Good day, everyone, and welcome to the Palo Alto Networks Fiscal Second Quarter 20 17 Earnings Call. Today's conference is being recorded. At this time, I'd like to turn the conference over to Kelsey Turcotte, Vice President, Investor Relations.
This call is being broadcast live over the web and can be accessed on the Investors section of our site at investors. Paloaltonetworks.com. With me on today's call are Mark McLaughlin, our Chairman and Chief Executive Officer and Stefan Tomlinson, our Chief Financial Officer. This Good afternoon, we issued a press release announcing our results for the fiscal Q2 ended January 31, 2017. If you would like a copy of the release, you can access it online on our call.
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 outlook for the Q3 and full year Our competitive position and the demand and market opportunity for our products and subscriptions, our ability to drive outside growth rates, trends in certain financial results and Our initiatives, plans and investments regarding our sales productivity, success and timing of integration of our newly acquired and innovations in our product, subscription and support offering. These forward looking statements involve a number of risks and uncertainties, release, 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 replay as of today, and you should not rely on them as representing our views in the future, and we undertake no obligation to update these statements after this call. For a more detailed description of factors that 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 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'd also like to inform you that we will Presenting at the Morgan Stanley Technology, Media and Telecom Conference on Thursday, March 2nd and the Raymond James and Associates 30 8th Annual Institutional Investors on Tuesday, March 7. And finally, once we have completed our formal remarks, we will be posting them to our Investor Relations and our earnings conference call will be recorded.
Thank you, Kelsey, and thank you everyone for joining us today on the call to discuss our fiscal 2nd quarter results. In the Q2, revenue grew 26% year over year to $423,000,000 and billings grew 22% year over year to 562,000,000 We generated free cash flow of $170,000,000 up 24% year over year and reported non GAAP earnings per share of $0.63 up 47 percent year over year. There are a lot of very positive things to discuss from the 2nd quarter, which I'll do later in my remarks. I want to start off by noting that we are disappointed in our Q2 revenue results and guidance for the balance of the year. Upfront, I want to discuss what is happening, what we're doing about it and then Stefan will discuss the impact to us for the second half of our fiscal year.
As far as what is happening, we believe that our weaker performance is primarily caused by go to market execution issues that are becoming more evident as we progress through the year. The impact from these issues is lower productivity than we planned for in the year with a broader base of slower pipeline conversion than what we started to experience in the Q1. Why would this be? For several years now, we've been running a playbook that has resulted in high growth rates. The basic components of that playbook are that each year we split territories, continually segment the market vertically by customer size and forward invest in sales and marketing resources.
These actions are of course designed to drive productivity. We've had very good results with this playbook for some time and continued with it in our fiscal 2017 planning. We were not seeing expected return on investment. And drilling into why our initial analysis is that we overcomplicated our go to market motion with a lot more territory splits and segmentation, as we change the coverage model from any customer relationships resulting in lower productivity and less accuracy in forecasting. So what are we doing about it?
We are working diligently and quickly to identify the actions to adapt at the midpoint of the year and are focused on the following things right now. First, we are reorganizing our account coverage model to drive more accountability and clarity. 2nd, we are recalibrating investments in our sales and marketing resources to better support and 3rd, we are updating our second half plan to better reflect our mid year forecast assuming near term disruption as we make the moves necessary to get back to the productivity levels we expect of our investments. While we continue to grow very quickly, I've stated many times both in the company and externally, the quality execution at rapid deal is very important for the success of the company. We are accountable for the issues and believe we can fix them.
Because we want to ensure that we do that in a thoughtful fashion and so that we And answer all the questions I'm sure you will have as we progress through that work, we're going to postpone our Investor Day currently scheduled for March 16 until September in 2017. This will allow us to be as thorough and definitive as possible when we gather in New York. Despite these execution issues, we continue to capture share at high rates. In Q2, we added approximately 2,000 new customers and are now privileged to be serving more than 37,500 services company that included all attached and non attached subscriptions including a significant Traps investment. A competitive win against Cisco to through the data center and perimeter at 1 of the world's largest physical security companies that included all attached subscriptions, a Cisco replacement and competitive win against Check point for a data center project at a major North American healthcare provider that included a significant investment in both hardware a Check Point replacement to secure the retail network at a large North American retailer including our VM Series and Autofocus and a competitive win Cisco and Check Point to secure the private cloud of a bank based in Europe.
Adoption across our platform also continues to drive lifetime value growth. All of our top 25 lifetime customers again made purchases in the Q2 and to make this list a customer had to have spent a minimum of $16,600,000 in and a $5,500,000 in Q2 of fiscal 2016. Customers are call. These are the hallmarks of our true platform and customers are seeing the results in better security, less complexity and a better total cost of ownership. And in looking at the offerings in the platform, we continue to see momentum across the balance of our attached subscriptions, including Wildfire, where we added include Traps, the M Series, Aperture and Autofocus are also growing very well and in the second quarter on a combined annualized run rate of over $100,000,000 in sales growing greater than 100% year over year.
Traps, our advanced endpoint protection, provides customers prevention capabilities and endpoints, seamless understanding of threats across the network and endpoints and the leverage inherent in our very large and growing customer system across our entire environment. In the Q2, we grew the Traps customer base more than 35% sequentially to 8 75 customers and saw significant increase and deal sizes. A recent survey of our Traps customer base indicated that over 70% of those surveyed chose to replace legacy antivirus with Traps due to its superior protection from malware and exploits combined with the integration with our next generation security platform. Our VM Series cloud security offerings are growing very quickly as well due to our unique abilities to provide superior and consistent security across all cloud and on premise environments and deep integration cloud automation and registration. This is evident with the success for our VM series where we now have well over 2,500 customers with increasing deal sizes.
To continue accelerating success in cloud security, we now have all technical sales engineers trained on cloud with a growing number of cloud specialists dedicated and with our expanded lineup of VM Series offerings and continued deep integration with leading private and With cloud platform providers, we are well positioned in cloud security. For Aperture, our SaaS security offering, we increased our customer count sequentially by over 40 and are quickly expanding the number of applications we can protect. The latest Aperture release now supports complete automation for data leakage and threat risk confirmation with the ability to instantly quarantine malware and remove sensitive data sharing in violation of policy to protect the network and enforce compliance and SaaS application. And on the machine learning front, we continue to make good progress with Autofocus with over 150 customers, including some of the world's largest organizations. AutoFocus was our first subscription developed to leverage the massive amount of data we are now ingesting and take advantage of our analytics and machine learning capabilities to make high quality predictive and proactive security decision that can be automatically enforced across our entire next generation security platform.
Along those lines, we are very pleased to be announcing today the acquisition of LightCyber, is a leading company in the behavior analytics space. We have spent quite some time evaluating the players in this fast growing space and are very impressed and capabilities and team at Lightsaber. The Lightsaber offering will continue to be sold as it is for now and will be integrated into the platform and offered as a subscription service by the end of this calendar year. And we're accelerating the platform advantage. We're very excited about the new product launch we held on February conference, where we had more than 20,000 participants attend both live and through our webcast.
At the event, we introduced PAN OS of our newest operating system with more than 70 new features and many new products and unique capabilities including 6 new hardware We have a number of applications designed to enable customers to deploy next generation security from large data centers to small branches, all managed issued by a new and faster version of Panorama. These appliances provide faster performance for deep visibility into and control over all traffic, including encrypted traffic, which is becoming an increasingly strategic need for effective security. 3 new VM Series models to add of the existing 4 we currently offer creating the broadest range of cloud security offerings in the market. This enables a wider range of deployment types and and greater integration with Amazon Web Services, Microsoft Azure and VMware NSX to deliver scale, redundancy and automation that allows customers to easily build cloud centric architectures. The industry's first multi method scalable and automated approach designed to prevent credential based theft and abuse by attackers.
Credential theft has become an increasingly popular tool for attackers as it often allows them to bypass a number of other difficult steps in the attack lifecycle. Our new capabilities include the unique ability to prevent sending password based corporate credentials to unauthorized sites and an innovative approach to policy based multi factor authentication enforced at the network level to prevent the reuse of stolen credentials and several new threat prevention capabilities, including automatic command and control signature generation, and positive reaction to our approach in our platform and strong market traction. And we believe in our ability to address the execution issues I noted earlier, allowing us continues to drive outsized market share gains. And with that, I'll turn the call over to Stefan.
Thank you, 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. Let me start by saying we're disappointed that we pointed that we fell below our revenue guidance range for Q2. In the quarter, we reported revenue of $422,600,000 an increase of 26%. Looking at the geographic mix of revenue, the Americas grew 28% and accounted for 69% share.
12% share. Product revenue of $168,800,000 was essentially flat compared to the prior year. We anticipated that Q2 product growth would be weak due to a difficult year over year comparable, but product revenue fell below our expectation due to the execution issues Mark discussed as well as some customers, more than we anticipated delaying purchasing decisions based on the significant product release in early February. Subscription and support revenue is now on an annual run rate north of $1,000,000,000 and continues to grow at very high rates. Q2 SaaS based subscription revenue of $134,300,000 increased 59 Attach rates grew to 2.6 subscriptions per device shipped, up from 2.3 in the prior year period and $253,800,000 increased 54% and accounted for a 60% share of total revenue.
Turning billings. Q2 billings of $561,600,000 increased 22%. The dollar weighted contract duration for new subscriptions and structure. For the first half of fiscal twenty seventeen, billings of $1,100,000,000 increased increased 27% year over year. Product billings were $334,300,000 up 6% and accounted for 31% of total billings.
Subscription billings were $395,900,000 up 41% and support billings were 348 point of $3,000,000 up 39%. Subscription and support billings accounted for 69% of total billings in the first half of fiscal 2017 compared to 63% in the first half of fiscal twenty sixteen. In Q2, total deferred revenue of $1,500,000,000 increased 61%. Moving on to margins. Q2 gross margin was of 78.6%, an increase of 140 basis points compared to last year.
The increase was driven by improvements in recurring subscription and support gross margins offset by a product gross margin decline of 50 basis points year over year. 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. Q2 Q2 operating expenses were $249,000,000 or 58.9 percent of revenue. Operating margin was 19.7 percent in Q2, representing 120 basis points of improvement year over year. Net income for the quarter grew 51% year over year of $59,600,000 non GAAP EPS grew 47 percent to $0.63 per diluted share.
On a GAAP basis for the 2nd quarter net loss was $60,600,000 or $0.67 per basic and diluted share. Turning to cash flows and balance sheet items. Q2 cash flow from operations of $214,300,000 increased 39 year over year. Capital expenditures in the quarter were $44,700,000 including $31,100,000 of CapEx related to our new headquarters. Free cash flow for Q2 was $169,600,000 up 24% at a margin of 40.1 conference.
Excluding CapEx related to our new headquarters, free cash flow was $200,700,000 up 46% year over year at a margin of 47.5 We finished January with cash, cash equivalents and investments of $2,100,000,000 And I'm pleased to announce that the Board of Directors authorized a $500,000,000 increase to our existing share repurchase program and extended the end date of the program to December 31, 20 team. This brings the total amount authorized under the current program to $1,000,000,000 During the second quarter, We purchased approximately 900,000 shares of common stock at an average price of $132 a share, leaving a balance of approximately 8 and $30,000,000 available for ongoing repurchases. DSOs were 78 days within the previously provided range of 70 to 80 days. As we look toward the future, we remain committed to our long term strategy to capture market share within our financial framework of growth and profitability. This afternoon, we announced that we have acquired privately held LightCyber for $105,000,000 in cash.
Expands our next generation security platform with its highly automated and accurate behavioral analytics technology. And while we will continue to offer the LightCyber products and to support existing customer implementations, we expect to make LightCyber available as a non attached subscription by the end of the calendar year. For fiscal 2017, LightCyber's contribution to revenue will be immaterial and we expect to invest approximately $5,000,000 per quarter in both Q3 and Q4, primarily in R and D and platform integration. For the Q3 of Fiscal 2017, our guidance anticipates that there will be some disruption as we implement changes to our go to market playbook And as a result, sales productivity will remain below our originally planned productivity levels in the second half. We expect revenue to be in the range of of $414,000,000 an increase of 17% to 20%.
Incorporating the approximately 26% to 30% using 93000000 to 95000000 shares. We expect Q3 product revenue to be in the range of 100 and $45,000,000 to $148,000,000 Based on our current pipeline analysis, we anticipate billings growth to trail revenue growth in each Q3 and Q4 by approximately 10 to 15 percentage points. Our current view for the full fiscal year 2017 is an annual revenue growth of approximately 25% and essentially flat product revenue growth for the year. We anticipate annual non GAAP We expect full year non GAAP EPS to be in the range of $2.45 to $2.50 which includes a 0 point CapEx and free cash flow margin to be the range of $160,000,000 to $170,000,000 and 35% to 40%, which includes approximately $100,000,000 related to our new headquarters of which we expect approximately $35,000,000 to fall into Q3. Excluding CapEx from the new headquarters, free cash flow margin is expected to be at least 40%.
Structurally, our hybrid SaaS model combined with operational discipline continues to drive strong deferred revenue, revenue and free cash flow generation. With that, I'll turn the call back over to Mark.
We appreciate you being on the call today. In summary, while we're excited and confident about the future, we know we have work to do to improve our provider. And with that, we'll open up the call for questions. Operator, please go ahead.
Thank you. With one follow-up. Again, that's star 1. We'll go to Matt Hedberg with RBC Capital Markets.
Hey, guys. Thanks for taking my questions. Mark, in your prepared remarks, you talked about reorging your go to market model. I I wonder if you could talk a little bit more specifically about changes you plan to make and maybe how long should we expect some of these to start producing the desired results?
Sure, Matt. Thanks. Great question. So we need to do 3 basic things here from a go to market perspective on the items I talked about. The first is we have to go I can do account mapping or remap the accounts from a coverage perspective because we have the account coverage blurred right now in a way that's not helping 2nd thing we're going to have to do is reallocate the resources to properly align with that account coverage.
And then the third thing is to make sure we've got the right people with the right skills in So it's a pretty big effort we have to undertake here. We started it already. We expect to be working through that in the second half and hopefully see the benefits of that as come out of the back half of the year into fiscal 2018.
And that's great. I'm sure we'll hear more about as we move. And I guess maybe drilling down specifically on the sales and marketing line item. I'm just kind of curious what you're talking about what you think in terms of capacity adds here. I know productivity is lower than you expect here, but Do you still expect to add capacity, maybe at a lower rate to sort of map to the billings growth or just sort of just trying to get a sense for capacity adds?
Yes, yes, it's a good question, Matt. So what we're very focused on is productivity at this point, right? So we have we brought a lot of people in, in the detail half of call 16 twice as many as we've done before. So, we're going to continue to add some heads into this from a go to market perspective. We'll slow that rate down in the back half of
question comes from Michael Turits with Raymond James.
Hey, guys. It's Michael Turits. I'm trying to understand exactly portfolio. And you were going through a very staged process of first adding vertical overlays and then getting rid of them and then integrating So what really was the disconnect and how are you planning to do things differently?
Yes, Michael, it's Mark. So we've had been running out of playbook very Especially for quite some time as I said and we continue to run that in fiscal 2017. What we did incorrectly as we look back on this and it's fighting Now is just the magnitude of what we did coming out of 2016 into 2017 and the rate of territory splits and I'll give source that accordingly. That turned out to not be produced productivity thoughts. So as an example, we have to bring big swaths of customer accounts From a mapping perspective back into territories, have the right people on the chairs in order to execute on those.
So we know the playbook has worked for us in the past and We realize what we've done incorrectly with that playbook, we're going to go.
And I guess just to continue in the same, Ben, any change in the channel strategy relative
We like our channel a lot. The channel has been very good to us and we've got great relationships with the channel. So we're not going
Our next question comes from Pierre Ferragu with Bernstein.
Conference. Hi, thank you for taking my question. Marc, what gives you confidence. And what's your level of confidence that like your disappointing productivity and disappointing Sales performance is an issue that really comes from internal problems and that it is not also Simply related by to the fact that maybe your competitive environment has been evolving and you're facing competitors who are like catching up and Putting that game together. And then on the productivity front, so if you had like product Sales this quarter that were about in line with where they were last year, you have like a significantly And then if you could maybe give us a sense of how did the sales force basically waste this productivity?
So where did their time go? Where did the
See if I can track all that. Let me start in with the first one. On the competitor front, we watch that very closely. We believe and have believed We have the best technical leadership in the market today. We just we vastly increased that with the new product launch we did on February 7, which is very well attended and the addition of a LightSiber is an example into the family as well.
The issues that we're dealing with, I think are primarily execution oriented and that we can go address those things. We've seen continued progress in the market. We just did another quarter of 2,000 net new customers increasing lifetime value as Well, very, very high customer sat scores and net promoter scores as well. So the feedback from the market seems very positive. This is something that appears what we've done to ourselves and something of the sales organization as we progress through fiscal 2016 than we did in 2015 and added some more in Q1 of 2017 as well.
So the rate and pace was a lot higher and in hindsight realizing that that is something that has created challenges for us and we're going to go fix that. And then on your last question as far as what are people working on? Everybody is working very hard and very diligently. But the amount of relationship changes that occurred with these various account coverage moves that we made, it's very high. So when you're moving the relationships around and trying to build on those relationships, it's hard.
And at a minimum, we would see something like we're seeing now. We should have seen this earlier, but
And we'll go to Andrew
And we'll go to Andrew Nowinski with Piper Jaffray.
All right, thanks.
I want to ask about a comment you made about the delayed purchase decisions that customers made with regard to the new products that you launched in the quarter. Given the performance improvements in the new products, you would think that it would compel those customers to move forward with Palo Alto, but your guidance suggests the opposite. So I guess can you help us understand why the deals that were delayed due to the new product launch would not come through in the April quarter?
Andrew, it's a good question. It's possible they may, and the new products have been received very well from customer feedback. So far we had a fantastic launch and they're really good. As Stefan mentioned, We did see some customers delaying purchases we got to the end of the Q2 in January. We was always trying to walk a very conference.
We're very pleased with the pipeline of the year. We're very pleased with the market at the end of the quarter. So we brought them out right in the beginning. You may have noticed that we did a lot of Advertising not specifically about the products, but something big was coming. And so that's always hard to get that right towards the beginning Unfortunately, what we have is the execution issue is going to overweight any goodness on that for some time and we have to work
Give us your thoughts on the pending refresh cycle this year and how we should think about that, with regard to your expectations for the remainder of the year?
Yes. As we've said in the past, We think we have a very significant refresh opportunity in front of us and that of course hasn't changed. I think the new products is going to help on that. It's going to be up against the headwind of the execution stuff we just mentioned. Kind of putting that in perspective.
So, if you look at all the cohorts or classes of customers as ours from 2,008 to 20 That hasn't changed, and we're confident about that, but we got to work through these other issues to really get the benefit of that.
We'll now hear from Philip Winslow with Wells Fargo Securities.
Hi, thanks guys. Just to build on that, You have two questions. I guess on the refresh side, how is how do you think sort of the changes to the go to market strategy maybe affected the timing of that refresh at all. I mean, obviously, its average is about, call it, 5 years, but things can slip. Did Any of the changes sort of impact, call it, existing customers and you're thinking of sort of your cadence of refreshing those?
And then also, one of the things you talked about in the past too was Service provider wins. I wonder if you could just double click on that space a little bit, sort of what's happened year to date? How are you thinking about sort of the second half?
Yes, sure. On the first question on the refresh, well, having execution headwinds doesn't help at all of course, but we're very confident that people are going to want to get a refresh On the new product line, the new product line is really good and it provides 3 or 4 different opportunities from Refresh perspective and it was clearly designed to do it that way. But again, it's going to be up against this, just getting our act together from a go to market perspective and implementing the changes we need to I'll let Mark Anderson answer the service provider question.
Yes. Hey, Phil. As you know, we started focusing on service provider about a year and a half ago and it's going very well, especially Given the new product map that we have for virtualized products, going much smaller and much bigger, is really going to help us quite substantially in our managed services business with those customers. But we feel very good about where we are and the team is ramping very
Okay, great. Mark, I wanted to ask your thoughts on the industry backdrop coming out of RSA. Does it seem like Cal 'seventeen budgets are getting better year on year? And then clarity, there's a lot of new players in the industry. It seems Crowded and combative at some points.
Maybe if you could talk about budgeting and then how people are going to spend their money? Thanks.
Yes, sure. Very good question, Jason, lots and lots of vendors up there and lots of people showed up at RSA, which is, I think a good thing in the sense of there needs to be a lot of innovation in the Security industry. But I'll answer your question in 2 different ways. First, from a backdrop perspective, it seems like securities has still remains a priority and spending is good on security. So what we're facing here is things that we've created ourselves here not so much a spending issue in security.
I think on the second front, it's becoming more apparent, I can see it up at RSA about what the consumption model of all that innovation is going to look like over time. And what I mean by that is very clear that the age of the platform for confirmation through platforms going to be less and less platform companies out there and a lot of the smaller companies who are highly innovative will be
Thank you. Thank you.
Our next question will come from from Ken Talanian with Evercore ISI.
Hi, guys. Thanks for taking my question. First off, just wondering, could you give us a sense if there are any changes that you've noticed in the go to market approaches by your competitors? And really, I'm thinking about Cisco here in
No, the competition has been fierce for a long time, Ken, and I think it will It needs to be that way. People buy usually on 3 angles security reduction in complexity and cost and different Players in the market have gone after different levels. Their ours is kind of top down, which is security reduction complexity and at a very good cost. People approach it from a different angle, but I haven't noticed anything different from the competitive landscape in that regard. Okay.
And then also based on your guidance for next quarter, it looks like product growth might actually decline both sequentially and year over year. So one just curious if that's directionally correct and then if you could give us a sense for what product growth will do in fiscal 2017
Unfortunately, we're inaccurate that regard because of the things we're facing here, but we also believe those things within our control and we can fix them and that we will be able to get back on track from a product growth perspective.
I will go to Sterling Auty with JPMorgan.
Yes, thanks. Hi, guys. Would you say that the execution issues were evident throughout the quarter or did they manifest later in the quarter. And the reason I'm asking just given the good results we saw out of off quarter companies like Barracuda and the December quarter earnings From everybody else, did this manifest late in the quarter?
Yes, great question Sterling. Let me actually back it up a little further and on from a Q1 perspective and what we saw in Q1, which we had talked to you guys about as well, which was the 1st 2 months being on track and then seeing some slowdown in month 3, in our case, specific to some large deals. In hindsight looking back on that and looking for your pattern in that, that's what we saw play out in So that's what it looked like as far as the Q2 playing out from a linearity perspective.
And even though you said
the sales execution changes would outweigh any pickup from stuff that was frozen waiting for the new products, Is there a way to at least quantify how much business you felt rose and waited for the new appliances and PAN-eight launch?
Yes. I don't think it was that much. If you look at we're not happy that we came in under the guide right in Q2 on that, but we weren't that far away from it. So It's not that much and it's also very hard to tease through like what's related to the execution and what people are saying specifically on product delays though, It's a little bit difficult to say.
Got it. Thank you.
Thanks, Sterling.
And Greg Moskowitz with Cowen and Company.
Okay. Thank you. I had a question for Stefan. If I recall correctly, at your last Analyst Day, You talked about Palo Alto being in high growth mode and put out expectations to continue to grow 30% or more for the foreseeable future. Obviously, you've guided to 25% growth for fiscal 2017.
And the question really is, do these results change your view Looking forward of where Palo Alto sits on the growth and maturity curve?
Yes. So we just came off a quarter where we posted 26% year over year growth Clearly, we're not satisfied with that. We've identified execution issues that we are, in the process of working through And we have a high level of confidence there within our control and we can fix them. We need to get through that work before we call the ball on future levels of growth. But I can tell you that we feel very confident in returning to growth and we get these execution
And we'll go to John DiFucci with Jefferies.
Thank you.
From our calculations anyway, new business growth was very modest for the 2nd consecutive quarter. And I know you're talking a lot about your mis execution, but you're really not the only ones to have some challenging quarters over the last year or so. I mean even Checkpoint, it was at a couple of quarters had some challenging periods before that. I guess, Mark, if there's anything else other than mis execution, what else might be happening out there that could be affecting your results?
That's a great question, John. So I think well, a couple of things on this. One on the new business side, we have to acquire new customers and we have to expanded our existing customer base as well. So we always watch both of those and the bulk of the business obviously as we get bigger will come from We just acquired 2,000 new customers in the quarter. So it seems like from a customer acquisition and win rate perspective in the It's been healthy.
It continues to be healthy. What we're seeing now is the slowdown from a conversion perspective, on the expansion downstream, which makes sense as we look back on to the go to market motions we made about changing So existing relationships you can change around a lot within 2, 3 different times in a short period of time is going to create Some anxiety from the customer account coverage perspective and that's where we see the slowdown in the conversion is down to the expansion
Okay. And then one area in particular that we've been hearing more about is just trying to protect the east west traffic, which as you know is sort of a it's not something that everybody does and it's not something every day as broadly. But I think it's generally thought of Palo Alto Networks actually does it very well compared to others. At the same It's an area where we do hear people questioning how much they're going to need to do that, especially if they start to move workloads to the cloud. Are you seeing anything around that today?
We're actually seeing an increase in East West traffic, interest in protection. And the reason it's actually is To the cloud as well because at the same time people are on a journey to the cloud. They're also doing lots of data center work to Optimize data centers. When they do that, they use a lot of virtualization inside those data center environments, which means that they're going micro segment, all those environments inside the data center, which is great, but then you have to also be able to protect the information that traverses east west that ever since we started off with that with VMware NSX, which has been pretty successful for us.
Our next question will come from Gabriela Borges with Goldman Sachs.
Great. Thanks for taking the question. Maybe just a little more on the assumptions that are going into guidance for the back half, if I could. Stefan, you mentioned that you are accounting for sales productivity being below the originally planned productivity levels. But how does that compare to the productivity levels you're seeing today?
And similar questions for the timing of deal cycles and how long you're assuming deal cycles take to close?
Thank you.
Yes. Good Gabrielle, when we were looking at sales productivity relative to our plan, we are looking at high single digit delta between what the planned productivity was and what is actually forecasted to be. And we're Factor that into our guidance for the second half. We're purposely being prudent and cautious around the guide because We understand that the execution issues will take a while to get through. We're actively working on those remediations right now.
And we factor that into the guide. And when you look at timing of sales cycle elongation, We've seen elongating sales cycles. We called that out in Q1. We saw an extension of that in Q2, but on a much broader base. So we're clearly not satisfied with the year over year growth that we're posting and we feel like after we make the
Thank you. And Walter Pritchard with Citi has our next question.
Thanks. Mark, I guess question for you. You look at the metric on new customer adds 2,000, it looked pretty good. I'm wondering as we look at the results in the context of the new customer adds and the sales changes or the sales disruption, It would seem like the sales disruption might impact your ability to bring in new customers and yet that metric was good. Could you give us some color on How you saw the impact here ripple across the existing customer base, the new customer base, maybe there was a deal size issue that was part of it as well.
Just trying to kind of round that altogether.
Yes, sure thing, So, we just put up another 2,000 net acquisition quarter which is good. We have to make some assumptions as we play out the second half of the year with execution issues as to how that would impact things. We'll see how that plays out. It's a little too early to call that right now. But as I was telling John a little earlier on his question We have to get 2 things right.
We have to get the net new customer acquisition right. And then even more importantly, we have to get the expansion right in the existing customer bases. And if you move the relationships around inside of there, it can create longer timeframes to know what's happening from a deal And I think that's the area where we broke things and we're going to go.
And then just a follow-up for Stefan. On the duration, you talked about 3 years, which it sounds like is an average. Did you open up a program or anything that drove? Because Because if you freeze the average, it sounds like there could be a substantial number of customers who
are actually
signing duration that's longer than 3 years. Was there something that was done programmatically either this year or in
There is nothing done programmatically to drive it higher. This is dollar weighted calculation, not a simple average, it's just number of customers. So we always see that customers we've been seeing this trend Over time customers are asking us to standardize for multi year periods on our architecture. We view that as a positive indicator of our technology lead. And so there was nothing new from an incentive standpoint to encourage that behavior.
It's more customer driven.
We'll go to Karl Keirstead with Deutsche Bank.
Thank you. I've got 2 questions, both on the guidance. First, your guidance suggests the second half of fiscal 'seventeen should See about 20% growth and I maybe I'll throw this one to Mark. Do you think that's a realistic target for fiscal 2018? Do you think you can hit 20% growth next fiscal year.
And then the second one is for Stefan. Stefan, you mentioned that if I heard you correctly, billings growth should be less than revenue growth by 10 to 15 percentage points in the back half. So if the back half revenue growth is 20%, you're suggesting that The billings growth should be 5% to 10%. And given that your subscription and maintenance billings are tracking close of 40%. It's almost hard to get the billings growth all the way down to 5% to 10% and maybe I'm missing something you could help me with.
Thank you.
Yes, I'll take the first one, So we're not happy with the guidance we've put out there. We're working to fix that of course. And we have a number of issues We got to go work on. We are going to progress through that through the back half of the year and expect that that will get us back on track. We need to go sort that out and we'll come back to you as fast as we can with much better answers on a long term basis for fiscal 2018.
We don't think that'd be prudent right now to set that out there.
Yes. And From a billings growth standpoint and you look at how that translates to revenue, let me start by saying it all really begins with sales productivity. And with sales productivity with sales productivity. And with sales productivity tracking high single digits below our plan That translates into much lower billings growth. If you remember, if you look at the composition of our billings, we get In the first half of twenty seventeen about 69% was subscription support and renewal.
When you look at Revenue, we're effectively indicating that product revenue is going to be flat for the full year Fiscal 2017 versus 2016. We're still anticipating high levels of subscription and We're intentionally taking corrective steps to fix that problem. We're anticipating much lower billings growth during this transition period as we're trying to correct than what we're seeing today and what we're forecasting for the balance of the fiscal year.
Got it. Okay. Thank you both. That's helpful. Thanks, Rob.
We'll continue on to Catharine Trebnick with Dougherty.
Hi. Thank you so much for taking my question. You had said that the product revenue growth was expected to be now flat year over year. Outside the execution issues you discussed, How much of that flat growth would be attributed to your VM series and rapid adoption of Migration to the cloud by your enterprise customers. And then the second piece of that, did I hear you correctly that you said the channel was okay, so Am I to assume that your competing overlay sales teams perhaps caused some of the execution issues in your and inaccuracy in your reporting?
Thank you.
Hey, Catherine. I was going to hear from you. On the cloud side, I don't think the product growth for the second half is has anything to do with the cloud. That's actually been is a good opportunity for us in a lot of ways a lead generator is always when there's something new whether it's virtualization or cloud in In this case, we've been able to exploit that opportunity is another reason to talk to Palo Alto Networks or somebody who may not otherwise and do start doing business in the 1st place and do more business over time and that's what we've seen. So we're not happy about the product guide for the second of the year.
I don't believe that's due to the cloud. I'm going to let Mark Anderson take the channel question.
Yes. So let me just add on a little bit to what Mark said. Firstly, The overlay team, there's no confusion, Catherine, in what our overlay teams are doing. It's primarily technical sales Overlaying our core sales teams to help them sell traps, sell into the cloud environment, sell aperture and autofocus. And we're very happy with the way that's going.
I I think as part of the channel goes, the channel is a very good channel. As we said before, they're executing very well. We're onboarding new channel partners like AWS and Microsoft Azure, our service provider channels continues to get better. All of this execution rests on me. It rests on The sales team and definitely know what we're doing to fix it and we're going to be fixing it as we go on through the fiscal year.
We'll now hear from Jonathan Ho with
Hey, guys. Just wanted to understand with a little bit more granularity, were there any particular geographies or market segments that we should be on the watch for where the sales execution challenges were more pronounced?
Hey, Jonathan. No, this is across the board, but, it may be obvious, but I'll state it anyway that with the Americas being such a large contributor to the business today, that's where we would see the
Got it. And then just in terms of the account coverage shift, how long do you expect that to take To really reestablish the results and do you see the potential to sort of get back to growth once these issues have been corrected?
Those through the back half of the year and we would hope to have them all finished by the back half of the year and we'd be able to come out of the year and in fiscal 2018 in Better position than we are.
As I was saying a little earlier, we
got a lot of stuff to sort out here. We know we can do better than we are today and what we're guiding, but it will be too early for us and really not prudent to call it what it may be into next year.
Got it. Thank you. Thanks, John.
And we'll go to Fatima Boolani with UBS.
Hi, thanks for taking the question. Question for you, Mark, just with respect to the new product lineup. It was obviously one of the bigger launches you've had in the last couple of years. And you did talk about some purchasing pauses with respect to the customer base. I'm wondering if you can help us drill down on how you are managing the forecast for any potential trade down effect or just generally how you're thinking about that?
Sure. That's a Very good question. So whenever we introduce new hardware, we're expecting movement from existing hardware products to new ones. So in all these Some customers are going to move up, some will move across, some are going to move down. It's just inevitable that it's going to occur.
So we have to try to take all that into account conference when we're forecasting. So with the introduction of the PA220, the 8 100 and the 5,200 series, those are the We expect we're going to see a lot of movement to new hardware platforms and we're going to see 2 incremental opportunities. 1 is going to be the refresh as we were talking a little earlier and they also give us a chance to just get new competitive wins with the hardware capabilities. And just I think something we have to think about we have done here is that when you are thinking through trade down impacts, we want to make sure that's minimal. So it's Our job to make sure we're offering customers a really compelling reason to want a higher capacity and performance.
For us, we see our very high attach rates and use of So it's that's art and science there. We hope we get the both of them right.
And a quick follow-up, if I may. You still demonstrated a traded a fair bit of confidence around their installed base to refresh dynamics. Could you parse out qualitatively for us To what extent that confidence is tied to the base doing sort of upsizing on hardware refresh versus incremental subscription attach rates? And this just in the context of the 2.6% attach rate, which didn't really change much versus the past 6 months?
Sure. So let me they're related very much. So we have the attach rates being up year over year from 2 point And of course the they're attaching to the hardware device itself. So when we think about refresh opportunities, we're giving customers A lot to progress towards from a refresh perspective. And we're also hoping that as it's happened in the past that people would attach Very high rates when they do that.
And then also we also have a great opportunity just to win new business as well with the new hardware along with the ever
Our next question comes from Saket with Barclays.
Hey, guys. Thanks for fitting me in here. Hey, first, Mark, maybe just for you. We've obviously talked about execution challenges, a bunch kind of impacting pipeline close rates, but can you just qualitatively talk about overall pipeline growth In the Q2?
Yes, that's a really good question, Tay. So from a pipeline perspective, we have done in the past, we We continue to do a very nice job in demand generation. So we have a very good pipeline in terms of the size of the pipeline. We issue. It's really just making sure that we get it converted in the time for when we get it converted, but the pipeline is good.
Got it. And then for my follow-up, It sounds like maybe one of the execution challenges besides increasing segmentation was maybe moving some accounts to inside sales, which might have created some noise. I'm sure that there were a multitude of things with this complex of sales organization that you have. But would you say that that was maybe one tangible item that contributed to some of the challenges this quarter?
There are multiple things there, but that's an example of I can't remember who asked the question before, but as an example of something that we've always done in running This playbook was increasingly segment the market. In this case, in trying to try to drive increasingly higher levels of productivity and better return investment. We moved a broad swath of customers into the inside sales organization and resource that accordingly. The folks who used to be in what we call in the territory. So just think of it simply along those ways.
And that's really not working out. So now we need to just one example of things we need You need to map those accounts back from where they were back into those territories, make sure we The right people focus on them and make sure we realign resources appropriately.
Got it. Very helpful. Thanks guys.
Thank you,
Thank you. And at this time, I'd like to turn the conference back over to Mr. Mark Laufman for any additional or closing
Thanks, operator. I appreciate that. Before I close, I'd like to thank the Palo Alto Networks team for their dedication and our customers and partners for the opportunity to work with them. And I'd really like to welcome the LightCyber team to the company. We take the responsibility of helping the world's largest organizations solve their most critical security
And ladies and gentlemen, again, that does conclude today's conference. Thank you all again for your