Good day, ladies and gentlemen, and welcome to the Q2 2013 Palo Alto Networks Inc. earnings call. My name is Sue, and I will be your operator for today. At this time, all participants are in listen-only mode. We will conduct a question-and-answer session towards the end of the conference. If at any time during the call you require assistance, please press star zero, and an operator will be happy to assist you. As a reminder, this call is being recorded for replay purposes. I would now like to turn the call over to Maria Riley, investor relations with The Blueshirt Group. Please proceed, ma'am.
Good afternoon. Thank you for joining us on today's conference call to discuss Palo Alto Networks' fiscal second quarter 2013 financial results. This call is also being broadcast live over the web and can be accessed on the investors section of Palo Alto Networks' website at investors.paloaltonetworks.com. With me on today's call are Mark McLaughlin, Palo Alto Networks' Chairman, President, and Chief Executive Officer, and Steffan Tomlinson, Chief Financial Officer. After the market closed today, Palo Alto Networks issued a press release announcing the results for its fiscal second quarter ended January 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, and we will email you a copy.
We would like to remind you that during the course of this conference call, Palo Alto Networks management will make forward-looking statements, including statements regarding continued revenue growth and overall momentum at the Palo Alto Networks business, trends in its business and operating results, including its gross margin, operating margin, and non-GAAP effective tax rate, and Palo Alto Networks' revenue and non-GAAP earnings per share for the third fiscal quarter of 2013 ending April 30, 2013. These forward-looking statements involve a number of risks and uncertainties, some of which are beyond our control, which could cause actual results to differ materially from those anticipated by these statements. These forward-looking statements apply as of today. You should not rely on them as representing our views in the future, and we undertake no obligation to update these statements after this call.
For a more detailed description of these risks and uncertainties, please refer to our quarterly report on Form 10-Q filed with the SEC on December 10, 2012, and our earnings release posted a few minutes ago on our website. Also, please note that certain financial measures we use on this call are expressed on a non-GAAP basis and have been adjusted to exclude certain charges. We have provided reconciliations of these non-GAAP financial measures to GAAP financial measures in the investors section of our website located at investors.paloaltonetworks.com. Before I turn the call over to Mark, I'd like to remind you that Palo Alto Networks is hosting its inaugural Analyst Day in New York City on March 21st. If you would like to attend, please contact me or Hadley Rokicki at The Blueshirt Group or email ir@paloaltonetworks.com.
In addition, a live audio webcast of the meeting will be accessible from the Investor Relations section of the company's website. Now I'd like to introduce Mark McLaughlin, Chairman, President, and Chief Executive Officer of Palo Alto Networks. Mark?
Thanks, Maria, and thanks everyone for joining us. I'm delighted to be here today to share with you our achievements in our fiscal second quarter of 2013. We had a strong second quarter. Our results continue to demonstrate Palo Alto Networks' recognition as the global leader in next-generation enterprise network security. This leadership position is driven by our high-value, disruptive technology, which we believe provides the highest level of security available in the market today. As customers rapidly adopt our technology as their strategic enterprise network security platform, we continue to demonstrate the ability to drive growth far in excess of any of the competition and with continued improving leverage. In the second quarter, we continued to see enterprise investments in security as a top-of-mind issue, strong end-of-calendar-year purchasing, improving customer sentiments in EMEA, and continued adoption of our technology as the primary firewall by new and existing customers.
As we've discussed in the past, our growth model is based on our ability to land in new customers as a best-in-class provider for any enterprise network security use case, expand across that customer's network with additional devices, and extend our value to the customer with subscription services that provide great performance and total cost of ownership advantages. In looking at the land component of our growth in the second quarter, we added over 1,000 new customers in the quarter. This is the fifth consecutive quarter where we've added over 1,000 new customers. We now have the privilege of servicing over 11,000 total end customers around the globe, most of which are choosing us over the legacy incumbent firewall provider. On the expand and extend side of our business, we continue to see strong increased buying and loyalty from our customers.
Our business coming from services continues to grow at impressive rates as our existing customers buy additional services and for longer terms. For example, in the second quarter, our top 25 customers' follow-on purchases averaged 11.4 times their initial purchase. This is up from 9.9 times last quarter. To make the top 25 list in the second quarter, a customer had to spend a minimum of $2.8 million with us, which is up from $2.5 million last quarter. This has all translated into second quarter results where we posted $96.5 million in revenue, which is a 70% year-over-year increase and 12% sequential increase, along with non-GAAP EPS of $0.05 per diluted share, demonstrating our continued ability to substantially outpace the competition and with continued growing leverage in the business. Our results are driven by our ability to provide demonstrably and substantially better network security than the competition.
Some examples of this over the quarter include us replacing Check Point as a data center firewall in the distributed network environment of one of Europe's largest broadcasters. We also replaced Check Point in the data center of one of the biggest insurance companies in the U.S. after starting our first deployment with them in December of 2011, and replaced Juniper, one of the largest electronic component vendors in the world, based here in California, and Cisco in one of Australia's largest retirement funds. As we've discussed and demonstrated in the past, we continue to displace all the legacy firewall providers at a rapid pace by growing our market share. The reason why we're able to win so many new customers and expand so significantly within our customer. This differentiation continues to grow.
Just a few days ago, I was pleased to see that Gartner once again recognized Palo Alto Networks as a leader in their latest Magic Quadrant for Enterprise Network Firewalls, and they reiterated their belief that by year-end 2014, the majority of new purchases will be next-generation firewalls. I'm also very pleased with the rollout of the four new products introduced in November at our Ignite user conference. Customer traction has been significant across all these products, most notably for our PA-3000 Series and WildFire subscription service. We now have more than 1,200 customers using our WildFire service and are ahead of our internal forecast for the paid attach rates for the new service. In summary, we're pleased to report another strong quarter of growth, new customer acquisition, and continued increasing operating leverage.
Our solutions address the fundamental network security issues that are facing enterprises across the globe. We enter the second half of our fiscal year 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 today to cover our results for fiscal Q2 2013. In Q2, total revenue grew to a record $96.5 million, an increase of 70.2% year-over-year and 12.3% sequentially. Looking at our two main components of revenue, in Q2, product revenue of $61.9 million grew 60.3% year-over-year and 11.6% sequentially, driven by sales of our series of appliances. Services revenue, which is comprised of both subscription and support, was $34.6 million, an increase of 91.5% year-over-year and 13.6% sequentially. Services revenue accounted for 35.8% of total revenue, an increase of 40 basis points sequentially. This is in line with our expectations and underscores the power of our hybrid revenue model as it provides enhanced visibility.
The geographic mix of revenue was 63% Americas, 25% EMEA, and 12% APAC, with all theaters posting growth on a year-over-year and sequential basis. Total non-GAAP gross margin in Q2 was 72.2%, in line with our target range of 70%-73%. Non-GAAP gross margins decreased 70 basis points year-over-year and 40 basis points sequentially. Putting a finer point on gross margin, Q2 non-GAAP product gross margin was 73.4%, down 10 basis points year-over-year and 80 basis points sequentially. The sequential decrease was primarily due to product mix and the impact of the launch of our new PA-3000 Series. As I mentioned in the last earnings call, product gross margins will fluctuate when we introduce new products as they have a higher initial cost of goods sold.
As volumes increase for new products, we expect reductions in cost of goods sold, which will result in an improvement of gross margins over time. Our non-GAAP services gross margin was 70.1%, down 140 basis points year-over-year and up 60 basis points sequentially. The sequential increase was primarily due to the benefit of more subscription sales in the quarter, and services gross margin will also fluctuate depending on the timing of the investment ramp of our services organization. Moving on to operating expenses, we continue to invest primarily in product development in our sales and go-to-market organization. Q2 non-GAAP R&D expense was $13.5 million, an increase of $1.9 million from the prior quarter, primarily related to program spend and headcount addition. As a percentage of revenue, non-GAAP R&D expense was 14%, up 50 basis points sequentially.
Q2 non-GAAP sales and marketing expense was $41.9 million, an increase of $3.6 million from the prior quarter. As a percentage of revenue, it was 43.4%, a decrease of 120 basis points sequentially, demonstrating operating leverage. Q2 non-GAAP G&A expense was $7.7 million, an increase of $500,000 from the prior quarter, or 8% as a percentage of revenue, down 40 basis points sequentially. In total, Q2 non-GAAP operating expenses were $63.1 million, an increase of $6 million from the prior quarter, or 65.4% of revenue, down 110 basis points sequentially. Q2 non-GAAP operating margin was 6.8%, an increase of 70 basis points sequentially, and the sequential improvement this quarter can be attributed to continued natural leverage as we scale and timing of headcount additions.
As we've 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 grow operating margin in a slow and steady manner while noting there may be near-term fluctuations. Our non-GAAP effective tax rate for the quarter was 41.5%. This rate will continue to fluctuate throughout the fiscal year as it's dependent upon our global pre-tax profit mix and potential discrete events such as the removal of our domestic valuation allowance. Non-GAAP net income for Q2 was approximately $3.9 million, or $0.05 per diluted share, using 77.5 million shares. This compares to non-GAAP net income of $2.9 million or $0.04 per diluted share in fiscal Q1 2013. Non-GAAP net income of $2.5 million or $0.04 per diluted share in fiscal Q2 2012.
On a GAAP basis, net loss was $2.6 million or $0.04 per basic and diluted share.
Turning to the balance sheet, we finished January with cash equivalents, and investments of $368.3 million. In Q2, cash flow from operations was $34.5 million, free cash flow was $28.3 million, and free cash flow margin was 29.3%. Cash flows benefit from our hybrid revenue model, in which we bill for our services at the beginning of the engagement and we collect the cash shortly thereafter. We ended Q2 with $68.6 million of accounts receivable, up from the Q113 balance of $56.4 million. Average DSOs were 58 days, up from 53 days last quarter, reflecting a slightly more back-end linearity to the end of the quarter. Moving down the balance sheet, total deferred revenue was $188.2 million, an increase of 92.2% year-over-year and 17.3% sequentially. Short-term deferred revenue of $117.4 million increased 15.8% sequentially.
The majority of our service engagements are on an annual basis, but we're continuing to see an uptick in multi-year deals. Billings were $124.3 million, an increase of 81.6% year-over-year and 12.4% sequentially. Let me now turn to our guidance for Q313. We expect revenue to be in the range of $100 million-$104 million, which equates to 52%-58% year-over-year growth. We expect non-GAAP EPS to be approximately $0.05 per share, using 79 million-81 million shares on a diluted basis. We're continuing to invest in product development, sales, and go-to-market, as well as discrete projects in G&A, all of which is reflected in our guidance for Q3. With that, I'll turn the call over to the operator to open the Q&A session.
Thank you. Ladies and gentlemen, if you wish to ask a question and a follow-up question, please press star followed by one on your touch-tone telephone. If your question has been answered or you wish to withdraw your question, press star followed by two. Press star one to begin. Your first question comes from the line of Greg Dunham, Goldman Sachs.
Hi. Yeah, thanks for taking my question. I guess first off, can you talk about the impact of Mark Anderson's kind of emphasis on strategic accounts and the opportunity to improve sales productivity from here? Thank you.
Yeah. Sure, Greg. It's Mark. How you doing? Yeah. Mark has been focused on a number of things. I mentioned this on a few of the other calls, one is on the strategic account side. Not surprisingly, as the company continues to grow into the size we are and the size we intend to become, large strategic major accounts are more and more important to the company. We've been very focused on the Global 2000. We've got very good penetration there and continued increased penetration. We continue to do really well in our large accounts on follow-on purchases as well. Mark's putting a lot of discipline in place, talent in place, how to sell into and service those large accounts. We expect to continue to get gains from that over time.
As you know, it takes time in order to develop sales forces like that. So far, very pleased.
One follow-up, if you permit. The billings number was just a monster number. Were there any anomalies in there? Is that mainly due to the WildFire release? How should we think about that?
Yeah. I'll probably give Steffan a little more detail. Just generally on the billings side, we had a nice quarter, as you can see. We had a nice increase in the services revenue side of it with the stall flowing through the billings and the defer. If you want to give any more detail.
That's right. When we look at the composition of billings, what we're seeing is a very nice uptick in our services line, both subscription and maintenance. We were pleased with the number.
Thank you.
Thank you. Your next question comes from Joel Fishbein, Lazard.
Just to follow up on that, guys. In terms of the take rates on the subscriptions, can you give us any more indication on the numbers that people are taking, what is particularly driving the deferred revenue in terms of the subscription base?
Yeah. Hey, Joel, it's Mark. As we said in the past, the attach rates on the services are good and high. They need to be that way. In addition to that, as you know, we continue to launch more services, in particular WildFire, which came out back in November. We like the attach rates we're seeing on that. It's early days there, but they're higher than what we internally forecasted in the last, call it, 90 days of selling. That's good, and we think that's continued uplift for the company.
At the end of the day, what's going on here is that when you've got a really disruptive device in the first place as the firewall and the ability to easily add very high-value services for folks at a much lower cost than they would pay for other boxes, it's a really compelling offering in the market, we keep seeing our customers take advantage of that in increasing rates and for longer terms. That's good.
Just as a follow-up to that, at RSA, the big talk was malicious threat protection. Can you just talk about how Palo Alto's positioned in that market? Maybe that's the better question to ask relative to what's driving the subscription growth.
Sure. It's a great question. Yeah, when I was up at RSA yesterday, there's definitely a big focus on APT malware. Not surprising, and their security changes a lot, and there's always something new that's important to take care of. As a general matter, I think what's going on there is that companies or enterprises are very concerned about that, and then the question is, what do you do about it? Bringing a service like WildFire to market is really important in and of itself because it is the only one out there that can detect and prevent malware.
More importantly, our big picture, I think, is what's happening architecturally, is that enterprises want the ability to have device services that can provide the best security and do so rapidly without having to make big capital expenditures for. What we've done is we've said in a lot of cases, majority of cases, we're already your firewall. We're deployed throughout your network with the WildFire service. You're getting a modern malware service right on top of the box you've already deployed in your network, and it's already your main enforcement point because it's a firewall. From a pure security perspective, what you'd like to have is the disparate pieces of technologies you're forced to get in different boxes today actually be integrated in a native way, because that's the best possible way to detect and then really quickly prevent that malware.
That is what we have in the market. I think just generally as an architectural matter, that's the way the world's going.
Great. Thank you.
Yeah.
Thank you. Your next question is from Michael Turits, Raymond James.
Hey, guys. Just a sort of a housekeeping question. Any more precision you can give us on the number of customers added in the ending customer count, and how much hiring you did this quarter? What was the net headcount adds, and what we should expect those going forward to look in the 75-100 range?
Yeah, sure. Hey, Michael. On the first question on the customers, we continue to add customers at a very nice pace. This is the fifth quarter with over 1,000. We haven't gotten into the numbers about what they are over 1,000. The reason for that is there's really no magic to 1,000. I mean, it's a great number that can you put out there. This is a really great quarter for us from a customer add perspective, very high numbers, and we hope to continue that for quite some time. Just as importantly as adding new customers, which is the land part of the model, is the expand part. Once we get them in the door, the way we've been able to demonstrate repeat sales with that is really important. You can see that driven through our services line and deferred revenue here.
All the cylinders are firing.
I know. I'm sorry, Steffan, go ahead.
I was going to say, just a follow-on point to that, you can also see that in the LTV metric that we talk about, which has increased very nicely sequentially to 11.4 times repeat order value for the top 10 or top 25 enterprise customers that we have.
We added 100 head in this quarter. We said we'd do anywhere from 75 to 100 on a quarter basis as far as the target. That obviously is going to fluctuate quarter-to-quarter, hiring patterns and when people show up. We put 100 in this quarter, we're going to stick to that.
If I could just ask you about the accounts receivable, and you said it was more back-end loaded. What was going on there that that happened?
It was typical of many companies in terms of the January month. The first couple of weeks are always a little bit slow because the majority of corporations are on a calendar year budget. Once those budgets are finalized, we saw a very nice pickup at the end of the month. That's a normal pattern that we've seen in January, in past Januaries. We also did see a good calendar year-end December month. We don't break that out specifically, but we did participate in a nice December month as well.
Okay, thanks.
Thank you.
Thank you. Your next question is from Jason Noland, Robert Baird.
Great, thank you. Mark, at RSA, there was talk of the perimeter being porous and ineffective. I guess part of the answer there is WildFire for APT and malware. Do you see any change architecturally, where PA appliances will be in more locations in the network or virtual NGFWs, I guess? What are you seeing more broadly?
The answer is kind of yes, meaning you see it everywhere, which is you want to protect the perimeter, you want to protect the branch office so the perimeter doesn't get attacked. You would definitely want to protect the data center. Those are the three main areas that generally enterprises focus on. That's where we have offerings for all three of them. Again, like I said a little earlier, because of that, because of the move to virtualization and data centers, flexibility from how you are able to provide security is very important. Ideally, you would want your firewall to be very flexible with services in order to do that in all those places in the network. You'd want a virtualized version of that as well, and we have all of those.
Thank you.
Thank you. Your next question is from Phil Winslow, Credit Suisse.
Hi, this is Harris Tyler on behalf of Phil Winslow. Thanks for taking the question. I was hoping you could comment on the pricing environment in the last quarter versus recent quarters. If you could just comment briefly on the attach rate renewal rates.
Yeah, sure. Your first question was on pricing, is that it, Harris?
Yeah.
Okay, yeah. Well, this has always been a very competitive market. It's not unusual for players to attempt to make up for lack of functionality by aggressive pricing. We've definitely seen that. What we've found in the past, we continue to see, is that our technology's really disruptive and it's solving really strategic issues. As a result of that, we're not immune to pricing pressures, but we've been able to maintain premium pricing for premium technology for quite some time.
On the attach rate on subscriptions, what we've said in the past still holds up. We're typically selling one or two subscriptions with the initial sale. We also sell maintenance. The attach rate on maintenance is extremely high. We've said it's well north of 90%. The renewal rates for maintenance, again, is very high. You can't really deploy enterprise network security without being on maintenance, because you'd get bug fixes and patches as part of that maintenance program. The renewal rate on subscriptions are high as well. We haven't put a finer point on that. That should cover both of your questions.
Okay, great. Thank you.
Thanks, Harris.
Thank you. Your next question is from Jonathan Ho, William Blair.
Hey guys. The first question I have is around the primary firewall adoption. Can you talk a little bit about the trend there and whether you're seeing I mean, historically, you've said over 50%. Are you seeing an acceleration there, especially relative to Gartner's comment?
Jonathan, we are. What we've said in the past is that over half of our new sales and over half of our existing customer base use the primary firewall, and that number continues to go in the right direction for us. I think what Gartner is saying here is that enterprises have been coming around, rapidly coming around to you really need a next-gen firewall in order to have the best level of security in the market today. Their expectation is that as those purchases occur, most of them, meaning more than half of those, are going to be for next-gen firewalls. I think that all points to continued opportunity.
Got it. Just in terms of the PA-3000 line, just wanted to understand a little bit about how much of an impact that product set is having. I know it's been out for a little while, but is this driving some of the new expansion opportunity or has it seen more market acceptance? Just want to get some sense of how that line is faring.
Yeah. We got a lot of input from customers along the way that they'd like to see a device in that range. We delivered it, and it's sold very well from the first day we introduced that, and I expect it to continue to sell well. We're very pleased with the performance.
Great. Thank you.
Thank you.
Thank you. Your next question is from Karl Keirstead, BMO Capital Markets.
Hi, this is Shakeel Alam in for Karl Keirstead. Two questions. Can you talk a little bit more about demand environment? You mentioned strong enterprise demand in your prepared comments, and I just wanted more color on that. You also talked about enterprises wanting to consolidate to more of a single architecture. Are you seeing an uptick in one demand and also just that kind of trend of a more consolidated architecture? Then also my second question, just if you're able to give a little more color around the 50% of new customers that are buying Primary Firewall. In terms of their size, are they getting larger? Anything you can give us there would be helpful.
Yeah, I'll take that in reverse just so I don't forget them. On the new ones, when we say 50% of the new customers are using some Primary Firewall, that's across the board, meaning that it's all across the entire customer base. We're really focused, as we said before, on the Global 2000, so it includes those folks as well. As we are continually and rapidly accepted in the market as an enterprise network, a firewall provider with the technology, what we have seen is that deals get done quicker and that the initial deals get bigger, and then the follow-on purchases get faster, and the follow-on purchases get bigger. That's generally what we've seen and continue to see. On your first question, just kind of plays into that, which is, yes, demand has been and continues to be very high for this technology.
Again, we have partners echoing that just a few weeks ago, but we certainly have seen that from a demand standpoint for our technology. Then on the other question around what I was saying architecturally, as you can call it consolidation, we think of it more as the native integration of the technologies required to combat what you're seeing in the security sphere today. We believe that over time, this doesn't happen overnight, but over time, architecturally, customers want and demand and will get more and more of the functionality natively from the firewall. Simply, I mean, one is it's great and convenient cost-wise, but way more importantly is that that is a better security solution. I'll use malware. I know everybody's focused on that these days, as we are, but I use malware as an example.
If you want to see the malware coming in, that would be traditionally a malware device, seeing the malware coming in. When the malware is in, you would want to see if it's trying to talk outside the network. The malware device won't do that. Your IPS device would be the one listening for the command and control to see if it's communicating out. If it was, and you were able to put a signature on it with your AV device, you'd want to communicate it back to your firewall so that you could have a signature to enforce it. That's kind of what the mishmash all looks like out there, and that's not very convenient or secure. That's why we continue to see customers driving and pressing for better security in a natively integrated fashion, which is what we brought to market.
Great. Thank you.
Thank you.
Thank you. Your next question is from Walter Pritchard, Citigroup.
Thanks. Mark, just on the product side, I'm wondering if you could compare and contrast sort of the pressure to move with a higher end box, even higher than where you are today, versus move down into the low end. I'm wondering just kind of branch versus data center, where are you being pulled more so as you see incremental demand?
Well, both directions. I think, let me talk about the smaller side first. I think customers would like to see us have even smaller boxes than the PA-200 with all of the functionality, right, that you get with the next-generation firewall, and that's the challenging, just from how do you deliver all that at the right cost and profitability to do that. We've thought about that, continue to think about ways to get that done. Then on the higher end, there is a set of the customer base that not everybody because they don't, and I'll tell you why in a minute, but not everybody, but would like to see a higher throughput box on the higher end doing all the next-gen functionality that we do in the boxes we have today. Those tend to be large data center deployments or carriers or folks like that.
We're definitely paying attention to that. We've taken that input very seriously. I think you could expect to see us do something in that area in the future. Generally, though, one of the things that the market's been used to for a really long time is saying, if I want to get X With everybody else's technology, if you want 2 gigs of protected throughput, you probably have to start with a 40-gig box to get it because all the performance degradation. We don't have that problem. You get 2 gigs in, 2 gigs out, right? You get what you pay for, as opposed to having to start with something very expensive. We've been able to service lots and lots and lots of throughput and bandwidth because of that.
Got it. Steffan, just a clarification on the deferred revenue. You did have a very strong quarter here. I'm wondering if there was any sort of abnormal seasonality. There's a lot going on in government, things like that. Any pull forward of maintenance, any longer-term maintenance deals, or anything that, because the seasonality here looks much more pronounced than it did last year?
Our deferred revenue grew nicely. We have seen an uptick in multi-year deals, both on the subscription side and on the maintenance side. Nothing too out of the ordinary is happening there.
Okay, great. Thank you very much.
Thank you. Your next question comes from Tal Liani, Bank of America Merrill Lynch. Thank you.
Hi, guys. This is Ron Zember on Tal Liani.
Hi.
Just a couple of housekeeping questions. Headcount, should we think of the same run rate for the rest?
We talked about a range of 75-100. Timing of heads on board, sometimes there are some variances. We still feel comfortable with that range. This past quarter, we added exactly 100. I think going forward, the 75-100 range makes sense for us for the balance of the fiscal year per quarter.
All right. How about the investment in the channel? How many partners have you added this quarter?
We haven't broken out what we've done on a quarter-by-quarter basis, what we said in the past. We've got about 800. Over about the last few years, we've added 250, and we'd expect to do that on a continued rate. If you can use that sort of as a benchmark. We're very interested in the quality of folks over the quantity of folks, just because when you have a newer or relatively newer disruptive technology, having highly trained partners being able to sell into accounts where you're almost always doing displacement is very important, so we focused a lot on that.
How has the ramp been on the recent adds?
Great. It's been in line with our expectation.
Great. Thank you very much.
Sure.
Your next question comes from Erik Suppiger, JMP Securities.
Yeah, two questions. First, just curious if you've seen any change in the competitive landscape coming from other next-generation firewall vendors. Secondly, on the WildFire, the subscribers, I think you said around 1,200. Was there any pent-up demand? Is that something that was kind of just because of the initial release, or might we expect that to continue growing at a similar rate?
Yeah, Erik. Well, on both. The first one on the competition side, the answer is no. We believe this to be true, that we're the only real next-generation firewall provider in the market. Lots of folks are doing marketing around application identification control, which they mean they can block applications, and then they try to call that next-gen firewall. We're the only offering in the market that can truly safely enable applications, and that's the difference. We've seen a lot of competitive marketing, but we haven't seen any catch-up from a competitive technology standpoint, which is the only thing we really care about at the end of the day. On the WildFire side, yeah, I should've been more clear a little earlier.
We've had a free version of WildFire in the market for over a year, and we've had a really good customer adoption of the free version. We have 1,200 total customers today using WildFire. Of that base of the customers, when we released our paid-for version of WildFire in November, we saw some new customers buying that and existing customers starting to pay for that from an attach rate perspective. I want to be clear, we don't have 1,200 paid-for subscriptions yet. That's the total base of customers that are using WildFire. The attach rates on these numbers are good so far for us.
The attach rate for the paid version?
For the paid version, yes.
Okay. Any details on how that performed in the quarter?
Better than we had hoped for.
Very good. Thank you.
Thank you.
Thank you. Your next question comes from Brent Thill, UBS.
Thanks. Mark, just on WildFire, how do you think of the ASP lift? If you just use maybe some simple numbers to help us understand what you're seeing initially in those paid-for customers.
Brent, we're trying to keep it really simple and light we have for all our subscription services. All of our subscription services are the same in that when you buy a device, the device costs X, right, and has a list price on it, and the subscription service is 20% of the list price. That's true for WildFire as well. If you're going to attach a paid-for subscription of WildFire, it's 20% of the list price of the box you're putting in.
Okay, that's great. If you could just give us your thoughts on the government, what you're seeing in your pipeline, how you think about the potential upcoming impact of things going on there right now, that'd be helpful. Thanks.
Yeah, the government market's been a good market for us, and I think it will continue to be just by the nature of what we do for a living. With that said, no vertical is more than 14-ish percent of our business today, so we have to keep that all in context. I think your second question, really, or part of it, is around sequestration. There's lots of speculation, anxiety in general about whether that's going to occur. I guess we'll find out tomorrow. If so, what that's going to mean impact-wise. I think it's too early to tell. There are a few things that remain consistent. One is that cybersecurity is a national priority. You can see that as lately as just a couple of weeks ago with the president's executive order on cybersecurity.
The second thing, in general, is all enterprises, and to some degree, the government more so than an enterprise, if you consider them that way, are being forced to do more solution, flexibility quickly at low cost, and I think that's a really desirable offering. That's what we have, and I think the government has found that attractive and will continue to find attractive. Having said all that, nobody really knows what the impact of sequestration is going to be, and we, of course, bake all that into our guidance.
Thanks, Mark.
Thank you. Your next question comes from Gregg Moskowitz from Cowen.
Okay. Thank you. Hi, Mark. Just to follow on to one of Walter's questions, how is demand this quarter across your current set of low, mid, and high-end appliances? Was it strong across the board or did one area, for example, perform a little better than the others?
It is strong everywhere, Gregg. What I was saying a little earlier was the 3000 is selling very well, higher than what we thought it would, selling, which is always great. I'll call that the everything's selling well. That's a good aberration, it's selling better than we thought it would. Everything continues to move.
Okay, great. For Steffan, your services gross margins have been on a nice upward trend over the past few quarters. Looking forward, I'm sure you're going to make some investments in your support organization at the same time. Presumably, your mix of subscriptions will continue to increase. Just wondering how you're thinking specifically about service margins from up here.
Well, we're not going to break out specifically how each of the components of the services gross margin work or the product gross margin. On the services gross margin, in particular, the dynamic around subscription versus maintenance and the customer support organization, subscription revenue is going to be recognized ratably over the life of the contract. There will be a consistent small tailwind that builds over time as we sell more subscriptions. The cost of support to deliver maintenance is very much headcount-driven and systems-driven, and those costs are more pronounced up front. We have a couple of countervailing forces playing against each other. We've been more disciplined in getting more efficiency out of our support organization, which is helpful. As WildFire and other subscriptions continue to build, there should be a positive tailwind to services gross margin over time. There will be some near-term fluctuations.
I think the biggest thing to understand is, given that this is the fifth consecutive quarter we've added over 1,000 new customers, we want to make sure that we're adequately resourced to ensure a great customer experience. That's a big differentiator between us and the competition.
Great. Thanks very much.
Thank you.
Thank you. Your next question is from Aaron Schwartz, Jefferies.
Good afternoon. Just a quick sort of follow-up question on the deferred revenue. Obviously, that's been well ahead of what we have modeled. I would assume we would, but should we expect a more pronounced revenue mix shift to services as we build the models out in the back half here and into 2014?
It's a little too soon to tell. We are primarily a book-and-ship business. If you look just on a revenue basis, still we're getting approximately two-thirds of our revenues from product. Over time, we think directionally, services as a percentage of total revenue and total billings will be building. Given the fact that we're adding so many new customers per quarter and we're following our land, expand and extend strategy of mining our install base and selling to new opportunities within that base, we expect to see both robust product growth and services growth. We'll monitor it over time, but right now, we're not making any predictions on the split.
Okay. Sort of just a follow-up question. You spoke about the trend of a couple more multi-year deals. I think you said that was balanced between the maintenance and the subscription services. What's actually driving that? Is that more of a customer preference, or do you have the sales and partner program actually out trying to do multi-year deals? Thanks.
Most of it's customer-driven, the fact that we're selling into the Global 2000 and high-end enterprise, they want to standardize on us, and they're effectively making that standardization call with a multi-year deal. That has translated into structurally us being very well situated in the account for both the existing deal and for follow-on purchases.
Great. Thanks for taking the question.
Thank you.
Thanks, Aaron.
Thank you. Your next question is from Keith Weiss, Morgan Stanley.
Excellent. Thank you for taking my question, guys, and very nice quarter. One of the things that I noticed in the quarter is you had a, I think this is the second quarter in a row of really robust sequential increases in EMEA. Anything in particular looking better there or sort of catalyzing growth there that's really leading to this two nice sequential upticks?
Yeah. Thanks, Keith. What you can see, as you noted from the numbers, we increased the business sequentially the last three quarters in a row, and particularly the last two quarters at a really healthy rate. Obviously, we're pleased with that. I think it's a little too early to speculate as whether any of that means, as a general matter, a resurgence of confidence in the EMEA market macro-wise. We're in a position of selling a really high-value technology and a great secular trend that's going to affect enterprises all around the world, including EMEA. We'd expect security to remain top of mind and a budget issue over there, or top of budget issue over there.
More specifically to your question for us, what we have seen is larger companies where we've been working on larger projects, starting to bring those projects to fruition and replacing legacy technology with Palo Alto. That's a positive again for us in the second quarter. I don't know if that means that the purse strings are opening more generally over in EMEA, but that's kind of what we're seeing specifically to us.
Got it. In terms of where you're investing in additional capacity or additional distribution capacity, can you give us any color on, is it spread out evenly across the globe, or is it more of an international focus?
We're investing pretty much everywhere. One of the things that Mark has done nicely is to do, I'll call it rationalization of when you're putting the dollar in, where do you expect to get the most out, and trying to get a good balance of that on earlier high-growth markets versus more stable places where you might just be splitting territories. Generally, we're investing everywhere because we're growing very nicely, but we're still under-distributed still pretty much on a global basis because the market's so large and there's so many folks to help.
Got it. Maybe if I could sneak in one last one. I think on the last conference call, you talked about really good volume increases from the PA-200. I think you talked about greater than 70% unit growth in the quarter. Any chance you'll give an update on that unit growth number?
No.
Just kidding.
I'm sorry, I don't remember that specifically, so I'm not going to comment on that, but yeah.
Yeah, on the volumes, we don't typically go to the level of granularity around giving product unit growth sequential or year-over-year numbers. I can tell you just by virtue of the revenue growth, unit volumes were up across the board. Each of the main appliances that we sell had very strong demand in the quarter. The biggest positive development that we had in this quarter was the traction we had with the PA-3000, which we introduced in November, and the uptake on that was extremely strong. I'll tell you, both the high end, PA-5000 and the low end, the PA-200, they all had nice performance in the quarter.
Thank you. We have time just to take two more questions, one from each of the following parties. The next question comes from Frederick Grieb, Nomura.
Hey, thanks, guys. Just to circle back quickly to the new customers added in the quarter, can you give us an idea if the average size of these new customer purchases is increasing and what the dynamics are that's causing those initial purchases to grow?
Yeah, Frederick. A couple things with that. The answer is yes. The quality ASP around that continues to go up. I think that the reason for that, again, just goes back to the more accepted Palo Alto becomes, the more likely you are to make a bigger purchase with us upfront. As we said many times in the past, though, we're really not focused on that number. What we really are focused on is lifetime value customer, and we have a raft of examples of folks who spend well over $1 million with us that started with a relatively smaller five-figure sort of deal, but then rapidly ramped it to well over $1 million. That's what we're focused on, is the time to ramp and the goal for the initial purchase.
Got you. Thanks a lot.
Yeah.
Thank you. Your next question is from Shebly Seyrafi, FBN Securities.
Yes. Your mix effect was negative because of the, I think you had ramping sales of the 3,000 Series. I think you hinted that as those sales mature, the margins will improve. I'm just curious about how you see the mix dynamics playing out over the next several quarters. You also hinted at potentially a new high-end box at some point, higher throughput box. It seems like this is the low point in terms of mix. Any thoughts on the mix dynamics going forward?
Yeah. As Steffan said it earlier, we have very strong demand for the 3,000 Series, which is great. It's selling very well. As with all new, particularly hardware launches, you don't want the same kind of product gross margins you get until you scale it to the volumes where you start to see the savings. We'd expect to see that over time with the 3,000 Series. We saw the exact same thing last year, roughly at this time in the introduction of the PA-200, where it sold really well out the door and had lower gross margin because it was a newer product, and that's improved as we'd expected over time. I did say a little earlier that there is a demand from part of the customer base for larger devices, which we would certainly think about if we did that. We would launch that device.
It'd have lower gross margin than it would later on when you had increasing demand. One thing I do is note is you should expect us to continue to launch devices in our family of products for probably all the time, based on what we're getting from the customers and where we see the ability to do that.
Thank you. I would now like to turn the call over to Mark McLaughlin for closing remarks.
Well, great. Thanks again, everybody, for being on the call today. I want to reiterate my appreciation of the Palo Alto Networks team and the support of all of our customers and partners as we continue to revolutionize the enterprise network security market. We look forward to seeing all of you at our Analyst Day in New York City on March 21st. Thanks a lot for your time.
Thank you for joining today's conference. This concludes the presentation, and you may now disconnect. Good day