Good afternoon, ladies and gentlemen, and welcome to the 4th Quarter and Fiscal Year 2012 Palo Alto Networks Incorporated Earnings Conference Call. My name is Chris, and I will be your conference moderator for today. We will facilitate a question and answer session. As a reminder, this conference is being recorded for replay purposes. And at this time, I would now like to turn the conference over to your presenter for today, Ms.
Maria Riley, Investor Relations with The Blueshirt Group. You may proceed.
Thank you. Good afternoon and thank you all for joining us on today's conference call to discuss Palo Alto Networks' fiscal 4th quarter 2012 Results. This call is also being broadcast live over the web and can be accessed on the Investors section of Palo Alto Networks' Web site at investors. Paloaltonetworks.com. With me on today's call are Mark McLaughlin, Palo Alto Networks' Chairman, President and CEO and Stefan Tomlinson, Chief Financial Officer.
After the market closed today, Palo Alto Networks issued a press is announcing the results for its fiscal Q4 year ended July 31, 2012. If you would like a copy of the release, you can access it online at the company's Web site or you can call The Blue Sugar Group at 415-217-7722 and we will e mail 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 our ability to sell additional products and services to existing customers our ability to extend our leadership position in next generation network security And increase our market share, trends in connection with the duration of service agreements, plans regarding our short and long term target operating model, including targets For gross margins, operating income, research and development, sales and marketing and general administrative expenses and our long term effective tax rate. Expectations regarding our growth rate relative to the growth rates in our other market and growth rates of other market participants our effective tax rate for fiscal 2013 and our revenue and non GAAP earnings per share for the first quarter of fiscal 2013 ending October 31, 2012.
These forward looking statements involve a number of risks and uncertainties, some of which are beyond our control, which could cause actual results to differ materially from those anticipated by these statements. These forward looking statements apply as of today and you should not rely on them as representing our views in the future and we undertake no obligation to update these statements after For a more detailed description of these risks and uncertainties, please refer to our final perspectives filed with the on July 20, 2012 as well as 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 And in our earnings press release.
Now I'd like to introduce Mark McLaughlin, Chairman, President and Chief Executive Sir, Palo Alto Networks. Mark?
Thank you, Maria, and thank you all for joining us for our first earnings conference call as a public company. I'm delighted to be here today to share with you Our fiscal Q4 fiscal 2012. Fiscal 2012 was a very exciting year for Palo Alto Networks. We significantly expanded our customer base. We're named a leader in enterprise firewalls by partner, released multiple new offerings to the market, continued to attract the world's Best and brightest in network security to our team, successfully completed our IPO and achieved impressive financial performance on both the top and bottom lines.
We also had a very successful fiscal 4th quarter, adding Mark Anderson as our new Head of Worldwide Field Operations, opening our new offices in Sao Paulo, Brazil and Mexico City, earning NSS Labs recommendation in their next generation firewall group tests, expanded our technology partner program with Avaya for data Center Solutions as well as with MobileIron and Zenprise for mobility solutions and achieving the ICSA certification We're very proud of all that we accomplished this past quarter and this past year and I'd like to thank all the team members at Palo Alto Networks for their hard work and results. I'll turn now to some highlights in our financial results. We had a strong fiscal 4th quarter and fiscal 2012. In our fiscal 4th quarter, we generated record revenue of approximately $76,000,000 which represents 88% year over year growth weighed 15% sequential growth and we delivered non GAAP EPS of $0.03 per diluted share. For fiscal 2012, we increased revenue by 100 and And in fiscal 2012, we generated approximately $18,000,000 in non GAAP operating income, which is a twenty $4,000,000 increase year over year.
Our technology differentiation continues to drive our customer growth. During the fiscal Q4, we added over 1,000 new end customers, bringing our customer count to over 9,000. This is the 3rd consecutive quarter in which we added over 1,000 customers. These new customers were across all verticals and geographies as we continue to focus on our land, expand and extend strategy to drive results For example, in the Q4, we replaced 2 of our major competitors with our PA5000 series to become the primary firewall for a major European utility. Additionally, we became the primary firewall for 1 of the leading U.
S. Universities replacing a different competitor also with our PA5000 series. And for this customer, we also provided them with our real time threat prevention and comprehensive URL filtering services. We also expanded our relationship with a Fortune 1 100 global We're based in the U. S.
At this customer, we won the primary perimeter firewall business 8 quarters ago. And this quarter, we expanded our presence to the data center as well as to multiple additional sites. And on the extend side, one of the leading consulting companies In the world bought us as a URL filtering solution about 5 quarters ago. And in the fiscal Q4, we expanded our presence as the customer deployed us as their global primary firewall, replacing one of the largest incumbent security firewall providers. These examples illustrate that the lifetime value of our customer base continues to grow and provide future opportunity.
These deepening relationships result in our customers deploying Palo Alto Networks as their strategic network security vendor and it's is a testament to our innovative and disruptive technology, which is transforming the enterprise network security space. Security is a Long term growth industry because of the ever increasing and rapidly changing threat environment, which is in part due to the surge in applications used across corporate networks from macro technology trends like mobility, SaaS, cloud computing and the consumerization of IT. While these trends and associated applications can drive productivity, they can also We increased the threat landscape for enterprises due to the legacy network security technology's inability to safely enable the use of those applications. Until the advent of Palo Alto Networks next generation of network security, companies were forced to either allow the use of these applications and suffer the security consequences Or block the applications and suffer the productivity consequences. By using our technology, customers are not forced to make that trade off.
And as Result, we are at the confluence of major technology trends that make our offerings timely, relevant, defensible and highly differentiated. This is unlike legacy stateful inspection firewall technology, which simply can't keep up with today's changing environment. We're also uniquely positioned with a platform that addresses all enterprise network security requirements. This allows us to address the entire enterprise network security market, which is over $10,000,000,000 Annually and growing. We believe that our competitive lead continues to grow with each new product introduction.
Palo Alto Networks has transformed network Security and customers all around the world have recognized the benefits of our solution to solve their pressing network security needs. As we look forward, we'll continue to be aggressive in maintaining our advantage increasing our market share and ensuring the highest levels of customer satisfaction. We operate in a very large market and I believe we can continue to capture market share with increasing leverage in the business over the next few years. And now I'd like to turn the call over to is on for a detailed look at our financial results. Stefan?
Thank you, Mark, and thank you all for joining us today. I'd like to mention that unless specifically noted otherwise, we're discussing all numbers except revenue on a non GAAP basis, which excludes share based compensation Expense and where relevant is related tax effects. In Q4 2012, total revenue grew to a record $55,600,000 an increase of 88% year over year and 15% sequentially. For fiscal 2012, we reported record revenue of 2 $255,100,000 a 115% increase over the prior year. In Q4 2012, Product revenue of $49,400,000 grew 70% year over year and approximately 14% sequentially, driven by sales of our series of appliances.
Services revenue of $26,200,000 increased 130 sequentially. Services revenue, which is comprised of both subscription and support, accounted for 34.6 percent of total and underscores the power of our hybrid revenue model as it provides enhanced visibility. The geographic mix of revenue was 66 percent Americas, 21% EMEA and 13% APAC with all theaters posting growth on a year over year and sequential basis. Total non GAAP gross margin in Q4 2012 was 71.9%, a 10 basis point decrease year over year and flat sequentially. A mix of higher margin appliances contributed to Q4 2012 non GAAP product gross margin reaching 74.8%, up 150 basis points year over year and up 120 basis points sequentially.
Our non GAAP services gross margin was 66 0.6% compared to 68.6% in the prior quarter and 68.4% in the same period a year ago, reflecting continued investment in our support organization. We'll continue to see fluctuations in both product and services gross margins due to product mix and investments we're making to support continued strong new customer acquisition.
Moving on
to operating expenses, we continue to invest In product development and expanding our sales and marketing organization. Q420 non GAAP research and development expense was 10,200,000 an increase of $1,200,000 from the prior quarter, primarily related to program spend and headcount additions. As a percentage of revenue, Non GAAP R and D expense was 13.5%, a decrease of 20 basis points sequentially. Q420 Non GAAP sales and marketing expense was $35,500,000 an increase of $6,200,000 from the prior quarter. And as As a percentage of revenue, it was 46.9%, an increase of 2 30 basis points sequentially, primarily due to headcount And related expenses as we expand our footprint as well as end of year accelerators.
Q420 Non GAAP G and A expense was $6,400,000 an increase of $1,200,000 from the prior quarter, primarily due to the increased cost of being public. As a percentage of revenue, it was 8.4%, an increase of 60 basis points sequentially. In total, Q4 2012 non GAAP operating expenses were $52,100,000 or 68.9 percent of revenue. Q42012 non GAAP operating margin was 3.1%, up 14.20 basis points year over year and as planned down 2 70 basis points sequentially. Given the Market opportunity and our traction, we intend to continue to invest in our sales and marketing support in R and D organizations, while also Demonstrating progress toward our target model.
For fiscal 2012, we reported total non GAAP operating expenses $7,500,000 or 65.7 percent of revenue and non GAAP operating margin of 7%. Our tax provision for the quarter was approximately $300,000 consisting of federal and state income taxes in the United States and and income taxes in foreign jurisdictions in which we conduct business. For fiscal 2012, our tax provision was approximately $2,100,000 and our non GAAP effective tax rate was 12.4%. In fiscal 2013, we expect a non GAAP effective tax rate of 34% to 39%, depending on our global pre tax profit mix and excluding any potential discrete items such as the removal of our domestic valuation allowance. In Q4 2012, we began the first steps of implementing our corporate international structure to more closely align with the international nature of our business activities, which we expect will improve our annual effective tax rate over the long term.
Non GAAP Net income for Q4 2012 was approximately $1,900,000 or 0 point shares. This compares to non GAAP net income of $4,700,000 or $0.07 per diluted share in fiscal Q3 2012 and non GAAP net loss of $5,100,000 or $0.34 per basic and diluted share in fiscal Q4 2011. For fiscal 2012, we reported non GAAP net income of $14,700,000 or $0.14 per diluted share, compared with a net loss of $7,800,000 or $0.55 per basic and diluted share in fiscal 2011. On a GAAP basis for Q4 2012, net loss was $4,600,000 or 0 point For fiscal 2012, we reported GAAP net income of $700,000 or 0 point 0 And diluted share. Now before I discuss our balance sheet, I'd like to review our target operating model that we expect to achieve in approximately 3 to 4 years.
On a non GAAP basis, we anticipate gross margin to be in the 70% to 73% range. As a percentage of revenue, we anticipate non GAAP R and D to be 13% to 15%, sales and marketing 30% to 33% and G and A 5% to 6%. We anticipate This will lead to a non GAAP operating income margin in the range of 22% to 25%. Turning to the balance sheet, we finished July with cash and cash equivalents of $323,000,000 which includes $215,000,000 in net proceeds from our initial public offering. In fiscal year 2012, cash flow from operations was $77,000,000 free cash flow was $63,000,000 and free cash flow margin was approximately 25%.
Cash flows benefit from our hybrid revenue model in In which we build for our services at the beginning of the engagement and we collect the cash shortly thereafter. We ended Q4 with $45,600,000 of accounts receivable, up from the Q3 'twelve balance of $38,800,000 Average day sales outstanding were hybrid revenue model helped increase total deferred revenue to $135,800,000 or an increase of 102% year over year and 16% sequentially. Short term deferred revenue of $86,300,000 increased 15% sequentially. The majority of our service engagements are on an annual basis, but we are seeing an uptick in multiyear deals. Let me now turn to our Q1 13 guidance.
We expect revenue to be in the range of $80,000,000 to $84,000,000 and non GAAP EPS to be approximately $0.03 per share using $80,000,000 to 82,000,000 shares on a diluted basis. Presents revenue growth of 40% to 47% when compared to a very strong comp in Q1 2012, which was up 42% sequentially due to the timing of certain large orders. On a bottom line basis, the change in share count and in taxes will impact EPS in the first quarter by About a penny a share when compared to the immediately preceding quarter. With that, I'll turn the call back over to Mark.
Thanks, Stefan. In summary, we had a very Strong quarter to close a very exciting year for Palo Alto Networks. Revenue grew significantly both on a quarter over quarter and year over year We continue to outpace the market. With that, Steph and I would be happy to take any questions you may have. So operator, I'll turn it over to you.
Thank you. Our first question comes from the line of Keith Weiss with Morgan Stanley. You may proceed.
Excellent. Very nice quarter guys and thank you for taking the question. When looking at the revenue by geo, it looks like Europe Slow down more so than the other geographies. Any sort of rising macro impact that you're seeing from that region? Or Any color you could give us on the apparent slowdown in Europe?
Hey, Keith, it's Mark. So big picture wise, when we look across the globe, the first thing we think about is the fact of what segment we serve, which is security, which is something that's becoming less Less of a discretionary spend and more important for folks to buy. So we think there's just general headwind or a general uplift Just because of the segment we serve. Now when you start to look on a geographic basis in EMEA, which is how we think about it, Europe is a subcomponent of that. We had good year over year And we had quarter over quarter sequential growth is modest, but we are growing there.
And also it's off a relatively small base The business when we think about Europe itself between Northern and Southern Europe, a lot of the problems we hear in Southern In Europe. So if we take all that into the mix, we think that Europe is still a growth sector for the business. We like the fact that it grew quarter over quarter. We like the fact that it grew And we think we can significantly outpace the market over there.
Got it. And then, the follow-up would be, if Understanding that the October quarter is a really difficult comp and kind of sort of the abnormal growth Much higher growth rate you saw in October 11 than you saw in the rest of the year. Can you give us some kind of idea of Sort of what we should be thinking about in terms of revenue growth for the full year or maybe give us an idea about seasonality and what would be a more Normal seasonality to expect off of that $80,000,000 to $84,000,000 guide that you gave us for Q1?
Yes, sure. So I'll take the first part and hand off to Steph from the second part. So just a big picture, we're not providing full year guidance. We're giving A quarter in advance on the guidance side. And if you think about the point that you raised, which is if you look at The last year, we like the fact that we think we've got healthy guides here in the range of 6% to 11%.
But you got to look back a year ago on a quarter where we had 42% quarter over quarter increase. That's probably the most difficult comp we're ever going to have on this. So we have to take that into Yes.
So as far as you look at the overall trajectory for the year, while we're not providing guidance For the full year, we expect to continue to grow market share and as evidenced by the number of new customers that we've added And we anticipate to continue to add new customers to the funnel. So we're not providing quarterly guidance, but By definition, it's market share gain and that's what we're looking at doing for the balance of the year.
Our next question comes from the line of Greg Madden with Goldman Sachs. You may proceed.
Yes. Thanks for taking my question. I guess the first Question I have switching gears, Mark Anderson obviously just joined and is leading the field operations today. How should that impact the business and what have you kind of learned thus far in him joining the team?
Yes. Hi, Greg. Thanks for joining us.
Well, a couple of things. First is that we can create a new organization with Mark coming on board, which was field Operations that we combined for the first time sales and customer support. And the reason we did that was really trying to get a holistic view of Customer plus just a great experience from the customer. We're selling something to them all the way through their continued support and that feeds Back into the sales cycle as well because of the expand and extend. If they're having a great experience with us, then they tend to buy more, they tend to buy more faster.
So The first thing is just Mark with his experience of being able to run the combined organization like that and having that viewpoint. The second thing with Mark's background from F5, he took that company as a head of sales from about $250,000,000 to well over $1,000,000,000 in sales Revenue, we have a very analogous sort of trajectory here at the company. So we want to make sure we have somebody who's been to that play before and all the indications in his In his first 90 days here of working with the team are that he's bringing a lot of that experience and discipline to the table.
I guess a follow-up would be there were 2 quick follow ups. You again added north of 9 excuse me, 1,000 customers. And my expectation would be that the momentum in the business within the installed base is continuing to pick up. How has the mix of business from new customers versus existing evolved? And how should we think about kind of new customer adds as we go or?
Yes, it's a great question. So we haven't broken out the business is coming from the new customers versus We expand customers, but basically there's a good balance between the 2. So the way we think about things is a lifetime value The customer, I think that's most important and we are trying to grow that through the land expand and extend. So the land is our funnel. We expand and extend And that grows the lifetime value to customer.
Both of those are doing very well for us. It's our 3rd quarter in a row where we've added over 1,000 customers in the quarter. So that's The land aspect to it. And then when you look at the LTV aspect, which is the expand and extend, we're on the road. We said that on average, the customer Per basis purchases 3 times their initial purchase.
The top 25 purchases 8 times their initial purchase. Well, those numbers continue to grow for us. So the model is working on
Our next question comes from the line of Joe Fishman with Lassner. You may proceed.
Hey, good quarter guys. Thanks for taking my question. First, on the support side of the organization, you guys scaled massively bringing on new customers. Can you talk about what you guys are doing to scale the support operation to handle the service levels for Your customers?
It's a great question, Joel. When we think about our customer support organization, we have The first customer principle, which makes very clear to us that we are giving the best level of customer service we can. We've added over 3,000 customers in the last 9 months. The types of investments we're making are in the area of personnel, of systems And for also Global Depots, which are being deployed in order to provide real time exchanges of product when necessary and making sure that we are as close to the customers we can be. We pride ourselves On differentiating our customer support versus the competition.
Great. And just as a follow-up, In terms of lead times, how have the lead times changed over the past call it couple of quarters to the customers that would be great?
Lead times have been stable. We have a standard call it 2 week lead Once we receive an order and that's been stable.
Okay.
Thanks, Joe.
Our next question comes from the line of Walter Pritchard with Citi. You may proceed.
Hey, couple of questions. Stefan, on revenue and So the billings calculation, it looks like your deferred sort of all year has grown faster than it did a year ago on an absolute basis. And in the Q4, it looks like it was sort of even to actually a little bit less growth than you saw a year ago. Wondering and that results in billings, it looked like it Slowed from over 100% or around 100% each in the first three to around 56% or 57%. I'm just wondering how should we think about the trend?
What's driving that trend? And how should we think about that trend going forward?
I think it's most important to note that we are primarily a book and ship business. We have a component of our revenues that are SaaS based, which is our subscription revenue, which provides enhanced visibility and which is why you saw Services as a percentage of total revenue increased to 34.6%. When you think about trending deferred revenue given The subscription element should be increasing because that's it's booked upfront, but it's recognized ratably. We have customer support and maintenance that gets booked upfront and Yes, ratably. The billings metric is not a metric that we actually track internally.
It's something that you Use the industry standard convention around current quarter revenue, plus change in deferred. You get to about $95,000,000 in bookings in billings, I should say, that's something that it's just kind of an is an output of math. It's not something that we track internally, but we do see that Deferred revenue should be increasing and billings will be whatever the billings are.
And then just on the product line, any update? I know the PA200 has been out now for 2 or 3 quarters. Any update on how that product is doing? And any thoughts of Actually introducing a product that's below that in terms of price point?
Yes, it's selling very well Walter. We came out with Very high and very low and both of those are doing nicely. You can see in our product gross margins, the impact of the higher end product sales, product margins doing very nicely. And when we think About serving the enterprise, you always think about all the way from the big data centers all the way down to the branch office. The 200s filled a very nice market Need for us there and we think about whether to bring out something lower than that and we'll take that into consideration based on the customer input.
Okay. Thank you. Thanks, Flor. Thank you.
The next question comes from the line of Phil Winslow with Credit Suisse. You may proceed.
Hi. Thanks, guys. Just wanted to get a sense for what you're seeing in terms of just average deal size right now? And then also in terms of just the maintenance and then also The subscription just attached to renewal rates, just curious what trends we're seeing there as well? Thanks.
Yes. So on an average deal size Basis, so we like we said earlier, we tend to look at lifetime value is more important to that. But so we just use rough and ready math from a deal size perspective. It took just all the total revenue in the company since its inception is about $440,000,000 and 9,000 customers. You can kind The average deal size, we don't think that tells us a heck of a lot because some of our very largest customers started off with very small purchases and have grown into multi Our customers, so but that's a way to look at it and that increases over time or has been increasing over time.
And then on the attach rate, Yes, we're we break that into 2 categories for us, so services for us are the subscription services and also the maintenance services. The maintenance services are close to 100% as you can imagine on that and the attach rates for the subscription services will depend on the use case And then this how long the service has been out. So the 2 services, the highest patch rate are Threat Prevention and URL They've been out the longest and very defined use cases. And usually when we sell a product, we're getting 1 to to attaches the services to it.
Great. Thanks guys. Congrats.
Thank you. Our next question comes from the line of Jeff Kvaal with Barclays. You may proceed.
Thanks, Mark, Stefan. I was wondering, would you mind telling us a little bit more about what happened in the quarter last year at this time that drove the sequential increase? That might help us sort of if we could think about what maybe a more normalized quarter last year would be. That way we could think more about what seasonality might be through the balance of the year?
Certainly. In Q1 of last year, on a sequential basis, revenues grew 17,000,000 Dollars were 42% quarter on quarter. And that was due in large part to timing of some certain large orders and contribution from the Federal government business. The growth rate was very steep, obviously 42% sequentially and that I've said a new baseline for the company from which to grow. This quarter, we factored in a number of things In terms of calculating what we think is an appropriate level from a revenue range from a guidance standpoint.
And we factored a number of things into that calculation and we feel comfortable that a 6% to 11% sequential increase or 40% to 47% year Year over year increase will continue to establish us as the clear market share gainer as we look at taking more market share From the competition.
Would it be too much Stefan to read into your statements that after we get through this quarter that the year over year growth rates would go up again and say the January quarter?
That's a Good question. We're not providing guidance more than 1 quarter out. But as I said in an earlier statement, our goal is to continue to take market share. And If you look at both the product and services growth rates, when you compare Palo Alto Networks to The competitive landscape, we're growing much faster than the competition on both on quarter over quarter and year over year basis.
Okay. Would you consider breaking out the services and software revenue from your services all in bucket line item?
Not at this point.
For the subscription, I mean, yes.
Yes, not at this point. We as a reminder, our services line is comprised of subscriptions and maintenance And they're both ratable in nature and we're not breaking them out.
Okay. And then finally, could you talk about What you've seen in the competitive landscape, I think Cisco has perhaps just recently launched the next generation firewall. Have you seen that in the market yet?
No, we haven't, Jeff. So I think the thing I'm most familiar with Cisco announced is probably what you're talking The last RSA conference last year, which was a blade sort of a blade concept to enable some application blocking. We don't consider That next generation firewall technology because it can't safely enable applications, but that's all we've seen.
Okay. So as far as you're concerned, everything is steady. I think Cisco has a new ASA CX box out there, but we'll take it offline. Okay. Thank you.
Thank you, Jeff.
Our next question comes from the line of Brent Thill with UBS. You may proceed.
Thanks. Mark, you've had strong momentum in the government businesses. Just curious if you could give us all an update from what you're seeing, especially as we go into obviously an important time in the U. S. And what you're seeing globally and had one quick follow-up for Stephane.
Yes, sure. So the government public sector and particularly the federal government on the DoD side of things has been a strong vertical No vertical at all represents more than about 13% of our overall business. So we're spread out pretty nicely. But that's been a good 1 in a growing one for us. If you think about what we do for a living and what they do for a living, it seems like a great combination.
And we see that in our results.
Okay. And Stefan, you mentioned uptick in multiyear deals. Can you just give us a sense of you're seeing in what percent of those deals are now going into the multiyear bucket?
Well, that's a great question. Still the vast Majority is still annual, but the guidance or the color commentary that we gave in the prepared remarks was we are seeing Multi year deals being typically 3 year deals and at times while it's on the margin 5 year deals that may come Into the mix, but you can look at the short term deferred revenue and that's still a it's a good proxy for kind of the The split between short and long term. So we're seeing while we're seeing an uptick, the majority is still annual.
Our next question comes from the line of Michael Turits with Raymond James. You may proceed.
Hey guys. A Little bit more on the competitive side. You mentioned about Cisco, but other major competitors whether they include Juniper or Checkpoint. Any change in the competitive dynamic? Any catching up that either of those competitors could possibly be doing that would make it any tough for you to close placements?
Hey Michael, it's Mark. No, we just haven't seen that in the market. I know there's a lot of stepped up marketing going on, but it's from a technology perspective, we haven't seen any new releases or reductions by anybody that indicates you're closing the gap. And I think you can From the number of new customers you're adding I think the market agreed with that.
Okay. And then just sort of housekeeping. Can you tell us where your ending headcount was? And A little bit about where you might think you'd be growing headcount in the next year and also what to expect in terms of CapEx for the next year?
Certainly. On the headcount front, we ended at 755 headcount and that came off Of the prior quarter at 6.90. Where we're going to be making investments is really Kind of tracking to innovation, which is product development, our go to market organization in our field operations. We're going to be adding sales and marketing professionals and then also in product management. There will be other growth across other parts of the organization as well, But those are the primary ones.
And as far as CapEx is concerned, For the quarter, we spent approximately 2.1 Got you right here. About $3,200,000 $3,200,000 $3,300,000 in CapEx for Q4 2012. Yes. That's kind of a I would call that normal baseline that you could look at from a modeling standpoint
And if I could just have a follow-up on that. That headcount is a slower sequential add than you've had previously. Should that be the new expectation for baseline for sequential headcount add? Or was it slower this quarter for some reason?
No. Look, We were adding about 75 to 100 per quarter. I think the distinction here is that that's actual FTE You have to take the pots and chairs plus folks who accepted offers haven't yet started. So we're using the actual number of shares as Stefan's number. If we take the offers Except the derivative of higher, but if he's like 75 to 100 a quarter, you're going to be in the right ballpark.
Great. Thanks a lot.
Thank you.
Thank you.
The next question comes from the line of Jason Nolan with Robert Baird. You may proceed.
Great. Thank you. And Stefan just to clarify, You're expecting a normal federal flush for
And a number of things. So as you would expect, federal government should be strong for us in fiscal Q1.
And any surprises by vertical on the quarter just completed?
Really no surprises. Again, we remain very horizontally distributed. There's no concentration From a vertical standpoint. So we felt very good about the balanced nature of the revenues.
And anything you guys can say about managed security service provider market MSSP now or in the future as an opportunity? Yes.
It's a good opportunity for us, Jason. We're actually been working quite well for quite some time with all the leading providers there. So the way we view that is those folks are going to manage network Work infrastructures for companies who want to make sure that they can manage Palo Alto on the customer's behalf. And I think if you go through the list of all the major Providers out there, we're working with all of them right now.
Okay. Thank you.
Our next question comes from the line of Jonathan Ho of William Blair. You may proceed.
Good afternoon. Starting off, can you characterize for us maybe how you think about the pipeline of opportunities this quarter and maybe what levers could potentially drive upside or some risk to the quarter as you look at the pipeline?
Yes. Hey, Jonathan, it's Mark. So from a pipeline perspective, maybe not surprisingly we look at that as we've got our targets in mind about What we think we're going to sell for the quarter, we've got a pipeline coverage ratio that's something X times bigger than that. And that has been working very consistently for The company for a number of years about what those numbers actually equate to from a sales perspective. It It's possible for us if we put more marketing dollars at work.
We found that we can drive a bigger pipeline. The problem with that is just the ability to actually high quality manner, we'll close the deals. So we don't want to be we certainly don't want to be under on the pipeline coverage and we don't want to be over in a pipeline coverage because that tends to be wasted money in the quarter. So we think we've got a pretty good fine tuned model here to get the coverage.
Got it. And just relative to prior quarters, Some of our discussions have suggested that more and more folks are viewing you as not just an application control blade or application control box, But also looking at this as an edge of network firewall displacement. Can you maybe characterize for us whether there's been a shift towards more people buying this as a firewall What that general trend looks like?
Yes, that's a great question. We know that over half of our installations Right now we're the primary firewall and we also know and we track this fairly closely in salesforce.coms in the field that more than half of our sales right now are sold as So we know that's happening out in the market and has been happening for quite some time. On the flip side is when we're Not that, if you think of the times we were not that, that's not bad either because we're the only provider in the market who can go in as whatever the need is for enterprise network security, Whether it's IPS or Web Gateway, it doesn't really matter. And historically, we've shown that sort of no matter how you get in the door, We ultimately get the chance and that's a high degree of the time become the firewall. And we're very patient on that and our experience shows it's working.
Great. Thank you. Thanks, Jonathan.
Our next question comes from the line of Shelby Sarafic with and Securities. You may proceed.
So your sales and marketing percentage of revenues, it has been increasing the last several quarters. Can Can you give us an idea of where you expect that to go longer term? I mean it's a little actually over the next year or so. You have a long term target 30%, 33%, but right now it's at 47%. You're investing for growth.
You want to gain share against the competition. Just give Give us a handle on where you see sales and marketing percent for example over the next few quarters.
I'll take that one. So this is Stefan. It's a good Question, we've kind of given you 2 effectively bookends, where we are today in our target model of 30% to 33%. What you're asking for is the equivalent of us guiding for the next couple of quarters and we're not going to be providing guidance on that. But if you were to look at, I would say, a normal trend where we get to the 30% to 33% over a multiyear period, there's There'll be some fluctuations in the next call it 12 to 18 months, but directionally that is the Key line in our operating expenses that will be providing the most leverage in our business.
We're going to be getting there through Increased sales productivity. The fact that we have close to 800 channel partners who will be becoming more productive We have new product introductions coming out, our market share goals, etcetera. The fact that we're growing faster than the market right now, we feel comfortable with sales and marketing being at these levels. But we will be With sales and marketing being at these levels, but we will be disciplined in the sense of how we are dividing territories, how we're Growing the sales organization, etcetera. So the directional trend will be down, but there will be some Fluctuations in the near
term. Okay. And also your product gross margin conversely has been increasing last several quarters and now it's almost 75%. You've mentioned before that part of this is due to the mix shift to higher end boxes. Do you expect that trend to continue going forward?
Should we think perhaps around 70 5% is the baseline for your product gross margin?
Product gross margins were strong this quarter. We were very excited about It's a little too soon to make a judgment call around if this is establishing a new bubble for the near term. There will always be product mix Depending on our customers' needs. What we talked about during our IPO roadshow was a couple Of course, we introduced our PA200 series of appliance, which is for the branch office. We're going to be coming out with new products as well over the year.
So there'll be product mix shifts. I'll also tell you though that in the face of pretty strong competition, we have not had to go down Discounting route either. So the product gross margins are a good indication that we are Competing on technological value and differentiation.
Okay. Thank you.
Thanks, Shelby.
Our next question comes from the line of Tagliani with Bank of America. You may proceed.
Hi, guys. Can you hear me?
Yes, we can.
Hi. Two questions. You mentioned you have 800 channel partners. From your numbers, it looks like you've been growing This number substantially, can you just discuss how much was it? How many channel partners you had a year ago?
And how do you manage the channel And things that come with the increase in channel partners. So let's start with that and then I have one more question.
Yes. So we have a bit over 800 channel Right now, we've added close to 200 in the last 18 to 24 months call it. And you could expect us to continue to grow at that rate. It's actually not a lot relative to the world. And then if you look at some of the competitors, we have a real quality versus quantity view around this.
So We want our channel partners to not only sell our products, but provide some value added services on their own as well. So we're fairly selective who those Sorry, and then we hold them to a very high standard, as far as their programs that we're running with them and they're performing well. I think They're making good money with us. From a channel conflict perspective, the best way we do that is we have really rigorous deal registration program. So we're very careful about somebody Who comes in, which deals, who's and then we protect the partner downstream as well, meaning that it's not just the initial sale, but it's for Follow on sales as well.
So if you're working with to get a chance to make good money for a long term basis with the customer. That's why when I say the quantity, quality thing is important. We want to make We're working with people who are going to be around for a while, have a good base of training and understanding of our technology Thank you for getting really good high customer satisfaction scores.
And you mentioned that you have a target expense ratio for sales and marketing of 30% to 33% long term. What kind of revenues you need to have in order to get to this ratio?
Tal, this is Stefan, how we are looking at that is more time based as opposed to revenue based. And what we've told folks is 3 to 4 years From today, we should be able to achieve those targets. So when you do your modeling, you should take that into consideration.
But are you going to They're through cutting the cost or you're going to get there through revenues. So the question is what should we assume that the run rate needs to be in order to get there because I assume you're only going to increase the number of channel partners, you're not going to reduce them?
Well, Tal, It's a combination, but obviously we're going to be growing revenues over the years and we are about a 3% market share player right now. The Market is $10,000,000,000 plus and growing and our desire is to continue to gain market share. So by definition, our top line revenue will grow. Our expenses in terms of absolute dollars will grow, but in terms of percentage of revenue, we'll get leverage from revenue growth and disciplined
Thank you.
Our next question comes from the line of Rob Owens with Pacific Crest Securities. You may proceed.
Great. Thanks and good afternoon guys. Could you talk about linearity in the quarter? I think DSO is at 60 days if I remember correctly. Do you typically see better linearity given the fiscal year shifted 1 month?
And how did the July quarter shape up?
Well, so this is Stefan. DSOs were 50 days At the lower end of our target range of 50 to 55. They did increase sequentially, but they were also down year over year. Linearity in Quarter, we didn't see anything abnormal. Q4 tends to have from a just an orders standpoint, but Yes, half the business comes in the last month of the quarter.
That's very typical with companies in our So we didn't see anything really different in terms of linearity.
Great. And then second relative to your deferred revenue, is Is there any deferred product revenue in there? And can you quantify it?
There is very little Product deferred revenue. We're not bifurcating it between product and services, but the vast majority This is services.
Under 10%.
Product revenue product deferred revenue is under 10%.
Great. Thank you.
You're welcome.
And we have no further questions at this time. I would now like turn the call back over to Mr. Mark McLaughlin for any closing remarks.
Great. Thanks a lot. We thank you for being on the call with us today. I want to reiterate My appreciation for all the hard work of the Palo Alto team and support of our customers and partners as we continue to revolutionize the IT security market and we look
Have a great day.