Good day, ladies and gentlemen, and welcome to the Third Quarter 2013 Palo Alto Networks Inc. Earnings Conference Call. My name is Tahisha, and I'll be your operator for today. At this time, all participants are in a listen only mode. Later, we will conduct a question and answer session.
As a reminder, this conference is being recorded for replay purposes. I would now like to turn the conference over to your host for today, Ms. Maria Riley, Investor Relations with The Blueshirt Group. Please proceed.
Good afternoon and thank you for joining us on today's conference call to discuss Palo Alto Networks' fiscal 3rd quarter 2013 financial results. This call is also being broadcast live over the web and can be accessed on the Investors section of the Palo Alto Networks website at investors. Palaltonetworks.com. With me on today's call are Mark McLaughlin, Palo Alto Networks' Chairman, President and Chief Executive Officer and Stephen Tomlinson, Chief Financial Officer. After the market closed today, Palo Alto network issued a press release announcing the results for fiscal Q3 ended April 30, 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 Blue Shirt Group at 415-217-7722 and we will e call. We would like to remind you that during the course of this conference call, Palo Alto Networks Management will make forward looking statements, including statements regarding continued revenue growth and overall momentum in the Palo Alto Networks business, especially as a result of its planned expand and extend strategy for deals to close in fiscal Q4 or future quarters our ability to develop innovative and differentiated products ahead of the competition, trends in its business and operating results including its sales pipeline, customer acquisitions, and gross margin, operating margin and non GAAP effective tax rate and Palo Alto Networks expected revenue and non GAAP earnings per share for for the 4th fiscal quarter of 2013 ending July 30, 2013 as well as CapEx expenditures for fiscal year 2014 ending July 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 the statements. These forward looking statements apply as 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 In addition to these risks and uncertainties, please refer to our quarterly report on Form 10 QA filed with the SEC on March 5, 20 13 and our earnings release posted a few minutes ago on our website. Also, please note that certain financial measures we use on this call are expressed on a non GAAP basis and have been adjusted to exclude certain charges. We have provided reconciliations of these non GAAP financial measures to GAAP Financial Measures in in the Investors section of our website located at investors. Palaltonetworks.com. Now I'd like to introduce Mark McLaughlin, and Chairman, President and Chief Executive Officer of Palo Alto Networks.
Mark?
Thank you, Maria, and thank you everyone for joining us. In our 3rd fiscal quarter, we saw good revenue growth of 54% year over year, surpassing $100,000,000 per quarter for the first time in our history, despite challenging macroeconomic conditions, particularly in the federal vertical and Europe. During the quarter, we had strong gross margin improvement, achieved non GAAP EPS of $0.06 per share and grew deferred revenues by 17% sequentially. Also in the Q3, we continued to demonstrate that This is the case because while security is not immune to macroeconomic factors, it is increasingly critical to enterprises. Threat landscape is not getting any better and it seems nearly impossible to pick up the paper without reading a story about a criminal organization hacking into ATMs or possible foreign government sponsored attempts to steal secrets from large companies.
In this environment, our leadership position is driven by our high value disruptive technology, which we believe provides the highest level of security available in the market. We now have over 12,500 customers using our next generation security platform and Our customer acquisition has continued for the 6th consecutive quarter at a pace of over 1,000 new customers added during the quarter. In addition to landing new customers, we also continue to grow revenue with the installed customer base by expanding our device footprint through the enterprise and extending our value with multiple services on their devices. One view of our success in implementing this strategy is the lifetime value of our customers. For example, during the quarter, The lifetime value of our top 25 customers averaged 14.1 times their initial purchase.
This is up substantially from 11.4 times last quarter. And to make the top 25 list in the 3rd quarter, our customer had to spend a minimum of $3,200,000 with us, which is up from $2,800,000 last quarter. This metric illustrates our ability to capture more wallet share once we've penetrated an account. Some specific examples of the success of our land, expand and extend strategy 3rd quarter include us closing a 7 figure deal with a very large industrial manufacturer in the United States in which we beat Check Point and replaced Juniper as the new perimeter firewall. This deal also includes the paid for wildfire service as part of the offering.
Also, we closed a 7 figure data center firewall deal with 1 of the largest banks in Japan where we replaced Cisco. In addition, we closed a large perimeter firewall deal with a leading turbine cable company in which we beat Checkpoint and functionality performance. And we also continued our expansion strategy into 1 of North America's largest financial services companies where we started in mid-twenty 11 and where we now have replaced all Check Point firewalls in their network perimeter. The reason why we're able to win so many new customers and and so significantly within our customer base is that our technology is fundamentally different than all of our competitors and this differentiation continues to grow. Customer traction has been significant across all of our new products and services.
In the Q3, our PA 3000 series sold very well as expected And we now have more than 1700 customers using our wildfire service, up from 1200 from last quarter with the attachment rate on the paid version of that service comfortably in the double digits in just 5 months from the launch. In addition, next week we'll start the marketing campaign for the Wildfire 500 appliance, a key new element of our Wildfire cybersecurity offering that implements on premise APT detection as a private cloud service for use by customers that cannot share data in public clouds. We will continue to aggressively distance ourselves from the competition as we further extend our technology lead. Looking forward, while the macroeconomic environment remains uncertain. We entered the 4th quarter with a strong pipeline and competitive momentum.
Our land expand and extend strategy continues to fuel our growth and we're pleased to reported strong third quarter of growth, continued strong new customer acquisition, accelerating repeat buying from our installed base and increasing operating leverage. I'm also delighted to welcome Carl Eschenbach, President of VMware to our Board of Directors. Carl's experience and expertise is highly valued and we look forward to his input and his advice. With that, I'd like to turn the call over to Stefan for a more detailed look at our financial results. Stefan?
Thank you, Mark, and thank you all for joining us today. I'll first increased 54.2% year over year and 5% sequentially. Looking at our 2 main components of revenue, in Q3 product revenue $8,800,000 grew 39.7 percent year over year and decreased 1.9% sequentially. The sequential decrease was primarily in Europe and in our federal vertical. Services revenue of $40,500,000 which represented 40 percent of total revenue grew 82.6% year over year and 17.2% sequentially, driven in part by an increase in the attach rates of our subscription services.
This growth in services revenue underscores the power of our hybrid revenue model. The geographic mix of revenue was 62% Americas, 23% EMEA and 15% APAC with posted solid growth, while EMEA declined by approximately 4%, following 2 quarters of 23% sequential growth for both Q1 'thirteen and Q2 'thirteen. Total non GAAP gross margin in Q3 was 74.1%, ahead of our target range of 70% to 73%. Non GAAP gross margin increased 220 basis points year over year and 190 basis points sequentially. Putting a finer point at gross margin, Q3 non GAAP product gross margin was 74.3%, an increase of 70 basis points year over year and 90 basis points sequentially.
The sequential increase was primarily due to cost reductions and product Our non GAAP service gross margin was 73.7%, up 510 basis points year over year and up 3 60 basis points sequentially. The sequential increase was primarily due to increasing services as a percentage of total revenue and higher attach rates for our subscription services, as well as leverage in our customer service organization. Having added over 1,000 end customers in the quarter, will continue to invest in customer support and services gross margins will fluctuate depending on the timing of the investment ramp of our service organization. Moving on to operating expenses, Q3 non GAAP research and development expense was 12 increase of $700,000 from the prior quarter due in part to the timing of expenditures related to certain projects. As a percentage of revenue, non GAAP R and D expense was 12.7%, down 130 basis points sequentially.
Q3 non GAAP sales and marketing expense was $45,600,000 an increase of $3,700,000 from the prior quarter due to the addition of quota carrying headcount and commission related expenses. As a percentage of revenue, it was 45%, increase of 160 basis points sequentially. Q3 non GAAP general and administrative expense was 9,300,000 increase, an increase of $1,500,000 from the prior quarter or 9.1% as a percentage of revenue, up 110 basis points sequentially. G and A was impacted by expenses related to setting up our international corporate structure, ERP implementation and litigation costs. In total, Q3 non GAAP operating expenses were $67,700,000 an increase of $4,600,000 from the prior quarter or 66.8 percent of revenue, up 140 basis points sequentially.
Q3 non GAAP operating margin was 7.2%, an increase increase of 40 basis points sequentially. The sequential improvement this quarter can be primarily attributed to the gross margin improvement. As we stated previously, Given our leading position in the market and the fact that we're growing revenue at a much higher rate than both the market and our competitors, Our goal is to continue to invest while growing operating margin in a slow and steady manner, noting there may be near term fluctuations and operating margin. Our non GAAP effective tax rate for this quarter was 38.5%. This rate will continue to fluctuate throughout the fiscal year as is dependent on our global pre tax profit mix and potential discrete events such as the removal of our domestic valuation allowance.
Non GAAP net income for Q3 was approximately $4,500,000 or $0.06 per diluted share using 78,000,000 shares. And this compares to non GAAP net income of $3,900,000 or 0.05 per diluted share in fiscal Q2 'thirteen and non GAAP net income of $4,700,000 or $0.07 per diluted share in in fiscal Q3 'twelve. On a GAAP basis, net loss was $7,300,000 or $0.10 per basic and diluted share. Turning to the balance sheet, we finished April with cash, cash equivalents and investments of $391,500,000 In Q3, cash flow from operations was $15,200,000 free cash flow was $8,800,000 and free cash flow margin was 8.7%. While cash flow from operations and free cash flow were impacted by the quarter's linearity, deferred revenue and billings grew strongly, giving visibility on future cash flows.
Capital expenditures in the quarter were within our anticipated range of $5,000,000 to $10,000,000 and totaled $6,400,000 As I mentioned previously, in fiscal 2014, we'll see an increase of approximately $10,000,000 to $12,000,000 in CapEx related to the relocation of our headquarters facility. Most of this increase will be in fiscal Q1 of 2014. The annual operating expense starting in FY 2014 for this new facility will be approximately $13,000,000 for the year. We ended Q3 with $91,500,000 of accounts receivable, up from the Q2 'thirteen balance of $68,600,000 The quality of our accounts receivables Excellent. Average days sales outstanding were 71 days, up from 58 days last quarter, reflecting both the back end loaded quarter subscription and multi year deals.
Moving down the balance sheet, total deferred revenue was 200 and $16,300,000 an increase of 88% year over year and 16.5% sequentially. Short term deferred revenue was 134,000,000 increase of 14.1 percent sequentially. We're continuing to see an uptick in multiyear deals. Billings were $132,400,000 an increase of 56.8% year over year and 6.5% sequentially. Let me now turn to our guidance for Q4 'thirteen.
We expect revenue to be in the range of $106,000,000 to $110,000,000 which equates to 40% to 45% year over year growth. And we expect non GAAP EPS to be approximately $0.06 per share using 78,000,000 to 80,000,000 shares on diluted basis. While we're mindful of the current macroeconomic uncertainty, we're continuing to invest in product development, sales and go to market functions, as well as 3 projects in G and A and have factored all of this into our guidance for Q4. With that, I'll turn the call over to the operator to open the Q and A session. Thank
question and a follow-up question as to allow everyone else to get their questions in. Your first question comes from the line of Greg Dunham from Goldman Sachs. Please proceed.
Yes. Thanks for taking my question. I guess I wanted to start on the macro and try to get a sense of how much that was an impact on the business. I mean, revenue growth was 54% versus your closest peers that are flattish to down 20% or close to 20% in this quarter. So clearly a strong outperformance there.
But I just want to get a sense of do you feel that you guys are more sensitive to some of the macro shifts going In terms of the growth numbers, how much did they play a role in terms of this quarter? And can you talk about the trend in the quarter? You mentioned it was a back end loaded quarter. Can you talk about How it progressed throughout the quarter and maybe what you've seen thus far this month? Thanks.
Yes. Hi, Greg. It's Mark. Yes, let me take those in a couple So the first thing is, I think there's no doubt that it's a challenging market right now and we're seeing that as our quarter progressed for us. We saw that play out towards the end of the quarter than The beginning of the quarter sentiment sort of changed on a call on a big picture basis.
I think you're correct. You noted that other folks have seen this as well and had And their performance. Despite that, we grew 5% sequentially, 54% year over year. So we're pleased with that in light of those macroeconomic conditions. Particularly for us though, the areas where we saw the impact around that were really in Europe and specifically in Central and Southern Europe and then in the Fed sector with The continued sequestration.
So in those cases we saw in each one of those cases saw a few $1,000,000 worth of deals in each one of those sectors Getting pushed, deals that we select for, but getting pushed to the right and we saw that occur as the month played as the quarter played itself out. So there's no doubt that It's a tough environment out there, but given all that we're pretty pleased with where we ended up.
Okay. Thanks guys.
Your next question comes from the line of Brent Thill from UBS. Please proceed.
Thanks, Mark. Just Follow on on federal, just in terms of what you're seeing in the back half of the year, are you giving any more sense in terms of how Those budgets are coming together. And just a quick follow-up on Europe. Did you believe that's more macro? Or is there anything you're seeing from execution or competitive issue.
Yes. So let me start with the second one, Brent, just big picture. On a competitive basis, we haven't seen change in the competitive market except us continuing to pull ahead. And I think the results show that our results relative to everybody else in this sector, we've done very well on Particularly in a relative basis. So we're not seeing that at all, not in Europe or anywhere else.
On the Fed side of it, the sequestration thing is real. This is the Q1 anybody's had to live set. And on a second half from a second half of the year basis, I would expect that sequestration would last through At least the end of the fiscal Fed year, which is at the end of October, there's really no reason to believe at this point that that's going to change. I think that will be with us through at least that long. Great.
Thank you.
Your next question comes from the line of Michael Turits from Graeme and James, please proceed.
Hey, guys. Two questions. First, again, when we look at the guide for next quarter, which A little bit below consensus. What's in the guide in terms of your assumptions regarding both Fed in Europe? In other words, Is that the source of the lower number there that you continue to expect those to be weak?
And also I just wanted you to comment on the deferred, which Which is actually particularly strong if I calculate your billings all in. I know some of that came from long term, but still grew faster than revenue. So Were there any rev rec issues where you were decrying more than expected?
Hey, Michael. So on the from the guide perspective, No, I think we'd say we have to assume that the sequestration continues like I just said. So we'll take that into account. And then on the Europe side, I don't think there's any reason to believe it right where we're sitting today that the sentiment over there is going to change in any big picture regard From what we saw I think particularly towards the tail end of our quarter. So we're thinking about those two things in particular As we look forward, so we're cautiously optimistic.
The guide does provide a 5% to 8. Something percent sequential growth and 40% to 45% on a year over year basis, but we have to take those things into account as we look forward. I'll let Stefan take the second question? On the deferred revenue piece, if anything, it underscores the power of our hybrid revenue model. We've been selling lots of subscriptions.
The attach rates have been going up. We've had very nice traction with wildfire. And when you look at the mix between short and long term deferred, short term deferred revenue grew 14.1% sequentially, long term deferred revenue grew 20.6% sequentially and that long term deferred, there There is no rev rec issue in there. It's just more we've seen an uptick in multiyear deals, which is a big vote of confidence from our customer base Who are designing us into their networks for a long period of time.
Okay. Thanks guys.
Your next question comes from the line of Jonathan Ho from William Blair. Please proceed.
Hey, guys. Just wanted to get a better sense of some of the deals that maybe got pushed out. Would you expect those to subsequently get potentially recognized this quarter? Or do you feel like there's just going to be sort of an increasingly cautious environment throughout the rest of the year?
It's a good question, Jonathan. So for the deals that we saw that got pushed to the right there in those two sectors are situations where we technically won, meaning the customer wants Palo Alto. So we're confident that ultimately we're going to get these deals. The win is a little harder to gauge because Like I said, the sentiment hasn't changed or if it does change, maybe that helps us. But we would expect that at some point we get these It's just really hard to say whether we get in the Q4 or Q1.
I just really can't nail that down right now.
Got it. And just in terms of your overall pipeline, are you taking With the guidance a more cautious approach across the board or does this reflect only sort of concerns in the Fed and Europe ongoing?
Well, 2 separate things there. So from a pipe perspective, we've got a strong pipe as we come into the 4th quarter. We saw things like we said was in those 2 places in Europe and the Fed space. I think as a general matter there's Macroeconomic concern, maybe it's stemming from those 2 sectors, not really sure, but as a general matter, it feels like there's some macro concern. But for us, that's where Great.
Thank you. Thanks, Jonathan.
Your next question comes from the line of Keith Weiss from Morgan Stanley. Please proceed.
Hi. This is Melissa Gorham calling in for Keith Weiss. I know that you mentioned federal being weak, but was there any other verticals that
came in below expectations? I know some of your peers had
cited the service provider segment being I know some of your peers had cited the service provider segment being sort of weak in the March quarter. And I know that it's relatively smaller for you all, but just wondering if you saw weakness there as well?
Server providers are much, much smaller vertical for us than a lot of our peers in there. So we saw a little bit of softness there, but it's a rounding error in absolute dollar terms. So I'd say it was consistent with other people saw, but it's just not nearly as for us as other folks. In other places we saw really good growth. So like in the not in the federal space, but in the state and local government education space, we saw very nice increase sequentially in that space.
So it's really there puts and takes across all the verticals, but the 2 that we were impactful to us really were the Europe and Thanks, Ed.
Okay, great. And then previously you've cited an attach rate of 1, 1.5 subscriptions per appliance. Was there any change to that in the quarter? And where do you see that going over the next year or so?
The attach rate did increase. We're not giving specific numbers on the attach rate. We're going to be doing that on an annual basis anchored around our Analyst Day. At the last Analyst Day, we said it was right around 1.6 for the prior quarter. So you can expect I would say it's a reasonable expectation that as we add more subscription services Like a wildfire, we should be able to see growth in that attach rate.
Okay. Thank you. Thanks.
Your next question comes from the line of Phil Winslow from Credit Suisse. Please proceed.
This This is Harris Haire. I'm calling on behalf of Phil. Thanks for taking the question. I was hoping you could comment on the price environment Just in general versus the last couple of quarters?
Hey, Harris. Yes, we actually haven't seen much change in price environment. The We said in the past is that the competition has been for quite some time, continues to be aggressive on our pricing. That's expected I think when we have the what we believe the superior technology, that's a card that they can play. We've been living at that for quite some time and have Extremely high win rates against all the competition.
That hasn't changed. So we didn't see any impact in that.
Okay.
One other thing, Harris is, our product gross margins have Increased sequentially and that demonstrates the value of the differentiated technology that we're bringing to the
Got it. Thank you very much.
Your next question comes from the line of Raimo Lenschow from Barclays. Please proceed.
Hey, thanks for taking my question. Quick one. If I look at the run rate, it looks at touch load and we had modeled in potentially what you thought given the reasons you discussed. Will that cause any change in the Thinking in terms of investment on the build out of distribution capabilities or the company as a whole? Thank you.
Hey, Ray. Yes. The answer the short answer is No, we're taking a very long view here on the business and our goal has been and we've demonstrated the ability to grow the business way ahead of the market growth and Way ahead of any of the competition. So we view this as a market share gain opportunity for us and we intend to be aggressive about that. You have a you might have a quarter where you have some tough macro conditions and other ones there won't be that way.
So we're taking a long approach on that. So we'll continue to invest. We'll invest aggressively and as long as we're able to post significant market share gains, we'll keep I'm doing
that. Perfect. Thank you.
Your next question comes from the line of Rob Owens from Pacific Crest Securities. Please proceed.
Thank you. Wondering if you could provide some color on just what your renewal rate on these subscriptions have looked like and how that's been trending over the last couple of quarters?
Renewal rates in general have been very robust. From a subscription standpoint, they vary by length of time that the subscription has been out. So wildfire is our newest one, obviously, and we just started selling that. But threat prevention and URL filtering They've been around the longest. They have the highest attach rates and the renewals on those are very high.
We haven't gotten specifics on what the exact renewal rates are, but they're very robust. And then the renewal rates on maintenance is extremely high. You can't really have you can't see the position that we're in, in customers not renewing their maintenance because you need to have access to the updates and upgrades that come through on the support side of the house.
So if I Not the maintenance side, but the subscription side just drilling in a little bit. I mean is this consistent with where other people would put blade renewals, since you're not giving specific comment or is it in excess of some of those kind of industry numbers that we see out there?
Yes. I would say it's either consistent or Slightly better than what a typical blade renewal would be.
And then number 2 with The new facility, I think you said annual operating expenses of $13,000,000 a year. Is that an incremental $13,000,000 or was that a total number?
That's it is a total number, but it is incremental because it's a new facility. And we had flagged that back In October, when we let everyone know that we had the facility that we leased it. So that's not new news. It's just putting a finer point. I'll find a point on it for you.
Great. Thanks for that.
Thank you.
Thanks, Sean.
Your next question comes from the line of Gregg Moskowitz from Cowen. Please proceed.
Okay. Thank you very much. Good afternoon, guys. It sounded as though things really did tail off at the end quarter. And as we're essentially wrapping up the month of May, just wondering if you had any anecdotal commentary on how this past month has Perhaps compared to the month of April, would you kind of characterize it as status quo or has it sort of gotten a little bit better or a little bit worse?
Just curious if you had any color there.
Hey, Greg. Yes, we did see as the last quarter tailed off, the sentiment was changing or eroding as the quarter progressed. We thought about that as we looked forward From a month of May perspective, May is where we thought it would be right about now, so from a linearity perspective. So we're on track with where we Thought we'd be in line with the guide given.
Okay, great. And then Stefan, how many heads did you add in the prior quarter? And going forward should we still expect roughly 75 to 100 per quarter?
Last quarter we added 85 heads with an ending head count of 1034 and the net additions of 85 are right in line of the range of 75 to 100, Which we've been talking about. There could be fluctuations, both on the top and in the bottom end, but as a directional guide, That's consistent with what we said before.
Perfect. Thank you very much.
Yes. Thank you.
Your next question comes from the line of Scott Zilar from Needham and Company. Please proceed.
Hi. Wanted to ask about The evolution of deals and maybe the size of deals that you're competing for, is there any change in the field that you're seeing where Perhaps there are few opportunities that are point around application control and perhaps they're larger Sort of like a network security refresh type project that will be more complex and take a longer cycle. Is this happening in the field?
Hey, Scott. Generally, what we've seen from a deal perspective is the continued realization from customers that the numbers that the stable inspection technology have been running on for a long time just doesn't cut it anymore because of the explosion of application. So it's really the basis of the application technology we have here that's driving the continued growth and interest in the company as more and more customers realize that that's something they need. So actually Mark Anderson is sitting right here with me, so I'll turn that over to him to see if you have any more color on that,
Yes. Thanks, Mark and Scott. So I'm just amazed continually what I see from customers in terms of how receptive they are to our technology. We did see some cautious spending primarily in Europe and certainly saw some projects get pushed in federal. But really I think the worst thing that we saw was Large quantity deals, maybe 8 unit deals were cut down to 4 unit deals.
So it cut down our overall PO size, but We really didn't lose any business and I don't think our proposition has ever been stronger than it is today.
I guess just to follow-up on that. Are you saying that the average scope of a deal is larger and more complex Than previously?
Yes. What we're seeing is that well, there's a number of factors you pay attention to. They're all positive. Of course, what we're seeing Is that as we're better known as in generally and what our value proposition is, we get to see larger deals at first as opposed Smaller deals that build over time. So we get to see bigger deals.
We're winning bigger deals. And then with our existing customers as well, the repeat buying patterns as I noted in the top continue at an accelerating pace, which is great, which means our follow on orders get to be bigger as they rely on us more across their enterprise.
Thank you.
Your next question comes from the line of Aaron Schwartz from Jefferies. Please proceed.
Good afternoon. Probably a question for Stefan. But with the deferred revenue outperformance here over the last couple I know we've talked about this historically, but it does seem like the revenue mix should change a little bit here going forward with a higher mix on services. Is that Sort of a fair statement as we build out our models a little further out. And then secondly with the trend in multi year deals that you've seen Presumably there is a pull forward in cash flow there.
Do you have any sort of directional trend of how cash flow should look next year? Thanks.
On the higher mix of services going forward, you can see just in terms of how revenues have played out. This quarter services as a percentage Total revenue was 40%. Last quarter, it was 35.8%. I don't expect to see that type of sequential increase In the near term, the fact that we are call it 5% to 10% penetrated in the largest accounts, we expect us to be selling a lot more boxes. And so with that as a dynamic, we should see nice growth in both product and services.
But with the subscriptions That we are selling, the attach rates are going up and directionally services as a percentage of total revenue should be Increasing, but I would just caution to say it's not going to be increasing. It shouldn't be increasing at the same rate it did over the last quarter. And As far as future visibility on cash flows is concerned, we are seeing an uptick Multi year deals, all of our deals that are multi year in nature are build upfront. The cash is collected upfront, so that will be a benefit to cash flows. We're not guiding on free cash flow or Cash flow from operations, but we certainly should be seeing a benefit to cash flows.
How much that is, we're not going to be getting into the specifics.
Okay. And a quick follow-up if I could.
Are there any concessions on the multiyear deals? Thanks.
On the multiyear deals, there is a discount For multi year and that's kind of in line with industry practice.
Your next question comes from the line of Dan Cummings from B. Riley. Please proceed.
Thank you very much. I'll actually ask a follow on to the last question before I get to what I wanted to ask about. I'm curious if the over performance on gross margin, has that helped at all By being a little bit short in federal or in any large deals in any region in particular? Thanks.
Yes. The over performance on Gross margin had very little to do with being off on Federal or EMEA. The over performance on margin was really driven by both line items. When you look at the product gross margin, we had nice COGS reduction and favorable product mix. And on the services side of the house, we had a benefit from higher attach rates And those were the primary drivers as a basket and it really had nothing to do with being light in Federal or Europe.
Okay. I wonder it would maybe be helpful. I think some of us on the call tend to View some of your peers at least right now in the current era as maybe 2 or 3 stories when we look at commercial businesses Versus federal business versus global or EMEA business, are you able to tell us a little bit more about your growth rate, your all in growth rate in commercial markets. And just helping us kind of isolate some of these temporary effects Modeling wise, I think would be helpful. And also curious if there were any 10% customers for the quarter.
I'm struck by A lot of companies said, well, things got very weak in March and you had an April quarter, yet DSOs were very, very high. So I'm just trying to reconcile All that. Thanks.
Yes, Dan, let me try to work through that. So first, the easiest one is there are no 10% customers in the business. So hasn't been wasn't last quarter. So that's not a factor at all around this.
And does that include federal?
Yes, it does. Okay. So we've mentioned before, no vertical at all represents more than 13% of our business. So it's a pretty well Diversified Business, right? That's a general statement.
The first part of your question, I'd say, specifically what we saw in, like I said in Central and Southern Europe and then Fed as well. In each of those situations we saw a few to $4,000,000 in each one of those deals that we believe push out of the quarter. So that is the majority of the impact from where we expect it to be to where we landed and That's not broader than that across the entire market for us. So as I said a little earlier in a number of verticals, we saw very good sequential growth? Across verticals, we haven't broken a lot of those down, not because they're not important, just as I said, No single vertical that represents more than 13% of the business.
So there were puts and takes in a lot of verticals generally strong, generally good quarter except in those two places.
Your next question is a follow-up question from Jonathan Ho from William Blair. Please proceed.
Hey, guys. Just wanted to ask about the linearity of legal expenses. Would you expect the legal expenses to peak around now during the discovery phase or should we expect it to move up or move down over the next several quarters?
Thanks, Jonathan. This is We expect that legal expenses will increase as we get closer to trial. So we're largely through the discovery phase and that did come at a cost. But as we've said previously, as you approach trial, which is scheduled for February of next year, legal costs related to Juniper will be increasing. Great.
Thank you. Thank you.
Your next question comes from the line of Shelby Arasi from FBN Securities. Please proceed.
Yes. So thank you very much. Can you quantify your government or federal exposure? I think in the past it was around mid teens percentage of revenue. EMEA is around 23%.
So it looks like combined you're faced with headwinds from segments consisting of basically 40% of revenues. And I think this lasts through the end of the October quarter. Can you talk about whether you agree with that that The October quarter itself is going to have a lot of challenges particularly related to the U. S. Federal.
And then what are the catalysts To look out for the next few quarters to counter some of these forces you're faced with.
Hey, Shelby, it's Mark. So I'll take that in Three parts if I can. The first part is just to make sure we're all talking about the same facts and figures. EMEA represents in the last quarter 23% of our revenues. That's Europe, Middle East and Africa.
What we're saying from a sales perspective what we saw in Europe is not that percentage. We saw Like I said about $3,000,000 or $4,000,000 in mix between Central and Southern Europe from a sales perspective from weaker than where we thought it would be. So just want to put that all in On the federal side of our business, we said no verticals more than 13% of our business in total. Fed for us is a high Single digit percentage revenue vertical for us. So put that in the context as well.
So all that say, it's nowhere what you were saying is nowhere near 40% Of revenue, the way you just described it. The second thing on the sequestration in October, specifically the federal government, they're on a fiscal year that ends in October. So my guess is that we probably wouldn't see anything change on sequestration. I don't see Any events that would dictate a change prior to the end of that fiscal year. It could go longer than that, but I think it would go at least till October.
And then on the driver side, the driver trusts are generally continue to be very positive, meaning customers really like our value position the differentiation of our technology, security is a really big deal and getting to be a really big deal every day of the week when you see constantly stuff going on And the cybersecurity realm that all plays to our favor. So I think the macro trends for us are very, very favorable about what we do for a living and The time we do it. And let's not forget, we're growing much faster than the market and our competitors. So we're We're going to continue that path.
Your next question comes from the line of Gray Powell from Wells Fargo. Please proceed.
All right. Thanks for taking the question. Just had a couple here. So how should we think about the market opportunity with wildfire, particularly Now that you have an appliance available. And then do you see that product cannibalizing the traditional antivirus market longer term?
So generally, if we back up for a minute and say wildfire is meant to serve the market that's dealing with detection and prevention of advanced persistent threats, which Pretty big deal today. And there's a lot of concern about that. So we think that's great. That's good opportunity for us and it's incremental opportunity for us as people are spending on Which kind of goes to your second question, which is, it's a little hard to tell where the budgets are coming from in there. They could be coming from antivirus, they could be coming from IPS, some of them could be I'm not really I'm not sure anybody really knows that yet other than that there's a good amount of money being spent on that today.
And we're very well positioned with Wildfire with the cloud service, a private cloud service and now an appliance as well to capture our fair share of that. Got it. Thank you very much. Thanks, Craig.
Your next question comes from the line of Daniel Ives from FBR. Please proceed.
Hey, guys. Look, a lot of questions I'm getting from accounts. I guess, I just wanted to basically know, Do you think, I mean that in some of these larger deals, obviously you guys carved out great next gen firewall product. But in some of these larger deals, it's tougher as you guys get into some of these sort of end to end deals. I mean is Is that accurate and that's a mischaracterization?
I think that network security Has been for a long time and I think it will continue to be well into the future, a fairly discrete line item from a purchase perspective. I know I mean, What I'm saying is I know there are other providers out there that are network providers that have a broader suite of services and we do except networking services and network security services. The buyers of these things don't think that way about this and that is becoming more pronounced with the worse The situation with cybersecurity and all these threats that are coming in our networks. So I think it's a very hard sale if you're a network service provider To say take my so so network security product because you're buying my networking here, they're just different buyers and the level of interest around that is off the chart. You just can't get by with that anymore.
You've got to buy the best stuff.
Okay. And then as a sort of follow-up, Do you feel like competitors, I mean, such as Checkpoint that they have maybe, We'll say a year ago sort of took the eye off the ball from a competition standpoint, but you've seen more fierce competition, some of the bake offs Maybe then you saw a year ago now that they've kind of aggressively focused on this area of the market?
No, I think well a couple of things. The first is From a technology differentiation standpoint, we've been at this for going on 7 years. So it's not new that we're doing something disruptive and have been fundamentally different than what everybody else is doing. I think it's also fairly obvious that none of the competition including Checkpoint has Done or indicated any desire to be able to compete with us really based on the technology. So when you're in those situations, the things that You do competitively as you tend to be very concerned about keeping your existing customer base, you get very aggressive on pricing.
You do things that are really kind of marketing driven as opposed to technology and value driven for driven as opposed to technology and value driven for the customer. And I believe at the end of the day that doesn't work out for companies. Like I said a little minute ago, Dan, the level of concern and anxiety over security is is really high and getting higher and price doesn't get it for you anymore, right? Bundling doesn't get it for you anymore. You better just have the best Network security solution to market and that's what we think we have.
Ladies and gentlemen, we have time for 2 more questions. Your next question comes from the line of Kathryn Trebnick from Northland Securities. Please proceed.
Thanks for taking my question. Yes. You talking with several of the carriers, it looks like you're ramping up staff for that area. I know that was one area you discussed quite a bit at the Analyst Day. Could you talk about some of the use cases that you would be looking to win at the carriers?
Thank you.
Hey, Catherine. Yeah, So we view the carrier market as really like 3 opportunities. 1 is to sell to the carriers as enterprises meaning we're protecting their networks. Their networks. And in that regard, we're doing very well.
That's a direct sales effort. It's major account stuff. Mark and team are very focused on doing that and some of the investments we're making that space from a people personnel standpoint are going towards that opportunity. The second opportunity is to have those carriers use our technology provide them on a managed services basis. That is 2 angles So that one is managed services to enterprise, which we're doing well with a number of the carriers on developing technologies or developing the rollout plans with to use our technology to service enterprises that way.
And the second space is the SMB market, which we're not penetrated in We believe we will be over time. There's some different products, software things we need to do there, but that's that opportunity. And the third one that we view is there are large systems and integrators And some of our largest commercial customers are using some big service providers as their systems integrators and in those cases We are working with those service providers because the customer has chosen us for network security. That's allowed us to start relationships with them on large scale distribution partnerships that over time we think can pay dividends for us.
Okay. Thank you very much.
Your next question comes from the line of Jonathan Rookaiver from Stephens. Please proceed.
Hi. So half the customer base uses Palo Alto as the primary firewall. And looking at the 5 year depreciation cycle on firewall what that implies from a growth standpoint, is there any concern that greater participation in that cycle potentially prolongs sales cycles I'm sorry, what is on activity?
Yes, Jonathan. So actually just want to correct the statistics because we gave some new ones out at Analyst Day, We said we would do every year. Right now 60% of our customers or more than 60% of our customers across our whole base are using us as The primary firewall and the other statistic we updated at the Analyst Day was that in our fiscal year 2013 so far 75% of all of our new sales Are going to us being the primary firewall. So just want to start with the right numbers. And I'm not sure I understand the actual question.
Could you give me that again?
Well, just that if you look at the network firewall market, it's a single digit type growth market and we know The process around displacing incumbents can be somewhat of a long sales cycle historically. So if you're being baked into more of those potential firewall refresh cycles, does that impact in any way your sales cycles relative to what you've seen historically as we move into the future?
Okay, I got that. So, yes, so generally, sales cycles for network security and particularly the firewall can be decently long because it's a really important technology and you take your time to make a decision on that. So when we think about the addressable market, in the multi $1,000,000,000 range just for firewalls, let alone network security, but that doesn't all happen at once. So there's always refresh like what's going on across was global buying base and every one of those is the opportunity for us to come in and compete and win as we have been in those buying cycles. Now once we're in as well, it's very sticky, right.
We know how hard it is to throw the incumbent out and you better have really, really different disruptive technology if you try to do that. So once we're in the door, we know how hard it is to take us out and you can kind of get a sense of that as well from the expansion that we've seen across The customer base. So the last thing I'd mention is that our largest customers continue to tell us that like penetration levels in their accounts Maybe 10% of what we could possibly earn over time inside of those accounts. So we're pretty Followed on what the opportunity here is.
Okay, good. That's helpful. Thank you.
Thanks, Tom.
We will take our last question from the line of Sterling Auty from JPMorgan. Please proceed.
Yes. Thanks. Hi, guys. Mark, you mentioned in your prepared remarks the success of the 3,000 series. Just Curious where you're seeing the adoption if it's helping you expand your market presence or if it's going into branch offices of existing customers?
Hey, Sterling. Yeah, It's actually it's kind of gone left and right, meaning that the 3,000 series is right up the middle for us. So that is something that you'd probably see more and we are seeing more than you'd see in the branch office or in a data center. And as I think you and I talked about at one point, we'd said at the Analyst Day that We saw an opportunity there to put something in that point in the market which would help us up sell off of the 2,000 series for folks who just had higher throughput requirements as throughput needs continue to grow at the perimeter. So that seems to be working very well.
And when you look at the quarter, any segmentation in terms of where you saw the weakness? Whether I think Mark talked about Yes, some of the bigger deals being segmented, but any sense if the weakness as the erosion as the quarter went on was uniform or particular End of the market, meaning larger deals versus smaller customers?
Generally on the larger side. So, again, we saw In Europe and particularly Central Southern Europe and in the Fed space, the things that we saw that added up to $3,000,000 $4,000,000 in each one of those Across maybe like a dozen deals. So they tend to be larger in nature. I think that's not surprising given the sentiment that was changing over time. Larger purchases would be the ones that either get downsized or pushed to the right.
All right. Thank you. Thanks, Joanne.
Ladies and gentlemen, I would now like to turn the conference back over to Mr. Mark McLaughlin for any closing remarks.
Yes. Thank you. I appreciate that operator. I want to thank everybody for taking the time to be with us today and also want to reiterate my appreciation for the hard work of all the Palo Alto team and support of our customers and partners as we continue to revolutionize the enterprise network security market. We look forward to updating you all on our next quarter.
Thank you.
Ladies and gentlemen, that concludes today's conference. Thank you for your participation. You may now disconnect. Have a great day.