Good day, everyone, and welcome to the Palo Alto Networks fiscal third quarter 2017 earnings conference call. Today's conference is being recorded, and at this time, I'd like to turn the conference over to Kelsey Turcotte, Vice President of Investor Relations. Please go ahead, ma'am.
Great. Thanks, Tom. Good afternoon, and thank you for joining us on today's conference call to discuss Palo Alto Networks' fiscal third quarter 2017 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, Steffan Tomlinson, our Chief Financial Officer, and Mark Anderson, our President. This afternoon, we issued a press release announcing our results for the fiscal third quarter ended April 30th, 2017. If you would like a copy of the release, you can access it online on our website.
We would like to remind you that during the course of this conference call, management will make forward-looking statements, including statements regarding our financial guidance, modeling points for the fiscal fourth quarter and full year 2017, our competitive position, and the demand and market opportunity for our products and subscriptions, our ability to drive outsize growth rates, trends in certain financial results and operating metrics, our initiatives, plans, and investments regarding our sales productivity, success and timing of integration of our newly acquired products, innovations in our product, subscription, and support offerings. These forward-looking statements involve a number of risks and uncertainties, some of which are beyond our control, which could cause actual results to differ materially from those anticipated by these statements. These forward-looking statements apply as of today.
You should not rely on them as representing our views in the future, and we undertake no obligation to update these statements after this call. For a more detailed description of factors that could cause actual results to differ, please refer to our quarterly report on Form 10-Q filed with the SEC on March 1st, 2017, and our earnings release posted a few minutes ago on our website and on the SEC's 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. 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 inform you that we will be presenting at the Bank of America Merrill Lynch 2017 Technology Conference on Tuesday, June 6th, and hosting Investor Day 2017 on Wednesday, September 27th in New York City. Finally, once we have completed our formal remarks, we will be posting them to our investor relations website under quarterly results. With that, I'll turn the call over to Mark.
Thank you, Kelsey, and thank you everyone for joining us on the call today to discuss our fiscal third quarter results. In the third quarter, revenue grew 25% year-over-year to $432 million, and billings grew 12% year-over-year to $544 million. We generated free cash flow of $163 million and reported non-GAAP earnings per share of $0.61, up 33% year-over-year. As many of you know, we initiated a sales force reorganization at the outset of our fiscal third quarter. We are making solid progress in these efforts and are on track with our project plans. While we have much more to do and it will take time to fully realize the impact of these changes, early feedback from customers, partners, and our sales team has been good. Now turning to the quarter.
In Q3, new customer adds were the second highest in the company's history. We are now privileged to serve more than 39,500 customers worldwide, including 86 of the Fortune 100 and approximately 1,200 of the Global 2000, 40 of which we added during the quarter. Feedback on our technology, approach, and strategy is very positive, as evidenced not only by high rates of customer acquisition, but also by external recognition. For example, customer satisfaction is very high, as measured by our Net Promoter Score of 73, which is more than 20 points higher than what is considered a best-in-class Net Promoter Score of 50.
In Q3, we were privileged to earn the SANS Best of 2016 Award for next generation firewalls, which was voted on by the SANS community of security operations professionals and security managers from around the world who have used our technology to increase the effectiveness and efficiency of their cybersecurity programs. In Q3, we continued to see strength not only in new customer acquisition, but also in increasing wallet share of existing customers for our Next-Generation Security Platform. In the quarter, all of our top 25 lifetime value customers again made purchases. To make this list, a customer had to have spent a minimum of $20.1 million in lifetime value, a 61% increase over the $12.5 million in Q3 of fiscal 2016.
Specific examples of customer wins and competitive displacements in the quarter included a Check Point data center replacement at one of the world's largest retailers, an eight-figure deal to replace Check Point in a large U.S.-based auto insurance provider, a seven-figure Cisco replacement that included all of our attach subscriptions, where we became the security platform for one of the world's largest travel companies based in Europe. A seven-figure Cisco replacement with our PA-7080 chassis and new PA-5200 series devices at a multi-state network of physician clinics, outpatient centers, and hospitals in the United States. A seven-figure deal to become the security architecture for one of the largest insurance companies in the United States, including securing their cloud initiatives. Two large antivirus replacements with Traps in one of Southeast Asia's largest banks, as well as a U.S.-based healthcare provider.
We were able to win at very high rates in a very competitive market because of the unique capabilities of our platform. As the recent WannaCry global attack illustrated, the need for integrated and automated security is growing quickly. We are always pushing the innovation curve to keep customers safe across their entire architecture, including on-premise, endpoints, third-party SaaS applications, and public and private cloud deployments. This approach is constantly enhanced by the network effect of tens of thousands of customers and our technology partner ecosystem, providing leverage to each other through our platform. Our continued innovation has been well-received by the market. Our new hardware generated very high interest in the quarter, and we were pleased that demand for these new products exceeded our internal forecast.
Also, market reaction was very positive to the introduction of our new high-performance virtualized firewalls, as well as our new 8.0 operating system with more than 70 new security features that enhance all aspects of our Next-Generation Security Platform. Momentum with our attached subscription services was also evident in Q3, including WildFire, where we added approximately 1,500 new customers. We've been adding over 1,000 WildFire customers per quarter for over three years, and are now serving approximately 17,000 WildFire customers. WildFire is a great example of how our integrated and automated approach to enterprise security not only improves prevention outcomes, but also drives operational efficiencies for customers overwhelmed by the numbers, cost, and complexity of legacy tools and point products. With the size of our customer base and capabilities deployed, we are also using analytics to provide differentiated tools and actionable intelligence.
We saw strong customer growth in AutoFocus, as well as a high degree of interest in our newly acquired LightCyber technology. We remain on track to have LightCyber integrated into our platform and offered as a subscription service by the end of this calendar year. In addition to analytics, cloud security is top of mind for our customers, and we continue to see solid uptake on our cloud offerings due to our unique ability to provide not only cloud-specific security capabilities, but also the consistency of security wherever data resides or is computed. In Q3, we saw strong sequential growth for Aperture, added hundreds of VM-Series customers, and are continuing to expand our market reach by leveraging our partnerships with all leading cloud infrastructure providers. Traction continues to grow nicely for Traps, where hundreds of channel partners are now selling Traps, and we are serving over 1,000 customers.
In early May, we announced the latest release of Traps endpoint technology. The enhancements in this 4.0 release include the addition of support for macOS and a beta for Android, plus several new prevention modules designed to detect, stop ransomware, and other advanced threats. When implemented with our next-generation firewalls, customers can now correlate endpoint and network security events in our network security management tool, Panorama. In just a couple of weeks, we're expecting thousands of guests to join us in Vancouver for Ignite, our annual user conference. This has proven to be a great and highly anticipated event by our customers and partners, and we hope to see you there. Registration information can be found on the Palo Alto Networks website. With that, I'll turn the call over to Steffan.
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. In our third quarter, we saw some early positive indicators of the changes we're making in the go-to-market portion of our business. Sales productivity improved sequentially, with product revenue coming in better than we had expected as customers invest in our Next-Generation Security Platform. We delivered record revenue, strengthened our balance sheet, and generated strong cash flows. Turning now to the financial highlights for the quarter. New customer acquisition and expansion within our existing customers drove revenue growth of 25% to $431.8 million. Looking at the geographic mix of revenue, the Americas grew 22%, EMEA grew 32%, APAC grew 33%. Product revenue of $164.2 million grew 1.3% compared to the prior year.
Increasing adoption of our eight subscriptions and high renewal rates continue to drive sales in the recurring portion of our business. Q3 SaaS-based subscription revenue of $143.2 million increased 55%. Support revenue of $124.4 million increased 37%. In total, subscription and support revenue of $267.6 million increased 46% and accounted for a 62% share of total revenue. Billings of $544.1 million increased 12%, and contract duration was unchanged compared to the prior year. Total deferred revenue of $1.6 billion increased 51%. Moving on to margins. Q3 gross margin was 76.4%, a decrease of 150 basis points compared to last year, and within our target range of 75%-78%. The decline was primarily attributable to the new products we introduced in the quarter. As we indicated on last quarter's call, new products typically have a higher initial cost of goods sold, which will improve over time.
Looking forward, we expect there will be fluctuations in product gross margin, particularly with the recent introduction of our new products, when we typically see a decline in product gross margin for a few quarters. In the quarter, discounting decreased sequentially and was essentially flat year-over-year. Q3 operating expenses were $250.8 million, or 58% of revenue. Operating margin was 18.4% in Q3. Net income for the quarter grew 35% year-over-year to $57.1 million. EPS grew 33% to $0.61 per diluted share. On a GAAP basis for the third quarter, net loss was $60.9 million or $0.67 per basic and diluted share. We finished April with cash equivalents and investments of $2.1 billion.
During the third quarter, we purchased approximately 1.1 million shares of common stock at an average price of $113 per share, leaving a balance of approximately $705 million available for ongoing repurchases. Q3 cash flow from operations of $211.2 million increased 24%. Capital expenditures in the quarter were $48.6 million, including $32.8 million of CapEx related to our new headquarters. Free cash flow was at $162.6 million, up 8%, at a margin of 37.7%. Excluding CapEx related to our new headquarters, free cash flow was $195.4 million, up 29%, at a margin of 45.3%. DSO was 78 days, within the target range of 70 to 80 days. Turning now to guidance and modeling points. This guidance takes into account the type of forward-looking information that Kelsey referred to earlier. It also takes into account the work we still have to do on the go-to-market changes we introduced last quarter.
For fiscal Q4 2017, we expect revenue to be in the range of $481 million-$491 million, an increase of 20%-23%. We expect non-GAAP EPS to be in the range of $0.78-$0.80, using 93 million-95 million shares. In addition, we expect the following modeling points for Q4 2017. Billings to be in the range of $625 million-$645 million, product revenue to be in the range of $188 million-$191 million, CapEx to be approximately $55 million, including $30 million related to our new headquarters. For the fiscal year, we expect non-GAAP operating margin to be 19.5%-19.6%, which is an increase of 220 to 230 basis points relative to FY 2016 non-GAAP operating margin of 17.3%, as reported.
Included in the 220 to 230 basis point improvement is approximately 100 basis points of organic operating margin expansion, 180 to 190 basis points positive impact from the deferred commissions change, offset by an approximately 60 basis point headwind from LightCyber. We expect fiscal 2017 free cash flow margin, excluding our headquarters investment, to be at least 40%. With that, I'll turn the call back over to the operator for questions.
Thank you, sir. Ladies and gentlemen, if you'd like to ask a question, it's star one on your touch tone telephone. Again, that's star one to ask a question. Please make sure your mute function is turned off to allow your signal to reach our equipment. We also ask that you please limit yourself to one question. You can rejoin the queue for follow-up questions. We'll take our first question today from Gabriela Borges with Goldman Sachs.
Great. Good afternoon. Thanks for taking my question. Maybe to start off for Mark, you mentioned in the prepared remarks a little bit on the progress you've made with the sales force and that there is still some work to do. Maybe you could just give us a little more detail there on what you feel you've accomplished thus far into the second half of the fiscal year, and what are some of the milestones that you're looking to achieve with productivity and other internal metrics as we go through fiscal year and into the next fiscal year? Thank you.
Sure, Gabriela. Thanks for being on the call. As we mentioned last quarter with the reorganization, we are taking a four-step approach to this. We needed to design what we wanted to do differently. We wanted to communicate that to everybody. We needed to do account mapping exercises to put these accounts in the right place coverage-wise. Then we need to make sure everybody's in the chairs to cover that. We have to run it that way. Over the course of the last quarter, we got the design work finished, the communication work finished.
We've mapped all the accounts, now we need to make sure that the folks are in the chairs to cover the accounts and that other folks who have just picked up accounts are working as fast and as hard as possible with our help to build those relationships and those accounts as well. That's where we are right now. We'll be continuing that through the fourth quarter for sure. Hopefully see the positive impact from this through FY 2018.
That's helpful. As a follow-up, if I could, just on the comment that discounting activity has moderated year-over-year, just your thoughts on what you think is driving that. Is it a function of some of the new products? Is it a function of the competitor environment or effects? Anything that would be helpful.
Well, different folks in the market have different go-to market motions. Ours has always been to really focus on security, reduction of complexity, and then of course, we want to deliver that in a way that is within the cost envelope of what customers have. Other folks have come at it from the bottom of that stack and really tried to go from a cost perspective and work their way up. That's not really been our go-to market motion. We believe there's a lot of value in the problem. We train our salespeople and talk very consistently to the value proposition that's going to provide for security, reduction in complexity, and better total cost of ownership. We think as a result of that, we've been able to maintain pretty good discounting discipline through the company's history, and you can see that in this quarter as well.
We'll take our next question from Gregg Moskowitz with Cowen and Company.
Okay, thanks very much, congratulations on a nice bounce-back quarter. Mark, just to follow on Gabriela's first question, if we could apply the overused baseball analogy to the progress made with respect to your sales reorg, what inning would you say that we're in right now?
I'd say bottom of the second, top of the third.
Okay, that's helpful. Just for Steffan, any color that you can provide on the percentage of units roughly that were shipped this quarter that came from the new product family? If you had any commentary just as it relates to ASPs for the new product sales vis-à-vis the other prior ones. Thanks.
Well, we were very pleased with the adoption of our new products. They fill a need in the market, and they also filled a need in our overall product lineup. We don't give exact percentages of what % products were shipped coming from different units. I can tell you that the adoption was very strong. As far as ASPs are concerned, the ASPs were very healthy, kind of in line with what we thought. Anytime you have a new product introduction, you're going to have a trade up, trade down, new incremental opportunities presenting themselves. We saw all of that, and overall, it was a net positive for our business.
We'll take our next question from John DiFucci with Jefferies.
Thank you. I guess my question is about the new products that came out. I know you had talked a lot about the sales reorg, and it sounds like that's going well, but it also seems like there was likely some pent-up demand sort of waiting for these new products. Do you think that that had ended up in, looking in hindsight, had an impact that was material on the results the last couple of quarters?
Hey, John, it's Mark. It's always hard to tell, right? When you have new product introductions, we have to assume that there would be some slippage from one quarter into the next as folks even hear what the new products are about. We assumed when we came out of the second quarter that we might've seen some of that fall into the third quarter. I have to assume that some of the overage in the third quarter is associated with that as well. I don't think that was the majority of the over-performance from what we guided there. It's very difficult to tell to be exact on that one way or the other, but I assume there's some of that in there, of course.
Okay. Thanks a lot, Mark.
Sure, John.
We'll go next to Matthew Hedberg with RBC Capital Markets.
Great. Thanks, guys. Congrats on the quarter as well from me. Growth in EMEA was particularly strong. I'm curious, is that more a function of easier compares, or are European customers starting to talk more about the breach notification going live next year?
Yeah, Matt, it's Mark. A couple things on that. One is just as a size of market, EMEA is a large market. When you look at just the dollars we're doing in that market, we think we have a long way to go and grow in that market. We expect to be able to grow very healthily in that market for some period of time. Sure, we'd like to see three handles or better on growth, so we'd like to see that in the quarter. For the GDPR, which is the legislation you're talking about, there's certainly a lot of attention and focus on it.
That basically is legislation that's going to present companies with some pretty large fines if they're found to be lacking in their duties of using state-of-the-art technology, which is not a defined term in the legislation, but it talks about it that way, state-of-the-art technology. There's a lot of focus from companies and boards of directors to say, "Are we doing that?" Right? I think that's really driving a lot of interest in getting off of legacy technology, and that's certainly a great opportunity for a platform provider like ourselves.
Great. Thanks.
Yeah.
We'll take our next question from Philip Winslow with Wells Fargo.
Hey, thanks, guys, and congrats on a great bounce-back quarter. I have a question about the, just the aging of your install base. At last Analyst Day, you all talked about just the potential wave of appliances coming up for renewal. Wondering if you could give some more detail, just sort of what you saw this quarter, maybe compare that to the prior few quarters, if that wave's starting to come on or if that's still on the come.
Hey, Phil. Yeah, it's Mark. I think that the majority of what I would call the refresh potential for us is in the future, and that's just simple math and looking at the classes. We consider our classes as cohorts and do them by year. If you look at how the cohorts build over time, each year is getting substantially bigger. If you think of a four- to seven-year average refresh cycle, somewhere in there, the big part of our customer base is going to be in refresh cycles in the coming couple few years' time versus the last couple few years' time. We think that that's something that should provide a tailwind for us go forward.
Got it. Then just one quick follow-up to that. In terms of just the new products that you all launched in February, how do you think that influences, either which way, just the timing of people refreshing the install base, considering you just have a new set of virtual and physical appliances out?
Yeah, I think it'd be helpful. Maybe an obvious point that when you have new capability sets in the market, it gives the customers more choices. We liked the lineup of technologies we had prior to the new products we launched. We just complemented them with a whole set of new products as well. When customers are thinking about what their needs are, price performance needs are, throughput needs are, that we've got a very full lineup now of capability sets and lots to upgrade or refresh with when they're so inclined, when they reach that sweet spot in their refresh cycle.
We'll take our next question from Saket Kalia with Barclays Capital.
Hey, guys. Thanks for taking my questions here. First, maybe for you, Steffan. You said last quarter that billings should lag revenue growth by about 10 or 15 points, at least for the back half of this year, and it looks like that relationship will hold here in the fourth quarter as well. Realizing that you're not ready to give us guidance for fiscal 2018 yet, can you talk qualitatively if that relationship between billings and revenue should maybe be consistent or perhaps widen? How do you think about that going forward?
Yeah. Thanks, Saket. Last quarter, we did say that the billings growth rate would trail the revenue growth rate by about 10 to 15 points. In Q3, we came right about in the midpoint of the range. Our Q4 guidance actually indicates that the range is improving. The range, if you were to benchmark it off of the midpoint of our revenue guide, billings growth rate is about 8.6%-12.1% below revenue growth. That range is actually improving. It's too soon to call what's going to happen in 2018. We're doing everything that we can to improve the growth profile of the company.
Got it. Maybe for a follow-up here quickly for you, Mark, and maybe more philosophically, how do you think that last quarter's experience is going to change that playbook in sales that's been successful for so long in terms of splitting territories, allocating resources? How do you think about that playbook changing perhaps after last quarter's experience?
I think that some of the chapters in the book are good, some of the chapters have to be modified, right? We would continue to split territories. We wouldn't do it at the rate and pace that we had done it in the past. I think we talked about that on the last call. We will continue to do market segmentation, but we won't be making assumptions about what the capability sets are from a sales team perspective on various customers that they could cover. There are things that I would say are somewhat timeless when you think about sales playbooks, there's the execution limitation of them, which may be unique to each company. We learned a lesson from that stuff, and we're going to apply that in this quarter and beyond.
We'll take our next question from Jonathan Ho with William Blair.
Guys, congratulations on the strong quarter. Can you just talk a little bit about the maybe shift or acceleration of virtual appliances and what you saw this quarter, especially relative to the public cloud?
Hey, Jonathan. It's Mark. Yeah. We continue to see really nice adoption from the VM-Series, and a lot of that's being used in the public cloud environments as well as private cloud. Our NSX is doing very well. We've had that relationship for quite some time. We're seeing hundreds of customers in the public cloud environments using the VM-Series as well, and we would expect that to grow over time. There's a lot of different angles on that that we look at. One is lead generation. We're seeing some customers use us for the very first time in AWS, for example, and then we get the lead in order to follow up to see if we can't provide additional security outside of just that public cloud infrastructure throughout their on-prem, through endpoints and things along those lines.
We see lots of people taking their own licenses up there, we see increasing sales in the marketplace just using AWS. We're seeing that across Azure, Google, other infrastructure providers as well. It seems like solid growth for us.
Got it. Then just relative to WannaCry, are you seeing any sort of impact from the increased attention around breaches, or do you think this is just more sort of support and removal of friction around the spending? Thank you.
Yeah, sure. A couple things on that. The first is WannaCry certainly got a lot of public attention. There's going to be another attack like that. Can't say what it is, don't know when it's going to be, right, but there's always going to be the next one. I think the WannaCry thing raised a lot of awareness and anxiety. One, because it really kind of focused in the healthcare community at first. It moved out of there, so further evidence of, I'll call, critical aspects of our society that are relying on the digital age of technology being at risk, and certainly would capture folks' attention. The other thing I think it highlighted for us as well, and as opportunity, is the increasing need for platforms. I think WannaCry was looked at primarily as an endpoint problem. It's broader than that.
Once it gets into an organization, it moves around. It has the ability to spread. Platforms like ours are uniquely able to handle that stuff. Traps, for example, would have stopped it on the endpoint. If it were in the network, WildFire would have picked it up. If somebody was going to download it from a malicious URL, PAN-DB would have stopped that. Threat Prevention would have stopped lateral movement and the internal spreading of the infection. It really helps to have multiple ways to beat these attacks, and WannaCry is a great example of a good position you'd be in if you had all those capability sets.
We'll take our next question from Michael Turits with Raymond James.
Hey, guys. Two questions. First, you had talked in the past about the back half of the calendar year getting some tailwinds, both from the product refresh in general as well as the new product cycle. Does that still look like something that could be an accelerant to growth at this point?
Hey, Michael. Yeah. We certainly talked about that in the beginning of the year, and we had laid out a number of reasons why we believe that product growth would accelerate, partly due to the ramping capabilities at sales force, partly due to the assumption there would be new product introduction, service provider business, increasing productivity. A lot of that holds true, we have the cross current of the sales force reorganization and things that we're dealing with. There's puts and takes on both sides of that. We're happy to see the product revenue come in where it did in the third quarter, frankly, we're not satisfied with where we are, and we think we can do better, and we aim to do better.
Okay. Second question, a bit more specifically on the VM-Series. One of the important things about the new release was the increase in throughput or capacity for the new virtual. Has there been a measurable impact from that, both in terms of cloud adoption and utilization and as well perhaps in the on-prem or in the private cloud, with people thinking about it relative to whether or not the trade-off of using virtual versus using physical boxes?
Well, here's how we think about it. I think a lot of customers are thinking this as well, which is it's really use case specific. Your data is going to reside in different places, it's going to be computed in different places, and it's going to move back and forth, hopefully very efficiently and without friction. That's really what we're trying to do with the platform is providing consistency of security in all those places. When you talk about the cloud and use cases for the cloud like east-west traffic and a highly virtualized data center, one of the things you're going to see there for sure is just an ever-increasing amount of throughput requirements because volume is growing from the number of applications, number of third-party applications being used, from encryption and decryption capabilities for decryption needs, for example.
Throughput is going to continue to rise over time. I think that in the case, just like we did with our hardware of having it be much higher performance, same with the virtualized firewalls as well, where we quadrupled the performance there. We're going to keep growing that performance because those use cases, whether they're physical or in the cloud, are going to demand higher and higher throughputs.
We'll take our next question from Andrew Nowinski with Piper Jaffray.
All right, thanks. Just a question on the product revenue guidance. You had great upside in the quarter. You had 1% year-over-year growth off a tough comp. I guess, why aren't you expecting that momentum to continue in the July quarter since your guidance suggests that product revenue will decline on a year-over-year basis? Is that just you being more conservative than usual?
Hi, Andrew. When we're looking at the product side, we're happy to see where we came in in the third quarter. Of course, like I said, we're not satisfied big picture of where we are, and we aim to do better than what we're doing. When we look at the third to fourth quarter, we're still looking at a 15% sequential increase from the third to the fourth quarter of the guide we gave. That's a big increase. It's a doable increase for sure, we think, and we expect to get that done. We're looking at that on a relative basis sequentially. Now we're looking on a year-over-year basis as well. We're coming off a very high comp for the fourth quarter of last year.
We're still in the midst of going through the sales force reorganization, that also is a cross current.
That's right. Okay. Got it. With regard to Traps, you certainly continue to add more customers, still has, I think, a penetration rate of less than 3% of your installed base. When do you think it's going to start to gain a little bit more traction? When do you think we'll start to see that penetration rate increasing at a faster clip?
Sure. That's actually an area of an intentional focus for us, Andrew, which is given that we've been in the market for about three years now as one of the next-gen providers after AV replacement budgets, like everybody else is, we've been very intentional in targeting new customers as well as our existing customer base for larger customers and larger deployments of endpoints. That's what we're accomplishing. We're very happy to have over 1,000 customers now. Rate of customer growth is good. We would expect the penetration rates to go up faster later, but as we solve for all this reference ability that we're getting now and increasing the technical capabilities like the 4.0 release, I think that with all that focus in mind, we're getting where we want to go.
When you think about the next-gen AV providers in the market today, based on what we know about that, we think we're one of the biggest from a sales perspective.
We'll take our next question from Michael Kim with Imperial Capital.
Good afternoon, guys. Just to follow up on Traps. Are you seeing an increase in head-to-head evals and any early feedback on win rates? Out of that 1,000 odd customers that you've accumulated, are the majority of those existing or net new logos?
Yeah, sure. We're doing lots of head-to-head. That's exactly what we're trying to do, right? We're focused on trying to take the AV budgets from legacy AV providers when a lot of people are dissatisfied with them. We're certainly seeing them head-to-head. In a lot of those situations, not surprisingly, a lot of the next-gen folks are being evaluated.
As a side note to that, Michael, one of the interesting things that we found with the customers that we've acquired so far when we surveyed them, that well more than half of those customers when asked, why are you buying Traps from Palo Alto Networks, in addition to saying it's a great best-of-breed, next-gen endpoint security capability, are saying, "Because it's actually very well integrated with my network security capabilities and increasingly with my cloud security capabilities." That consistency is very important, and that approach that we're driving is very important. Can you remind me of your second part of your question?
Yeah. I was curious, out of the 1,000 odd customers you have today, how many of those were net new logos to Palo Alto versus existing customers? Curious what the initial uptake has been.
Yeah, Michael. Mark Anderson here. It's actually a pretty good balance that we have. I'd say close to 50/50. The great thing is our core sales team is getting better and better enabled each quarter at being able to integrate the Traps story into their next-generation network security story and prove the value of these two things working closely together. Whenever we do get a Traps customer that's a first-time buy, we're able to go back in and very seamlessly sell network security as well.
Great. Thank you very much.
We'll take our next question from Pierre Ferragu with Bernstein.
Hi. Thank you for taking my question. We talked a bit about the refresh opportunity, and I eventually got confused about how much refresh do you have in product revenues reported this quarter. Am I right thinking it's still a very negligible, very small part of your business, and most firewalls you're selling today are still adding up to your install base? Or is the refresh business already something fairly sizable, and would you have an idea of what percentage of your product revenues would be refresh already today? I'll have just a very quick follow-up on sales cycle. We've heard a lot over the last six to nine months in the industry that sales cycles were getting a bit longer. Clients were taking more time to figure out what they want in terms of network security.
If you could give us a latest update on that front as well.
Pierre, it's Mark. I'll take the first question, pass off the second one to Mark Anderson. The refresh side of it, we don't break out the percentage of what portion of product is coming from new expand versus refresh. What I can say on the refresh side is the refresh for us has been strong in the past through our cohorts, which is great. You can kind of get a sense of that when you think about our renewal rates, our NPS scores, all these other externalities that point to customers really like Palo Alto Networks, they tend to refresh with us as well.
Back to the cohort thing I was talking about earlier, the percentage of the business that's coming from the refresh has been increasing just kind of naturally, mathematically as we graduate years, if you will, through those cohorts, we would expect it to increase into the future. I'll let you take the other one.
Yeah, bonjour, Pierre. As far as the sales cycles go, I think the new normal is that these sales cycles are taking longer. Clearly, security continues to be a board-level number 1 or number 2 priority for customers at every level. There's also copycats out there in the market that are mimicking the value proposition that Palo Alto Networks kind of pioneered. Really that's getting our sales teams trying to work hard to solve to a technical proof of concept, because when we get a chance to demonstrate with their live network traffic how differentiated we are, we typically win. That does take a little extra time. We've sort of factored that into our forecast and guidance each quarter, certainly our sales teams have factored that into their campaigns to win customers to really get to that technical proof of concept.
Thank you.
Yeah.
We'll take our next question from Shaul Eyal with Oppenheimer.
Thank you. Good afternoon, guys. Congrats on the solid execution quarterly performance. Mark, how's the LightCyber integration has been coming along so far? I don't know if you can quantify or provide us with some color about some potential contribution this quarter.
Sure. Let me take that financially first and technically second. On a financial basis, the contribution was de minimis from a top-line perspective, and we gave some guidance last quarter from the impact from an operating margin perspective, which Steffan went over. On the technical basis, the integration is going as planned. We're on our project plan for that, which is fantastic. We expect that will be a subscription-based service, like I said, before the end of the calendar year.
Just as a side note on that, you'll hear more about this at Ignite if you attend Ignite, that's an example of a capability, which is a really great technical capability, highly innovative for network behavior analytics, that when it is integrated in a platform, will take something that had historically been a product sale, like we buy products and deploy it everywhere, to something that is a software, so as a subscription service, without having to deploy additional hardware. The feedback from the customer base on that model and what we're demonstrating there with LightCyber has been very positive so far feedback-wise. They also like the service itself. It's a very important service to find anomalies when somebody's moving through your network, and they're looking forward to just getting that best-of-breed capability as well inside the platform.
Yeah, if I can just add to that, Mark, I think from a people standpoint, we're really impressed with the quality of the people that came over with LightCyber. They've co-located with our Tel Aviv team in Israel, and it's a really good fit.
Got it. In the latter part of calendar 2016, if I'm not mistaken, you've established a telco-related type of activity or maybe telco-related group. Just interested, Mark, to learn how the ramp-up has been coming along so far.
Sure. Yeah, that's the service provider group. We talked about that a couple of years ago, actually, saying we wanted to be very focused on that more so than the past on the service provider, because it had been, a couple years ago, a relatively untapped market for us. The service provider market has some very specific technical needs and capabilities. It also has some very specific go-to-market requirements where you have to understand them, you have to talk their talk, you have to know what their needs are, and relationships really matter. Over the course of the last couple of years, we've been building up a service provider team that has been built out very well, and they're contributing very nicely to the business. We'd expect that business to grow over time for us.
We'll take our next question from Catharine Trevick with Dougherty.
Thank you for taking my question. Mark, I have a question regarding your virtual firewalls. It seems to me, you said earlier in your commentary several hundred this quarter. Could you explain how differentiated you are with your virtual firewall versus Check Point in the AWS cloud or Azure? It seems to be rapid migration to cloud right now. Where do you see fitting into this migration, and how fast is this possibly replacing some of your core hardware products? Thanks.
Let me come at that backwards, Catharine, for a second, which is so far, we think this will continue into the future. We've seen the cloud in general, some of our VM-Series and other cloud aspects like Aperture be additive. We think that's a lead provider for us and a growth provider for us for new use cases. As far as differentiation relative to any of the competitors, 3 things going on there. The first is that our VM-Series does exactly everything that our physical capability set would do, and the physical capabilities, as you know, the hardware capabilities are highly differentiated on what we do with App-ID, Content-ID, User-ID, plus all the services for able to run on that. We virtualized all that quite some time ago.
The differences that customers really loved and appreciated in the physical world, they get all those in the virtual world as well. That's a starting point, a very important point. The second part of that is it's part of the platform. You don't have to give up or accept different or lower security capabilities when you go to the cloud with Palo Alto Networks. You get to have all those capabilities seamlessly from endpoints to network to cloud to private cloud, third-party SaaS applications. It's exactly the same outcome, and customers really love the orchestration, the automation that you get as a result of that as well. Those are the fundamental 2 differences on a competitive aspect that people really appreciate when they look at our VM-Series.
Thank you.
We'll take our next question from Ken Talanian with Evercore ISI.
Hi, guys. Thanks for taking the question. First off, have you seen any changes in the customer's desire to do multi-year deals? Along with that, can we expect contract duration to remain relatively constant going forward?
Over the years, we've seen a slight uptick in contract duration, and that's really been customer led. It's indication of the value that we're bringing to the table and that customers want to standardize on us for a multi-year period and also renew at very high rates. Contract duration has been stable year-over-year. It's hard to predict where contract duration's going to go. At this point, from our own internal modeling standpoint, we're not assuming any wide variation in contract duration on a go-forward basis. Time will tell.
Okay. This is a follow-up. I know we've sort of touched on this before with some of the prior questions, but I'm just curious, which of the new appliance families demonstrated the most traction in the quarter?
Well, we saw great traction from the PA-5200 series and also the PA-220. The 800 was also good too. It was really kind of across the board, we saw really nice adoption.
We'll take our next question from Walter Pritchard with Citi.
Hi, question on your product revenue. You've had pretty dramatic difference in growth rates over the last couple of years. Your billings are growing probably in line with the industry. Your product revenue probably growing below the industry, although as many have pointed out, off of tough comps. I'm wondering how you think about that going forward, just roughly you generate a lot of subscription attach, you have the unattached subscription. I'm wondering if we'll continue to see a total business that grows well in excess of product or if you think those will converge as things start to normalize here.
Hey, Walter. Yeah, a few thoughts around that. One is like I said earlier that where we were happy to see where we got the product revenue from a quarter perspective. As a general matter, we think we could do better. We plan to do better along these lines. When we think about the industry, it doesn't look as though people really break out product or what's hardware specific in the industry. One of the things we look at is just how much money gets spent by everybody that they report on the hardware side. We continue to take more than our fair share on that from a product perspective. We also know, of course, there's a relationship between the products or the hardware and the attached services as well.
As we work to improve the product revenue growth over time, that would have some impact on the attached subscription services. We're doing very well on the non-attached as well from a growth perspective. That's a small part of the business, but growing very quickly, we'd expect that to do better over time as well. There's a lot of things into the mix around that, which all comes out in the wash on billings growth and total revenue growth over time, which is we're very focused on as part of the total platform.
Any comment on unattached revenue this quarter? Just any run rate or anything to help us understand traction collectively in that part of the subscription business?
Sure, yeah. We talk about the attached business on a semi-annual basis, we said last quarter it was about 2.6 on the attached side. It went up.
On the unattached business, it was very good. We referenced in our prepared remarks the number of new customers. That's an indication as well of the traction that we're getting.
ladies and gentlemen, our final question today comes from Keith Weiss with Morgan Stanley.
Thank you guys for sneaking me in. One of the things that I want to just drill down into is, or better understand, is the dynamic on how you're able to keep adding customers so well. You had a really good new customer add quarter, despite the fact that you're going through a sales reorg. One, how does that dynamic sustain? How do you guys sustain new customer adds so well while you're going through the sales reorg? On the flip side of the equation, while new customer adds look to be up pretty nicely on a year-on-year basis, product revenue was basically flat on a year-on-year basis. Should we take away that sort of where the weakness resides is more in terms of expanding existing customers more so than getting new customers in the door?
That's a great question, Keith. A couple thoughts on that. The first was, I'll take this in reverse. As we said last quarter, when you look at our business, it's going to come from new customer acquisition and expansion of existing customers. About two-thirds of our business today is driven by expansion opportunities with customers we've already acquired. Of course, we want to continue to have high rates of customer acquisition. I'll come back to that thought in just a second. We're very happy to see high rates of customer acquisition. The trick is to expand the business side of this. Where we had some issues, and we're working through them with the reorg stuff, was looking at the lifetime value expansion when you looked at the segments of the market.
When we look at the highest end segment of the market, which is the Global 2000 and the biggest customers, wallet share, lifetime value expansion has done very nicely there, and continues very nicely there, despite some of the issues that we've talked about before. It's really about getting the lifetime value expansion where we want it to be and where we've had it historically below that segment of the market, and that's where a lot of the reorg and alignment issues were, and that's what we're really focused on fixing. From a new customer acquisition perspective, we're getting new customers not only from our direct team as well, we're also getting customer acquisition through the channel. Our channel is strong and growing over time, we're going to continue to get more customers from them.
I love the fact that we just had our second-highest customer acquisition quarter in history, I think we could do better, right? The better we get from a go-to-market perspective, we should be able to continue to acquire even more customers than that. Look forward to being able to do that.
Got it. If I could just sneak in a follow-up. While 1% product revenue growth was better than what we had anticipated, it's still undergrowing the marketplace. I'm assuming it's those dynamics around sort of the new customer acquisition, being able to continue to get the customers in the door that give you guys the confidence that you're not kind of losing share, if you will, that that opportunity remains. It's just more of untapped within these existing customers versus kind of net losing opportunity.
Hey, Keith. Just on the year-over-year growth rate, we're clearly coming off of, what is it, very high, tough comparable. We grew product revenue last year 33% year-over-year. If you look at the dollar amount of product revenue that gets done in a particular quarter, as Mark mentioned earlier, we're taking more than our fair share. There are some vendors that don't even give out product revenue, and so we're shadow boxing with them a little bit. We are doing very well in the market, and the new products that we have that we've just introduced, the rate of new customer acquisition, we feel like there are crosscurrents that we've talked about around sales reorganization, but we're laser focused on increasing the growth prospects of the company.
That of course includes product revenue as well.
Ladies and gentlemen, that does conclude our question and answer session for today. Mr. McLaughlin, I'd like to turn the call back over to you for any closing remarks.
Thanks, operator. Appreciate it. Before I close, I wanted to thank the Palo Alto Networks team for their dedication and our customers and partners for the opportunity to work with them. We hope to see everyone at Ignite in just a couple of weeks. Thanks for being on the call today. Bye-bye.
Ladies and gentlemen, this does conclude today's conference. We appreciate your participation.