Q2 2025 Summary
Published Feb 14, 2025, 10:09 PM UTC- Strong operating margin improvements driven by platformization and AI initiatives, giving confidence in sustaining free cash flow margins of 37% or higher through fiscal '27.
- Successful transition from hardware to software in network security, with growth of 21% between hardware and software, reducing reliance on hardware and positioning for higher growth in network security.
- Strategic partnership with IBM is exceeding expectations, leading to very large deals, such as increasing ARR with an Asian bank by 5x through joint efforts, expanding the company's reach and opportunities.
- Gross margin pressure due to faster growth in newer SaaS offerings and hardware write-offs: The company experienced a decrease in gross margins, attributed to faster growth in newer SaaS offerings that have not yet matured and scaled. Additionally, there were one-time inventory write-offs on the hardware side affecting gross margins. This suggests potential ongoing margin pressure as the SaaS business scales.
- Decline in net new ARR growth over the last two quarters: Despite positive trends in large platformization deals, the company's net new Annual Recurring Revenue (ARR) declined year-over-year for the last two consecutive quarters when excluding the $74 million from QRadar in Q1. This raises concerns about the sustainability of ARR growth.
- Challenges in transitioning from hardware to software amid low hardware growth: The company expects its hardware (appliance) business to grow only in the low to mid-single digits. While they are transitioning to software and cloud-based solutions, there is risk associated with managing this transition effectively, especially since hardware revenue is a significant part of the business.
| Metric | YoY Change | Reason |
|---|---|---|
Total Revenue | +14% (from $1,975.1M to $2,257.4M) | Total revenue increased by 14% driven by sustained growth in both recurring and product revenue streams, as well as strong geographic performance—Americas grew by 13%, EMEA by 18%, and APAC by 17%—building on the previous quarter’s momentum. |
Product Revenue | +8% (from $390.7M to $421.5M) | Product revenue grew by 8%, reflecting a boost in hardware and software sales from enhanced product offerings and new-generation product launches, which continued the positive trend observed in the prior period. |
Subscription and Support Revenue | +16% (from $1,584.4M to $1,835.9M) | Subscription and Support revenue advanced by 16% YoY, driven by increased customer adoption, renewed contracts, and innovation in subscription offerings such as enhanced cloud and security services, following a strong base in the previous quarter. |
Americas Revenue | +13% (from $1,334.2M to $1,502.4M; U.S.: from $1,248.2M to $1,400.5M; Other Americas: from $86.0M to $101.9M) | Americas revenue rose by 13% fueled by robust U.S. performance and notable growth in Other Americas. The increase builds on earlier successful investments in the sales force and market expansion strategies that had already established a high base in prior periods. |
EMEA Revenue | +18% (from $406.8M to $480.0M) | EMEA revenue increased by 18%, benefiting from continued investments in global sales and market penetration, reinforcing the positive trajectory noted in the previous quarter. |
APAC Revenue | +17% (from $234.1M to $275.0M) | APAC revenue grew by 17%, reflecting steady regional expansion and consistent performance improvements from earlier periods, underpinned by ongoing sales force investments. |
Operating Income (EBIT) | +347% (from $53.6M to $240.4M) | Operating Income surged by 347%, as the significant increase was primarily driven by revenue growth, enhanced gross profit, and improved operational efficiencies including lower operating expenses relative to revenue, a stark contrast to the more modest EBIT in the previous period. |
Basic EPS | Fell from $5.53 to -$0.13 | Basic EPS declined notably despite revenue and EBIT improvements, likely due to non-operational factors such as dilution, extraordinary charges, or restructuring impacts that negatively affected per-share earnings relative to the strong operational performance of the prior period. |
| Metric | Period | Previous Guidance | Current Guidance | Change |
|---|---|---|---|---|
NGS ARR | Q3 2025 | $4.70B to $4.75B (35% to 36% increase) | $5.03B to $5.08B (33% to 34% increase) | raised |
Remaining Performance Obligation (RPO) | Q3 2025 | $12.9B to $13.0B (20% to 21% increase) | $13.5B to $13.6B (19% to 20% increase) | raised |
Revenue | Q3 2025 | $2.22B to $2.25B (12% to 14% increase) | $2.26B to $2.29B (14% to 15% increase) | raised |
Diluted Non-GAAP EPS | Q3 2025 | $1.54 to $1.56 per share (5% to 6% increase) | $0.76 to $0.77 (15% to 17% increase) | lowered |
NGS ARR | FY 2025 | $5.52B to $5.57B (31% to 32% increase) | $5.52B to $5.57B (31% to 32% increase) | no change |
Remaining Performance Obligation (RPO) | FY 2025 | $15.2B to $15.3B (19% to 20% increase) | $15.2B to $15.3B (19% to 20% increase) | no change |
Revenue | FY 2025 | $9.12B to $9.17B (14% increase) | $9.14B to $9.19B (14% increase) | raised |
Operating Margins | FY 2025 | 27.5% to 28% | 28% to 28.5% | raised |
Diluted Non-GAAP EPS | FY 2025 | $6.26 to $6.39 (10% to 13% increase) | $3.18 to $3.24 (12% to 14% increase) | lowered |
Adjusted Free Cash Flow Margin | FY 2025 | 37% to 38% | 37% to 38% | no change |
| Metric | Period | Guidance | Actual | Performance |
|---|---|---|---|---|
Revenue | Q2 2025 | $2.22B to $2.25B | $2.2574B | Beat |
| Topic | Previous Mentions | Current Period | Trend |
|---|---|---|---|
Platformization strategy | Emphasized as a core strategy for consolidating products, aiming for 2,500+ customers in the future and driving higher ARR. | Highlighted 1/3 of sales reps participated in platformization deals, with 75 new deals in Q2, targeting 2,500 to 3,500 platformized customers by FY 2030. | Continuing momentum with larger deals and broader sales rep adoption. |
AI initiatives | Introduced AI security products, co-pilots, and AI firewalls with 20%-30% price uplift, noting strong early adoption. | Focus on operational efficiencies (50% reduction in contract labor), 7-figure AI firewall transaction, and 8-figure pipeline; AI boosts operating margin. | Expanded scope from product innovation to cost efficiencies and margin improvements. |
Operating margin improvements | 200 bps YOY expansion, guiding 26.8%-27.0% for FY24, driven by scale and large deals. | Raised operating margin guidance to 28%-28.5%, benefiting from AI-based efficiencies and cost reductions. | Increasing margins with confidence in sustainable expansion. |
Transition from hardware to software | Discussed hybrid market with hardware, software, and SASE; hardware remains key for campuses, software for cloud. | Software now about 40% of product revenue, driving double-digit growth and reducing reliance on hardware; 21% growth in combined hardware/software. | Greater shift toward software-driven revenue. |
Gross margin pressure from SaaS | No mention. | One-time 40 bps impact due to SaaS-related inventory write-offs, not expected to repeat in H2. | Newly cited pressure but viewed as temporary. |
Net new ARR growth variations | No specific commentary on net new ARR growth variations; focus was on NGS ARR trends. | Cited decline for two consecutive quarters YOY, attributed to tough comps; still strong momentum in new products, aiming for $15B in NGS ARR. | Slight slowdown versus prior high comps, but still bullish on long-term growth. |
Strategic partnership with IBM | Described as a one-of-a-kind arrangement, acquiring QRadar assets for $500M, co-developing with Watson X. | Called IBM a “spectacular partner”, with deals like the U.K. Home Office modernization and 5x ARR expansion at an Asian bank driven by this alliance. | Deepening collaboration leading to larger deals and market expansion. |
Hardware write-offs | No mention. | Reported a one-time 40 bps write-off on hardware, not expected to recur. | Newly disclosed issue but isolated event. |
Native cloud integrations | Touted native integration with AWS, Azure, GCP, Oracle, enabling seamless firewall deployments; key for multi-cloud. | Launched Cortex Cloud with real-time security and deep integration into SOC; merges Prisma Cloud with Cortex for end-to-end coverage. | Broader integration covering cloud-to-enterprise security. |
Increasing deferred payment terms | Increasing preference due to high interest rates, leading to more periodic billings but better visibility into future cash flows. | $1.4B in deferred payments, ~41% of adjusted FCF; expecting to reach $2B by FY26, managed via guardrails on sales compensation. | Continuing rise in deferred structures, improving long-term cash flow visibility. |
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Margin Pressure and Outlook
Q: What caused margin pressure this quarter, and what's the outlook for margins?
A: Dipak explained that gross margin was impacted mainly due to the services gross margin, affected by faster growth in newer SaaS offerings that need time to mature and scale. Additionally, there was a one-time inventory write-off in hardware, amounting to 40 basis points, which will not repeat in the second half. Nikesh added that despite this, they still outperformed margin expectations both internally and externally. -
Net New ARR Growth
Q: Why isn't positive momentum translating into net new ARR growth recently?
A: Dipak noted that while they're happy with net new ARR growth, last year's significant increase was due to transitions to cloud-delivered advanced subscriptions, creating a tough comparison. They don't have the same step-up this year, but net new ARR from newer products continues to strengthen. Nikesh added that strengths in software firewalls, SASE, cloud security, and XSIAM are contributing to net new ARR, which is nearing $5 billion, and they believe they are on track to reach $15 billion in NGS ARR. -
Free Cash Flow and Profitability
Q: Can you discuss the success in driving better profitability and free cash flow?
A: Nikesh highlighted that they are achieving scale, with platform deals being more efficient and leading to operational efficiencies. They've improved operating margins consistently over 2.5 years, driven by efficiency in sales, marketing, and customer support. Early AI experiments have potential to further increase operating margins in the future. Dipak added that growing deferred payments provide visibility and confidence in their financial outlook. -
Hardware Growth Outlook
Q: Is the recent hardware strength sustainable or a one-time event?
A: Nikesh stated that hardware revenue is expected to grow in the low to mid-single digits, around 5%-8%. While hardware may fluctuate, transitioning the network security business from hardware to software led to a 21% growth in that category. As cloud volumes increase faster than data center volumes decline, focusing on software firewalls can drive higher growth in network security over time. -
QRadar Acquisition and IBM Partnership
Q: Is the QRadar acquisition and IBM partnership meeting expectations?
A: Nikesh said the QRadar acquisition and IBM partnership have been spectacular, exceeding initial expectations. They collaborated on large deals, such as a significant modernization contract with the U.K. Home Office. In one instance, an Asian bank, previously a QRadar customer, increased ARR by 5x after the partnership. The partnership has led to very large opportunities, making it highly successful. -
Billing Practices and Deferred Payments
Q: What determines when sales choose multiyear vs. 1-year billings and financing?
A: Dipak explained that deferred payments are mainly requested in higher-end deals. Lower-end transactions, especially through distributors, are typically paid upfront. For firewalls, payments are usually upfront due to budgeting around refresh cycles. Offering financing becomes a negotiation based on cost of money and customer requirements, with guardrails like sales compensation and approvals ensuring tight management. -
AI Impact on Cloud Security
Q: How is leveraging AI across the platform affecting cloud security and competition?
A: Nikesh emphasized that their platform strategy allows for harmonious data collection, enabling the building of AI agents for security tasks. With 1,150 customers on their platform, they can leverage this data for better security outcomes. Lee added that using AI in products like XSIAM has reduced remediation times from days to minutes. This integrated approach enhances security and operational efficiency, improving win rates against competitors. -
Integrating CNAPP into Cortex
Q: Why add CNAPP to the Cortex platform, and how does it accelerate adoption?
A: Lee explained that integrating CNAPP and code security into Cortex allows for more context in automated actions, preventing issues before production and improving cloud posture. This results in a cleaner cloud environment and enhances the effectiveness of runtime and SOC capabilities. By connecting all cloud aspects, they offer better outcomes for customers, accelerating adoption and platformization. -
Agentic AI Security and Identity
Q: What's your perspective on security foundation for broader agent rollout?
A: Lee stated that while identity is important, securing the AI portion of the agentic platform is complex, requiring proper guardrails and protection from attackers. Identity must be combined with securing machine-to-machine communication. Nikesh added that with over 200 XSIAM sales in 24 months, they expect to see agentic activity in XSIAM. Controlling activity will require AI-enabled SOC capabilities, and they see future opportunities to build agentic detection and management within XSIAM. -
Impact of DeepSeek AI
Q: What does DeepSeek mean for AI proliferation and Palo Alto Networks?
A: Nikesh believes DeepSeek is a pivotal moment for AI, noting its quality is comparable or superior to models like OpenAI's, at a fraction of the cost—$0.14 per million words vs. $7.50 for others. This cost efficiency is driving experimentation among SaaS companies. He emphasizes the need for securing AI models with sequestered environments and AI firewalls to prevent data leakage. Any technology advancement requires additional security measures, beneficial for Palo Alto Networks.