Palo Alto Networks Inc (PANW) 2014 Q4 法說會逐字稿

Good day, ladies and gentleman, and welcome to the fourth-quarter and full-year FY14 earnings conference call.

My name is Jasmine and I will be your operator for today.

(Operator Instructions)

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

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

Please proceed.

Great, thank you.

Good afternoon, and thank you for joining us on today's conference call to discuss Palo Alto Networks' fiscal fourth-quarter and FY14 full-year 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 fourth quarter and full year ended July 31, 2014.

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 first quarter, targeted operating model gross margin range, expectations regarding revenue, cost and expenses.

Billings, free cash flow, capital expenditures, expected tax rate and our share count.

Our ability to accelerate growth in our market share, expectations relating to our acquisition of Cyvera, demand for and adoption of our products and services, expected availability and efficacy of new products 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 those anticipated by these statements.

These forward-looking statements apply as of today, and you should not rely on them as representing our views in the future.

We undertake no obligation to update these statements after this call.

For a more detailed descriptions of these risks and uncertainties, please refer to our quarterly report on Form 10-Q filed with the SEC on June 3, 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 supplemental financial information that can be found in the Investor section of our website located at Investors.

PaloAltoNetworks.com.

Before I turn the call over to Mark, we would like to inform you that we expect our first-quarter FY15 earnings conference call will be held after the market closes on Monday, November 24.

In addition, we would like to invite you to participate in an investor webinar on Tuesday, September 30, at 1:30 PM Eastern, 10:30 AM Pacific, to discuss our next-generation security platform and technology differentiation.

Webcasting information can be found on our website at Investors.

PaloAltoNetworks.com.

And with that, I'll turn the call over to Mark.

Thanks, Kelsey.

Thanks, everyone, for joining us this afternoon.

I'm happy to be a today to share with your our results for our fiscal fourth-quarter and full FY14.

We continue to see a large amount of momentum in the business, and Q4 was strong across the board.

We delivered record billings and revenue, with revenue for the fourth quarter growing 18% sequentially, and 59% year over year to $178 million, along with Q4 non-GAAP earnings per share of $0.11.

It was a great end to a very good year for us, and I'd like to thank the Palo Alto Networks team for their hard work, and our customers and partners for their ongoing support.

Our results continue to demonstrate our ability to significantly top-grow both our competitors and the market, and we are more confident than ever that our platform architecture and strategy is unique, compelling and far ahead of the competition.

In addition to our strong financial performance, we also celebrated a number of milestones and highlights.

In Q4, we added a record number of new customers by a wide margin, and we are now privileged to serve more than 19,000 global customers, up from 13,500 at the beginning of the fiscal year.

This customer base is highly diversified across verticals and geographies, and includes more than 850 of the Global 2000 and 75 of the Fortune 100.

On this list are some of the largest high-tech financial services, government, manufacturing and service provider organizations in the world, who entrust their security to our unique platform and superior solutions.

New customer wins this quarter include a large US retailer, where we replaced Cisco to become their enterprise-wide security platform.

A Canadian government agency, where we beat Check Point and replaced Juniper to become their agency-wide security provider.

And a substantial expansion of our footprint in one of Check Point's largest global customers in financial services.

In addition to continued acceleration in the pace of new customer acquisition, the size and commitments from our customers is growing, underscoring our momentum in the market and the power of our platform.

To make our top 25 customer list in the fourth quarter, the customer had to have spent a minimum of $5.6 million in lifetime value, a good measure of the power of our land and expand model.

This threshold is a more than 10% increase over last quarter, and a more than 50% increase over last year.

And if I expand this list to our top 100 customers, each has spent a minimum of $2.3 million on our solutions, up 20% sequentially and 75% year over year.

Customers across our installed base continue to make larger and larger commitments to us as they remove legacy technologies and point products in favor of our next-generation security platform.

On the product side, we generated significant traction with our newly introduced security offerings.

Sales of our PA 7050 chassis significantly exceeded our internal forecast as our customers move to adopt Palo Alto Networks as the platform of choice in high-throughput environments like the data center.

We also see a strong pipeline for our Palo Alto Networks for NSX offering with our partner VMware.

And we were happy to close a number of deals in the quarter around the solution, including a new opportunity with one of the most highly recognized brands of the world.

The data center is one of our fastest-growing use cases, as enterprises realize the need for the most advanced security at the highest levels of enterprise performance for both north-south and east-west traffic protection.

On the scripts and services side, we had another great quarter with WildFire, the market's only advanced persistent threat detection and prevention offering.

In Q4 we added a record number of paid customers, bringing our total paid base to over 3,000.

We achieved this footprint in just under two years, making us one of the largest APT solution providers by customer count in the market.

WildFire attach rates on devices shipped grew to over 40% in the quarter.

And we're not resting on our laurels.

To further extend our technology leadership in the APT solution space, we recently reduced the average time from APT detection to prevention to approximately 15 minutes, down from approximately 28 minutes last quarter.

We will continue to aggressively compress this timeframe to provide the best prevention capabilities to our customer base, which is clearly voting for the power of the highly integrated and automated capabilities in our platform versus standalone point products.

The newest addition to our platform is TRAPS, the advanced endpoint protection offering we acquired with Cyvera in the spring.

We have ambitious and aggressive plans for TRAPS, and we're very happy to report they were hitting all our milestones.

Integration of the two companies is going well.

We have completed proof of concepts with major customers who have very strong interest in unique exploit prevention capabilities in the offering, especially with the added integration with WildFire.

We will make this new version of TRAPS generally available to market by the end of September, and look forward to updating you on our progress throughout our new fiscal year.

Our sustainable growth is not only driven by unique and differentiated technology, but also by highly productive and meaningful distribution partnerships.

We'd like to thank our global partners for their dedication and support in FY14, as they're key to our success.

We will continue to focus on increasing distribution and expanding routes to market with strategic partners like Westcon Group.

In fact, in August, we announced that we will now be doing business with Westcon in over 40 countries.

Our unique and differentiated offerings, combined with our global distribution capacity and logistics capabilities, will generate significant opportunities for both Companies.

And we also recently announced the creation of Unit 42, our new threat intelligence team, which will provide actionable security-related context to our customers and further enhance our ability to prevent future attacks.

And finally, we took advantage of a market window to complete a convertible debt offering on very favorable terms.

The net proceeds of just over $525 million add additional resources to our already-strong balance sheet.

In hindsight, this was a very productive quarter and year for us.

Our market-leading, consistent growth is due to the superiority of our unique platform approach to security.

Unlike other providers in the security market, we have a true platform that is designed and built from the ground up.

We provide tightly integrated and automated detection and prevention capabilities at enterprise-class performance levels, and have proven to be extremely flexible and extensible in the face of ever-changing security needs.

We do this for all users, on all devices, on all parts of the network, all the time.

And we believe that our results demonstrate that the market is quickly adopting Palo Alto Networks as a leading enterprise security platform.

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

Thank you, Mark.

And thank you for joining us on our call today.

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

Let me start with an overview.

The acceleration of customer acquisition, billings, revenue and adjusted free cash flow underscore the power of our land, expand and retain strategy.

The enterprise security market is 16 billion, growing to over 19 billion in 2017, and we're substantially outpacing the growth rates of both our competitors and our addressable market.

We continue to balance investment and growth of profitability, and our hybrid SaaS model plays a key role in our success, with increasing revenue visibility, leverage and cash flow generation.

Our results highlight the differentiation of our solutions and the power of our financial model.

Turning to the numbers.

Q4 total revenue grew 59% over the prior year and 18% sequentially, to another record of $178.2 million.

For the fiscal year, we reported revenue of $598.2 million, a 51% increase over the prior year.

The geographic mix of revenue for Q4 was 68% Americas, 21% EMEA and 11% APAC.

Compared to the prior year, the Americas grew 74%, EMEA grew 54% and APAC grew 7%.

As in previous quarters, 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 very well in FY14, with particular strength in Q4.

Q4 product revenue of $99.7 million increased 52% over the prior year and 19% sequentially.

We saw strong demand across our entire product family, with particular strength in the contribution from our highest-end appliances, including the PA 7050, which is providing greater opportunity in the data center market.

When we ship a product, we typically bill and recognize all of the revenue at the time of shipment.

Our recurring services revenue of $78.5 million increased 67% over the prior year and 18% sequentially, and, accounted for a 44% share of total revenue.

Recurring services are built at the time of shipment, and revenue is recognized over the duration of the contract.

Looking at the two components of recurring services, the first component is our SaaS-based subscription revenue of $37.6 million, which increased 74% over the prior year and 18% sequentially.

We currently have four subscription services, each priced at 20% of the appliance list rise per year.

In the fourth quarter, customers purchased on average 2.1 subscriptions per devices, compared to 1.9 in Q2 FY14 and 1.7 in Q4 FY13, as they continue to move to our integrated platform approach versus standalone offerings.

Support and maintenance revenue, the second component of recurring services, was $40.9 million, an increase of 62% over the prior year and 18% sequentially.

Support and maintenance is priced at approximately 16% of the appliance list price per year.

Billings in Q4 were $232.9 million, an increase of 64% year over year and 20% sequentially.

From an annual perspective, total billings for FY14 were $771.4 million, and grew 51% year over year.

Product billings were $340.2 million, and grew 40%, accounting for 44% of total billings.

Support billings were $216.7 million, and grew 59%, accounting for 28% of total billings.

And subscription billings were $214.5 million, and grew 65%, accounting for 28% of total billings.

Growth in recurring services billings positively impacts deferred revenue.

Total deferred revenue in Q4 was $422.6 million, an increase of 70% year over year and 15% sequentially.

Short-term deferred revenue increased to $259.9 million, an increase of 69% year over year and 12% sequentially.

Total gross margin for Q4 was 76.7%, an increase of 220 basis points compared to last year and 60 basis points sequentially.

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

Product gross margin was 75.7%, an increase of 50 basis points year over year and a decrease of 60 basis points sequentially.

We expect there will be fluctuations in product gross margin, primarily due to product mix, which was the case this quarter.

Services gross margin for Q4 was 78%, an increase of 450 basis points year over year and 210 basis points sequentially, due in part to ongoing growth in the contribution from subscription services.

For the quarter, research and development expense was 11.6% of revenue, increasing approximately $2.1 million sequentially to $20.8 million.

This was primarily due to the addition of Cyvera.

Sales and marketing expense for Q4 was 51.9% of revenue, increasing approximately $21.5 million sequentially to $92.6 million.

The primary driver of sales and marketing expense was sales commissions and end-of-year accelerators attributable to very strong top-line performance in Q4.

It is worth noting that we incur the full commission expense when the order is booked, but recognize revenue for the majority of an order ratably over the term of the contract, which does not match the expense with the revenue in the quarter.

General and administrative expense for Q4 was 5.1% of revenue, decreasing approximately $2.3 million sequentially to $9 million.

As a reminder, non-GAAP G&A expense does not include the final IP litigation expense of approximately $2 million related to the settlement announced with Juniper earlier this quarter.

Total headcount at the end of the quarter was 1,722, up from 1,556 at the end of Q3 FY14.

In total, Q4 operating expenses were $122.3 million or 68.6% of revenue.

Operating margin grew 10 basis points year over year to 8.1%, and decreased sequentially 100 basis points.

As I mentioned, momentum in the business drove especially strong performance this quarter, which amplified the typical commission-related seasonality we anticipate at fiscal year-end.

We expect to see sequential improvement in non-GAAP operating margin in Q1 FY15.

Our effective non-GAAP tax rate for Q4 and FY14 was 38%.

And net income for the quarter was approximately $9.1 million or $0.11 per diluted share, using 83 million shares, compared with net income of $5.5 million or $0.07 per diluted share in Q4 2013.

For FY14, we reported net income of $31.8 million or $0.40 per diluted share, compared with net income of $18.2 million or $0.24 per share diluted share in FY13.

On a GAAP basis for the fourth quarter, net loss was $32.1 million or $0.41 per basic and diluted share.

This compares with a Q4 2013 GAAP net loss of $15.8 million or $0.22 per basic and diluted share.

And for the full FY14, we reported GAAP net loss of $226.5 million or $3.05 per basic and diluted share, compared to GAAP net loss of $29.2 million or $0.43 per basic and diluted share in FY13.

The increase in GAAP net loss was primarily driven by settlement expenses.

We finished July with cash, cash equivalents and investments of $974.4 million.

This includes the $527.7 million of net proceeds from our offering of Convertible Senior Notes due in 2019, which priced at a 0% interest rate in June.

Excluding the $75 million cash settlement payment related to Juniper, our adjusted cash flow from operations, free cash flow and free cash flow margin for Q4 were $48.9 million, $44.1 million and 24.8%, respectively.

Capital expenditures in the quarter totaled $4.7 million.

For FY14, adjusted cash flow from operations and adjusted free cash flow were $163.4 million and $127.3 million, respectively.

Capital expenditures for the year totaled $36.1 million.

Consistent with the strength we saw in the quarter, linearity in Q4 tracked slightly better than both Q3 and the prior-year period.

Our accounts receivable balance was $135.5 million this quarter, up from $114.8 million in Q3.

DSOs increased sequentially by 3 days to 63, and declined year over year by 9 days.

Turning to guidance.

In Q1 2015, we expect revenue to be in the range of $178 million to $182 million, which represents 39% to 42% growth year over year.

We expect non-GAAP EPS to be approximately $0.12 per share, using 83 million to 85 million shares.

Before I conclude, I'd like to highlight a number of considerations for modeling purposes.

While seasonality has been difficult to determine due to strong growth, we believe that over the longer term, fiscal Q2 and Q4 may show our strongest sequential growth in revenue.

And as we said previously, in FY15, we expect to invest approximately $25 million or approximately $0.18 and $0.19 per share in TRAPS, our advanced endpoint protection offering, which we acquired with Cyvera.

Pricing for TRAPS will be on a per endpoint basis, and we expect billings and free cash flow to ramp in the back half of FY15, and meaningful revenue contributions to begin in FY16, given the subscription nature of this offering.

We expect CapEx for FY15 to be in the range of $45 million to $50 million for the year.

And we expect to exit FY15 with a low-teens non-GAAP operating margin.

And we continue to expect to exit Q4 of FY16 at a 22% to 25% non-GAAP operating margin.

The effective tax rate for FY15 will be 38% on a non-GAAP basis, and our share count is expected to increase by approximately 1% to 2% per quarter.

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

(Operator Instructions)

Phil Winslow with Credit Suisse.

Congrats on another great quarter.

You guys provided some commentary on gross margins, and obviously gross margins were quite strong this quarter.

I wonder if you can give us a sense of just what you're seeing in the pricing environment out there, just broadly speaking, versus the mix, and how that's impacting your gross margins.

And how can you think about that going forward here?

Thanks.

Yes, Phil, thanks for being on the call.

As a general matter, what we're seeing from a pricing perspective is our ability to maintain premium pricings due to the premium nature of our offering.

We've seen a lot of pricing competition in the market as we continue to gain share from other folks, but it hasn't apparently affected our ability to hold the line on that, and I think you can see that across the line in the margin side.

So we have a nice increase in margins, and discounting for us has been very disciplined and consistent over time.

That's generally what we're seeing in the market today.

The other thing, Phil, is when you look at our increasing attach rate for subscriptions, the overall total gross margins are benefiting from the tailwind that we are getting from increased subscription attach rates.

So the fact that WildFire increased sequentially and we have very high attach rates for threat and URL filtering, those are all benefits for gross margin.

Great.

Also, switching gears for a second to the relationship with VMware.

You guys have been talking about it for a couple of quarters, but it seemed like you started to see some traction in that with the VM series.

Wondering if you can provide some more detail and just what the feedback you're getting from potential customers there.

Thanks.

The feedback has been really strong.

What we've seen in the early previews of this, about six months ago, was an extremely high level of interest from folks across the board when we would talk about it and be able to show them about POCs.

We were in the market this quarter with the solutions that we actually -- we sold things in this quarter, including a very nice large deal at one of the largest brands in the world.

It was one of the first customers for the joint solution, which was fantastic.

From the VMware perspective, my understanding is that within the next 45 days, this solution will be on their price list with a SKU, as well.

So the entire VM sales force will have the ability to bring this to market, as well.

We feel all this is very positive momentum for this, for the technology specifically, and then just as a general matter, advanced security in the data center space.

And it's great to be working with the leader there, VMware.

Next question, please.

Karl Keirstead with Deutsche Bank.

It's actually Tas on behalf of Carl.

[Even though] you say that you had [powerful] performance in the PA 7050 appliance this quarter, can you talk about that ASP trends?

Do you see meaningful improvement in the ASPs in this quarter?

As a general matter, Tas, from an ASP perspective, which we look at as from an initial sale, those have been going up every quarter very consistently on a modest basis.

We spent a lot more time and attention on what the lifetime value of the customer looks like, because from a buying patterns perspective, customers tend to test us.

They tend to find a place in the network.

Their first purchase is to put us in the network somewhere and see that it actually works.

And then the repeat purchases come faster and consistently higher.

But just a general matter, ASPs continue to uptick every quarter, which is nice.

Got it.

And then just one follow-up.

You had a strong [fees] these this quarter on top line, [the length of that] is really strong.

But then when I look at the guide for next quarter, you're guiding almost flat revenues for Q1 versus Q4, which is quite a bit lower than your seasonal growth from Q4 to Q1.

You're just being conservative here, or was it deals that you [thought] got pulled forward in this quarter?

Well, first, our guidance methodology is to always to give one quarter out guidance.

And exiting Q4, we look at a number of things, including pipeline, and pipeline is very strong heading into Q1.

When you look at the year-over-year growth rate in Q1, we're looking at 39% to 40% year-over-year growth, which is much higher than a lot of the models that were out there.

Additionally, you think about seasonality in our business, and we feel like fiscal Q2 and fiscal Q4 will be the stronger quarters for us, from a seasonal standpoint.

Most companies of our size, actually, see sequential declines in revenue from Q4 to Q1.

So with that as the backdrop, we feel good about the quarter.

The pipeline is good and we have a lot of momentum and visibility heading into fiscal Q1.

Next question, please.

Keith West with Morgan Stanley.

Very nice quarter.

It's somewhat unusual for a Company of your scale to see this size of acceleration in their overall business, particularly if you look at the billings growth going to, I think, 64% this quarter from 50% last quarter.

Anything in particular driving that acceleration?

Is it new products turning on?

Is it a better acceptance within the marketplace?

Anything that you could point this at to explain how business is actually getting better as you guys get bigger?

Thanks, Keith.

It's all of the above.

I think what we're seeing here is just a really big picture is, from a security perspective, it's very apparent that security spending is growing, that enterprises around the world are recognizing that cyber security is a very lasting and important and probably permanent line item from a spend perspective.

They're seeking out the best possible solutions for that from the most advanced technology providers.

I think that's what our reputation to market is perceived at today, and growing very quickly.

So when you think about that, you think about the size of the addressable market, to have the right technology at the right time in history to take care of all these problems for enterprises, it's really driving some fantastic growth.

And we had a very nice year; we had a fantastic quarter.

As Steffan said, we've got a very nice pipeline going into Q1, as well.

So I think we've got a lot of momentum here.

Got it.

And then as a follow-up, on the flip side of the equation for Steffan.

You reiterated the targets or operating margins, exiting up on 2015 and [not] using FY16.

And if I'm not mistaken, that's still not reflected in sales side models, or at least in the consensus expectations.

So there's some skepticism about that operating margin leverage.

Maybe you could walk us through some of the key components of where we should be expecting that leverage, and how you guys push that extra margin out of the business.

Well, margin expansion is going to come primarily from sales and marketing as a percentage of revenue.

When you compare where we are today versus what our target is, we're at 51.9% ending in Q4, and our target exiting Q4 FY16 is to be 33% to 36%.

How we bridge where we are today to where we will be in the future, it comes out of having more productive sales folks that are in the mix.

And given the great performance in Q4 -- and we'll have more ramped salespeople then ramping, exiting Q4 FY15 and Q4 FY16 -- that will be a very helpful.

From a partner standpoint, we have Westcon in the mix that will help with global distribution, and we will look to get more leverage out of our partner infrastructure.

The other part of the equation is going to be contribution from other partners, such as VMware, and other partnerships like that, that will strike.

When you think about a salesperson and what they can contribute to the Company, it's all about adding more tools to the tool bag.

And with these partnerships and the global distribution capacity and the great sales and marketing leadership that we have in the Company, we feel comfortable that we can get the leverage out of that line.

Every other line in our operating margin structure is at or near our target model.

So we will have a very strong focus on sales and marketing leverage over these next eight quarters, and we feel like we're set up to do it.

The final point I'll make is, we always take an eye towards balancing growth with profitability.

And the fact that we were able to re-accelerate top-line growth at these levels, and you look at the billings performance, we were able to take down a lot of business on the street in a profitable manner, and we'll continue to look to take share.

We have 5% market share -- 5% to 7% market share in a $20 billion market.

There is a lot of wood left to chop.

And Keith, one other point I'd make as well, and I think you've written about this a couple of times, is, when you look at our installed base and the repeat purchasing patterns our installed base, repeat purchases come at a lower cost of sale for us.

So the power of that installed base and that LTV numbers we're looking at every quarter will also drive reduced cost of sale over time.

Great.

Next question.

Walter Pritchard with Citi.

Just had a question around -- I think you talked on the call in your prepared remarks about 70% of each of the either the Fortune 100 or Fortune 500 are customers.

And I know that your largest-- or I guess your second-largest competitor in Check Point has similar [staff], although a bit higher.

I'm wondering if getting to this point with the 70%, could you compare and contrast -- you must coexist on a lot of accounts, and there's some accounts I'm sure where you've had success in displacing incumbents.

Can you talk about, in those large accounts, how you code this, when you do code this?

Sure, that's a great question, Walter.

I think what we've seen consistently -- and it's really picking up as Palo Alto Networks is becoming the more recognized leader here from the most advanced security -- is that everybody started somewhere, right?

Everybody's got a legacy vendor.

And a lot of cases, those are Check Point.

In almost every situation we come into, as we've said, we're displacing [talent].

So we're coming into the network, we often coexist for a while in the network with whoever legacy vendor is, and then over time, we gradually displace them.

And that's what you're seeing through the LTV analysis and the customer acquisitions.

So it's not surprising to be in a network with somebody else.

But I think it's a very clear trend that we are taking people out of the network every quarter more and more.

And then just one follow-up on -- I think you mentioned that Asia was -- I mean, great performance in US especially.

I think you noted that Asia was up 7%, I think it was, year over year.

Can you talk about that territory?

I know it's not that large from a revenue perspective, but what's going on there, and is there any change in terms of leadership or something that's driving that?

APAC basis is a great market for us and we think a fantastic growth opportunity.

It's the last of the markets we entered from an entrance perspective a number of years ago.

So as far as coming up the curve on getting distribution capabilities, feet on the street, it's the least mature of our theaters.

And in the quarter on the 7% growth, you have to look back at the last one, where we had a really great Q4 last year.

So the compare was pretty tough there.

But we really like that market.

Great.

Next question, please.

Rob Owens with Pacific Crest.

I was wondering if you can touch a little bit on the acceleration that you saw in customer acquisition.

Is this a function of the Juniper lawsuit finally being behind you?

Are you guys coming to market now with a much broader product set with the 7050?

Or is this a function of replacement cycle and where we are there?

Thanks.

Hi, Rob.

I don't think it had anything to do with the Juniper thing.

I think what's happening, and we saw it consistently every quarter -- so our customer count grew every quarter very nicely, and by a wide margin in the fourth quarter.

So it was fantastic.

I think what we're just seeing is the recognition of Palo Alto Networks, particularly on a global basis, as not only the technology leader here, but also with the Company's ability to execute against that.

So when we think about our -- everything else that's going on in the Company outside of technology, from all the work that Mark and his team have done, from a very mature, repeatable sales process, all the discipline we're bringing in the channels organization, the fact that we have major distributors who are now agreeing to distribute us on a global basis.

We just can't be ignored any more from that perspective.

We have the highest customer satisfaction scores in the industry.

All those things are very important.

And from your reputation perspective, customers talk to each other.

And what they're hearing is that Palo Alto actually solves very hard problems.

The installations get done; the deployments work; the technology works.

And that the customers continue to buy in more and more from us.

And that's a self-fulfilling thing for us, which we just continue to grow off of, our really high customer satisfaction.

We have rabidly positive fans, which is our customers, which is great to have that kind of fan base, and they do a lot of the selling for us.

Great.

Can you talk a little bit about the revenue model in and around the NSX solution, as we look at micro segmentation?

Are you moving to more of a subscription-based model for your traditional firewall?

[That's in it.] But we have two -- well, just for NSX, we have two models there.

One is a perpetual license, and the other is a per use license.

So we've given customers the option to go either per server or -- I'm sorry, for term, or for perpetual.

And we'll see what happens as it plays out.

Some of that will come down to whether they're more interested in CapEx models or OpEx models.

But time will tell which of those might be more popular.

Great.

Next question.

Brent Thill with UBS.

Mark, in EMEA, you've seen several quarters of sequential growth on a year-over-year basis.

And I know you mentioned back at the Analyst Day that you were making good progress in converting some of distributors over that were on legacy solutions to your platform.

I'm just curious if you could give us an update.

And what's happening there, is that what's happening with this conversion that you're seeing in terms of acceleration of growth?

And I had a quick follow-up for you.

Yes, that's part of it, Brent.

We have focused in the past, and we mentioned to you guys about distribution being very important from a capacity perspective.

When you think about the size of the Company right now, we're actually a pretty large player and growing at excessive rates relative to any of the competition.

And what that's resulted in, I think, is, from a distribution and partner perspective, is folks that may have had a concern about maybe they're going to [rep] Palo Alto Networks because they're going to upset one of their existing vendors -- they just have to get past that.

We're just too big to not be on everybody's line cards at these points.

And that's what we're seeing.

But the announcement with Westcon we announced recently is a perfect example of that.

There was increased our capability to vend over 40 countries.

A lot of those are in Europe.

They've been a great partner in the US already.

So this is expansion outside of our core market with one of the best in the world.

So that's a perfect example of what is happening with distribution, which is the recognition and desire to want to work with Palo Alto and [wheat] with Palo Alto, because that's what the customers clearly want.

Okay.

And just from a federal government perspective, we're obviously coming into an important close for their fiscal year.

I'm curious if you could just highlight what you're seeing there this year versus, perhaps, what you saw last year -- if there's any contrast in the overall environment.

The fed market has always been a good one for us.

It's a good vertical, I think.

If you think about what those folks need and what we provide from a solution perspective, it's a match made in heaven.

And from a customer perspective, they buy at good rates from us.

No vertical is more than 12% of our business, so we're not really dependent on any single vertical.

But we have experienced good growth in the fed space, and we would expect with their year-end being in our first quarter, we'd see a nice quarter with the federal space, as well.

I think if you look historically -- two years ago, a year ago -- I think it seems to be settling out.

There was all kinds of anxiety from budgets and sequestration, all those sorts of things that have substantially subsided in that market over the last year.

Which is a benefit to everybody, but to us, as well.

Next question.

Jonathan Ho with William Blair.

Strong results, congratulations.

Just wanted to dig in a little bit into the spending environment.

Clearly, it looks like things are picking back up again.

I just want to get a sense from you guys, number one, around the magnitude of the -- if you could quantify what the spending environment strength looks like.

And number two, primarily where you're seeing that strength in terms of verticals.

Jonathan, on the spending environment side, what I've witnessed over the last couple of years is that security as a line item in the IT budget, I think, has increased just as a budget line item.

And I think there's a growing realization that with that increase, it's going to stay there over time.

Because security is very real, it's very lasting, it's global in nature, and everybody has to deal with that.

And I think that's a net positive for everybody.

From a vertical perspective, as a general matter, you usually see some verticals out ahead of other ones, on being on the edge of technology.

I think we're beyond that, at this point, for cybersecurity, as a general matter.

Meaning we're seeing middle America -- at least these are from our own results -- middle America, very large companies in the Fortune 500, that they're never the first to go to newer platforms, are quickly adopting Palo Alto Networks as a platform of choice.

And I think that's an example of what you are going to see across the board, where the recognition of cybersecurity is very important, and you have to spend on it.

It's going to be persistent over time.

Got it.

Just regarding the TRAPS and Cyvera opportunity, can you guys talk about the initial customer reception?

I think you mentioned a lot of interest there and the potential to integrate with WildFire.

But can you just talk to what is it that's differentiated, and the initial reception from customers based on that differentiation?

Yes.

The thing that I think the customers are desiring and we hopefully will be delivering for them is that the endpoints are the Wild West, cybersecurity-wise right now.

I think we've done a nice job on the network and with our cloud-based services from a detection and prevention perspective.

But unless you have better protection at the endpoint, that's very porous and a lot of bad stuff gets in there.

Most everything in the market today there is really focused on just detecting bad things, right?

And then, you go into all the forensics for remediation mode.

And what Cyvera has, and we have now and bringing to market, is something that is actively preventative in nature -- is true realtime exploit prevention.

And that's an extremely disruptive technology and concept.

I think it's disruptive; it's what we did with firewalls, next-generation firewall space, is what we're bringing to market with the endpoint space with this TRAPS technology.

So you have this realtime exploit prevention, and then we integrate it -- and this is what we're bringing to market the end of September, into WildFire.

So you have all the fantastic benefits of WildFire from a malware detection prevention capability, and all those thousands of customers that are on WildFire right now and growing at leaps and bounds every quarter, and we've connected that.

We connected the power of what's happening on the network, and now we have the same advanced disruptive capabilities on the endpoint.

And that's what customers are reacting to very positively in our POCs with them, and the early looks that we've given them.

So it's very positive feedback, which is great.

Thanks.

Next question.

Raimo Lenschow with Barclays.

If I can stay on the Cyvera case here, how will it change your sales set up?

Because if you look at -- if the [lash] organization is probably a different buying center, how do -- do you need a specialized sales force for that?

How is that going to work for you?

And then I have a follow-up here.

Good question, Raimo.

Traditionally, network and endpoint are different buyers.

That is the case today, and I expect that to continue for some time.

Although I think when you get to CIO-CTO level, more and more they're talking about securing the enterprise, and not trying a technology distinction between those two things.

They're just saying, we need to protect the enterprise.

So when we come in with a solution that says, here's a network cloud-based service with an endpoint for all highly integrated and highly automated (inaudible).

All together, that resonates extremely well at the C level.

However, there's still different buying centers.

And even though that may change over time, we want to be cognizant of that.

So what we're doing from a sales force perspective is building an overlay team for endpoints that are specialists, and they now have a sell to that buying center.

All of our sales people will be able to tell the story about the strategic solution.

And from a customer perspective of interest about endpoints, we have people coming in, primarily in the [SC] side, and plus some sales -- expertise.

They know how to talk to that buyer, so that will be a joint call to go get that closed for, hopefully, the entire solution set that we sell.

Okay.

And to follow up, if you look at WildFire, and obviously having -- gaining really good traction there.

But if you look at the market, there's obviously some other big players in there that having some momentum.

What do you see in terms of the customer use cases?

How are you getting deployed?

Are you kind of the starting point for guys, and they go up-market for some extra stuff?

Or how are you fitting in, in that kind of competitive environment?

Thank you.

We're seeing a couple of things there, Raimo.

The first is, is that our very large and quickly growing installed base -- what we're selling is a platform play, right?

This is a strategic solution that can take care of your cybersecurity needs across your entire enterprise.

And WildFire is an important part of that.

If you're an existing Palo Alto Networks customer and you see the WildFire technology as highly integrated and automated and in this platform, that is a good sale, you want that technology.

And we're seeing that from the installed base.

The other thing we're seeing, which is fantastic -- and you saw by a wide margin this very high customer acquisition in the quarter -- is, that's a fantastic selling point for us for new customers.

So if the top-of-mind issue for a prospect is advanced for system threats, we're able to come into it with WildFire and say, this is the market's only detection and prevention capability.

I've got thousands of customers using it to prove it to you, from a reference perspective.

And when they take a look at WildFire, the entry point -- but often extremely interested in that and that's what they want to buy.

And in the process of that, they're often taking more of the platform.

So it's not that we're indifferent about how we get into [an account], but we can serve any use case.

And this is a very compelling use case for folks and a top-of-mind issue, so it also works on the prospecting side for new customer acquisition.

Great.

Next question?

Andrew Nowinski with Piper Jaffray.

Congrats on the great quarter.

Just a follow-up on the gross margin set.

I think you said product gross margin was down this quarter due to product mix, though you noted the 7050 significantly exceeded your internal forecasts.

Given the significant revenue upside, can you provide more clarity with regard to what products negatively impacted your product gross margins?

Sure, Andrew.

We've been pretty clear with the street around every time we introduce a new product, it will take several quarters to get up to scale, in terms of volume.

And as volumes scale, COGS go down, gross margins go up.

With the 7050, we've been shipping it for about a quarter and a half, so we are not yet at scale for the 7050.

So while it's great from a top-line revenue standpoint, it's not at scale yet from a gross margin standpoint.

Over time, we should be getting more gross margin benefit out of the 7050.

That's probably the biggest driver.

So when we refer to product mix, we had more 7050s sold, and that's great for top-line revenue.

It had a slightly depressive impact on gross margins, but we're talking about 60 basis points sequentially.

Year over year, we were up.

So we feel very good about the discipline around gross margin management and COGS reduction efforts.

Can you just talk about the competitive landscape and whether you're anticipating any changes going forward, by way of perhaps new product refreshes coming from some of the legacy firewall vendors?

Thanks.

Andrew, it's Mark.

I don't see anything on the market front that's changing the game at all, except us.

We continued to innovate.

I think, ever year, we've brought out a number of really nice product innovations, new product lines like 7050, WildFire enhancements, what we're doing with VMware, the TRAPS.

I think we're pretty far ahead technically.

And I haven't seen the competitors do anything other than revise the traditional legacy technology they have.

And to me, that doesn't appear to be working in the customer base, as you can see from customer acquisition and our growth rates.

Great.

Next question, please?

[Jeff Bowe] with Northland.

I'd like to follow up on Raimo's a little bit for my entry, and that is, we hear from some of the other APT players.

They talk about how they would like to win in the high-end.

They do it knowledge that they are not as strong in the low-end.

I'm wondering if you feel as though your own wins place yourself generally in the low-end of the market, or is that generally across your customer base?

Jeff, it's Mark.

It's across the customer base.

We're seeing ever-increasing strength there.

When I look at customers we sold into from an installed base perspective, it's a very high percentage of those Fortune 100 and Global 2000 customers we mentioned earlier.

When I look at new customer acquisition, some of the largest brands in the world are buying WildFire right out of the gate.

We're closing lots of six-figure deals there, even bigger than that.

So I think that's a myth.

Okay, great.

Then secondly, Mark and Steffan, you both talked about the data center market as being a very strong one for the 7050.

Can you bring us up to date on the service provider side?

Is that an area where you're seeing some success?

It's still early from a 7050 perspective in the service provider market, in the sense of those folks buying it for other purposes than for their own networks.

As large enterprises, they're no different than other folks about wanting the most advanced security in high-throughput environments.

So they're good customers for that technology.

From a sell-through perspective, we've been able, now that we have the offering, to sit down and start working road maps with them about new opportunities to work with them to sell through, where they're using that technology in order to provide services, say, to SMBs.

And that's a good opportunity for us in the future, but that's in the road map planning phases.

Great.

Next question?

Gur Talpaz with Stifel.

With Cyvera, is there a replacement sale, or can you actually operate in similar fashion to the core firewall market where you can come in behind a previously [AV] solution and then eventually displace them down the road?

Yes, Gur, I think it's exactly like that, right?

And what we are seeing from a customer perspective is folks very willing to take a look at a complementary technology with what they have, with an idea that perhaps it could be displacement down the road.

But our initial selling motion is very much like in the early days in the firewall, which is, we have something disruptive, we have something better.

You don't have to -- it's not a binary decision; you don't have to take somebody out for us to come in.

We like that approach because when we get in and solve a really hard problem for the customer, we have a much better chance over time of going inside there and displacing the legacy provider.

But we don't try to make the sale harder than it is by saying this is a binary thing.

Great.

And with WildFire, can you talk about how many total customers you have?

And then, with regard to the new paid customers, are these unpaid customers being up-sold to a paid subscription?

Thank you.

Our total paid customers right now is over 3,000, we said, from a total base which includes the free customers, usually runs about 1,000 ahead of that or so.

As you can tell from those numbers, we've been focused very much from a conversion perspective on taking free-to-pay and installing those to volume customers.

So I would say we will continue to have the free offering because there's really no downside to that for us, to get somebody to test the technology and then convert to paid.

So we'll continue to have that free offering, but I think as you can tell from the momentum here, we're much more focused on the paid customers.

In an effort to try and get through everyone's questions, we ask that you limit yourself to one question now.

That would great.

Thanks.

Matthew Niknam with Goldman Sachs.

Congrats on the quarter.

Obviously, customer growth remains really strong.

I wonder if you can talk about how much of your revenue growth is coming from the existing base, and the opportunity for incremental up-sell you currently see among your customer base.

Thanks.

With over 19,000 end customers -- and we've been adding over 1,000 customers now for well over 10 quarters -- it's been a dynamic where once we land into a customer, it's all about the expansion value.

And Mark had mentioned earlier on the lifetime value metric.

We feel like we are -- call it less than 10% penetrated across the entire install base of customers.

As we continue to sell more appliances, subscriptions and maintenance, that opportunity will only grow over time.

The other thing is, with Cyvera coming into the mix, we'll have 19,000 customers in our installed base to go after in order to cross-sell and up-sell the opportunity there.

So we feel like we're in the very early innings of a nine-inning game around customer expansion opportunity.

I'd say as well, Matthew, we mentioned this back at the Analyst Day -- when you start to think about the power of the installed base and look at the momentum around the LTV metrics, we anticipate that there are multiple billions of dollars in the installed base right now, without adding another customer, that over time we can unlock.

Great.

Next question.

Greg Moskowitz with Cowen and Company.

Mark, it's very clear that you're continuing to benefit from all the sales investments that were made last year.

Just wondering if there are any notable changes that you would point to over the last six months or so with regard to sales cycles?

Sales cycles tend to be fairly consistent for us, in that some are really short and some are really long.

We said over the past is, they generally average out about 90 days.

That really hasn't changed for us.

I don't anticipate the change either, because sometimes you have a customer who's in dire need of something right away.

And a lot of our customers that we bring down, we might have worked with for two years over the course of many tasks and projects, and then they make a large purchase.

But generally, 90 days is about the average.

Okay.

Thank you.

Michael Turits with Raymond James.

Mark, obviously this huge move having bought Cyvera gets you from network into endpoint.

How are you feeling about strategic positioning, and whether or not there are other meaningful market segments that you need to get into, possibly through [our] position, whether or not they're attractive targets out there?

I've never felt better about our position in the market, Michael, particularly with the addition of TRAPS to bring the endpoint.

With that, we often show customers a triangle picture of the network, the cloud-based services and the endpoint.

I don't anticipate that becoming a rectangle.

I think that we have all the coverage we need from an enterprise security perspective.

With that said, we look at the product road map, it's very aggressive.

If we saw things that could accelerate us on that, we would be interested buyers in those sorts of things.

From an addressable market opportunity, it's massive, right?

It's like $19 billion, $20 billion and a single-digit percentage.

We don't have to buy market share, we don't have to buy customers, we don't have to buy distribution capabilities.

We're in a very good spot.

Great.

Next question?

Catharine Trebnick with Dougherty and Company.

I have a quick one on managed services, Mark.

It seems like 451 just -- you had said that there is an uptake in mid-sized companies wanting to outsource due to the complexity and the number of threats.

What would your product road map match to a managed service offering?

Thanks.

There's a couple ways on that, Catharine.

Right now, what's happening in a lot of situations is, there are service providers who run things on an outsourced network basis.

The simplest form of that is a managed service offering where a large telco, for example, is running a network on behalf of another company.

Sometimes not even small companies, sometimes pretty large companies.

We do very well there.

All those large systems integrators and service providers are very familiar with our technology, and there's a lot of cases where they're running that technology on behalf of the customer.

Usually they're running probably the entire network on behalf of the customer, and we're the security solution there.

Great.

We have time for one more question, please.

Daniel Ives with FBR Capital Markets.

This is Jim Warren for Dan Ives.

Just wondering if you can talk a little bit about any changes you might have seen in customer sentiment over the last quarter now with the Juniper litigation behind you.

Jim, this is Mark.

We said in the past with litigation that we hadn't seen in the market that people were not going to buy from Palo Alto Networks as a result of that litigation.

And I think our numbers historically have shown that.

Customer acquisition, LTV, revenue growth -- I think everything supports that statement.

And then when you look today, there's really no evidence that we were wrong about that.

So I don't think that really had any impact at all.

Great.

Thanks, everyone.

Turn it over to Mark for a few ending thoughts.

Great, thanks.

And thanks for being on the call this afternoon, everybody.

We had a really great quarter and great year.

We're energized by the opportunities as we move into our FY15 and beyond.

I'd like to take one more opportunity to thank the Palo Alto Networks team for all their hard work and their support of our customers and partners as we continue our march to become the global legal in enterpriser security.

Thanks for your time.

Ladies and gentlemen, that concludes today's conference.

Thank you for your participation.

You may not disconnect.

You all have a great day.