Good day, ladies and gentlemen. Thank you all for joining. Welcome to the fourth quarter 2013 Palo Alto Networks Inc. earnings conference call. Today's conference is being recorded. At this time, all participants are in listen-only mode. Following the prepared remarks, there will be a question and answer session. If you would like to participate in this portion of the call, please press star followed by one at any time during the conference. If assistance is needed during the call, please press star followed by zero, the coordinator will be happy to assist you. Now I'd like to turn the conference over to Maria Riley for opening remarks. Please proceed.
Good afternoon and thank you for joining us on today's conference call to discuss Palo Alto Networks' fiscal fourth quarter 2013 financial results. This call is also being broadcast live over the web and can be accessed on the investor section of the Palo Alto Networks website at investors.paloaltonetworks.com. With me on today's call are Mark McLaughlin, Palo Alto Networks Chairman, President, and Chief Executive Officer, and Steffan Tomlinson, Chief Financial Officer. After the market closed today, Palo Alto Networks issued a press release announcing the results for its fiscal fourth quarter and year end of July 31, 2013. If you would like a copy of the release, you can access it online at the company's website, or you can call The Blueshirt Group at 415-217-7722, 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, increases in market share, and overall momentum in Palo Alto Networks business, especially as a result of its planned expand and extend strategy, ability to achieve its target operating model, trends in its business and operating results, including customer growth, its services revenue, gross margin, operating margin, services margin, non-GAAP effective tax rate, DSOs, and seasonality, Palo Alto Networks revenue and non-GAAP estimated earnings per share for first fiscal quarter of 2014 ending October 31, 2013, Palo Alto Networks' non-GAAP expected tax rate for fiscal year 2014 and expected rate at which its outstanding share count will increase in each quarter of fiscal 2014, and Palo Alto Networks' expected capital expenses for 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 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 June 4th, 2013, our earnings release posted a few minutes ago on our website. Please note that certain financial measures we use on this call are expressed on a non-GAAP basis and have been adjusted to exclude certain charges.
We have provided reconciliations of these non-GAAP financial measures to GAAP financial measures in the investor section of our website, located at investors.paloaltonetworks.com. Now I'd like to introduce Mark McLaughlin, Chairman, President, and Chief Executive Officer of Palo Alto Networks. Mark.
Thank you, Maria, thank you everyone for joining us today. I'm happy to be here to discuss Palo Alto Networks' 2013 and fiscal fourth quarter results. 2013 was a very good year for the company with record growth in new customers, revenue, subscription service revenue, penetration of G-2000 accounts, and the launch of multiple new offerings. During the year, we continued our rapid displacement of legacy network security vendors and enterprise customers across all business verticals around the world. Our lifetime value in our customer base continues to grow quickly, and our focus on customer satisfaction is best in class. In 2013, we continued our aggressive global go-to-market expansion, and we rapidly took share in our large $12 billion addressable market. We continued our investment in R&D, maintaining our clear technology leadership over the competition as we have every year since Palo Alto Networks came to market.
We were able to accomplish all these achievements while growing operating income over 50% during the year. I'm proud of the results and even more proud of our team and world-class partners that delivered them. We're very aware and appreciative of the confidence that our customers place in us each and every day. We have grown at such significant rates relative to the market and relative to all of our competitors, and we expect to continue to do so because we've established ourselves as the clear leader in next-generation security at a time when enterprises, governments, and service providers face increasingly more frequent and sophisticated cyber attacks. These organizations have realized that legacy network security technology cannot protect them, and as a result are switching to Palo Alto Networks as their strategic partner in this fight.
Our growth strategy as we continue to establish our position as the global leader in next-generation security is to continue to rapidly grow our market share and the number of new customers, expand our wallet share within our customer base, leverage our hybrid SaaS revenue model to grow the percentage of business that's recurring, and demonstrate increasing operating leverage while investing to capture the significant market opportunity still in front of us. I am proud to report that our performance in our fourth quarter and fiscal 2013 offered clear evidence of our progress in all these areas. Let me start with customer growth. In Q4, we once again added over 1,000 new customers, representing the seventh quarter in a row that we've added over 1,000 customers.
For the fiscal year 2013, we added over 4,800 new customers, including leading government organizations, large healthcare organizations, technology leaders, and some of the largest Fortune 100 companies in the world, almost always doing so by displacing our competition in the account. We are honored today to service over 13,500 enterprise customers. Our customer additions are driven by our demonstrable ability to provide substantially better network and cybersecurity solutions than the competition. We expect our customer growth trend to continue. Some examples of customer wins in the fourth quarter include us replacing Check Point as the main firewall in a major semiconductor equipment company in Silicon Valley and replacing Check Point as the data center firewall at a global provider of business software and solutions in the legal, educational, and government space.
We also replaced Cisco as the data center firewall at one of the largest insurance companies in North America. We expanded our footprint to the data center of one of the largest European broadcasting companies after landing it with an initial sale in Q1 of fiscal 2013. Also, we beat Sourcefire to become the cybersecurity platform at the Asian operations of a Fortune 10 company. Winning new customers is an important part of our growth strategy. Just as important is our expansion capabilities and our existing customer base. As an indicator of our ability to significantly increase wallet share in our customer base, in the fourth quarter, a customer had to spend a minimum of $3.6 million with us in lifetime value to make the top 25 list. This is up from $3.2 million in the fiscal third quarter and $2.1 million at the beginning of fiscal 2013.
Our top 25 customers have now purchased over 15.4 times their initial purchase, compared with 14.1 times in the third quarter and 9.5 times at the start of fiscal 2013. The combination of our rapid acquisition of new customers and our ability to grow our wallet share within our customer base resulted in another record quarter for Palo Alto Networks. Revenue increased 11% sequentially and 49% year-over-year in Q4 to $112.4 million. Demand was strong across all our major geographies and verticals. Our strong fourth quarter performance capped an impressive year with 55% revenue growth to over $396.1 million. While product sales increased strongly during the fourth quarter and the year, our services revenue grew at an even faster clip, demonstrating our expansion potential in the customer base and the power of our hybrid model.
As Steffan will articulate in more detail, the rapid adoption of our subscription services is a significant driver in the overall services revenue growth. The attach rate of our subscription services was 1.8 in Q4, up from 1.5 at the end of our second quarter in fiscal 2013. The success of WildFire, which is the market's only detection and prevention cybersecurity offering, is a driver in this trend. Currently, we have more than 2,000 total WildFire customers. Over 630 of them pay for the premium solution, and over 20% of the devices shipped in the fourth quarter included the paid premium version of WildFire. During the quarter, we announced that WildFire is capable of analyzing Android applications to identify advanced threats in Android applications running on smartphones and tablets. In addition to revenue growth, we continue to demonstrate the operating leverage in our model.
For fiscal 2013, operating profit grew approximately 50%, and EPS grew by 50%. We will continue to make investments in our sales organization and R&D to rapidly capture the significant market opportunity, most of which is still ahead of us. As we enter our fiscal 2014, we are laser-focused on our land and expand strategy. Our technology lead remains the foundation of our success, and feedback from the field is that our technological differentiation continues to increase. We plan to continue widening this gap and expect to introduce new products in 2014, starting with our high-end 100G+ chassis in early calendar 2014. This innovation is important and will allow us to expand our adoption in the data center space, as well as to penetrate the service provider space. To summarize, we delivered a strong fourth quarter to cap a very strong fiscal 2013.
I'm pleased with our progress on all fronts, and we enter 2014 with good momentum. I'd now like to turn the call over to Steffan for a detailed look at our financial results. Steffan?
Thank you, Mark, and thank you all for joining us. As we conclude FY 2013 and look towards FY 2014 and beyond, I'll provide a brief refresher on our hybrid revenue model and highlight the positive impact it's having on the business. I'll discuss our results and conclude with guidance. First, our revenue model is comprised of three components. The first and largest component is our PA-Series of appliances and other products. When these products ship, we bill and recognize all the revenue at the time of shipment. The second component is maintenance and support services, which is priced at approximately 16% of the appliance list price per year. The third component is subscription services, which is the recurring SaaS-based revenue element of our business. Currently, we have four subscriptions, each priced at 20% of the appliance list price per year.
For both maintenance and support and subscription services, we have annual and multi-year options. For either option, we bill the entire amount up front, and it goes onto the balance sheet in deferred revenues, and revenue is recognized ratably over the term of the contract. All three components of our model grew well in fiscal 2013. Product growth was strong in Q4 and the fiscal year, and we expect that to continue in FY 2014. Services growth was also strong, and this has had a positive impact on billings, deferred revenue, the visibility of future revenues, and free cash flow. With that context outlined, I'll now turn to our results. In Q4 2013, total revenue grew to a record $112.4 million, an increase of 49% year-over-year and 11% sequentially. For the fiscal year, we reported record revenue of $396.1 million, a 55% increase over the prior year.
Our results were driven by our land and expand strategy. The geographic mix of revenue in Q4 was 62% Americas, 22% EMEA, and 16% APAC, with all theaters posting growth on a year-over-year and sequential basis. Our revenues were diverse, as we did not have any vertical or end customer concentration. Looking at the different components of revenue in Q4, product revenue was $65.5 million, an increase of 32.4% year-over-year and 7.7% sequentially. Growth was driven by sales of our mid-range 3000 and high-end 5000 PA-Series of appliances. Our services revenue totaled $46.9 million, an increase of 79.1% year-over-year and 15.9% sequentially. The growth in services revenue can be attributed to strong billings in previous quarters and to the increasing adoption of our subscription services. Services revenue accounted for a 41.8% share of total revenue, which is a 720 basis point increase year-over-year and 180 basis point increase sequentially.
We expect strong contribution from our services business to continue. While of course, there may be some fluctuations in services as a percent of total revenue due to relative stronger product growth in any given quarter. The support and maintenance revenue component of services in the quarter was $25.3 million, an increase of 85.6% year-over-year and 15.9% sequentially. The renewal rate on maintenance is currently greater than 95%. The recurring subscription component of services revenue in the quarter was $21.7 million, an increase of 72.1% year-over-year and 15.9% sequentially. The renewal rate for our subscription services is currently greater than 85%. As the attach rates for subscriptions increase and the renewal rates for both subscription and maintenance remain high, billings has become an increasingly more meaningful metric to our business. Billings in Q4 were $142.3 million, an increase of 50.1% year-over-year and 7.5% sequentially.
To provide some annual insight, billings for FY 2013 were $509.5 million and grew 57.4% year-over-year. Product billings were $243.8 million and grew 43% year-over-year, accounting for 48% of total billings. Support billings were $136.2 million and grew 75% year-over-year, accounting for 27% of total billings. Subscription billings were $129.6 million, which grew 71% year-over-year and accounted for 25% of total billings. Additionally, the length of our services contracts has been increasing over time. The dynamics we've outlined for billings naturally impact deferred revenue. Total deferred revenue in Q4 was $249.2 million, an increase of 83.5% year-over-year and 13.6% sequentially. Short-term deferred revenue was $153.9 million, an increase of 14.9% sequentially. Turning to gross margin, total non-GAAP gross margin in Q4 was 74.5%, an increase of 260 basis points year-over-year and 40 basis points sequentially.
Q4 non-GAAP product gross margin was 75.2%, an increase of 40 basis points year-over-year and 80 basis points sequentially. The sequential increase was primarily due to product mix and cost reductions. As a reminder, there will be fluctuations in our product gross margin primarily due to when new appliances are shipped. Q4 non-GAAP services gross margin was 73.5%, up 690 basis points year-over-year and down 20 basis points sequentially. We're pleased with the leverage we're demonstrating in our services business, as evidenced by the year-over-year increase. The sequential decline was primarily due to investments in our customer support organization as we continue to add systems and personnel to accommodate the rapid growth of our customer base. Longer term, provided subscription attach rates continue to increase and renewal rates remain high, this should be a positive tailwind for services margin expansion. Moving on to operating expenses.
In Q4, we continued to execute our investment plan of focusing on product development and expanding our sales and go-to-market organization. In Q4, non-GAAP R&D expense was $14.3 million, an increase of $1.5 million from the prior quarter due in part to headcount additions and project-related expenses. As a percentage of revenue, R&D expense was 12.8%, an increase of 10 basis points sequentially. Q4 non-GAAP sales and marketing expense was $53 million, an increase of $7.4 million from the prior quarter. The cost drivers in the quarter were primarily due to a very strong end-of-year performance, which resulted in increased sales commissions and accelerators, as well as increasing our go-to-market headcount prior to the new year in order to get maximum impact on productivity in 2014. As a percentage of revenues, sales and marketing was 47.1%, up 210 basis points sequentially and up 20 basis points year-over-year.
It is worth noting that all sales and marketing expenses are incurred upfront, but services revenues are recognized ratably over the term of the contract, which doesn't match the expenses with the billings in the quarter. Q4 non-GAAP G&A expense was $8.7 million, a decrease of $0.6 million from the prior quarter. As a percentage of revenue, it was 7.8%, a decrease of 140 basis points sequentially. While the cost of setting up our international structure decreased in Q4, G&A was impacted by increased expenses related to the IP litigation with Juniper. In total, Q4 non-GAAP operating expenses were $76 million, or 67.7% of revenue. Non-GAAP operating margin was 6.8%, up 370 basis points year-over-year, and down 40 basis points sequentially.
Free cash flow margin was 31.9%, compared to 21.6% in Q4 2012, which is a result of the evolution of our model to increasingly higher services components. Our non-GAAP effective tax rate for Q4 was 38.7%, and for the fiscal year, it was 40.1%. These rates give effect to tax adjustments in Q4 related to the valuation allowance on our deferred tax assets and interim tax costs associated with the implementation of our international structure. Non-GAAP net income for the quarter was approximately $4.7 million, or $0.06 per diluted share, using 76.7 million shares, compared with non-GAAP net income of $4.5 million, or $0.06 per diluted share in Q3 2013, and non-GAAP net income of $1.9 million, or $0.03 per diluted share in Q4 2012. Non-GAAP results for Q4 included $1.4 million of expenses related to IP litigation with Juniper.
If we had excluded IP litigation expenses from our non-GAAP results in Q4, our non-GAAP EPS was $0.07 per diluted share. To provide transparency, on our IR website, we've provided a supplemental schedule that shows the historical impact of the IP litigation costs. Beginning in Q1 2014, we'll be excluding the IP litigation expenses from our non-GAAP results and guidance, as we believe the expense is not indicative of the underlying business. For fiscal 2013, we reported non-GAAP net income of $16 million, or $0.21 per diluted share, compared with non-GAAP net income of $14.7 million, or $0.14 per diluted share in fiscal 2012. Non-GAAP results for the fiscal year 2013 included $3.6 million of expenses related to IP litigation, which on a tax-effective basis was $0.03 per diluted share.
On a GAAP basis for the fourth quarter, net loss was $15.8 million, or $0.22 per basic and diluted share, compared to Q3 2013 GAAP net loss of $7.3 million, or $0.10 per basic and diluted share, and a Q4 2012 GAAP net loss of $4.6 million, or $0.18 per basic and diluted share. For fiscal year 2013, we reported GAAP net loss of $29.2 million, or $0.43 per basic and diluted share, primarily related to stock-based compensation expense, compared with net income of $0.7 million, or $0.00 per basic and diluted share in fiscal 2012. Turning to the balance sheet, we finished July with cash equivalents, and investments of $436.9 million. In Q4, cash flow from operations was $41.7 million, and free cash flow was $35.9 million. Capital expenditures in the quarter totaled $5.8 million.
For fiscal year 2013, cash flow from operations and free cash flow were $114.5 million and $92.1 million, respectively. In Q4, the accounts receivable balance was $87.5 million, down from the prior quarter balance of $91.5 million. The quality of our receivables remains excellent. Average day sales outstanding were 72 days, up from 71 days last quarter. We are updating our DSO target range to 65-75 days, reflecting the changing nature of our revenue stream as recurring services revenue continue to increase as a percentage of our business. Let me now move to our guidance. In Q1 2014, we expect revenue to be in the range of $118 million-$122 million, which represents 37%-42% growth year-over-year. In Q1 2014, we expect non-GAAP EPS, excluding the impact of IP litigation expenses, to be approximately $0.07, using 76 million-78 million shares.
I'd also like to highlight a number of points for modeling purposes. While seasonality has been difficult to determine due to our strong growth, we believe that over the longer term, Q2 and Q4 may show our strongest sequential growth in revenues. We expect to increase operating margin throughout the year, exiting Q4 in the low double digits, and we remain on track to achieve our non-GAAP operating margin target of 22%-25% exiting Q4 FY 2016. CapEx for FY 2014 will be in the range of $45 million-$50 million, with the majority of the spending occurring in the first half of the year. The effective tax rate for FY 2014 is anticipated to be in the range of 38%-40% on a non-GAAP basis. This rate is dependent on our global pre-tax profit mix.
Finally, the share count is expected to increase by approximately 1% per quarter. With that, I'll turn the call back over to the operator for Q&A.
Ladies and gentlemen, if you have a question, please press star followed by one on your phone. If your question has been answered or you would like to withdraw your question, press star followed by two. Questions will be taken in the order received. Only one question will be allowed. Please press star one to begin. Your first question comes from the line of Keith Weiss. Please proceed.
Excellent. Thank you guys for taking my question. Good quarter. I was wondering if we could start off on just your guys' view of the macro environment. You talked last quarter about seeing something of a stalling in purchasing behavior. Maybe you could give us an update on what you guys saw through the end of your fiscal year in that regards.
Keith, it's Mark. We think things are looking better across the board in this quarter. We can see that from other companies who reported and ourselves. I think particularly last quarter, folks were a little worried about what the growth rate of the security market was. I think it shows this quarter it remains very healthy. I think that's going to continue to grow over time, as far as I can tell. The attention that you've seen in cybersecurity has been with us a long time. It's with us now. Whatever happened in the last quarter, hiccup-wise, appears we've moved beyond it, at least in this quarter.
Got it. If I could throw in one follow-up. There's been a lot of rumor and speculation about changes going on in your sales force, changes with sales management. Maybe you could give us an update on what exactly is going on in terms of changes in sales management. Heading into this next fiscal year, are there any big changes in the sales structure, sales comp plan, or sales management that we should be expecting heading into FY 2014?
Yeah. Last quarter, people had asked about the changes in the sales leadership. As I mentioned last quarter, when Mark Anderson joined us, he's been here more than a year now. He has gone through in the sales leadership ranks and made a number of changes to get folks who have the experience to scale very rapidly to a $1 billion and beyond, because we have a pretty big appetite for that. We want people to know how to do that. Over the course of the last six or nine months, he's made a number of changes in the leadership team there, which we think have gone very well. All those folks are on board. It seems to be gelling very nicely. The team's executing really well, and I think you can see some of that coming through in the fourth quarter results.
Excellent. Thank you very much, guys.
Thanks, Keith.
Thank you.
Your next question comes from the line of Jayson Noland with Robert W. Baird. Please proceed.
Thank you. I wanted to ask about the major account team ramp. I think we were at about 40 in FY13. Maybe, Mark, if you can talk about how successful that's been and how many account teams you would expect to add in this new fiscal year.
Yeah. Hey, Jayson. That's going very well for us. We put a big focus on major and global accounts about 18 months ago. I did, and then when bringing Mark on board, he adopted that immediately. He knows how to do that from his previous life. Has done a great job in recruiting for those teams. We're seeing bigger and bigger deals. We're getting in front of more deals on a global basis. That's working really well, and particularly with a really targeted approach into the G2000s, where the penetration is going up really nicely for us, winning new logos. Plus, importantly, selling into the accounts we already have. We'll continue to push on that in fiscal '14 and beyond, as there's a lot of money in those accounts around the world and we want to make sure that we get more than our fair share.
Thanks, Mark.
Thanks, Jayson.
Your next question comes from the line of Brent Thill with UBS. Please proceed.
Good afternoon. Mark, if you could just give us a sense of how the WildFire 500 appliance sold in the quarter. I know it was a relatively new joiner to your family. What you're seeing on that trajectory, and then I had a quick follow-up.
Sure. Just as a reminder on WildFire, when we come to market with WildFire, there's really three ways to buy that service, and it's the only detection and prevention service out there. The first and foremost is the cloud offering, which has the most impact because it's got the network effect of all customers seeing, from a malware sample perspective, what other customers have seen. There was a number of customers who came to us, depending on the verticals, and said, "We really like the WildFire technology, but because of our industry, we have some concerns about sharing those samples into the cloud. We don't think we can do that." Because of that, we developed the WildFire 500 appliance, which allows for the creation of a private network for those folks.
They could also buy it and use it as a standalone appliance, although that's not what we're attempting to get folks to do, because those appliances tend to be very expensive so that you get more benefit from going into the private or the public cloud approaches, bang for your buck. With that kind of background in mind, the WF-500 is designed for the private cloud folks who are in the verticals that really wanted that capability. In the quarter, it met our expectations, and it's been out shortly, and we expect that to be nice for us in the future to serve that part of the market.
Okay. Maybe for Steffan, on the government, you're obviously coming into a critical period here, and I know it's probably too early to call, but what's embedded in your expectations for the current quarter in terms of the government follow through?
With the government year-end coinciding with our fiscal Q1, we're anticipating to see decent growth in the federal business, and we should participate in the year-end budget flush if there is one.
Your next question comes from the line of Greg Dunham with Goldman Sachs. Please proceed.
Billings, again, was another very strong quarter, and I appreciate the further detail you provide from the mix of billings from product support and subscriptions. Can you remind us how sales people are comped, and if you think this trend is going to continue, I guess, what are your plans and the margin targets there? Thanks.
Yeah. Hey, Greg, it's Mark. Yeah, subscription's doing very nicely for us, and that's the reason we wanted to put a little more highlight on that right at the end of the year, and give a year-over-year view on that. As you can see that it's really powering the business, and we really love that recurring revenue because it goes into the deferred, it gives more visibility into the business. There's lots of things to like, and it's growing at a very outsized rate. Very happy with the performance of that. We'd expect that to continue over time as well. From a compensation perspective, our sales folks are comped on selling products. You got to remember that you can't sell a subscription till you get a product in the account, right? They're primarily comped on putting products into the account, expanding the footprint of products.
In addition to that, they get compensated for services, and the amount of that depends on the term of the contract for which it's sold.
Ladies and gentlemen, as a reminder, please limit your questions to one. Your next question comes from the line of Walter Pritchard with Citigroup. Please proceed.
Thanks. Mark, I'm wondering if you could talk about, it sounds like you're having some more success in the data center. You gave a couple examples in the script, then you have a high-speed product coming towards the beginning of next calendar year. Could you talk about maybe what percentage of your sales today are into the data center? How many of those are a primary firewall in the data center, how you expect what you're releasing here in the next 12 months to impact your success rate in that market?
Yeah, Walter. Yeah, we're doing really well in the data center space, which is great. When we came out with the PA-5000 Series, the adoption rate on that for data center usage was very strong. As you know that, or maybe you don't know, but the PA-5060 runs at 20 gigs right now with full on next-gen capabilities. Folks have adopted it very rapidly there. If we go look back historically, the data center space for us is around the 30%-ish right now and growing nicely. We expect that to pick up even more steam when we come out with the 100 gig chassis, which customers have been saying, "We love everything about this technology, and if you can make it faster, we'll love it even more." We're going to do that.
Also, that's an entree point for us into the service provider space. As you know, those guys demand very high throughput devices as well. We've been working with a lot of those service providers to secure their networks, now they'd like to work with us with this new appliance to help them secure other people's networks as well because of the throughput capabilities.
Are you generally a primary firewall in the data center, or I know you started out obviously in the perimeter as not a primary firewall, became a primary firewall. What would you say the role is at this point in the data center?
We're winning the vast majority of deals when we go into the data center right now as the primary.
Great. Thank you.
Thanks, Walter.
Your next question comes from the line of Michael Turits with Raymond. Please proceed.
Hey, guys. I wonder if you could just give us your headcount adds and also maybe just reiterate what the margin guidance?
For headcount, we ended the year at 1,147, that was an increase from the prior quarter of 113 heads. As far as operating margin guidance is concerned, we remain steady progress towards our target model on a non-GAAP basis of 22%-25% exiting Q4 FY 2016. We had also provided some prepared comments around operating margin expansion within fiscal year 2014. We anticipate exiting Q4 in the low double-digit operating margin. I'll also just take a moment to note that free cash flow is becoming a more meaningful metric to our business as the profile of our billings has been morphing more positively into a hybrid SaaS model. You can note that free cash flow margin this last quarter was very robust, exceeding 30%.
Just as a follow-up on the headcount issue. You mentioned the sales management seem to be stabilizing, but where are you in terms of attrition? Has attrition trends been stable, increasing, decreasing?
We're good on that, Michael. We're better than industry average on attrition. We manage some folks out over time as folks do. Really, we're doing really well in the market. The winners want to be with the winners, so it's not a hard place to stay.
Thanks, guys.
Thank you.
Thank you.
Your next question comes from the line of Philip Winslow with Credit Suisse. Please proceed.
Hi, guys. Just got a question on the pricing side. Obviously, there's been a lot made just across the market about just how the pricing dynamics are across this core firewall next-gen, these add-on services. Yeah, just comment if you could, what you saw this quarter, maybe compare that to recent quarters.
Yeah. Phil, it's Mark. We've maintained for quite some time that we have something really different and unique in the market relative to the legacy competitors. As a result of that, we've been able to charge a premium price for a long time, and that was the same in the last quarter. You can see some of that reflected in our product gross margins, which are up. Discounting is stable. We're able to power through the competition's reduction of prices in order to make up for shortfalls in technology, and expect that's going to continue.
Got it. Thanks, guys.
Thanks, Phil.
Thank you.
Ladies and gentlemen, as a reminder, only one question will be taken with a follow-up. Your next question comes from the line of Rob Owens with Pacific Crest Securities. Please proceed.
Thank you very much. I guess along the lines of Phil's question around competition, are you seeing more aggressive behavior around customer acquisition given the massive share gains that you guys are currently seeing? Also, given the discussion right now around APT protection that's out there, where do you think points of differentiation are in this market?
Yeah. Hey, Rob. On the competition front, it's been very competitive for a really long time for us. I can't remember when it hasn't been. None of that's changed. As we've said in the past, we think that the customers buy primarily for security. They want it at a point where it makes sense from an enterprise perspective, and then they want a great value. We nail all three of those value propositions for the customer. A result of that, we continue to sell very nicely, even in the face of the competition, pricing their stuff aggressively. They've been doing that for a long time now, so it doesn't seem to make much difference. On the APT front, lots of attention, as you know, on that. When we think about that, we think about detection and prevention.
The APT angle is in the detection space. Our offering is detection and prevention, which is unique. The amount of attention that goes into the detection space helps us, and the only folks out there that can do detection and prevention. I think from a differentiation standpoint, the things to watch for are cloud offerings. Can you analyze all files? Can you analyze everything application-wise instead of just email and web? Can you do that at a very fast speed to meet these enterprise class performance? Are you going to be able to share, for lack of a better term, what you're seeing in your environment with other folks that they're seeing in their environment, so you can get the benefit of the network effect out there? That's how we based our WildFire offering. We think that's why it's doing so well.
Thank you.
Thanks, Rob.
Your next question comes from the line of Jonathan Ho with William Blair. Please proceed.
Hey, guys. I just wanted to understand a little bit about some of your plans to scale the business next year, now that you've added about 4,800 customers this year. Can you talk about where you intend to make the investments in the P&L, and just trying to support scaling of the enterprise over that timeframe?
Hey, Jonathan. Well, it's kind of a both category thing, which is we've added over 4,800 customers last year. We would anticipate the ability to continue to add customers at a very rapid clip. In customer acquisition, obviously, we'd be investing from a sales and marketing perspective, and in also in servicing those customers as well. We're making continued investments into the services organization to do that. We're running a world-class services organization here today, and we intend to keep in front of that, because we know that unhappy customers don't purchase things. As you can see from our expansion, LTV, and wallet share, customers appear to be very happy and buying a lot, and we want to keep them that way. We'll keep making investments there. It probably goes unsaid, but I'll say it anyway.
You have the rest of the company out there, supporting the point of the spear. We have to continue to invest in this company to maintain this very rapid growth to perform services for our customers, internal customers, external customers, in a world-class manner. We'll be doing that as well.
Yeah. One additional follow-on point, Jonathan, is relative to scaling the business. We are looking to get operating leverage out of sales and marketing over time. When you look at FY 2014, this will be the first year where the percentage of ramped versus ramping heads eclipses one another. The percentage of ramp heads are higher than the ramping heads in FY 2014. We should be starting to get more leverage in the business in sales and marketing.
Great. Thank you.
Your next question comes from the line of Gray Powell with Wells Fargo. Please proceed.
On the WildFire products, specifically the appliance side, how do you see that impacting your addressable market? do you think that WildFire and similar products could potentially cannibalize traditional IPS offerings over time?
Yeah, that's a fair question, Gray. I think it's unclear right now still where the addressable market is coming from a wallet perspective for the things that are going on in the detection space around APT. I've heard a lot of folks think that that might be IPS budget. Maybe it's a new budget. For us, we've been winning in the IPS market with our threat prevention for a very long time, so we know how to do that. If that budget is shifting into the APT market, it's good for us. We continue to take the IPS budget, and we'll take that budget as well. If it's new budget, then it's additive. But the win rates are very high, and we like the fact that the addressable market's big, even though it may not be exactly clear yet where that money's coming from.
Got it. Thank you very much.
Thanks, Gray.
Your next question comes from the line of Aaron Schwartz with Jefferies. Please proceed.
Hi. Good afternoon. I had a follow-up question on WildFire. You're giving the metrics on the total sort of customer count there, as well as the paid customer count. On the paid side, is that primarily new customers coming into Palo Alto, or are you actually seeing conversion of sort of existing customers on the paid WildFire version?
Hey, Aaron. It's actually both. We're doing nicely in both. Lots of new customers are buying the service when they're buying the products for the first time. Then with that large of an installed base of folks who are using the free service, it's a fantastic place to go mine and upsell them to the paid-for service. We like the results in both categories.
Okay. Then a quick follow-up question maybe for Steffan. On the deferred revenue, I know it was very minor, but the mix shift, it ticked a little bit to the shorter term, and you had been seeing a trend of
Multi-year service engagements. I would have thought that would have been a little bit concentrated towards your Q4. Was there anything to read into there in the mix shift between short and long-term? I know that was just a very modest shift there, but it did shift back towards short-term.
Every quarter, there's going to be fluctuations between the short-term deferred and long-term deferred revenue growth. If you look at long-term deferred revenue growth on an annual basis, it grew north of 90% year-over-year. We were very happy with that. The length of the services contracts has been increasing over time, but there will be some fluctuation.
Terrific. Thank you.
Thank you.
Ladies and gentlemen, we only have time for two more questions. Your next question comes from the line of Gregg Moskowitz. Please proceed.
Good afternoon, guys. Mark, just wondering if you can comment on the linearity in the quarter. Steffan, there was a fairly large increase in CapEx that was guided for fiscal 14. I know some of that is due to the relocation of your headquarters. Just wondering if you could put a finer point on the nature of the increase versus 13. Thank you.
Hey, Greg. Yeah, on the linearity basis, we saw a back-end loaded quarter as we would expect, and particularly at the end of the year. As we're getting bigger, we see more and more of that going to the back end of the quarter, but nothing that's not in line with what you'd expect across the industry.
From a CapEx standpoint, we did guide $45 million-$50 million in annual CapEx. We're assuming roughly call it $5 million-$7 million per quarter in typical CapEx. We have a couple of discrete projects that we're working on. The biggest one is the move to our new facility. From a timing standpoint, in putting a finer point on it, in the first half of the fiscal year, we'll be spending the majority of the $45 million-$50 million as we conclude the move to the new facility. Hopefully that gives you a little bit more insight.
It does. Thank you, guys.
Thank you.
Your next question comes from the line of Tal Liani with Bank of America Merrill Lynch. Please proceed.
Excellent. Thanks for squeezing me in. My question is actually a follow-up on a previous question about quarter linearity and understanding. I'd like to understand if you have information on how much of this quarter growth, sequential growth is attributed to the weakness last quarter. When I look at April, the previous years, I see pretty robust growth, and last quarter was much weaker, which I believe is the macro. How much of the growth this quarter, in the July quarter, is reversion to the mean, and that means that the growth going forward may be slower than what we are seeing now. Maybe you could speak about what you've seen this quarter that is spillover from previous quarter or whether it's the macro that is driving it. Thanks.
Hey, Tal. It's Mark. A couple things, I guess. The first is last quarter we did mention a number of deals that have slipped to the right, and we closed the majority of those already, which is great. On the macro side, we discussed Fed and EMEA last quarter. Both of those did really well for us in the fourth quarter, so that's great as well. I think the rest of the industry has done pretty decently, so maybe the concern about macro and security growth slowing down seems to be an aberration. I put all that in perspective and say we grew very nicely, 8% sequentially, 55% for the year. We think we're going to maintain some very respectable growth as we look forward and doing a hell of a lot better than all the rest of the competition.
We're pretty confident that we've got a really good baseline here to grow from.
Got it. Thanks.
Your next question comes from Scott Zeller with Needham & Company. Please proceed.
Thank you. I wasn't sure I was going to get on there. Just a question about sales cycles, if you could. As you're increasingly being considered as the primary firewall on accounts, what does that do to the length of sales cycles, since it's probably more often that you're considered a replacement for a competitor? Any commentary about changes in sales cycles?
Yeah, Scott. No, sales cycles have been fairly steady for us for quite some time because we're always proposing our technology as a firewall and more and more, much more than the majority of time it's being adopted as the firewall. There can be some very long sales cycles on some really big deals, and then there can be some really short ones where we are literally selling a lot over the phone here. When we look at that on the aggregate, we've said in the past that sales cycles are about 90 days or so, and that seems to be the case as we go forward.
Thank you.
I would now like to turn the call over to Mr. Mark McLaughlin, CEO, for closing remarks.
Thanks, operator. Thanks, everybody, for being on the call today. I want to reiterate my appreciation for all the hard work of the Palo Alto Networks team, support of our customers and partners as we continue to revolutionize the cybersecurity market. Thanks to all our shareholders as well. Thank you.
Ladies and gentlemen, that concludes today's conference. Thank you for your participation. You may now disconnect. Have a great day.