the datacenter incur MPLS costs. So that will drive more and more of SD-WAN use case. And I think if you look at what's happened in the last even six months, Gartner coined the term, if you go search for SASE on Google, favorite search engine, you'll find every vendor now has converted their offering to SASE. Now SASE requires you to have SD-WAN capability and security capability in one UI, one cloud managed capability. So we think this is the new trend. We think this trend is going to be around for the next few years, as customers kind of rearchitect their network infrastructures. So we think there's going to be solid tailwind in that category. In terms of trajectory it really depends on customer's ability to execute in this environment whether or not in the office.

That concludes the Q&A portion of our call. Thank you for all your questions. I'm going to turn it back to Nikesh for closing remarks.

As I close, I actually want to thank every one of you for joining us today. And thank you, everyone for your encouraging comments to do this again in a Zoom format. Although, Kathy and I had a big debate about this and somehow we feel we have radio voices as opposed to video voices. So we'll figure it out. But sorry, jokes apart, thank you again for joining us. I do once again want to call out our employees across the company, across different functions, our sales teams for working on the execution to get us out of the challenges we had in the past quarter, our supply chain teams, our product teams, our go-to-market teams, our IT teams. There's not a single person at Palo Alto Networks, who has not put their heart and soul over the last few months in really getting us through this quarter, while we settle into new normal. So I want to say thank you from the bottom of my heart. My heart also goes out for the people who are impacted by the pandemic. And I hope they stay safe and healthy. I want to thank our customers, our partners, everyone around the world. So I think the hard work and dedication that I see in these times gives me hope that we will all come out stronger from this pandemic. And I look forward to seeing you guys in the next earnings call. Thank you.

This concludes the Palo Alto Networks earnings call. Thank you.