Good day, and welcome Call. Today's conference is being recorded. At this time, I would like to turn the conference over to Ms. Kelsey Turcotte, Vice President of Investor Relations. Please go ahead, ma'am.
Good afternoon, and thank you for joining us on today's conference call to discuss Palo Alto Networks' fiscal second quarter 2018 financial results. This call is being broadcast live over the web and can be accessed on the Investors section of our website at investors. Paloaltonetworks.com. With me on today's call are Mark McLaughlin, our Chairman and Chief Executive Officer Kathy Banano, our Chief Financial Officer and Mark Anderson, our President. This afternoon, we issued a press release announcing our results for the fiscal second quarter ended January 31, 2018.
You would like a copy of the release, you can access it online on our website. We'd like to remind you that during the course of this conference call, management will make forward looking statements, including statements regarding our financial guidance and modeling points for the fiscal third quarter full fiscal year 2018, our competitive position and the demand and market opportunity for our products and subscriptions benefits and timing of new products and subscription offerings, our ability to drive outside growth rates, expectations regarding the impact of the U S Tax Cuts and Jobs Act, and trends in certain financial results, operating metrics, mix shift, and seasonality. 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 would undertake no obligation to update these statements after this call.
For a more detailed description of factors that could cause actual results to differ, please refer to our quarterly report on Form 10 Q filed with the SEC on November 21, 2017 and our earnings release posted a few minutes ago on our website and filed with the SEC on Form 8 K. 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. For historical periods, we have provided reconciliations of these non GAAP financial measures to GAAP financial measures in the supplemental financial information that can be found in the Investors section of our website located at investors. Paloaltonetworks.com. We would also like to for you that we will be participating in the Morgan Stanley Technology, Media And Telecom Conference in San Francisco on Thursday, March 1st.
And the Raymond James, 39th Annual Institutional Investors Conference in Orlando on Tuesday, March 6. And finally, once we have completed our formal remarks, we will be posting them to our Investor Relations website under Quarterly Results. And with that, I'll turn the call over to Mark.
Thank you, Kelsey. Thank you everyone for joining us this afternoon for our fiscal second quarter 2018 results. I'm pleased to report that we delivered a strong second quarter. On a year over year basis, Q2 revenue was $542,000,000, up 28%. Billings were $675,000,000, up 20% Non GAAP operating margin was 20.5 percent and non GAAP earnings per share was 0.97 dollars.
In the quarter, we continued to see healthy security spending and strong demand for our next generation security platform. With the addition of close to 3000 new customers in the quarter, we are privileged to now serve approximately 48,000 customers around the world. In addition to robust new customer acquisition, we also continue to rapidly increase our wallet share Our top 25 customers, all of which made a purchase in this quarter, spent a minimum of $25,600,000 in lifetime value in Q2. A 54% increase over the $16,600,000 in Q2 of fiscal 2017. Specific examples of customer wins and competitive displacements in the quarter included a Cisco replacement to secure the global network of 1 of Europe's largest manufacturing companies with more than 150 branch offices and factories, a legacy AV replacement and competitive win against multiple stand alone next gen endpoint providers in a U.
S.-based hospital system on tens of thousands of endpoints, a checkpoint replacement to secure 2000 gas stations with our VM Series in a deal a global oil company, a 7 figure on premise deal with a global retailer that started with us as an Amazon marketplace customer, and an expansion deal with 1 of the world's largest insurance companies to implement GlobalProtect cloud service to secure 100 of branch offices and tens of thousands of mobile users. We continue to see customers adopt and expand the uses of our platform at rapid rates. The world is undergoing a digital transformation that is driving massive productivity gains. However, this digital transformation is also creating significant cyber risk that requires a corresponding security transformation. At Palo Alto Networks, we've been consistently delivering on the transformation of security through increasingly rapid technical evolutions to build on each other, reinforce each other, share the attributes of automation, leverage, consistency and ease of use and get more powerful and valuable due to ecosystem growth.
A decade ago, we introduced the first evolution in security with the creation of the next generation firewall and cloud delivered network security services designed to improve security outcomes through integration and automation. And we continue to innovate on the foundational element the first evolution. Most recently with last week's announcement of PANOS 8.1, the PA 3200 series with 3 models the PA-five thousand two hundred and eighty, the ruggedized PA 220R and 2 new models of M Series management appliances. Our new heat.1 software It adds over 60 new features to our next generation firewall, including more granular control SaaS applications, expanded SSL decryption capability making it easier to secure encrypted traffic, many features to simplify the adoption of security best practices and much more In addition, the new hardware appliances increase SSL decryption throughput bring higher performance and capacity for securing large data center and provide additional stability for managing large viral deployments. We're very excited by these recent announcements that complement the hardware and software we introduced last year and further expand our technology leadership.
In building on the first evolution, 5 years ago, we drove the second evolution, which is extending the capabilities of our platform to consistently secure customer's data no matter where it resides from the network to the endpoint and throughout the cloud and SaaS applications. In Q2, we continued to innovate in 2nd Evolution. We enhanced our partnership with AWS, where we are now the only security vendor to achieve AWS networking competency status, which recognizes that we provide proven technology and deep expertise in helping customers adopt develop and deploy networks in AWS. This complements the AWS and security competency we achieved in 2016. And just a few weeks ago, we hosted a global cloud security event for over 15,000 attendees.
We announced additional second evolution advancements, including Traps for Linux, provided insights into how customers can accelerate the move to the cloud, featured our cloud partnerships and announced new cloud capabilities. These include enhanced features for Azure and AWS environments, simplified and centralized management for all major cloud platforms, automated integrations for frictionless workflows in multi cloud environments and extending protection to the Google cloud platform The announcements were very well received by our customers and further establish our leadership position in Endpoint And Cloud Security. These first two evolutions are the building blocks required to make the 3rd evolution in security, the application framework a reality. Customer reaction has been very enthusiastic as they see the superior security and the agility that can be achieved by using innovative security applications that leverage the data from their existing Palo Alto Network platform deployments and provide increasing value from their investments with Palo Alto Networks. We will develop some of these applications ourselves, while others will be built by third parties.
Earlier this month, we introduced our newest application, magnifier, in the application framework, tightly integrated with our next generation security platform and our logging service, this cloud based behavioral analytics application, which we acquired in Lightcyber, enables highly accurate attack detection powered by scalable cloud based machine learning. We're very excited about the application framework and look forward to the availability of the framework's third party applications in the coming months. These evolutions have resulted in a large and quickly growing global ecosystem of customers leveraging the automation orchestration, consistency and ease of use achieved through our platform. Of our approximately 48,000 customers globally, Approximately 42,000 are using threat prevention, approximately 35,000 are using URL filtering, approximately 23,000 are using wildfire, and approximately 7000 are using GlobalProtect. And our endpoint and cloud offerings are also experiencing significant growth and adoption.
More than 2200 customers using Traps with over 3,000,000 endpoints under protection, while approximately 5000 customers are using our cloud offerings, including over a dozen who have already adopted our new GlobalProtect cloud service, which delivers our next generation security capabilities in the cloud. Endpoint and cloud together with our application framework offerings of quarter focus, magnifier and logging service are growing very quickly with the Q2 billings exit run rate of approximately $240,000,000, growing over 85% year over year. And we're very excited about the future of these offerings. With digital transformation, the threat landscape will constantly evolve, which is why security transformation is critical. Will continue to focus on delivering technology evolutions that push the boundaries of today's capabilities and lead the way to the security paradigm of the future.
I want to thank our employees for their relentless dedication to our customers, our partners for their continued support and our customers for placing their trust in Palo Alto Networks. And with that, I'll turn the call over to Kathy.
Thanks, Mark. Before I start, I'd like to note that except for revenue and billings figures, All financial figures are non GAAP and growth rates are compared to the prior year periods unless stated otherwise. I'm very pleased with We're seeing a high degree of us growing expanded non GAAP operating margins, delivered record non GAAP EPS and generated strong cash flow. In Q2, total revenue grew 28 percent to a record $542,400,000, Looking at the geographic growth of and APAC grew 33%. Q2 product revenue of $202,200,000 grew 20% compared to the prior year.
Sales of the new hardware, which we launched in fiscal Q3 2017, continued to perform well with both new and existing customers. Q2 SaaS based subscription revenue of $183,300,000 increased 36%. Support revenue of $156,900,000 increased 31%. In total, subscription and support revenue of $340,200,000 increased 34 percent and accounted for a 63% share of total revenue. Turning to billings, Q2 total billings of $674,600,000 increased 20%.
The dollar weighted contract duration for new subscription and support billings in the quarter was approximately 3 years, essentially flat compared to the prior year period. For the first half of Product billings were $387,200,000, up 16% and accounted for 30% of total billings. Subscription billings were 492.6 $3,000,000, up 12%. Renewal rates for a SaaS subscription business are strong at more than 90% while renewal rates for support are approximately 100%. Total deferred revenue at the end of Q2 was $2,000,000,000 and increased 33%.
Q2 gross margin was 75.9%, which was down 270 basis points compared to last year. The decline was primarily attributable to the very strong traction we continue to see with the new products introduced in the third quarter or 55.4 percent of revenue, which is a 350 basis point improvement year over year, driven primarily by ongoing increasing leverage in sales and marketing. Operating margin was We ended the second quarter with 4833 employees. Non GAAP net income for the second quarter grew 50 4% to $91,500,000 or $0.97 per diluted share. Excluding the impact of the Tax Cuts and Jobs Act, 2nd quarter non GAAP net income and non GAAP earnings per diluted share were respectively.
The Act lowered our Q2 non GAAP effective tax rate to 22% from the previously guided rate of 31%. On a GAAP basis for or $0.38 per basic and diluted share. Turning to cash flows and balance sheet items. We finished January with cash cash equivalents, 3000 shares of common stock at an average price of approximately $145 per share. Leaving a balance of approximately $330,000,000 available for ongoing repurchases through December 2018.
Turning to cash flow, Q2 cash flow from operations of $243,700,000 increased 14%. Capital expenditures in the quarter were $25,600,000. Free cash flow was $218,100,000 up 29% at a margin of 40.2%. DSO was 59 days, a decline of 19 days forward looking information that Kelsey referred to earlier. Our fiscal third quarter fiscal year 2018 guide includes the company's updated non 22% is a reduction from our previously guided non GAAP effective tax rate of 31%.
For fiscal Q3 2018, we expect revenue to be in the range of $538,000,000 to $548,000,000, an increase of 25 percent to 27 percent year over year. Product revenue to be in the range of $193,000,000 to $196,000,000, an increase of 18% to 19% year over year. Billings to be in the range of $665,000,000 to $680,000,000 an increase of 22 percent to 25 percent year over year. Using the updated non GAAP effective tax rate of 22 percent, We expect non GAAP EPS to be in to 96,500,000 shares. This EPS range includes a benefit of approximately due to the new non to be approximately $25,000,000.
And now expect revenue to be in the range of $2,190,000,000 to $2,220,000,000, representing growth of 24% to 26% year over year. Product revenue to be in the range of 810 to $820,000,000, representing growth of 14% to 16% year over year. Billings to be in the range of 2.715 $1,000,000,000 to $2,770,000,000, representing growth of 18% to 21% year over year. We also expect a full which includes fiscal Q1 at the prior 22%. Using this updated tax rate, we expect non GAAP EPS to be in the range of $3.84 to $3.91 using $94,000,000 to 96,000,000 shares.
This EPS guidance includes a benefit of approximately $3.6 from our new full year non GAAP tax rate. And we continue to expect capital expenditures to be approximately $100,000,000. Before I conclude, I'd like to provide some additional modeling points for the fiscal year We continue to expect fiscal Q2 and fiscal Q4 to have the strongest sequential total revenue As reflected in consensus heading into this call, our non GAAP EPS guidance continues to include approximately 150 basis points of organic operating margin expansion, excluding first half investments associated with the Lifestyle acquisition. Our fiscal Q4 non GAAP effective tax rate will be 22% and we expect fiscal year free cash for questions, I'm happy to announce that Jean Campo, formerly Senior Vice President Accounting And Corporate Controller, has been appointed Chief Accounting Officer with ongoing responsibility for accounting and tax functions. Jean, who joined us in 2012, has 20 years business experience, having held senior accounting or corporate controller positions at various technology companies.
Congratulations, Jean. Operator, please
questions. And we'll take our first question from Andrew Nowinski with Piper Jaffray.
All right, great. Thanks for a nice quarter and thanks for taking the question. I guess I want to ask about panel essay.1, you talked about some of the new SSL encryption capabilities in that platform. Are your customers seeing an increase in traffic coming into the data centers? And are the new features that address this problem a free upgrade for customers?
Or could that potentially drive a refresh cycle?
Yes, it's Mark. Good question. Yeah, we're seeing across the board an increase in encrypted traffic. That's been the case for quite some time actually. It's not uncommon for us to see in a customer environment north of 35%, 40% of all traffic being encrypted these days, which is simply because the bad guys know that the legacy technology is not going to be to be able to decrypt it or if it can, it can't do it fast enough to have traffic continue to be in essence the real time aspect it has to be.
So we've been continuously trying to improve the capabilities there. Every release we've done is improved the SSL decryption throughput. The release of the new hardware has about 20 times your performance, which is fantastic. And the 8.1 software also has capabilities in it as well to help with throughput and performance. As you know, I think for our operating system, we don't charge extra for that.
So features and functionality that go into the software just make us better and better and better over time. So we hopefully will continue to be sticky. And then the last one of the question as far as upgrades and refresh capabilities. Yeah, anything that has an opportunity for us to speak with customers about new use cases is a great opportunity as well for refresh and upgrade and expansion.
Okay. Thanks. And then maybe just as a quick follow-up, I see you launched vanilla service as part of the application framework. Can you just give us an update on the progress that third parties have made regarding the development of applications that could start to contribute revenue to your framework?
Yes, sure. And just briefly, the one we launched is called Magna Fire that came through us through the Light Cyber acquisition last year. So we're super happy to see that go live. It basically light cyber has a fantastic behavior analytics capability. It formally would be something that you would have to.
Plugin is another piece hardware is somewhere in your environment. So we've taken the algorithm out and made it the application. So it's a SaaS application and the application framework. And that's theory behind application framework in a lot of cases. 3rd party wise, we're working about 30 companies right now to get their applications live and we expect that to happen in in the coming months here.
We're excited about that. And, stay tuned as we progress through the spring to hear more about
Our next question will go to Michael Turits with Raymond James. Hey guys,
really strong quarter and again, a really strong quarter on product. Last quarter, you talked about some of the things that really drove, hardware and you drill down a little bit on that this quarter and especially the extent to which that some of that may be coming from a product refresh cycle?
Yes, Michael. Yes, we had a good quarter across the board on the entire platform. So really, really pleased to see the market coming to the platform for all three of the evolutions. We have driven and obviously product is performing very well indeed. So we're super happy to see that.
As we said coming into the year that on the refresh side, that's a net positive for the company. We expect that to continue to be the case, but it wouldn't be the primary driver for hardware in the year. That is still the case. So we're seeing the over performance being driven from new customer acquisition. You can see it's really high in expansion as well.
Refresh is going very well by the way, but that's still not the major driver for the business. So we think that that's something that is in front of us, which will be great.
Okay. Let's follow-up and maybe just more drill down. I think the service provider was really strong, high end chassis were strong last quarter. Did that continue? And was that a material part of the upside this time?
Our service provider business is doing very well for us. Last quarter, we had said on the the hardware side, we had seen some over performance on hardware dollars associated specifically with what's called NDC cards. So those are slot cards put into the chassis and we saw more than usual. This quarter was nothing unique in that regard. So back to kind of normal run rates we see along that So that's what we've talked about last quarter for some of the hardware over performance, but the service provider business in general is doing well for us and continue to grow.
Expect that to keep going. As we said every time we do a release, whether it's hardware or software, we've been adding more features and functionalities to make us continually more attractive for service providers.
We'll take our next question from Matt Hedford with RBC Capital Markets.
Hey guys, thanks for taking my questions and congrats from me as well. Maybe for Mark, the product refresh, it seems to be moving nicely. And clearly, you called out growth in SaaS and some of the emerging products that was strong there. I'm curious if you could drill down a little bit on pricing, both within more firewall, but also some of the newer products that are seeing quite a bit of growth?
Yes, that's a great question, Matt. We are absolutely selling the value proposition of the entire platform, which has all the 3 evolutions put into automation orchestration and consistency and now an entirely new consumption model with the application framework. And I mentioned that because that allows us from a pricing perspective to be on the one hand very competitive, but also on the other hand, to be able to not have to sell to price many, many of our competitors continue to do. So is this example in this quarter that we saw discounting improve again sequentially and year over year, we've seen for a number of quarters now, which is fantastic. Our team, I think, has done a great job of selling to value and selling to the strategic nature of the platform.
That's great. And then I'm not sure if Mark Anderson's on the call, but EMEA looked like it was particularly strong this quarter. A lot of us have been talking about GDPR as a potential driver this year. I'm curious, is that showing up as just dialogue at this point or is it actually driving real deals as far as you can Yes.
Hi, Matt. GDPR, I think, or any other phenomena that drives awareness for companies to build better security defenses is a good thing for us because it allows us to get in front of people to have budget and show how differentiated we are from our competitors. So I think we've got a good talk track around GPR and more importantly, it's backed up with supremely better security. In terms of attaching it to deals, I think we've been, I think, considered in Europe, the thought leader for security for a couple of years now. And I think more than anything else, just the awareness that customers have about what we can do for them has ramped as we built out a very nice team and great partner coverage there.
We'll go now to Greg Moskowitz with Cowen and Company.
Okay. Thank you very much. And I'll let my congratulations as well. Mark, more recently you've seen you effectively widen the gap growth rate of 50 years. And I'm wondering if you're seeing any changes in the competitive landscape or in your view, is this just a function of having fixed your go to market issues?
For the year again?
Yes, Greg, you're kind of broken up there. I think the question was, competitive differentiation. Is that summary? It was tough to
hear you. That's exactly right, Mark. Just a question of the widening gaps that we've seen on growth versus your peers.
Thanks. Yes. Well, thanks for noticing. Yes, we continue to perform very well in the market, we think. And we are growing at outsized rates relative to the efficient and at scale at a couple of $1,000,000,000 at size right now.
So that's not insignificant. And I think that's due to the fact that the the platform approach we've taken is really resonating for with customers. I think a lot of security vendors all sound the same when they talk about automation and integration and vendor reduction things along those lines. But what we found and we found it to be a competitive advantage for us is the architecture really matters. So we can sit with customers and say, this is how we've done it over time.
We have a very high degree of confidence because we primarily build most of it ourselves that it actually works together. It does drive that automation. It does drive that orchestration. And increasingly at scale, you can see the consistency from network cloud endpoints as well. It's really resonating with the customers.
And I think that's showing through with the results.
And if I could just add, I think comparing the just the vast amount of innovation that our engineering team has cranked out in the last year, if you just think about the new products, new services, new capabilities, the new features in the 2 new versions of operating systems that have come out, it really does separate us from anybody else.
Okay. Terrific. And then for my follow-up, I'm curious since older appliances like the PA2000 and PA 4000 can run on PANOS ASAP X. Is that driving some incremental refresh at this point? Or do you think that it will going forward?
It doesn't appear
to be the case now. And I think anytime we have more or different newer operating systems or new hardware, that gives a great reason to talk to and hopefully get them to upgrade things along the lines. But those 2 things, particularly, I wouldn't call that yet.
We'll go next to Sterling Auty with JPMorgan.
Looking at the, I think it's the billings for subscription and support that grew 24% I'm just curious, any FX or duration type of impacts that, that would have prevented that from growing even faster when you look at the first half over first half?
No, Sterling, no, there's a very minimal FX inside of here. And then we in U. S. Dollars. And then, on the duration side, duration has been very steady for about at very steady to about 3 years for quite some right now.
Okay. And then the one follow-up, I think you called out the endpoint plus cloud bookings run rate of like around 2 40. Think at the Analyst Day, you talked about a $140,000,000 run rate. Can you kind of compare and contrast what was the timeframe for the $140,000,000? And is this just seeing a lot more customers moving into production and just buying a lot more expansion that's driving that growth?
Yes, sure. So at the Analyst Day, we had talked about a $40,000,000 run rate. That was the Q4 billings run rate. And today, we gave you the Q2 bill run rates. So we're trying to do the apples to apples along that.
You can see it's growing very nicely. It's certainly contributing pretty well. It's close to giving me like 9 percentage or 10 percentage of a total billings contribution overall, which is great. Also considering if you strip it out, the other portion is growing close to 20% in size of billings as well as 9 times bigger. So yes, so I think the whole platform is selling very well and as far as what's driving the non attached One of the key capabilities are very good in them themselves.
And I think customers are increasingly realizing the value of the consistency aspect of being able to have the same security outcomes and network cloud endpoints. And then just to make that even better, we've put the application framework on top of that and said for all those things that you're deploying, cloud to network. So you've got consistency. We're going to drive even more value over the top for every dollar you spent with us down there.
And just a point of clarification, the 140 was for our cloud and endpoint, which we broke out separately in our Analyst Day presentation. And the number that we provided today included, auto focus, which was a separate category at Analyst Day.
Which was what? Do you remember? Yes,
$50,000,000 sorry, I'm sorry, $15,000,000. Yes,
$15,000,000 starting at 90 right?
So if
you add those together, Sterling, so we had 140 plus 15 at auto focus 155 at blended mix of somewhere between 85% to 90%. And now we've put those together into $240,000,000 growing at over 85%.
There you go.
All right, perfect. Thank you.
We'll take our next question from Catharine Trebnick with Dougherty.
Thanks for taking my question. Excellent quarter. Could you dig a little bit more into the cloud and how differentiated you are from your competitors? It seems to be that's an area that you'd continued to widen the gap on and particularly what are the cylinders or products or services that are driving and widening that gap? Thank you.
Sure. Well, thanks, Karen. Catherine, we've been at cloud security now for over 5 years in the second evolution. Which I talked a lot about in the script, which is making sure we have that consistency. So when we're talking about cloud security, there's a number of aspects inside of there.
About delivering security from the cloud, using cloud as a third party infrastructure as well and making sure that we can secure that for folks and also making sure that we can provide the same seamless security and third party SaaS applications as well. If you kind of think about the approach we've taken we've been very native with the 3rd party providers like AWS and Azure. Now you may have noticed we just announced support for the Google Cloud platform, which I talked about in the script as well. So we have all the major platforms covered. And inside all those platforms, we've taken a very native approach to not only protect the I'll call it the networking aspects of that with VM series, but also protecting the host.
We just announced Traps for Linux, which is very Linux, which is very important. In cloud environments and then also on an API basis with aperture for both SaaS and public public cloud as well. So increasing things like visibility, compliance and storage security. So we're making a lot of progress with that. You may also heard me talk about, in addition, having security competency with AWS for the only security vendor to get networking competency as well.
Which is kind of interesting because when some security vendors try to go to the cloud, they want to just virtualize something, right, and take into the cloud as opposed to working very natively with the cloud providers and really using their tools and capabilities as well so that we can do lots of creative things along with them like auto scaling and load balancing that really take advantage of their network capabilities as well. So lots and lots going on there. We think the cloud is super important. Customers are talking about the cloud for sure. Some of them are moving rapidly in that direction.
And we're absolutely in front of all that. We believe with the customer base and increasingly thought as thought leaders there and also the technology leaders as well.
And I just have one thing there, Catherine, it's Mark Ay here. The go to market relationships that we have with all three of these large the cloud vendors is really strong. They're becoming very important distribution partners for us. All right. Thanks guys.
We'll take our next question from Ken Talanian with Evercore ISI. Guys, thanks for taking the question. I wanted to go back on product.
I was wondering if you could actually rank order the drivers of product growth in the quarter and how, if at all, you expect that to change in the back half of the year?
Sure. Don't think it's going to change much in the back half of the year, Ken. This is Mark, by the way, and there's really 3 drivers in there and I'd order in this direction. The first is expansion opportunities in the customer base. That's simply a magnet statement when you have those larger customer bases we have and they continue to buy from us along the way for their needs and use cases.
That's going to drive a lot of business. And we have new customer acquisition as well. You can see we just put up another close to another 3000 net customers. So that's very helpful as well. And then the third is the refresh opportunity, which continues to grow over time.
And of course, with adding more customers helps that in the long term. I don't see that changing to the rest of the fiscal year there.
Okay, great. And as a follow-up, I was you have another hardware release out there. I was wondering if you could tell us when gross margin might normalize?
Yes, it's a great question. So on the gross on the product gross margin side, there's really 2 dynamics at play here. So we have the product gross margins on the new hardware itself, right? And then we have the mix of the new hardware and the total hardware mix. The product gross margin clients we've seen for the last few quarters is due to the mix increase of the new hardware.
So let me break that down for just a second for you. So when we launched new products last year, we're going to naturally start off with lower margins on them and then they're going to improve over time. Now we've seen, along the way, higher memory and component costs even with that dynamic in play, we've continued to have modest improvements each quarter since we released the new hardware. And we expect that's going to continue. But at the same time, we have built that's going to be an offset with the mix of the new of all the hardware selling, having more and more new hardware in it as well.
So the mix will drag down the product gross margin one way. So we're sitting here at the midyear with an increased product guide, another great set of new hardware we just put out in the market last week and some headwinds on component pricing. So we're expecting that we're going to see the same, this mix dynamics to continue throughout the end of the year. But expect the total gross margins to be based on the zip code where we are today. And then of course, as you can see, we're continuing to manage the business so we can get continued operating leverage Okay, great.
Thanks very much.
We'll go next to John DiFucci with, excuse me, John DiFucci with Jefferies. Thank
you. You can add a lot of people too. No problem. Kathy, I wanted to ask you a question on the numbers, but the numbers are really clean and they look really good. So to go to Mark.
Those new
products that you just came out with over the last, I guess, week or 2. Do you see these? I just want to make sure, because try to model this? Do you see these more as evolutions or upgrades to existing products? Or are these brand new offerings that sort of fill some holes in your current portfolio along the range of next generation or around the range of firewalls?
Yes, I think of it kind of both ways, John. So as said in the past, if you or the way we think about it with customers is customers are going to have various use cases that you're trying to solve for over time. And then these use cases have different price performance requirements. So if you want to be competitive in the market, right? So if I laid out all the hardware capabilities and NRVM Series I should throw in there as well.
So, right amount in the table varies kind of get left to right. Smaller form factors and throughput, all the way up to really big ones. And then what we've been doing is filling it in every year, right, along the way of putting more and more capabilities in there or form factors in there. Get the right price performance for the use cases. And that, of course, that makes us more competitive.
So the competitors can't come in over top or underneath us from a pricing to put throughput. So that's what we would expect to continue to do into the future is just make sure that we're always solving for that. Those don't stand still. The SSL decryption These, for example, as those go up over time, that's going to drive up throughput. So we want to make sure we've got the right throughput capabilities there.
Okay. Okay. Thanks. And if I could, I know you gave some billings metrics, but when we take a look at this and we kind of try to back into new product, excluding refresh and new subscriptions, excluding renewals, the new product numbers look stronger than the new subscription. First of all, I guess, is that right, I guess, direct And what is, is that due?
I mean, if you're seeing some benefit from product refresh, that would be one cause of that, but just, is that what's happening here?
No, I
think, well, I'm not sure there's I'm not sure exactly the questions. Let me try to answer what I think it is though. But, when customers are purchasing from us or starting out with us, on purchases. If you look at the lifetime value creation over time, it takes time to get maximum lifetime value creation, which by the way, is not standing still, right? So when you go into the mix of what our customers are buying from us over time with hardware services that would attach, not at that services and then they're going to lap over, they're going to renew their support, they renew subscriptions, get a chance to sell more stuff.
The lifetime value, I think naturally grows over time with a customer
We'll take our next question from Rob Owens with KeyBanc Capital Markets.
Great. Good afternoon, everyone. I was curious on Traps and some of the big wins you saw. Are you the exclusive, are you exclusive to the endpoint at that point? Are you implementary to someone else?
And in those bake offs, who are you seeing typically?
Sure. Hey, Rob, it's Mark. Take those in reverse. And as far as who we see, we see everybody, primarily, we're going to see the legacy incumbent folks in there. Who are providing AV protection and we're doing our best and doing a good job in taking them out.
And then we see a lot of next gen folks in there as well next gen import providers who are also trying to do the same thing. And on your first question, it's a mix. Sometimes we get to be the We get to be the only provider when we're done. Other times we may be run as a compliment, or sometime. Sometimes you guys get to think of endpoints as suites as well.
So there's other capabilities and endpoints that we don't have like GLP, full on GLP capabilities, for example, so that we continue to run different endpoint providers, but not specifically for the security precautions we provide.
And second, you mentioned that when you
get your subscription and support upfront, it's typically 3 years. What does it look like on a renewal?
Renewal has been very, consistent for quite some time. We're in a steady range. It's not really changed. So it's been pretty consistent. The overall renewals as you heard us say are about 3 years.
That's 3 years as well. Okay. Thank you.
No, I'm sorry, Rob. Just to be clear, the overall duration is about 3 years. And then inside of that, for, for renewal durations. Those have been in a steady range for quite some time inside of that number yet.
Okay.
Just just want to clarify.
We'll take our next question from Fatima Mulani with UBS.
Good afternoon. Thank you for taking my question. Mark, a question for you. You spoke about the first recognized appliance in your portfolio that was last week. And I'm wondering how you think about this broader opportunity around protection of critical and industrial control systems?
And maybe your perspective on why this particular area has kind of been habitually under invested? And then a follow-up for Kathy Simon.
Sure, great. Yes, so on the question is really about the PA220 R, which is the ruggedized version of our PA220, which is a great opportunity for us. A lot of our customers, which are in environments where you would consider these not just IT abilities, but OT capabilities, ICS, SCATE environments, harsh environments, where the line is blurring between IT and OT. They want to have the same capabilities that Palatin provides, but they want them in those harsh environments. We've had a number of folks ask us when you recognize the 220 because the great form factor for oil rigs, for example, different places.
It might be utility substations and things along those lines. So they actually should have been doing that kind of themselves with different contract manufacturers to rugged hydro equipment for us. So we said, well, we can do that. So that was the impetus to launch the PAC-twenty. Now what that does for us is with customers who already like our capabilities, it gives us a whole new outlet of where to install this hardware because it can now go into those environments that require those ruggedized those.
Kathy, I'll let you take whatever the next part is.
Thank you. That's really helpful. Kathy, as the portfolio expands and begins supporting more cloud delivered services like GlobalProtect, and what are the implications for your CapEx profile? And how are you thinking about that this year and at a qualitative level for next year in the years out?
Yes, thanks. We are, definitely investing in our, application framework as we look to deliver more cloud delivered services. Obviously, that requires a bit of infrastructure investment. And so the $100,000,000 CapEx number that we've provided as full year guidance in fiscal 'eighteen definitely includes some investments, in that infrastructure. Sure.
And I think we would expect that to be ongoing and continue as we build out the application framework.
Yes. And logging service as well. So some of the new services that we're brought to market are a good amount of infrastructure in the back end like logging, for example. That's not an expensive to do that.
Jonathan Ho with William Blair.
Good afternoon and congratulations on the strong results. Just wanted to start out with the sales force And in terms of the sales execution challenges that you guys saw last year, how should we be thinking about sort of the room for productivity and maybe where we are in terms of, correcting those challenges?
Hey, John, this is Mark Anderson here. Thanks for the question. Yes, so I think on the sales force reorg that we started working about a year ago, I think, I got to really compliment Dave Pranish for doing a terrific job of restructuring and getting the right, butts and seats to focus on the right customers and clearly driving the right outcomes. From a productivity standpoint, very happy with the productivity improvements that we've seen. We talked about that in Analyst Day and We still see continued improvements there.
I think with all the new services and the new products that we have. We've got more arrows in the quiver for the sales reps and SEs out there.
And I think
we're optimistic in being able to see improvements there.
Yes, we are expecting in our guide we gave for the second half of the year as well that there will be continued productivity improvement.
Got it. And then, as we look at sort of the tax rate reduction as well as the strong balance sheet that you have, how should we think about use of capital, going forward?
Yes, we take a very traditional approach to that, Jonathan, and really looking at 3 possible capital, 1st and most important in our opinion would be to invest back in the business assuming we can get the right greater returns on that. And we invest very nicely in the business you can see, while continuing to drive leverage and capturing market share along the way to do that, so we feel like that's working out for us. The second priority would be if we see technology capabilities in the market that we like that we think could help accelerate the evolutions that we've been driving for some time. We've demonstrated the ability to go to market and do some M and A to do that. And that could be the case in the future for us.
And then the third is, if we not doing the first 2. We've also demonstrated the ability to return value to shareholders, primarily through stock repurchases, while maintaining a good healthy balance sheet for any
We'll go next to Ann Meissner with Susquehanna.
Hi, thanks for taking my question. At Analyst Day, you talked about leveraging AI tools along with your customer data to better implement some customer targeting program. You give us an update on that and what sort of strategies have resulted from that initiative? And then in particular, as it relates to the refresh cycle, whether you think helping you optimize that opportunity?
Yes. And that's a great question. And really appreciate the fact that you took note of that at let's say because we're really a data driven company here. So lots of mathematicians running around and including in the marketing department as well as CIO organization who are using and harnessing the same kind of AI and machine learning capabilities you're seeing coming through in our products the number of the things that we talked about at Analyst Day that are tools for our sales team to use like things called quota crusher, for example, and the deal doctor those are using AI capabilities to tell sales reps. What is the next thing you should do with this customer to recommend?
For example, or if you want to optimize your earnings. This is how to do that. And those are being very heavily used by our team as well as our partners. To better and better effect. So as we continue to train those tools, they get better.
So again, going back to the last question that just came up in productivity, I would definitely put some of the productivity, growth that we're seeing from the sales team in this bucket, which has given them fantastic tools to use in order to grow the productivity.
Perfect. Thank you. Nice quarter.
Thanks, Ann. Thanks.
We'll go next to Saket Kalia with Barclays.
Hey guys, thanks for taking my questions here. First, maybe for you Kathy, just a quick accounting question on product. Could you just talk about how the accounting for VM Series works? Meaning, could we see any carve out of VM Series in the product line as that business gets bigger or perhaps as accounting rules change, just any color on how VM Series could or could not impact the product lines down the road?
Well, the VM Series is really should not change the categorization of where we put revenue one way or the other.
Yes, Zack, you may have heard us in the past, we talked about the M Series, historically, a long time, it had like a 2 flavors of perpetual, right, and a not perpetual petual piece would go into product. That's pretty much gone like it's just almost nothing there. So every time you hear us talk about the M series, it's going to go into a ratable line for us.
Got it. That's super helpful. Maybe a follow-up for you, Mark. Kind of a follow-up from quarter actually, but can you just talk about how the application framework is changing conversations with customers? And maybe tying it to this quarter, whether the application point framework is actually helping the core network security business at all?
Yes. It's, I think it's definitely helping the overall business across the board. And as far as the conversation with customers, the 100 percent of the time, and I'm not exaggerating on that, I believe 100 and 100 of customers as Mark has as well. We hear the same thing, which is then saying, we have this seemingly insurmountable challenge, which is how do we harness new innovation, which we know has to come. We know no one company can do it, but we can't operationalize it because we can't run one more thing, right?
So this implementation framework sounds like you've figured out how to solve this problem substantially for us. So we hope you get this right. And that's very consistent. Now this afternoon, we know we're trying to sell something this afternoon. It really goes back to the 2nd evolution on consistency which we're doing a great job at for each of the capabilities, the consistency of security.
And now we've just given the customer a really powerful reason if they're going to think about us versus that endpoint provider, is that firewall provider or that cloud provider, why you go with Palo Alto Networks in order to future proof your investment, which is now they're going to put the application on top of that. So if I buy their firewall today, their endpoint today, their BM today, their CASB capability today, they're going to continue to bring more innovation to that purchase and make that purchase more valuable for me for every dollar I spend with them when I deploy them that way. So it's been very, very positive. I think that's really helping us in the market.
That's great. Thanks guys.
Thanks, Saket.
Thank you.
Our next question from Keith Weiss with Morgan Stanley.
Thank you. This is Melissa Franke calling in Mark, I'm just wondering if you're seeing any change in customer behavior around refresh and I'm mostly interested in if you're seeing any customers that are opting to instead deploy a VM Series instance. Versus a physical deployment? And what would be sort of the use cases around that?
We've seen everything going in many directions. Melissa, we kind of see it's the the cloud side of the business is growing. The M Series, the hardware side is growing as well. But back to this consistency thing, if we get a chance to do something for a customer, they're more often not are going to use in these in the environment everywhere. So we gave an example on the call.
I thought it was kind of interesting about a customer who is a large company, net new to us the customer never bought anything. First thing they bought was in the AWS marketplace for VM series. And then, over time, after we saw them there, we contacted and said, How are you doing? It's a lead gen for us. And we just closed a 7 figure deal with them on prem, right?
Because people are living in these hybrid worlds and high environments. We can kind of see it going in VM to physical, physical to VM and people are going to operate in these hybrid environments for quite some time, we think, and it's beneficial for us.
Okay, thanks. And just one quick follow-up for Cathy. It was helpful to see the tax guidance for the fiscal 2018. I'm just wondering if you could put some color on what we should think on the impact to cash taxes? Because as far as I understand, you still have some NOLs?
Yes, that's right. We do have NOLs and we don't expect to be a cash taxpayer or a significant cash taxpayer for the next 4 years or so. We mentioned at Analyst Day that we, expect to pay about $10,000,000 to $25,000,000 per year over the next 4 ish years And that doesn't change with the new tax law, because of the NOLs essentially.
Got it. All right. Thank you.
Thanks, Melissa.
We'll go next to Phil Winslow with Wells Fargo.
Hi, thanks guys for taking my questions and congrats again on just an awesome quarter. I have a question on gross margins and most of my other questions have been asked already, but Mark, you laid out sort of the impact of the newer appliances versus some of the older appliances affected on gross margins. But as you sort of look up and down kind of that way, the appliance set to call it the service provider, large enterprise branch office etcetera. How should I think about the differential in gross margins there? And as you think about what sort of impacting gross margins the past year, then as you kind of think about that guidance going forward, how do you think about that mix called between up and down the appliance range?
Yes, I think a better way to think about it, Phil, is not so much the size of things. It's really about what goes into them from a componentry perspective. And there's a mix of components in all these things, right? They don't they're not all the same across all the devices either. So it's not just about like a small thing versus a big thing.
Usually, and then we're definitely seeing in this case, newer things, right? We'll have lower product gross margin than things that are much more mature over time because we continue to drive economies of scale. The components of your pricing improves over time. Thanks a lot of those lines. So I think about it that way and the mix comment I making was as the mix of our hardware goes more to the newer things that we've developed and we can see we're over performing very nicely on the hardware side.
That's positive for the business, of course. It's got some short term impacts on the product gross margins as that mix is larger inside there, even though we're continuing to improve the gross margins on those products every single quarter as well.
Got it. Thanks, guys. Congrats again.
Thanks, Phil.
That concludes today's question and answer session. At this time, I'll turn the conference back to Mr. Mark McLoughman. For any closing remarks.
Thanks, operator. Appreciate that. I want to thank everybody for your time this afternoon and I know we're going to see many of you over we look forward to that. I hope everybody has a great evening and thanks so much for joining us on the call today.
This does conclude today's conference. Thank you for your participation. You may now disconnect.