Palo Alto Networks Inc (PANW) 2014 Q3 法說會逐字稿

Good day, ladies and gentlemen.

Welcome to the third-quarter 2014 Palo Alto Networks Incorporated earnings conference call.

My name is Denise and I will the operator for today.

(Operator Instructions)

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

I would now turn the conference over to your host for today, Kelsey Turcotte.

Please proceed.

Good afternoon, and thank you for joining us on today's conference call to discuss Palo Alto Networks' fiscal third quarter 2014 financial results.

This call is being broadcast live over the web, and can be accessed on the investor section of the 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.

This afternoon Palo Alto Networks issued a press release announcing the results for its fiscal third quarter ended April 30, 2014 and its settlement of litigation with Juniper Networks.

If you would like a copy of the release, you can access it online at the Company's website.

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 our revenue and earnings per share guidance for our fiscal fourth quarter, target operating models gross margin range, accelerating growth for all of our subscription services, expectations, plans, and strategies relating to our acquisition and integration of Cyvera, demand and adoption of our products and services, including demand for both our higher-end appliances and WildFire products, as well as our subscription services and our competitive position.

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 these 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 February 24, 2014 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 www.investor.paloaltonetworks.com.

Before I turn the call over to Mark, we would like to inform you that we expect our fourth-quarter and full-year FY14 earnings conference call will be held after the market closes on Tuesday, September 9. With that, I will turn the call over to Mark.

Thank you Kelsey, and thank you everyone for joining us this afternoon.

I am pleased to report another strong quarter of growth.

In Q3 revenue grew by 49% year over year to approximately $151 million.

Billings grew 46% year over year to approximately $194 million.

And we delivered non-GAAP EPS of $0.11.

These results were driven by continued strong product demand, robust services growth, and a rapid market share gains in the large and growing strategic enterprise security market.

We also announced this afternoon that we have settled all existing litigation with Juniper.

I'll provide some more details about that later in my remarks.

The enterprise security market has been changing rapidly in the last few years due to a number of factors.

The increasing number and sophistication of attacks has shown enterprises everywhere that cyber attacks are a global, growing, and lasting phenomenon.

This realization has led enterprises to focus on the negative consequences of relying on legacy thinking, legacy technology, and point products to try to secure their networks.

And it is driving the demand for disruptive platform solutions that do not just detect and remediate, but those that can protect and prevent.

We believe that the solution for this challenges is a highly integrated and automated platform that enables enterprises to safely use all applications on their networks and to quickly turn unknown threats into known threats, thereby protecting enterprise from today's most sophisticated attacks.

We built this platform, starting with our next-generation firewall, than continued with our next-generation threat intelligence cloud that allows us to quickly add high-value services to the platform, and now with the addition of Cyvera, we will provide complete protection for the enterprise by extending prevention technology to the endpoint.

This next-generation enterprise security platform approach is driving our success as each of the technically disruptive capabilities we bring to the market are superior to conventional point solutions, and when combined, provide a truly unique solution to address modern security requirements.

We saw a multiple proof points in the value of our platform in the third quarter.

We reported record financial results, we achieved the highest rate of new customer acquisition in the Company's history.

We held a highly successful Ignite User Conference with close to 2,000 attendees, a 100%-plus increase from last year.

We closed the acquisition of Cyvera.

For the third year in a row, Gartner positioned us in a leaders' quadrant of the Magic Quadrant for enterprise network firewalls.

We added more than 600 paid WildFire subscribers, and now have over 2,000 paid subscribers.

We were named Technology Partner of the Year by VMware for our integration with their NSX platform.

We saw very high interest in our new PA 7050 chassis, as well as a large number of inbound requests for demonstrations of our Cyvera endpoint protection technology.

It was a very busy quarter, and I'm really proud of all that the team accomplished.

More important, our continued success momentum in the third quarter positions us well for the future as we rapidly take market share in the global enterprise security market.

At the end of the day we are winning in this market because our enterprise security platform is disruptive and solves very complex and important problems that customers face today.

A few examples of what we did in the third quarter around this are a seven-figure deals to secure the entire network of one of America's largest airports where WildFire was a key differentiator; a win at a premier sports network production company to secure video traffic, where we sold PA 7050s into the data center and PA 5000s into every stadium; and strategic wins for distributed firewall projects at a large electric utility in Japan, as well is Asia's largest casino.

These are just a few examples of how we are serving our customers' needs.

Our customer base grew to well over 17,000 in the third quarter, including continued growing penetration rates into the Global 2000.

This high rate of new customer acquisition, plus demonstrated repeat selling into the install base is the basis for a land-and-expand growth model.

On the expand side of that equation, in Q3 a top 25 customer had to have spent a minimum of $5 million with us in lifetime value to make our top 25 list, and their lifetime value measured by the increase from their first purchase grew to 24.5 times.

This compares to $4.6 million and 21.3 times last quarter.

One of the fastest growing areas for us, both in landing new customers as well as expanding in the install base, is with WildFire, our subscription service for detection and prevention of sophisticated cyber attacks.

On any given day, we typically analyze more than 280,000 unique files with WildFire, and often find over 10,000 new instances of malware, over 70% of which is not detected by traditional security technologies.

Importantly, we then quickly deliver preventative signatures to protect against newly discovered malware through content updates every 30 minutes to paid WildFire subscribers.

This not only provides very fast prevention from future attacks to the customer where the new attack originated, but it also provides proactive protection and prevention from future attacks to the entire paying customer base.

No other company in the security market can provide this level of detection and prevention, and we will soon provide additional and unique prevention capabilities at the endpoint with the integration of the Cyvera endpoint protection technology.

Endpoints are currently the most exposed part of an enterprise to threats, and oftentimes the entry point onto the network for the most damaging and sophisticated attacks.

Legacy endpoint security technology is very far behind the curve on solving this problem, and newer endpoint technologies focuses primarily on detection and forensics.

However, customers want to be proactive rather than just reactive in this battle, and we see time and again they are hungry for prevention capabilities.

That's why we spent more than a year looking at the endpoint security market and ultimately chose to acquire Cyvera due to its unique ability to prevent endpoint attacks at the critical exploit phase.

We are moving quickly to integrate the Cyvera product into our platform by calendar year end, and we believe this endpoint capability will be as disruptive to the endpoint security market as our next-generation firewall and cloud-based subscription services are today in the network security market.

In addition to customers wanting our prevention platform approach at the endpoint, we are also seeing increasing demand in the data center, which is our fastest growing market segment.

That's why we recently introduced the PA 7050, our high-end chassis, which is designed to serve the data center and service provider markets.

Early demand for the chassis is high and we anticipate this being a strong contributor for our future growth.

On the go-to-market front we have been able to attract and develop career paths for some of the best sales talent in the industry.

We continue to optimize our distribution channels globally.

Our customer satisfaction scores are well above industry average, and we know that satisfied customers buy more, which you can see from our lifetime value members.

We will continue to refine territories and add to our major account team to constantly improve the focus that enterprise customers receive from their sales teams and our value-added partners.

Before I turn the call over to Steffan I want to provide some details around the settlement we reached with Juniper.

Under the terms of the agreement, the parties have dismissed all existing litigation against each other, have licensed the patents in dispute to each other for the life of the patents, and have entered into a covenant not to sue each other for patent infringement for eight years.

In addition, we will pay Juniper a one-time settlement amount of $175 million, of which $75 million is in cash and $100 million is in shares of our common stock.

There is no royalty being paid as part of the settlement.

As we said from the beginning of this case, we do not believe that we infringe on any Juniper patents, and we still believe this to the be the case.

However, over the course of the last 2.5 years, we have spent a large amount of time, money, and other resources on this litigation.

While we are confident of our position in the case, we believe that this outcome will allow us to continue to focus our efforts on what we do best: innovating and developing new products, servicing our customers, and the growth that results from that.

With that, I'll wrap it up and turn the call over to Steffan.

Steffan?

Thank you, Mark.

Before I get into the details of Q3 results in Q4 guidance, I'd like to note that except for revenue figures that are GAAP, all financial figures are non-GAAP unless stated otherwise.

A reconciliation between GAAP and non-GAAP results can be found in our press release and on our Investor Relations website.

Q3 results once again underscore the power of our land-expand-and-retain strategy and our hybrid sales model.

We added a record number of new customers in Q3, and continue to expand within our existing customer base, where we drive repeat purchasing through sales of our products and recurring services.

Every time we sell or renew a subscription service, it's equivalent to selling a new product, except that we've chosen a SaaS model to deliver and monetize it.

In addition to better visibility to future revenue streams, growth in our subscription services has contributed to ongoing gross margin improvements.

All of these factors were catalysts for record billings, revenue, and deferred revenue in Q3.

Q3 total revenue grew 49% over the prior year, and 7% sequentially to another record of $150.7 million.

The geographic mix of revenue was 66% Americas, 21% EMEA, and 13% APAC.

Compared to the prior year, the Americas grew 56%, EMEA grew 40%, and APAC grew 32%.

We saw broad strength across a wide range of verticals, and we did not have any end customer concentration.

Product subscription and support, the three components of our hybrid SaaS model, all grew well in the quarter.

Product revenue of $84.1 million increased 38% over the prior year and 4% sequentially.

We saw a nice adoption across a number of our different appliance families in the quarter, with particular strength in the contribution from our higher-end appliances, including our newly introduced PA 7050, which is providing greater expansion opportunity in the high-end data center market.

Our recurring services revenue of $66.6 million increased 64% over the prior year and 11% sequentially, and accounted for a 44% share of total revenue.

Looking at its two components our SaaS-based subscription revenue of $32 million increased 71% over the prior year and 11% sequentially.

On a year-over-year basis, we expect that subscription revenue will continue to grow at a faster pace than product revenue.

Support and maintenance revenue of $34.6 million increased 58% over the prior year and 10% sequentially.

Compared to the prior year, billings in Q3 grew 46% to $193.9 million.

Total deferred revenue increased 68% to $367.9 million, and short-term deferred revenue increased 73% to $231.2 million.

Total gross margin was 76.1%, an increase of 200 basis points compared to last year and 80 basis points sequentially.

Our target operating model gross margin range is 73% to 76% as we exit Q4 FY16.

Product gross margin was 76.3%, an increase of 200 basis points year over year and 80 basis points sequentially.

The sequential increase was due in part to contribution from our higher-end appliances and COGS reduction efforts.

As a reminder, we expect there will be fluctuations in our product gross margin, primarily due to mix and the timing of new appliance shipments.

Services gross margin was 75.9%, an increase of 220 basis points year over year and 70 basis points sequentially, due in part to increased contribution from subscription services.

Our results continue to demonstrate the power and leverage of our hybrid SaaS model as we scale our business.

For the quarter, research and development expense was 12.4% of revenue, increasing approximately $0.8 million sequentially to $18.6 million.

Sales and marketing expense was 47.2% of revenue, increasing approximately $5.3 million sequentially to $71.1 million.

New headcount additions, commissions, and expenses associated with both RSA and our annual Ignite User Conference contributed to the increase.

General and administrative expense was 7.4% of revenue, increasing approximately $1.4 million sequentially to $11.3 million.

As a reminder, this does not include our IP litigation expense with Juniper, which was $4.7 million in Q3 2014.

Total headcount at the end of the quarter was 1,556, up from 1,375 at the end of Q2 2014.

This includes the addition of 47 members of the Cyvera team.

In total, operating expenses were $101 million, or 67% of revenue.

Operating margin increased approximately 60 basis points year over year to 9.1%, and increased sequentially 10 basis points.

Our effective tax rate for Q3 was 38%.

Net income for the quarter was approximately $8.7 million, or $0.11 per diluted share using 80.2 million shares, compared with net income of $5.3 million, or $0.07 per diluted share in Q3 2013.

Turning to our GAAP results and the Juniper settlement.

As Mark mentioned, we will pay Juniper a one-time settlement amount that is valued at approximately $175 million.

This consists of a cash payment of $75 million, stock issuance of $70 million, or approximately 1.1 million shares of common stock, and a warrant to purchase $30 million, or approximately 460,000 shares of common stock at a nominal exercise price.

The warrant will be subject to mark-to-market accounting beginning in Q4 FY14 and continuing through no later than Q2 FY15.

We'll exclude this non-cash expense from our future non-GAAP results.

The accounting for the $175 million value of the settlement is as follows.

$113.7 million is a one-time expense reflected in our Q3 2014 GAAP results.

In Q4 2014, the remaining $61.3 million is an intangible asset on the balance sheet, which will be amortized ratably over a five-year period into product cost of goods sold.

Because this is a non-cash charge, we'll exclude the amortization expense from our future non-GAAP financial results.

On a GAAP basis, net loss was $139.1 million or $1.86 per basic and diluted share for the quarter, which includes the $113.7 million expense associated with the settlement with Juniper.

This compares with a Q3 2013 GAAP net loss of $7.3 million, or $0.10 per basic and diluted share.

Turning to the balance sheet, we finished April with cash, cash equivalents, and investments of $471.9 million.

This takes into account the $82.6 million of cash consideration we spent to acquire Cyvera, which closed during the fiscal third quarter.

Cash flow from operations, free cash flow, and free cash flow margin were $34.3 million, $28.4 million, and 18.8% respectively.

Capital expenditures in the quarter totaled $5.9 million.

Q3 tracked at typical linearity, was more backend loaded than Q2.

Our accounts receivable balance was $114.8 million this quarter, up from $86.1 million in Q2, which resulted in DSOs increasing to 60 days, up from 57 days in Q2.

Let me now move to modeling assumptions and our guidance.

I'd like to highlight several assumptions.

First, our strong performance has muted expected seasonality in the business.

Going forward, we would expect Q1 and Q3 to reflect a more typical seasonality pattern.

Second, as we stated previously, we are making the necessary investments in Cyvera, and we anticipate spending $3.5 million in Q4 2014 and $25 million in FY15.

Third, from a cash planning standpoint, we expect full year capital expenditures to be in the range of $42 million to $47 million in FY14, and as a reminder, the cash payment of $75 million to Juniper in Q4 2014 will impact both cash flow from operations and free cash flow.

Finally, our guidance excludes expenses related to the Juniper IP litigation.

Given our settlement with Juniper, after Q4 2014 we no longer expect to incur IP litigation expenses related to this matter.

Turning to guidance.

In Q4 2014, we expect revenue to be in the range of $158 million to $162 million, which represents 41% to 44% growth year over year.

We expect non-GAAP EPS to be approximately $0.10 to $0.11 per share, using 81 million to 83 million shares.

This includes shares issued in the acquisition of Cyvera, as well as the equity component of our settlement with Juniper.

With that, I'll turn the call back over to the operator for Q&A.

Operator?

(Operator Instructions)

[Ramo Wolinchow], Barclays.

Sakit here for Ramo.

Thanks for taking my questions, and congrats on getting the settlement behind you.

Question for Mark.

Now that the settlement is behind you, do you see any changes to your product roadmap, maybe over the next one to two years?

Hello, [Sakit].

Thanks for being on the call.

No, our roadmap is fairly well set right now for the next 12 to 18 months.

We are really focused on the 7050 which we've just launched, the next edition of WildFire, getting NSX out the door, which is already GA, but there will be some improvements to that later on with VMware with the NSX/Palo Alto addition, and also probably some more device changes we will make in the next 12 to 18 months as far as introducing some new parts of the family and devices.

Then the big picture, obviously, is getting the Cyvera integration done so that we have the Cyvera as part of the platform.

That will be done by calendar year end.

So we like the roadmap that we have right now for about the next 12 to 18 months.

Great, that's helpful.

For my follow-up, apologies if I missed it.

Mark, can you talk about the subscription attach rate on WildFire in the quarter?

Is there any reason to think that that subscription rate couldn't approach maybe the rates that you see on your other three offerings?

Sure.

The subscription attach rate in the quarter was well over 35%, so a good growth in attach rate.

We added over 600 paid WildFire subscribers.

So the paid base is over 2,000 subscribers now.

I think about that in a number of ways.

The paid subscribers against the total base of our customers, which is well over 17,000, is more than 10% of the customer base using the paid-for portion of this technology today.

We think that will continue to grow over time.

Or a different way to think about it is there's no reason to think that WildFire can't grow to the size of our UR web-filtering business or threat prevention business over time, and it looks like it's heading in that direction.

Next question, please.

Keith West with Morgan Stanley.

Thank you, guys, for taking the question.

Very nice quarter.

Wanted to talk a little bit about WildFire.

You guys mentioned WildFire being a key differentiator in getting [into] some large deals.

Could you talk to us a little bit about the competitive environment around WildFire?

It seems like a lot of vendors coming into this space with a (technical difficulties) threat solution or a sandboxing solution.

How do you see that competitive environment putting out, and where are you doing best, in terms of against competitors?

Sure, Keith.

Thanks for being on the call.

WildFire is very important to us as a differentiator.

I think it's moving through phases.

The first phase for us was as a door opener, in order to be able to speak around cyber security, advanced persistent threats at the highest levels in companies, and we got a lot of traction from that.

It's into its selling phase now, meaning that it is selling very, very nicely.

Attach rates are high.

The reps really like to talk about it.

The customers are very interested in it.

I think is where it's settling out now is it's part of our platform.

Just like the other components of the platform, it's the entire platform working together that's really unique and disruptive in the market, and that is what differentiates us from all the competition, not just WildFire.

It's all those components working very, very well to gather in one automated platform approach, and soon to have Cyvera in that as well.

The highest level, the difference between us and everybody else in the market who's got a solution like this is the difference between detection and prevention.

Everybody either has or say they has advanced detection capabilities for advanced persistent threats.

We're unique in having the most advanced detection capabilities, but because we are the firewall, the ability to do prevention as well.

That's absolutely critical for companies as they think about protection and prevention.

Got it.

Maybe just a follow-on on that in terms of partnerships around WildFire.

You guys talked about the detection and prevention, but remediation is definitely part of the equation.

Can you talk to us about how your partnerships are evolving around (inaudible) fill out that side of the equation?

We are very open for partnerships across the board.

The way we think about the business, not just WildFire, is what's right for the customer.

Customers definitely want the ability to do detection, which we do.

They definitely want the ability to do prevention, which we're unique in, and some stuff will get through.

The idea that you'd want to have some forensics capabilities, some remediation capabilities, is true.

There's nothing wrong with that.

Over time that should abate as prevention capabilities get better, but that's definitely needed in the market today, and we are very open to partnerships across the board with folks who can do those sorts of things for customers, even in some competitive examples.

We have Cyvera.

We are partnered with some of the endpoint technology providers, and other folks in the market because that's what customers are asking for.

We want to deliver the solution they're looking for.

Next question, please.

Karl Keirstead with Deutsche Bank.

Hi, thanks.

One for Mark and maybe one for Steffan.

Mark, first of all congratulations on getting that IP litigation risk off the Company and the stock.

Actually, that's where I wanted to ask you.

You've disclosed in the press release the financial settlement.

I just wanted to ask you what it means more broadly for Palo Alto Networks in terms of potentially getting management focused 100% on the business now.

To the extent that you had a workaround team in place, I presume those resources are freed up.

Maybe it takes away an issue that your competitors were throwing at customers in bid situations.

Can you give a perspective on maybe what some of the indirect benefits might be for getting this out of the way?

I think there's the very tangible benefits of we're not spending millions of dollars a quarter in legal expenses on a go-forward basis.

From a management perspective, the burden of all this is primarily fall on myself, Steffan, and our General Counsel, Jeff True did a fantastic job on all of this, by the way.

And not much beyond that.

We have had a lot of focus on the litigation, but frankly it's been primarily from investors, and I understand why.

It is an important thing, but that's where a lot of our time and attention was from management perspective.

From our legal team's perspective, obviously, they've been spending a lot of time on this, as well.

Below that or around that, on the sales side we got very, very few questions about the litigation from the minute it was filed up until today, even less so over time.

It doesn't appear to have impacted our selling whatsoever.

If that happened, it's behind us now.

But it doesn't look like it's the case.

From an engineering perspective, the team's been very heads-down on the product roadmap, really not worrying about the litigation aspect of trying to do engineering work around it.

The outcome was always uncertain and we don't think we infringe in the first place.

The team, the engineering team, hasn't been focused on this at all.

Great color.

If I could follow up with Steffan.

The maintenance support growth, 58%.

Still tracking at a very healthy clip and well above what the product revenue growth is growing, or is.

So I'm just curious.

What are the factors propping up that support maintenance line?

Is your renewal rate increasing?

Perhaps a little color there.

Thank you.

Maintenance has been performing at a very high clip.

It grew 10% sequentially, 58% year over year.

It's a differentiated products that we have.

You can't really buy a platform and an appliance without buying maintenance services.

The value-added engineering that we're putting into releases and fixes, et cetera, customers have to have maintenance.

So the attach rate on maintenance has historically been very high.

As we sell larger appliances down the road, we will have an incremental dollars benefit, dollar contribution benefit from maintenance revenue as well.

So we have a great customer support team.

Our customer satisfaction scores continue to be best-in-class, and we view that line as a competitive differentiator.

Next question, please.

Phil Winslow with Credit Suisse.

Hi.

Thanks, guys.

Congrats on a great quarter, and the settlement as well.

Just two quick questions.

First on the pricing environment out there.

You guys had another strong gross margin quarter coming ahead of our numbers on the Street.

Wondering if you could comment on the pricing environment that you are seeing out there.

Then just one follow-up to that.

The competition has been pretty aggressive on pricing for quite some time in response to our success.

It's not any news that they continue to price very, very aggressively.

We've been able to hold the line on that for a long time now, as we've reported every quarter, as you can see from the gross margin discounting.

This is the premium security technology network in the market today with a platform approach, and people understand that and are willing to pay for that.

On the gross margin side, on the product side, we had a fairly nice lift from our higher-end appliances and the 7050 and the 5000, and even the 3000 series, which carry a nice gross margin.

So that's what you saw in this quarter.

And just an add-on point to that, we really look at our product portfolio as a platform.

When you have a hybrid SaaS model with high attach rates on subscription services, and you look at the benefit to the total gross margin, we are seeing a tailwind around the benefit that we're are getting from subscriptions.

So we are holding the discounting line on products.

We're selling more higher-end appliances, and the power of the subscription model is coming into play here.

Great.

Thanks, guys.

Just a quick follow-up with Cyvera.

Hoping to get to some early feedback from customers as you been talking to them about the product.

It's really great.

We have a lot of inbound requests from our existing customer base, particularly the large customers, wanting to understand how the technology works.

I think they've got a good sense of what are description was of it being very different.

Now they want to touch it, they want to test it.

There's a lot of interest in doing POCs with them.

We're going to manage that very carefully so that we can get those done, but in a very high quality manner from getting the technology to where it needs to be, and also the ability to support it and sell it in the field.

So we have a plan around all of that.

You will see a lot of activity in the fall around this product coming to market.

Next question, please.

(Operator Instructions)

Greg Moskowitz with Cowen and Company.

Thank you very much.

Congratulations, as well, on the settlement.

Mark, from a demand driver standpoint, just wondering if you have an updated view that you can share with us regarding magnitude or timing of a possible network refresh cycle?

Greg, it's hard to tell, right?

Those are inexact things.

Our best way to gauge that kind of thing, as it turns out, I think is coming from our major accounts team.

We've put a tremendous amount of effort, as you've heard, into major accounts in the last 18 months or so.

Our uptick in the GT 2000 accounts, we're adding a couple dozen or more every quarter.

We've got over 800 and some GT 2000 accounts now.

We keep adding more every quarter, and we get visibility into those accounts on a long-term roadmap perspective.

These are really big companies' long-term roadmaps.

We are getting our own sense of what they're thinking about doing, and the level of interest in moving to next-generation technology I would say is very high, generally.

Specifically, the things we're doing on the virtualization side, almost 100% hit rate on door-openers and conversations around that.

Then obviously cyber security is top of mind for everybody, as well.

It's, again, back to the platform approach.

We do all those things in the platform.

So instead of thinking about things as firewall refresh cycles, I think people are thinking about moving to the next generation of technology in the face of the really complex things they have to face today.

I think we are a big beneficiary of that, and are going to continue to do that in the future.

That's helpful.

A follow-up for Steffan.

You mentioned that you have now over 2,000 paid users of WildFire.

Just wondering how many total WildFire customers exist today encompassing both free and paid?

Greg, it's Mark.

We have close to 4,000 total customers today.

Like I say, we've added over 600 paying customers in the quarter.

Next question, please.

Rob Owens with Pacific Crest.

Great.

Thank you very much.

Couple questions.

You mentioned this was the highest rate of customer acquisition in the Company's history.

Maybe a little bit more color there.

Security is obviously been in the spotlight.

There's been speculation around what this refresh could look like.

Coming off the quarter with the highest customer acquisition in history, maybe just some color on what (inaudible) the pipe looks like.

Well, well over 1,000 customers.

This is our 9th or 10th quarter in a row, I'm losing track here, over 1,000 in this quarter, and like I said the highest one we've had.

Very importantly around that, Rob, as well as it's great to feed the funnel at the top under the land part of this, but the expand side is equally as interesting for us.

The number we share every quarter on the LTV of the top 25 just continues to go up and to the right.

This is the second quarter or third quarter, I have to go back and look at the data, but every top 25 customer purchased again in the quarter.

So with the way we think about that, is over 17,500 total customers today, all of which continued to do repeat purchasing patterns that are following the trends of those top 25.

So just a lot of existing additional sales to be made to the existing base, and then throwing in 1,000-plus new customers every quarter is just a great model.

As we approach Q4 here, and I know gun for Q4, any high-level thoughts around 2015?

Maybe just where we should see product revenue at a minimum?

We are going to be updating folks on modeling assumptions for FY15 at the end of the Q4 call.

I can tell you that our goal is to continue to outpace the market in terms of growth rate and in the competitive landscape.

We are definitely committed to continuing to prudently and consciously invest in parts of the business that have a good ROI, and you can see the results that we've been posting.

So our plan is to continue to grow at a very brisk pace in FY15.

Including on the product side.

Next question, please.

Jonathan Ho with William Blair.

Hello, guys.

Congratulations on the strong quarter.

Just wanted to get a sense from you, as you've released this new VMware product, can you give us a sense of maybe what that opportunity looks like and what type of contribution you are looking for?

Maybe not for this fiscal year, but in the short run, and how that would potentially scale over time?

Definitely a tailwind for us, I think.

Just from my own experience out talking to prospects about this and existing customers, and what I hear from the field.

It is, like I said, a close to 100% hit rate on when you have this conversation with folks that you are definitely invited back for the next meeting if they are VMware customers today.

VMware spent a lot of time and effort into the NSX platform itself, which certainly helps us since we are integrated into that platform.

They have trained up specialized sales folks who are training their entire sales team on this as well.

The product is now GA, and as far as all of the field work that needs to be done with their folks, comp plans, all that kind stuff, my understanding is that's all completed and they will be bringing that to market in an organized way in June.

So I would expect, just from the pipeline we're seeing in interest level, that this is going to be a good thing for us as it plays itself out through the end of this calendar year and into calendar 2015.

It's a fairly complex sale.

This is virtualized data center stuff.

These are not 30-day sales.

These are longer sales.

We definitely have the benefit of having VMware really organized and rallied around this as well in addition to our own sales team.

I think good things are going to happen from this.

Great.

Just as a follow-up.

In terms of your international distribution opportunity, clearly the Americans region is showing some strength here.

How do you guys think about seeing similar growth materialize in terms of the international components over time?

The international markets are great markets for us, as you can see from our numbers.

We are growing as a Company at very, very high rates.

I would say at pretty good scale.

When you look at the Americas, which is the largest contributor to this from a revenue perspective, and its growth rate is fantastic.

You look at the international side, which is less mature in the sense of when we came to market with that, and the development of the teams and territories and all the things you do to grow markets, all growing at very nice rates, as well.

I think on an absolute dollar basis, if you get outside the United States here and look at just how many dollars we bring in a quarter, say, in APAC, for example versus what all the companies in that region spend on security technology, it's just the tip of the iceberg.

We are committed to the international markets.

They are performing well for us, and we think they're going to be great contributors over the long haul for us.

Next question, please.

Eric Suppiger with JMP.

Congratulations on a good quarter.

First off, how much of a factor has the litigation been with Juniper, in terms of your sales, sales execution?

How much do think that getting that settlement behind you will change your sales prospects going forward?

Eric, as I was saying a little earlier, it doesn't appear that we really had any impact from a selling perspective from the litigation.

The number of times that I got asked about it by somebody in the field to talk to a customer, Steffan, are maybe 10 in 2.5 years.

The bottoms-up feedback from the field is this has not been a significant issue from going-to-market.

The numbers wouldn't suggest it is either.

So, but if it were in a way that was not visible to us, that's now removed, and that's a good thing for us.

Okay.

Steffan, can you give us a little sense from what we can expect from a cash-from-operations outlook for next quarter?

What we should think about with CapEx?

What we ended up giving was some guidance on CapEx, which for the full year we are looking at $42 million to $47 million in CapEx.

To date we've spent around, call it, $31 million, $32 million of CapEx.

So there will be some additional CapEx in Q4.

As far as cash flow from operations or free cash flow, we would expect to deliver healthy free cash flow, cash flow from operations.

You're going to have to exclude the $75 million payment to Juniper.

Kind of looking at pro forma cash flow for that.

So we expect to continue to drive healthy free cash flows.

Part of that hybrid SaaS model that we have has been a differentiator for us from a business model standpoint.

Our free cash flow margins tend to be, call it anywhere between 8% to 12% higher than our operating margins.

That's because how we license and how we go-to-market.

So we think that free cash flow and cash flow from ops will continue to grow healthily.

Next question, please.

Gray Powell with Wells Fargo.

Great.

Thanks for taking the question.

Can you talk about the integration of your Morta acquisition with WildFire?

I believe some of Morta's capabilities were going to be introduced into the next version of WildFire.

Can you update us there on the timing and the additional functionality that Morta brings?

Yes.

The Morta acquisition for us was about getting two things.

One was an extremely talented group of guys who have a lot of expertise and have built technology about a second thing, which is really the subtle -- subtleties of lateral movement of APTs and malware through networks, which is becoming more and more important in the data center as things find their way in there.

So they're moving quietly through the network into the data center.

When we use the terms detection and prevention, this would fall really into the detection side of if something was in your network being able to see it was there so that you could then protect against it.

That technology is well along in its path and integration into the whole platform, including WildFire by the end of this calendar year.

You should see that in the next release of WildFire early next year.

But we are excited about that, the technology we got there, and it does a lot of great things around a very sophisticated detection.

Got it.

Thank you very much.

Next question, please.

Walter Pritchard with Citigroup.

Hi.

Steffan, wondering, you talked about strong sales of the 7050.

Can you talk of you had any supplies constraints or any troubles fulfilling demand on that product during the quarter?

No, thankfully we didn't.

We had very good product demand planning cycles that we go through.

We have a stellar operations and project management team who are able to forecast, and we have very close customer intimacy.

So we had a good handle on what the demand was coming into the quarter.

So we were well situated to fulfill that demand.

Got it.

On the attach rate, you talked a little bit about the WildFire attach rate.

I'm wondering, looking at some of the more mature subscriptions like URL and IPS and GlobalProtect, are you at a point there where those have sort of steadied out and plateaued in terms of the attach you are seeing coming in on new purchases?

Or are we still seeing those escalate as the quarters go on?

Interestingly enough, each of the subscriptions that we had this quarter all grew sequentially, which was nice.

As we've mentioned before in threat prevention, filtering, are already at a very high rate.

The sequential growth rate will, by definition, be just a little bit less.

But as you point out, it's really the power of the platform, and the subscriptions are a big differentiator, and we have -- pursuing an integrated appliance, which is a big differentiator for us.

Next question, please.

Daniel Ives with FBR Capital Markets.

Good, thanks.

Look, obviously you guys are doing a great job on the larger deals.

Maybe you could sort of talk about, have you seen a difference strategically, in terms of recent attacks, like Target and eBay in terms of just going up to a C-level or board level in terms of fast-track on some of the cyber security initiatives?

Hello, Dan.

I think it's definitely the case because of these high profile, very well-publicized attacks that folks are seeing that the ability to have a conversation around cyber security, advanced persistent threats, and then very importantly, the high differentiation of a platform that can do protection or prevention, doesn't hurt us at all.

These things all play to our favor.

Our sales guys, they definitely understand how to take advantage of that, and they've been doing that very successfully in the field.

Thanks.

Next question, please.

Scott Zeller with Needham and Company.

Thank you.

Is there any color you can offer us on the number of opportunities where customers are standardizing on Palo Alto as a platform?

I would say lots and lots of cases of standardization.

The reason for the pause there for a second was that when companies standardize on Palo Alto, particularly large companies, that that is the beginning of a multi-year process of putting Palo Alto all throughout the enterprise, all throughout the network.

That take time.

Interestingly, that's one of the reasons you see on LTV of the top 25, our ability to come on the phone every quarter and say that number goes up, everybody's buying every quarter.

Those companies begin with an initial purchase for something, and then ultimately, or in a lot of cases say, we are going to make Palo Alto Networks the backbone of our enterprise network security.

Then that manifests itself through all these repeat purchases.

Only the customer knows what the big picture roadmap around those things look like.

We get the visibility into that in our strategic planning sessions with them.

And then what we see on a quarterly basis when they are putting in orders against what they've shared with us from those decisions.

But I think when you just think about over 60% of our base today is using us as a firewall, over 75% of our initial sales are as a firewall, That's a great indicator of standardization when you become the firewall for an enterprise

Thank you.

Next question, please.

Brent Thill with UBS.

Mark, you mentioned the data center's the fastest-growing segment in the business.

I'm curious, if you could just give us a mile marker, where you think you are, and if you had some achievements you'd like to put on the board in that segment, how would you look at that over the next year?

I think it's early innings around that, Brent, for two reasons.

The first is, is that for the data center itself, having the next-generation capabilities we bring to that has been very interesting for customers for some time.

The ability in the north-south traffic to now do that at 100 gig-plus just opens up tons of possibility for existing customers who are already using us and new customers where they were looking for that throughput requirement, and then the Greenfield opportunity in the data center is really in the virtualization space with their own VMware series or the NSX technology for east-west protection.

That's a use case that is fairly new for companies, really starting to understand they have to provide that same level of next-generation security to their own traffic in the data center.

That's not something that they had to do before, before APTs became so prevalent, for example.

The combination of those two things, which is very high throughput north-south, east-west Greenfield opportunity.

But being the only company that can do the next-generation platform capabilities in both of those instances is a tremendous opportunity for us.

Like I said, I think it's early innings in all that for us.

Okay.

For Steffan, on the subscription attach, just more to Walter's question on if you look through each of the big buckets, is there a simple attach rate you can give us on each of those to just give us a sense of where each of those are at?

Or are you not going in that level of detail?

Historically what we've done is semiannually we give the total metric.

We don't get into each specific subscription.

So as of Q2, we had an attach rate of about 1.9 across the -- as an average across the four subscription.

That metric has increased over the last several periods.

The reason why it's increasing is customers are continually looking for an integrated solution so they don't have to have a proliferation of devices behind the firewall.

The elegance of the platform with the subscriptions provides a big differentiator.

Next question.

Shaul Eyal with Oppenheimer.

Thank you.

Hi, good afternoon, guys.

Congrats on a good quarter and the settlement.

You had a very solid quarter in APAC.

Have you been displacing anyone, as some of your peers have been seeing some softness in that region?

Just as a general matter, you should assume that regardless of where we on the world, almost 100% of our sales are displacement sales.

Generally somebody is loosing for us to win, and we do that at very high rates.

It doesn't matter around the geography.

I mentioned just a few things we did in APAC in the last quarter, the largest casino in Asia, for example.

Electric utility in Japan.

Both are displacements in those cases.

Again, almost everything we do is a displacement.

Fair enough.

Steffan, are you looking any different on capitalization in light of the settlement?

Obviously, you've got plenty of cash, even when embedding the settlement.

Currency is probably about to get stronger near term.

Any views you can share with us on that point?

We feel good with our cash position right now.

I think as a differentiator to our business model relative to some other folks out there, we've been able to generate over $80 million in free cash flow fiscal year to date.

We will look to keep our options open.

But we feel comfortable with our cash position and our ability to continue to generate cash.

We have time for one last question, please.

Fred Grieb with Nomura.

Hello, guys.

Congrats on the settlement.

Hopped on a bit late.

So apologize if this has already been asked.

Can you give us an update on the Cyvera acquisition?

I'm curious whether this is having any impact on customers conversations or bringing more customers essentially to you.

It's been very positive for us.

As far as selling the product, we will be doing that in a very organized approach in the fall of this year, meaning having it integrated into the platform, having the salespeople know how to sell it, and the support personnel who can support that.

Putting that aside for a second though, this is another instance of being able to have really strategic conversations with folks in companies.

A great door-opener for us right now.

We're definitely talking about this.

We are talking about how it fills out the third corner of our enterprise security platform.

So we have the firewall, we have the cloud, and now we have the endpoint as well.

That's resonating very well.

As a result of that, the interest level, like I said earlier in the call, is very high.

The request for POCs are off the charts.

So we've got more inbound interest than we can handle at the moment.

We want to make sure we do that in a very organized way.

We bring this to market, it's Palo Alto Networks quality.

Great.

Thanks a lot.

We have no further questions.

I would now turn the call back over to management for closing remarks.

Please proceed.

Thanks, operator.

Thanks everyone for being on the call this afternoon, and I want to say a special thank you to all the Palo Alto Networks team for all the hard work in support of our customers and partners as we continue to redefine the next generation of enterprise security.

We appreciate your interest in the Company.

Thanks.

This concludes today's conference.

You may now disconnect.

Have a great day.