Good day, everyone, and welcome to the Palo Alto Networks Fiscal Fourth Quarter and Fiscal Year 2016 Earnings Conference Call. Today's conference 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. Thanks, Matt. Good afternoon, and thank you for joining us on today's conference call to discuss Palo Alto Networks' fiscal Q4 and full year 2016 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 Stefan Tomlinson, our Chief Financial Officer. This afternoon, we issued a press release announcing our results for the fiscal Q4 and full year ended July 31, 2016. If you'd 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, the impact of a change in accounting policy, the spending environment and market opportunity for our products, subscriptions and services trends in certain financial results and operating metrics our revenue, billings, deferred revenue and free cash flow growth rate, sales productivity, seasonality, ability to expand market share, scale the business, gain leverage and deliver profitability, benefits of our partner ecosystem, innovations in our product description and services capabilities, our competitive position and our plans with respect to our share repurchase authorization. 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.
Forward looking statements apply as of today, and you should not rely on them as representing our views in the future, and we undertake no obligation to update these statements after this call. For a more detailed description of factors that could cause actual results to differ, please refer to our quarterly report on Form 10 Q filed with the SEC on May 27, 2016 and our earnings release posted a few minutes ago on our website and on the SEC's website. Also, please note that certain financial measures we use on this call are expressed on a non GAAP basis and have been adjusted to exclude certain charges. For historical periods, we have provided reconciliations of these non GAAP financial measures The GAAP financial measures in the supplemental financial information can be found in the Investors section of our website located at investors.paloaltonetworks.com. For planning purposes, we expect our fiscal Q1 2017 earnings conference call to be held after the market closes on Monday, November 21.
We'd also like to inform you that we will be presenting at the Citi 2016 Global Technology Conference on Thursday, September 8 The 2016 Deutsche Bank Technology Conference on Wednesday, September 14 and the Dougherty and Company Institutional Investor Conference on Wednesday, September 28. And finally, for your reference, once we have completed our formal remarks, we will be posting them and a related slide deck to our Investor Relations website under quarterly results. And with that, I'll turn the call over to Mark.
Thank you, Kelsey, and thank you, everyone, for joining us this afternoon. I'm happy to be here with you to share our results for the fiscal Q4 and full fiscal year 2016. Our fiscal Q4 capped off another record year for Palo Alto Networks. In the quarter, we grew revenue 41 percent year over year to $401,000,000 billings were up 45% year over year to $572,000,000 Free cash flow was up 72% year over year to $171,000,000 and we reported non GAAP EPS of 0.50 In Q4, we saw a better macro sentiment than what we witnessed in Q3. For the fiscal year 2016, we reported revenue of $1,400,000,000 of 49% year over year, billings of $1,900,000,000 up 56% year over year, free cash flow of 586,000,000 percent year over year and non GAAP EPS of $1.67 up 94% year over year.
In our industry, these growth rates at our scale are unprecedented and I want to thank our customers, our team and our global partners for these results, their hard work and their ongoing support. We've been driving a paradigm shift toward a real platform, which customers
are adopting in record numbers. As a result, we form,
which customers are adopting in record numbers. As a result, we continue to outpace the competition and rapidly capture market share. Financially, the paradigm shift is providing us with sustainable benefits evident in our strong product sales, significant growth in attached and non attached subscription services and very high renewal rates. In particular, the rapid growth in recurring services provides sustainable growth in both short and long term deferred revenue, increasing visibility into future revenue, higher operating margins over time and high free cash flow generation. As a result, we are confident that we will continue to deliver high revenue growth at scale for years to come.
This paradigm shift is inevitable in an age where attacks are increasingly automated and sophisticated. Historically, the answer to the attack growth and sophistication has been to attempt to detect an attack through a combination of best of breed technologies, often delivered at individual hardware appliances for disparate software agents and then had the customer be responsible for acting as a back end integrator to try to gain some leverage from the products. Is increasingly obvious that this approach is failing and instead of providing leverage against the automated attacker, it's resulted in security defined by the least common denominator security stack, increased complexity in network, increased cost to deploy the technology and increased reliance and manpower, which is hard to find and it's the least leverageable resource the company has. As a result, customers are moving away from point products that do detection and drive manual responses to real platforms that provide high degrees of prevention through native integration of best free capabilities, which are increasingly delivered at services, high automation, increasing ecosystem leverage and seamless deployment in all environments, including the cloud. Vendors today are being judged against these requirements and we can clearly see a few things occurring.
First, customers are making purchasing decisions based on strategic actual consideration as opposed to the more transactional one of each hardware models in the past. Customers want better security, a reduction in the number of vendors and better value for their spend. They're being more thoughtful about their decision, more open than ever to transition from legacy technology and awarding larger deals to fewer vendors. 2nd, those vendors that have traditionally served the firewall market are relying primarily on price, bundling of free services or promises a future roadmap to try to stay in the network. And third, point product vendors are finding it increasingly difficult to justify their standalone value when their capabilities are being consumed into the platform.
As the primary driver of this paradigm shift, we are benefiting disproportionately compared to the rest of the industry. Our next generation security platform prevents threats across the entire attack lifecycle simply and seamlessly by automating security in a way that transcends individual capability and is easily deployed at either hardware or software in the network, on endpoints and in the cloud. Customers recognize and embrace the uniqueness of our approach and our metrics show we're delivering on these requirements. In terms of customer growth, in the 4th quarter, we had the highest rate of new customer adoption in our history, adding over 2,000 new customers and are now proud to be serving approximately 34,000 total customers globally. This includes over 85 of the Fortune 100, over 70% of the Fortune 5 55% of the Global 2 1,000.
In terms of capabilities of the platform, we continue to see rapid adoption, real usage and very high renewal rates. At the end of the Q4, we now have more than 29,500 customers using threat prevention, more than 24,000 using URL filtering and 3,500 using global percent. We added the highest number of quarterly wildfire customers in our history to bring totaled our customer base over 12,500. Our Traps offering and our VM Series offering each are on mid 8 figure run rate in sales growing at triple digits. Specifically, we grew our number of VM Series customers to over 1700, up from the approximately 1,000 reported recently at Analyst Day, with 100 to these customers deploying in the public cloud.
And Traps continues to ramp quickly. We now have well over 500 Traps customers up from the approximately 300 we discussed at Analyst today. Finally, we have approximately 100 customers using autofocus and aperture, resulting in a combined 8 figure run rate in sales for these offerings growing at triple digits. Platform adoption is driving record lifetime value growth across the board. For example, all of our top 25 value excuse me.
For example, all of our top 25 lifetime value customers again made purchases in the 4th quarter and to make this list, the customer had to have spent a minimum $14,000,000 in lifetime value, a more than 50% increase over the $9,200,000 in Q4 of fiscal 2015. With the market's only true platform, our technology, ecosystem and competitive advantages are increasingly evident. Some examples of wins in the quarter include a checkpoint replacement at a large U. S. Financial services company to secure their data center with our PA-seven thousand series chassis, a competitive win against Cisco in the defense industry for significant IoT use case utilizing the M Series, a perimeter and data center Cisco replacement with PA5000s, Preparvention, URL Filtering and Wildfire, 1 of Europe's largest retailers with over 6 thousand scores, a checkpoint replacement including dozens of devices across product lines, threat prevention, URL filtering and GlobalProtect, where we became the standard security platform for 1 of Europe's largest media company.
The Cisco replacement the Internet operation of 1 of the world's leading SaaS vendors with our PA 7050 chassis, threat prevention and URR filtering and we closed a 7 figure traps deal for 30,000 endpoints with a U. S.-based integrated healthcare organization where we replaced Symantec for antivirus. We are also increasing leverage and return on investments for our customers with additional partnerships designed to reduce the burden on customers to integrate technology. For example, earlier this month, we came with Accenture, Splunk and Tanium to develop an integrated security offering wrapped with Accenture services and includes our next generation security platform. This unique combination will help organizations better defend their network, protect their endpoints, gain insight into the security behavior within their enterprise and effectively automate breach detection, prevention, response and recovery efforts.
And we are always working to further extend our technological advantage by consciously fostering a culture of innovation and continually enhancing the capabilities of our platform. Most recently, we announced the release of Traps version 3.4 with new functionality, including increased significant machine learning capabilities for real time unknown malware prevention and quarantine of malicious executables. These updates further strengthen the malware and exploit capabilities of Traps and alleviate the need for legacy antivirus technology to protect end We also introduced the wildfire EU Cloud. Customers will now have the option to submit unknown files and email link to a wildfire cloud within the EU for analysis, where the customer submissions will be fully analyzed and stored without ever leaving EU orders. Data privacy and protection is paramount when it comes to cloud based spread analysis and with the Wildfire EU Cloud, it is now much easier for global and European customers alike to fully utilize this critical threat prevention capability.
Response to our recent platform releases and roadmap continues to be very positive. On the go to market front, we just completed sales kickoff or 2017 where more than 2,000 enthusiastic sales, marketing and product team members sat side by side with over 800 partners hearing about our objectives for the fiscal year as well as participating in the same training programs and certifications as our own sales professionals. This event is a great way to kick off the year and I can assure you the team is fired up. We are in a very large addressable market with high single digit market share. We have significant runway ahead of us and we have been continuously optimizing the team across all functions of the company for deep bench strength to ensure we can seamlessly scale unprecedented growth rates.
I was very pleased to announce the next step for us in that regard at our sales kickoff with Dave Paranich joining the team as EVP Worldwide Sales and Mark Anderson, being promoted to President. Dave, who will be reporting to Mark, will focus exclusively on sales channels, while Mark will retain ownership of sales, lead our go to market strategy as well as customer support and business development. I'm very pleased with these appointments and look forward to working with Mark and Dave for a long time to come. Congratulations to you both and welcome to the team Dave. As we look forward, we have confidence that we are the leading beneficiary of the move to real platforms and we are anticipating another exciting year of high growth for the company.
And with that, I'll turn the call over to Seth.
Thank you, Mark, and thank you all for joining us. Before I start, I'd like to note that except for revenue and billings figures, All financial figures are non GAAP unless stated otherwise. As it's the end of the fiscal year, I'll be covering more material than a standard quarterly call. This includes Q4 and fiscal 2016 financial results and key metrics, a discussion on the model and related mix assumptions, And I'll conclude with guidance and modeling points. I'll start with the results.
For both the quarter and the year, We delivered industry leading top line growth at scale and increased profitability. Our platform and our unique hybrid SaaS financial model provide a combination that translates into sustainable growth and structural leverage both now and in the future. Turning to the numbers. In Q4, total revenue grew 41% year over year to a new record of $400,800,000 For the fiscal year, we reported total revenue of $1,400,000,000 a 49% increase over the prior year. The geographic mix of revenue for Q4 was was 72% Americas, 17% EMEA and 11% APAC.
Compared to the prior year, both the Americas and EMEA each grew 41% and APAC grew 42%. Q4 product revenue of 191,100,000 increased 24% year over year and growth was healthy across our product portfolio. Recurring Services revenue of $209,700,000 increased 61% over the prior year and accounted for a 52% share of total revenue. SaaS based subscription revenue of $106,500,000 increased 66%, while support and maintenance revenue of $103,200,000 increased 57%. Q4 billings were $572,400,000 up 45% year over year.
For fiscal 2016 billings were $1,900,000,000 up 56% year over year. Product billings were $670,100,000 up 35% and accounted for 35% of total billings. Support billings were $579,600,000 up 70%. Subscription billings were $655,900,000 up 72%. Support and subscription billings accounted for 65% of total billings in fiscal 16 compared to 59% in fiscal 2015.
Total deferred revenue was $1,200,000,000 an increase of 74% year over year and 16% sequentially. Short term deferred revenue of $703,900,000 increased $280,000,000 year over year and accounted for 57% share of total deferred revenue. Long term deferred revenue of $536,900,000 increased $247,100,000 year over year and accounted for a 43% share of total deferred revenue. On a semi annual basis, we update a number of metrics which give insight into the drivers of top line performance. In Q4, Customer adoption of our 8 subscription services continued to be strong.
The attach rate of the 4 attached subscription services increased to 2.6 subscriptions per device sold in the quarter, up from 2.3 in Q2 and 2.2 in Q4 of fiscal 2015. Of note, these services are being attached to higher priced devices, which has consistently been increasing the dollar value of transactions over time. And finally, renewal rates for subscriptions and support continue to be high at greater than 90% and approximately 100% respectively. With the top line details covered, I'll now turn to margins. Our Q4 gross margin was 79.4%, an an increase of 110 basis points compared to last year and 150 basis points sequentially.
The year over year increase was driven by improvements in recurring services gross margins. Total Q4 operating expenses were $245,700,000 or 61.3 percent of revenue. Operating margin was 18.1% in Q4, representing a 400 basis point increase year over year to 100 basis points sequentially. The year over year improvement was primarily comprised of gross margin improvement of 110 basis points and sales and marketing margin improvement of 2 10 basis points. For the full fiscal year 2016, operating margin was 17.3%, representing a 440 basis point increase year over year.
Net income for the quarter was $46,200,000 or $0.50 per diluted share using 91,700,000 shares compared with net income of $25,000,000 or $0.28 per diluted share and Q4 2015. For fiscal 2016, we reported net income of $152,600,000 or $1.67 per diluted share compared with net income of $75,200,000 or $0.86 per diluted share in fiscal 2015. On a GAAP basis for the 4th quarter, net loss was $54,500,000 or $0.61 per basic and diluted share. This compares with the Q4 2015 GAAP net loss of $46,000,000 or $0.55 per basic and diluted share. For fiscal 2016, we reported a GAAP net loss of $225,900,000 or $2.59 per basic and diluted share compared to a GAAP net loss of 165,000,000 or $2.02 per basic and diluted share in fiscal 2015.
Turning to cash flows and balance sheet items. On a GAAP basis, in Q4, cash flow from operations was $187,500,000 up 68% year over year. Free cash flow was $171,200,000 up 72% year over year and free cash flow margin was 42.7%. We finished July with cash, cash equivalents and investments of $1,900,000,000 DSOs were 69 days, an an increase of one day on a sequential basis and 11 days compared to Q4 last year, reflecting a strong July and an increased mix shift towards subscriptions and support. With the Q4 and fiscal year recap complete, I'd like to provide some insight to the continued evolution of our hybrid SaaS model and the mix shift in the business.
In the execution of our model, We're driving a shift towards more products being delivered as SaaS like services resulting in more recurring revenue. This is a natural outcome of selling all elements platform and is beneficial from a financial standpoint because it makes us more strategic and sticking with customers, its higher margin business, provides increasing visibility into future revenue streams and drives sustainably high free cash flow generation. As customers commit to our platform, a natural outcome is increased scope and duration of contracts. In Q4, duration for new contracts both on a quantity and dollar weighted basis were 2.1 and 2.7 years respectively. Of note, when we look at our top 25 customers, we can see that all of them have made multiyear purchases and all of them continue to make many and frequent additional purchases during and after these multi year commitments.
This behavior is unlike traditional SaaS models and is consistent across our customer base. The result is that the lifetime value of each customer cohort continues to increase significantly. And also unlike traditional SaaS models, we bill and collect cash for deals upfront instead of annually, which is driving high deferred revenue growth and strong free cash flow. Over the past 3 years, our short term deferred revenue has grown more than 60% year over year and long term deferred revenue has grown more than 70% year over year. This of course provides us with increasing visibility into our high growth expectations on future revenue.
I now would like to move to an update on the deferred commissions project, guidance and modeling points. As discussed at Analyst Day, we've been working on a project that allows us to better match commission expense to our ratable revenue. Starting in Q1, we plan to move from our historical approach of expansion all commissions during the period in which the related revenue contract was booked to the accounting policy used by many other companies where commissions related to ratable revenues are amortized over the term of the revenue 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. Guidance provided this afternoon reflects this anticipated change of accounting policy.
It's important to note that the contribution of this change is not linear over the year and the vast majority occurs in the second half of the fiscal year when accelerated commission payments are in effect. Accordingly, we anticipate the change will have less than $0.01 contribution to fiscal Q1 non GAAP EPS and approximately $0.25 contribution to full year non GAAP EPS. And for reference purposes, if the anticipated change had been in effect for fiscal 2016, the estimated incremental contribution to non GAAP EPS would have been approximately $0.12 to $0.15 in Q4 and $0.19 to $0.23 for the full year. And the corresponding operating margin would have been 22.6 percent to 23.6 percent in Q4 and 19.3% to 19.8 percent for the year. Now turning to guidance.
For fiscal Q1 of 2017, we expect revenue to be in the range of $396,000,000 to $402,000,000 which represents 33% to 35% growth year over year. And we expect non GAAP EPS to be in the range of $0.51 to $0.53 per share using $92,000,000 to 94,000,000 shares. While we don't provide annual guidance and will not be updating this information in the future, in order to assist in modeling the deferred commission's plan impact for the fiscal year, we want to provide a one time full year view on non GAAP EPS. Using current fiscal 2017 consensus of $1,827,000,000 for revenue, our outlook for the full year non GAAP EPS is expected to be in the range of 2.75 to $2.80 per share using 94,000,000 to 96,000,000 shares. This range includes the benefit of at least 100 basis points of organic non GAAP operating margin improvement at approximately 150 basis points to 200 basis points from the deferred commissions change.
Before I conclude, I'd like to provide a number of modeling points. First, it's important to note that as a percentage of total revenue in fiscal 2017, We expect that recurring services revenue will be approximately 60% and product revenue will be approximately 40%. We expect total recurring services revenue to grow at least 50% year over year with about $700,000,000 of short term deferred revenue coming from the balance as of July 31. This represents approximately 65% of total recurring services revenue for the year. We expect year over year annual product revenue growth of approximately 12% to 13% in the full year 2017, taking into account the challenging year over year comparables, particularly in the first half.
We expect product revenue to grow sequentially from fiscal Q1 through the remainder of the year and we would expect the lowest year over year growth in Q2 and the highest year over year growth and Q4. Additionally, we expect higher product revenue growth rates in fiscal 2018 given lower comparables relative to fiscal 2017. We're planning for DSOs to be in the range of 70 to 80 days for the year as the mix of business shifts towards more subscriptions and support. The effective non GAAP tax rate for fiscal 2017 will be 31%. CapEx for fiscal 2017 is expected to be in the range of to $170,000,000 for the year, taking into account the one time $100,000,000 investment associated with construction of our new headquarters.
Normalizing for this one time event, CapEx would be in the range of $60,000,000 to $70,000,000 for the year and we expect total CapEx will be more heavily weighted towards Q2 and Q3 with approximately 60% of capital expenses falling in these two quarters. Excluding the one time $100,000,000 CapEx investment in our headquarters, free cash flow margin is expected to be at least 40% for the fiscal year. Including the CapEx for the new headquarters building, free cash flow margin is expected to be in the range of 35% to 40%. And finally, I'd like to note that our Board of Directors has recently authorized a stock repurchase for $500,000,000 effective through August 31, 2018. With that, I'll turn the call back over to the operator for Q and A.
As a reminder, ladies and gentlemen, you can find the prepared remarks and related slides posted at the Palo Alto Networks Investor
16.
And at this time, we'll take our first question from Keith Weiss with Morgan Stanley.
Yes, thank you guys for taking the question. Mark, you talked about a better macro environment this quarter versus What you've seen in prior quarters. I was wondering if you could expand a little bit on that. And then in terms of the guidance into next year, When we think about a low to mid teens product revenue growth, should we think about that as a unit volume growth expectation for the overall business that's made up with ASPs or how should we think about that type of growth rate in terms of garnering sort of incremental share within the broader market opportunity.
Yes, Keith. Thanks. So on
the first question on macro side,
as we said last quarter, and I think that we kind of saw this broadly across the whole technology industry, there was Fairly negative sentiment out there. And we saw that improve in Q4. We're very happy to see that, of course, we hope that that would expect into the future. We had mentioned a couple of soft spots last quarter as well. One being Australia, we saw very good performance there in the Q4 with this race.
It's really quite the team was able On the product Revenue side, when I think about what's happening in the industry with the paradigm shift, I'm really looking at the growth of the platform, right? So we are attempting To sell the entire platform. I think when you look at the success of that and the total top line revenue growth of the company, we are outpacing everybody in the grew by very wide margin. And that's true in every aspect of the platform, including the product portion of it as well. We're coming off some pretty tough comps through fiscal 2017 compared to 2016, but we still expect that we would outpace all the players in the industry by a wide margin in product as well as for the total platform.
Got it. So from a competitive standpoint, no change in sort of your view on competitive positioning Versus some of the incumbents?
No, not at all. I mean, I think we're doing very well competitively and doing better and better as time goes on. It's pretty evident that I think if you kind of look at That customers are really rallying around the idea of a platform for the reasons I mentioned on the call there. I mean this is evolutionary in nature, but I think it's picking up steam. They're really fed up with the cost expense, complexity of point products and legacy Technology and I think the platform concept for real platform is resonating very well with them.
When you look across the board at some of the statistics That I noted and Stephan noted about the growth that not only on the hardware side of the business, but the attached and non attached subscription services are all growing at very high
I'd just also add on that Keith is this was the highest new addition of customer logos in the quarter that we've had, which demonstrates that we are taking market share in a meaningful way. And the other point that I'd like to make is, We're able to monetize our customer base and platform much better than the competition. And if you look at any metric on a revenue per customer Our base has been stacked us up against any of the competitors out there. We are multiples ahead of them, which demonstrates
the
fact that the customer base wants the entire platform, both the hardware and the 8 attached or the 8 subscriptions that we sell, the 4 attached and for non cash.
We'll move along to Brent Thill with UBS.
Good afternoon. Stefan, just on the bottom line, you posted 4.40 basis points this year and you're guiding to 100 organic For next year, just given the recurring subscription, which seems like it's going to come in at a pretty high margin, what's such a delta this year from From what you put up this year versus how you're thinking about 2017 on an organic basis?
Well, we're running the playbook that we've been running for a long time now. And we updated at our Analyst Day, we have a growth and profitability framework where when we're in high growth mode, where revenues are growing greater than 30%. We are focused on growing that top line, but also increasing operating margin. And what we committed was we'd be in 100 to 200 basis point range of annual operating margin improvement, which is exactly what we're calling for with our guide. And then we have the incremental benefit from the deferred commissions project, which gives us another 150 bps to 200 bps on top of that.
But this is the playbook we're running and we have call it low high single digit market share in what will be a $22,000,000,000 TAM And the platform is resonating so well with customers, we are not trying to stretch for profitability at this point. The other point I'll make is, operating margin is a lagging indicator of the business. People need to be looking at free cash flow as an indicator of profitability in addition to operating margin. And we're looking at posting free cash flow margins of greater than 40% on an adjusted basis for the fiscal year. And that goes back to the power of the model.
And I don't know of many other companies who are able to post that type of top line growth and those types of free cash flow growth and margin structure.
Okay. And real quick for Mark, just on the transition To Dave, as the new Head of Sales, clearly, Mark is still there. So it's not necessarily a traditional sales change that we've seen, but there are also some that are nervous at any time of change like this goes down. Can you just walk through The handoff in terms of the transition here and how you see that going?
Yes, sure. It's completely understandable, As well. So as we've grown the business and we're running at a pretty big scale right now or as you can see from The billing side of well over $2,000,000,000 and growing very quickly. We have to keep trying to invest in advance everywhere in the company to To maintain seamless growth. We've been doing that for a long time from a people process and business perspective.
We're going to keep doing that into the future. At this size, we thought it would be very good for us to have a great professional who's been around the block a number of times to pay attention exclusively to sales channels, working with Mark in that regard who has done a great job for us over the last 4 years and has built up a great rapport with the customers and the team as well. And we also want to give more focus and capacity capabilities to Mark for some very important things that we need to do in the future like driving relationship with strategic systems integrators. He's going to take on the bulk of the strategic relationships with our cloud partners, and business development as well. So we can get more focused capacity in those areas which are going to be important for us to grow into the future.
And then of course, benefit of that as well is that it gives me some more focus and capacity to work on the most strategic things in the company. So I would just look at this as a continued increase in focus Same capacity and we're really glad to have Dave on the team.
We'll now move to Saket Kalia with Barclays.
Hi guys. Thanks for taking my questions here.
First, maybe just
to start off, Very nice to see the capital return with the share repurchase authorization. Mark, we haven't historically seen share repurchase from Palo Alto. So Maybe touch on why the change in direction and more importantly to the extent you can comment, is this something that you think could be done
a little bit more regularly?
Good question, Saket. So we're looking at our business model and where we are as a size of the company today. We've got a great model with the platform. Stephan mentioned it has very high free cash flow generation. We expect that to continue in the future.
So we've benefited a lot from that. We got about 1,900,000,000 In cash, primarily onshore. We're throwing off very high numbers from a free cash flow perspective and we're going to keep doing that into the future as people adopt the platform. Yes. So with all that in mind, we talk about use of cash regularly at the Board as you want us to and expect us to do.
There's always Three objectives in that, right. One is to make sure that we then invest well into the business, which we're doing. You can see we've put a lot of money into the business appropriately to continue to get market share at these rates. We also want to make sure we have appropriate amounts of cash that we could action in the M and A that we might find At any given time, we certainly have the capability to do that. And then also, if possible, opportunities to return some cash to shareholders, we can take that into account as well.
So at this size with the kind of cash flow generation, we think we can accomplish all those effectively.
Got it, very helpful. And then for my follow-up for you, Stefan, just on the accounting change, and you just touched a little bit on this earlier, but As we go beyond 2017 and as you hopefully continue to be in high growth mode, should we normalize 200 to 200 bps of expansion that we talked about at Analyst Day? Or does the accounting change maybe adjust that range with that given growth rate, if that makes sense?
We feel committed to the ranges that we talked about at Analyst Day. And so when you look at what we are delivering for FY 2017, we're a little bit above that stated range because of the impact of deferred commissions. Post 2017 because of the amortization you're going to have some of the FY 2017 expense hitting in FY 2018 etcetera. So we are still committed to the 100 to 200 bps post FY 2017 provided we're in high growth mode. When we are at some point in the future, as the model indicates, we'll start delivering more operating margin expansion If and when revenue growth moderates a bit, but we remain confident that we're going to be in high growth mode for years to come.
And we have a framework that we're running the business to and we wanted to be very transparent with investors on both the organic improvement and the improvement from the deferred commissions change.
Sterling Auty with JPMorgan has the next question.
Yes, thanks. Hi, guys. You talked about the improved macro in the quarter. Can you talk a little bit about what you saw in terms of the linearity in the quarter relative to what you saw in the Q3?
Hey, Sterling. Yes, we had a strong July. We would expect that when everybody is into their accelerators in the Q4. So not unusual to be the case. We did say in the Q3, we saw a more, loaded 3rd month in that quarter.
I think that was really sentiment related, but really not unusual from a 4th quarter perspective.
Okay. So maybe a bounce back to what you normally see in the quarter. And then just follow-up in terms of looking to fiscal 2017, what changes have you made around either sales structure, quotas, etcetera to think about driving some of the subscription, especially some of the standalone
Sterling, I'm going to hand it over to our new President, Mark Anderson.
Hey, Sterling. How are you?
Good.
Yeah. So really Not a ton of changes. I think we've got a really good solid playbook that drives really good productivity across the board. We expect to continue to run that. We did a lot of segmentation last year by bringing in a new service provider organization and adding a commercial tier To our enterprise go to market, both of those are tracking well ahead of plan and feel really good about kind of Stabilizing FY 'seventeen and beyond with this organizational structure that can really scale for years, I think.
Next question?
Next question will be from Walter Pritchard with Citi.
Hi, thanks. You gave some color on the Aperture and Autofocus revenue run rate. I'm wondering if you could give us any sort of Update around Traps or any just sort of view as to how you're thinking about the how the unattached billings performed in fiscal 2016 and how you look at them performing into 2017?
Yes, great question.
The unattached subscription. The unattached subscription. Yes. They're all doing very well. We put out some slide materials Well, which I'm not sure if you're able to reference, but if you have them Walter or not, but when you get a chance you can take a look at them.
One of the slides that we dropped in there is is really showing the customer adoption rates of all the services, right? So that's Slide 12 in the deck if you're looking at it. So we're trying to show a number of things there. One is you can see where the services were introduced from availability perspective, right? As you can see historically over time After we've done introduction of the service over the years, it has grown very nicely from a customer adoption perspective.
And it certainly looks like the newer services are tracking in that regard. I just mentioned, Apturn Auto Focus have about 100 customers now, the year after launch and that's growing very nicely. Traps were well over 500 customers now. I think for sure we hit an inflection point in that business in the second half of twenty sixteen. We're hearing very, very good feedback from Customers and partners on that now and we expect it will be a major player net business and on VM Series, it's growing very well too.
We have over 1700 customers into the M Series and it continues to grow at higher rates. One of the interesting things about the M Series as well as if we took what we did in business and I mentioned some of the magnitude on that and looked at that in fiscal 2016 Product wise, it's not product revenue, of course, it is subscription services revenue, but that would add in a few points of product revenue in Fiscal 2016. And then finally I gave this on the call in the script but we're running Traps business and Each of those are at multiple mid figure and mid eight figures right now growing at triple digits. So we're very happy with the progress of all the unattached services and we'd expect that to keep growing over time.
Great. Thank you.
At this
time, we'll take a question from Gabrielle Borges with Goldman Sachs.
Great. Thanks so much for taking the question. Maybe just a little bit of follow-up on the commentary on Product revenue growth rates, if you don't mind. Just particularly on the comment that fiscal 2018 product revenue could accelerate a little bit. I understand the dynamic here with tough comps and easier comparisons, but if you could just give us a little bit of color into how you're thinking about industry growth rates normalizing over that timeframe?
Yes, sure. I think when we
look at the nature of the industry, if you took like a 10 year view, right, particularly in the firewall market, it's sort of In nature and with various ups and downs over time. But regardless of the cyclical nature in that and you look at our performance over that period of time, we continue to significantly outperformed the market on all aspects of the platform, including like the hardware portion of that as well. And we're looking at fiscal 2017 over 2016 we've got some pretty tough comps as you can see particularly in the first half. We do expect to grow the product revenue sequentially every quarter after Q1 We said, and we also believe that we've got the benefit of our own internal refresh, which is good and Increasing over time. And when you look at sort of the cohort analysis of the number of customers in the cohorts, almost 29,000 of the 34,000 And customers are after 2012, right.
So it's a very significant uptick post the 2012 cohort as well and we expect to see that continue to add steam towards the back half of the year and into fiscal 2018 and beyond.
And putting things in context, Our guidance indicates that we're running roughly a $0.75 of a $1,000,000,000 product revenue business in FY 2017, Which is by far and away the largest from a product revenue standpoint versus the competition. And the other thing is we are driving a platform sale. So product is it is an important component, but it's not the only component. We've been driving the business Andy, you're seeing the impact of recurring revenue coming into the mix in a meaningful way. So it is a platform approach And we're calling for high growth mode for this year.
So the product is one component of the analysis.
That's very helpful color. And as a follow-up if I could, Maybe just on the platform approach and the capital allocation, an update on how you're thinking about M and A and what sort of criteria you're screening for as you think about Building that platform and engaging on customers more deeply over the longer time. Thank you.
Sure. That's a great question. We're very convinced that the platform is the winning strategy. It's been the case for years now. And our view of the platform is that it's very important that the capabilities are doing a number of things.
One is that they're actually doing something from a security perspective to try to find and stop and it's back somewhere in its lifecycle. The second thing is that there is native to each other. And what I mean by that is they actually work very, very closely together so that you can get a high degree of automation. And then from that you can get leverage when you add every new customer in that right. So every single customer helps every other So that's really the kind of the simplest definition of a platform.
And it is way more possible to get that outcome when things are actually Under your control and you build them yourselves. Our motion here to get into a more than $2,000,000,000 run rate in billings has been primarily to do those things ourselves because we get all three of those very important points from a platform perspective. Now that doesn't mean that there can't be M and A in the future. It's possible we've done a few deals like that. We would action that if we thought it was important from a platform perspective.
We put something See mostly into the platform if it met all those definitions into the future. But customers really know the difference. They know the difference when you're trying to smash Together that you purchased in the market and try to call it a platform or pseudo platform, they don't like the fact that those things don't really get integrated. They have to be the integrator of those technologies over time. They're really just rebelling against that.
So anyway, the native concept of the platform, I think, is very, very important and our primary motion would be to make things ourselves when we can.
We'll now move to Rob Owens with Pacific Crest.
Great and thanks for taking my question. With regard to Traps, you mentioned the inflection that you've seen in the back half of fiscal 2016. What do you think is driving that? Is it broader market acceptance of the technology? Was it the last rev?
Just the market maturation overall?
Yes, Rob, it's a good question. I think it's a mix of all those things. But the if I had to weight them, right, I would say that primarily, We're getting better and better and better at this, right? So we've got some competitive advantages here on Traps in and of itself like every other one of our platforms are far we use for that and it has to be as good if not better than any best of breed capability And we're definitely doing that with every release of making it the best possible endpoint protection you can get and AV replacement, right. And 3, 4, which we just released as a major step forward to this being a head on AV replacement, right?
The second thing is we want to make sure that we leverage Those best of breed capabilities from an endpoint perspective into the network itself. So a unique competitive advantage we have here is that they're very tied into, for lack of a Fair term, the networks of the network and the endpoints are learning from each other and actually being able to do prevention with each other in a highly automated fashion. And then the third point is the very native integration into Wildfire. So we get the leverage from a threat intelligence perspective both to the endpoints entered networks. Customers really understand that and I think that when they're comparing them to either a legacy solution That really isn't working and they know it.
They're choosing Palo Alto more often than not. I mean, it compares to the multitude of Next gen endpoint providers in the market, those providers really can't stand up to the platform, the power of the platform. And we're seeing that, like I said, in the second half of fiscal 2016 that team did a fantastic job of growing the customer base, growing the bookings on that and I expect that will continue into the future.
Great. And then second,
some of your competitor side of discounting and frankly discounting maintenance in this quarter. Things have become more competitive. So Curious what you're seeing either in terms of what customers are asking for or a rational competitive behavior out there? Thanks.
Well, Rob, it's always been a very competitive market that we live in and I expect that that's going to continue and maybe even heat up as we go into the future. I mentioned in my prepared remarks that if you are a legacy firewall vendor, They're kind of getting down to the last cards you can play increasingly one of those is price, right? And if you're a point provider, That's maybe the only card you can play at this point. So we're definitely seeing very aggressive behavior in the market. Nonetheless, we continue to win at very high rates.
You can Steve, our gross margins, they continue to be very good. So we're able to sell value. We're not intentionally, we're not selling on price, we're selling on value. And we expect we'll be able to continue that into the future, but people are getting kind of desperate out there.
At this time, we'll move to Pierre Ferragu with Bernstein.
Hi. Thank you for taking my question. I have actually a question, Tom, on the color you provided on guidance. You started by making reference to where consensus expectations At that moment. So am I right thinking you've built your earnings guidance based on that revenue number of 1 $800,000,000 or so.
And then if that's the case, my question would simply be how do you feel about that number? Do you What would be your own perspective on what kind of revenue number you can achieve in 2017 is a consensus strategy? Is that like an easy mark? That would be very helpful.
Yes, fair. Good question. So, as you know, we don't provide annual guidance right now. We would not be doing that in the future, but we want to be as helpful as Possibly can from a modeling perspective here. And with the impact of the deferred commissions, it has a good positive contribution to EPS in a contribution EPS on a full year basis, but it kind of liked itself in over the full year, right.
So we really want to make sure that we can be helpful with the models on thinking about what the impact That would be over the year. So that's why we wanted to give a one time full year view on what the EPS range could look like. And of course if you're talking about EPS and you don't have kind of revenue in mind that's not very helpful as well. So we just anchor that into current consensus which we're comfortable with and that's why we did
Okay. And then I have a quick follow-up, which is on the product revenue, gross number you gave. Is that like in the same picture? So is that It's like backing off from this $1,800,000,000 consensus revenue number, your revenue growth in products would be 12% to 13%? Or is that something on which you have like better visibility and it's more of a statement that this is what you expect for next year Just on product revenues?
We considered in the commentary to give some guidance on the EPS related to the current consensus on revenue, what we talked about from a product revenue perspective of the 12% to 13% growth rate.
We'll We'll now move to Karl Keirstead with Deutsche Bank.
Thank you. I've got 2 related questions about the product revs. Maybe I'll start with Stefan. Stephen, not to be too short term here, but it looks like you're guiding to something below 12 to 13% product revs growth for the October quarter. You mentioned it would be lowest in Q1 and increase thereafter.
What is it about October that might result in a slowdown in product revs growth from 24% this past quarter to 2012, 2013 because it doesn't appear as if the comp gets that much more difficult. So is there anything else happening that's causing that? And secondly, for you, that's giving you confidence that in January, that trend can increase? And then, for Mark, I've got a related question. This mix shift away from product to subscription and recurring is not just a Palo Alto Networks phenomenon.
We're hearing it across the industry and It's really picked up in the last 6 months or so. And I'm wondering if you could give us some perspectives given your client conversations as to What fundamentally is driving that shift? Thank you very much.
Yes. So on the first one, Carl, In the prepared remarks, I had mentioned that actually the January quarter, not the October quarter, was going to have the lowest year over year growth from a product standpoint. And that's because Q2 of last year, We posted our highest year over year product revenue growth in that quarter at close to 47% Year over year, a year ago. So it is largely due to the comp. And we're looking at growing revenue sequentially after Q1.
And the other thing is when we look at our pipeline view for the first half and the full fiscal year. We see pipeline very strong. The comps get easier in Q3 and Q4. And we look to accelerating product revenue growth at the back half the year and into FY 2018?
Yes, Carl. And the second point, I think you're spot on for sure. Tria is talking about what we're talking about here and that's because of this paradigm shift I mentioned, right, which I and not to give ourselves too much credit, I think we're the main driver of that Over time, we created the concept of a real platform. We're subsuming services into that platform at a rapid rate and very seamlessly, And I think if you're a point provider in the market today and your capabilities are Going away from a hardware perspective, you only have one direction to go, which is try to add try to turn them into services, which people are trying to do. But at the same time, you're facing those things And if you're a legacy firewall vendor, you don't have a real platform.
Of course, you're all Coming up with the services. And as far as I can tell, I mean, I don't have all the details, right? It looks like a lot of those folks are trying to bundle them in for free as a way to maintain the firewall position. But if they're not used, right, they're not very useful. In our case, we know that people are using them, they're paying us, I think it's full boat for those things renewing them at very high rates which is great and they're buying them at very rapid That's right.
We can see that across the board from a purchasing perspective. Stefan mentioned that in our prepared remarks and our top 25 customers on lifetime value. And I don't know if you have those charts, but if you get a chance check out number 17, which really is the view that you've seen for some time on lifetime value. But we went back and took a look at customers with multiyear purchases as well, right, because multiyear purchase I mean they're committing to Palo Alto Networks and more and more capabilities and for longer periods of time. But also I think people were a little worried about People are making multiyear purchases, are they gone, right?
And what's happening from buying perspective? On Slide 17 there, Even if people are making multiyear purchases, they're making frequent purchases inside that multiyear period excluding renewals, right. And though they're continually come back and adopt more and more of that platform. And if we look out over our top
1,000 customers and look at all those who've made a
multiyear purchase just to expand this numbers and look at all those who've made a multiyear purchase just to expand this view for a second and made a multiyear purchase. Over 90 percent of them have made a subsequent purchase after they made a multiyear purchase, right? So anyway, I'm sorry, I'm going on at length here. But I think this whole paradigm shift You're seeing and you've noted the entire industry is very important and there's definitely a move into more of these capabilities being delivered to services. And like I said, not to give ourselves too much pat on the back, I think we actually reinvented that and we're disproportionately benefiting from.
We have time for one more question. This will be from Michael Turits with Raymond James.
Hey, guys. Granted the tough comps On product and also mix shift. But is there anything inherent in the market, even if we could get that on a unit basis in terms of the amount of, let's call it, boxes to be sold that would be slowing that growth rate now in terms of penetration or greater competition, it's still quite a significant to sell.
Yes, Michael. No, I don't think so. I think we're looking at the overall numbers that we're driving. Let me start with that Just what's happening from wins in the market. We're always going to start with and try to drive the total revenue rates on the platform.
So you can see we're Very committed to high continued high growth in this and that includes the product component. It's like I said to the earlier question, Yes. If, to the extent that there's cyclical natures in product purchases over time, we've outperformed that very handily in any of those kind of environments as well. But mostly we're just dealing with tough comps here as we look at fiscal 'seventeen to 2016.
And also, Stefan, you had talked about still being on plan for the 100 bps of organic expansion on plan with 100 to 200, but That is still at the low end of that range. So why this year are we at the low end of that range?
Because the market opportunity is so great. We have single digit market share in a $22,000,000,000 market. We're posting top line growth that's far in excess of all the competition. There's no reason to stretch to maximize operating margin in the near term to slow down the revenue growth. We've been driving from the date of the IPO to balance growth and profitability.
We've been growing way faster than the rate of the market and we've been expanding operating margins. So our plan is to continue to do that on a go forward basis. We're committed to that. And we look forward to continuing to take market share and increased profitability?
I think that's all the time we have. So I'd like to thank everybody for being on the call this afternoon. Just to reiterate, fiscal 2016 was a very good year for us. I want to once again thank the Palo Alto Networks team and our partners for all their hard work and support and particularly our customers as well for the trust they continue to put in us. As you look ahead, we're more convinced than ever of our ability to continue to take market share and distance ourselves from the competition.
We look forward to updating you on that progress on the next call. Thanks everybody.
And again, that does conclude today's conference call. Thank you all for your participation.