Palo Alto Networks, Inc. (PANW) Q1 2019 Earnings Conference Call Transcript

Palo Alto Networks, Inc. (PANW 0.11%)
Q1 2019 Earnings Conference Call
Nov. 29, 2018, 4:30 p.m. ET

Contents:

• Prepared Remarks
• Questions and Answers
• Call Participants

Prepared Remarks:

Operator

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

Amber Ossman -- Director of Investor Relations

Good afternoon and thank you for joining us on today's conference call to discuss Palo Alto Networks' fiscal first quarter 2019 financial results. This call is being broadcast live over the web and can be accessed on the investors section of our website at investors.paloaltonetworks.com. With me on today's call are Nikesh Arora, our Chairman and Chief Executive Officer; Kathy Bonanno, our Chief Financial Officer; Lee Clarich, our Chief Product Officer, and Dave Peranich, our Executive Vice President Worldwide Sales.

This afternoon we issued a press release announcing our results for the fiscal first quarter ended October 31, 2018. If you would like a copy of the release, you can access it online on our website.

 

We would like to remind you that during the course of this conference call, management will make forward-looking statements, including statements regarding our financial guidance and modeling points for the fiscal second quarter 2019, our competitive position, and the demand and market opportunity for our products and subscriptions, benefits, and timing of new products, and subscription offerings.

These forward-looking statements involve a number of risks and uncertainties, some of which are beyond our control, which could cause actual results to differ materially from those anticipated by these statements. These forward-looking statements apply as of today and you should not rely on them as representing our views in the future. We undertake no obligation to update these statements after this call. For a more detailed description of factors that could cause actual results to differ, please refer to our annual report on Form 10-K filed with the SEC on September 13, 2018, and our earnings release posted a few moments ago on our website and filed with the SEC on Form 8-K.

Also, please note that certain financial measures used on this call are expressed on a non-GAAP basis and have been adjusted to exclude certain charges. For historical periods, we provide the reconciliations of these non-GAAP financial measures to GAAP financial measures in the supplemental financial information that can be found in the investors section of our website, located at investors.paloaltonetworks.com.

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

Lastly, once we have completed our formal remarks, we will be posting them to our investor relations website under quarterly results. With that, I'll now turn the call over to Nikesh.

Nikesh Arora -- Chairman and Chief Executive Officer

Thank you, Amber. Hello, everyone, and thank you for joining us this afternoon for our fiscal first quarter 2019 results. As you know, it's been a busy few months for me at Palo Alto Networks and I am delighted to report that we had another outstanding quarter. And once again, we have been able to grow our top line significantly faster than the market.

I'm also happy to say that my cybersecurity education is progressing nicely as I continue to meet more customers, partners, and employees. During this quarter we held our first ever European Ignite, our user event, in Amsterdam, and our second annual Federal Ignite event in Washington DC. At these events for our customers and partners, we consistently heard from multinationals to governments all the challenges that are associated with protecting data in a digital world. Mobility, the movement of data in the cloud, data analytics, and machine learning are some of the trends that we believe are forcing companies to reevaluate their security posture in a more comprehensive manner, looking for high levels of integration and automation.

In this way, we believe we are uniquely positioned to support our customers across all these three events: 1) securing their enterprise, 2) enabling them on their journey to the cloud, and 3) helping them with their desire to deploy advanced AIML across their enterprise. So, let's discuss some current examples of how we're solving customer problems and what we have in store.

Service provider is a segment where we have traditionally not done as well as we would like. We're about to change that. We're excited to announce a new product for our service provider partners, and any of you planning to focus on and invest in for future growth. Our service partner providers are facing a major mobile infrastructure transition from 4G to 5G. We want to be there with them to help them succeed.

We're announcing a new super-scale next-generation firewall, the K2-Series, that has been developed specifically for service providers with their high super needs, taking into account the price considerations and upcoming 5G and IoT transitions. We expect it will be available shortly in early 2019.

In a segment where we have done well, the federal space, WildFire, our cloud, delivered malware analysis service, achieved groundbreaking status during fiscal Q1. This extends our ability to provide advanced threat prevention analysis capabilities to US Federal agencies.

For our largest customers, we introduced Federal Interconnect. The new federal plugin gives customers the ability to manage configurations of over 30,000 next-generation firewalls from a single driver on the console, and they can push configuration changes to all managed devices from one single location. This continues our quest to simplify a large-scale security management for our customers.

And offering cloud security, we close our RedLock acquisition this quarter. RedLock adds to our already extensive set of cloud security offerings, which include Evident, Aperture, GlobalProtect Cloud Services, and VM-Series. By combining the Evident and RedLock technologies, we will provide customers with cloud visibility and compliance, cloud security analytics, and advanced threat detection in a single offering to be released very early next year. The offering will help security deal better understand their cloud deployment, detect and respond faster to the most critical events, and achieve automated remediation.

I don't think there's a lot of discussion around our philosophy and my philosophy on M&A, so I'd like to use the subject of RedLock to refine our point on the M&A philosophy. The technology required is best in class. We have a clear opportunity to be a leader in this space, and we believe that we can significantly enhance the value of the asset we acquired. We invested a product-focused team in technology that we believe we can integrate quickly and effectively into our infrastructure.

I want to reiterate that, as a shareholder and an investor, my interests are aligned with yours to create long-term shareholder value. So, to give you some guidance, any activities in the area of M&A are gonna be disciplined, they're gonna be guided by our aspiration to 1) participate in a large market, 2) become number 1 or number 2 in that market, and 3) bring the past execution capability of Palo Alto Networks to any acquisition, so that we can instantly enhance value.

Moving forward, we will continue to stay strong in network security, adding capabilities to solve our customer problems. Additionally, we will lean forward into the trans-up cloud, machine learning, and AI in a big way. These important technologies build our vision of simplifying security and providing a platform with consistent protection across an (inaudible) environment is resonating with customers.

The application framework in XDR are the next step in our evolution toward this goal. We're making good progress under the leadership of our founder Nir Zuk, and while we're still in the early days during Q1, seven partners launched applications of framework. The technology these partners bring to the framework include analytics, MSSP, identity, (inaudible) Intelligence, security for industrial control systems, IoT, and network access control.

Before I move on, I'd like to add a little bit more color of my first 180 days. As we all know, execution has been a key variable in our success as a company and will continue to be so in the future. During the last earnings call, I mentioned launching speedboats with focused leadership accountable for results in our more nascent market opportunity. Once we have a great execution machine, we want to make sure our speedboats give us the flexibility to operate and execute effectively in some of the newer areas.

Our first speedboat in cloud security has been launched and is off to a good start. We have product and sales leaders driving our cost performance, and we expect this focus will allow us to execute as well in new areas as we have done historically. We'll likely launch additional speedboats in the future and we'll keep you posted on our progress. We have an excellent global market engine that is running well. And with our new president, Amit Singh, we have a leader in place who brings extensive experience bringing enterprise and cloud businesses and driving revenue skill.

Amit joined us on November 1st and has been extremely busy in his first few weeks on the job. He's finished over 58 (inaudible) reviews, met as many customers already this quarter to both share our commitment to them and learn from our customers on how we can best partner with them. He's running hard and I'm excited that we found such a capable leader to fill this important role. He joins a great team, and together they will remain focused on executing the (inaudible) significant market opportunity and momentum across the platform.

In our fiscal Q1, the team lived up to their reputation as we once again acquired new customers at a rapid rate and expanded our world share with existing customers. Our top 25 customers each spend a minimum of $33.6 million in lifetime value, which is a 45% increase over the $23.2 million they did in Q1 of fiscal '18.

Examples of customer wins and competitor displacements in fiscal Q1 that demonstrate the progress we are making across the network endpoint and cloud are: we landed the top 3 airlines in the U.S. to secure their data centers, we also replaced a competitor in the data center and sold all of our job subscriptions at a U.S. based investment management company, our cloud firewalls VM-Series were selected as a security standard for one of the world's largest network and telecom companies in the world. Our cloud monitoring compliance offering Evident was selected to secure the public cloud infrastructure on one of the world's largest banks based in Europe. GlobalProtect Cloud Service was selected to secure more factories, offices, and stores of one of the world's leading manufacturers and marketers of quality skincare, makeup, fragrance, and haircare products -- no points for guessing who that is. And our advanced endpoint prediction offering Traps was selected to protect 10,000 devices at a leading healthcare provider in Australia.

Throughout all the news in the quarter, we were happy to be positioned as a leader for the seventh consecutive year in Gartners' 2018 Magic Quadrant for enterprise network firewalls. This positioning reflects our commitment to staying ahead of the tech landscape and providing our customers the best protection against the ever-evolving threat of cyber-attacks. I personally am extremely excited about the opportunity ahead of us and plan to keep my head down and continue to execute with our leadership team.

I'd like to thank our customers and our partners for their support and, of course, the team at Palo Alto Networks for their dedication to our mission. I've really enjoyed becoming more established at Palo Alto Networks and learning about cyber-security and working with this great team. I wake up every day excited to be part of this great company.

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

Kathy Bonanno -- Chief Financial Officer

Thank you, Nikesh. Before I start, I'd like to note that except for revenue and billing, all financial figures are non-GAAP, and growth rates are compared to the prior year period unless stated otherwise. Our current and prior period financials discussed are reflected under ASC 606 as we adopted the new standard as of August 1, 2018.

As Nikesh indicated, we had a great start to our fiscal year. We continued to see healthy security spending and strong demand across our platform. In the first quarter, total revenue grew 31% to $656 million. By geography, Q1 revenue grew 29% in the Americas, 35% in EMEA, and 35% in APAC. Q1 product revenue of $240.5 million grew 30% compared to the prior year. Q1 SaaS-based subscription revenue of $231.3 million increased 37%. Support revenue of $184.2 million increased 24%. In total, subscription and support revenue of $415.5 million increased 31% year-over-year and accounted for 63% of total revenue.

Q1 total billings of $758.5 million increased 27% year-over-year. The dollar-weighted contract duration for new subscription and support billings in the quarter was approximately 3 years, consistent with what we have seen in prior periods. Total deferred revenue at the end of Q1 was $2.4 billion, an increase of 34%. Q1 gross margin was 76.7%, relatively flat to last year. Q1 operating expenses were $366.5 million or 55.9% of revenue, which represents a 140 basis point improvement year-over-year. Q1 operating margin was 20.8%, an increase of 150 basis points year-over-year. We ended the first quarter with 5,645 employees.

Non-GAAP net income for the first quarter grew 64% to $115.4 million or $1.17 per diluted share. On a GAAP basis for the first quarter, net loss declined 39% to $38.3 million or $0.41 per basic and diluted share.

Turning to cash flow and balance sheet items, we finished October with cash, cash equivalents, and investments of $3.8 billion. Q1 cash flow from operations of $252.3 million declined by 8%. Free cash flow for the quarter was $218 million. During the quarter, we redeemed $327 million of the $575 million 2019 convert. Per GAAP accounting, $52.3 million of the amount redeemed is categorized as cash flow from operations. Adjusting for this and other cash charges, free cash flow in the quarter was $275.4 million, up 27% at a margin of 42%. Capital expenditures during the quarter were $34.3 million. CSO was 58 days, a decline of 12 days from the prior year period.

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

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

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

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

Questions and Answers:

Operator

Thank you. At this time, we'd like to open the floor for questions. If you would like to ask a question, please press the * key followed by the 1 key on your touchtone phone now. Questions will be taken in the order they are received. If at any time you'd like to remove yourself from the questioning queue please press *2, and please limit yourself to one question and one follow-up question. Again, that is *1 to ask a question. It looks like our first question will come from Ken Talanian with Evercore ISI.

Ken Talanian -- Evercore ISI -- Analyst

Hi, thanks for taking the question. So, first off, could you give us a sense for what, if any changes, you've made to your go-to-market efforts on the firewall side? And I'm thinking of that inclusive of the channel.

Nikesh Arora -- Chairman and Chief Executive Officer

Thank, Ken. Thanks for your question. We haven't made any particularly major changes to our go-to-market on the firewall side that I can think of, including the channel. I think the efforts continue to be the same. Dave is there anything you...

Dave Peranich -- Executive Vice President Worldwide Sales

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

Ken Talanian -- Evercore ISI -- Analyst

Okay, and the second question -- could you give us an update on your traction with GlobalProtect Cloud and how you'd characterize your win rates there?

Nikesh Arora -- Chairman and Chief Executive Officer

On the GlobalProtect Cloud front, we think we have a unique opportunity as we see people trying to go ahead and automate and put security and come up with a new architecture for their remote branches and for their remote offices. We can give you suggestions and unique products which does really well. We've had some good success with some very large players. We'll share more about the success in our next quarterly call, but for now, again, it's an interesting product. It's unique in the way Palo Alto existing customers and Palo Alto networks be able to extend their network security, which they already have in the data centers, out to their remote branches without having to change the management control systems, etc. So, really exciting. We're seeing a lot of traction and hopefully, we'll tell you more about it next quarter.

Ken Talanian -- Evercore ISI -- Analyst

Great. Thanks very much.

Operator

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

Matt Hedberg -- RBC Capital Markets -- Analyst

Hey, guys. Congrats on the quarter. Nikesh, in your prepared remarks you talked about an increased focus on the service provider segment, which is great to hear. Sounds like there's a new product early next year and there's obviously a lot of drivers here. You mentioned a couple of them, including 5G. I guess I'm wondering, can you give us a little bit more detail on how this new product portfolio might accelerate the momentum there? And then, is there anything else from a go-to-market perspective that needs to be also augmented?

Nikesh Arora -- Chairman and Chief Executive Officer

Matt, thanks for your question. Let me give you a very high-level point of view and then I'll have Lee jump in and give you some more insight into why we believe this product meets the needs for the future for our service provider customers. It's a segment when I came here, we realized we haven't done as well as we'd like to do, and there's structural reasons for it. There's reasons on the service provider side for it. But that's not enough of an answer, so we sat down and looked at what we should be doing and what we can do, and the product team really rallied hard the last 6 months to be able to put this together because we believed we already had the industry-leading firewall from a security and networking perspective. We just needed to make sure we were emphasizing some of the features that the service providers need in the future.

So, from that perspective, I think the team has done a phenomenal job in getting us ready. And remember, the sales cycles for service providers are long, so you're not going to be hearing us blow the top from a sales perspective in 3 months, but this is a prerequisite for us to be strong in that sector. We have a very dedicated go-to-market team in the SP space. That's one of our few spaces where we have a dedicated team around the world, and they're very excited about this new product. Now, I'll let Lee jump in and talk about why this product is relevant for a 5G IoT and a next-generation perspective for the service providers.

Lee Clarich -- Chief Product Officer

Yeah, thanks, Nikesh. When we look at what's happening in the transition from 4G to 5G there's some really significant changes that are taking place. The first is just the advent of IoT becoming really high-scale on mobile networks with the capabilities that 5G offers. Second is, a lot of that is going to be high-value IoT. It's going to be medical device use cases, it's going to be connected cars, it's going to be things that are really important. And the third is, more and more applications are moving into these mobile environments. And so, when we think about that, you can just imagine the need for the best security all of a sudden becomes a critical driver for this change from 4G to 5G. And so, our timing of bringing out the (inaudible) Series is aligned with this big shift in the SP space for this move to 5G.

Matt Hedberg -- RBC Capital Markets -- Analyst

That's great. Maybe one other for Lee on the product side, obviously. RedLock seems like a great acquisition -- really complementary to everything you've done. I think, specifically, from what I can tell from Evident Io, maybe a bit more color there? I guess it shares sort of -- it's an API framework. So, it looks like it's gonna mean a nice integration, but maybe just a little more detail on how that sort of supplements what you guys have done there, including continuing to build out that side of the business.

Nikesh Arora -- Chairman and Chief Executive Officer

I think, Matt, that's a great question. And I think as I walked around and talked to a lot of customers it was evident that -- no pun intended -- every one of our customers was undergoing some sort of journey toward the cloud. And in different shapes or forms -- some people have a public cloud, for instance, some people are analyzing it, some people are trying to decide. And many of them talk of a hybrid environment or a multi-cloud environment because none of them is quite yet sure where they want to land in the long-term.

And as we went around and understood that journey, we understood that they need a multi-cloud security platform that allows them to guide a security posture from their existing data centers and the existing infrastructure into the cloud. And as we looked at that, we thought we had a product in that space called Evident, which was leading in its own way, in its own category. But we looked to the market and saw RedLock also was nipping at our heels. It was also sort of doing really well in adjacent parts of the same market, and so a good offering would be the integration of the two. And to the credit of our Evident-RedLock team, they will integrate in the next month and be able to have an integrated product on the market by the first week of January, which I think is phenomenal given the pace of that market and given the opportunity in that market. We believe this is the only product of its kind in this space, but Lee, I'll let you talk more about it.

Lee Clarich -- Chief Product Officer

Yeah, absolutely. So, one of the things we've seen when we talk to our customers and their journey to the cloud is 1) they're all going through this journey, but 2) they almost 100% don't fully understand everything that they have in the cloud already. And so, the combination of Evident and RedLock really gives us a great window into -- and our customers a window into everything they have. So, visibility, active inventory. Based on that it then gives them the next step, which is how to provide security analytics for that, ultimately detect threats and respond to those threats.

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

Matt Hedberg -- RBC Capital Markets -- Analyst

Super helpful. Thanks, guys.

Operator

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

Andrew Nowinski -- Piper Jaffray -- Analyst

Great, thank you, and congrats on a nice quarter. You announced a new service provider product today and that's only a market that you should be in, and you've also refreshed your low-end and mid-range firewalls. So, I'm wondering, when can we expect a refresh of the large enterprise 7000-Series?

Nikesh Arora -- Chairman and Chief Executive Officer

I'm gonna let Dave answer that question.

Dave Peranich -- Executive Vice President Worldwide Sales

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

Andrew Nowinski -- Piper Jaffray -- Analyst

Okay, fair enough. And then a question for Kathy. In talking to your sales team or your channel partners, do you feel like the enterprise buying cycle is perhaps more back-end loaded this year than it was last year as it relates to the calendar year-end enterprise budget slush?

Kathy Bonanno -- Chief Financial Officer

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

Andrew Nowinski -- Piper Jaffray -- Analyst

So, normal seasonality you're expecting this quarter?

Kathy Bonanno -- Chief Financial Officer

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

Andrew Nowinski -- Piper Jaffray -- Analyst

Okay, very good. Thank you.

Kathy Bonanno -- Chief Financial Officer

Thank you.

Operator

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

Tom -- Morgan Stanley -- Analyst

Hi. This is Tom (inaudible) for Keith Weiss. Thank you for taking my question. I wanted to just dig into just the security demand environment more broadly heading into 2019. It seems like we've had this strong refresh activity in previous quarters, where do you think we are in terms of this opportunity. Are we early innings still? Or middle innings? Just wanted to get your thoughts on that.

Kathy Bonanno -- Chief Financial Officer

Yeah, in terms of refresh opportunity, we've talked about the fact that it's an important variable for us as our cohort size increases every year over our history. It becomes a bigger and bigger opportunity for us as time goes on. While it's an important variable, it's not the most important of our growth as you see we continue to add customers at a very high clip every quarter, and our expansion opportunity within our existing customer base is quite significant. So, relative to the numbers in our customer cohort of 5 or 6 years ago, just the opportunity within our existing install base and the new customers that we're adding are really the primary driver of our growth.

Tom -- Morgan Stanley -- Analyst

Got it. And just a follow-up question on that. So, it seems like the RedLock acquisition was a pretty good one for you. I've gotten some good feedback from the partner channel that we've talked to on that product. What other functionality gaps do you see from a cloud security standpoint that you still have to fill? And do you think these could be addressed organically? Or are you looking at all options?

Lee Clarich -- Chief Product Officer

Yeah, look, public cloud security is obviously very important and we're putting a lot of our weight behind that with VM-Series, which continues to do very well for inline security. With Evident-RedLock combination, which we believe is the leading solution for API-based security in public cloud, and with some of the enhancements we made to Traps over the last many months to include support for Linux, which is obviously the predominant operating system behind applications that run in the public cloud.

And so, that combination of inline security, API-based security, and host security, we believe is the right approach and we feel very good about being in a position where we have leading solutions in all 3 of those.

Tom -- Morgan Stanley -- Analyst

Thank you.

Operator

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

Eric -- Raymond James -- Analyst

Hi guys, this is Eric for Michael. Nikesh, you indicated several times that Palo Alto would be focused on utilizing security data. So, does this mean that you want to enter the SIM market? And with the automation aspect -- what we call now the SOR market? How should we think about that?

Nikesh Arora -- Chairman and Chief Executive Officer

Look, we have some very exciting products coming up early next year in XDR which allows you to do some bigger investigation and some bigger remediation. We are looking carefully at what it entails. Our application framework will allow for SIMs and SORs to run on top of it, so we believe that we will be able to provide a comprehensive solution to our end customers as long as we can deploy our firewalls and our endpoint agents more ubiquitously across the entire base.

Eric -- Raymond James -- Analyst

Got it. So, I mean, just to kind of piggyback on that -- so, without a major investment, whether organically or inorganically, can you develop the intellectual capital and the culture around analytics and data science if you decide to go that way? Need it to kind of become a data-focused company? Or...

Lee Clarich -- Chief Product Officer

Well, we have a significant effort around analytics with our product Magnifier, which does a bunch of behavioral analytics which fits in all of the application framework. We have embedded ML people in almost every one of our product teams, albeit small. But our intention is to keep beefing that up because we believe -- you know, machine learning is not just about taking a lot of data and trying to train it. Machine learning is about taking every product of yours, understanding the data that it gives you, understanding how you use that data to be able to create a better product to start with, and then leverage the ubiquity of that product to improve the outcome for every customer.

So, we're embedding ML people across the board across the company. We also have analytics apps on our black form, and as we see the deployment of the application framework, as we see the users' behaviors of customers, we'll decide which areas we need to put more work behind.

Eric -- Raymond James -- Analyst

That's helpful. Thank you.

Operator

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

Sterling Auty -- JP Morgan -- Analyst

Yeah, thanks. Hi, guys. Kathy, you mentioned, I think, $0.01 to $0.02 impact in terms of Chinese tariffs. I had some discussion with (inaudible) and had some question as to if we see something go further in terms of the trade war, is there any concern about supply of product coming out of China? And do you have alternative sourcing, if necessary?

Kathy Bonanno -- Chief Financial Officer

Yeah, you know, it's important for us to remind everyone that we do manufacture our products in the U.S. There are some components that we source that are only available in China and we are looking at a number of options in terms of being able to mitigate the impact of tariffs or ensure that we have dual source opportunities. And so, our supply chain management is always very aggressive in terms of ensuring that we have a number of options available to us, and we're doing the same in the current environment.

Sterling Auty -- JP Morgan -- Analyst

All right, great. And then, just one follow-up just -- strategically, how should we think about the product subscription growth from here or subscriptions that are not attached to a physical appliance. So, whether that's a virtual firewall, etc., moving forward. How should we think of the growth dynamic there versus some of the physical product sales, as you talked about service provider and other strategies?

Kathy Bonanno -- Chief Financial Officer

Well, we've talked historically about the non-attached business being at a $274 million run rate as of Q4 of '18, growing at 68% year-over-year. And so, these are newer markets for us. We're seeing very nice growth in them, and Nikesh mentioned launching speedboats that we believe will help us to execute very well in these newer markets where we think we have great products. Particularly in the cloud base. We've talked about the Evident and RedLock combination, and so we're very excited about the opportunity there.

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

Sterling Auty -- JP Morgan -- Analyst

Got it. Thank you.

Operator

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

Saket Kalia -- Barclays Capital -- Analyst

Hi, guys. Thanks for taking my questions here. First, maybe for you, Nikesh, you know you talked about some of the early partners on application framework. Can't you zoom out a little bit and can we talk about how customers are using logging service, and maybe some of the next couple milestones that you look forward to that can help drive the app framework opportunity.

Nikesh Arora -- Chairman and Chief Executive Officer

Look, I think part of the app framework piece has always been of trying to collect the data once and use it many times across multiple applications, because today every cybersecurity solution that the customer sees requires some degree of intrusive probes into their infrastructure, whether it's the network or the endpoint or even their cloud security, in some cases. So, the notion is let's collect all the data once and then use it multiple times for multiple apps. Towards that end, for example, our Traps product is probably going to collect close to a hundred megabytes of data per user per month, which I think is probably 15 or 20 times higher than any other endpoint product in the market. So, that's what allows the customers to be able to collect the data once and we can deploy multiple applications against it. That's how we're going to be able to deploy XDR for them.

And there's no reason why these customers need to have that data collection happen multiple times. You know, some customers are running 6 to 8 endpoints at the same time because each endpoint is taking a sliver of data for the deployment life cycle of that endpoint is anywhere from 3 months to 12 months, depending on the complexity of the customer and the locations of their employee base. So, in that context, we're seeing good progress when we deploy (inaudible) with Traps, or people use Traps management services on the cloud to be able to manage their endpoints and other enterprise. We're probably going to be able to leverage the same thing without an incremental sort of endpoint deployment for the same customer with XDR. We can just offer that as a service, a (inaudible) service.

Similarly, there are products like Magnifier but use similar data to be able to deploy the application on top of data collected from firewalls and reach our endpoints. So, we're seeing the evolution of the application framework as an integration point across multiple solutions. We're starting with our own first. We want to make sure that our stuff works so there's proof in the pudding. And for me, the key milestones are, can we get multiple Palo Alto network apps to be useful without deploying multiple sensors into the customer's infrastructure, and be able to turn them on extremely rapidly because the speed of deployment is a key component in the future for cybersecurity.

So, as long as we believe we're headed down that track, I'm excited. As long as we can see other partners come in and say, oh this is interesting. We like the fact that you have all this data. We don't have to go deploy multiple sensors across our customer base or your customer base. We can just sit and talk with this data. As long as there's an economic model which allows them to utilize that data and there's customer consent, we're fine letting them use.

Saket Kalia -- Barclays Capital -- Analyst

That makes a ton of sense. Thanks for that. Maybe for my follow-up for you, Kathy. Just a quick housekeeping question. Was there anything to note on the other income line this quarter and last. Feels just a little bit higher than what we've seen historically. Just wondering if you could talk about some drivers there.

Kathy Bonanno -- Chief Financial Officer

Well, you know, there are probably a couple of drivers. Number 1, interest rates have been increasing and then, Number 2, we have a higher cash balance given the convert that we recently did.

Saket Kalia -- Barclays Capital -- Analyst

Okay, got it. But no other sort of one-time investment gains or anything like that?

Kathy Bonanno -- Chief Financial Officer

Nope. Nothing like that.

Saket Kalia -- Barclays Capital -- Analyst

Got it. Thank you.

Kathy Bonanno -- Chief Financial Officer

You're welcome.

Operator

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

Gregg Moskowitz -- Cowen and Company -- Analyst

Okay, thank you very much. First question is for Nikesh or Lee. How did Traps do this quarter? And can you perhaps provide an update on the integration of Secdo as part of your XDR approach?

Lee Clarich -- Chief Product Officer

Yep. Traps continues to do well. We added a lot. We added a lot of new customers, of course. You know, as Nikesh mentioned, the new Traps Manager Service, which is a cloud-based service, the majority of these new customers are deploying using that service, which is great because that ties into logging service and the application framework and sets us up for some of the futures around things like XDR. And so, on that topic, we continue to make good progress on the integration of Secdo. As we've told you before, we believe that EDR is not sufficient, so the idea of doing detection response based on single data source is not enough.

We think that the endpoint data needs to be combined with network and cloud data as well, and so we are actively working on that. We have some of the endpoint data, we're getting more. We have network data. We have cloud data. And then, in parallel to that, we're making good product on the XDR application and we're getting on top of that and use that data. And we're on track for early calendar 2019 to have that available.

Gregg Moskowitz -- Cowen and Company -- Analyst

Okay, that's very helpful, thankfully. And then just for Kathy, as you noted, your operating margins were up about 150 basis points year-over-year and see it seems that you're absorbing the incremental costs from Evident, Io, and Secdo quite well. And I know, of course, that you're not providing fiscal '19 guidance, I'm just wondering, though, if there are any unusually high investments that you're targeting at this time over the balance of the year. Whether it be the K2 launch or anything else.

Kathy Bonanno -- Chief Financial Officer

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

Gregg Moskowitz -- Cowen and Company -- Analyst

Okay. Thank you very much.

Operator

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

Jonathan Ho -- William Blair & Co. -- Analyst

Hi, can you hear me? Fantastic, so just wanted to start out with the reference that you made to the speedboats. Can you maybe give us a sense of what this entails and maybe contrast that with your traditional approach?

Nikesh Arora -- Chairman and Chief Executive Officer

Yeah, look, what happens when you have very successful large teams selling a large amount of revenue and you start a new product initiative, typically some of those efforts get buried across a very large sort of team of functional organization. So, what we've done is we've taken all the people who are focused on some of our newer product areas, put them on the same floor rather than taking them across functions, and effectively created two leaders -- one on the product side, one on the go-to-market side. And they have carte blanche to move as fast as they'd like to move within certain guardrails. And this has really increased our agility and our speed, both in terms of deployment of product, but also decisions that they make on a customer-by-customer base and from a go-to-market perspective.

The early results are promising on our cloud security space. It has really helped us, for example, the cloud security team is run by Varun Badhwar, who we brought on-board as part of the RedLock acquisition. He's was the CEO there. He's very excited. He's very motivated to keep driving the product strategy. And Dean Darwin, who's a long-standing member of the Palo Alto Network's go-to-market and business team, they're both partnering really well.

Dean brings the capability to be able to deploy that product across our very large sales force. It gets globally distributed. Varun doesn't have to worry about that. Varun has to worry about continuing to build a market leading product and going in partnership with Dean and making sure that some of our best customers sign up for the product.

So, that's kind of like the model behind it. It's working really well so far for one of the product areas. We're working on carving out the next set of product areas, so we are almost onto our second. We'll be able to carve out a time that's going to focus on GPCS and Aperture and our second speedboat. And I'm really excited about being able to do that, which will be driven by Adam on our product side and running our CMO. So, just trying to create speed and agility on the speedboat front.

Jonathan Ho -- William Blair & Co. -- Analyst

Got it. That's helpful. Just wanted to also follow-up on some of the newer developments with AWS and maybe get your early thoughts in terms of what outposts and some of the newer impacts could have on the business.

Nikesh Arora -- Chairman and Chief Executive Officer

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

Now, as people are going to the cloud, they're realizing that, yes, the cloud is a fantastic platform. It gives you leniency, it allows you availability, allows you to scale globally very rapidly. But it's very hard to think about cybersecurity in that context, and there's a whole set of conversations that come up about my data integrity, how do I move my security posture from my existing platforms to the future? And that's where we think none of these cloud transitions are going to happen in a meaningful way unless customers are able to think about and secure transition.

So, our job is to make sure that we partner with our enterprise customers today and help them to journey as they make the cloud journey and transition. And there's a debate whether people are going to use the AWS native security or GCP native security or is there's room for somebody like us? That answer is yes, there is because there is no -- there is very few -- no is never a good answer. But there's very few dedicated single-cloud only customers out there. Most customers are either hybrid customers. Most customers are multi-cloud customers, in which case you need an independent cloud security partner who can help you cross this myriad of platforms because it's very hard for one native platform provider to produce a multi-cloud hybrid and public cloud environment securely.

So, we believe that it behooves both us and AWS and GCP and Azure to partner in this journey because it's beneficial for them and beneficial for us. And honestly, security's at 2% or 2.5% spend across a cloud transition. Maybe 3. So, they're not going to go try and compete with us in that 3% to 4% span. I know I went from 2.5 to 4 but it depends on the customer. I'd like it to be more, but it depends on the customer. So, we think there is enough room for a partnership in this space.

Jonathan Ho -- William Blair & Co. -- Analyst

Fantastic. Thank you.

Operator

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

Patrick Colville -- Arete Research -- Analyst

Thanks for taking my question. Can I ask about this core next-generation firewall? What continues to differentiate you guys -- because you guys are crushing it and doing a great job. And from your perspective, what continues to differentiate Palo Alto versus the competition to produce these results?

Nikesh Arora -- Chairman and Chief Executive Officer

Look, in my 6 months that I've spent talking to customers and traveling around the world trying to understand both, you know, why are customers buying us and what's differentiated in our product? I have to say, at least the feedback I get from our customers is that there is a very clear differentiation around security. Palo Alto Network's firewalls were built with security first in mind and that's why -- you know, you heard us launch the service provider K2-Series just now because they balance both the need to service providers as well as the high-security requirements for 5G and IoT.

So, we are a security first set of firewalls and that resonates with a lot of our customers, and it's kind of the right time in the journey because early cloud migrations, early data center migrations were a lot about moving data there. Now it's a lot about opening up the internet. The moment people start opening up ingresses and egresses to the internet in a large-scale basis, you open the door for cybersecurity attacks across the infrastructure. At that point in time, every CIO, every CISO is concerned about making that their environment is protected.

So, security's becoming a more and more relevant topic on the agenda of CISO, CEOs, and CIOs, and they turn around and say do we have good security or not? And that's not a bright sensitive conversation. It's a security sensitive conversation, and from that perspective, I think -- and I can't take credit for this -- this is the team here and the prior management. They did a phenomenal job in making sure we have people around the world. We have customers, we have gone ahead and worked with these customers all year. Some of the deals coming to fruition now are deals teams have been working on for 12 months, 18 months, and 24 months. So, this is a journey that had been started a while ago. It is a security-focused journey and it is a product that is clearly differentiated in the marketplace. And we hope, given the more sensitivity around security, we will continue to take market share.

Patrick Colville -- Arete Research -- Analyst

Good. Can I ask in my follow-up another high-level question like that? So, some investors are skeptical that an appliance company can transition to be more of a software company over time because history and technology over the last 30 years shows us that that can be quite difficult. You know, clearly, the numbers you guys are putting in unattached subscriptions are very healthy, with the growth momentum being very strong. So, the indicators, for now, are that this transition is happening very effectively.

But what gives you confidence that that can continue? And that you guys can continue pivoting away from product and more toward subs?

Nikesh Arora -- Chairman and Chief Executive Officer

Look, I think while we look at it from an industry transition perspective because some of us analyze the industry and look at it from afar, if you ask a customer, for them, it is a continuous spectrum. They see it as a continuous journey and they want to be able to take their existing partner with them through the journey because security is kind of a thing where your customers have to believe and trust in you that you are going to protect them.

We have many instances, many, many, many instances that happen on a daily basis where the customers -- we understand breaches. They call us, we work with them, we show them how to protect themselves, we show them how to improve their security posture. So, we build trust and reliability with over 50,000 customers around the world.

And I think as we come out with new products, would a customer rather buy the next generational product from a small start-up of 40 people? Or would they rather have the capability of a team that's been working with them for 3 to 5 years helping their security posture? We believe the latter.

Look, I'm sitting in the pit working with the team for the last 6 months -- you know, it's 12-hour days working hard on every product every part of the transition. So, I'm convinced we can make the transition. So, as far as the skeptical investors, it's for us to know and for them to find out. By the time they find out it will be too late.

Patrick Colville -- Arete Research -- Analyst

Good stuff. Yeah, good job. Keep it up. Thanks very much.

Nikesh Arora -- Chairman and Chief Executive Officer

Thanks.

Operator

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

Gabriela Borges -- Goldman Sachs -- Analyst

Good afternoon. Thanks for taking my question. I was hoping you could characterize for us the level of sophistication and education that you're seeing around cloud security when it's from your customers. At this stage, how much of it is a push from Palo Alto where you really need to educate her on her actual firewall, and GlobalProtect and Aperture and some of the cloud products that you have versus customers maybe reaching a consensus and realizing that, in order to be secure in the cloud, they need more Palo Alto products? Thanks.

Nikesh Arora -- Chairman and Chief Executive Officer

Thanks, Gabriela. That's a brilliant question because when we did the acquisition of RedLock and we looked at what we have I realized we have an awareness problem. Many of the existing customers we have GCP or Azure don't know what they need. And part of the effort in the last even few weeks in going forward has been to get in front of our customers, demonstrate the product to them, and it's about them saying, "Oh my God, yes. I do need this."

So, you're right. There's not a flash realization across the space that we need the security because some of these, you know, they think they're moving from a DevOps beam upwards into the Enterprise, so there's a lot of awareness and education that is required and we are stepping up our efforts to do that education, to do the partnerships to create the awareness. But we also believe, like I said earlier, we are the only players right now with a product with this sophistication and we intend not to lose the sophistication and leadership of this product.

Gabriela Borges -- Goldman Sachs -- Analyst

That's helpful. Thank you. And the follow-up is not specifically on the 7000-Series refresh, but I do want to ask how you're thinking about the cadence of appliance introductions at a higher level. If I think back to 2017, there are a number of product instructions on the appliance side. So, maybe some high-level thoughts on how you think about those instructions going forward, and how much more (inaudible) plays into that, if at all. Thanks.

Lee Clarich -- Chief Product Officer

I'm sorry. Can you clarify your question? Appliance what?

Gabriela Borges -- Goldman Sachs -- Analyst

How are you thinking about the cadence of new appliance introduction at a higher level?

Lee Clarich -- Chief Product Officer

Ah, got it. Yeah, got it. Sorry, thank you. Look, our desire as we build our hardware roadmaps and overall strategies... You know, our large enterprise customers are (inaudible) that, in general, they do not want to see hardware technology change too fast because that necessitates that need for them to then go through and do a whole bunch of work to swap out old hardware for new hardware and things like that.

On the flip side, of course, we want to stay very up-to-date on the latest and greatest technology in order to be able to provide the best products. So, we're always balancing between those two aspects and there's no single answer to it. It's just always looking for where the big technology inflections are on the hardware side, and then looking at how we can swap those into a development schedule that makes a lot of sense to both us and our customers. You know, what you've seen us do over the last couple years is obviously introduce a number of new hardware platforms that have been very well received. And then, where we need to, we'll continue that process of bringing to market new hardware technologies where we get a lot of bang for the buck and really help our customers.

Gabriela Borges -- Goldman Sachs -- Analyst

I appreciate the call.

Operator

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

Erik Suppiger-JMP Securities -- Analyst

Yeah. Yeah, thanks for taking the question. Two questions -- 1) Nikesh, how do you feel your channel is currently prepared for moving into the cloud? What kind of evolution do you need to see from your channel partners? And then, secondly, on the service provider front, one of your competitors does a lot of development with the hardware with ASIX. Is that something that you would consider in order to achieve the performance that you need to meet service provider requirements for 5G?

Nikesh Arora -- Chairman and Chief Executive Officer

So, thanks for the question. I think, look, the channel -- do you mind going on mute, Erik? We're getting a lot of feedback. There we go. Thank you.

Erik, from a channel perspective, the channel is not one entity. Channel is very large sort of set of partners where we have people who are very cloud-savvy and very cloud-ready, and we have people who are going through their own journey of transitioning to the cloud because they've been very hardware's entry. So, they come in different shapes and sizes. We're very excited about the partners who are stepping up and creating the cloud education focus within their own teams to be able to pass the journey. There are some others who are called BICs -- everyone called Born in the Cloud. So, they are people who are focused exclusively on the cloud space and working with us and other players in the cloud space. So, there is a transition going on in the channel as much as there's a transition going on in our customer base. And the channel is getting ready to be able to provide these capabilities to our customers.

So, you know, we see a very, very set of healthy partnership going forward with the channel where they're going to end up providing a lot of services to our customers, giving a lot of education and awareness. The question Gabriela asked about how do we create the awareness across 50-plus thousand customers of the public cloud companies and get them to see our product? Can't do it alone with our smaller team on that scale. We're going to have to leverage a large distribution network which is in place which is the service provider network.

So, I think that's kind of the answer for the first part of the question. And as it relates to the ASIX and throughput part, look, we believe in the K2-Series product. We are gonna match the price performance of everybody else out there from a throughput perspective. And we believe we're going to be industry leading in security. In fact, the only ones in the industry who can deliver the security requirements for 5G and IoT.

So, if you're very comfortable with the new K2 product that I said very early, their sales cycles and SP are long, but as we've announced this today, we're gonna be launching efforts toward our teams and our go-to-market teams to start approaching some of the largest service providers around the world. Working with them to make sure they understand the capabilities of the -- effectively the next generation firewalls now. And make sure that they keep us in consideration as they go toward their own journey of going to 5G and IoT.

Operator

Thank you. Our next question will be from Catherine Trebnick with Dougherty.

Catherine Trebnick -- Dougherty & Company -- Analyst

Oh, thanks for taking my question. A brilliant quarter. Did you provide the number of customers you added during the quarter? That's my first question.

Kathy Bonanno -- Chief Financial Officer

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

Catherine Trebnick -- Dougherty & Company -- Analyst

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

Kathy Bonanno -- Chief Financial Officer

Yeah. No, we had nice performance across our subscription portfolio, and obviously, we're very happy with the growth we saw there.

Catherine Trebnick -- Dougherty & Company -- Analyst

So, none of them underperformed? Like Aperture? Autofocus? I'm just trying to quantify.

Kathy Bonanno -- Chief Financial Officer

No. We will break out -- yeah, we break out more details from time to time, but we haven't provided details by product of how each one grew.

Catherine Trebnick -- Dougherty & Company -- Analyst

All right. Thanks. Keep up the good work.

Kathy Bonanno -- Chief Financial Officer

Thank you very much.

Operator

Thank you. I'd now like to turn the call back over to Nikesh for closing remarks.

Nikesh Arora -- Chairman and Chief Executive Officer

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

I've been reading many of your notes and I know that some of you are still anxious to understand me. So, before I wish you a Happy Holiday, I wanted to send out this invite to all of you who would like to come meet me. We're gonna -- we're trying to schedule over the next 3 weeks our southside analysts to come visit. If you reach out to Amber in our investor relations team, she can schedule it. That way, hopefully, next time around when I read your notes you won't be as anxious about me. I'm anxious enough about myself, I don't need you to be more anxious about me.

So, with that, thank you again for your interest in Palo Alto Networks, and goodbye.

Operator

Thank you, ladies and gentlemen. This concludes today's conference. You may now disconnect.

Duration: 59 minutes

Call participants:

Amber Ossman -- Director of Investor Relations

Nikesh Arora -- Chairman and Chief Executive Officer

Kathy Bonanno -- Chief Financial Officer

Dave Peranich -- Executive Vice President Worldwide Sales

Lee Clarich -- Chief Product Officer

Ken Talanian -- Evercore ISI -- Analyst

Matt Hedberg -- RBC Capital Markets -- Analyst

Andrew Nowinski -- Piper Jaffray -- Analyst

Tom -- Morgan Stanley -- Analyst

Eric -- Raymond James -- Analyst

Sterling Auty -- JP Morgan -- Analyst

Saket Kalia -- Barclays Capital -- Analyst

Gregg Moskowitz -- Cowen and Company -- Analyst

Jonathan Ho -- William Blair & Co. -- Analyst

Patrick Colville -- Arete Research -- Analyst

Gabriela Borges -- Goldman Sachs -- Analyst

Erik Suppiger-JMP Securities -- Analyst

Catherine Trebnick -- Dougherty & Company -- Analyst

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