Good day, everyone, and welcome to the Palo Alto Networks Fiscal First Quarter 2016 Earnings Conference Call. Today's conference is being recorded. At this time, I would like to turn the conference over to Kelsey Turcotte, Vice President of Investor Relations. Please go ahead, ma'am.
Thank you. Good afternoon, and thank you for joining us on today's conference call to discuss Palo Alto Networks' fiscal Q3 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, President and Chief Executive Officer and Stefan Tomlinson, our Chief Financial sir. This afternoon, we issued a press release announcing our results for the fiscal Q3 ended April 30, 2016.
If you would like a copy of the release, You can access it online on our website. We'd also 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 fiscal Q4 2016, the future of the security landscape the spending environment and market opportunity for our products, subscriptions and services investments in and increasing demand for our products, subscriptions and services by both new and existing customers trends in certain financial results and operating metrics, our revenue, billings, deferred revenue and free cash flow growth rates, sales productivity, seasonality, operating leverage, ability to expand market share, gain leverage and deliver profitability, hiring expectations, expansion of our partner ecosystem, product and services development and our competitive position. These forward looking statements involve a number of risks and uncertainties, some of which are beyond our control, which could cause actual results to differ materially from those anticipated by these statements. These forward looking statements apply as of today, and you should not rely on them as representing our views in the future, and we 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 February 26, 2016, and our earnings release posted a few moments ago on our website and on the SEC's website.
Also, please note that certain financial measures we use on this call are expressed on a non GAAP basis and have been adjusted to exclude certain charges. For historical periods, we have provided reconciliations of these non GAAP financial measures to GAAP Financial Measures in the supplemental financial information that can be found in the Investors section of our website located at investors. Paloaltonetworks.com. For planning purposes, we expect our fiscal 4th quarter 2016 earnings conference call to be held after the market closes on Tuesday, August 30. We'd also like to inform you that we will be presenting at the D.
A. Davidson 8th Annual Technology Forum on Wednesday, June 1st The Cowen and Company TMT Conference on Thursday, June 2 the R. W. Baird Consumer, Technology and Services Conference on Thursday, June 9 and the William Blair Growth Stocks Conference on Tuesday, June 14. And finally, at the conclusion of today's conference call, we will be posting our prepared remarks 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 pleased to report that in Q3, we once again delivered record results, significantly outpacing the growth of both the market and our competitors despite macro volatility. Q3 revenue was $346,000,000 up 48% year over year. Billings were $486,000,000 up 61% year over year. Free cash flow was $151,000,000 up 95% year over year, and we reported non GAAP earnings per share of 0.42 Our results demonstrate not only that security is as important as ever and a priority spending item, but also that we are cementing our leadership position in the market scale.
Customers agree that having the right foundational approach to security is critical. From inception, we have been focused on a prevention oriented approach, which we believe is the only way to combat the imbalance between a highly automated adversary and increasingly manually dependent responses. And we're delivering that approach with a true next generation platform that integrates and automates prevention capabilities, It's extensible and flexible to address the ever changing security landscape, provides consistent security in both physical and cloud environments and leverages the ecosystem effect of our expanding customer base so that our customers do not have to fight this battle alone. This approach has enabled us to continually widen the gap in in a highly competitive market. In the quarter, new customer additions were very strong.
We're proud to now be serving over 31,000 customers across the globe. Competitive wins in the quarter included a Checkpoint and Juniper replacement at 1 of the largest life insurance companies in the U. S. With our full platform running on PA-seven thousand and fifty's and PA-seven thousand and eighty's, including Wildfire, Autofocus and Traps. A new win with a global semiconductor company where Symantec and FireEye to secure more than 10,000 workstations and servers with Traps and more than 20,000 users with Aperture, a multi legacy vendor replacement at a U.
S. Federal agency to secure their Internet access with PA-fifty60s, PA-seven thousand and fifty's and PA-seven thousand and eighty's and a Cisco replacement to one of the world's largest hosting companies to protect their infrastructure and ensure security compliance. We also continue to expand the customer lifetime value of our top 25 customers, all of whom purchased in the quarter. To make the list in Q3, A customer had to have spent a minimum of $12,500,000 in lifetime value compared to $8,200,000 in the prior year period. These wallet share gains underscore that customers understand the mathematical advantage of having an effective prevention capability at each part of the attack lifecycle built natively from the ground up with highly automated outcomes and increased security, and result in significant total cost of ownership advantages.
Customers are securing their environments by adopting all aspects of our platform, especially our subscription services where revenue grew 69% year over year. Our overall recurring revenue now represents 53% of total revenue. This trend is very good for the business long term as it creates revenue visibility and strong cash flow generation as well as greater leverage over time. Importantly, we are constantly improving and extending our platform capabilities through development efforts and partnerships. On the development side, we recently released several updates to our next generation security platform, including augmentation of our universal protection across multi cloud environments and SaaS applications, including the announcement of integration with Microsoft Azure and enhancements to our VM Series, extension of Aperture's SaaS Security to safely enable Microsoft Office 365, advancements in certificate and 2 factor authentication to help protect and the addition of Mac OS 10 coverage to wildfire as well as the reduction in time from APT detection to prevention from 15 minutes to 5 minutes on average.
This is a major value proposition in the battle against advanced persistent threats. Our more than 10,000 wildfire Customers appreciate the capabilities that we are delivering to them and how the large, fast growing ecosystem around wildfire is providing them with significant leverage. And it's not just customers who see the value in our approach, but also partners. Our Next Wave partner community is thriving with both new and existing partners defocusing on legacy vendors and shifting their investment to Palo Alto Networks as we become increasingly strategic to each other. Hundreds of those partners attended our 3rd annual Ignite user conference in early April, which brought together thousands of security practitioners to network and share best practices on their use of platform in the battle for cybersecurity and breach prevention.
And we are developing new routes to market with global systems integrators and service providers who are building out practices and managed services that will allow customers to benefit from our platform and our partners' offerings and expertise. For example, we are working with Honeywell Process Solutions to boost the cybersecurity capabilities of ICT and SCADA systems Houston Industrial Facilities and Critical Infrastructures. Telstra announced they will be offering Palo Alto Networks as a virtual NFV solution launching later this year as part of their cloud gateway protection offering on their SDN network platform. And Palo Alto Networks and PwC's cybersecurity and privacy practice have joined efforts to design a next generation security framework that will serve as a guide for customer organizations to establish a breach prevention oriented security architecture. These efforts and partnerships will help ensure we have capacity to grow with the market demand for our platform.
I'm also pleased to announce that yesterday, Gartner positioned us in the leaders quadrant of the Magic Quadrant for Enterprise Network Firewalls for the 5th year in a row. We are well positioned in the paradigm shifts from legacy to next generation, detection prevention, physical to virtual and on premise to cloud. And I'm incredibly proud of our team and their hard work, and I'm grateful for the trust our customers and partners place in us. And with that, I'll now turn the call over to Stefan to discuss the financials in more detail. Stefan?
Thank you, Mark, and thank you all for joining us. Before I start, I'd like to note that except for revenue figures which are GAAP, all financial figures are non GAAP unless stated otherwise. Demand was strong in Q3, which once again resulted in record revenue, billings, non GAAP operating margin, free cash flow and free cash flow margin. Core growth drivers in the business remain healthy as we continue to see broad adoption of our next generation security platform, particularly our subscription services. New customer additions were robust and we continue to expand customer lifetime value across cohorts.
These drivers resulted in Q3 total revenue of $345,800,000 an increase of 48% over the prior year. The geographic mix of revenue for Q3 was 71% Americas, 18% EMEA and 11% APAC. Compared to the prior year, the Americas grew 56%, EMEA grew 34% and APAC grew 24%. We saw broad strength across a wide range of verticals and did not have any end customer concentration. The 3 components of our hybrid SaaS model, product, subscriptions and support all grew well in Q3.
Q3 product revenue $162,100,000 increased 33% over the prior year. Growth was healthy across our product portfolio with strong contribution from the PA-seven thousand and fifty and PA-seven thousand and eighty chassis. Adoption of subscriptions and high renewal rates for both subscriptions and support continued to be catalysts for our recurring services business. Recurring services revenue, $183,700,000 increased 63% over the prior year and accounted for a 53% share of total revenue. Looking at the 2 components of recurring services revenue, the first component is our SaaS based subscription revenue of $92,600,000 which increased 69% over the prior year.
Support and maintenance revenue, the second component of recurring services, was $91,100,000 an increase of 57% over the prior year. Billings in Q3 were $486,200,000 an increase of 61% year over year and annual contract duration ticked down slightly sequentially. Total deferred revenue grew to $1,100,000,000 in Q3, 3, an increase of 77% year over year and 15% sequentially with strong growth in both short term and long term deferred revenue. The growth in deferred revenue underscores the power of our hybrid SaaS model and provides increasing visibility into future revenue streams. Total gross margin for Q3 was near the high end of our target range at 77.9%, an increase of 40 basis points compared to last year and 70 basis points sequentially.
Product gross margin was 76.3 percent, a decline of and Basis Points Year Over Year and Sequentially. Over time, we expect there will be fluctuations in product gross margin. Services gross margin for Q3 was 79.4%, an increase of 80 basis points year over year and 130 basis points sequentially. Services gross margin continues to benefit in part from ongoing growth of our high margin subscription services. Total headcount at the end of the quarter was 3,591, up from 3,343 at the end of the prior quarter.
We continue to thoughtfully add talent across the business as we scale to support our growth. For the quarter, research and development expense was 10.6 percent of revenue, decreasing approximately $800,000 sequentially to $36,700,000 Sales and marketing expense for Q3 was 45.3 services related to the RSA Security Conference and our Annual Ignite Users Conference. General and administrative expense for Q3 was 4.9 percent of revenue, decreasing approximately $1,200,000 sequentially to $16,900,000 In total, Q3 operating expenses were $210,200,000 or 60.8 percent of revenue. Q3 non GAAP operating margin was 17.1 percent, representing growth of 3 20 basis points year over year and 20 basis points sequentially. Net income for the quarter was $38,500,000 or $0.42 per diluted share using 91,300,000 shares compared with net income of $20,500,000 or $0.23 per diluted share in Q3 2015.
Our effective tax rate for Q3 was 38%. On a GAAP basis for the Q3, net loss was $70,200,000 or $0.80 per basic and diluted share. This compares with a Q3 2015 GAAP net loss of $45,900,000 or $0.56 per basic and diluted share. We finished April with cash, cash equivalents and investments of $1,800,000,000 Cash flow from operations, free cash flow and free cash flow margin for Q3 were $170,100,000 150.5 $150,800,000 43.6 percent respectively. Capital expenditures in the quarter totaled 19,300,000 The accounts receivable balance was $267,600,000 in Q3, up from $254,400,000 in Q2, Reflecting a more back end loaded quarter, DSOs increased sequentially by 7 days and year over year by 13 days to 68 days.
Now turning to the fiscal Q4 guidance and modeling considerations. As we look at the Q4, we continue to see robust pipeline coverage and strong demand and a volatile macro environment. Our guidance takes all of this into account. We expect revenue to be in the range of 386 to $390,000,000 which represents 36% to 37% growth year over year against an exceptionally strong comparable in Q4 fiscal 2015. And we expect non GAAP EPS to be in the range of $0.48 to $0.50 per share using $91,000,000 to 93,000,000 shares.
Turning to modeling points. First, we've anticipated for some time that seasonality would evolve in the business and this is becoming increasingly evident in our Q1 and Q3 sequential results. Given the current size and scale of our business, we would expect the seasonality to continue and to grow over time. Consistent with previous comments, we expect fiscal Q2 and Q4 to show our strongest sequential total revenue growth. We continue to see a mix shift in our business towards ratable services billings as customers more broadly adopt our platform capabilities.
As we said previously, we expect to exit Q4 at approximately 18% to 19% non GAAP operating margin, which represents an approximately 400 basis point to 500 basis point increase year over year. We expect CapEx to be in the range $85,000,000 to $90,000,000 which includes investments in infrastructure, cloud services and facilities to support the growth of our business, And we expect free cash flow margin to be approximately 40% for Q4 of fiscal 2016. With that, I'll turn the call back over to the operator for Q and A.
So that your signal will reach our equipment. We respectfully request that you limit yourself to one question and one follow-up question And we will take our first question from Sterling Auty with JPMorgan.
Yes, thanks. I wanted to just start off with Point that was really a topic conversation through most of the quarter, which was the duration, because it still looks like A healthy amount of long term deferred revenue growth, but you mentioned that the duration ticked down. So wondering how we kind of connect those stats. What contributed to the strong long term deferred with the shortening duration?
Well, both short term and long term Fird grew very nicely and that is, that's a phenomenal statement that our customers are making because they want to standardize on us long term. The way that we calculate duration is a units based duration. It's not a dollar weighted duration, and we use that contract unit duration as a way to manage the business internally because it takes out the variability of any large deals coming in and out of a quarter. So we feel very good about, the quality of the deferred revenues, the fact that we have over $1,000,000,000 of deferred revenues on the balance sheet. Our standard process is to collect the cash upfront, and that is also a benefit to our model as well and we have very healthy renewal rates.
So all of those things put together, we've seen both a great increase in short term and long term deferred revenue.
Okay. And then one follow-up, Mark, for you. Looking at the example you gave of Aperture and Traps selling into Replaced Symantec and FireEye, Are you seeing, A, I guess increasing traction with larger deals on Traps in terms of larger production deployments? And I guess, B, along with that, are you seeing a better tie ratio, meaning that you're seeing more customers that want Traps and Aperture going in at the same time?
So in the first point, Sterling, On Traps, yes, we're definitely seeing continued strong adoption of Traps and we're also seeing larger deployments as well, which is exactly what we would expect over As we get referenceability and really work our installed base there as well. From a Traps and Aperture perspective, we're seeing good growth in all of our services. So, Aperture did well in the quarter or 2. There's not really so much of a tie between Aperture and Traps. There really is a tie in on the concept of location about where your data is and where you have to protect it, right?
So if data is increasingly moving endpoints, you definitely want to protection there. And we're for sure seeing a strong move of folks using third party SaaS applications. So you want to have your data protected there and that's what Aperture I'm going to do for you. So it all points of the platform from a service perspective, we're seeing good strong adoption.
Thank you. And our next Question is from Saket Kalia with Barclays Capital.
Hi, guys. Thanks for taking my questions here. First, so obviously another strong subscription billings quarter. Can you just talk a little bit about how much of that strength is coming from Getting the existing installed base to turn on more subscriptions like wildfire versus the higher attach for some of the new appliances sold versus renewals, if that makes sense.
Yes. Hey, Zach, it's Mark. So as you saw, we had a good billings growth, 61% year over year. So we're very pleased with that. As Stephan mentioned, that's a great indication that customers are adopting more and more of the capabilities across the platform.
We're seeing that in the installed base, really understanding the mathematical leverage they get every time they take one more service. They're increasing the mathematical probability that prevention is going up for them. We are definitely doing our best job to convince that to new customers When they come in the door, we had very good customer adoption, net new customers this quarter. And we're trying to make that point to those customers as well to take as much of the services As they can and they want right upfront because it increases that mathematical prevention. So a lot of them are buying services, in addition to buying a product.
And on the renewal side, as you can see as our business grows like this over time, we have a very healthy renewals business with very high renewal rates and with a large customer base like this and adding 1,000 plus customers every quarter that's going to continue to feed us into the future.
Very helpful. And then for my follow-up, I think we've all heard the pushbacks on stock compensation and share dilution. Of course, understand demand for talent in the Bay Area. But can you just talk to us a little bit about How you can leverage that stock comp line item? And also how you think the Board really thinks about the use of capital when it comes to share buyback?
Yes, sure. I'll take that one as well. So from an SBC perspective, as you noted, we're here in the heart of Silicon Valley in a very, very competitive talent environment and we're a very fast growing company. So the combination of those two things has meant to support the growth we're hiring a lot of people. And we do that.
We are granting them equity to put make them part of the team and have ownership skin in the game as well along with the shareholders. And that has driven stock based compensation, as you can see. And I know it's high, by the way, we're high along with some of our very fast growing Appears along those lines. As we think about that into the future, the SBC will come down. I certainly expect that to be the case, and I would expect that Start is next year, as a matter of fact.
So and then as far as using cash for buybacks related to that concept of dilution, When you're a fast growing technology company like ourselves, we watch cash all the time, how much comes in the door and thinking about what the The most uses of the cash would be as a Board, and we don't think it's at this time the appropriate thing to do to be using it to buyback stock.
Okay. Thank you so much, Saket, for your question. Our next question comes from Ken Talanian from Evercore ISI.
Hi, guys. Thanks for taking my question. If I did my math right and heard your headcount right, it looks like, you hired fewer people in this quarter than you did in the last couple of quarters. I was wondering if you could give us a sense for, how we should think about that uptick going forward and how it might relate to operating expenses from a trend perspective.
Yes, Ken. So As far as on the headcount side, we've added a lot of people. We've added almost 1,000 people in the 1st 9 months of the year, And we have to continue to add lots of team members into the organization to support the high growth you're seeing, 48% year over year revenue growth, 1% volume growth, that takes a lot of talent to do that at scale. So we'll continue to hire folks onto the team, but we'll also be doing that thoughtfully. And we would assume that Over time in size that the absolute numbers and people that we would hire would come down over time.
On the operating margin side, Obviously, we would get less expense for less numbers of people you bring into the equation. But on the driver for that for us In the short term is really the strong growth you're seeing in subscription services when you're posting up numbers like this on the billing side with subscriptions growing at really high rates Like that, having that mismatch between the commissions and the ratable revenue on that, that's put some short term pressure on the operating margin.
Okay, great. And if I may, one follow-up. You're somewhat early on with your Endeavors on the service provider side, I was wondering if there's anything you could update us with there in terms of your traction?
Sure. Happy to do that. On the service provider side, we called that out a number of times in the last few quarters. It's something we're very focused on. We have been for a while looking at that market as an opportunity.
And with every release that we put out the door and introduction of new capabilities, particularly in the hardware side, Ensuring that we have capabilities that will address the very specific needs of the service provider market. And then we also organizationally made a change about 9 months ago where we Created a very specific service provider theater concept, build a team around that who are very aggressive right now, working with service providers. We have a number of design wins coming from that team already. So we would expect that we would get growth into the future in the service provider market, which is something we really haven't touched yet.
Great. Thanks very much.
Thanks, Ken.
And our next question comes from Matt Hedberg with RBC Capital Markets.
Hey, guys. Thanks for taking my questions. So recurring revenue, obviously strong. I think you mentioned 53% is ratable, SaaS growing 69%. Is there a rule of thumb longer term to think about what the right mix is on ratable revenue?
And then I have a follow-up question to that.
Well, it's certainly going to grow over time As our platform is more fully adopted by all of our customers and when you think about what we've done over the past Several years, we've gone from a couple of subscription services now to 8, and the adoption rates And penetration rates continue to be very high, and the renewal rates for both subscriptions and support are extremely high as well. So you have this compounding of the services business, which will play out over time. So we haven't given a long term model around kind of revenue split, between services product, but it should be growing over time. And we would call it $1,100,000,000 on the balance sheet. We have more visibility in future revenue.
So think of it as up into the right. It will be a little bit it could be a little bit lumpy relative to the traction that we are The strong traction that we're still getting out of our product business.
That's helpful. And then, Stefan, I guess as a follow-up to that, you mentioned seasonality, increased seasonality As we go in Q3 is a seasonally weaker quarter for you guys. Strong services, but product was a little bit light. And I realize you guys guide to the license component, but I think it grew about 33%. I guess, what's the right way to think about that, given that I think a lot of these subscription services are additive versus cannibalistic to the product side?
And services are additive versus cannibalistic to the product side.
Well, as you mentioned, I mean, the 33% year over year growth It's very strong considering that we're operating at scale. And when you think about seasonality in our business, what we've always said, And now it's playing out is that Q2 and Q4 will be our strongest sequential quarters and Q1 and Q3 Well, on a relative basis, just be less strong. And our fiscal Q3 is kind of a proxy for like a calendar Q1, budgets Still being set, that sort of thing. The other part of your question, as it relates to call it subscriptions business, We have 4 subscription services that actually don't attach to the device. So there is a Separation between the product revenue that we're bringing in, half of the subscriptions that we offer attached to the device, but half of them do not.
And to half that don't, our newly introduced relatively newly introduced subscriptions that have a high growth rate trajectory, that we're looking to monetize over time. So less and less there'll be less and less tying of subscriptions revenue to product revenue. They'll still be tied, but it's less of a concrete tie than it has been in the past.
Got it. Thanks.
Our next question comes from Michael Turits with Raymond James.
Hey, guys. Two drill downs. 1, in terms of Stefan, in terms of those or markets, in terms of those non attached subscriptions, which were the ones that really Drove things in the quarter. And also I just wanted to see if we could look at the duration question again and explain to us what that unit versus dollar issue was?
Sure. I'll take the first one and Steph can take the second one. On the non attached subscriptions, we just as a reminder for folks who are keeping track, we have traps with Aputure, Auto focus, and then we have our VM series. And of those 4, the 2 that are larger than the other 2 right now, mostly because of when they were introduced in the VM series and Traps. But all 4 of them did well in the quarter.
Jeff, you may? Yes.
So on the duration, as I said on the call, The way that we calculate it is a units based duration, and it ticked down slightly. An alternative Viewpoint on that is you can look at a dollar weighted base duration. That's something that, we track internally, but we haven't chosen to I'll share that with The Street because the way that we manage our business is off of the units based metric and it takes up the volatility. Now I'll tell you that You look at the profile of both the short term and long term deferred growth, they both had extremely high growth rates. Short term actually grew on a dollar basis greater than long term year over year.
And then the other kind of lens that we look at is, If you were to look at a proxy for, call it, current billings, which is you take our revenue plus change in short term deferred, you're looking at growth, a growth rate north of 50%. So all of those things together kind of point to a very healthy both billings and deferred revenue business and the contract duration as measured on a units basis ticked down slightly.
And just a housekeeping, did you give the wildfire paid customers this quarter?
We said, Michael, it was over at 10,000 on quarter. Thanks.
Missed that. Sorry. Thank you.
Yes. Next, we have Keith Weiss from Morgan Stanley.
Excellent. Thank you guys for taking the question and nice quarter. I think The question that I'm getting after hours is really on the deceleration in the product revenue from Q2 to Q3. And guys, just really asking me the question, has anything changed in terms of the competitive environment or the macro environment out there to cause that slower pace of growth. You talked about seasonality.
I see in the results that Asia Pac seemed to have slowed down a lot. So maybe that's the Two questions. 1, from a competitive standpoint, anything changed to slow down that rate of product revenue growth? Or from a geographic or macro standpoint, Anything change in the macro environment that caused
the gazapac to slow down like that? Hey, Keith, it's Mark. So let me take the competitive question first. On the competitive front, we haven't seen anything different from the competition. And The way we always think about that is we'll fall into 2 buckets, technology and marketing.
We care more about the technology bucket than the marketing bucket. Both are important. But on the technology side, we haven't seen the competition. Do anything technically interesting there that would cause us any concern? I think you can see that also Just kind of as a proof point on very strong new customer adds, very strong lifetime value increases, strong attach rates, Strong penetration rates.
I mean, everything was working well there from that side. So on the marketing side, we continue to see people be very aggressive From a pricing perspective, but that's an environment we've lived in for quite some time. On the macro side, we did mention that, and we've seen from the beginning of the calendar year, A lot of macro volatility. And what I mean by that is, there's things hovering around out there, whether it's the price of oil or what's going to happen with interest rates, China, the Stock market being up and down. And I think from a sentiment perspective for customers, it has them more cautious than they had been in the past They're doing more inspection on deals.
It's taking longer from a deal sales cycle as they look at Things different number of times and also in some cases trying to do with less Today that they can into the future. So a bit of you obviously have better environment or macro environment, those things go away. So But that's what we saw in our guide implied a sequential decline, as we thought about that from beginning from January. And as you can see from our guide going forward, Yes. It's a very, very strong comp, of course, but we took that macro into account when we provided the Q4 guidance.
Got it. And then maybe just one quick follow-up. In terms of the linearity in the quarter, anything unusual in In terms of, linearity, the quarter end is as strongly as it began?
Yes, we see it on the DSOs. You can see we had a Back ended loaded quarter there, Keith, on what we saw and more getting done in April than we usually see Historically, I think that's very tied to what I was saying on the macro sentiment of people just taking longer to get deals done. The team did a great job bringing the business home in April, so we're very proud of But we did see a different looking April than we had in the past.
Excellent. Thank you very much, guys.
Thanks, Keith.
Our next question comes from Gregg Moskowitz with Cowen and Company.
Okay. Thank you very much
and good afternoon, guys. I just wanted to touch on the number of customers, and you mentioned over 31,000. But unless there is significant rounding involved, that would seem to imply some degree of slowdown in net adds versus what you've been showing over the past several quarters. And just wondering if there's any additional color you can provide on the rate of new customer acquisition this quarter as compared with historical periods?
Yes, Greg. Yes, there is rounding going on there just using round numbers when we report these, but no slowdown at all that number was well over 1500 in the quarter, Closer to 2000.
Okay. That's helpful, Mark. And then just as a follow-up on Keith's question, because I noticed also the Asia Pac growth at 24% Was lower than we've seen in some time and just wondering if there was anything particularly pronounced from a macro standpoint or anything else that you would call out
Yes, we did see in different places in the world we saw some of this, what I would call the macro sentiment impact. And one of them was in Australia. For Asia, it's about 24 Year over year growth as you saw. What we saw in Australia that was concern I think from customers in that environment. They're very tied into China, if China's got a cold, right, they got the flu.
So there's from a specific area, Australia, We saw some weakness there in the quarter. We also saw the Middle East, having some concerns around the price of oil and budgets being reset by governments and companies over there as a result of that. So that was an area as well. But generally, you can see strong growth in the top line numbers, the billing numbers. In our most mature market, the Americas at 56% year over year growth, so very strong there.
Okay. That's helpful. Thanks very much.
Thanks.
Our next question comes from Rob Owens with Pacific Crest Securities.
And with regard to the July quarter and kind of what's coloring your guidance, can you talk a little bit about velocity of business versus large deals and what you're Seeing in the pipe, I know you said there's some modest extension as people are looking at deals more closely right now. But just curious as we look at the 4th quarter here versus what you've seen traditionally. How does it look from a velocity perspective versus a big deal perspective?
Rob, I think just as a general matter, we've Very strong velocity in the business. And at the same time, associated with that, we are continuing to work with larger and larger companies on bigger and bigger deals. When you look at our penetration Well over 1,000, the Volvo 2,000 now in the high 80 percentage range on the Fortune 100s. And as we get to work with bigger companies We're going to get to work with them on larger deals as well. So from a Q4 perspective, that's always a seasonally Strong quarter for us and we would expect that to be the case here.
We are working against, I'll call it, a monster comp, if you recall. We had a fantastic Q4 last year, but we're also taking that macro into account when we set that guide.
And secondly, you mentioned success with the federal agency. As we look at some of the newer opportunities that Palo Alto is getting into, whether it be government or critical infrastructure and SCADA systems, which you've mentioned, or service provider, What do you think can provide the most upside over the next 6 months to 12 months just in terms of the overall business and monetization of Some of these newer opportunities. Thanks.
Yes, sure. As you've seen from our business when we've shown you every year at our Annual Analyst Day, The vertical penetration we have, we're a very horizontal business, and I'd like to see that personally in running the business just because it shows, 1, we don't have used exposure anywhere, and 2, We have a useful capability to all verticals. So that continues to be the case by the way. We've seen increasing interest and Business. In the federal space, you can definitely see that we put a great team together there about 2 years ago.
They're really performing well. It takes a very long Time to crack into that market, but when you're in, you start to perform better and better if you're doing something useful for the customers. So we see that service provider, which I just mentioned a few minutes ago, is an area They're putting a lot of attention and focus in, and we think that, that will go well for us. And then just as a general matter, in the enterprise space with large companies, The attention and focus that Mark has put into the major accounts and global accounts, I mean that organizationally has really been paying off dividends for us. We'd expect that to continue as well.
All right. Thank you. And our next question comes from Walter Pritchard with Citi.
Hi, thanks. Mark, I'm wondering if you could talk about specifically the VM series and there was, I think, some notion that Depending on customers deployed VM versus an appliance, the rev impact is different. Did you see any unexpected volatility in the mix between the VM series and the appliances in the quarter.
So VM just for background for everybody from Walter is talking about is with our VM series. Depending on how the customer takes it, either perpetual license or non perpetual is going to fall in category of product versus subscription services. That's basically the background for the question. The VM Series has continued to perform very well for us, including in the Q3. But the breakdown between the perpetual and non perpetual has been consistent, so we didn't see any big swing there.
Okay, great. Thank you very much. Thanks, Walter.
Next, we have Ryan Hutchinson with Guggenheim.
Thanks. So I appreciate the color on duration and deferred. My question Back to billings. As a percentage of revenue, it's the highest it's been in any given quarter with billings accelerating year over year to 60 I believe it's 61%. But revenue guidance is in line.
I'm trying to get a better understanding of the relationship between billings and revenue, especially as the adoption of software and subscription services increases as a percentage of the overall mix. So the question is, as we look forward over the next, call it, 12 months, Will billings as a percentage of revenue stay or improve off these higher levels? Any color on how to think about the change in the model and the relationship Between the 2 would be appreciated. Thanks.
Yes. When you think about the relationship between the two, it all starts with the concept of mix. And over the last couple of quarters, and at our Analyst Day, we devoted a fair amount of time giving insight into how that mix has been shifting In the first half of fiscal twenty sixteen, that mix was 60 53% services relative to where it was the first half 15%, which was 58%. So you're starting to see that shift over time. So billings is increasingly benefiting from higher adoption rates of all of our subscription services and high renewal rates of both subscriptions and support.
And that as a percentage of the business is growing and you're seeing that with percentages that I just mentioned. And by the way, in Q3 That mix shift continued, in the direction of favoring subscriptions. So the relation between billings and revenue Should continue to have a separation that should continue to grow over time because those the services billings that go on to the deferred revenue new side of the house will come off ratably, whereas the product revenue that's associated with those buildings is Shrinking as a percentage of the total. It's still growing in terms of absolute dollars, but on a percentage mix standpoint is decreasing. So On a relative basis, billings, and specifically services billings should be outpacing the rate of product billings over time.
And that same or similar proportion relates to revenue as well.
Thank you. Our next question comes from Brent Thill with UBS.
Thanks, Tim. Mark, there's a lot of metrics that we probably aren't really accustomed Seeing from you guys, you saw a spike in the ARDSO shot up. I think you mentioned sales cycles are extending. I know there's some seasonality, but what do you think is happening? You mentioned it's not really competitive.
So are you just pinning this all to macro? Or is there some type of overall customer behavior maybe you haven't seen for a while? I'm just trying to understand If they're saying, hey, we're
going to go with you, but we're just taking a little
more time, we're having trouble getting funding, what was the common denominator out of the customer conversations during the quarter that caused those dynamics, which you haven't really seen
in the past several quarters. Yes. Just to be specific from a dynamics Perspective, Brian, what I was saying was that the one metric you can look at there with DSOs being higher, you can see we had a more back end loaded quarter in April than 4. And the reason for that, we believe, because we're very engaged with the customers, is them taking longer to get approvals for deals. I think this I've used this term volatility before.
There's a lot of things that play out there, but it also blows down to sentiment, right, about how the customers feel about things. And I think that sentiment in that environment, has been cautious from January and continues to be that case. And they're putting more attention and focus on what they're going spend and how they prioritize that. I think in a very good way, and as you can see from a lot of other companies reporting in the IT sector, and what they reported and how they felt about future. Security, I think, obviously, remains at the top as a priority spend item.
How do we see customers taking longer to get deals approved as they're getting checked 2 or 3 times in a row just to make sure that they want to spend that money.
Just to be clear, were deals did you slip deals to the 4th quarter Given how back end loaded it was that you were anticipating those to come in, in Q3?
Brent, we're doing 1,000 and 1,000 and 1,000 and 1,000 of deal of this size right now as a company. So in any given quarter, we're going to get pushes and pulls across quarters in the last month. So We saw that, but that's no different than what we've seen for some time now.
Okay. Thank you.
Our next question comes from Michael Kim with Imperial Capital.
Hi, good afternoon, guys. Just going back to international, Noah, can you talk about the progress on your go to market initiatives, especially around channel enablement? And then just aside from the macro volatility, is that changing Yes, your pace of hiring or where you're shifting your resources by geo?
Yes, it's a good question, Michael. So from a channel management perspective, one One of the things for sure we're seeing across the board is in the channels, whether it's distributors or whether it's resellers or even business integrators, We've achieved the size in the market and continuing to have very, very high growth rates where everybody's paying And they definitely want to have Palo Alto Networks as a place where they're going to invest in and partake in that high growth. So we're delighted with that, of course, We have to continue to add capacity to do that. We're doing that on a global basis as well, and we'll stay very focused on that As well. So from a headcount perspective, we're always watching resourcing wise where we're going to put resources.
We obviously start the year with a plan off of what the assumptions would be as we progress through the year, depending on How we're the ROI we're getting out of those places headcount wise, we may shift heads around into places with higher productivity. So that's a dynamic Thanks for us. We don't try to just set a static thing at the beginning of the year and live with it no matter what's happening. But those headcount rates, as I said earlier, they're high and They remain high from a sales perspective, just because the demand is obviously there and we want to make sure that we have the people and the place where we can satisfy demand.
And are you seeing a significant difference in the purchasing patterns of some of the international customers versus what you typically would be seeing in the Americas?
It just stands on a couple of countries. And this is every quarter we're going to see something in different places like the world's never firing on all cylinders at all I said, I think a little earlier in this quarter, areas where we saw more weakness than usual was the Middle East. That was pronounced, again, I think Because the price of oil has been so volatile and lower than I think many of the governments and then companies have set their budgets against, so they have to reset those things And look for cost savings. So we saw that in the Middle East. We saw that in a couple of the oil producing regions of Canada.
And then we saw, not associated with the world, but just political stability issues in Brazil. We saw some weakness down there as well.
Okay, great. Thank you very much.
Our next question comes from Karl Keirstead with Deutsche Bank.
Hi. A question for Stefan. I know you don't guide to product revenues, but given your macro commentary and the fact that you've got a 10% tougher compare, I suspect many on the line will end up modeling that product revenue for 4Q in the perhaps low to mid-20s. As we model that line item, Besides macro and the tougher compare, anything else that you'd encourage us to keep in mind?
I'd encourage you To really kind of look at the mix shift in our business, our while we don't guide, as you said, specifically on product revs, The implied guide would call for a sequential increase in product, for sure. But I think where some of the modeling has been off base has been the contribution from the subscriptions and services side of the house. So when you look at the guide that we gave off of an extremely tough comparable last this year. There's going to be healthy growth in both product and services, but the mix I think you should really take a look at. So I would say look at the mix patterns and take into consideration what we've said as a company around how The power of the platform is playing out.
Yes. Makes sense. Thanks, Stefan.
Thank you.
Our next Question comes from Catharine Trebnick with Dougherty.
Thank you very much for taking my question. Nice quarter. Mine is on endpoints. And could you give us a little commentary on within the security budget, what you're seeing is the concentration towards endpoints? And then do you Thank you, believe you have the right product at this time to tackle that piece of the market.
Thank you.
Sure. Hey, Catherine, it's Mark. Yes. So from an attention perspective, endpoints are very high attention. It's pretty obvious to Our customers at the legacy technologies are really not working that well for them.
And I think as a result of that, There's also been a shift of influence on those budgets as well, up the chain into the CISO office or the CIOs as well. We like that a lot by the way because we are really trying to operate at those levels with a true platform approach. So when we can get into the CIO, CISO, CTO level conversations, those folks are thinking about how do I Tech. You know my entire enterprise, and that entire enterprise consists of all the data, and that data is all over the place, right? So our story and our reality of being able to deliver the story of the platform as we can protect the data everywhere, including at the endpoints.
Now from how you do that to your second part of your question. We think that a prevention oriented approach is the right one, just as we've done at the network level very We've successfully in the past. We think that's the right approach at the endpoints as well. And that's what Traps does. It's a very prevention oriented approach.
Because it's tied into wildfire, it also provides of having your network and endpoint understand each other from a threat perspective. And then also very significantly because it's tied into wildfire, you also get the ecosystem coverage of everything that we're finding from our customer ecosystem is being updated not only at the network level, but at the endpoint level as well. So we think we've got the right technology to solve a very important problem and that problem is growing in awareness and attention for
Well, a follow on to that, Mark, who do you guys typically see in a bake off for some of these endpoints? And do you think you're winning more of the bake offs And less of the bake offs. Thanks.
We're doing well in the bake offs, Catherine. When it's a very, very, busy market right now here in the endpoint space. So almost in every case that you're involved in, you have the legacy provider in there, and then you have a very, very long list of next gen endpoint companies who are showing up trying to compete there. I think we're doing very well in that competitive environment for the reasons I said, which is in addition to say we do something very important, which is actually prevention at the endpoint. Nobody then can match the follow on statements of saying, oh, and it works with your network, and you get the advantage of having 30 some 1000 from a threat intelligence perspective at the endpoint level as well.
Thank you so much. And our final question is from Scott Zeller with Needham and Company.
Thanks. Just looking for a little more color regarding the 4Q guidance, given the comments earlier about the seasonality, saying F2Q and F4Q are the strongest. It appears that the guide is conservative for the fiscal Q4.
What we said, Scott, is that from a seasonality perspective, we'd expect Q2 and Q4 to be stronger As you've noted and that would continue to be the case from a guide perspective. And as I said a little earlier, we've taken into account into that guide Not only the really, really strong comp that we're working against, but also the macro environment we're working in as well.
Thank you.
That does conclude our question and answer session. I would now like to turn the call over to Mark Hoffman for closing comments.
Thanks, operator. Appreciate that. Thanks, everyone, for joining us this afternoon. We're all very excited here at Palo Alto Networks about the future, and I want to thank our customers, partners and the entire Palo Alto Networks team for their hard work and support in the Q3, and we look forward to updating you for the