Palo Alto Networks Inc (PANW) 2013 Q2 法說會逐字稿

Good day, ladies and gentlemen, and welcome to the Q2 2013 Palo Alto Networks Inc.

earnings call.

(technical difficulty) and I will be your operator for today.

At this time all participants are in listen-only mode.

We will conduct a question-and-answer session towards the end of the conference.

(Operator Instructions).

As a reminder, this call is being recorded for replay purposes.

I would now like to turn the call over to Maria Riley, Investor Relations with The Blueshirt Group.

Good afternoon, and thank you for joining us on today's conference call to discuss Palo Alto Networks' fiscal second quarter 2013 financial results.

This call is also being broadcast live over the web and can be accessed on the Investors section of Palo Alto Networks' website at investors.paloaltonetworks.com.

With me on today's call are Mark McLaughlin, Palo Alto Networks' Chairman, President and Chief Executive Officer; and Steffan Tomlinson, Chief Financial Officer.

After the market closed today, Palo Alto Networks issued a press release announcing results for fiscal second quarter ended January 31, 2013.

If you would like a copy of the release, you can access it online at the Company's website or you can call The Blueshirt Group at 415-217-7722 and we will email you a copy.

We would like to remind you that during the course of this conference call, Palo Alto Networks management will make forward-looking statements, including statements regarding continued revenue growth and overall momentum at Palo Alto Networks (technical difficulty), trends in its business and operating results including its growth margin, operating margin and non-GAAP effective tax rate and Palo Alto Networks' revenue and non-GAAP earnings per share for the third fiscal quarter of 2013 ending April 30, 2013.

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.

And we undertake no obligation to update these statements after this call.

For a more detailed description of these risks and uncertainties please refer to our quarterly report on Form 10-Q filed with the SEC on December 10, 2012, and our earnings release posted a few minutes ago on our website.

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.

We have provided reconciliations of these non-GAAP financial measures to GAAP financial measures in the investor section of our website located at investors.paloaltonetworks.com.

Before I turn the call over to Mark, I would like to remind you that Palo Alto Networks is hosting its inaugural analyst day in New York City on March 21.

If you would like to attend please contact me or Hadley Rokicki at The Blueshirt Group or e-mail IR at paloaltonetworks.com.

In addition, a live audio webcast of the meeting will be accessible from the Investor Relations section of the Company's website.

Now I would like to introduce Mark McLaughlin, Chairman, President and Chief Executive Officer of Palo Alto Networks.

Mark?

Thanks, Maria, and thanks, everyone, for joining us.

I am delighted to be here today to share with you our achievements in our fiscal second quarter of 2013.

We had a strong second quarter and our results continued to demonstrate Palo Alto Networks' recognition as the global leader in next-generation enterprise network security.

This leadership position is driven by our high-value disruptive technology which, we believe, provides the highest level of security available on the market today.

As customers rapidly adopt our technology as their strategic enterprise network security platform, we continue to demonstrate the ability to drive growth far in excess of any of the competition and we continue to improve in leverage.

In the second quarter, we continued to see enterprise investment and security as a topline issue, strong end of calendar year purchasing, improving customer sentiments in EMEA and continued adoption of our technology as the primary firewall by new and existing customers.

As you've discussed in the past our growth model is based on our ability to land in new customers at a best in class provider for any enterprise network security use case, expand across that customer's network with additional devices and extend our value to the customer with subscription services that provide great performance and total cost of ownership advantages.

And looking at the land component of our growth in the second quarter, we added over 1,000 new customers in the quarter.

This is the fifth consecutive quarter where we have added over 1,000 new customers.

We now have the privilege of servicing over 11,000 total end customers around the globe, most of which are choosing us over the legacy common firewall provider.

On the expand and expense side of our business, we continue to see strong increased buying and loyalty from our customers.

Our business coming from services continues to grow at impressive rates as our existing customers buy additional services and for longer terms.

For example, in the second quarter our top 25 customers' follow-on purchases averaged 11.4 times their initial purchase.

This is up from 9.9 times last quarter.

And to make the top 25 list in the second quarter, a customer had to spend at minimum $2.8 million with us which is up from $2.5 million last quarter.

This is all translated into second-quarter results where we posted $96.5 million in revenue, which is the 70% year-over-year increase and 12% sequential increase along with non-GAAP EPS of $0.05 per diluted share, demonstrating our continued ability to substantially outpace the competition and with continued growing leverage in the business.

Our results are driven by our ability to provide demonstrably and substantially better network security than the competition.

Some examples of this over the quarter include us replacing Check Point as a data center firewall in the distributed network environment of one of Europe's largest broadcasters.

We also replaced Check Point in the data center of one of the biggest insurance companies in the US after starting our first deployment with them in December of 2011, and replaced Juniper at one of the largest electronic component vendors in the world based here in California and Cisco in one of Australia's largest retirement funds.

And as we have discussed and demonstrated in the past, we continued to displace all the legacy firewall providers at a rapid pace by growing our market share.

The reason why we are able to win so many new customers and expand so significantly within our customer (technical difficulty) and this differentiation continues to grow.

Just a few days ago I was pleased to see that Gartner once again (technical difficulty) recognized Palo Alto Networks as the leader in their latest Magic quadrant for Enterprise Network Firewalls and they reiterated their belief that, by year-end 2014, the majority of new purchases will be next-generation firewalls.

I am also very pleased with the rollout of the four new products introduced in November at our Ignite User Conference.

Customer traction has been significant across all of these products, most notably for our PA-3000 Series and WildFire subscription service.

We now have more than 1,200 customers using our WildFire service and are ahead of our internal forecast for the paid attach rates for the new service.

In summary, we are pleased to report another strong quarter of growth, new customer acquisition and continued increasing operating leverage.

Our solutions address the fundamental network security issues that are facing enterprises plus across the globe and we entered the second half of our fiscal year with good momentum.

I would now like to turn the call over to the Steffan for a detailed look at our financial results.

Steffan?

Thank you, Mark.

And thank you all for joining us today to cover our results for fiscal Q2 '13.

In Q2 total revenue grew to a record $96.5 million, an increase of 70.2% year over year and 12.3% sequentially.

Looking at our two main components of revenue, in Q2 product review of $61.9 million grooves 60.3% year over year and 11.6% sequentially, driven by sales of our series of appliances.

Services revenue, which is comprised of both subscription and support, was $34.6 million, an increase of 91.5% year over year and 13.6% sequentially.

Services revenue accounted for 35.8% of total revenue, an increase of 40 basis points sequentially.

And this is in line with our expectations and underscores the power of our hybrid revenue model as it provides enhanced visibility.

The geographic mix of revenue was 63% Americas, 25% EMEA, and 12% APAC with all theaters posting growth on a year-over-year and sequential basis.

Total non-GAAP gross margin in Q2 was 72.2%, in line with our target range of 70% to 73%.

Non-GAAP gross margins decreased 70 basis points year over year and 40 basis points sequentially.

Putting a finer point on gross margin, Q2 non-GAAP product gross margin was 73.4%, down 10 basis points year over year and 80 basis points sequentially.

The sequential decrease was primarily due to product mix and the impact of the launch of our new PA-3000 Series.

As I mentioned in the last earnings call, product gross margins will fluctuate when we introduce new products as they have a higher initial cost of goods sold.

As volumes increase for new products, we expect reductions in cost of goods sold which will result in an improvement of gross margins over time.

Our non-GAAP services gross margin was 70.1%, down 140 basis points year over year and up 60 basis points sequentially.

The sequential increase was primarily due to the benefit of more subscription sales in the quarter and services gross margin will also fluctuate, depending on the timing of the investment ramp of our services organization.

Moving on to operating expenses, we continue to invest primarily in product development in our sales and go to market organization.

Q2 non-GAAP R&D expense was $13.5 million, an increase of $1.9 million from the prior quarter, primarily related to program spend and headcount addition.

As a percentage of revenue, non-GAAP R&D expense was 14%, up 50 basis points sequentially.

Q2 non-GAAP sales and marketing expense was $41.9 million, an increase of $3.6 million from the prior quarter, and as a percentage of revenue it was 43.4% -- a decrease of 120 basis points sequentially, demonstrating operating leverage.

Q2 non-GAAP G&A expense was $7.7 million, an increase of $500,000 from the prior quarter or 8% as a percentage of revenue, down 40 basis points sequentially.

In total, Q2 non-GAAP operating expenses were $63.1 million, an increase of $6 million from the prior quarter or 65.4% of revenue, down 110 basis points sequentially.

Q2 non-GAAP operating margin was 6.8%, an increase of 70 basis points sequentially and the sequential improvement this quarter can be attributed to continued natural leverage as we scale and timing of headcount additions.

As we stated previously, given our leading position in the market and the fact that we are growing revenue at a much higher rate than both the market and our competitors, our goal is to grow operating margins in a slow and steady manner while noting there may be near-term fluctuation.

Our non-GAAP effective tax rate for this quarter was 41.5%.

This rate will continue to fluctuate throughout the fiscal year as it is dependent upon our global pretax profit mix and potential discrete events, such as the removal of our domestic valuation allowance.

Non-GAAP net income for Q2 was approximately $3.9 million or $0.05 per diluted share, using 77.5 million shares.

This compares to non-GAAP net income of $2.9 million or $0.04 per diluted share in fiscal Q1 '13 and non-GAAP net income of $2.5 million or $0.04 per diluted share in fiscal Q2 '12.

On a GAAP basis, net loss was $2.6 million or $0.04 per basic and diluted share.

Turning to the balance sheet, we finished January with cash, cash equivalents and investments of $368.3 million.

In Q2, cash flow from operations was $34.5 million, free cash flow was $28.3 million and free cash flow margin was 29.3%.

Cash flows benefit from our hybrid revenue model in which we bill for our services at the beginning of the engagement and we collect the cash shortly thereafter.

We ended Q2 with $68.6 million of accounts receivable up from the Q1 '13 balance of $56.4 million.

Average DSOs were 58 days, up from 53 days last quarter, reflecting a slightly more back end linearity to the end of the quarter.

Moving down the balance sheet, total deferred revenue was $188.2 million, an increase of 92.2% year over year and 17.3% sequentially.

Short-term deferred revenue of $117.4 million increased 15.8% sequentially.

The majority of our service engagements are on an annual basis, but we are continuing to see an uptick in multiyear deals.

Billings were $124.3 million, an increase of 81.6% year over year and 12.4% sequentially.

Let me now turn to our guidance for Q3 '13.

We expect revenue to be in the range of $100 million to $104 million which equates to 52% to 58% year-over-year growth.

And we expect non-GAAP EPS to be approximately $0.05 per share using 79 million to 81 million shares on a diluted basis.

We are continuing to invest in product development, sales and go to market as well as discrete projects in G&A, all of which is reflected in our guidance for Q3.

With that, I will turn the call over to the operator to open the Q&A session.

(Operator Instructions).

Greg Dunham, Goldman Sachs.

I guess first off, can you talk about the impact of Mark Anderson's emphasis on strategic accounts and the opportunity improved sales productivity from here?

Thank you.

Yes.

Mark has been focused on a number of things and I've mentioned this on a few of the other calls but one is on the strategic accounts side so not surprisingly as the Company continues to grow into the size we are and the size we intend to become, large, strategic major accounts are more and more important to the Company.

So we have been very focused on the Global 2000.

We have got very good penetration there and continued to increase penetration and we continued to do really well on our large accounts on follow-on purchases as well.

Mark is putting a lot of discipline in place, talent in place who know how to sell in to and service this large account.

So we expect to continue to get gains from that over time.

And as you know, it takes time in order to develop sales forces like that.

But so far, very pleased.

One follow-up if you permit, the billings number was just a monster number.

Were there any anomalies in there?

Was that -- is that mainly due to the WildFire release?

How should we think about that?

Yes so I will give it to Steffan for a little more detail.

Just generally on the billing side, we had a nice quarter as you can see.

We had a nice increase in services revenue side of it and it's just all flowing through to fill in to the [in deferreds].

(technical difficulty) do you want to give any more detail?

That's right.

When we look at the composition of billings, what we are seeing is a very nice uptick in our services line, both subscription and maintenance.

And we are pleased with the number.

Joel Fishbein, Lazard.

Just to follow up on that.

In terms of the take rates on the subscriptions, can you give us any more indication on the numbers that people are taking?

And what is particularly driving the deferred revenue in terms of the subscription base?

As we said in the past the attach rates on the services are good, [how we like] they need to be that way.

And in addition to that as you know we continue to launch more services, in particular, WildFire which came out back in November and we like the attach rates we're seeing on that.

It is early days there, but they are higher than what we internally forecasted in the last call it 90 days of selling.

So that is good and we think that is plenty of uplift for the Company.

I mean, at the end of the day what is going on here is that we have got a really disruptive device in the first place with the firewall and the ability to easily add very high-value services for folks at a much lower cost than they would pay for other [machs at] really compelling.

It is a really compelling offer in the market and we keep seeing our customers take advantage of that and at increasing rates and for longer terms.

So that (technical difficulty).

Just as a follow-up to that, at RCA the big talk was malicious threat protection.

Can you just talk about how Palo Alto is positioned in that market and maybe that is the better question to ask, relative to what is driving the subscription growth.

That is a great question.

And yes I was up at RCA yesterday and there is definitely a big focus on [APE], malware, not surprising.

And there are security changes a lot and there's always something new that is important to take care of.

So as a general matter, I think what is going on there is that company -- that enterprise is very concerned about that and then the question is what do you do about it.

And bringing a service like WildFire to market is really important in and of itself because it is the only one out there that can detect and prevent malware.

But more importantly, our big picture I think is what is happening architecturally is that enterprises want the ability to have a device and services that are -- that can probably have the best security and do so rapidly without having to make big capital expenditures for the best of breed point solutions, like the next box.

So what we have done we have said in a lot of cases, majority of cases where we are already are firewall, we are deployed throughout your network.

With the WildFire service you are getting a modern malware service right on top of a box that is already deployed in your network and it is already your main enforcement point because it's the (technical difficulty) firewall.

So from a pure security perspective what would like to have is the disparate pieces of technology that are forced to get into different boxes that they actually be integrated in an innovative way because that is the best possible way to detect and then really quickly prevent -- prevent that malware.

That is what we have in the market so I think just generally as an architectural matter, that is the way the world is going.

Great.

Thank you.

Michael Turits, Raymond James.

Sort of a housekeeping question.

Any more precision you can give us on the number of customers added and then customer account and how much hiring you did this quarter, what was in that headcount adds and what we should expect of those going forward still looking in the 75 to 100 range?

So, on the first question, the customers we continue to add customers at a very nice pace and this is the fifth quarter with over 1,000.

We haven't gotten into the numbers of what they are over 1,000.

The reason for that is there is really no magic to 1,000.

I mean it is a great number that you can put out there, but this is a really great quarter for us from a customer add perspective, very high numbers.

And we hope to continue that for quite some time.

Just as importantly as adding new customers which is the land part of the model is the expand part and once we get them in the door, the way we have been able to demonstrate repeat sales of that is it is really important to see that driving -- driven through our services line and deferred revenue there.

So, all the cylinder are firing.

(inaudible).

I'm sorry, Steffan, go ahead.

I was going to say and just a follow-on point to that, you can also see that in the LTV metric that we talk about which has increased very nicely sequentially to 11.4 times repeat order value for the top 10 -- or top 25 enterprise customers that we have.

And we added 100 heads this quarter.

We said we would do anywhere from 75 to 100 on a quarter basis as far as the target.

That obviously is going to fluctuate quarter to quarter hiring patterns and when people show up but we put 100 in this quarter.

(technical difficulty).

If I could just ask about the accounts receivable and you said it was more backend loaded.

What was going on there that that happened?

It was typical of many companies in terms of the January month, the first couple of weeks are always a little bit slow because the majority of corporations are on a calendar year budget.

So when once those budgets are finalized we saw a very nice pickup at the end of the month and that is a normal pattern that we have seen in January, in past Januarys.

We also did see a good calendar year in the December month.

We don't break that out specifically, but we did participate in a nice December month as well.

Thanks.

Jayson Noland, Robert Baird.

Mark, at RSA there was talk of the permit or being poorish and ineffective and I guess part of the answer there is WildFire for APT and malware, but do you see any change architecturally where the PA appliances will be in more locations in the network or virtual NGFWs?

I guess, what are you seeing more broadly?

The answer is kind of, yes, meaning you see it everywhere which is you want to protect the perimeter.

You want to protect the branch office so the perimeter doesn't get attacked.

You definitely want to protect the data center.

Those are the three main areas that we generally enterprise is focused on.

That is where we have offerings for all three of them.

And again like I said a little earlier, because of that, because of the move to virtualization and data centers, flexibility for how you are able to provide security is very important and, ideally, you would want your firewall to be very flexible with services in order to do that in all those places in the network.

And you would want a virtualized version of that as well.

And we have all of those.

Thank you.

Phil Winslow, Credit Suisse.

This is [Harris Hyer] on behalf of Phil.

I was hoping you could comment on the price environment in the last quarters versus recent quarters and also if you can just comment briefly on tax rates (technical difficulty)?

Yes, sure.

Your first question is on pricing.

Is that it, Harris?

Yes.

Well, this is, has always been a very competitive market and it is not unusual for players to attempt to make up for a lack of functionality by aggressive pricing so we have definitely seen that.

But we have found in the past we continue to see is that our technology is really disruptive and it is solving real strategic issues, and as a result of that, we are not immune to pricing pressures, but we have been able to maintain premium pricing for premium technology for quite some time.

And on the attach rate on subscriptions, what we have said in the past still holds up.

We are typically selling one or two subscriptions with the initial sale and then, we also sell maintenance and the attach rate, I mean, this is extremely high.

What we've said is it is well worth of 90%.

The renewal rates for maintenance, again, is very high.

You can't really deploy enterprise network security without being on maintenance because you would get [plug] fixes and patches as part of that maintenance program.

And the renewal rate on subscriptions are high as well.

We haven't put a finer point on that and that should cover both of your questions.

Great.

Thank you.

Jonathan Ho, William Blair.

The first question I have is around the primary firewall adoption.

Can you talk a little bit about the trend there and whether you are seeing -- historically you have said over 50%.

Are you seeing an acceleration there especially relative to Gartner's comment?

Yes, we are.

So, what we have said in the past is that over half of our new sales and half of our existing customer base use this as a primary firewall and that number continues to go in the right direction for us.

And I think what Gartner is saying there is that enterprises have been coming around rapidly coming around to you really need a next gen firewall in order to have the best level of security in the market today.

So their expectation is that as those purchases occur, most of them, meaning more than half of those are going to be for next gen firewalls.

So I think that will point to continued opportunities.

Got it.

And just in terms of the PA-3000 line, just want to understand a little bit about how much of an impact that product set is having.

I know it has been out for a little while, but is this driving some of the new expansion opportunity or has it seen more market acceptance?

Just want to get some sense of how that line is faring?

Yes, we got a lot of input from customers along the way that they would like to see a device in that range.

So we delivered it and it's sold very well from the first day we introduced that.

And I expect it will continue to sell well.

So we are very pleased with the performance.

All right.

Thank you.

Karl Keirstead, BMO Capital Markets.

This is [Shakil Alam] in for Karl Keirstead.

Can you talk a little bit more about demand environment?

You mentioned strong enterprise demand in your prepared comments and I just wanted more color on that.

You also talked about enterprises wanting to consolidate to more of the single architecture.

Are you seeing an uptick in one demand and also just that kind of trend of more consolidated architecture?

And then also my second question is if you could just give a little more color around the 50% of new customers that are buying primary firewall.

Are they in terms of their size, are they getting larger?

Anything to do with there would be helpful.

I'll take that in reverse just so I don't forget them.

On the new ones when we say 50% of the new customers are using primary firewall, that is across the board meaning that it's that all across the entire customer base.

We are really focused, as we said before, on Global 2000 so it includes those folks as well.

And as we are continually rapidly accepted in the market as an enterprise network of firewall provider with technology what we have seen is that deals get done quicker and that the initial deals get bigger and then the follow-on purchasing get faster and the follow-on purchases get bigger.

So that is generally what we have seen and continue to see.

On your first question, it is kind of played to that which is if demand is, has been and continues to be very high for this technology and, again, partners echoing that and just a few weeks ago, but we have certainly seen that from a demand standpoint for our technology.

And then on the other question around what I was saying architecturally -- you can actually involve consolidation.

We think of it more as the native integration of the technologies required to combat what you are seeing in the security sphere today.

We believe that over time -- it doesn't happen overnight -- but over time architecturally customers want and demand and will get more and more of the functionality natively from the firewall.

But simply one is it's [break, meaning cost wise], but way more importantly is that that is a better security solution.

I will use malware and I know everybody is focused on that these days as we are.

But I will use malware as the example if you have the if you want to see the malware coming in, so that would be traditionally a malware device seeing malware coming in.

When the malware is in, you would want to see if it is trying to talk outside the network.

The malware device won't do that.

Your IPS device would be the one listening to the command and control to see if it is communicating out.

And then if it was and you were able to put a signature on it with your AV device then you would want to communicate it back to your firewall so that you could have a signature to enforce it.

That is kind of what the mishmash all looks like out there, and that is not very convenient or secure.

So that is why we continue to see customers driving and pressing for better security in a natively integrated fashion which is what we brought to market.

Great.

Thank you.

Walter Pritchard, Citigroup.

Mark, just on the product side, I'm wondering if you could compare and contrast the pressure to move on with a higher end box even higher than where you are today versus move down into the low end?

And I am wondering just kind of branch versus data center where you are being pulled more so as you see incremental demand?

Well both directions.

So I think on the let me talk about the smaller side first.

I think customers would like to see us have even smaller boxes than the PA-200 with all of the functionality, right, you get with the next-gen firewall and that is the challenge just from how do you deliver all that at the right cost to profitability to do that.

So we thought about that and continue to think about ways to get that done.

And then on the higher end there is a set of the customer base that not everybody because they don't tell you why (technical difficulty) but not everybody, but would see a higher throughput box on the higher end doing all of the next-gen functionality that we do in the boxes we have today.

Those tend to be large, large data center deployments or carriers or folks like that.

So we are definitely paying attention to that.

We have taken that input very seriously and I think you can expect to see us do something in that area in the future.

The -- generally though, one of the things that the market has been used to for a really long time is saying if I want to get X throughput, protected throughput with everybody else in technology if you want 2G of protected throughput, you probably have to start with a 40G box to get it because all of the performance degradation.

We'll have that problem so you get 2G in, 2G out.

You get what you pay for as opposed to having to start with something very expensive.

And we have been able to serve a lot of throughput demand because of that.

Got it.

And Steffan, I am wondering on -- just a clarification on the deferred revenue.

You did have a very strong quarter here.

I'm wondering if there is any sort of abnormal seasonality.

You know there's lots going on in the government things like that any pull forward or maintenance, any longer-term maintenance deals or anything that -- because the seasonality here looks that much more pronounced than it did last year.

Our deferred revenue grew nicely and we have seen an uptick in multiyear deals both on the subscription side and on the maintenance side.

So nothing too out of the ordinary is happening there.

Great.

Thanks very much.

Tal Liani, Bank of America Merrill Lynch.

This is [Ron Zepper].

Just a couple of housekeeping questions.

Headcount, should we think of the same run rate for (technical difficulty)?

We talked about a range of 75 to 100 and timing of heads on board, sometimes there are some variances.

But we still feel comparable with that range.

This past quarter we added exactly 100 and I think going forward, the 75 to 100 range makes sense for us for the balance of the fiscal year per quarter.

All right.

And how about the investment channel?

How many partners did you add this quarter?

We haven't broken out what we have done on a quarter by quarter basis where we have said in the past week have got about [800] (technical difficulty) and over about the last few years we have added 200, 250 and we would expect to do that on a continued rate.

Expect to use that sort of as a benchmark.

We are very interested in the quality of folks over the quantity of folks just because when you have the new -- a newer relatively new or disruptive technology having highly trained partners, being able to sell into accounts (technical difficulty) almost always doing displacement very important to (technical difficulty).

We focus a lot on that.

And how has the ramp been on the recent ramp?

Great.

It is in line with our expectations.

(technical difficulty).

JMP Securities.

Two questions.

First just curious if you have seen any change in the competitive landscape coming from other next-generation firewall vendors?

and then secondly on the WildFire the subscribers, I think you said around 1,200.

Was there any pent-up demand?

Is that something that was just because of the initial release or might we expect that to continue growing at a similar rate?

Hi, Eric.

Well on both.

So the first one on the competition side the answer is no.

So, we believe this to be true that we are the only real next-generation firewall provider on the market.

Lots of folks are doing marketing around application, identification control which they mean the can block application and then they try to call that next-generation firewall.

But we are the only offering in the market that can truly safely enable applications and that is the difference.

So we have seen a lot of competitive marketing, but we haven't seen any catchup from a competitive technology standpoint, which I think is all we really care about at the end of the day.

On the WildFire side, yes, I should have been more clear a little earlier.

So we had a free version of WildFire on the market for over a year and we have had a really good customer adoption on the free version, so we have 1,200 total customers today using WildFire.

And then of that base of the customers when we released our paid for version of WildFire in November, we saw some new customers buying that, some different customers starting to pay for that from a tax rate perspective.

So I want to be clear.

We don't have 1,200 paid for subscriptions yet.

That is the total base of customers that are (technical difficulty) WildFire and the attach rates on these numbers are good so far for us.

The attach rate for the paid version?

The paid version, yes.

Any details on how that performed in the quarter?

Better than we hoped for.

Very good.

Thank you.

Brent Thill, UBS.

Mark, just on WildFire.

How do you think of the ASP list and if you just used maybe some simple numbers to help us understand what you are seeing initially in those paid for customers.

Yes.

We are trying to keep it really simple and like we have for all of our subscription services.

So all of our subscription services are the same in that when you buy a device the device costs X. It has a list price on it and the subscription service is 20% of list price.

That is true for WildFire as well.

So if you are going to attach a paid for subscription of WildFire it is 20% of the list price of the box you're putting in.

That's great.

And if you could just give us your thoughts on the government, what you're seeing in your pipeline, how you think about the potential upcoming impact of things going on there right now, that would be helpful.

Thanks.

Yes, the government market has been a good market for us and I think it will continue to be just by the nature of what we do for a living.

With that said, no verticals more than 14-ish percent of our business today.

So keep that all in context.

I think your second question is really or part of that is around sequestration.

So there's lots of speculation anxiety in general about whether that is going to occur.

I guess we will find out tomorrow.

Right?

And if so what that is going to mean impact-wise.

I think it is too early to tell.

But as you know, there are a few things that remain consistent.

One is that cyber security; that's a national priority.

You can see that lately couple of weeks ago with the President's Executive Order on cyber security.

And then the second thing in general is all enterprises and to some degree the government, more so than enterprise if you consider them that way, are being forced to do more with less from a budget perspective.

But if you have got a better solution, flex (technical difficulty) quickly at low cross and I think that is a really desirable offering.

That is what we have and I think the government has found that attractive and will continue to find it attractive.

But having said all that, nobody really knows what the impact of sequestration is going to be and we of course baked all that into our guidance.

Greg Moscowitz, Cowen.

Hi Mark, just a follow-on to one of Walter's questions.

How is demand this quarter across your current level of low-end and high-end appliances?

Was it strong across the board or did one area for example perform a little better than the others?

It is strong everywhere.

And what I was saying a little earlier was the 3000 is selling very well, higher than what we thought it would -- selling, which is always great.

So I call that but everything is selling well.

That is the aberration -- a good aberration in it is selling better than we thought it would.

But everything continues to move.

Great.

And for Steffan, your services gross margin have been on a nice upward trend over the past few quarters.

Looking forward, I'm sure you are going to make some investments in your support organization at the same time.

Presumably your mix of subscriptions will continue to increase.

I'm just wondering how you are thinking about specifically about service margins coming up from here?

Well, we are not going to break out specifically how each of the components of the service's gross margin work or the product gross margin.

On the services gross margin, in particular, the dynamic around subscription versus maintenance and the customer support realization, subscription revenue is going to be recognized ratably over the life of the contract.

And so, there will be a consistent small tailwind that builds over time as we sell more subscriptions.

The cost of support to deliver maintenance is very much headcount-driven and systems-driven.

And those costs are more pronounced up front.

So we have a couple of countervailing forces playing against each other.

We have been more disciplined in getting more efficiency out of our support organization which is helpful and as WildFire and other subscriptions continue to build, there should be a positive tailwind services gross margin over time.

There will be some near-term fluctuation.

I think the biggest thing to understand is given that this is a fifth consecutive quarter, we have added over 1,000 new customers, we want to make sure that we are adequately resourced to ensure a great customer experience.

And that is a big differentiator between us and the competition.

Aaron Schwartz, Jefferies.

Good afternoon.

Just a quick follow-up question on deferred revenue.

Obviously that has been well ahead of what we have modeled.

Should we expect -- I would assume we would but should we expect a more pronounced revenue mix shift to services as we build the models out in the back half here and into 2014?

It is a little too soon to tell.

We are primarily a book and chip business if you look just on a revenue basis still we are getting approximately (technical difficulty) of our revenues from product.

Over time we think directionally services as a percentage of total revenue and total billings will be building but, given the fact that we are adding so many new customers per quarter and we are following our land expanded expense strategy of mining our installed base and selling to new opportunities within that base, we expect to see both robust product growth and services growth.

We will monitor it over time, but right now we are not making any predictions on the split.

And a follow-up question.

You spoke about the trend of a couple more multiyear deals.

I think you said that was balanced between the maintenance and the subscription services.

What is actually driving that?

Is that more of a customer presence or do you have -- you know it is a sales and partner program actually out trying to do multiyear deals?

Thanks.

Most of it is customer-driven and the fact that we are selling into the Global 2000 and high-end enterprise they want to standardize on us and they are effectively making that standardization call with a multiyear deal and that has translated into structurally us being very well situated in the account for both the existing deal and for follow-on purchases.

Keith Weiss, Morgan Stanley.

Very nice quarter.

One of the things I noticed in the quarter is you had a -- I think this is the second quarter in a row of really robust sequential increases in EMEA.

Anything in particular looking better there or [catalyzing] growth there that is really leads to those two nice [incremental objects]?

Well you can see as you noted from the numbers we increased the business sequentially the last three quarters in a row and particularly in the last two quarters at really healthy rates.

So obviously we are pleased with that.

I think it is a little too early to speculate as whether any of that means as a general matter of resurgence of confidence in the EMEA market macro wise.

But word of position is following really high-value technology in a great secular trend.

It is going to affect enterprises all around the world including EMEA.

So we would expect security to remain top of mind and the budget issue over there -- top of budget issue over there.

More specifically to your question for us, what we have seen is larger companies where we have been working on larger projects starting to bring those projects to fruition and replace (technical difficulty) technology with Palo Alto and that is a positive again for us in the second quarter.

So I don't know if that means that the purse strings are opening more generally over in EMEA but that is kind of what we are seeing specifically to us.

Got it.

And then in terms of where you are investing in additional capacity or additional distribution capacity, can you give us any color on is it spread out evenly for us (inaudible) or is it more of an international focus?

We are investing.

We are investing pretty much everywhere.

We don't want to think that markets done nice is due to I will call it rationalization of where you are putting the dollar and where do you expect to get them is now trying to get a good balance of that on earlier high-growth markets versus more stable places where you might just be splitting territories.

But generally we are investing everywhere because we are still growing very nicely, but we are still underdistributed pretty much on a global basis because the market is so large and there's so many folks (technical difficulty).

Got it.

I think on the last topic you talked about really good volume increases from the PA-200.

I think you talked about greater than 70% unit growth in the quarter.

Any chance you will give an update on that (inaudible)?

No.

I'm sorry, I don't remember that specifically but --.

Yes, on the volumes we don't typically go to the level of granularity around giving product unit growth sequentially year-over-year numbers, but I can tell you just by virtue of the revenue growth unit volumes were up across the board.

Each of the main appliances that we sell had very strong demand in the quarter.

The biggest positive development that we had in this quarter was the traction we had with the PA-3000 which we introduced in November, and the uptake on that was extremely strong.

But I will tell you both the high-end, PA-5000, and the low end the PA-200, they all had nice performance for the quarter.

Thank you.

We have time just to take two more questions one from each of the following parties.

The next question comes from [Frederick Gregg], Nomura.

Just to circle back quickly to the new customers added in the quarter.

Can you give us an idea if the average size of these new customer purchases is increasing and what the dynamics are that's causing those initial purchases to grow?

Yes, a couple of things that the -- so the answer is yes.

The I will call it A is pure on that, continues to go up.

And I think the reason for that again just goes back to the more accepted (inaudible) the more likely you are to make a bigger purchase with us upfront.

As we said many times in the past that we are really not focused on that number.

What we are really focused on is (inaudible) customer and we have a raft of of examples of she spent well over $1 million with us.

It started with a relatively smaller five figure sort of deal but then rapidly ramped into well over $1 million.

So that is what we are focused on is the time -- timing ramp and the bolt on initial purchase.

(technical difficulty).

Shelby Seyfari, FBN Securities.

(technical difficulty).

Your mix effect was negative because of the -- I think you had ramping sales of the 3000 series but you -- I think you hinted that as those sales mature the margins will improve.

So I am just curious about how you see the mix dynamics playing out over the next several quarters.

You also hinted at potentially a new high-end box at some point, higher throughput box.

So it seems like this is a low point in terms of mix.

So any thoughts on the mix dynamics going forward?

Yes as Steffan said it earlier, we have very strong demand for the 3000 (technical difficulty) as with all new, particularly hardware launches, you don't get the same kind of product growth margins you get until you see (technical difficulty) savings.

We expect to see that over time with the 3000 series.

We saw the exact same thing last year roughly at this time the introduction of the PA-200 where it sold really well out the door and had lower gross margins because it was a newer product and that's improved as we expected over time.

And I did say a little earlier that there is demand from part of the customer base for larger devices which we certainly think about.

We did that.

We would launch that device if it had lower gross margin than it would later on when you had increasing demand.

And one thing I'd do is -- note is you should expect us to continue the launch devices in our family of products for probably all the time, based on what we are getting from the customers and where we see the ability to do that.

Thank you.

I would now like to turn the call over to Mark McLaughlin for closing remarks.

Great.

Thanks, again, everybody for being on the call today.

I want to reiterate my (technical difficulty) networks team and the support of all of our customers and partners as we continue to revolutionize the enterprise network security market.

Look forward to seeing all of you at our analyst day in New York City on March 21.

Thanks a lot for your time.

Thank you for joining today's conference.

This concludes the presentation and you may now disconnect.

Good day.