Palo Alto Networks Inc (PANW) 2015 Q4 法說會逐字稿

Good day, everyone, and welcome to the Palo Alto Networks fourth quarter 2015 earnings conference call.

As a reminder, today's conference is being recorded.

At this time, I would like to turn the call over to Kelsey Turcotte.

Please go ahead, ma'am.

Great.

Good afternoon, everyone, and thank you for joining us on today's conference call to discuss Palo Alto Networks fiscal fourth quarter and FY15 financial results.

This call is being broadcast live over the web, and can be accessed on the Investor 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 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, 2015.

If you would like a copy of the release, you can access it online on our website.

We would like to remind you that during the course of this conference call, management will make forward-looking statements, including statements regarding our financial outlook for the fiscal first quarter of 2016, our business strategy, demand for our products and services, certain financial results and operating metrics, our market size, our growth rate, our operating leverage, product and service development, and the timing and impact of these releases, extensive benefits of partnerships, client satisfaction and competitive positions.

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 28, 2015, and our earnings release posted a few minutes ago on our site.

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.

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 Investor section of our website located at investors.paloaltonetworks.com.

For planning purposes, we expect our first quarter FY16 earnings conference call to be held after the market closes on Monday, November 23.

We would also like to inform you that we will be presenting at the Deutsche Bank Technology Conference in Las Vegas on Thursday, September 17.

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 happy to be here with you to share our results for our fiscal fourth quarter and full year FY15

2015 was another great year for the Company, one in which we continued to distance ourselves from the competition.

In the year, we grew our customer base more than 35% to over 26,000 customers, and are now privileged to serve almost half of the Global 2000.

The number of WildFire customers increased approximately 140% year-over-year to over 7,000 customers.

We grew both revenue and billings more than 55% year-over-year.

We significantly expanded our non-GAAP operating margin.

We generated free cash flow of more than $300 million.

We expanded key technology partnerships and distribution relationships around the world, and we continued to strengthen our platform with new offerings including TRAPS, WildFire enhancements, and data center appliances.

We were able to grow at these rates and deliver these results because we have established ourselves as a leader in next-generation security.

Cyber security is an increasingly complex and long-term issue that threatens the fabric of our day-to-day digital lifestyle.

To meet this challenge, enterprises, governments and service providers are having to re-architect their systems and networks off of legacy platforms, and onto next-generation technology.

This has led to an increase in investment levels in security that we do not expect to change any time soon.

Customers recognize that security is not a problem that can be solved by cobbling together disparate point products or legacy solutions, but an entirely new approach is needed.

There's a growing global market recognition that our prevention-first mindset with the market's only true natively integrated and automated next-generation security platform delivers demonstrably better protection and prevention at a very attractive total cost of ownership.

And our singular focus on innovation continues to strengthen this platform with highly disruptive offerings, each of which provides market-leading prevention capabilities.

And when natively integrated in a platform, increases the overall capabilities of the platform.

As a result, we are rapidly replacing the existing security solutions and winning new opportunities and organizations around the world.

And we are taking market share with growth rates that significantly outpace the market and the competition.

We can see this once again in our Q4 results.

Revenue of $284 million grew 59% year-over-year, while billings of $394 million grew 69% year-over-year.

Our non-GAAP operating margin was 14%, and we reported non-GAAP earnings per share of $0.28.

We added a record 2,000-plus new customers in the quarter, including a North American brokerage and banking company where we replaced Cisco in a seven-figure data center deal, a utility provider of natural gas and electricity where we beat both CheckPoint and Cisco for their advanced network protection project.

A diversified managed healthcare company in North America which purchased Palo Alto Networks for NSX in a seven-figure transaction.

An Asian government security agency where we replaced Cisco and their security infrastructure, and one of the largest airlines in the world located in United States where we replaced CheckPoint in an outbound internet project.

Equally important as new customer acquisition, is the expansion of customer lifetime value.

To make our top 25 customer lifetime value list in Q4, a customer had to have spent a minimum of $9.2 million in lifetime value, a more than 60% increase over the $5.6 million required in Q4 of last fiscal year, and up from $8.2 million in Q3.

This lifetime value expansion is being driven by a number of factors.

One example is the continued rapid adoption of WildFire, where we saw attach rates grow to well over 50% in Q4.

While we're very pleased with these results, we continue to believe there's a lot of runway ahead with us with WildFire, which appeals not only to existing customers, but attracts a significant number of new ones as well.

In the fourth quarter, we also saw a continued strong adoption of TRAPS, our advanced endpoint capability which we introduced in the first quarter of FY15, and we are now serving close to 150 customers.

Wins included a large Japanese multi-national telecommunications and internet corporation, and a large US regional supermarket chain.

Given the vulnerability of endpoints and the deficiency of current legacy solutions that market is right for disruption, and we believe our prevention-oriented approach offers customers the most scalable and effective solution.

Feedback from our customers is that our platform advantage continues to resonate and differentiate us from the competition, and we look to widen that gap in FY16, with the introduction of capabilities that will further enhance our platform.

By the end of this month, we expect to bring two new services to the market.

The first service, AutoFocus, gives security practitioners highly relevant access to the threat intelligence and context we gather from our large and ever-increasing customer base.

This helps them focus on stopping the truly unique and targeted attacks.

We have been running an AutoFocus community access program for several months now, and are very pleased with the level of participation and feedback we've received.

The second service, Aperture, is based on the technology we acquired with CirroSecure in fiscal Q4.

Aperture expands our ability to safely enable applications by providing visibility and control for sanctioned SaaS applications such as Box, Google Drive or salesforce.com that are highly collaborative, but often contain organization's most sensitive data.

We also recently announced availability of our newest high end chassis, the PA-7080.

At 200 gigs a second, the PA-7080 is now our fastest throughput chassis designed to help organizations secure high speed internal networks, data centers, and large internet-facing connections without compromising their need for true, next-generation security capabilities.

Early interest has been strong, and in addition to the enterprise customer we expect the PA7080 will help us further penetrate the service provider market.

And in early August, we announced an exclusive agreement with Tanium to integrate Tanium's technology with WildFire to enhance both network and endpoint security.

On the distribution front, we are very pleased with the continued progress we are making with our channel partners on a global basis.

The largest and most respected channel partners are making significant investments with Palo Alto Networks, providing great leverage for us, high rates of revenue growth for them, and value add for our joint customers.

For example, in FY15, CDW grew their business with us more than 85%, while Dimension Data and close to 500 other channel partners all doubled their business, giving us the capacity needed to support our growth.

It is clear to the partner community that Palo Alto Networks is leading the market, and very quickly taking market share from all legacy and [point] providers.

As a result in FY15, well over 12,000 of our partner security professionals invested in education, training and building capabilities around our platform, which should allow us to continue to grow together into the future.

Q4 was a fantastic end to a record-setting year for us, one in which we delivered unprecedented growth at scale, while delivering consistent and meaningful non-GAAP operating margin expansion and cash flow.

I would like to thank the Palo Alto Networks employees for their hard work, and our customers and partners for their ongoing partnership and support.

We completed our global sales kick-off a few weeks ago, and I can tell you that there's a lot of energy and excitement around what we hope to accomplish in FY16.

And with that, I'll turn the call over to Steffan.

Thank you, Mark, and thank you for joining us on our call today.

Before I get into the details of our results and guidance, I would like to note that except for revenue figures which are GAAP, all financial figures are non-GAAP unless stated otherwise.

Q4 was a strong finish to FY15, a year in which we delivered industry-leading sales growth, expanding operating margins, and increased free cash flow generation.

During the fourth quarter, our land and expand sales strategy resulted in a record number of new customer additions and expansion in existing customers, that once again drove growth across the entire portfolio of products, services and support.

We delivered record revenue, deferred revenue, billings, non-GAAP operating income and free cash flow As we look to FY16, we feel good about our ability to continue to grow the top line, and drive incremental leverage in the business.

Now let me turn to the numbers.

Q4 total revenue grew 59% over the prior year and 21% sequentially to reach a new record of $283.9 million.

For the fiscal year, we reported revenue of $928.1 million, a 55% increase over the prior year.

The geographic mix of revenue for Q4 was 71% Americas, 18% EMEA, and 11% APAC.

Compared to the prior year, the Americas grew 68%, EMEA grew 32%, and APAC grew 61%.

We saw broad strength across a wide range of verticals, and did not have any end customer concentration.

The three components of our hybrid-SaaS model, product, subscription services and support, all grew well in FY15 with particular strength in Q4.

Q4 product revenue of $154 million increased 54% over the prior year, and 27% sequentially.

On a year-over-year basis, we saw healthy growth across our product portfolio.

In particular, the PA-7050 chassis continues to help accelerate growth in the high end data center market.

Recurring services revenue of $129.8 million increased 65% over the prior year and 15% sequentially, and accounted for a 46% share of total revenue.

Looking at the two components of recurring services revenue, the first component is our SaaS-based subscription revenue of $64.1 million which increased 70% over the prior year, and 17% sequentially.

Excluding TRAPS, which does not ship as an attach to our appliances, in the fourth quarter customers purchased on average 2.2 subscriptions per device, compared to 2.1 in Q4 FY14.

Support and maintenance revenue, the second component of recurring services, was $65.8 million, an increase of 61% over the prior year and 14% sequentially.

Billings in Q4 were $393.6 million, an increase of 69% over the prior year, and 30% sequentially.

Total billings for FY15 were $1.2 billion and grew 58% year-over-year.

Product billings were $496.7 million, and grew 46% accounting for 41% of total billings.

Support billings were $342 million and grew 58% accounting for 28% of total billings, and subscription billings were $380.4 million and grew 77% accounting for 31% of total billings.

Total deferred revenue grew to $713.7 million in Q4, an increase of 69% year-over-year and 18% sequentially, underscoring the power of our hybrid-SaaS model and increasing visibility into future revenue streams.

Total gross margin for Q4 was 78.3%, an increase of 160 basis points compared to last year, and an increase of 80 basis points sequentially.

Product gross margin was 77.8%, an increase of 210 basis points year-over-year, and 140 basis points sequentially.

Fluctuations in product gross margin are due in part to product mix and the introduction of new products.

Services gross margin for Q4 was 78.8%, an increase of 80 basis points year-over-year, and 20 basis points sequentially.

Services gross margins continues to benefit in part from ongoing growth of our high margin subscription services.

Total head count at the end of the quarter was 2,637, up from 2,317 at the end of the prior quarter.

We continue to add talent across the business as we scale to support our growth.

For the quarter, research and development expense was 10.6% of revenue, increasing approximately $2.6 million sequentially to $30 million.

The increase was primarily due to head count.

Sales and marketing expense for Q4 was 48.2% of revenue, increasing approximately $29.8 million sequentially to $136.8 million.

The increase was primarily due to headcount and end-of-year commissions expense.

General and administrative expense for Q4 was 5.4% of revenue, increasing approximately $1 million sequentially to $15.4 million.

The increase was primarily due to head count additions.

In total, Q4 operating expenses were $182.3 million or 64.2% of revenue.

We achieved our near-term milestone of exiting Q4 FY15 in the low teens for non-GAAP operating margin, with Q4 non-GAAP operating margin of 14.1% representing growth of 600 basis points year-over-year, and 20 basis points sequentially.

Net income for the quarter was $25 million or $0.28 per diluted share using 90.1 million shares, compared with net income of $9.1 million or $0.11 per diluted share in Q4 2014.

For the full year FY15, we reported net income of $75.2 million or $0.86 per diluted share, compared with net income of $31.8 million or $0.40 per diluted share in FY14.

Our effective non-GAAP tax rate for Q4 and FY15 was 38%.

On a GAAP basis for the fourth quarter, net loss was $46 million or $0.55 per basic and diluted share.

This compares with a Q4 2014 GAAP net loss of $32.1 million or $0.41 per basic and diluted share.

For the full FY15, we reported a GAAP net loss of $165 million or $2.02 per basic and diluted share, compared to a GAAP net loss of $226.5 million or $3.05 per basic and diluted share in FY14.

We finished July with cash, cash equivalents and investments of $1.3 billion.

Cash flow from operations, free cash flow, and free cash flow margin for Q4 were $111.3 million, $99.4 million and 35%, respectively.

Capital expenditures in the quarter totaled $12 million.

The accounts receivable balance was $212.4 million this quarter, up from $150.5 million in Q3.

DSOs increased sequentially by 3 days, and decreased year-over-year by 5 days to 58 days.

Turning to guidance.

In Q1 FY16, we expect revenue to be in a range of $280 million to $284 million, which represents 46% to 48% growth year-over-year.

We expect non-GAAP EPS to be in a range of $0.31 to $0.32 per share, using 91 million to 92 million shares.

And before I conclude, I would like to highlight a number of considerations for modeling purposes.

Due to continued strong growth, seasonality has been difficult to forecast, but we believe that fiscal Q2 and Q4 will show our strongest sequential revenue growth.

We continue to expect to exit Q4 FY16 at a 22% to 25% non-GAAP operating margin, which was the target range and date we set at the time of our IPO in 2012.

To achieve this objective, we currently expect sequential non-GAAP operating margin expansion, with the majority of the acceleration into the back half of FY16.

The effective non-GAAP tax rate for FY16 will be 38%.

And with the completion of our FY16 plan, we now expect CapEx to be in the range of $85 million to $90 million for the year, which includes investments in infrastructure, cloud services, and facilities to support the growth of our business.

We expect free cash flow margin to be greater than 30% for FY16.

And finally, our share count is expected to increase by approximately 1% to 2% per quarter.

With that, I'll turn the call back over to the operator for Q&A.

Thank you.

(Operator Instructions)

We'll go first to Andrew Nowinski with Piper Jaffrey.

Okay.

Congratulations on a great quarter.

Just wanted to ask about the product growth, and it's clearly probably the best we've seen in a couple years here for you.

And I was wondering if you could dissect that a little bit, and give us some color on whether big deals may have influenced that product growth, versus some of the market share gains you appear to be capturing?

And then, specifically on the market share side, I'd be curious as to where you're seeing the most gains from, whether it's a vendor or a specific market segment?

Thanks.

Hey, Andy, it's Mark.

They are very related questions.

And the answer is, on the second part is we're seeing gains everywhere competitively, so from the legacy firewall vendors as well as a lot of the point guys, who over time are being subsumed into our platform, from a services perspective.

So we're seeing gains pretty much everywhere where we compete, and also now, including on the endpoint side as well, and that plays into the product growth.

So on the product growth side, you have these very healthy numbers as you can see, and we're experiencing both of the things that you just mentioned.

One is we are seeing larger deals.

We're getting into the Global 2000 at accelerating rates.

So we're seeing larger deals with larger customers, and their -- our existing customer base has continued to buy more over time as well, as you can see from the lifetime value.

So it's winning larger deals with larger customers up front.

And then, just a continuation of something we've been seeing for quite some time, which is customers continue to just buy more from us.

The other angle on that Andrew is we're getting deeper into the data center.

So we're selling our 7050 chassis and our 5000 Series, and we're seeing larger deal sizes as we get further into the data center.

And that should continue as we get more traction with our 7080 which we just announced.

That's great.

Keep up the good work, guys.

Thank you, Andy.

We'll go next to Phil Winslow with Credit Suisse.

Thanks, guys, and congrats on what was just an awesome quarter, ending a pretty huge year.

Just wanted to double click on the subscription side.

Steffan, you mentioned you're up to 2.2 subscriptions per box.

Just as you kind of think about the guidance going forward, how do you expect that to trend?

And obviously, you're introducing some, call it non-box attach via subscriptions.

You already have TRAPS.

You've talked about AutoFocus.

Maybe some more color on just how TRAPS is doing, and how we should at least think about AutoFocus beginning to contribute once its launched?

Hi, Phil.

Yes, thanks.

So a couple thoughts.

First, on the subscription side, you can see the attach rates continue to grow year over -year.

There's a lot of value in the subscription services that used to be point solutions.

So as we subsume them into the platform which we have over time, customers are finding a lot of value from that approach.

So we like that a lot, of course.

You can see our subscription services business as we look at the fourth quarter, is approaching like $480 million of billings run rate.

So growing it over 75%.

So you can just see very strong growth in the attach of the subscription service.

Then in addition to that as you correctly note, as we go forward, we have a number of new services, TRAPS is one of them, Aperture, AutoFocus both coming out here in the next few weeks time, that are services.

They will be billed as such from a sales and revenue and defer revenue perspective, but they won't have the concept of attach.

So some of the attach rates commentary made in the past may be a little less meaningful, as we go forward with bringing more services to market that don't have those attach rates.

And then on the TRAPS itself, we're very happy with TRAPS where it is right now.

There's such a strong demand in the market for endpoint security.

100% or close of the sales calls I go on, customers are talking about the need for something dramatically different to happen at the endpoint, and we think we have the answer for that.

So we have seen a heck of a lot of interest in that.

We think we've got a really great technology there, that very importantly is part of the platform.

So at the end of the day, we're selling the platform, and that's what people find value in.

Got it.

And then, just one quick follow-up for Steffan.

You guys had another quarter of improving product gross margin.

I know a lot of this has to do with mix sometimes and when product is introduced, but you maybe give us more color on what happened this quarter, sort of this year too?

And then, how you're sort of thinking about that going forward?

Well, mix definitely plays a factor, and as we sell higher margin boxes, that plays to the favorability, but mix is only one part of the story.

We also focus on cost reduction, and we have we think the best supply chain team on the planet, and they are going out and trying to drive cost down.

So we are looking at a favorable product mix environment but also reducing [COGS], and we have great manufacturing partners as well.

So we have both of those dynamics going on which is helping with product gross margins.

Great.

Next question?

We'll go next to Rob Owens with Pacific Crest.

Great, and thanks for taking my question.

First off, want to talk about the renewal cycle, and your own renewal cycle, as you look at pre-existing customers over the last three and four years.

And is that beginning to influence and drive some of this product growth we saw?

And then second, in and around TRAPS, Mark, I appreciate the color around the platform play, but maybe you can give us just a little more -- with regard to the technology, and are you actually getting technology wins?

Is it driving new customer acquisition?

And lastly on the TRAPS front, what are you guys seeing in terms of relative price per endpoint?

Thanks.

Yes, hey, Rob.

So on the renewal cycle, I take that to mean like a refresh cycle on our own?

Yes, a refresh of your own install base (multiple speakers).

Okay, no problem.

That's what I thought you meant there.

As you said before, from a -- we have a great customer base, and we continue to add it, we added over 2,000 customers and last quarter alone.

So that's the gift that keeps giving on a long-term basis, when you think about renewals and refresh cycles.

So we talked before about seeing a refresh cycles in our 2009 and 2010 cohorts.

I would start to throw in there the 2011 cohort as well, as these things get to the four to five year natural refresh cycles.

And if you combined 2009, 2010 and 2011 together, it's like a little over 4,000 customers out of 26,000, right?

So our glass is not even tiny bit full yet, right, from a refresh cycle perspective, on a very large and growing customer base.

We like that a lot.

On TRAPS, the question of technology, and what's working there, there are two things really that are going on.

The first is, on a pure play technology or head-to-head basis I'd say, TRAPS is the only technology in the market that actually does exploit prevention.

And then, when you combine that with WildFire to get realtime known malware prevention, and realtime unknown malware detection, and very quick turnaround in prevention, that's a very serious technology difference.

And just on a standalone basis, best-of-breed against anything in the market, customers understand that, that's real prevention as opposed to the other things in the market today.

Then when you have that in the platform, connect the platform through WildFire, and you have the power of WildFire plus the 7,000-plus WildFire customers where all that information is now being shared on a very, very fast basis, to in essence automatically reprogram networks and endpoints it's extraordinarily compelling.

And in price, aside from TRAPS, as you said before, we're selling TRAPS on a per endpoint per month basis, billed annually over one, two or three year contracts.

Yes, on the price side, I guess, the question is, are you seeing it at a premium relative to where traditional AV vendors were, and thus are you seeing TAM expansion?

Thanks.

Yes, no problem.

So on the TAM expansion side, the -- we naturally pick up TAM expansion because we were in the endpoint security business before, so it's a $4 billion-plus market we didn't address before, and now we have the opportunity to do that.

And when we brought TRAPS to market, we intentionally priced it in line with traditional endpoint security technologies because we didn't have to really break any glass there, or tread new direction.

So we priced it at anywhere from $2 to $5 per endpoint per month on these multi-year contracts -- one, two or three year contracts.

So nothing dramatically different than what people were paying already.

Great.

Next question?

We'll go next to Jason Noland with Robert W. Baird.

Great, thanks.

I wanted to ask Steffan about the Q4 2016 target of 22% to 25% op margins.

Like you said, that was set back at the IPO in your growth rate has accelerated this last year.

Is that still the right target, or how do you get comfortable with backing off on growth, or doing what you need to do to get there?

Well, when we set the target model back at the time of the IPO, we had the philosophy that we want to be balancing growth and profitability.

And over the last, call it three years, we have been delivering growth and profitability, and we define that as an operating principle that we try to stay true to.

So 22% to 25% is what we reiterated exiting Q4 of FY16.

We believe we can deliver industry-leading growth and expand profitability over that time period.

We give that range for a reason.

It gives us latitude to -- if we want to be at the lower end of the range, we can invest more in the business.

If we want to be at the higher end of the range, we would let more fall to the bottom line.

But with, call it single-digit market share and close to a $20 billion TAM, we are laser-focused on growing both top line and profitability.

Okay, thanks for that.

And then, a quick follow-up.

At VMWorld last week, Palo came up a lot.

Maybe Mark, if you can touch on the relationship with VMware?

And then, anything on the software-only side, along software-only product alongside NSX from VMware?

Yes, thanks.

I was up there a little while at VMWorld, which was very well-attended.

I had a chance to talk to a number of customers about NSX, and what we're doing with VMware, which is very significant we think.

And that the -- there's a lot of move into virtualized data centers, security is becoming a paramount concern.

And one of the major use cases that the VMware continually talks about, because people care about, is micro segmentation which is in essence a security use case.

And Palo Alto Networks for NSX is the answer for the east-west traffic protection in that regard.

So we like that relationship a lot.

It's opened a lot of doors for us.

We're winning deals.

We just talked about a seven-figure deal we won last -- in the fourth quarter around NSX.

So we like the traction there a lot.

And then, on the software side, we had completely virtualized everything that we've done before years ago with our VM Series.

And then, the NSX relationship, what we've done with AWS as well, is to expand, extend that into the private and public cloud environment, so you can have complete software-based solutions in any those cloud environments, which is pretty significant and getting a lot of attention in the market.

We'll go next to Sterling Auty with JPMorgan.

Yes, thanks.

Hi, guys.

Mark, in your prepared remarks, you talked about the reseller and the reseller channels.

Do they still have enough capacity with the group that you have to grow and hit all the targets that you have for FY16, or how much channel expansion would you need to deliver your goals this year?

Yes, it's a great question, Sterling.

So a couple years ago, we were thinking about this a lot, which was there's a great opportunity in this market with our platform approach, we believed that we could capture historic market share.

We still continue to believe that.

And vendors -- you get into the practicality or pragmatics of lots of stuff, one of which is capacity for distribution.

So we were intentionally thoughtful about trying to establish deeper and deeper relationships, not only with the channel partners we have today, but folks who have global reach and a lot of capacity.

So we spent a lot of time and effort organizing around that principle as a Company, from a leadership and talent perspective, and then going, working these relationships which were now bearing fruit, and we're -- you hear us talking about right now.

So we think with the partner community we have today and some of the relationships we are continuing to drive, that we've got a lot of capacity to grow at outside market-rates for quite some time, which is our intent.

Got you.

And then one follow-up.

Steffan, you mentioned kind of the sales and marketing expenses in the quarter.

You mentioned both hiring and the commission.

Can you give a little bit more detail, how much of the sales and marketing percent of revenue was more due to the overage in bookings and the commissions that you generated?

And then, just the reason why I asked, just so we can get an understanding, why should we see the margin expansion be more back-end loaded in FY16?

Sure.

We are not going to quantify it, the exact percentage.

But you can, it's in this, call it, a few percentage points that had an impact for sales commission expense that were related to end of year accelerators, and that sort of thing.

As we mature as a business, and we have our sales force that proportionately has more ramped salespeople than ramping salespeople, we achieve that in FY15, we are going to see even more salespeople who are fully ramped.

And that means they are going to be doing more productivity per person which helps to drive leverage.

We also have our reseller and channel infrastructure becoming more productive, and that will be an element that will help drive operating leverage in sales and marketing.

And lastly, if you think about our land and expand strategy, the expansion value of our accounts are, come at a much lower cost of sales because the initial cost of customer acquisition has already been spent.

And when you look at the proportion of our business coming from our install base relative to new business.

At our last Analyst Day, I believe was about two-thirds coming from the existing business, and that's the trend that we've seen to be consistent.

So as that, as those dynamics play out, we should be getting more leverage in sales and marketing over time.

And that's part of how we're getting leverage to get to the 22% to 25% exit in Q4 FY16.

Great.

Next question?

We'll go next to Matt Hedberg with RBC Capital Markets.

Yes, thanks for taking my questions, guys.

Mark, it sounds like your carrier grade box is doing well.

I know you highlighted the PA-7080 has had strong early interest.

Can you talk about the performance of your box versus other or high throughput boxes, and how you guys hold up under increased traffic?

Yes, that's a great question, Matt.

There's a very different architecture at play here, and one that's been very compelling for our customers.

So let's use the PA-7080, for example, 200 gigs a second.

That is very high performance just in and of itself, but way more importantly it's very high performance with the next-generation security that's unique to Palo Alto Networks.

So what we are not doing, is we are not trading off performance for, quote, turning on additional feature sets because we have an architecture with a single pass engine.

So at 200 gigs we're able to do that, with all of the security capabilities that all of our customers have come to know and love.

And not have them in a position where to say, you have to have higher and higher performance capabilities from a box perspective, to get lower and lower rates of outcome as you turn on security features.

So this is a true architectural difference here, that's very compelling, and I think pretty well understood by our customer base, when it comes to most importantly security, and then the total cost of ownership.

That's great.

And then, maybe a quick follow-up on TRAPS, 150 customers is a nice data point.

I am wondering who the most likely buyer is of TRAPS?

It would seem WildFire would make a lot of sense, given its deep integration.

I'm wondering if we should -- is that right way to think about the next steps for customer additions?

Yes, we've seen adoption in a couple three different buckets, all which are fantastic, and you're exactly right.

The one that would seem to make the most sense would be people are using WildFire already, because the integration into the platform is through WildFire.

So if you have a customer with the Palo Alto platform running, and they ar using WildFire, the idea you have endpoint prevention, and also that's populating and receiving from WildFire, which then means you get 7,000-plus other networks working for you as well, is a great value proposition.

Interestingly, we've also seen a number of customers who have purchased nothing yet from Palo Alto Networks, except TRAPS.

It's the very first purchase that they're making, which is fantastic.

It's another door opener for us, that then we think can lead to downstream further sales to those folks.

We'll go next to Keith Weiss with Morgan Stanley.

Excellent.

A very nice quarter guys, and thank you for taking the question.

As we look into FY16, you guys do have a lot more products in the product portfolio, both in terms of expanding out the core firewall or [traditional] firewall portfolio, but also going into newer sort of solutions.

TRAPS is, I'm sure the distribution is expanding, but also with the new services.

Any change in the distribution model, or sort of the sales structure to account for the bigger product portfolio, or does it -- does everything just go into everybody's tool bag on a go forward basis?

Yes, it's a good question, Keith.

So what we've done historically, and it's worked out well for us is when we bring something new to market depending on what that is, and I use WildFire as an example of that, of building a small overlay team that become experts in what that capability set is.

And then, having them learn the technology, and see what the customer objections are for that, make sure we understand all the kinks in the technology.

And then rolling them out to the entire salesforce, depending what that looks like.

So we did that for WildFire, we did that, and are currently doing that for TRAPS.

We have an overlay sales team we built up over FY15.

At our sales kick-off a few weeks ago, we did a lot of training for the entire salesforce for TRAPS.

We quota-ed everybody on TRAPS for FY16, now that we have worked out all of the -- all the how do you sell this thing with that overlay sales team.

So those are two areas where we've done that.

For Aperture and AutoFocus, those will not have overlay sales teams.

Those are great technologies, they are fairly self-explanatory in the sense of how it adds value to the platform.

We're confident that our salespeople will get that.

Excellent.

And maybe if I could sneak in one last one, just on federal business.

From what we're hearing from our checks, it sounds like federal spending around security is definitely ramping up again, going into the federal fiscal year end.

I know Q1 is not typically one of your seasonally strong quarters, but how are you guys feeling about that federal business heading into their federal fiscal year end?

We feel good about that, given what the federal government has to do for a living, some of the challenges that are very evident that they're facing.

You can read about in the papers and what our technology does, we always felt like that was some vertical, we can provide a lot of value.

Last year was very tough.

I mean, the last government fiscal year was very tough as everybody knew.

And we heard many times, sort of walking the hallways as I do out in the Pentagon and places like that, that the next fiscal year for the fed government will be better than the last one, when they are working on their budgets.

That appears to be what's happening, and that's fantastic for everybody, but for us in particular, given what our technology does, and the problems we can solve for their customer base.

We'll go next to Michael Turits with Raymond James.

Hey, guys.

Different kind of question about refresh.

Historically, you've gotten a lot of opportunity in terms of displacing, let's call it, legacy vendors to Telco, like Cisco and Juniper.

Is there any slowing of that opportunity?

Or are you still replacing those guys at the same kind of rates, and just see plenty of roadmap for that, or runway for that?

Hi, Michael.

Yes, we are.

So we haven't seen any changes there except perhaps acceleration, as you can kind of see from the numbers here as everybody continues to donate to the cause, and customers see that with their legacy technologies and their point products.

What we are seeing is a recognition by the customer base, that if you're really trying to get prevention done, it's very important that one, you can see all the traffic, which is why we win in the firewall space against a legacy (station] inspection firewall vendors.

And in addition to that, when you have that architecturally favored position you should be able to do allow lot of prevention with that, which is subsuming a lot of point technologies into our platform.

So that's what we are going to see from.

So no slowing or shortening of the opportunity there?

Shortening of the opportunity, sales cycle you mean?

I'm sorry, wrong word.

But no lessening of the opportunity that you see for displacing legacy vendors?

No, we continue to displace them at very high rates.

We'll go next to Brent Thill with UBS.

Thanks.

Steffan, on the billings number, obviously, one of the best numbers you've had in the last couple years.

Was there any change in the billing duration that you saw in Q4, or are most of the billing terms pretty similar to what you've seen historically?

Billing terms were very similar, and there was really no change in contract duration.

Okay.

And for Mark, you highlighted the move into the data centers as one of the bigger opportunities.

Is there a way to frame where you're at, whether it's a baseball analogy or another approach, in terms of how you're thinking about the penetration that you see right now?

Yes, I think it's early.

The data center use case for us has grown very rapidly.

It's approaching 40% of the business from a sales perspective, and we like that a lot.

Those are larger devices, lots of subscription services that go in there.

So it's a great move for us.

But when we look at some of the big picture items like the Global 2000, we are very fortunate right now to serve just about half of that.

So a glass half empty situation there.

We've got another 1,000 to go, we haven't sold a dime to yet.

Those are very large companies, all of them have big data centers.

And just as a general matter, there's a lot going on in the data center space in general, and security is a prime driver as people think about what they are going to do with data centers in the future.

So I think we've got a lot of wood to chop there.

We'll go next to Karl Kierstead with Deutsche Bank.

Thanks for taking the question.

One for Steffan, and one for Mark.

Steffan, the October revenue guide was, I think well above the Street, but implies sequentially flat revenues, which I don't think we've seen from Palo Alto in quite some time.

My guess is it's simply a function of the incredible outperformance in the July quarter, which makes for a pretty tough comparison.

But I just wanted to ask you, if there's anything else for us to keep in mind?

And then, the follow-up for Mark.

Mark, the world in August felt like a slightly rockier place.

My guess is, given your numbers and guide, and the fact that you're in the security sweet spot, it had no effect on Palo Alto.

But I just wanted to ask you whether you saw any trickle-down from what looked like a tough macro into your business?

Thank you.

Hi, Karl.

Yes, you hit the nail right on the head.

Given the 21% sequential growth in Q4, we just saw a very strong finish to the year.

And when you look at our guide, while it does imply a flat quarter on quarter, we're looking at 46% to 48% year-over-year growth.

So there's nothing else going on there, other than just an extremely tough sequential compare.

Got it.

And Karl, I think big picture for us on the macro.

I mean yes, August was very choppy right from -- at least from the market perspective, I'm not so sure about all of the real macro drivers behind that.

And if you take this week, it feels better than last week, right?

(Laughter).

So I wouldn't put too much into looking in the short-term, short-term things like that.

One of the things I am very confident of though, is that security is here to stay.

It's a very important thing for all companies.

As I've said before, I think becoming a fabric item in every IT decision that is being made, and I don't think that's going to change over time.

As a result of that, we've seen security spending going up.

I don't think that's going to change any time soon.

Got it.

Thank you both for the color.

Thanks, Karl.

We'll go next to Fred Grieb with Nomura.

Hi, guys.

Two questions for me.

First on TRAPS, are you seeing any customers completely replace their AV, or maybe move to free AV when they purchase TRAPS?

Or is TRAPS largely being deployed as an additional solution, kind of additional to existing AV?

Hey, Fred.

We've seen both, and it's early here, using the baseball analogy.

It's maybe the top of the first inning right, and what's going to happen in next-generation of endpoint security.

But our customer base we've sold to, we've seen both things occur.

We see more of a complement, meaning some of these (inaudible) AV and they're using TRAPS or another endpoint technology as a complement to test it out, and see what the difference is.

Most of those companies say that they're hopeful, that it's a very different technology, and that it can replace AV over time, because that would be simpler for them.

So less complex networks and endpoints is a good thing for the customers.

Some customers have just jumped all the way down there and said, look this does real prevention, because of that I'm not -- no longer need the AV technology.

So they are just in a different mind sets right now about how fast when they get to that end state.

Got it.

And then, I guess, on that next-gen endpoint side, who if anyone are you seeing in competitive deals where customers are looking to purchase TRAPS?

Yes, it's a very crowded market out there right now.

We've got the legacy vendors that they are by definition, are in every deal.

I mean, there's some legacy vendor there.

We're very familiar with that dynamic when you think about the firewall space, and how to compete and win there.

And then there's a lot of smaller players out there, who are trying to make a company on their endpoint technology.

In those situations, one of the things we find to be very valuable for Palo Alto Networks is, not only does our endpoint capability actually do prevention, but it's part of the larger platform.

So particularly, if you're an existing customer already at Palo Alto Networks, you get the value proposition of the platform, having an endpoint capability that does prevention and being tied seamlessly into that platform is a huge differentiator.

We'll go next to Gregg Moskowitz with Cowen and Company.

Okay.

Thank you very much and good afternoon.

Mark, as part of the strength that you showed in Q4, are there any verticals that you would call out as having done significantly better relative to your expectations?

No, there's not, Greg.

One of the things we love about this business, and that really goes to prove the true platform aspects of what we're doing here, is its extraordinarily horizontal in nature.

I think, last time we talked about this at Analyst Day, we said that no vertical is more than 12%,13% of the business, and that continues to be the case.

So this is a high degree of utility for all verticals and on a global basis.

So to me that gives me great comfort.

Everybody has to talk about platforms.

The true measure of a platform is, does it have a lot of value of very horizontally, and I think that we've proven that's the case here.

Okay, that's great.

And then, just one for Steffan.

Your FY16 CapEx guidance is significantly greater than FY15, although your CapEx last year did come in roughly $10 million below the mid point of your guidance.

Was some of the expected spend deferred until FY16?

Really just wondering if you could provide some color around that, and if we should think about the FY16 CapEx as the new normal for Palo Alto, or if you think it's a bit inflated for that reason?

Thanks.

Sure, Gregg.

When you look at what happened with CapEx in FY15, there's a little bit of a timing and lumpiness to it.

So some of the FY15 CapEx ended up, just from a timing standpoint, being delayed relative to projects we're doing, so that's hitting FY16.

So that's part of the increase.

As we run the business, we will have capital expenditures that are running at different rates, given the projects that we're working on.

So currently, we have a burgeoning cloud services business and infrastructure business.

You look at the subscription services growth rates, the WildFire traction we've had, we're processing over 3 million unique files per day.

And the amount of traffic there is going there to build the infrastructure to support that.

So we can't necessarily call a new normal on CapEx.

But when you look at CapEx and free cash flow, what we're saying is free cash flow for FY16 should be greater than 30%.

And that's about as far out as we'd comment.

We'll go next to Ryan Hutchinson with Guggenheim.

Great, thanks.

Questions on sales force productivity.

I think last quarter you talked about it exceeding 50%.

Where does it stand at the end of the fourth quarter?

And then, as you think about headcount additions and productivity levels 12 months out, just any comment would be helpful there?

And then, any material changes to the comp plan at the beginning of the year that we should be mindful of?

Thanks.

Hey, Ryan.

I'm going to take those in reverse.

No material changes to the comp plan.

We continue to have an aggressive comp plan, that people make good money at Palo Alto Networks, and you can see that they're doing well with all that they are selling.

From the head count perspective, we are adding a lot of sales heads.

It's just from an absolute number perspective that's -- I think that's obviously, because the opportunity in front of us.

We continue to take down big numbers.

We'll do that with a balanced approach, but we are definitely want to get as much opportunity as we can, and deliver on the bottom line as well.

So very confident in the ability to balance the profitability and growth of the Company.

And yes, the first question was percentage of folks who are fully ramped.

We don't give that specific percentage.

We usually hold off until an Analyst Day to give that, but we're north of 50% and its improving directionally which is part of the margin expansion story of the Company.

Okay, great.

Thanks.

We'll take our final question from Jonathan Ho with William Blair.

Hi, guys.

I just wanted to echo my congratulations.

Just wanted to start out with the Tanium partnership.

What does this bring to the table, in terms of the incident response side, and could this potentially help accelerate the TRAPS adoption?

Hey, Jonathan.

Great question.

So we're happy to have announced that partnership, and as with all of our strategic technology partnerships, we build something first, and announced it second, right?

So what did we typically do is, we integrated the Tanium capability set into WildFire.

And the reason we did that was, that when we seen an [indicative] compromise in WildFire, the Tanium technology has the ability to query all of the endpoints on an enterprise, and see if it's out there.

So an easy way to think about that is, we're the security company saying, we know what to look for from a security perspective, and those guys have fantastic capability to find things very quickly, and demonstrate that scale.

So bringing those two things together, allows us to deliver to the customers the detection capabilities, prevention capabilities and very fast isolation defined capabilities, and then moving into remediation beyond that, right.

So to deliver on the road map that we've laid out for endpoints, at which TRAPS is extraordinarily important around detection and prevention, and then to get to isolation and remediation as well.

Got it.

And then European growth seems to always lag the US and other regions.

I guess, just want to understand maybe the dynamic there, and what sort of a message you're making towards that region in 2016?

Thanks.

Yes, EMEA has been a tough market for awhile on a relative basis, primarily just because of all of the macro issues over there and [FX] fluctuations.

So we like the growth that we seen in the 30%-some percent in the fourth quarter, over 40% on a year-over-year basis.

So it's a fast growing market, despite the fact that it's got some challenges that we are not seeing in North America or Asia Pacific as an example.

We think, along a long-term basis for all markets and what those opportunities are, and one of the primary ways we think about it, that is our market share.

The market share, just as a general matter on a global basis, is still relatively low compared to some of the larger competitors, and it's even lower when you look at some of the non-north American regions.

So we think those are fantastic opportunities for us to capture a lot of market share, which we intend we will do over time.

So we're investing accordingly.

Great.

That brings things to a close.

Mark, do you want to finish up?

Yes, thank you for being on the call everybody today.

We appreciate it.

FY15 was a great year, and I once again want to thank the entire Palo Alto Networks team for all their hard work and support of our customers and partners.

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 the next call.

This does conclude today's conference, everyone.

We thank you for your participation.

You may now disconnect.