Palo Alto Networks Inc (PANW) 2015 Q2 法說會逐字稿

Good day, and welcome to the Palo Alto Networks' second-quarter 2015 earnings conference call.

Today's conference is being recorded.

At this time, I would like to turn the conference over to Kelsey Turcotte.

Please go ahead.

Great, thanks.

Good afternoon, and thank you for joining us on today's conference call to discuss Palo Alto Networks' second-quarter FY15 financial results.

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

PaloAltoNetworks.com.

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

This afternoon, we issued a press release announcing our results for the fiscal second quarter ended January 31, 2015.

If you would like a copy of the release, you can access it online on our website.

We would like to remind you that during the course of this conference call, management will make forward-looking statements, including statements regarding our revenue and earnings-per-share guidance for our fiscal third quarter, and non-GAAP operating margin for Q4 of FY15, and Q4 of FY16, as well as our expectations regarding our growth, gross margins, seasonality, future investments, CapEx, leverage, profitability, cash flow, and 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, 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 November 25, 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 investors 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 third-quarter FY15 earnings conference call will be held after the market closes on Wednesday, May 27.

In addition, we would like to invite institutional investors and sell-side analysts to join an investor track at Palo Alto Networks' Ignite Conference at the Cosmopolitan in Las Vegas.

Our program will start with lunch at noon on Monday, March 30.

Formal presentations will kick off at 1:00 PM Pacific time.

While the event will be webcast, guests who attend in person are invited to stay for the conference, which will run through Wednesday, April 1. To register, please email me at kturcotte@PaloAltoNetworks.com, or call me at 408-753-3872.

And with that, I will turn it over to Mark.

Thanks, Kelsey.

And thank you, everyone, for joining us this afternoon.

I am pleased to report that we delivered very strong results in our second quarter across all metrics, and I would like to thank our team and our partners for their support and hard work.

In Q2, revenue was $218 million, up 54% year over year; and billings were $283 million, up 51% year over year.

We also continued to show the leverage in our operating model, with non-GAAP operating margin expanding to 12.4%, as well as Q2 non-GAAP EPS of $0.19.

Our results continue to demonstrate our belief that our next-generation enterprise security platform is highly differentiated, and is the right approach to security at the right time in history.

And that our business model is unique in allowing us to deliver industry-leading revenue growth rates at scale, while doing so with consistently increasing leverage.

At the highest levels, it is more and more evident that the world has changed, and that cyber security is now critical to the fabric of all things related to technology, business and national security.

This means that cyber security has attained a status as a fundamental imperative for every company and organization in the world; and that this paradigm shift is not abating, but likely to continue for many years.

It is also becoming increasingly obvious that legacy technology solutions are incapable of protecting businesses in the age of sophisticated and aggressive cyber attacks.

What is needed is a true enterprise-class integrated and automated platform, capable of not only detection, but prevention as well.

Palo Alto Networks is delivering this platform.

And, as a result, we are able to capture more market share more quickly than other companies have been able to do so in the past.

Our customers' consistent feedback is that they are more secure when using our platform than they were with their previous legacy architecture.

And, as a side benefit, they are spending less on our integrated platform than they used to, by cobbling together disparate and point products.

In addition to having the right platform at the right time in history, we have also been working very diligently to ensure that we can execute well against a large and growing addressable market opportunity.

This requires continuing to develop our world-class sales and distribution capabilities, including doing some unique things, like hosting our partner representatives, and our sales and technical training, as well as ensuring that all the other functions required to support the Company's continued fast growth are scaling well.

I am exceptionally proud of the team in this regard, and we continue to plan and invest for outsize market share gains, while not losing sight of driving leverage in the model.

As you can see from our results, the market is voting in favor of our philosophy, approach and platform.

And we are beating and displacing the competition at very healthy rates, and quickly becoming the industry standard.

In Q2, we added well over 1,500 new customers, bringing our total customer count to over 22,500, a more than 40% increase year over year.

And our global and major account focus continues to pay off, with us now serving 81 of the fortune 100, and 916 of the global 2,000.

Examples of new customer wins this quarter include: a Check Point and Cisco replacement at one of the United States' largest energy providers that purchased high-end data center appliances, in combination with subscription services, including WildFire; a global financial institution in Europe, where we replaced Check Point and Cisco, and sold PA-7050s for the data center, and, working with our partner, VMware, also included Palo Alto Networks' edition for NSX; and one of the world's largest insurance companies, where, with our partner, Dimension Data, will replace the incumbent Cisco in a global firewall refresh, and won a very competitive bake-off for an APT solution with WildFire.

On the expand side of the Business, we know that satisfied customers make repeat purchases, and we have placed a great deal of emphasis on customer service and support.

Our customer satisfaction scores are among the highest in the industry, and we continue to invest in the infrastructure and talent required to ensure that our customers are getting the most out of their technology investment.

As a result, we see significant expansion in the lifetime value of our customers.

For example, to make our top-25 customer list in Q2, a customer had to have spent a minimum of $7.4 million in lifetime value, a more than 60% increase over the $4.6 million required in Q2 of our last fiscal year.

These customers typically make purchases quarter after quarter, as they add new products and subscriptions.

In fact, all of our top-25 customers placed a repeat order with us in Q2.

Additionally, we continue to widen the innovation gap, with new products and subscription services which address our customers' greatest security needs, and are driving a market share shift in our favor.

In the high-end data center market, our 120-gig PA-7050 chassis continues to resonate with enterprise customers across all verticals.

This quarter, we closed multiple seven-figure PA-7050 deals to protect north/south data center traffic, including one with a multi-billion-dollar North American media company.

When coupled with our Palo Alto Networks edition for NSX to secure east/west traffic, we have a very compelling and highly differentiated data center security solution.

In the mid-range data center market, the PA-3060, which we launched in Q2, did very well, further expanding our footprint in that segment of the market.

WildFire had yet another strong quarter as well.

We now have over 5,000 customers paying for WildFire, up from approximately 4,000 last quarter.

WildFire is being purchased across all verticals, with organizations, including an international digital-based eCommerce business and a large North American-based public utility company, making purchases in the quarter.

Both are examples of businesses that bought WildFire for its ability to turn unknown threats into known threats in a matter of minutes, and the benefits of its automated threat intelligence sharing over the entire customer base.

Q2 was our first full quarter in the market with Traps, our advanced endpoint protection solution, integrated with WildFire.

Traps opens an incremental $4-billion endpoint market, which is yet untapped for us.

Similar to what we saw in the firewall market about a decade ago, we believe that legacy endpoint solutions have not kept pace with the threat landscape, leaving customers vulnerable to attack, and the market ripe for disruption.

In Q2, we added dozens of new Traps customers, and closed our first seven-figure transaction with a large healthcare organization.

While it is early, we are pleased with our progress, and excited about the future in this market.

It is a very exciting time, in general, for Palo Alto Networks.

I consistently tell our team that our platform is solving very hard problems for customers; and as a result, we believe that we have the potential to capture historic market share in a very large addressable market, and that we have only just begun.

We believe that our innovation engine, proven and scalable go-to-market capabilities, and focused and scalable support capabilities, will allow us to drive outsized growth, while expanding profitability, and generating significant cash flow with our model.

Before I conclude, I would like to reiterate Kelsey's invitation to join us for our Ignite 2015 conference and investor track starting on Monday, March 30 at the Cosmopolitan Hotel in Las Vegas.

I hope to see all of you there.

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

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 would like to note that, except for revenue figures that are GAAP, all financial figures are non-GAAP, unless stated otherwise.

In Q2, we continued to execute well against our land, expand and retain sales strategy, and are pleased with both the rate of new customer additions, as well as expansion in our current customers.

Growth in sales of products, subscriptions and support drove double-digit sequential growth, resulting in record billings, revenue and deferred revenue.

Additionally, with approximately 47% of total revenue coming from recurring services, our hybrid SaaS revenue model and ramping economies of scale continue to drive leverage in the Business, resulting in strong non-GAAP operating margin and free cash flow this quarter.

I am very pleased with the results in the first half of FY15.

We believe we can continue to capitalize on macro tailwinds and security spend, the technological advantage of our next-generation platform, and the untapped spend in our large customer base, to drive growth and continue to take market share, as we head into the back half of our fiscal year and beyond.

Now let me turn to the numbers.

Q2 total revenue grew 54% over the prior year, and 13% sequentially, to reach a new record of $217.7 million.

The geographic mix of revenue for Q2 was 67% Americas, 21% EMEA, and 12% APAC.

Compared to the prior year, the Americas grew 62%, EMEA grew 35%, and APAC grew 51%.

As in previous quarters, we saw broad strength across a wide range of verticals, and we did not have any end-customer concentration.

The three components of our hybrid SaaS model -- product, subscription and support -- all grew very well in Q2.

Q2 product revenue of $115.6 million increased 43% over the prior year, and 14% sequentially.

We saw healthy growth in our mid-range PA-3000 series, high-end PA-5000 series, and PA-7050.

In particular, the PA-7050 continued to show strength, and is a catalyst to capture more market opportunity in the data center market.

Our recurring services revenue of $102 million increased 69% over the prior year, and 12% sequentially, and accounted for a 47% share of total revenue.

Looking at the two components of recurring services revenue, the first component is our SaaS-based subscription revenue of $50.1 million, which increased 74% over the prior year, and 15% sequentially.

Support and maintenance revenue, the second component of recurring services, was $52 million, an increase of 65% over the prior year, and 10% sequentially.

Billings in Q2 were $282.8 million, an increase of 51% year over year, and 18% sequentially.

Growth in subscription attach rates and higher renewal rates are driving recurring services billings, which positively impact deferred revenue.

Total deferred revenue in Q2 was $535.8 million, an increase of 65% year over year, and 14% sequentially.

Short-term deferred revenue increased to $324.5 million, an increase of 60% year over year, and 13% sequentially.

Total gross margin for Q2 was 77.8%, an increase of 250 basis points compared to last year, and 100 basis points sequentially.

Product gross margin was 77.1%, an increase of 160 basis points year over year, and 200 basis points sequentially.

The sequential increase was due, in part, to favorable product mix.

We expect there will be fluctuations in product gross margin, primarily due to mix.

Services gross margin for Q2 was 78.7%, an increase of 350 basis points year over year, and 10 basis points sequentially, due, in part, to ongoing growth in the contribution from high-margin subscription services.

For the quarter, research and development expense was 12.2% of revenue, increasing approximately $3.6 million sequentially, to $26.5 million.

This was primarily due to headcount growth and project-related expenditures.

Sales and marketing expense for Q2 was 45.8% of revenue, increasing approximately $9.6 million sequentially to $99.6 million.

This was primarily due to an increase in headcount, and sales commissions related to first-half sales performance.

General and administrative expense for Q2 was 7.4% of revenue, increasing approximately $2.1 million sequentially to $16.4 million.

This was driven, in part, by headcount growth and outside services.

Total headcount at the end of the quarter was 2,083, up from 1,900 at the end of Q1 FY15.

In total, Q2 operating expenses were $142.5 million, or 65.4% of revenue.

Operating margin grew 340 basis points year over year to 12.4%, and increased sequentially 180 basis points.

Net income for the quarter was $16.9 million, or $0.19 per diluted share, using 86.6 million shares, compared with net income of $7.8 million, or $0.10 per diluted share, in Q2 2014.

On a GAAP basis, for the second quarter, net loss was $43 million, or $0.53 per basic and diluted share.

This compares with Q2 2014 GAAP net loss of $39.9 million, or $0.55 per basic and diluted share.

We finished January with cash, cash equivalents and investments of $1.1 billion.

Our cash flow from operations, free cash flow, and free cash flow margin for Q2 were $76.8 million, $70.7 million and 32.5%, respectively.

Included in our cash flow results is an approximately $12.8-million payment to Israel made in conjunction with transferring the intellectual property rights acquired from Cyvera out of Israel.

Capital expenditures in the quarter totaled $6.1 million.

Consistent with the strength we saw in the quarter, linearity in Q2 tracked better than the prior-year period.

Our accounts receivable balance was $135.3 million this quarter, up from $116.2 million in Q1.

DSOs decreased sequentially by seven days, and year over year by five days, to 52 days.

Turning to guidance, as we enter Q3, we feel good about the security spending environment, and our ability to execute against that opportunity.

In Q3 2015, we expect revenue to be in the range of $219 million to $223 million, which represents 45% to 48% growth year over year.

We expect non-GAAP EPS to be in the range of $0.19 to $0.20 per share, using 87 million to 89 million shares.

Before I conclude, I would like to highlight a few considerations for modeling purposes.

Due to strong growth, seasonality has been difficult to forecast, but we believe that, over the longer term, fiscal Q2 and Q4 may show our strongest revenue growth.

As a reminder, in FY15 we expect to invest approximately $25 million, or $0.17 to $0.18 per share, in Traps, our advanced endpoint protection offering.

We're on track to hit this investment goal.

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

And, as we said previously, we continue to expect to exit Q4 FY15 with a low-teens non-GAAP operating margin, and to exit Q4 FY16 at a 22% to 25% non-GAAP operating margin.

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

(Operator instructions)

Matt Niknam, Goldman Sachs.

Hey, guys.

Thank you for taking the question, and congrats on the quarter.

The question on margin.

So the margin guidance, Steffan, as you alluded to, exit rate this year, fiscal year, exiting in the low teens.

You are already just under 13% this quarter.

Is it fair to assume margins remain fairly flattish in the next two quarters?

And maybe if you can help us think through where you see the incremental spending going towards?

Thanks.

Yes, we remain committed to the low teens exiting this fiscal year, and 22% to 25% exiting Q4 of 2016.

And I do think it is fair to say that we are going to continue to balance top line growth with investing in the business.

And the incremental dollars that are being spent are primarily in our innovation engine, which is R&D and product management, as well as our field marketing organization and field sales operation, with a low percentage market share, and a very large market.

We are very much focused on taking as much share as possible, but doing it profitably.

So you look at operating margins and free cash flow margins.

We are able to drive very healthy top line growth and increase profitability.

Keith Weiss, Morgan Stanley.

Hi, this is Melissa Gorham calling in for Keith.

Thanks for taking my question.

Just a question on TRAPS.

Mark, you mentioned dozens of TRAPS deals in the quarter.

I'm just wondering if you could maybe provide some color on the early customer feedback there?

And of those deals that you saw, are they taking spend from existing endpoint solutions, or is this just net new opportunities?

Yes, good question, Melissa.

The feedback has been very positive.

It is interesting.

And I think it also drives a lot of optimism for us in this business.

When we're talking to customers about this, and saying this is what TRAPS does.

It actually does real time exploit prevention.

That is such a disruptive concept that sometimes you have to explain to them twice, and then show (inaudible) the demo.

But when they see it, their reaction is, wow.

That that is pretty disruptive technology, and a big step forward.

And the second part of your question, we are taking business from competition in some of these deals.

Some folks are buying it to run side-by-side with their existing vendors.

And some of these cases, including that seven-figure deal that I discussed on the prepared script, we took that from a legacy vendor in a competitive win.

Okay.

Great.

And then just one quick one for Steffan.

One of the things that many of us picked up in the quarter was perhaps longer lead times in terms of inventory.

Was that an issue in the quarter?

And if so, what have you done to maybe remediate that potential issue?

Yes, due to high order volume, we extended our standard shipping lead time from two weeks to up to four weeks.

The reality was, we're able to ship most of all the orders that came in within a two-week lead time.

But it was really due to high order volume.

So there is no supply chain issue, and we were able to satisfy all of the demand.

Raimo Lenschow, Barclays.

Congrats on the great quarter.

Two quick questions from me.

First, it is maybe just me, but I am hearing a lot more competitive replacements for checkpoint.

Can you talk a little bit about the environment that you're seeing there?

It seems like it is slowly changing for you guys.

And then the second one is obviously, we all hear about increased security spending.

How do you see that, in your conversations with clients, in terms of ad hoc, I need to react to an emergency, versus more longer-term planning, which you guys should see?

Yes, good questions, Raimo.

This is Mark.

So on the checkpoint one, we have been displacing checkpoints for a very long time at good rates.

So when you look at this quarter, well over 1,500 new customers for the quarter, last quarter, 2,000.

It is very hard to post those kind of numbers from new logos, if you are not having the -- everybody in the market be a donor to the (inaudible), because -- and checkpoint donates quite a bit to us.

And that is increasing over time, I think, as we become the industry standard here.

I think that is what is really happening is, as we continue to take this many customers and build a lot more relevance in the market, a lot more awareness in the market on the global basis.

And on your spend question, spending seems very healthy right now, from a security perspective.

Really no reason to believe that that's going to change any time in the future.

And particularly, if you have got the enterprise class platform, that solves a lot of customers' hardest problems.

We think we are the big beneficiary of that.

Philip Winslow, Credit Suisse.

Congrats on a great quarter.

Just wanted you to follow-up on some of your remarks on WildFire.

Obviously, you guys are having continued success there.

Wondering if you could give us more details on win rates versus the competition?

How you are seeing -- who you are seeing out there, how you are comparing with them?

And then also, from just a task perspective, not just with WildFire, but your other subscription offerings, maybe you could give us a sense -- I know you only give us metric once a year.

But a sense of how those attach rates are trending, as well as renewal rates?

Thanks.

Let me take those in reverse.

So attach rate for all our services are doing well.

They are all increasing.

So that is the trend that has been continuing for quite some time, including WildFire, which is growing at a very fast pace.

And if you come to Ignite, you will get some more detail around those things.

On WildFire itself, everybody in the market today, from a network security perspective, has some sort of APT offering in the space today.

But from who we see in the market, we are primarily see [fire eye] in the market, and we continue to win new business where they don't exist.

We continue to win business where people have put us side-by-side, and ultimately choose our platform over a standalone product approach.

Karl Keirstead, Deutsche Bank.

Thanks.

My question is for Steffan.

I just wanted to go back to your guidance around seasonality during the quarter.

I think you said that you should see the strongest growth in 2Q and 4Q.

If you could just clarify?

I know it is super preliminary.

But are you suggesting that the July 4 quarter might see a growth rate higher than what Palo Alto put up in Q1, and would likely put up in 3Q?

That is a good question, Karl.

We guide one quarter out.

But directionally, you can think about a fourth quarter being typically very strong, like most companies' fiscal year end.

We can't really get into the details around what our fourth-quarter projection is going to be, relative to last year's fourth quarter.

But the way that the organization is set up, where we are positioned for growth, and in the way the sales cycles work, at the end of a fiscal year, lots of people are in sales accelerators.

So you would typically see an increase in sales productivity and deal closure, et cetera.

So that's about all I can get into, in terms of the fourth quarter.

Andrew Nowinski, Piper Jaffray.

Great.

Congrats on the nice quarter.

I just want another follow-up question on WildFire.

It is clearly gaining traction.

You added about 1,000 customers this quarter, and then 1,500 total customers.

I was wondering if you could give us any color on the mix of new customers that were deploying WildFire versus existing customers that deployed it?

Yes, Drew, yes, we are doing very well on both regards.

So with well over 1,500 new customers in the quarter, we are seeing very nice win rates for new logos, as they come in the door.

And having WildFire as the most advanced APT detection prevention capability baked into the platform, allows our sales team to tell a great story for new logo acquisition, because we're able to talk about something that is very important for all companies, which is advanced persistent threats and malwares.

So it is good to have that as a lead, for somebody who is not yet using Palo Alto Networks.

With the existing customer base, we see very good adoption there, as well.

Because if you are already using portions of the platform, our story is, and what customers are experiencing, is the more of the platform you use, the better you are, from a protection prevention perspective.

And WildFire is a very strong aspect of that.

So we see a lot of demand from our existing customer base, as well.

So I want to add that portion of prevention into the platform we're already on.

So both cylinders are firing very well.

Walter Pritchard, Citigroup.

Thanks.

Steffan, two questions for you.

One, we have heard some of your competitors, in the last 3 to 6 months, talk about up-ticking their level of spending, and bringing down their profitability goals, through obviously sticking with your profitability goals, as you stated them today.

How do you think about the market dynamic there?

In this (inaudible), you're all in the same space, and if they spend more, you may need to spend more.

Do you feel like you're adequately covered?

Or is there anything that could happen in the market that could cause you to similarly uptick your spending, more so than you're guiding to today?

So, on that front, what I have picked up around the competitive space is, a lot of folks are spending more in sales and marketing, in order to try to get into the enterprise.

Where you -- historically, you have companies who have been focused on the SMB or telco, trying to get into the high end enterprise, that they are building out their sales forces.

We believe that it starts with a differentiated product.

So we have the best platform out there.

And when we start with that product and that platform, we have been building to scale under Mark Anderson's leadership, the worldwide field operations, that we are already at, call it, 45% of revenues for sales and marketing.

And over time, we are going to be getting leverage over that.

But there is not some big reinvestment plan that we need to make, in order to get incremental growth.

And additionally, if you think about this -- the productivity of the sales force, we are going to have more ramped sales people than ramping sales people, very soon.

And that increases the overall capacity that we are bringing into the model.

So we don't envision any derailment from our track right now.

Brent Thill, UBS.

Good afternoon.

Mark, on TRAPS, you mentioned you added a couple dozen customers.

I am curious what you saw on those deals, with the rest of the portfolio from Palo Alto?

And perhaps, when you look at some of the new versus existing, if you could maybe give us a little more color on what you're seeing in that early adoption?

And I had a quick follow-up for Steffan.

Yes, the -- we are seeing a lot of interest in the existing customer base, not surprisingly.

So the question I answered a little while ago, where I said the power of the platform is that the more of the platform you use, the better security you get.

And usually at a better total cost of ownership.

TRAPS, with its integration to WildFire, is a very compelling part of that story.

So our existing customer base, particularly those people who are using WildFire, already are very enticed by what that brings to bear for their security posture.

So we are getting very positive feedback from the existing customer base.

Also, even though this is in the future for us, as far as putting up the numbers against it, the ability to talk to customers who don't own any Palo Alto Networks yet at all, and just talk to them about TRAPS, is another entry point for us, as well.

And of course, we are telling that story to our as-yet signed-on customers, that you should just look at TRAPS if you have an endpoint need, and then that can drive the adoption of more of our platform later, too.

Okay.

And Steffan, you mentioned strength in the 7050.

I'm just curious if you could maybe add a little more color what you're seeing in the data center market?

We are seeing more invitations to play in the data center market, and we see that in a couple of different ways.

The first is just organically, where, with the 7050, we're getting brought in.

But also with our partnership with VMware.

We had a great use case where there was a NSX -- VM for NSX deal that was out there.

We ended up selling not only the VM series for that engagement, but we also sold the 7050 to protect north-south traffic for that data center.

And that is just one example of a number that we are working on, where the 7050 is increasing our overall wallet share for the overall data center market.

Matt Hedberg, RBC Capital Markets.

Thanks for taking my questions, guys.

Congrats on the quarter as well.

Mark, I wanted to ask about Westcon.

I believe they had you initially in 40 countries.

I wanted to get an update on that distribution channel, versus some of your initial expectations.

And then I had a quick follow-up for Steffan after that.

Yes, great question, Matt.

So about a year ago, Westcon had us about a little over 30 countries.

And today, we are a little more than double that number.

So in that last 12 month timeframe, we've increased that by 100%.

We have also -- which is important, because with that relationship, the number of resellers that were under that umbrella has gone up very dramatically, as well.

So just our distribution -- I mean, the reseller capability below that distribution has grown a lot in the last 12 months.

We are very pleased with that.

That is great.

And then maybe a quick one for Steffan.

I know you guys price in US dollars.

But I'm curious, are you seeing any evidence of the strengthening dollar in demand overseas?

Yes, since we price in US dollars, we don't really see any material shift for the revenue.

Where we do see a little bit of benefit is, as the dollar strengthens, we pay our foreign locations' salaries, benefits and expenses in local currency.

So that does have a modest benefit.

But outside of that, the real top line risk isn't there.

Because we do pricing USD.

Daniel Ives, FBR Capital.

Thanks.

Mark, could you talk about deals getting fast tracked?

Maybe more the board level, in terms of what you're seeing on the cyber security?

Especially in terms of some of the high-level threats we have seen over the last 3 to 6 months?

Yes, Dan, I think what we are seeing is, is that there is certainly a large and growing amount of attention, at the board level, the highest levels in companies and boards, on these -- the threats.

What we are actually seeing below that, though, is good spending, as you can see in the market in general, in order to try to solve those things.

But as far as that is working out at the buyers, we are seeing more thoughtful and strategic purchases.

Meaning that we are finding folks who are stepping back and saying, we want to think about something that is going to be very valuable for us for 3 to 5 years, not just the latest threat that just came out next week.

We tend to do very well in that kind of environment, because we come in with solutions architects.

We get to show them an architectural standard for security that covers all of their enterprise, at every point of the kill chain, and how that can provide a very strong dose of prevention.

And that is resonating extremely well in the market.

Okay.

In terms of -- from the White House, some that you were at, and obviously, you are really involved with what you see on the government side.

Do you think 2015 is going to see an inflection point on the federal side, in terms of spending on cyber security?

Or do you think we are still not there, and there still needs to be some bureaucracy and red tape that needs to get cut through?

Thanks.

I think generally, the government recognizes, like all organizations, the need to be at the forefront of cyber security.

It is not so much an inflection point, in terms of acceptance of what has to happen, from a technology perspective.

I think it has a lot to do with budgets.

So as -- if you recall, that FY15 budget for the government was a very tough one.

It was going into FY15, we were coming off of a lot belt tightening, just generally, in the government.

So I would just expect that the FY16 budget is actually just going to be a better budget.

It is going to be more money in the budget FY16 than there was in FY15.

That is a good thing for providers.

And if you are a provider like us, who has got a really good solution for the government, who needs to be at the very front of this, we think that bodes well.

Gregg Moskowitz, Cowen and Company.

Thank you very much.

And I will add my congratulations, as well, on a strong quarter.

Question for Mark.

Mark, some security vendors held the view that -- or are taking the view, anyway, that any APT solution that is effectively part of the firewall has some detection and prevention limitations.

Just really because so much of the network traffic is being generated by mobile and other sources.

I just wanted to get your perspective on that, if I could?

Our view is, is that what you're trying to accomplish at the end of there, or should be trying to accomplish, is not only great detection, but a very strong level of protection.

And that has got to be across the entire enterprise, right?

So in order to do that, you need to be able to see the traffic everywhere, whether it is mobile or data center or [print], it doesn't really matter, right?

And if you can't see all that traffic, and meaning you are not in line, then you're going to have a very difficult time doing anything from a security perspective, whether it is APT or anything else.

So that is the view that has driven the importance of being in the -- I call it the architecturally favored position of being the firewall in the first place, because the firewall is generally the only security device that is going to see all the traffic in or out of the network.

Now, if it is off a mobile device, and you VPN it into your traffic flow, then you are going to supply those network security policies to that traffic, regardless of what the device is coming off, which is exactly what recommend that folks do.

And that is what global protect does, for example.

So I would completely agree with the statement that you have to see all the traffic, in order to secure it, and that you're going to be unable to do that unless you're in the firewall position.

Terrific.

Thanks.

Michael Turits, Raymond James.

Hey, guys.

A quick question on -- the question earlier about 2014 versus 2015, in terms of -- on the spend sustainable.

Mark, any shift, at all, in terms of security spending, in terms of priorities, that you see from 2015 versus 2014?

Yes, I think that, as we -- what we've seen folks at the highest levels being -- paying more attention to is what I mentioned earlier, which is, I'll call it the -- what is the security architecture?

And more and more, we're the ones being invited in that conversation to say, how should I think about this, big picture, across the board, top to bottom, from an enterprise perspective?

As opposed to thinking about the point products, where it's time refresh this product, or refresh this product.

And as the platform provider for prevention in that, that is great for us, because we have the ultimate answer for that, for folks in the market, and it is resonating very well.

And then, obviously, it was very strong overall, but Europe went a little slower than last quarter.

Anything going on there?

Or -- and I didn't check if it was a tough comp or not, but anything new (inaudible)?

Europe, we like Europe's good market.

You may recall, last quarter, we grew a little over 60% year over year in Europe, and then we grew 16% sequentially off of that.

So that's a -- we like those numbers.

Great.

Thanks very much.

Gur Talpaz, Stifel.

Great.

Thanks.

So there has been a lot of noise within the endpoint market.

Can you talk about what you're seeing out there competitively?

And do you think customers are starting to understand the inherent advantages of an integrated offering with WildFire?

Versus, let's say, a standalone offering?

Yes, a couple of angles on that.

The first is, is that I agree with you.

There is a lot of noise in the market on the endpoint side.

The reason for that, it is becoming evident that the endpoints are very important, from a solution perspective, in order to secure an enterprise, right?

Because it is the wild west in the endpoints.

And the first thing we see for sure is customers recognizing that the legacy AV technologies are incapable of doing that, right?

So the second thing is the rush of lots of other players in the markets saying, we're going to fix that for you.

Fixing it actually requires doing prevention, right?

That's -- at the end of the day, that is what you have to do, in order to have a good fix there.

And we think that our approach with TRAPS, and the customer feedback we are getting, as I mentioned a little earlier, is they agree with us, that it actually does prevention at the endpoint.

And because of that, it is very compelling.

Jonathan Ho, William Blair.

Hey, guys.

I just wanted to understand a little bit better.

Are you starting to see much revenue come from the installed base, in terms of refreshes from 4 or 5 years ago?

The initial customers?

And how should we think about that trend for the course of 2015, and going into 2016?

Yes, Jonathan.

So what we look at is, we definitely see refresh going on to our earlier cohorts.

The first really measurable ones for us are 2009, 2010, by numbers.

So we're seeing refreshes occurring there.

To put that in perspective, the combined customer base for 2009, 2010 is less than 2,000 customers.

We have got over 22,000 customers now.

So if we continue to see refreshes into those larger cohorts, which we would expect to, that is a tailwind.

Got it.

Excellent.

And then, as you start to think about the NSX and VMware relationship, can you maybe talk a little bit about how significant this could be, from a selling perspective?

And just the initial reception that you are seeing?

I know you talked about the winds, but just why customers would choose the solution?

And what, potentially, the alternatives are, if any?

Yes, the -- we think of it in two regards.

The first is, is that you definitely want to have relevance, in the sense of, there is a changing environment in the data centers.

It is not just North/South; it's got to be East/West.

So the first thing is, can you adequately represent yourself in that conversation, back to the strategic architectures?

And say, I have you covered not only North/South, but East/West as well.

We definitely have North/South covered, and we are uniquely integrated, and working closely with VMware, on the East/West.

And when we show that to customers, and how tight that integration is, and it provides the same level of protection as North/South, they are very impressed with that.

And we can see that playing out through the numbers.

NSX is selling very well, as you may have seen from VMware's results.

And as a result of that, we are getting pulled into lots and lots of conversations with customers that is resulting in deals, and we have well over 300 POCs going right now, as an example with VMware customers.

Aaron Schwartz, Macquarie.

Good afternoon.

Thank you.

On the metric you gave for the top 25 customers, that increased quite a bit.

And I am sure a number of things are driving that.

But was there anything in particular that stood out?

Yes, Aaron, we are seeing our relevance continue to grow in the market.

And particularly with the larger companies that -- they are making larger purchases with us.

These are our largest customers, right?

And then they continue to make larger purchases.

And also, we are seeing some customers, on their first purchase, drop right onto the top 25 list.

So it is the mix of those two things that is driving that number up and to the right.

Okay, and secondly, if I could, on the attach, you talked about that directionally moving higher, as well.

Can you just comment on the duration of what you're seeing now?

Has that changed at all, relative to 1 or 2 years ago?

Thanks.

Yes, relative to one or two years ago, for durations, they are basically in the same zip code, relatively.

They are up modestly.

But there hasn't been any real like sea change, in terms of duration.

Great.

Thank you.

Jeff Kvaal, Northland Capital Markets.

Yes.

Hello.

Can you guys hear me okay?

Yes.

Good.

Thank you.

Perhaps I've got [Barcelona] on my mind, perhaps, but I was wanting to ask you how you were telling in the service provider market.

I know that you have been pushing into that realm a bit.

And then secondly, I think you opened the call a little bit, Mark, talking about seeing a better runway, I think, for the security market, over the period of a few years than you might have a quarter or two ago.

I am wondering if you could delve into this (inaudible) a little bit more (inaudible).

Yes, sure thing, Jeff.

Good question.

Let me take those in reverse.

What I was saying on the prepared remarks, in the security market, is that the -- I see a paradigm shift, which is security, becoming what I am calling fabric to all technology decisions that are being made by organizations, governments and companies.

And that is the result of all of these attacks we are seeing, and the incredibly evident fact that the legacy technology can't withstand that.

So I think that paradigm shift, that security is fabric, and will be -- remain that way for quite some time, is the point I was trying to make is, that is not it going to abate over time.

I think that is going to continue to grow over time.

On your first question, the service provider market, we like that market a lot.

We do very well in that market.

As I have said before, we view that market a couple, three different ways.

From an opportunity perspective, the area where we are doing very well right now is selling to service providers who are using our technology in their our own Networks.

The 7050 is an example.

It has been a great boon for us there, because there are big Networks, lots of throughput, lots of data center usage.

And we're seeing very strong demand in service provider industry for that.

Gray Powell, Wells Fargo Securities.

Thanks for taking the questions.

Just a couple.

So obviously, you have a lot going on with WildFire and TRAPS, in terms of newer products.

How do you feel about the level of internal innovation, or R&D.

And then, do you see any technologies that could supplement your current offerings?

There's one thing we never forget is, is that we are doing well in the market, and Palo Alto has been as successful as we have because we have because we have been very innovative and very disruptive.

So we start everything with that.

And as a result of that, we put a lot of time, effort, people, resources, into innovation.

And I think our track record is pretty good on that.

We have a number of things, if you just think back on the last 12 months, that we have done, around TRAPS, around the PA 3060, improvements at WildFire.

And we're going to continue to innovate, as we go forward, as we always have done, every single year.

If you come to Ignite, we will talk to you a little bit about that, as well.

So I feel very good about the level of innovation, our track record on delivering that, and the pace at which we roll that out.

Got it.

Thank you very much.

Thank you.

Our last question today comes from Scott Zeller, Needham & Company.

Thanks.

I just wanted to ask if Steffan has any color he could share for the deferred seasonality?

If there is an update on that, please?

Yes, deferred seasonality would most likely trend towards what the revenue seasonality is.

So Q2 and Q4, you would see -- if those are the quarters in which we would see the most pronounced strength, then the subsequent quarter, you would basically see deferred go up, as well.

I would give you that as color commentary.

I can also say that both long term and short term deferred revenue have also been growing very well.

And so we see a nice balance between customers who are signing up for a one-year deal, but we are seeing proportionally more customers signing up for a multi-year deal, as well.

And some of those multi-year deals tend to be skewed to our fiscal Q4.

So you should definitely see some seasonality there.

Thank you.

Thanks, everybody, for being on the call this afternoon.

We appreciate it.

We had a great first half of our FY15, and we are very excited about the second half of the year and beyond.

As I said earlier, I think we are in the right place at the right time in the market, with the market-leading protection prevention platform.

I want to once again thank the Palo Alto Networks team for all their hard work and their support for our customers and partners, as we continue our march to the global leader in enterprise security.

Thank you for your participation.

This does conclude today's call.