Seeking Alpha
We cover over 5K calls/quarter
Profile| Send Message|
( followers)  

Executives

Maria Riley - IR, The Blueshirt Group

Mark McLaughlin - Chairman, President & CEO

Steffan Tomlinson - SVP & CFO

Analysts

Greg Dunham - Goldman Sachs

Joel Fishbein - Lazard

Jayson Noland - Robert W. Baird

Harris Heyer - Credit Suisse

Jonathan Ho - William Blair

Walter Pritchard - Citigroup

Ron Zember - Bank of America Merrill Lynch

Erik Suppiger - JMP Securities

Brent Thill - UBS

Gregg Moskowitz - Cowen

Aaron Schwartz - Jefferies

Keith Price - Morgan Stanley

Frederick Grieb - Nomura

Palo Alto Networks, Inc. (PANW) Q2 2013 Earnings Call February 28, 2013 4:30 PM ET

Operator

Good day ladies and gentlemen and welcome to the Q2 2013 Palo Alto Networks, Inc. Earnings Call. I'll be your operator for today. At this time, all participants are in a listen-only mode. We will conduct a question-and-answer session towards the end of the conference. (Operator Instructions) As a reminder, this call is being recorded for replay purposes.

I would now like to turn the call over to Maria Riley, Investor Relations with The Blue Shirt Group. Please proceed ma’am.

Maria Riley

Good afternoon and thank you for joining us on today's conference call to discuss Palo Alto Networks’ fiscal second quarter 2013 financial results. This call is also being broadcast live over the web and can be accessed on the Investors Section of Palo Alto Networks website at, investors.paloaltonetworks.com. With me on today's call are, Mark McLaughlin, Palo Alto Networks’ Chairman, President and Chief Executive Officer and Steffan Tomlinson, Chief Financial Officer.

After the markets closed today, Palo Alto Networks issued a press release announcing results for the fiscal second quarter ended January 31, 2013. We would like you to have you the release you can access it online at the company's website or even call The Blue Shirt Group at 415-217-7722 and we will email you a copy.

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

These forward-looking statements involve a number of risks and uncertainties some of which are beyond our control which could cause actual results to differ materially from those anticipated by these statements. These forward-looking statements apply as of today and you should not rely on them as representing our views in the future and we undertake no obligation to update these statements after this call.

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

Also please note that certain financial measures we use on this call are expressed on a non-GAAP basis that have been adjusted to exclude certain charges. We have provided reconciliations of these non-GAAP financial measures to GAAP financial measures in the Investors Section of our website located at, investors.paloaltonetworks.com.

Before I turn the call over to Mark, I would like to remind that Palo Alto Networks is hosting its inaugural Analyst Day in New York City on March 21st. If you would like to attend, please contact me or (inaudible) at The Blue Shirt Group or email ir@paloaltonetworks.com. In addition, a live audio webcast of the meeting will be accessible from the Investor Relations section of the company’s website.

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

Mark McLaughlin

Thanks, Maria and thanks everyone for joining us. I am delighted to be here today to share with you our achievements in our fiscal second quarter of 2013. We had a strong second quarter and our results continue to demonstrate Palo Alto Networks recognition as the global leader in next-generation enterprise network security. This leadership position is driven by our high value, disruptive technology which we believe, provides the highest level of security available in the market today.

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

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

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

And looking at the LAN component of our growth in the second quarter, we added over 1,000 new customers in the quarter. This is the fifth consecutive quarter where we have added over 1,000 new customers. We now have the privilege of servicing over 11,000 total end customers around the globe, most of which are choosing us over the legacy common firewall provider.

On the expand and expense side of our business, we continue to see strong increased buying and loyalty from our customers. Our business coming from services continues to grow at impressive rates as our existing customers buy additional services and for longer-terms. For example, in the second quarter our top 25 customers’ follow-on purchases averaged 11.4 times of initial purchase. This is up from 9.9 times last quarter and to make the top 25 list in the second quarter our customer had to spend minimum $2.8 million with us, which is up from $2.5 million last quarter. This is all translated in the second quarter results where we posted $96.5 million in revenue which is a 70% year-over-year increase and 12% sequential increase along with non-GAAP EPS of $0.05 per diluted share. Demonstrating our continued ability, the substantially outpacing competition and with continue growing leverage in the business.

Our results are driven by our ability to provide demonstrably and substantially better network security than the competition. Some examples of this over the quarter include us replacing the Check Point as a datacenter firewall in the distributed network environment of one of Europe’s largest broadcasters. We also replaced Check Point in the datacenter of one of the biggest insurance companies in the U.S. after starting our first appointment with them in December 2011. And replaced Juniper one of the largest electronic component vendors in the world based here in California. And [Cisco] one of Australia’s largest retirement funds. And as we have discussed and demonstrated in the past, we continue to displace all the legacy firewall providers at a rapid pace while growing our market share.

The reason why we are able to win so many new customers and expand so significantly within our customer [Technical Difficulty] and this differentiation continues to grow. Just a few days ago, I was pleased to see that Gartner once again recognized all the networks as a leader in their latest metric quadrant for enterprise networks firewalls and they reiterated they believe that by year-end 2014 the majority of new purchases will be next generation firewalls. I am also very pleased with the rollout of the four new products introduced in November at our Ignite User Conference; customer attraction has been significant across all these products most notably for PA-3000 Series and WildFire subscription service. We now have more than 1200 customers using our WildFire service and are ahead of our internal forecast for the pay the tax ratio service.

In summary, we are pleased to report another strong quarter of growth, new customer acquisition and continued increasing operating leverage. Our solutions address the fundamental network security issues that are facing enterprises across the globe and we enter the second half of our fiscal year with big momentum.

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

Steffan Tomlinson

Thank you, Mark and thank you all for joining us today to cover our results for fiscal Q2, ‘13. In Q2, total revenue grew to a record $96.5 million, an increase of 70.2% year-over-year and 12.3% sequentially. Looking at our two main components of revenue, in Q2, product revenue of $61.9 million grew 60.3% year-over-year and 11.6% sequentially driven by sales of our series of appliances. Services revenue which is comprised of both subscription and support was $34.6 million, an increase of 91.5% year-over-year and 13.6% sequentially. Services revenue accounted for 35.8% of total revenue, an increase of 40 basis points sequentially and this is in line with our expectation and underscores the power of our hybrid revenue model as it provides enhanced visibility. The geographic mix of revenue was 63% Americas, 25% EMEA and 12% APAC with all theaters posting growth on a year-over-year and sequential basis.

Total non-GAAP gross margin in Q2 was 72.2% in line with our target range of 70% to 73%. Non-GAAP gross margin has decreased 70 basis points year-over-year and 40 basis points sequentially. Putting a final point on gross margin, Q2 non-GAAP product gross margin was 73.4% down 10 basis points year-over-year and 80 basis points sequentially.

The sequential decrease was primarily due to product mix and the impact of the launch of our new PA-3000 Series. As I mentioned in the last earnings call, product gross margins will fluctuate when we introduce new products as they have a higher initial cost of goods sold.

As volumes increase per new products, we expect reductions in cost of goods sold which will result in an improvement of gross margins over time. Our non-GAAP services gross margin was 70.1%, down 140 basis points year-over-year, and up 60 basis points sequentially.

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

Moving on to operating expenses, we continue to invest primarily in product development and our sales and go-to-market organization. Q2 non-GAAP R&D expense was $13.5 million, an increase of $1.9 million from the prior quarter primarily related to program spend in headcount addition.

As a percentage of revenue, non-GAAP R&D expense was 14% up 50 basis points sequentially. Q2 non-GAAP sales and marketing expense was $41.9 million, an increase of $3.6 million from the prior quarter. As a percentage of revenue it was 43.4%, a decrease of 120 basis points sequentially demonstrating operating leverage.

Q2 non-GAAP G&A expense was $7.7 million, an increase of $500,000 from the prior quarter or 8% as a percentage of revenue, down 40 basis points sequentially. In total, Q2 non-GAAP operating expenses were $63.1 million, an increase of $6 million from the prior quarter or 65.4% of revenue, down 110 basis points sequentially.

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

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

Our non-GAAP effective tax rate for the quarter was 41.5%. This rate will continue to fluctuate throughout the fiscal year as its dependent upon our global pretax profit mix and potential discreet events such as the removal of our domestic valuation allowance.

Non-GAAP net income for Q2 was approximately $3.9 million or $0.05 per diluted share using 77.5 million shares. This compares to non-GAAP net income of $2.9 million or $0.04 per diluted shares in fiscal Q1 ’13 and non-GAAP net income of $2.5 million or $0.04 per diluted share in fiscal Q2 ’12. On a GAAP basis, net loss was $2.6 million or $0.04 per basic and diluted shares.

Turning to the balance sheet, we finished January with cash, cash equivalents and investments of $368.3 million. In Q2, cash flow from operations was $34.5 million, free cash flow was $28.3 million and free cash flow margin was 29.3%.

Cash flows benefit from our hybrid revenue model in which we build for our services at the beginning of the engagement and we collected the cash shortly thereafter. We ended Q2 with $68.6 million of accounts receivables, up from the Q1 ’13 balance of $56.4 million.

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

Moving down to balance sheet, total deferred revenue was $188.2 million, an increase of 92.2% year-over-year and 17.3% sequentially. Short-term deferred revenue of a $117.4 million increased 15.8% sequentially. The majority of our service engagements are in annual basis but we're continuing to see an uptick in multi-year deals.

Billings were a $124.3 million, an increase of 81.6% year-over-year and 12.4% sequentially. Let me now turn to our guidance for Q3 ‘13. We expect revenue to be in the range of $100 million to $104 million, which equates to 52% to 58% year-over-year growth and we expect non-GAAP EPS to be approximately $0.05 per share using 79 million to 81 million shares on a diluted basis.

We're continuing to invest in product development, sales and go-to market as well as three projects in G&A all of which has reflected in our guidance for Q3.

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

Question-and-Answer Session

Operator

Thank you. (Operator Instructions) And your first question comes from the line Greg Dunham, Goldman Sachs.

Greg Dunham - Goldman Sachs

I guess first up, can you talk about the impact of Mark Anderson’s kind of emphasis on strategic account? And the opportunity improved sales productivity from here. Thank you.

Mark McLaughlin

Mark has been focused on a number of things. And I mentioned this on a few of the other calls. One is on the strategic account side. So not surprisingly as the company continues to grow into the size, we are in the size we intend to become, large strategic major accounts are more important for the company. So we have been very focused on the Global 2000, we got very good penetration and we continue to increase penetration and we continue to do really well our large accounts on follow on purchases as well.

Mark is putting a lot of discipline in place, talent in place, he know how to sell and who and in service because larger accounts so we expect to continue to get gains from that overtime and as you know it takes time in order to develop sales forces like that, so far directly.

Greg Dunham - Goldman Sachs

One follow-up if you permit. The billing numbers or is just a number? Were there anomalies in there? Was that, I mean, is that mainly due to the WildFire release? How should we think about that?

Mark McLaughlin

Yeah. Sure I would like to give Steffan a little more detail. Just generally on the billing side, we had a nice quarter as you can see we have a nice increase in services revenue side of it, it start flowing through the end of…

Steffan Tomlinson

That’s right when we look at the composition of billings what we are seeing is a very nice up tick in our services line both subscription and maintenance. And we are pleased with the number.

Operator

Your next question comes from Joel Fishbein, Lazard.

Joel Fishbein - Lazard

Just a follow-up on that guys, in terms of the take rates on the subscriptions, can you give us any more indication on the numbers that people are taking and what is particularly driving the deferred revenue in terms of the subscription base?

Mark McLaughlin

So as we said in the past, attach rates on the services are good, how do you like they need to be that way and in addition to that as you know, we continue to launch more services in particular WildFire back in November end and we like the attach rates we are seeing on that, it's early days there but they are higher than what we internally forecasted in the last 90 days of selling.

So that’s we think that contribute uplift for the company. I mean at the end of the day, what is going on here is that when you got really disruptive provides the first place to firewall and the ability to easily add very valued services for folks at a much lower cost, I would say rather obnoxious to really possibly coming off in the market we keep seeing our customers take advantage of that and increasing rates in the longer term.

Joel Fishbein - Lazard

This is the follow-up to that, I mean, you know, the big talk was malicious threat protection, can you just talk about how Alto is positioned in that market and maybe that’s the better question to ask relative to what’s driving the subscription growth?

Mark McLaughlin

Yeah, sure, it’s a great question. You know, something [Technical Difficulty] yesterday there is definitely a big focus on a key malware, not surprising and their security changes a lot and there is always something new that's important to take care of, so it’s a general matter I think what is going on there is that company, a enterprise is very concerned about that and they question what do you do about it, and you are bringing the services like [Technical Difficulty] is really important in itself because it is the only one out there that can protect and prevent, malware.

But importantly a big picture I think is what is happening architecturally is that the enterprises once the ability to have device and services provide a security and do so rapidly with the architecture as big since capital expenditures with the best of three points (inaudible) right so what we have done as we have said in lot of cases, majority cases were already a firewall [Technical Difficulty].

So from the peer security perspective what you would like to have is the (inaudible) of technologies forced to get in different boxes today actually we integrated in a creative way because that's the best possible way to detect and then really quickly prevent that malware that is what we have in the market. So I think just generally it’s an architectural matter, that's the way the world’s going.

Operator

Your next question is from Michael (inaudible) Raymond James.

Unidentified Analyst

Just a sort of housekeeping question, anymore precision you can give us on the number of customers out and then the customer count and how much hiring you did this quarter and what was the net headcount adds and what would expect going forward still looking in the 75 to 100 range.

Mark McLaughlin

That's right Michael. So on the first question the customers, you know we continue to add customers that have a very nice space of this third quarter with over 1000. We haven't gotten into the numbers about what they are over a 1000, the reason for that is there's really no magic to a 1000, I mean it’s a great number thinking to put out there but this is a really great quarter from a customer ad perspective very high numbers and we hope to continue that for quite some time, just as importantly as adding new customers which is land part of the model is the expand part and once we get into the door the way we've been able to demonstrate (inaudible) does that is really important. We see that driving, you know driven through our service line of deferred revenue there. So all the cylinders are firing for us.

Steffan Tomlinson

And just a follow on point to that you can also see that in the LTV metric that we talk about which has increased very nicely sequentially to 11.4 times repeat order value for the top 25 enterprise customers that we have.

Mark McLaughlin

And we added 100 head this quarter we said we'd do anywhere from 75 to 100 on a quarter basis, as far as the target, that's obviously going to fluctuate quarter-to-quarter [hiring] patterns and when people show up about a 100 in this quarter (inaudible).

Unidentified Analyst

And if I could just ask you about the accounts receivables was more backend loaded, what was going on there that happened.

Steffan Tomlinson

It was typical of many companies in terms of the January month; the first couple of weeks are always a little bit slow because the majority of corporations are on a calendar year budget. So once those budgets are finalized we saw a very nice pick up at the end of the month and that's a normal pattern that we've seen in January and past Januarys. We also did see a good calendar year end December month. We don't break that out specifically but we did participate in a nice December month as well.

Operator

Your next question is from Jayson Noland with Robert W. Baird.

Jayson Noland - Robert W. Baird

Mark at RSA there was talk of the perimeter being porous and ineffective and I guess part of answer there is wild fire for APT and malware but do you see any change architecturally where the PA appliances would be in more locations in the network or virtual in GFWs I guess what are you seeing more broadly.

Mark McLaughlin

The answer is going to be yes, you see it everywhere which is you want to protect the perimeter, you want to protect the branch office so the perimeter doesn't get it back. You would definitely want to protect the datacenter. Those are the three main areas we generally enterprisers focus on that where we have offerings for all three of them. Again like I said a little earlier, because of that, because of the move to virtualization and datacenters, flexibility from how you are able to provide security its very important and ideally you would want your firewall to be very selectable with service in order to do that in all those places in the network and even want a virtualized version of that as well and we have all of those.

Operator

Your next question is from Phil Winslow, Credit Suisse.

Harris Heyer - Credit Suisse

Hi, this is Harris Heyer on behalf of Phil. Thanks for taking the question. I was hoping if you could comment on the pricing environment in the last quarter versus three quarters and also if you can just comment briefly on your tax rate [renewables]?

Mark McLaughlin

Yes, sure. Your first question is on pricing, Harris?

Harris Heyer - Credit Suisse

Yeah.

Mark McLaughlin

Okay. You know, this has always been a very competitive market and it's not unusual for players to tend to makeup for lack of functionality by an aggressive pricing that we definitely seen that. But we found it in the past we continue to see as our technology is dully disruptive and it's solving really strategic issues. As a result of that, we're not immune to pricing pressure but we've been able to maintain premium pricing for premium technology for quite some time.

Steffan Tomlinson

And on the tax rate description, what we’ve said in the past still holds up. We are typically selling one or two subscription with initial sale and then we also sell maintenance and the tax rate is extremely high. As we said, its well north of 90%. The renewal rate for maintenance again is very high. You can’t really deploy enterprise network security without being on maintenance because you get [rough] fixes and patches as part of that maintenance program and the renewal rate on subscription are high as well. We haven't put a final point on that and that should cover both of your questions.

Operator

Thank you and your next question is from Jonathan Ho, William Blair.

Jonathan Ho - William Blair

The first question I have is around the primary firewall adoption. Can you talk a little bit about the trend there and whether you are seeing, just roughly you said over 50%. Are you seeing an acceleration there in terms of relative to Gartner’s comments?

Mark McLaughlin

Yes, Jonathan, we are. So what we said in the past is that over half of our news deals and half of our existing customer base use primary firewall and that number continues to go in the right direction for us. And I think what Gartner is saying here is that enterprises are have been coming around roughly coming around, you really need an next gen firewall in order to have the best level security in the market today. So their expectation is that as those purchases occur most of them meaning more than half of those are going to be for next gen firewall so that will point to (inaudible).

Jonathan Ho - William Blair

Got it. Just in terms of PA3000 line, just wanted to understand a little bit about how much an impact that product set is having. I know it’s been out for a little while, but just driving some of the new extension opportunity or has achieve more market acceptance just want to get sometimes (inaudible)

Mark McLaughlin

If we got a lot of input from customers (inaudible) that they liked to see a device in that range, so we delivered it at the end. I mean it's sold very well from the first day we introduce that and we expect to do that (inaudible) so we are very pleased with it.

Operator

Thank you and your next question is from Carl [Kirst] from BMO Capital Markets.

Unidentified Analyst

Hi this is Shakeel (inaudible) for Carl Kirst. Two questions can you talk a little bit more about demand environment you mentioned strong enterprise demand in your prepared comment and I just wanted more color on that? You also talked about enterprises wanting to consolidate to more of a single architecture are you seeing an uptick in one demand and also just that kind of trend of kind of more consolidated architecture? And then also my second question just are you able to give a little more color around 50% new customers that are buying primary firewall, are they in terms of anything you can give us there would be helpful.

Mark McLaughlin

Now we’ll get reverse (inaudible). On the new ones we say 50% of the new customers (inaudible) primary firewall that’s across the board meaning that it’s all crossing entire customer based. We are really focused as we said before on the Global [2017] to those folks as well, and as we are continually rapidly accepted in the market as enterprise networks firewall provider with the technology what we have seen that deals get done quicker and the initial deals get bigger and then the follow on purchase gets faster and the follow-on purchases get bigger, so that’s generally what we would continue to see.

And in first question was kind of place that which is the demand has been and continue to be very high for this technology and again your partners echoing that just a few weeks ago, but we (inaudible) from the demand standpoints for our technology and then on the other question around what I was saying architecturally, I mean you guys you can call consolidation, we think about it as more latest integration of the technologies required to combat what you are seeing on the security and secured today.

We believe that overtime architecturally customers want demand and will get more and more of the functionality needably from the firewall, but simply I mean (inaudible) cost wise but way more importantly that that is a better security solution. I use Malware and everybody is focused on that. We use Malware as an example. If you want to see the Malware coming in, so that would be traditionally a malware device, seeing the malware coming in when the malware is in you would want to see its trying to talk outside the network of the malware device want to do that, your IPS device would be the one listening for the command and control to see if its communicating out, and then if it was and you are able to put a signature on it with your [AB] device then you would want to communicate it back to your firewalls so that you could be ready to have a signature to enforce it, that's kind of what mismatch actually looks like out there and that's not very convenient or secure. So that's why we continue to see customers striving and pressing for better security in a daily integrated fashion which is focused by the market.

Operator

Thank you. And your next question is from Walter Pritchard with Citigroup.

Walter Pritchard - Citigroup

Mark, just on the product side I am wondering if you can compare and contrast sort of the pressure to move on with a higher end box even higher than where you are today versus moved down into the low end and I am wondering just kind of branch versus datacenter where you've been called more so as you see incremental demand?

Mark McLaughlin

Well, both directions, so I think on this let me talk about the smaller side first, I think you know customers would like to see us have even smaller boxes than the PA-200 with all of the functionality right with the next-gen firewall and that's challenging just from how do you do it for all that at the right cost of profitability to do that. So we thought about that continuing about ways, we get that done and then in the higher end there is a set of the customer base that not everybody does, they don't and I'll tell you why, but not everybody would see a higher throughout box and higher end doing all the next-gen functionality that we do in the boxes we have today. Those tend to be large, large datacenter deployments or carrier or folks like that, so we definitely are paying attention to that and taking that input very seriously and I think you could expect to see us do something in that area in the future.

Generally though, one of the things that the market is used to for really long time is saying if I want to get X throughput, protected throughput with everybody else in technology if you want 2 gig, the protective throughput you probably have to start with a 40-gig box to get it because of all of the performance degradation and we don't have that problem. So you get 2 gigs and 2 gigs operation so you get what you paid for as opposed to having to start with something very expensive and we've been able to serve it a lots and lots of throughput because of that.

Walter Pritchard - Citigroup

And then just, I have been wondering on just a clarification on the deferred revenue; you did have a very strong quarter, I am wondering if there was any sort of abnormal seasonality, lots of going on in the government and things like that any pull forward in maintenance in longer term, maintenance deals that or do you think that because the seasonality here looks much more pronounced than it was in last year?

Steffan Tomlinson

Our deferred revenue grew nicely and we have seen an uptick in multi-year deals both on the subscription side and on the maintenance side, so nothing too out of the ordinary is happening there.

Operator

Thank you. And your next question comes from Tal Liani, Bank of America Merrill Lynch.

Ron Zember - Bank of America Merrill Lynch

Hi, guys, this is Rom Zember, on for Tal Liani. Just a couple of housekeeping questions; headcount, should we think of the same run rate for the (inaudible)……

Steffan Tomlinson

We talked about a range of 75 to 100 and timing of heads on board sometimes there are some variances, but we still feel comfortable with that range. This past quarter we added exactly a 100. And I think going forward the 75 to a 100 range makes sense for us for the balance of the fiscal year, for the quarter.

Ron Zember - Bank of America Merrill Lynch

And then how about investment in channel; how many partners you guys added this quarter?

Mark McLaughlin

We haven't broken out what we have done on a quarter-by-quarter basis. We said in the past we've got about 800 [Technical Difficulty] and over about the last year’s we've added 200 to 250 and we expect to do that on a continued rate that's sort of the benchmark. We are very interested in the quality of those, over the quantity of those, just because when you have the newer or relatively newer disruptive technology having highly trained partners being able to sell into accounts major almost probably doing displacement; very important to since we focus a lot on them.

Ron Zember - Bank of America Merrill Lynch

And how is the ramp been on the refinance?

Mark McLaughlin

Great, it's in line with our expectation.

Operator

[Technical Difficulty] Erik Suppiger, JMP Securities.

Erik Suppiger - JMP Securities

I had two questions. First, just curious if you have seen any change in the competitive landscape coming from other next generation firewall vendors? And then secondly on the WildFire, the subscribers, I think, you said around 1,200. Was there any pent up demand? Is that something that was kind of just because of the initial release or it might we expect that to continue growing at a similar rate?

Mark McLaughlin

So first one, a competition I would say. The answer is no. So we believe this to be true that we are the only real next generation firewall provider in the market. Lots of folks are doing marketing around application identification trial --- they can block application and then they try to call that Next Gen firewall but we're the only offering in the market that can truly safely enable applications and that’s the difference.

So we have seen a lot of competitive marketing but we haven't seen any catch up from a competitive technology standpoint. I don't think we really care about it at the end of the day. On the WildFire side, yes, I should have been more clearer a little earlier. So we had a free version of WildFire in the market for over a year and we’ve had a really good customer adoption on the free versions. So we have 1,200 total customers today using WildFire and then off that base to the customers when we released our paid-for version at WildFire in November, we saw some new customers buying and existing customers starting to pay from attach rate perspective. So I want [Technical Difficulty] we don’t have 1,200 paid-for subscriptions to suggest that the total base of customers (inaudible) WildFire and attach rates on these numbers are good so far for us.

Erik Suppiger - JMP Securities

Do you have attach rate for the paid version?

Mark McLaughlin

For the paid version, yes.

Erik Suppiger - JMP Securities

Okay, any details on how that performed in the quarter?

Mark McLaughlin

Better than better we [Technical Difficulty].

Operator

Thank you. And your next question comes from Brent Thill of UBS.

Brent Thill - UBS

Thanks Mark. Just on WildFire, how do you think of ASP list if you just used may be simple numbers to help us understand what you are seeing initially in those paid for customers?

Mark McLaughlin

Yeah, Brent we are trying to keep it really simple and like we have for all our subscription services, so all of our subscription services are the same and that when you buy a device cost X right and it has a list price on it and the subscription service is 20% of list price. That's true for WildFire as well so you are going to attach the paid for subscription of WildFire get 20% of the list price of the box you are putting in.

Brent Thill - UBS

Okay that’s great. And if you just give us your thoughts on the government what you are seeing in your pipeline? How you think about the potential upcoming impact of things going on there right now? That would be helpful, thanks.

Mark McLaughlin

The government market has been a good market for us and I think we continue to be just be by the nature of what we do for living. With that said, no verticals more than 14ish percent of our business today. So we have to keep that all in context. I think your second question is really or a part of that is around sequestration, so there is a lot of speculation and anxiety general about whether that’s going to occur, I guess why don't tomorrow right. And if so what's that going to mean impact wise, I think it's too early to tell but there are few things that remain, the one is the type of security is a national priority you can see that as lately its just a couple of week to go at the President, executive board of Cyber Security, and then second thing in general is as enterprises and to some degree the government so more than an enterprise if you consider that way they are being forced to do more with flash from a budget perspective, but we got a better solution [Technical Difficulty] I think that’s a really desirable offering that’s what we have and I think that government has and we will continue to find it attractive things and all that nobody really knows what the impact of sequestration [Technical Difficulty].

Operator

Thank you. And your next question comes from Gregg Moskowitz from Cowen.

Gregg Moskowitz - Cowen

Just to follow onto one of Walter’s questions, how is demand this quarter across your current set of low, mid and high end appliance was it strong across the board or to one area for example, pro forma a little better than the other?

Mark McLaughlin

Its strong everywhere Gregg and what I was saying a little earlier was the 3000 is selling very well higher than what we thought it would selling which is always great. So I call that everything is selling well that's a good (inaudible) in the selling better than we thought it would but everything continues to improve.

Gregg Moskowitz - Cowen

Okay, great and then for Steffan your services gross margin tapping on a nice upward trend over the past few quarters, looking forward I am sure you can make some investments in your support organization at the same time presumably your mix of subscriptions will continue to increase, so just wondering how you are thinking about particularly about service margins come up near?

Steffan Tomlinson

We are not going to break out specifically how each of the components of the services gross margin work or the product gross margin. On the services gross margin in particular, the dynamic around subscription versus maintenance and the customer support realization, subscription revenue is going to be recognized rapidly over the life of the contract and to be consistent small tail win that builds overtime as we sell more subscriptions.

The cost of support to deliver maintenance is very much headcount driven and systems driven and those costs are more pronounced upfront. So we have a couple of countervailing forces playing against each other. We have been more disciplined in getting more efficiency out of our support organization which is helpful and as WildFire and other subscriptions continue to build, there should be a positive tailwind to services gross margin over time. There will be some near-term fluctuations. I think the biggest thing to understand is given that this is a fifth consecutive quarter, we've added over a 1,000 new customers but we want to make sure that we are adequately resourced to ensure a great customer experience and that's a big differentiator between us and in the competition.

Operator

Thank you and your next question is from Aaron Schwartz, Jefferies.

Aaron Schwartz - Jefferies

Just a quick sort of follow-up question on the deferred revenue, obviously that's been well ahead of what we have modeled, should we expect and I'd assume we would but should we expect a more pronounced revenue mix shift to services as we build the model out in the back half of the year and into ’14.

Steffan Tomlinson

It’s a little too soon to tell. We are primarily a booking ship business. If you look just on a revenue basis still we are getting approximately periods of our revenues from products. Over time, we think directionally services as a percentage of total revenue and total billings we'll be building but given the fact that we are adding so many new customers per quarter and we are following our land expanded expense strategy of mining our installed base and selling to you new opportunities within that base, we expect to see both robust product growth and services growth. We will monitor it over time but right now we are not making any predictions on the split.

Aaron Schwartz - Jefferies

Okay and the sort of just a follow-up question, you spoke about the trend of a couple of more multi-year deals, I think you said that was balanced between the maintenance and the subscription services. What's actually driving that, is that more of a customer preference or do you have the sales and partner program actually out trying to do multi-year deals.

Steffan Tomlinson

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

Operator

Your next question is from Keith Price, Morgan Stanley.

Keith Price - Morgan Stanley

The one thing that I noticed in the quarter is you had in the second quarter a really robust sequential increases in EMEA, anything in particular looking better there or sort of catalyzing growth there that's really leading to those two nice [uptick].

Mark McLaughlin

Yeah, what you can see is you know different numbers we increased the business sequentially in last three quarters and particularly in the last two quarters at really healthy rates so you know obviously we are pleased with that. It’s a little too early to speculate as whether any of that means as a general matter or resurgence with confidence in the EMEA market macro wise, but we are in a position that's going really high value technology and a great secular trend, that's going to affect enterprises all around the world including EMEA so we would expect security to remain top of mind to budget issue over there, or you know top of budget issue up to there.

More specifically your question for us what we have seen is larger companies where we've been working on larger projects starting to bring those projects to fruition and replacing [low key] technology with (inaudible) and that's a positive again for us in the second quarter. So I don't know if that means that the (inaudible) strings opening more, generally over EMEA but that’s kind of what we're seeing specifically to us.

Keith Price - Morgan Stanley

Got it. And in terms of where you are investing in additional distribution capacity, can you give us any color is it spread out evenly across the globe or is it more of an international focus?

Mark McLaughlin

We were investing pretty much everywhere. We have (inaudible) market and basically is we do or call it rationalization of when you are putting the dollar rate, where do you expect to get some most out trying to get a good balance of that on like earlier high growth market versus more stable places where if I just be splitting territories. But generally we're investing everywhere as we're still growing very nicely but still under distributed, pretty much on a global basis because the markets are still large for something (inaudible) felt.

Keith Price - Morgan Stanley

Got it, and maybe if I can sneak in one last one. I think on the last conference call, we talked about really good volume increases from the PH (inaudible). I think you talked about greater than 70% unit growth in the quarter, any chance of update on that (inaudible).

Mark McLaughlin

I am sorry I don’t remember that specifically.

Steffan Tomlinson

Yeah, on the volumes, we don’t typically go to a level of granularity on giving the product unit growth sequential or year-over-year numbers. But I can tell you just by virtue of the revenue growth, unit volumes were up across the board. Each of the main appliances that we sell had various strong demand in the quarter. The biggest positive development that we had in this quarter was the traction we had with the PA-3000 which we introduced in November and the update on that was extremely strong. But I will tell you, both the high end, PA-5000 and the low end the PA-200 they all had nice performance in the quarter.

Operator

We have time just to take two more questions; one from each of the following parties. The next question comes from Frederick Grieb, Nomura.

Frederick Grieb - Nomura

Just to circle back quickly to the new customers added in the quarter, can you give us an idea if the average size of these new customer purchases is increasing and what the dynamics are that’s causing those initial purchases to grow?

Mark McLaughlin

Yeah Frederick couple of things that would be - the answer is yes, call the ASP around that continued to go up and I think the reason for that again just goes back to the more step with (inaudible) more likely you want to make a bigger purchase with those upfront. As we said many times in the past that we were really not focused on that number, what we are really focused on is (inaudible) customer and we have a raft of examples of folks who spend well over million dollars with us it started with a relatively small five figure toward the [year] but then rapidly ramping well over $1 million. So that’s what we focused on is the time spend that (inaudible) initial purchases.

Operator

Thank you. And your next question is from (inaudible) FBM Securities.

Unidentified Analyst

Yes. Your mix effect was negative because of the I think you had ramping (inaudible) of the 3000 series, but you hinted that as the sales mature the margins will improve. So I am just curious about how you see the mixed dynamics playing out over the next several quarters. You also hinted at potentially a new high end box at some point, higher throughput boxes, it seems like this is the low point in terms of mix any thoughts on mixed dynamics going forward?

Mark McLaughlin

As Steffan said it earlier we had a very strong demand for the 3000 (inaudible) is going very well has been all new particularly hardware launches with the same kind of product growth margins we get until you scale into the volumes start to do savings we expect to see that overtime with that 3000 Series. (Inaudible) last year roughly at this time in the introduction of PA-200 where it sold really well out the door and had lower gross margins that because it was new product has improved as we expected overtime. And I did say a little earlier that there is demand from all the customer based for the larger devices which we certainly to think about. If we did that we would launch our device at the lower gross margin than it would later on but you had increasing demand.

And one thing as you always noticed, you should expect that to continue to launch devices in our family of our products for probably all the time based on what we are getting from the customers and where we see the ability to do that.

Operator

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

Mark McLaughlin

Well, great, thanks again everybody to be in our call today. I want to reiterate my appreciation (inaudible) Palo Alto Networks been the supportive for all our customers and partners, as we continue to revolutionize the enterprise networks security market. We look forward to seeing all of you at our analyst day in New York City on March 21st. Thanks a lot for your time.

Operator

Thank you for joining today's conference. This concludes the presentation, and you now disconnect. Good day.

Copyright policy: All transcripts on this site are the copyright of Seeking Alpha. However, we view them as an important resource for bloggers and journalists, and are excited to contribute to the democratization of financial information on the Internet. (Until now investors have had to pay thousands of dollars in subscription fees for transcripts.) So our reproduction policy is as follows: You may quote up to 400 words of any transcript on the condition that you attribute the transcript to Seeking Alpha and either link to the original transcript or to www.SeekingAlpha.com. All other use is prohibited.

THE INFORMATION CONTAINED HERE IS A TEXTUAL REPRESENTATION OF THE APPLICABLE COMPANY'S CONFERENCE CALL, CONFERENCE PRESENTATION OR OTHER AUDIO PRESENTATION, AND WHILE EFFORTS ARE MADE TO PROVIDE AN ACCURATE TRANSCRIPTION, THERE MAY BE MATERIAL ERRORS, OMISSIONS, OR INACCURACIES IN THE REPORTING OF THE SUBSTANCE OF THE AUDIO PRESENTATIONS. IN NO WAY DOES SEEKING ALPHA ASSUME ANY RESPONSIBILITY FOR ANY INVESTMENT OR OTHER DECISIONS MADE BASED UPON THE INFORMATION PROVIDED ON THIS WEB SITE OR IN ANY TRANSCRIPT. USERS ARE ADVISED TO REVIEW THE APPLICABLE COMPANY'S AUDIO PRESENTATION ITSELF AND THE APPLICABLE COMPANY'S SEC FILINGS BEFORE MAKING ANY INVESTMENT OR OTHER DECISIONS.

If you have any additional questions about our online transcripts, please contact us at: transcripts@seekingalpha.com. Thank you!

Source: Palo Alto Networks' CEO Discusses F2Q13 Results - Earnings Call Transcript
This Transcript
All Transcripts