Kelsey Turcotte - VP, IR Mark McLaughlin - Chairman, President and CEO Steffan Tomlinson - EVP and CFO Mark Anderson - President.

Keith Weiss - Morgan Stanley Brent Thill - UBS Saket Kalia - Barclays Capital Sterling Auty - JPMorgan Walter Pritchard - Citigroup Gabriela Borges - Goldman Sachs Rob Owens - Pacific Crest Securities Pierre Ferragu - Bernstein Karl Keirstead - Deutsche Bank Michael Turits - Raymond James.

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'd 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 fourth quarter 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 Steffan Tomlinson, our Chief Financial Officer. This afternoon, we issued a press release announcing our results for the fiscal fourth quarter 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 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, the impact of change in accounting policies, 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 rates, 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 subscription 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.

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 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've 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 first quarter 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 & Company Institutional Investor Conference on Wednesday, September 28.

And finally, for your reference once we've completed our formal remarks, we will be posting them and the related slide deck to our Investor Relations website under Quarterly Results. And, with that, I will turn the call over to Mark..

Thank you, Kelsey. And, thank you everyone for joining us this afternoon. I am happy to be here with you to share our results for our fiscal fourth quarter and full fiscal year 2016. Our fiscal fourth quarter capped off another record year for Palo Alto Networks.

In the quarter, we grew revenue 41% year-over-year to $401 million; billings were up 45% year-over-year to $572 million; free cash flow was up 72% year-over-year to $171 million; 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 $1.4 billion, up 49% year-over-year; billings of $1.9 billion, up 56% year-over-year; free cash flow of $586 million, up 85% 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 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 as individual hardware appliances or disparate software agents, and then have the customer be responsible for acting as a back-end integrator to try to gain some leverage from the products.

It 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 in the security stack, increased complexity in the network, increased cost to deploy the technologies, and increased reliance on man power which is hard to find and is the least leverageable resource a 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 of breed capabilities which are increasingly delivered as 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 architectural considerations as opposed to the more transactional “one of each” hardware model seen 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 decisions, more open than ever to transition from legacy technology, and awarding larger deals to fewer vendors.

Second, those vendors that have traditionally served the firewall market are relying primarily on price, bundling of free services, or promises of future roadmap to try to stay in the network.

And third, point product vendors are finding it increasingly difficult to justify their standalone value proposition when their capabilities are being subsumed into the platform. As the primary driver of this paradigm shift, we are benefitting 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 capabilities and is easily deployed as 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 are delivering on their requirements. In terms of customer growth, in the fourth 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 500, and 55% of the Global 2000. 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 fourth quarter, we now have more than 29,500 customers using Threat Prevention, more than 24,000 using URL filtering and 3,500 using Global Protect. We added the highest number of quarterly WildFire customers in our history to bring our total WildFire customer base to over 12,500.

Our Traps offering and our VM series offering each are on mid-eight figure run rate in sales growing at triple digits.

Specifically, we grew our number of VM series customers to over 1,700, up from the approximately 1,000 we reported recently at Analyst Day, with hundreds of 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 Day.

Finally, we have approximately 100 customers using AutoFocus and Aperture resulting in a combined eight 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 lifetime value customers again made purchases in the fourth quarter and to make this list a customer had to have spent a minimum of $14 million in lifetime value, a more than 50% increase over the $9.2 million in Q4 of fiscal '15.

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 Check Point replacement at a large U.S.

financial services company to secure their datacenter with our PA-7000 series chassis; a competitive win against Cisco in the defense industry for a significant IoT use case utilizing VM series.

A perimeter and datacenter Cisco replacement with PA-5000s, Threat Prevention, URL Filtering and WildFire in one of Europe’s largest retailers with over 6,000 stores; a Check Point replacement including dozens of devices across product lines, Threat Prevention, URL Filtering and GlobalProtect where we became the standard security platform for one of Europe’s largest media companies; a Cisco replacement in the internet operations of one of the world’s leading SaaS vendors with our PA-7050 chassis, Threat Prevention and URL Filtering.

And, we closed a seven-figure Traps deal for 30,000 endpoints with a U.S.-based integrated health care organization where we replaced Symantec for anti-virus. 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 teamed with Accenture, Splunk and Tanium to develop an integrated security offering wrapped with Accenture services that includes our Next-Generation Security Platform.

This unique combination will help organizations better defend their networks, 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 anti-virus technology to protect endpoints. We also introduced the WildFire EU Cloud.

Customers will now have the option to submit unknown files and email links to a WildFire cloud within the EU for analysis, where the customer’s submissions will be fully analyzed and stored without ever leaving the EU borders.

Data privacy and protection is paramount when it comes to cloud-based threat 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 Kick Off for 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 in the company for deep bench strength to ensure we can seamlessly scale at unprecedented growth rates.

I was very pleased to announce the next step for us in that regard at our sales kickoff event with Dave Peranich 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 and channels, while Mark will retain ownership of sales, lead our go-to-market strategy, as well as customer support and business development. I am 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. With that, I’ll turn the call over to Steffan..

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 will 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 will conclude with guidance and modeling points. I’ll start with the results. For both the quarter and the year we delivered industry-leading topline 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, our total revenue grew 41% year-over-year to a new record of $400.8 million.

For the fiscal year, we reported total revenue of $1.4 billion, a 49% increase over the prior year. The geographic mix of revenue for Q4 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 $191.1 million increased 24% year-over-year and growth was healthy across our product portfolio. Recurring services revenue of $209.7 million increased 61% over the prior year and accounted for a 52% share of total revenue.

SaaS-based subscription revenue of $106.5 million increased 66%, while support and maintenance revenue of $103.2 million increased 57%. Q4 billings were $572.4 million, up 45% year-over-year. For fiscal 2016, billings were $1.9 billion, up 56% year over year. Product billings were $670.1 million, up 35% and accounted for 35% of total billings.

Support billings were $579.6 million, up 70%. Subscription billings were $655.9 million, up 72%. Support and subscription billings accounted for 65% of total billings in fiscal ‘16 compared to 59% in fiscal ‘15. Total deferred revenue was $1.2 billion, an increase of 74% year over year and 16% sequentially.

Short-term deferred revenue of $703.9 million increased $280 million year-over-year and accounted for 57% share of total deferred revenue. Long-term deferred revenue of $536.9 million increased $247.1 million 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 eight subscription services continued to be strong.

The attach rate of the four 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 ’15. 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 topline details covered, I will now turn to margins. Our Q4 gross margin was 79.4%, 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 $245.7 million, or 61.3% of revenue. Operating margin was 18.1% in Q4 representing a 400 basis points increase year-over-year and 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 210 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 $46.2 million, or $0.50 per diluted share using 91.7 million shares, compared with net income of $25 million, or $0.28 per diluted share in Q4‘15. For fiscal ‘16, we reported net income of $152.6 million, or $1.67 per diluted share, compared with net income of $75.2 million, or $0.86 per diluted share, in fiscal ’15.

On a GAAP basis for the fourth quarter, net loss was $54.5 million, or $0.61 per basic and diluted share. This compares with a Q4’15 GAAP net loss of $46 million, or $0.55 per basic and diluted share.

For fiscal ’16, we reported a GAAP net loss of $225.9 million or $2.59 per basic and diluted share, compared to a GAAP net loss of $165 million or $2.02 per basic and diluted share in fiscal ’15.

Turning to cash flows and balance sheet items, on a GAAP basis, in Q4 cash flow from operations was $187.5 million, up 68% year-over-year; free cash flow was $171.2 million, up 72% year-over-year; and free cash flow margin was 42.7%. We finished July with cash, cash equivalents and investments of $1.9 billion.

DSOs were 69 days, 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 into the continued evolution of our hybrid-SaaS model and the mix shift in the business. In the execution of our model we are 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 of the platform and is beneficial from a financial standpoint because it makes us more strategic and sticky with customers, is 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, durations 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 multi-year 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 the cash for deals upfront instead of annually which is driving high deferred revenue growth and strong free cash flow.

Over the past three 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 have been working on a project that allows us to better match commissions expense to our ratable revenue.

Starting in Q1 we plan to move from our historical approach of expensing 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 revenue 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 a $0.01 contribution to fiscal Q1 non-GAAP EPS and an 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% to 23.6% in Q4 and 19.3% to 19.8% for the year.

Now, turning to guidance, for fiscal Q1 2017, we expect revenue to be in the range of $396 million to $402 million, 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 to 94 million 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 commissions plan impact for the fiscal year, we want to provide a one-time, full-year view on non-GAAP EPS.

Using current fiscal '17 consensus of $1.827 billion 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 to 96 million shares.

This range includes the benefit of at least 100 basis points of organic non-GAAP operating margin improvement and approximately 150 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 '17, 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 million of short term deferred revenue coming from the balance sheet 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 in Q4. Additionally, we expect higher product revenue growth rates in fiscal '18 given lower comparables relative to fiscal '17.

We are 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 '17 will be 31%.

CapEx for fiscal '17 is expected to be in the range of $160 million to $170 million for the year taking into account the one-time $100 million investment associated with the construction of our new headquarters. Normalizing for this one-time event, CapEx would be in the range of $60 million to $70 million for the year.

And, we expect total CapEx will be more heavily weighted toward Q2 and Q3, with approximately 60% of capital expenses falling in these two quarters. Excluding the one-time $100 million 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 would like to note that our Board of Directors has recently authorized a stock repurchase for $500 million effective through August 31, 2018. With that I will turn the call back over to the operator for Q&A..

Just to remind our ladies and gentlemen, you can find the prepared remarks and related slides posted at the Palo Alto Networks Investor site. [Operator Instructions] And at this time we will take our first question from Keith Weiss with Morgan Stanley..

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 incremental share within the broader market opportunity?.

Yeah. Keith thanks. So in the first question on macro size, we said in the last quarter and I think that we saw this broadly across the whole technology industry, there was fairly negative sentiment out there. And we saw that improve in Q4 and we’re happy [indiscernible] that would expect into the future.

And we had mentioned a couple of soft spots last quarter as well that one being Australia. We saw very different performance there in the fourth quarter and very excited team who has done a great job for us there, and we see increasingly nice revenue growth rates in APAC as a result.

On the product revenue side, when I think about what's happening in the industry with the paradigm shift and really looking at the growth of the platform, right. So we are attempting to build the entire platform.

I think when you look at the success of that and the total topline revenue growth of the company, we are outpacing everybody in the industry by very wide margin. And that’s true in every aspect of the platform including the product portion of it as well.

We know we're coming off some pretty tough comps through fiscal '17 compared to '16, but we still expect that we would outpace all the players in the industry by wide margin in product as well as for the total platform..

Got it so from a competitive standpoint, no change in your view on competitive positioning, versus some of the incumbents?.

Not at all. I think they were doing very well competitively and doing better and better as time goes on. It's pretty evident that I think if you look at the result 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 taken up steam.

They're really fed up with the cost expense [indiscernible] 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 Steffan noted about the growth that's not only on the hardware side of the business, but the attached and non-attached subscriptions side are all growing at very high rates..

And I'll 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 would 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 basis, and you stack us up against any of the competitors out there, we are multiples ahead of them, which demonstrate the fact that the customer base wants the entire platform both the hardware, each subscription that we sell, the four attached and the four non-attached..

We'll move along to Brent Thill with UBS..

Good afternoon. Steffan, just on the bottom line, you posted 440 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 at a pretty high margin, why such a delta this year from what you put up this year, versus how you're thinking about '17 on organic basis?.

Well we are 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 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 be in 100 to 200 basis points range of annual operating margin improvement which is exactly what we are calling for with our guide.

And then we have the incremental benefit from the deferred commissions project which gives us another 150 to 200 bps on top of that, but this is a playbook we are running and we have call it, top high single digit market share and what will be a $22 billion 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 will 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 are looking at posting free cash flow margins of greater than 40% on an adjusted basis for the fiscal year.

And that was actually 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 is also some that are nervous any time a change like this goes down.

Can you just walk through the hand off, and in terms of the transition here, and how you see that going?.

Yes, sure it’s completely understandable Brent as well.

So as we've grown the business and we're running at a pretty big scale right now, whereas you can see from the billings side as well to well over $2 billion and growing very quickly we have to keep trying to invest in advance everywhere in the company to maintain seamless growth and we've been doing that for a long time from people process and business perspective and 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 has been around the block a number of times to pay attention exclusively to sales and channels, working with Mark in that regard who has done a great job for us for the last four years and has built up a great rapport with the customers and the team as well.

And we also wanted to give more focus and capacity, capabilities to Mark for some very important things that we need to do in the future, like driving relationships with strategic [integrators] [ph]. He is going to take on the bulk of the strategic relationships with our cloud partners and business development as well.

So we can give more focus and capacity in those areas which are going to be important for us to grow into the future. And of course benefit of that as well as that gives me some more focusing capacity to work on the more strategic things in the company.

So I would just look at this as continued increase in focus and 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. 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. Steffan mentioned, has very high free cash flow generation. We expect that to continue in the future as we benefited a lot from that. We had about a $1.9 billion in cash primarily on shore.

We're throwing off very high numbers from our free cash flow perspective and we’re going to keep doing that into the future as people adopt the platform. And so with all that in mind, we talk about use of cash regularly and the Board as you want us do and expect us to do. There are 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 when I make sure we have appropriate amounts of cash that we could action in the M&A that we might find interesting.

At any given time we certainly have the capability to do that. And then also, if possible opportunistically to return some cash to shareholders. You can take that into account as well. So at this size, with the kind of cash flow generation we think we can accomplish all this effectively..

Got it, very helpful.

And then for my follow-up, for you Steffan, just on the accounting change, and you 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 the 100 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 '17, we are little bit above that stated range because of the impact of deferred commissions. Post '17, because of the amortization you're going to have some of the FY '17 expense hitting in FY '18 etcetera.

So we are still committed to the 100 to 200 Bps post FY '17 provided we’re in high growth mode. 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 want 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..

Yeah, 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 linearity in the quarter, relative to what you saw in the third quarter?.

Hey, Sterling. We had a strong July. We would expect that when everybody is into their -- accelerates in the fourth quarter. So it's not unusual to be the case. We did say in the third quarter we saw some more loaded third month in that quarter I think that was really sentiment related, but really nothing unusual from a fourth quarter perspective..

Okay, so maybe a bounce back to what you normally see in the quarter? And then just a follow-up, in terms of looking to fiscal '17, what changes have you made around either sell structure, quotas, et cetera, to think about driving some of the subscriptions, especially the standalone stuff like Traps?.

Sterling I am going to hand it over our new President Mark Anderson line today..

Hey, Sterling.

How are you?.

Good..

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 '17 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 us some color on the Aperture and AutoFocus revenue run rate. I'm wondering on this if you can give us any update around Traps, or any just view as to how you're thinking how the unattached billings performed in FY '16 and how you look at them performing into '17, the unattached subscription..

The unattached, they're all doing very well. We put out some slide materials as well which I am not sure if you are able to reference, but if you have them Walter or not, but when you get a chance, you can take a look at them. And one of the slide that we dropped in there 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 and you can see historically over time, after we've done introduction of a 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 mentioned Aperture and AutoFocus have about 100 customers now and the year after launch and that’s growing very nicely. Traps are well over 500 customers now. I think for sure we're hitting an inflection point in that business in the second half of '16.

We are getting very, very good feedback from customers and partners on that now and we expect it will be major playing in that business. And the M-series is growing very well too. We have over 1700 customers in the M-series and it continues to grow at higher rates.

One of the interesting thing 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 look at that in fiscal '16, product wise, it’s not product revenue of course. It is subscription services revenue but that would add a few points of our product revenue in fiscal '16.

And then finally, I gave this on the call and the script, but we're running Traps business and VM-Series business each of those are at multiple mid-figure at mid eight figures right now growing at triple digit, and so we're very happy with the progress of all the unattached services and we’d expect that growing over time..

Great. Thank you..

At this time, we’ll take a question from Gabriela 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.

In particular on the comment that fiscal '18 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 on how you are thinking about industry growth rates normalizing over that time frame?.

Yes, sure.

I think when we look at the nature of the industry, if you took like a 10-year view, right, particularly in a borrower market and sort of cyclical in nature and with various ups and downs over time, but regardless of the cyclical nature in that, and if you look at our performance over that period of time, we continue to significantly outperform the market on all aspects of the platform, including like the hardware portion of that is well.

And we’re looking at fiscal '17 over '16. 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, as 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 the cohort analysis of the number of customers into the cohorts, almost 29,000 of the 34,000 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 '18 and beyond..

And putting things in context, our guidance indicates that we’re running roughly three quarters of $1 billion product revenue business in FY '17, which is by far in a way, the largest from a product revenue standpoint versus the competition. And the other thing is we are driving a platform sale.

So product, it is an important component, but it’s not the only component. We’ve been driving the business and 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 products 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&A and what criteria you're screening for, as you think about building that platform, and engaging with customers more deeply over the longer term? 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, 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 an attack somewhere in its lifecycle. The second thing is that there is need to each other and what I mean by that is they actually work very, very closely together, so that you 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 consumer. So that's really the kind of 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 is to get it to a more than $2 billion 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, right? Now that doesn’t mean that there can’t be M&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 and we put something seamlessly into the platform to fit all those definitions into the future, but customers really know the difference.

They know the difference when you’re trying to smash things together that you purchased in the market and try to call the platform a pseudo platform. They don’t like the fact that those things don’t really get integrated and they have to be the integrator of those technologies over time and 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 '16.

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 if I had to weigh 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 capabilities in our platform.

Our bar we use for that it has to be as good, if not better than any best of breed capability and we're definitely doing that with every release and making it the best possible endpoint protection you can get and AV replacement, right, in three, four, which we just released is a major step forward to this thing ahead on AV replacement, right? The second thing is we want to make sure that we leverage those best capabilities from an endpoint perspective into the network itself.

So a unique competitive advantage we have here is it that they’re very tied into, for lack of a better term, the networks to 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 and to the 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.

And when they compare us 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 '16 that the team did a fantastic job of growing the customer base, growing the bookings on that and I expect that will continue in the future..

Great, and then second, some of your competitors started discounting and frankly discounting maintenance in this quarter, as 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.

And if you’re a point provider, that maybe the only cards 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 see from 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 that we’ll be able to continue that into the future, but, people are getting 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 on like the color you provided on guidance.

You started by making reference to where consensus expectations are at the moment, so am I right thinking you have beat your earnings guidance, based on that revenue number of $1.8 billion or so? And then if that's the case, my question would simply be how do you feel about that number? What would be your own perspective on what revenue you can achieve in 2017? Is it a stretch, or like an easy mark? That would be very helpful..

Yes, Pierre, good question. So as you know, we don’t provide annual guidance right and we would not be doing that in the future. But we want to be as helpful as we possibly can from a modeling perspective here.

And with the impact of the deferred commissions, it has a good positive contribution to EPS on a full year basis, but it lags itself 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 of that would be over the years.

So that’s why we wanted to give a full, 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 some kind of revenue in mind, that’s not very helpful as well. So we just anchored that into current consensus, which we’re comfortable with, and that’s why we did that..

Okay. And then I have a quick follow-up which is an on the product revenue gross number you gave.

Is that like in the same picture, so is that like backing off from this $1.8 billion consensus revenue number, your revenue growth in products would be 12% to 13%, or is that something on which you have better visibility, and it's more of a statement 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’ve talked about from a product revenue perspective of the 12% to 13% growth rate..

We’ll now move to Karl Keirstead with Deutsche Bank..

I've got two related questions about the product revs. Maybe I'll start with Steffan. 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 12% to 13%, 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 six 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..

So on the first one, Karl, in the prepared remarks; I had mentioned that actually, the January quarter not the October quarter is 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’s largely due to the comps 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 of the year and into FY '18..

Yes, Karl, and the second point, I think you’re spot on for sure. The whole industry is talking about what we’re talking about here, and that’s because of this paradigm shift I mentioned, right, and not to give ourselves too much credit, I think we’re the main driver of that over time. We created a concept of a real platform.

We’re assuming services into that platform at a rapid rate and very seamlessly, right? 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 tournament the services, which people are trying to do.

But at the same time, you’re facing those things just being subsumed into the platform. 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 as far as I can tell.

I don’t have all the details, right? It looks like a lot of those folks are trying to bundle them from 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.

They’re paying us full boat for those things, renewing them at very high rates which is great and they’re buying it very rapid rates, right? And we can see that across the board from a purchasing perspective, right? Steffan mentioned that in our prepared remarks, in 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 multi-year purchases as well, right, because multi-year purchases mean they’re committing to Palo Alto Networks and more and more capabilities and for longer periods of time but also, I think people are little worried about it.

People are making multi-year purchases, are they gone, right? And what’s happening from buying perspective, on Slide 17 there, even if people are making multi-year purchases, they're making frequent purchases inside that multi-year period, excluding renewals, right? And though they’re continuing to come back and adopt more and more of the platform.

And if we look at over a top 1,000 customers and look at all those who made a multi-year purchase just to expand this view for a second and made a multi-year purchase, over 90% of them have made a subsequent purchase after they made multi-year purchase, right? So anyway, sorry, I’ve going on in length here, but I think this whole paradigm shift you’re seeing and you've noted in the entire industry is very important and there is definitely a move into more of these capabilities being delivered in services.

And like I said, not to give ourselves too much pat on the back, I think we actually, we invented that and we’re disproportionately benefiting from it..

We have time from one more question. This will be from Michael Turits with Raymond James..

Hi guys. Granted the tough comps on product and also mix shift, but is there anything inherent in the market, even if we think of it 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 comps, it's still quite a significant decile..

Yes, Michael, no, I don’t think so. I think we’re looking at the overall numbers that we’re driving if we start with that for a second, right, 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. And like I said to the earlier question, to the extent that there is cyclical natures and 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 2017..

And also Steffan, you had talked about still being on plan for the 100 BPs of organic expansion on plan of 100 to 200, but that's 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 billion market. We’re posting topline growth that’s far in excess of all the competition. There’s really no reason to stretch to maximize operating margin in the near term to slowdown the revenue growth.

We’ve been driving from the day to 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 increase profitability..

I think that’s all the time we have. So I’d like to thank anybody for being on the call this afternoon. Just to reiterate, fiscal '16 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 their support and particularly our customers as well for their trust they continue to put in us. As we 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 in the next call. Thanks, everybody..

And again, that does conclude today's conference call. Thank you all for your participation..