Good day, everyone. Welcome to the Palo Alto Networks fiscal first quarter 2017 earnings conference call. Today's call is being recorded, and at this time, I would like to turn the conference over to Kelsey Turcotte, Vice President of Investor Relations. Please go ahead, ma'am.
Great. Thank you everyone for joining us on today's conference call to discuss Palo Alto Networks' fiscal first 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, and Steffan Tomlinson, our Chief Financial Officer. This afternoon, we issued a press release announcing our results for the fiscal first quarter ended October 31st, 2016. 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 outlook for the second quarter and full year fiscal 2017, our competitive position, the demand and market opportunity for our products and subscriptions, our growth rates and trends in certain financial results and operating metrics, sales productivities, sales cycles, seasonality, and 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 annual report on Form 10-K filed with the SEC on September 8th, 2016, our earnings release posted a few minutes ago on our website and on the SEC's website. 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. For planning purposes, we expect our fiscal second quarter 2017 earnings conference call to be held after the market closes on Tuesday, February 28th.
We would also like to inform you that we will be presenting at the Credit Suisse 20th Annual Technology Conference on Thursday, December 1st, the Barclays Global Technology, Media and Telecommunications Conference on Wednesday, December 7th, and the 19th Annual Needham Growth Conference on Tuesday, January 10th. For those of you doing long-range planning, we will be hosting our 2017 Analyst Day in New York on Thursday, March 16th. A formal save the date with event details will be emailed shortly. In addition, the supplemental financial information posted this afternoon to the quarterly results section of our investor relations website provides recast tables reflecting the change in accounting for sales commissions. Finally, once we have completed our formal remarks, we will be posting them to our investor relations website under quarterly results. With that, I will turn the call over to Mark.
Thank you, Kelsey, and thank you everyone for joining us this afternoon to report our fiscal Q1 results. In the first quarter, our results significantly outpaced the growth of the market and the competition. Revenue for the quarter grew 34% year-over-year to $398 million, while billings grew 33% year-over-year to $517 million. We generated free cash flow of $182 million, up 43% year-over-year, and reported non-GAAP earnings per share of $0.55, up 62% year-over-year. Security remains a strategic priority for global enterprises and organizations, and we continue to capture mind share and market share at very high rates. In the quarter, we saw strong demand for our next-generation security platform from both new and existing customers, who are also increasingly deploying our eight subscription offerings. We added well over 1,500 new customers and are now privileged to be serving more than 35,500 customers worldwide.
New customer wins and competitive displacements in the quarter included a Check Point replacement in the data center at one of the world's busiest airports, a competitive win against Check Point and Cisco at an EMEA-based investment management and services organization, which made a seven-figure investment in our next-generation security platform, a large cloud deal with a global systems integrator where we replaced Cisco, Fortinet, and FireEye with a significant investment in both our hardware and subscription, including AutoFocus, which served as a strategic competitive differentiator, a McAfee replacement on more than 10,000 endpoints in a government agency in EMEA, and a Fortune 500 manufacturing company where we beat and replaced Cisco for data center segmentation. On the expand side of our business, adoption across our platform continues to drive lifetime value growth across the board. All of our top 25 lifetime value customers again made purchases in the first quarter.
To make this list, the customer had to have spent a minimum of $15.2 million in lifetime value, a 50% increase over the $10.1 million in Q1 of fiscal 2016. Customers are choosing Palo Alto Networks because our platform provides high degrees of automation, ever-increasing leverage from our large and growing ecosystem of customers, consistency of security regardless of where data resides from network to endpoints in the cloud, and the power that comes from the increasing analytic capabilities we're applying to the petabytes of data we now process. These are the hallmarks of a true platform, and customers are seeing the results in better security, less complexity, and better total cost of ownership. Our native platform approach has put us at the forefront of technology evolutions over the last decade and continues to do so with important macro trends like cloud, analytics and machine learning, and IoT.
For cloud computing, private, hybrid, or public, we are uniquely able to help customers achieve the same consistency of security in the cloud as they can achieve in their on-premise environments, which is removing a major inhibitor for large enterprises to move to the cloud. This is increasingly evident with the success of our VM-Series, where we now have well over 2,000 customers. Half of our new VM-Series customers in the quarter were first-time customers, Palo Alto Networks, with the VM capability being their first experience working with us. In addition to the private and public cloud, the need to protect SaaS applications delivered from the cloud also continues to grow in importance, and we saw strong sequential growth in customer count for Aperture. On the machine learning and analytics front, AutoFocus grew very well in the quarter.
This is our first offering that provides high degrees of relevance and correlation across our large data set. Customer feedback in this offering has been very good, and we are now seeing service providers create revenue streams around this capability to provide their MSS customers with highly relevant and actionable threat intelligence. We also continue to see the increasing importance of visibility and enforcement capabilities at both the network and endpoint, especially with the growing focus on IoT. Traps, our advanced endpoint protection, provides customers prevention capabilities on endpoints, seamless understanding of threats across the network and endpoints, and the leverage inherent in our very large and growing customer ecosystem across their entire environment. Standalone endpoint products cannot compare on these three important differentiators.
This quarter, Traps received independent verification that it can help customers meet specific PCI, DSS, and HIPAA security compliance requirements, allowing financial and healthcare organizations to replace legacy AV on client PCs. We now have well over 600 Traps customers, are seeing the Traps pipeline and deal sizes increase, and are currently protecting more than 1 million endpoints and servers. We continue to see momentum across the balance of our subscription offerings, including WildFire, where we added more than 1,000 new customers, bringing our total customer base over 14,000. While continued adoption of the platform was borne out in Q1 across many metrics, including new customer acquisition, increasing lifetime value, and growing penetration rates of our new subscription offerings, our Q1 results were not as robust as we expected.
We are seeing purchasing decisions have to go through additional approvals, particularly in larger companies on the increasingly larger opportunities we are winning. As a result, we saw some deals push. Our win rates remain as high as ever. A good number of the pushed deals have closed. We are benefiting long-term as a security provider of choice. In the short term, we have taken the longer sales cycle into account in our guide. It is clear that security is a priority and will remain so for companies, governments, and organizations across the globe for a very long time. We are highly technically differentiated, and our competitive position continues to grow rapidly. Heading into calendar year-end, the team is focused on helping our customers solve their toughest security challenges in an increasingly complex environment with the market's leading next-generation security platform.
With that, I'll turn the call over to Steffan and look forward to taking your questions. Steffan?
Thank you, Mark. Before I start, I'd like to note that except for revenue and billings figures, all financial figures are non-GAAP unless stated otherwise. In Q1, we continued to execute our financial strategy of growing both the top line and expanding profitability. Our hybrid SaaS model continues to pay off as we posted record deferred revenue, significant year-over-year margin expansion and non-GAAP EPS growth, and record free cash flow. Turning to the numbers, we reported Q1 revenue of $398.1 million, an increase of 34% year-over-year. Looking at the geographic mix of revenue for Q1, the Americas grew 33% and accounted for 70% share. EMEA grew 32% and accounted for 18% share, and APAC grew 47% and accounted for 12% share. Q1 product revenue of $163.8 million increased 11% year-over-year, and growth was healthy across our product portfolio.
To better describe the value we're delivering and to improve clarity, we've renamed the services revenue line on our income statement to subscription and support revenue. In the quarter, subscription and support revenue of $234.3 million increased 57% over the prior year and accounted for a 59% share of total revenue. SaaS-based subscription revenue of $121.2 million increased 65%, while support revenue of $113.1 million increased 49%. Q1 billings were $516.9 million, up 33% year-over-year. Total deferred revenue was $1.4 billion, an increase of 69% year-over-year. Short-term deferred revenue of $758.1 million increased 59% year-over-year and accounted for 56% share of total deferred revenue. Long-term deferred revenue of $601.5 million increased 84% year-over-year and accounted for 44% share of total deferred revenue.
The growth in deferred revenue is driven by customers adopting our subscription and support offerings and renewing them at very high rates. With the top-line details covered, I'll now turn to margins. Q1 gross margin was 79.4%, an increase of 150 basis points compared to last year. Turning to expenses, please note that starting in Q1 fiscal 2017, we moved from our historical approach of expensing all commissions during the period in which the related revenue contract was booked to an accounting policy where commissions are initially deferred and subsequently amortized over the term of the contract. With our business evolving to more of a recurring revenue model, this method provides a much better match between revenue and expenses on the income statement.
Q1 fiscal 2017 operating expenses were $244.4 million or 61.4% of revenue. Operating margin was 18% in Q1, representing a 170-basis point increase year-over-year. Net income for the quarter was $51.2 million, compared with net income of $30.8 million in the same period last year. Using 93.2 million shares, non-GAAP EPS in Q1 was $0.55 per diluted share, increased 62% year-over-year, compared with non-GAAP EPS of $0.34 per diluted share in Q1 2016. On a GAAP basis for the first quarter, net loss was $61.8 million or $0.69 per basic and diluted share. This compares with the Q1 2016 GAAP net loss of $39.9 million or $0.47 per basic and diluted share. Turning to cash flows and balance sheet items. On a year-over-year basis, Q1 cash flow from operations was $203.3 million, up 39%.
Free cash flow was up $182.4 million, up 43%, and free cash flow margin was 45.8%. Capital expenditures in the quarter, including investments in our new corporate headquarters, totaled $20.9 million. We finished October with cash equivalents, and investments of $2.1 billion. During the first quarter, we purchased approximately 340,000 shares of common stock at an average price of approximately $146, leaving a balance of approximately $450 million available for ongoing repurchases through August 31st of 2018. DSOs were 79 days, within the range we provided during our Q4 call in late August. Turning to guidance. For the second quarter of fiscal 2017, we expect revenue to be in the range of $426 million-$432 million, which represents 27%-29% growth year-over-year and implies a first-half fiscal 2017 growth rate of 30%-31%.
We expect non-GAAP EPS to be in the range of $0.61-$0.63 per share using 93.5 million-95.5 million shares. Before I conclude, I'd like to provide modeling points for the full year fiscal 2017. We expect revenue growth will be in the range of 30%-31%. We continue to expect full-year product revenue growth of 12%-13%, and we expect sequential growth from fiscal Q1 through the remainder of the fiscal year, with the lowest year-over-year growth in Q2 and the highest year-over-year growth in Q4. The non-GAAP tax rate is 31%, and we continue to expect full-year non-GAAP EPS to be in the range of $2.75-$2.80 per share using 94 million-96 million shares.
This non-GAAP earnings per share guidance range includes at least 100 basis points of organic non-GAAP operating margin improvement and roughly 150-200 basis points from the deferred commissions change. We expect CapEx and free cash flow margin to be in the range of $160 million-$170 million and 35%-40% respectively, which includes approximately $100 million related to our new headquarters. CapEx will be more heavily weighted towards Q2 and Q3, with approximately 60% of total CapEx falling in these two quarters. Excluding CapEx for the new headquarters building, free cash flow margin is expected to be at least 40%. With that, I'll turn the call back over to the operator for Q&A.
Thank you. If you'd like to ask a question, please signal by pressing *1 on your telephone keypad. If you're on a speakerphone, please make sure your mute function is turned off to allow your signal to reach our equipment. We ask that you please limit yourselves to one question and one follow-up. Again, press *1 to ask a question. At this time, we'll take the first question from Ken Talanian with Evercore ISI. Please go ahead.
Hi, guys. Thanks for taking my question. Just wanted to get a sense for the contribution from unattached subscriptions to subscription billings, and then how we should think about that going forward.
The contribution from unattached subscription billings was healthy on a year-over-year basis. We still have a predominant amount of billings from attached subscriptions, but the % growth rate for unattached subscriptions, it tends to outpace the attached at this point, just given the relative sizes.
Would you say it's doubling year-over-year, like triple digit growth, something in that range?
For our unattached subscriptions, they're growing triple digits.
Okay, great. Thanks very much.
Move now to Weiss with Morgan Stanley.
Excellent. Thank you guys for taking the question. In looking at Q1 and it not being as robust as expected, can you help us understand what gives you guys the comfort that it's not competitive or it's not market saturation, that it's just really extended deal cycles? Sort of how that confidence extends to the full year guidance, which is now looking for acceleration into the back half of the year, particularly on that product revenue side.
Sure thing, Keith. It's Mark. I'm pretty sure it's not competition related, right? You can just see that playing through from a data perspective. We look at the quarter we just posted with 34% revenue growth and look at the major competitors, we're 3x higher than Cisco in growth, 5x higher than Check Point in growth, right? Those win rates are very high. They've been consistently very high, and we expect them to continue to remain that way into the future. It doesn't look to be anything competitive there. Importantly, we always look at the technical stuff as well competitively. Haven't seen anything that competition has done differently, and I think those kind of rates of growth in the compares really prove that out.
From a second half perspective, we said earlier that we expect the second half to be stronger than the first half. We still expect that to be the case. We know that the second half comps are better than the first half. We've got the increasing cohort opportunity on bigger cohorts for refresh and the innovation engine to fuel that. We're also continuing to see pickup from the service provider business, which had a very good first quarter, beating their numbers.
Got it. Q1 is always the time when if there's going to be any changes in go-to-market strategy, there is. Anything unusual this year about the go-to-market strategy or any changes that you guys put into place that might have impacted getting those deals signed on time in the quarter?
No. We've been growing at very high rates, as you know, over time. We've prided ourselves in trying to make sure that we're putting all the people, processes, and system changes in place to scale with that growth in advance. We make changes every year, from a go-to-market perspective, just in order to keep up with that kind of growth. We didn't do anything different this year.
Excellent. Thank you, guys.
We'll now move to Sterling Auty with JPMorgan.
Yeah, thanks. Hi, guys. Trying to put into context, reiterating the full-year EPS, but a tougher start on revenue, especially product revenue. What are you baking in terms of improvement in the environment to hit that acceleration in the back half of the year, versus how are you changing your construct in terms of the growth versus margin expansion?
I'll take the first part of that, Sterling. From a change perspective, we haven't changed what we were thinking before, which was we expected the second half to be stronger than the first half. That still obviously is the case, given the guidance that we're giving today for the reasons that I just gave to you, Keith. From an environment perspective, looks like a mixed environment out there. If you look at all the security companies and peers reporting, that hasn't changed a lot in the last couple three quarters. That got better, and that would be a positive for everybody. Still in that mixed environment, we're delivering way faster than all the competition in the space. I'll turn the EPS question over to Steffan.
Yeah. We continue to expect to grow revenues greater than 30%, but closer to the 30%-31% for the year. That's really due to elongating sales cycles. As Mark mentioned, it's much faster than the growth rate of the competition, the rate of the market. We feel comfortable that even with a little bit of a lower revenue number for the year, we're able to still get to the $2.75-$2.80 non-GAAP EPS through operational discipline and rigor. That's why we feel comfortable with the $2.75-$2.80.
Maybe just to clarify for people, because I've gotten the question already a few times in email and IM, the $2.75-$2.80 is not because of the sales commission accounting change, correct?
Well, it's inclusive of it. Our guidance range when we talked about it on our Q4 earnings call for the setup for FY 2017 was $2.75-$2.80, and that was including a benefit of the deferred commissions change. That's still baked into it. The $2.75-$2.80, as we're calling it right now, is not changing any assumptions that we talked about from Q4.
Moving now to Andrew Nowinski with Piper Jaffray.
All right, thanks. Maybe from a geographic perspective, looks like this is the first quarter in about 2 years where your revenue growth in EMEA outpaced the Americas. Can you give us any color on what impacted the moderation in revenue growth, and specifically in the Americas?
Yeah, Andrew, it's Mark. Yeah. As we noted earlier, we've seen a number of deals, a handful of deals that would push these larger deals because we're winning bigger deals with bigger companies, and it doesn't take a lot of those to push to swing a quarter. Given that our biggest market is the Americas, and that's where a lot of our customer base is, that would be the place that would be most impacted.
All right. On the VM-Series, you had strong growth this quarter, and I think you said 50% of those customers in the quarter were new to Palo Alto. Is it possible that the VM-Series might be cannibalizing some of your product revenue, selling to those new customers?
That's a good question. I don't think that's the case, Andrew. The VM-Series or cloud in general, I think, continues to be a great selling point for us because we can provide the consistency of security both across on-prem, hybrid to public cloud environments, and that's what customers are responding to. The front end of that for us is the VM-Series, and I said in my prepared remarks, about half of the customers that came to us in the first quarter, their first experience with Palo Alto Networks was to buy VM-Series, so it's clearly opening doors for us. Maybe more interesting to your question, though, if we looked at over the 2,000-plus customers we have on VM-Series today, that trend is holding. About more than half of those were first-time customers of Palo Alto Networks with VM-Series.
If we look back at that, more than a majority of those have come back and purchased hardware, for example, since they've joined us with the VM-Series. This looks to be a positive and additive for us.
We'll now move to Shaul Eyal with Oppenheimer.
Thank you. Hi, good afternoon, guys. Mark, any specific products that either outperformed or underperformed this quarter? How did the PA-7080, the PA-7050 perform specifically this quarter?
Yeah, we saw good contribution across our entire family, not just on the hardware side, but across all the services side as well. One thing that we really like to see in the first quarter went well for us was particularly on the high-end stuff is in the service provider business. We organized a lot around that in the last year's time, and that team did a great job beating their number in the first quarter. That's fantastic. Like to see more of that coming, and those customers tend to buy the higher-end device.
Got it. How was the Federal vertical specifically this quarter?
It was good. We've got a good Fed business. That's true across the civilian, the intelligence community, the defense community as well. We're growing a very nice Fed business. That quarter came in well for us. As you know, the Fed year end is inside that quarter. The only blemish on the business there was we had one high seven-figure deal that pushed into the next week, literally a few number of days. Mostly due to the government still operating under a continuing resolution, it had a couple more approvals that had to get done on the budget side. Other than that, it was exactly as we expected.
At this time, we'll hear from Karl Keirstead with Deutsche Bank.
I think, Steffan, on the long-term DR, super strong performance during the quarter, given that this underpins your billings growth and to some extent your free cash flow growth, I'd just like to understand that a little bit better. The mix is, I think, now 44% of all of your DR. Do you think that can still increase? Help us understand how some of the environmental stuff you talked about with longer sales cycles, et cetera, that didn't seem to have any impact on long-term DR. I'm wondering if you could explain that and if there was any kind of lengthening of duration that might have offset that. Thank you.
We did see a modest uptick in duration on a sequential basis. When we see growth in long-term deferred revenue in this quarter on a year-over-year basis is about 84%. That's been in a relatively, call it, tight range over the last several quarters. That is a indication that our customers are wanting to standardize on us as a platform to lock us in as a strategic partner, and we believe that's a very good indication. It's actually a sign of the strength of the platform. We have seen some larger deals that Mark had highlighted that they ended up slipping past the end of the quarter. Sales elongation is the reason there. Had those deals not slipped, we would've seen even a more healthy increase in both short-term and long-term deferred revenue. The deferred revenue would've been better had we not had the sales cycle elongation.
Going forward, we've factored in sales cycle elongation into our guide. That is a prudent thing to do at this point. If sales cycles start to shorten, we'll update that then. Right now, we're basically taking our sales cycles and factoring that into the methodology for the guide for not only the quarter but for the year.
Okay. That's helpful. Thank you.
Yep.
We'll move now to Jayson Noland with Baird.
Okay, great. Thank you. Just to ask on the longer sales cycles, was there any feedback from the customer base that would be helpful? I'm just wondering if that was the U.S. election or just more general.
Hey, Jayson. It's Mark. It's hard to parse through that at that level of detail with the customers. First of all, we're just talking about a handful of deals, so it's not a lot of things. Getting to the specifics as to why that may occur, whether it was related to the election or not, that's hard to get from customers. I think generally, it's a good thing that election's over from a consistency and certainty perspective, regardless of who wins, right? I think everybody probably feels that, but we didn't hear that being expressed through the customer base. What we are just seeing is that we're winning bigger deals and bigger companies. We're working on architectural, strategic, long-term projects with companies, which is great, but we're seeing them take longer to get done.
Okay, that makes sense. I wanted to ask on service provider, too. It's been a challenging vertical for some key suppliers. You're underexposed but gaining traction. I guess, Mark, how should we think about SP into cal 17?
We think a couple things there. The first is that as you know, was a vertical that we hadn't been super focused on for a number of years, and we organized around that last year to, both from a product perspective, every release has got something for the service providers, so that's been a lot more focus on that internally. That's primarily because we think that that industry can benefit from the advanced security we have. Also, when you see data moving around as it is, it's going to continue with IoT and things like that, the mobile framework is going to become increasingly important in order to make those things happen, right? Security's going to become increasingly important there. We want to make sure that we're bringing our advanced security capabilities to that market, and we're doing that.
Like I said, I was pleased with the service provider results. That business is not as big as the rest of our business yet, but it's growing at very nice rates, and the feedback so far has been very positive on what we brought to the market.
Again, that is star one for questions. I'll now take a question from Michael Turits with Raymond James.
Hey, guys. Two questions. First of all, back on the sales cycle question. Is there any sense that there's hesitation regarding or extension of what's called decision cycles, given people's plans for what they will do in cloud, which tends to be complex for them sometimes?
Yeah, I'll take the first question on that. Cloud's in everybody's mind, of course, right? It's a big deal. It's a macro trend. As people are thinking about cloud, one of the main things we hear from customers, not surprisingly, is the security aspect of that. Increasingly, what's obvious to us as well is they need and want the consistency of security in with their on-prem, in cloud, and any flavor of the cloud, right? That's what we're uniquely bringing to the customer base here, is say, you don't have to have different security, and nor would you want to have different security outcomes in the cloud than you would like to have on-prem. They're looking for that answer, and they also know that they're probably going to have multi-cloud strategies as well. Who can bring the consistency of security in all of those situations?
That increasingly is Palo Alto Networks. I think that's showing through with not only our relationships, but the results for our VM-Series. I think it's a good thing. All those kind of accurate things, whether IoT or cloud or all those things, go into the mix when people are making their decisions over time, particularly with larger companies, we think that it's a positive force.
The other question was on Traps. I'm not sure if you addressed this directly. You pointed out that Traps is doing well, anything to point to concretely in terms of an uptick or a positive reaction following the new release of Traps and how people are reacting to that?
Yeah. Michael's speaking about version 3.4, which we brought out in the late summer timeframe, which got very positive reviews, both externally and from our prospects and customer base. The main reason for that is that we continue to iterate Traps, and that was a very big iteration there, as it became very clear after that release that it could be a head-on AV replacement. That's where the big budget in the market is, and that's where people are increasingly buying Traps to do that. In addition to having those capabilities to be an AV replacement, which it has, you also want to get the external validation of that. We're going to get that in a number of ways. Some is third-party testing, so you may have seen some of the reports coming out where we're those tests and scoring well.
Getting the kind of compliance check-offs, like I mentioned on the call for HIPAA and PCI is important, so that people from an auditing perspective say, "Yeah, that can be an AV replacement." The third is just referenceability. Now that we have over 1 million things under protection with Traps and a good size and very fast-growing customer base is people talking to people saying, "This really works," not just only as an AV replacement, more importantly, as real-time prevention endpoints, and probably just as importantly, to seamlessly bring together prevention from endpoint to network to cloud and all the things the platform can provide them.
We'll now take a question from Saket Kalia with Barclays Capital.
Hi, guys. Thanks for taking my questions here. Just first for Mark. Mark, you talked about some of the stronger cohorts in the past, like 2012, for example, starting to come up for refresh. Presumably, we've just seen the beginning of that trend. From what you've seen so far, are you seeing anything different in this refresh cycle versus others that you've seen in the past?
No, Saket. A couple things on that. One is you correctly noted that from a refresh cycle perspective and the amount of customers that would even be up for refresh, the vast majority of that is coming into play starting in the second half of this year and beyond. That's the first thing. The second thing of the refreshes we have seen in the earlier cohorts, even though are small, have been very strong. Just as a general matter, it's not really a Palo Alto Networks viewpoint, just from an industry perspective, haven't seen anything different in the cycles of refreshes. A little hard to call those, generally four to six years, that seems to be the case still.
Got it. For my follow-up, just specifically on the WildFire subscription, presumably you're going to see more competition from other specialists that are going to maybe compete with cloud delivery. Do you still think that WildFire has the advantage as being part of the firewall and being cloud delivered, or is that something that you've maybe start to hear from customers as maybe sandbox delivery starts to change?
A couple of three things on that, probably, Saket, the first is that WildFire has to be and is very good as a sandbox. It's super capable, it's best of breed from a sandbox perspective, and those are table stakes in order to do that for people. I think with the size of the customer base and the kind of customers that we're adding, you can see it gets very high marks. That is one. Two, WildFire is really well done in a sense that it is delivered from the cloud. The second thing is that for us to have the ability to bring that kind of capability from the cloud and do it at enormous scale, which we're doing today, is a competitive differentiator for us. The third thing is that it is kind of the brains of the platform.
When you have WildFire and you're using it, that is how you actually get, in about five minutes' time, real-time update to everything we know across our ecosystem of customers, provided to you automatically. High degrees of automation. The last point, which I think is going to be increasingly important over time, and here we're way ahead, just given the size of the customer base and the architecture, is we're dealing with gobs of data. As I said, petabytes of data here. Our ability to make that data useful for WildFire itself to get the five-minute updates and then to do additional things like we've done with AutoFocus, which is to provide high degrees of relevance and correlation almost in real time to that data and be able to continue to do that with that kind of scale is increasingly important.
I think those are very high competitive barriers for anybody to get over, let alone somebody who's just showing up to the ballgame.
We'll now move to Rob Owens with Pacific Crest Securities.
Great, thanks for taking my question. Mark, you mentioned how you're participating in more architectural, strategic, long-term deals. Those are typically falling into a budget process. That, along with the large deal slippage, is it your sense that there's more of a lack of confidence in IT budgets getting spent at this point, or do you think there might be some reprioritization going on?
I think it looks like security's still a big deal, right? I would guess that that was going to be the case for a really long time to come, just because it's so important to underpinning all of the trust in the digital age. I don't see that changing whatsoever. What we're seeing in our business is that we're in bigger and bigger companies getting these larger deals done, and they tend to be more complex because of the architectural aspects of it, and we're winning them. It's just taking longer to get some of them done, which is unfortunate, but on a long-term basis, it's very beneficial for the company. We put a hell of a lot of focus, as we mentioned before, into the G2000 customer segment because we think 70-plus % of the addressable market opportunity is in that segment.
We've got over 1,100 customers in G2000 right now. We've added dozens in Q1. We added over 100 year-over-year. About 40% of our sales in Q1, for example, is coming out of the G2000, and that's growing high and up and to the right. It's an increasingly important segment, but what you get with that is you're going to get these larger architectural
designs that are taking longer to get done. Like I said, that's a good thing for us in the long term, but it might have some impact in the short term. All that said, not only do we have to win these deals, we've got to call the ball and get them when we're going to get them as well. We realize that we can do a better job on that. We're definitely focused on that.
As a follow-up, can you talk about the level of discounting in the quarter that you're seeing, either from competitors or expected discounting from end customers?
Yeah, sure. Two angles on that. One is, this has been a very competitive market. It continues to be a competitive market. We definitely see people going to the price card, Cisco, Check Point, Fortinet, have been doing that for quite some time. If we look at our quarter, again, you can see our gross margins are good, they're high. We didn't see any discounting pressure meeting on us from a sequential basis. We were able to combat that, like I said, with these architectural design wins and what we bring from a platform perspective, and we expect to be able to continue to do that into this quarter.
We'll now move to Pierre Ferragu with Bernstein. Go ahead.
Hey, good evening. Thank you for taking my question. I'd like to come back to your elongating sales cycles. You've mentioned a lot of things. You've talked about more complex deals going to larger clients as well. My question is, how much of that is actually just more like the broader environment and macro drivers? I'm thinking about the Brexit in Europe, in the U.S., we've had the run-up to the election. Did you see an element of the macro affecting also decision cycles just because people were more careful with their budgets? If that's the case, any indication of how significant it was compared to things that are more specific to the mounting complexity of what you're selling?
Yeah. I think that's a great question, Pierre. I have two angles on that one. The first would be for the things that we think we know for sure. Which would be when in these bigger companies and bigger deals with, like I said, these architectural design wins and then leading to the architectural wins that are strategic in nature. We have a very good sense of that because we're winning the deals. We know who we're competing with. We're winning at very high rates on that. As far as how long they may take from an approval process or spending cycle process to get done, there could be lots of factors at play around that. You mentioned a whole bunch of them, right?
Elections, price of oil and Brexit and interest rates and all sorts of stuff that can put some uncertainty into the macro spending environment, which looks today, like I said earlier, mixed. That's what it sounds like from reports that we've seen. Certainty, consistency, and those things that would help improve over time. Those would be great. We're trying to really pay attention to things that we can see for sure that are in our control.
Thank you.
We'll now move to Gregg Moskowitz with Cowen and Company.
Okay. Thanks very much. Mark, you've talked about the sales cycles at length and a handful of the larger deals that pushed. Of the business that did close in the quarter, did you see any change to average deal size?
No, it's very consistent. One of the things we had mentioned in the past, Gregg, that continues to be the case is from an ASP perspective, generally, those continue to grow over time. A lot of our wins are first times wins with somebody, then we get in and expand very dramatically over time, none of those dynamics have changed.
Okay, thank you.
Thank you.
Move along to Walter Pritchard with.
Hi. Thanks, Mark. Just wondering if you could talk to the customer count, the customer additions in the quarter. I think it was 1,500 last year, and this quarter was about 2,000. I guess I think about large deals pushing, it's probably not impacting that number that much. I'm wondering generally how we should think about that metric as a driver of particularly your product growth going forward.
Yeah. Hey, Walter. Good question. Yeah, on all these quarters when we talk about these numbers tend to round. I said well over 1,500 in a quarter, that would have been closer to 2,000 this quarter than 1,500. New customer acquisition continues to be very strong.
On a year-over-year basis, it was the largest Q1 customer adds that we've ever had.
Yeah.
Relative to the contribution, we still get, call it three quarters to 80% of all of our business from our install base of customers. You can imagine with 34,000 customers that we had entering the quarter, the purchasing power of that install base is extremely high. Contribution from new customers definitely helps, but the purchasing power really lies in the install base.
Steffan, on the duration, you did mention it was up a little bit. Is there anything about certain types of customers tend to drive longer duration, or is it service providers, or anything systematic that's happening there? Or is it more just how the chips fall in a quarter?
It's kind of how the chips fall in the quarter with the one nuance that larger customers tend to do multi-year deals. We do see smaller customers doing multi-year deals too. Just the impact of the larger customers is more pronounced just because the ticket size is oftentimes it could be four or five times greater than what the smaller customer is purchasing.
At this time, we'll move to Brent Thill with UBS.
Mark, I just wanted to clarify, you mentioned a lot of the deals in Q1 that slipped had closed already in Q2. I wanted to understand, was that the majority of the deals? Can you just give us a little more color on what you meant there?
Sure. Well, just if I back up for a minute on it, a handful did come over the line as I mentioned before, in over 10,000 plus deals. It only takes a few of the bigger ones to not come across the line to have the less robust quarter than we would've liked, and that's what happened in this situation. When we look at what's happening right now, about half of those have closed so far. We've got good line of sight for the rest of them.
Okay. Just the comments on sales cycle, that you're not alone. There's been numerous security companies that are citing the same reason. I guess, is there any other further explanation why the industry is seeing this? I think everyone's pointing to the cloud. Is there digestion of past purchases that still are happening?
Yeah, I've seen commentary along that. You've read in the past as well. I think it looks as though in the last few years' time, a lot of stuff has been bought in security from a lot of different providers, right? What we've seen from the people working their way through that is a lot of the point capabilities that were sold and bought by these folks, they have to work their way through those capabilities, meaning from a minimum, from an amortization depreciation cycle perspective, right? You can see that we're subsuming a lot of that into the platform at very higher rates, but it's not unusual to go into a customer and say, "Hey," we'll use WildFire, for example. "We want to sell you WildFire. You already bought parts of the platform before." Get a comment from them to say, "Yeah, I love it.
It sounds great. I tested it. I got to amortize the thing I have or depreciate the thing I have just a little further, so talk to me in six months," right? Whatever the situation may be. That could be true for proxies, for sandboxes, for IPS capabilities, for endpoints go across the board. Folks digesting a lot of the things that they got over the last few years can have an impact on when they might purchase our thing that is part of the platform.
At this time, we'll hear from Matt Hedberg with RBC Capital Markets.
Hey, thanks for taking my questions, guys. Mark, your growth in EMEA was better. I'm curious, are some of your European customers talking about the pending GDPR breach notification? Maybe if they're not yet, do you see that as a potential driver next year?
Yeah, a lot of people are talking about that. I think it's going to be important, just as a general matter and what Matt's talking about there is, in the not too distant future, like in the U.S., there'll be similar kind of legislation that will take effect. It's already passed. It'll take effect in Europe that says, you have to report breaches, right? When those things happen, the focus and attention for companies, once they actually have to report stuff, should go up. We certainly saw that in the U.S. We think we would see that in Europe. Now, an interesting part of that legislation is that it uses a term that's very important, and it says that you need to use state-of-the-art security capabilities, right? State-of-the-art is great, right?
That's next generation, that's advanced, that's platform, that's all of the things that we've been so successful selling. To double underline that point, just to make sure that folks in Europe know that Palo Alto Networks is a provider, that we've taken a lot of the marketing capabilities that have been so successful for us in North America, and we've exported them. Most recently, for example, we published a version of our book, which is called "Navigating the Digital Age," which is something that is designed for C-suite executive and board members and has been incredibly well-read in the United States. We just published that in French, and that one came out in the last quarter. As an aside, we also launched it in Australia as well. Not that you asked that question about APAC, but they have similar legislation going to come into play very soon.
We're pushing materials like that in local languages with local experts, and very much aligning ourselves with the, in the case of Europe, with state-of-the-art and defining what that means for security into the future.
Great. Thanks, guys.
Thanks, Matt.
At this time, we'll take a question from Gray Powell with Wells Fargo.
Great. Thanks for taking the questions. Just a couple, if I may. Product revenue, it slowed for everyone in the network security space this year. If I just look at some of the public players in the group, it looks like product growth expected to be in the, call it, the high single-digit range in the second half of 2016 versus more like 25% last year. Do you think we're back at sort of a normalized level of growth? Do you see anything that could move it in either direction going forward?
A couple things, Gray, on that. One is, I think this is definitely the age of the platform, right? We're definitely seeing the move from a paradigm shift from point solutions that are detection-oriented, delivered as hardware into next gen platforms that are prevention-oriented, some of which will be delivered as hardware, and a lot of which will be delivered as software and from the cloud capabilities, and that's what's driving the growth in our platform. You're going to have both of them. It's going to be hardware and software capabilities. We would expect that the hardware component of that, or what we call the product component of that, would be healthy and continue to grow over time. We said we saw second half acceleration, which we do expect to see for some of the reasons we expressed already.
That's our view as to where this is going to go.
Okay. That's helpful. Just a quick follow-up. You have your 30% long-term growth target. Is there some sort of base level of product revenue growth that's required for you to hit that target?
Well, we have this growth and profitability framework which we've outlined and that we're adhering to. What we've called out is that in this fiscal year, we're going to be in high growth mode, which is greater than 30% revenue growth. What we've given as a construct for the year is that product revenue growth on a year-over-year basis would be approximately 12%-13% year over year. We would need that to be the case in order for the projections to be achievable. That's basically the construct for the year. We don't have a product growth rate on a long-term model basis that we've talked about, because ultimately it's about selling the whole platform. We're focused on selling all elements of the platform, and that's why we talk about total revenue growth as the primary indicator.
There are sub-components that we give headlights to, like product and subscription and services and renewals, but it's really total revenue growth.
We'll now take a question from Erik Suppiger with JMP Securities.
Hey, guys. This is John Lucia on for Erik. Thanks for taking my questions. My first question is, can you just remind us what % of the billings comes from existing versus new customers, and how that's trended over the last year? Were the push deals concentrated on either new or existing customers?
Yeah. On the % of billings from new versus existing, it's approximately call it three quarters to 80% of billings come from our existing install base of customers. The dynamic which I referenced in the past is, this quarter we added north of 1,500 customers in the quarter of new customers, but that's to a base of 34,000 customers. You think about the flywheel that's going on around repeat purchasing the top 25. You look at all of those LTV stats, those are all up and to the right. The purchasing power is a lot greater from the install base of customers, which is why you have three quarters to 80% contribution coming from there. Your second question was on push deals and whether those came from new customers or existing customers.
It was primarily new customers, where we saw a little bit of elongation of sales cycle.
Okay. Last question, all of the 1 million Traps endpoints paid or are some of those unpaid? If so, how many of them?
They're all paid.
Okay, thank you.
Thanks, John.
We have time for one more question. This will be from Jonathan Ho with William Blair.
Hey, guys. I just wanted to understand a little bit better your public cloud opportunity. We saw VMware sign a deal with AWS, clearly you're in that platform. Could you just give us a little bit more color in terms of what that opportunity set looks like for you guys and maybe what this deal could mean?
Yeah, I think that deal is a bridging, if you will, of the public and private cloud. I think it's a growing recognition by public cloud providers and hybrid or private cloud providers, that it's going to be a hybrid world into the future. That's going to be on-prem, it's going to be hybrid, it's going to be public as well. What companies want to do, I mentioned this consistency aspect, is they want to be able to move their data seamlessly across all of them. They sometimes are going to want to be in the cloud, sometimes they want to be in on-prem, sometimes they want to be between both of those.
I think that's what the AWS and VMware deal represents, recognition by both of those companies and probably more in the industry, that that's going to be the case in the future. From a security perspective, our ability to tell a customer that we can provide exactly the same kind of security in a highly consistent manner wherever the data may be in the cloud, whether it's on-prem, hybrid, or public. Even more important to that, or maybe just as important to that, is everywhere else, too, across endpoints and third-party SaaS applications being delivered from the cloud. We get to say we can do the exact same level of security, which is the most advanced security you can possibly have, exactly the same in all those cases. That's a very powerful statement.
Got it. Just relative to your comments around the platform, can you talk a little bit about the number of subscriptions that you're attaching to new product and whether you're seeing that continue to increase or shift around based on the activity this quarter?
For the core subscriptions that attach to the appliance, we've seen very strong growth rates and very high attach rates. Well, we talk about it on a semi-annual basis. I'd have to go back and take a look if the number grew on a year-over-year basis, but the attach rates were very healthy. The unattached business, which we have four subscription services that are AutoFocus, Aperture, Traps, and VM-Series, those don't have a concept of an attach. They're lower in terms of the base, but they have triple-digit growth rates. Both subscriptions, both the attached and unattached, are growing very healthily. I just have to get back to you on whether or not the second half, if the attached growth rate grew on an annual basis.
That concludes the question and answer session. I will turn things back over to Mark McLaughlin for any additional closing remarks.
Great. Well, thanks everybody for being on the call this afternoon. Before I close, as always, I want to thank the Palo Alto Networks team for their dedication and our customers and partners for the opportunity to work with them. We take the responsibility of helping the world's largest organizations solve their most critical challenges very seriously. Also, I hope everyone has a safe and enjoyable Thanksgiving. Thanks for your time.
Once again, this does conclude today's conference call. Thank you all for your participation.