Good day, ladies and gentlemen, and welcome to the First Quarter 2014 Palo Alto Networks Earnings Conference Call. My name is Britney, and I'll be the operator for today's conference. At this time, all participants are in a listen only mode. Later, we will conduct a question and answer session. At this time, I would now like to turn the presentation over to your host For today, Ms.
Kelsey Turcotte. Please proceed ma'am.
Good afternoon and thank you for joining us on today's conference call to discuss Palo Alto Networks' fiscal Q1 2014 financial results. This call is being broadcast live over the web and can be accessed on the Investors section of the Palo Alto Networks website at investors. Paloaltonetworks.com. With me on Today's call are Mark McLaughlin, Palo Alto Networks' Chairman, President and Chief Executive Officer and Stefan Tomlinson, Chief Financial Officer. After the market closed today, Palo Alto Networks issued a press release announcing the results for its 2014 That's it online at the company's website or you can call the Blueshirt Group at 415-217-7722 and they will e mail you a copy.
We would like to remind you that during the course of this conference call, Palo Alto Networks' management in Palo Alto Networks business trends in its business and operating results, including customer growth, its services revenue, gross margins, services margins and DSOs expectations regarding investments in research and development and the introduction of products and Palo Alto Networks revenue and non GAAP estimated earnings per share for the 2nd fiscal quarter of 2014 ending January 31, 2014. 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 We take no obligation to update these statements after this call. For a more detailed description of these risks and uncertainties, please Please refer to our annual report on Form 10 ks filed with the SEC on September 25, 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 on 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 Investors section of our website located at investors. Paloaltonetworks.com. Before I turn the call over to on December 4 in Scottsdale, Arizona. And with that, I'd like to introduce Mark, Chairman, President and Chief Executive Officer of Palo Alto Networks. Mark?
Thank you, Kelsey, and welcome to the team, and thanks everyone for joining us today. Q1 was a strong start to our fiscal 2014. Our results continue to prove that our next generation enterprise security platform is quickly becoming the mainstream market choice for enterprises around the world and that it uniquely positions us as a leader in the fast growing cybersecurity market segment. The combination of These market drivers, our land and expand strategy and the power of our fast growing subscription services model drove record revenue and strong bottom line results in the Q1. Revenue in Q1 grew by 49% year over year to over $128,000,000 and We delivered high gross margins, significant operating leverage and non GAAP EPS of $0.08 per share.
We are very pleased with what we have accomplished this quarter And believe that the reasons for such high growth positions us well for continued growth. Today, global enterprises are facing an extremely difficult environment, Which protecting their networks against the ever increasing threats is paramount. The risks are very high and include lost revenue, loss of customer data, loss of intellectual property And loss of customer trust. At the same time, it's more and more evident that the legacy security technologies that enterprises have relied on for a long time are incapable of addressing their This has led to a major market disruption in favor of Palo Alto Networks. Our platform is at the forefront of next Generation enterprise security and is now being rapidly adopted by the Global 2,000 as their mainstream solution at the expense of the legacy vendors.
In addition, we're uniquely positioned as a firewall, the main protection point for network security with the next generation platform, which provides a highly integrated and automated level of visibility and intelligence around detection and prevention. This allows us to benefit from the drive for advanced cybersecurity solutions. The mainstream adoption of our platform is the firewall of choice as well as our unique ability to provide the most Automated cyber threat detection and prevention capabilities in the market is showing our growth. And we can see this playing out in the numbers. Our adoption as the primary network security Platform by Global Enterprises continues to grow.
In the Q1, we saw continued penetration of the largest companies in the world with over 65 Also in the quarter, our wins against legacy competitors included 1 of the largest oil and gas companies in the world, where we're Replacing Check Point at Cisco, a major Canadian bank, a large healthcare organization that will be deploying our full solution In addition, we demonstrated last quarter how we are well positioned to rapidly expand within our customer base. For example, we expanded within a Fortune Manufacturer based in the United States with a 7 figure deal to be their primary firewall. And we also expanded within a U. S. Federal agency where our platform is displacing large amounts of legacy technology.
These results show that we continue to rapidly move into the mainstream with the largest companies This trend is further evidenced by the climb in our lifetime customer value. For example, in Q1, a top 5 customer had to spend a minimum of $4,100,000 with us and lifetime value to make the top 25 list. And our lifetime value measured by The increase from their initial purchase rose to 19.6 times. This compares to $3,600,000 15.4 times in the immediately preceding quarter and $1,500,000 on our solutions, which is double from what it was a year ago. We believe our continued increase in wallet share will enable high growth over the long term.
Our position as the firewall and our innovative approach to increasingly sophisticated attacks also sets us up well for high growth in the market for cybersecurity solutions. This has been a big factor in our platform adoption that I mentioned earlier and we can also see it in the rapid growth in Wildfire, the market's most highly automated and integrated detection and prevention solution. In Q1, wildfire customer adoption grew to approximately 2,400 customers, up from about 2,000 in the prior quarter, with approximately 1,000 paying customers using the platform, up from around 600 customers in Q4. The wildfire Attach rate was over 20% in the quarter and Wildfire continues to act as a driver and differentiator for our core network security platform. Wildfire requirements.
The hybrid SaaS business model means that we're able to benefit over time with recurring revenues as we build our In a constantly evolving and complex threat landscape, we continue to deliver solutions that solve our customers' This is an approach that makes sense as our core platform sits in the single most important spot for network security as the firewall. And of course, we continue to invest in innovation and aggressively grow our go to market capabilities. On the innovation front, in early calendar 2014, we We expect to introduce our high end 120 gig chassis for the data center and service provider market, deliver significant enhancements to our wildfire service, release our Next major OS revision and bring our joint virtualization solution to market with VMware. Expect more innovation throughout the year as the technology gap between Palatin Networks and our competitors continues to widen as it has every year since we began Providing solutions to our customers. In terms of our go to market focus, the growth of our sales force, continued growth in investment channel partners, penetration in emerging markets And building out our alliance ecosystem, our accelerating delivery of our solutions to the market and growth in the business.
We'll continue to All these focus areas to grow into our large addressable market. Before concluding, I want to mention that we completed the summary judgment and claims construction hearings and our litigation with Juniper on November 15. We remain confident in our position in that case. To wrap up, our first quarter results We continue to demonstrate that we're on the right track. We've reached over $500,000,000 in annualized run rate revenues and continue to grow at almost 50% as we rapidly gain
Stefan? Thank you, Mark. I'm pleased to report that Q1 results for fiscal 2014 exceeded We continue to demonstrate rapid revenue and billings growth, solid bottom line performance and healthy free cash flow generation. Before I get into the details, I'd like to note that except for revenue figures that are GAAP, all financial figures are non GAAP unless stated otherwise and exclude IP litigation expenses for both the Q1 and historical comparisons. New wins from customers in the quarter, our expansion within our existing customer base and our hybrid SaaS revenue model were the catalyst for Revenue, billings and deferred revenue growth.
In Q1, total revenue was a record $128,200,000 growing 49 percent over the prior year and 14% sequentially. The geographic mix of revenue was 67% Americas, 19% EMEA and 14% APAC, all theaters posted solid growth year over year led by the Americas, which grew From a vertical and customer standpoint, we saw broad strength across a wide range of verticals, including federal and we had no end customer concentration. All three components of our hybrid SaaS model grew well in the quarter. Product Revenue of $75,500,000 increased 36% over the prior year and 15% sequentially. Growth was driven in part by demand for our mid range 3000 and high end 5000 PA series of appliances.
Our recurring services revenue of $52,700,000 increased 73% over the prior year and 12% sequentially and accounted for a 41% share of total revenue. Looking at its two components, support and maintenance revenue of $27,900,000 increased 75% over the prior year and 10% sequentially. Our SaaS based subscription revenue of 20 Our SaaS based subscription revenue of $24,800,000 increased 71% over the prior year at approximately 15% sequentially. As a result of our land and expand strategy and the recurring nature of our support and subscription We expect the services revenue will continue to grow at a faster pace than product revenue as we continue to monetize our incumbent position in the network. Every time we sell a new subscription or renew an existing subscription, It's equivalent to selling a product except that we've chosen the SaaS model to deliver and monetize it.
Increases in services revenue as a percentage of total will improve our gross margins as well as increase visibility into future revenue streams. The strength of our business model was evident in Growth rate in billings, deferred revenue and free cash flow. Compared to the prior year, billings in Q1 grew 43% to $157,900,000 Total deferred revenue increased 74% to $279,000,000 and short term deferred revenue increased 69% to $171,600,000 Turning to gross margin, total gross Gross margin of 75% increased 50 basis points sequentially. Product gross margin was 76.6 percent As a reminder, there will be fluctuations in our product gross margin, primarily due to product mix and the timing of new appliance shipments. Services gross margin of 72.8 percent declined 70 basis points sequentially due In our customer support organization as we continue to add systems and personnel to accommodate the rapid growth of our customer base.
Moving on to operating As Mark discussed, we believe there's considerable opportunity for us to drive growth and capture market share and we continue to invest in both product development and our sales and go to market organization. Research and development expense was 12.9 Approximately $2,100,000 sequentially to $16,500,000 Headcount additions and project related expenses supporting our development activities contributed to the increase. Sales and marketing expense was 47% of revenue, essentially flat with the prior quarter as a percentage of sales and increasing approximately $7,300,000 sequentially to $60,300,000 New headcount additions at the beginning of the fiscal year, Partner conferences and our worldwide sales event that we held to kick off the new fiscal year contributed to the increase. General and administrative expense was 7 6% of revenue, increasing approximately $2,500,000 sequentially to $9,800,000 The sequential On a GAAP basis, IP litigation expense in our G and A line was $1,900,000 in Q1, 2014, dollars 600,000 in Q1, 2013 and $1,400,000 in Q4, twenty thirteen. We've provided a supplemental schedule on our IR website that shows the historical impacts of the IP litigation costs.
In total, operating expenses were $86,600,000 or 67.5 percent of revenue. Operating margin 70 basis points year over year to 7.5% and declined 50 basis points sequentially. Our effective tax rate for Q1 was 38%. Net income for the quarter was approximately 6,200,000 share using 77,200,000 shares compared with net income of $3,300,000 or $0.05 per diluted share in Q1 'thirteen. On a GAAP basis for the Q1, net loss was $7,900,000 or $0.11 per basic and diluted compared to a Q1 'thirteen GAAP net loss of $3,500,000 or $0.05 per basic and diluted share.
Turning to the balance sheet. We finished October with cash, cash equivalents and investments of $470,400,000 Cash flow from Operations, free cash flow and free cash flow margin were $38,900,000 23,200,000 and 18.1% respectively. Capital expenditures in the quarter totaled $15,700,000 and were related to facilities purchases and acquiring intellectual property. The accounts receivable balance was $91,400,000 up from the prior quarter balance of $87,500,000 Linearity in the quarter improved, which helped improve average days sales outstanding to 63 days, down from 72 days last This is below our DSO target range of 65 days to 75 days. Let me now move to our guidance.
As a reminder, guidance $132,000,000 to $136,000,000 which represents 37% to 41% growth year over year. And we expect non GAAP EPS to be approximately $0.08 to $0.09 per share using 77,000,000 to 79,000,000 shares. With that, I'll turn the call back over to the operator for Q and A.
You may press star 1 to begin. And your first Question comes from the line of Greg Dunham representing Goldman Sachs. Please proceed.
Yes. Thanks for taking my I guess Q4 was a good quarter for you guys. You improved your execution, but this quarter actually jumps out It's better than that with accelerating product revenue growth. How can you decipher between how much of that is just increased tenure Of the reps that you hired last year versus just generally improving macro, any way to distinguish that?
Hey, Greg, it's Mark. Yes, the answer is more likely not all of the above, which is I think the security market It continues to be very robust. You can see that not just from ourselves, but other folks have reported. The needs out there are very strong. Customers are buying to solve those needs.
And then And then on top of that, we have a unique platform. So we're benefiting disproportionately from that. As you know, we put a hell of a lot of focus into The major global accounts and the sales organization over the last year and I think that that's paying off very well as you can see from the numbers too. So I think a lot of these things are moving in our direction. Some are macro and some are about the solution and some are about the things we're doing on an execution basis with the company.
And then one quick follow-up If you may. Where are we in terms of customers migrating to 5.0 on an OS basis?
Yes, a bit over 60%.
Okay. Perfect. Thanks guys.
Thank you.
And your next question comes from the line of Keith West representing Morgan Stanley. Please proceed.
Excellent. Thank you guys for taking the question and very nice quarter. I was wondering
if we could talk
a little bit about going into any Q1 there's some level of sales changes that take place. Maybe you can mark to market for us the level of changes that were enacted this year compared to prior years and how comfortable you feel with everybody kind of marching to orders for the rest of the year from where we're standing today?
Yes, sure, Keith. Well, as you know, over the last year, we made a number of changes in Organizations about 18 months ago with Mark Anderson joining us, under an assumption that he would do a certain number of things that she's done very From a team perspective, starting with leadership and then also getting the reps who know how to service and close large accounts. That's really worked itself out through the better course of the last year and all those changes have been made and we think People are really humming down. We mentioned at last call that this will be the 1st year by the end of the year we'll have more ramped than ramping sales the organization, which we think is a good thing for us as we continue to march down the field.
Excellent. Excellent. And then maybe on the from a potential overhang perspective, If you could get your comments on 2 aspects. 1, just in terms of litigation, we are sort of into the thick of this past the Markman hearing. Any more FUD in the market in terms of tying up sales cycles, any impacts on the actual fundamentals from that litigation?
It doesn't appear to be the case. We've said before that we haven't seen any impact in the market that we can discern from a selling perspective. We continue to grow at extremely healthy rates. We continue to beat all the competition handily whenever we face them. So I don't see it really playing out in the market.
Excellent. And then one last one, just in terms of the competitive environment. Cisco obviously made a pretty big acquisition of Sourcefire, what's the initial indications on sort of how that's impacting you guys in terms of the competitive environment? Are people taking Cisco more seriously? Or is it just Corruption in the near term?
I think to the extent there's any impact at all, it's been positive for us and that's primarily because we We handily beat Cisco when we face them. We've beat Sourcefire and head to head competitions as well. And taking an IPS technology and bolting on a stateful inspection Firewall is not a fundamental disruptive technology change. So I don't think it changes anything from a technical solution perspective. We've also seen In the market from the Sourcefire customers about what that means, what's going to happen to them.
Over time, we've been able to develop hundreds and hundreds of leads from dissatisfied or So at least from our perspective, it's been a positive.
Excellent. And again, very nice quarter guys. Thanks, Keith. Thank you.
And your next question comes from the line of Rob Owens representing Pacific Crest Securities, please proceed.
Great. Thanks for taking my question. Mark, you mentioned how the spending in security markets were I think if you go back a couple of quarters, it was a little more choppy. So maybe just talk about general demand how the space Are we in front of that perceived firewall replacement cycle that I think a lot of folks have been talking about for the last year?
Yes. Hey, Rob. It's a little hard to come by hard data around the refresh cycles as far as anybody who We'd know for sure, but I've heard a number of anecdotal points that a big refresh cycle is upon us in the next 12 to 15 months. We think we can see that from what we're seeing from a pipeline perspective, close rates. I mean, it all points in that direction that there is a big Refresh like in front of us.
On the big picture about security, I know that there was a 1 quarter bump in the road before, not just security, There are various reasons for that, but it appears as though at least from a security perspective that that's rebounded very nicely and that security is a top of mind issue and is likely to remain that way for
Great. And as we look at
some of your incremental services and those SaaS capabilities and wildfire or the URL filtering or threat Any sense of where renewal rates are running on those services?
Yes. We said earlier that the renewal rates were Better than 85% and more likely than that higher than that. One of the reasons that we were less exact on the higher number was that when a customer Upgrades from an equipment perspective for us it looks like a new sale not a renewal. So we're highly confident it's higher than that, but
Great. Thanks guys.
Thanks, Rob.
And your next question comes from the line of Jonathan Ho. Please proceed.
Good afternoon and great results. Just wanted to Start out with the EMEA and APAC regions. What type of opportunity do you see to sort of accelerate growth there? Are there any sort of Things that restrict the growth from maybe being a little bit faster than what you're seeing, especially relative to your North American results?
Yes. So if we look at the results in EMEA and APAC on the EMEA side, we saw good year to year year over year growth and a slight sequential Decline of about 2%. We like EMEA as a market. We think that's a big growth opportunity for us. There continues to be some concern in Southern Europe.
I think that's going to last for a while from a macro standpoint. But we're investing there and we think that that's a good growth market for us. Also just as a General matter coming from a Q4 to Q1, it's not surprising to see sequential decline there. In APAC, we had a 2% sequential as well, but we had very strong year over year growth in APAC. We're coming off extremely high comp, last sequential growth quarter over quarter in APAC.
So it's across the board generally pleased with all the performance in the regions.
Got it. And Just in terms of the latest products that you're seeing released, what type of opportunity do you think that's going to drive in terms of accelerating growth, Particularly relative to the high end of the market and the mid range, and what could that mean in terms of your growth expectations?
Yes. So the ones that we've talked about from a roadmap Perspectives coming up in relatively short order, following the category of a new version of Wildfire coming out, which is going to help us to continue Even faster accelerate the need for cybersecurity solutions. We've talked about our 120 gig chassis, which is coming out, which will help us expand even Faster than we are today in the data center environment and open up a new part of the addressable market for us, which is the service provider market. And we've also talked about our joint technology offering coming to market shortly with VMware, which is going to allow us to even penetrate faster into the virtualization So those are a couple of 3 we've discussed a lot. There's more obviously, we're not going to get into laying out the entire roadmap.
But we think those allow us to get bigger opportunities in in different deployment models like virtualization and also get more than our fair share of the real fast growing Cybersecurity sub segment of the enterprise security market.
Great. Thank you.
Thanks, Jonathan.
And your next Question comes from the line of Bill Winslow representing Credit Suisse. Please proceed.
Guys and congrats on a great quarter. Just wanted to focus on your comments about improving attach rates and renewal rates of your subscription offerings and particularly Wildfire. Just what are you hearing from Customers as far as just the sort of the ability to adopt more subscriptions from you all. And in particular Wildfire, what are you hearing from customers about why they're choosing Wildfire for Some of the other offerings that are on the market?
Sure. So from an attach rate on subscription services, they continue to go out for us, which is Greatness as we've expected they would. And as a reminder, the reason for that is that these subscription services are generally taking the place of what a customer used to have to buy
from a
standalone product. So this is best of breed functionality, a highly integrated, highly automated fashion At a much lower cost than what they would have to get by buying a standalone product. On the wildfire side, that's a very fast grower for us. And the Reason for that is, is this solving a real important problem for customers right now in this whole advanced persistent threat space. And the reason they're going with wildfire So it's primarily three things.
The first is that because we are the firewall in most customers' cases already, not only can we do advanced detection capabilities, But we can also do prevention because ultimately it has to be the firewall, in order to do that. The second thing is from a deployment standpoint, we're doing It's primarily in the cloud. So there's it's got infinite compute capacities and is wicked fast as a result of that. As an aside, we also have a private cloud solution with our And the third reason is you get the network impact because we do it in the cloud and we have thousands of customers in all verticals in every geography, We're able to share on a highly leveraged basis what we're seeing across the customer base. So you don't have to be attacked yourself in order to see From an attack perspective, you're getting the benefit of what we're seeing across the entire customer base that's using wildfire today.
So those are really driving the adoption.
Great. Thanks guys.
Thanks Bill.
And your next question comes from the line of Catherine Trebnick representing Northland Securities. Please proceed. Catherine, are you there?
Yes, I am. Can you hear me?
Yes. Now we can hear you.
Okay, sorry. Congratulations. Quick question is on Wildfire. You have 2 solutions, the cloud based solution And then the appliance, is there any pushback from your clients at all regarding security in the cloud and not wanting security in the cloud? Could you pretty much give us more color around that if that's the case or not the case?
Thanks.
Hey, Catherine. Yes, so primarily what we've And providing the customers, which they like is cloud based. And the reason for that is it's easy, it's very fast. As you get the leverage of the network and the sharing that goes on with that. However, there's a subset of customers that can't or For various reasons, send files to the cloud.
And because of that subset of the customer base, we developed the 500, which in essence allows you to create a private cloud solution. So if you have those concerns, you can still have all the power of this technology without worrying about the public
Are you also in some of your customers you also share FireEye is also a customer. Can you talk a little bit about how the differences between your solution and maybe perhaps their pure play?
Yes. What I was just mentioning a little while ago, which was, first Well, you got to start with the ability to do highly integrated and automated detection and prevention. And as the firewall, we can do both of those, not just the detection capabilities. We have the cloud aspect, which allows for a very fast ability to process files and get answers And then we're highly leveraged because we use the network so that all the customers can get the benefit of what other customers are seeing. So Generally, those are the high level architectural differences that allow us to put these kind of growth rates up.
All right. Thank you very much.
Thanks, Kevin.
And your next question comes from the line of Brent Thill representing UBS. Please proceed.
Good afternoon. Stephane, on your comment on linearity improving, I'm curious if you could just give us a little more color. Typically Q1, you wouldn't think you You would see that. What do you think caused that linearity improvement in Q1?
There are
a couple of factors, Brent. When When you think about the sales mechanisms we put in place around large account selling, we saw some nice from some of our larger customers in the first half of the quarter. So that was one thing. And then we We have the other part of our sales engine, which is keep the lights on business and we have a very robust high touch and direct fulfillment model with our channel partners helping. So we Very nice quarter from a linearity standpoint.
It helped drive DSOs down nicely quarter over quarter. So we felt really good about the quarter.
Okay. And can you just comment on the impact of the federal market?
Yes. So we're pleased with the Fed business in the Q1. We saw the end of the year Fed spend. I mean, they're end of the year as we expected we would Despite all the sequestration anxiety and I just think that's primarily the continued validation of our solution for a very discerning customer base. We like that sort of a lot and given what their needs are and what we do for a living, we think that that will continue very nicely for us.
Okay. So that in your Exceeding your expectation or matter was below, how would you characterize that business?
In the Q1, our expectations were met as we Expect them to be with the end of the year flush. Great. Thanks. Thanks, Brett.
And your next question comes from the line of Michael Turtis, representing Raymond James. Please proceed.
Hey, guys. I'm Michael Turtis. Thanks. One question on APAC, which It's a strong year over year. Any impact from the NSApolitical issues in China?
And how much China exposure do you have? So could this be an issue going forward?
Yes. Hey, Michael. Not that we can tell. So So I understand from Cisco's reports that they were seeing had some anxiety around that. In a big picture for us, our emerging market Opportunities grew very, very well in the quarter on a sequential and year over year basis.
So we haven't seen any of that kind of impact. We have a smaller base of business than those guys But it performed very well first.
Okay. And then kind of a high level question about the security market. Obviously, you did well overall and you did well with wildfire. Some People have questioned what the impact is of APTs on budgets on security budgets. In other words, is there any and taking oxygen out of the room relative to next And firewall with APT or do you view this especially since it's not a pre budgeted line item or is this something which is therefore expanding what you think the IT security budgets are like in the next 12 months?
I think it's a good thing for us. The way we think about this is We have a platform right, Ann, that years ago was considered just primarily a next gen firewall, but it's really a platform that has multiple solutions that are highly integrated From the firewall and IPS and filtering and others. And when additional security needs need to be met, we have a unique ability to add services into that platform. So that platform I think is really in a mainstream adoption phase of getting taken in by Global 2,000 Fortune 100 and companies across the globe. And that's just starting of of displacing all that legacy firewall plus the disparate other pieces of technologies.
In addition to that, we've got something This popped up in a relatively recent term on EPT or cybersecurity threats. And that for us is a feature set of our platform. So we get to And the next thing that's coming after that whatever that may be we have the ability with our platform architecture to bring that So we've got the mainstream adoption of our core platform plus another accelerator called APT, which is a feature of us on that platform. So we think it's Additive opportunity.
Great. Thanks a lot.
Thanks, Michael.
And your next question comes from the line of Jason Nolan representing Robert W. Baird. Please proceed.
Great. Thank you. First for Stefan, we didn't really see Seasonality in FQ1, Stefan, should we think about the rest of the year as FQ3 soft relative to A more positive FQ2 and FQ4?
That's a good question. We've highlighted this in the past where Our growth rates are have been so robust, it's hard to call the ball in seasonality. So what we originally thought was our fiscal Q2 Q2 and Q4 may be strongest in terms of year over year and sequential growth rates. Q1 obviously We saw no seasonality, which was a good thing. So what does that portend for the rest of the fiscal year?
I would still say that We would think that Q2 and Q4 would be very good quarters for us. We think Q3 would be too, but If there's any historical pattern that's shaping up last fiscal Q3 more from a macro standpoint had hurt us. In that quarter, we were still able to grow 50% year over year. So we it's still too soon to call the ball on seasonality, but We feel good about the prospects of growth for the rest of the fiscal year.
Okay. Thanks for that color. And then just a follow-up from me on U. S. Fed Gov, was the growth there a specific deal or broad based?
And Mark, can you continue to grow in this vertical given the challenges that likely remain?
Yes, Jason. No, it's broad based. The Fed's a unique vertical in that it takes a long time to get yourself established in there. But when you do, it really starts to pay off So I think this is a specific example of the focus we put into the major account program that we've been running for a while. This is a very like I said, discerning customer, but Once they start to adopt your technology, they can start they do that in a broad basis and we're seeing that happen.
So it's across the board, it's good growth in that vertical and we think that We continue in time. Of course, we're keeping our eye on the ball like everybody else about sequestration and all the budgets swirl that's Going on in Washington D. C. That's not a helpful thing for anybody, ourselves included. And obviously as we go into Q2, You don't have the end of the year Fed flush that you have in our Q1, but that's all baked into our guidance.
Okay. Thanks Mark. Thanks, Jason.
And your next question comes from the line of Gray Powell representing Wells Fargo. Please proceed. Hi.
Thanks for taking the question.
So I think you touched on this earlier, but I guess I'll ask it again.
So I mean network security spending has been somewhat constrained the
last couple of years. How do you feel about
the potential for improved refresh cycle for the industry as a whole?
And then do you think that provides you A better opportunity to displace incumbents and take share.
Yes. Hi, great. Yes, a couple of thoughts. The first is that the The addressable market opportunity we're playing in is $13,000,000 going to $16,000,000,000 $17,000,000,000 in next 3 or 4 Lots of studies out there suggest that that grows anywhere in a 5% to 7% CAGR. So just from a greenfield opportunity Your new opportunity 5% to 7% not a huge growth rate, but it's on a really big number, right?
So that's 100 and 100 of 1,000,000 of dollars gets created every year and we think we do very Well, there more importantly than that though is the installed base that you just mentioned and the refresh opportunities that come with that that are measured in 1,000,000,000 of dollars of addressable market And we can see just in the displacement of the competitors across the board, it doesn't matter who it is, we displacement at very high rates that we continue To win these refresh opportunities. We've heard from it, like I said a little earlier, it's hard to be mathematically exact in this, but a number Sources of the refresh that comes up every 3 or 4 years really big ones and we think we're at the beginning of one of those. Got it. Okay. That's helpful.
And then
just one more if I may. Can you help us think about the opportunity with wildfire longer term?
Do you see that subscription being as meaningful Some of the other early ones like IPS. And then just I don't know like sort of in life to date how would you benchmark it versus some of the other subscriptions? Yes. So the one that is probably closest akin to just from the way it might be thought of in the market is threat prevention. So So I'd expect over time that we could achieve rates in that zip code, which is pretty high.
And then from just a growth perspective, It's been growing at the rates that we saw some of the earlier subscription services grow at over time. It takes time to get them going. The customers have to adopt 5.0. That's why I think it Greg, you asked before what the percentage of the customer base is on 5.0. Right now that's a bit over 60% and growing every quarter.
So that's good just For our installed base. So there's a number of moving parts around that, that would lead that to grow over time, but we have very high hopes for Understood. Okay. Thank you very much. Okay.
And your next question comes from the line of Scott Zillow, representing Needham and Company please proceed.
Hi. I wanted to ask over the just as a trend anecdotally over the last few quarters, how have the Deals in the pipeline shaped up as far as breadth of service, point solution This is broad deployment of firewall. Can you give us some anecdotal color please?
Yes. A couple angles on that Scott. First is, recently we had said that, over 75% of the deals that are coming through the pipeline for us that we're winning, we're the primary firewall in those deals and A bit over 60%. This is an up we gave a couple of quarters ago, a bit over 60% of the installed bases were the primary firewall. So Those continue to rise.
So if you take that as one angle on the question. And then the second thing is our attach rates continue to rise as well. Meaning every We continue over time to attach more and more services to it. So the combination of those two things bodes well for
One follow on point to that. It really goes to the versatility of our platform. We can sell into any enterprise networking security need that exists. It could be for firewall, it could be for IDSIPS, filtering, you go down the list And the platform approach that we have really gives us a unique position against all the other vendors that are out there.
Just a follow-up, is that 75% We've heard that previously. Has that been a consistent number?
Yes. We said we're going to update that it's on a semiannual basis. That was the last time we gave That's what it was.
Okay. Thank you.
And that's up from the last time we talked about that.
Okay. Next question.
And your next question comes from the line of Hendi Susanto, with Gabelli and Company. Please proceed.
Welcome, Stefan. Thank you for taking my questions. I have one question for Stefan, management is targeting exiting the 4th quarter with operating margin in the low double digit. Considering the current investment, Then how should we expect the timing of margin expansion and operating leverage in the current fiscal year?
Well, We think that exiting Q4 will be in the low double digit operating margin on an exit rate basis. And Given the size of the market that we're going after, our if you look at our revenue growth, our customer additions, If you look at the power of our hybrid SaaS model, we've always said that we want to have more of a slow and steady approach to operating margin expansion throughout the fiscal year and towards our overall long term target model. So we feel like there's going to be room for incremental investment, but We're doing it in a disciplined way where we're generating positive operating margin right now. You look at positive cash flow and free cash flow generation. So the model is working.
And when you combine all that together exiting Q4, we feel Pretty comfortable that will be in the low double digit operating margin.
Thank you.
Okay. And your next question comes from the line of Shelby Sarrafi from FBN Securities. Please proceed.
Yes. So thank you very much. Very nice quarter. So your product gross margin has increased for about 3 quarters in a row And is it 76.6 percent non GAAP? And your total gross margins is 75% above your previous long term target of 70% to 3%.
So I'm just wondering with this 120 gig product coming out next year, should we think about the product gross margin Staying at this level or potentially even increasing? Or do you think that it's above where you think it should be longer term?
There are
a couple of parts to that The first is remember anytime we introduce a new product, we typically see a little bit of pressure on the product gross margin line because we haven't Achieved full scale and volume in that product line. So depending on the early level traction, there's usually a little bit of A negative fluctuation for new platforms that we introduce. To your broader point, we have a target gross margin range of 70% to 73% total. We've been operating above that, which is great. It's Because to the how we're operating our business in terms of a disciplined approach.
Once we get to our target model of 22% to 25% non GAAP operating margin. We're going to look at all the elements of that target model including Gross margin and we'll revisit at that point. But in the interim, we think there is going to be some fluctuation. We're still making investments in our services organization as an So you're going to see fluctuations there. But directionally over time, we feel good about the targets and We'll revisit once we get to the target operating margin.
Okay. And your IP litigation expense picked up again to $1,900,000 as you're And pass the Marksman hearings etcetera. Where do you see that going over the next few quarters?
Unfortunately, we see it going up. As we get closer to the trial, we will definitely see increases in IP litigation expenses. We're not calling the ball specifically on the specific dollar amount, but in order to provide full transparency, we are we'll break it out Every quarter, both on the call and in the supplemental documents that we post on our IR website.
Okay. Thanks. Thank Thank
you. And your next question comes from the line of Tal Liani representing Bank of America Merrill Lynch. Please proceed.
Yes. Hi. Thanks for taking my question. This is Eric Gennady for Tal. Just on the refresh cycle opportunity that you have ahead of you Next 12 to 15 months, is service provider included in that?
And if so, can you just give us a sense of what you're Seeing there from customer interest in your upcoming platform and how soon you can convert that into, I That's meaningful revenue from the time you introduce the product. Thank you.
Yes. Hey, so on the refresh that's specifically just called the Standard enterprise, meaning this is firewalls used in a standard enterprise environment. That's where the majority of the money sits today and that's what I meant from a refresh In the service provider market, as we mentioned before, other than working with the service providers as systems integrators and also as a We've had decent penetration with them from a technology perspective, in selling our technology to them, meaning they're Enterprise using our technology to protect their own environment and also an increasing opportunity where they're using our technology to provide service to their customers specifically enterprise customers. So we think the 120 gig chassis that we're coming out with is really going to go That last one I mentioned, which is the ability to use our technology to provide services to their customers as a And that's a new portion of the TAM for us as far as serviceability and we expect good things from that over the future.
And then just on your EMEA business, if I'm guessing the math is correct, it's been kind of within a tight range the last three quarters, Certainly up this quarter albeit off of an easier comp. Just give a sense on what you think is needed there aside from a good macro Of course, to drive the growth rate a little faster in this region. Thank you.
What's needed is a good macro environment. Unfortunately, that's the Sure. I mean, we're doing very well on a relative basis competitively in the market, but in the absence of, I'll call it, a more normalized The selling situation, the macro environment, it's tough sledding for everybody.
Thanks. Okay. Thank you.
We are taking our final question from Eric Stuttgart representing JMP Securities.
Yes. Good afternoon. Congratulations. Thanks Eric. First off, the 20% attach rate you said for wildfire, I think you said that it was Consistent with that last quarter, where do you think that attach rate could go?
And can you also comment as to how much of that is going into your existing Customers versus how much is going into new deployments?
Yes, Eric. Yes, a couple of things. It's over 20% in the first quarter What I just mentioned. And as I mentioned a little while back on a different question, we think that the attach rates can approach the ones that we have today for like threat prevention particularly in filtering so much higher than they are today. So we have a lot of Hope for that is a driver for us and a tailwind for us in the future.
And new customers versus existing?
Yes. On that, we don't break that out specifically, but we're doing well in both places. So we've got about 2,400 total customers on wildfire today. Yes, that's up from over 2,000 last quarter. So we're growing the total customers well.
And the paid customers are close to 1,000 close to 1,000 which is up nicely from last That quarter as well. So the more that we continue to grow the free customer base, the more opportunity we have to penetrate that base and we are doing The other thing is just given all the concern about advanced persistent threat cybersecurity today, we find that wildfire is also a Great appointment gutter for us just from a prospect perspective on getting into accounts in the 1st place and then being able to sell them the full solution not just that feature
Okay. And then last one. On the Wildfire 500, do you think that can become a meaningful revenue stream? Or do you think that's still We're going to stay a minority kind of customer base just looking to not use the cloud.
It was designed and has continued to be designed to solve the needs of customers who don't want to send or can't send files up to the public cloud. I think that's a it is a minority segment of the customer base. So our main driver for wildfire is not going to be wildfire 500, but of course we want to make sure we have total market For anybody who wants a private account solution as well.
Very good. Thank you. Okay. Thank you.
At this time, we have run out of time for Q and A. I will now hand the call back over to Mark McLaughlin for closing remarks.
Great. Thanks again for being on the call today. I want to reiterate my appreciation for the hard work of the Palo Alto Networks team and support of all of our customers and partners as we continue to define
for today's conference. You may now all disconnect and have a wonderful day.