Kelsey Turcotte - Vice President of Investor Relations Mark McLaughlin - Chairman and Chief Executive Officer Steffan Tomlinson - Chief Financial Officer and Executive Vice President Mark Anderson - President

Gabriela Borges - Goldman Sachs Gregg Moskowitz - Cowen and Co. John DiFucci - Jefferies Matthew Hedberg - RBC Capital Markets Philip Winslow - Wells Fargo Securities Saket Kalia - Barclays Capital Jonathan Ho - William Blair & Company Michael Turits - Raymond James Andrew Nowinski - Piper Jaffray Michael Kim - Imperial Capital Pierre Ferragu - Bernstein Shaul Eyal - Oppenheimer & Co. Catharine Trebnick - Dougherty & Co. Ken Talanian - Evercore ISI Walter Pritchard - Citigroup Keith Weiss - Morgan Stanley

Good day, everyone, and welcome to the Palo Alto Networks Fiscal Third Quarter 2017 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, Tom. Good afternoon, and thank you for joining us on today’s conference call to discuss Palo Alto Networks fiscal third quarter 2017 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 and Chief Executive Officer; Steffan Tomlinson, Chief Financial Officer; and Mark Anderson, our President. This afternoon, we issued a press release announcing our results for the fiscal third quarter ended April 30, 2017. 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 guidance and modeling points for the fiscal fourth quarter and full-year 2017, our competitive position and the demand and market opportunity for our products and subscriptions, our ability to drive outside growth rates, trends in certain financial results and operating metrics, our initiatives, plans and investments regarding our sales productivity, success and timing of integration of our newly acquired products, innovations in our product, subscription and support offerings. These forward-looking statements involve a number of risks and uncertainties, some of which are beyond our control which could cause actual results to differ materially from those anticipated by these statements. These forward-looking statements apply as of today, 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 March 1, 2017, and our earnings release posted a few minutes ago on our website and on the SEC’s website. Also, please note that certain financial measures we use on this call are expressed on a non-GAAP basis and have been adjusted to exclude certain charges. For historical periods, we have provided reconciliations of these non-GAAP financial measures 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. We’d also like to inform you that we will be presenting at the Bank of America Merrill Lynch 2017 Technology Conference on Tuesday, June 6, and hosting Investor Day 2017 on Wednesday September 27, in New York City. And finally, once we have completed our formal remarks, we will be posting them 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 on the call today to discuss our fiscal third quarter results. In the third quarter, revenue grew 25% year-over-year to $432 million, and billings grew 12% year-over-year to $544 million. We generated free cash flow of $163 million and reported non-GAAP earnings per share of $0.61, up 33% year-over-year. As many of you know, we initiated a sales force reorganization at the end – at the outset of our fiscal third quarter. We’re making solid progress in these efforts and are on track with our project plans. While we have much more to do and it will take time to fully realize the impact of these changes, early feedback from customers, partners and our sales team has been good. Now turning to the quarter. In Q3, new customer adds were the second highest in the company’s history. We’re now privileged to serve more than 39,500 customers worldwide, including 86 of the Fortune 100, and approximately 1,200 of the Global 2000, 40 of which we added during the quarter. Feedback on our technology, approach and strategy is very positive, as evidenced not only by higher rates, customer acquisition, but also by external recognition. For example, customer satisfaction is very high as measured by our net promoter score of 73, which is more than 20 points higher than what is considered a best-in-class net promoter score of 50. And in Q3, we were privileged to earn the SANS Best of 2016 Award for Next Generation Firewalls, which was voted on by the SANS community of security operations professionals and security managers from around the world who have used our technology to increase the effectiveness and efficiency of their cybersecurity programs. In Q3, we continue to see strength not only in new customer acquisition, but also in increasing wallet share of existing customers for our next-generation security platform. In the quarter, all of our top 25 lifetime value customers, again, made purchases. And to make this list, a customer had to have spent a minimum of $20.1 million in lifetime value, a 61% increase over the $12.5 million in Q3 of fiscal 2016. Specific examples of customer wins, competitive displacements in the quarter included a Check Point data center replacement for one of the world’s largest retailers and eight-figure deals to replace Check Point in a large U.S.-based auto insurance provider; a seven-figure Cisco replacement that included all of our tax subscriptions, where we became the security platform for one of the world’s largest travel companies based in Europe; a seven-figure Cisco replacement with our PA-7080 chassis and new PA-5200 series devices at a multi-state network of physician clinics, outpatient centers and hospitals in the United States; a seven-figure deal to become the security architecture for one of the largest insurance companies in the United States, including securing their cloud initiatives and two large antivirus replacements with Traps and one of Southeast Asia’s largest banks, as well as a U.S.-based healthcare provider. We’re able to win at very high rates in a very competitive market because of the unique capabilities of our platform. As the recent WannaCry global attack illustrated, the need for integrated and automated security is growing quickly. We are always pushing the innovation curve to keep customers safe across their entire architecture, including on-premise endpoints, third-party SaaS applications, and public and private cloud deployments. And this approach is constantly enhanced by the network effect of tens of thousands of customers and our technology partner ecosystem providing leverage to each other through our platform. Our continued innovation has been well received by the market. Our new hardware generated very high interest in the quarter and we’re pleased that demand for these new products exceeded our internal forecast. Also market reaction was very positive for the introduction of our new high-performance virtualized firewalls, as well as our new 8.0 operating system with more than 70 new security features that enhance all aspects of our next-generation security platform. Momentum with our attach prescription services was also evident in Q3, including WildFire, where we added approximately 1,500 new customers. We’ve been adding over 1,000 WildFire customers per quarter for over three years and are now serving approximately 17,000 WildFire customers. WildFire is a great example of our integrated and automated approach to enterprise security, not only improves prevention outcomes, but also drives operational efficiencies for customers overwhelmed by the numbers, cost and complexity of legacy tools and point products. With the size of our customer base, the capabilities deployed, we’re also using analytics to provide differentiated tools and actionable intelligence. We saw strong customer growth in AutoFocus, as well as a high degree of interest in our newly acquired LightCyber technology. We remain on track that LightCyber integrated into our platform can offer us a subscription service by the end of this calendar year. In addition to analytics, cloud security is top of mind for our customers, and we continue to see solid uptick on our cloud offerings due to our unique ability to provide not only clouds specific security capabilities, but also the consistency of security wherever data resides are computed. In Q3, we saw a strong substantial growth for Aperture added hundreds of VM-Series customers and are continuing to expand our market reach by leveraging our partnerships with all leading cloud infrastructure providers. Interaction continues to grow nicely for Traps, where hundreds of channel partners are now selling Traps, and we’re serving over 1,000 customers. In early May, we announced the latest release of Traps endpoint technology. Enhancements in this 4.0 release include the additional support for macOS and a beta for Android, plus several new prevention modules designed to detect and stop ransomware and other advanced threats. When implemented with our next-generation firewalls, customers can now correlate endpoints and network security events in our network security management tool, Panorama. In just a couple of weeks, we’re expecting thousands of guests to join us in Vancouver for Ignite, our annual user conference. This is proven to be a great and highly anticipated event by our customers and partners, we hope to see you there. Registration information can be found on the Palo Alto Networks website. And with that, I’ll turn the call over to Steffan.

Thanks, Mark. Before I start, I’d like to note that except for revenue and billings figures, all financial figures are non-GAAP and growth rates are compared to the prior year periods unless stated otherwise. In our third quarter, we saw some early positive indicators of the changes we’re making in the go-to-market portion of our business. Sales and productivity improved sequentially, with product revenue coming in better than we had expected as customers invest in our next-generation security platform. We delivered record revenue, strengthened our balance sheet, and generated strong cash flows. Turning now to the financial highlights for the quarter. New customer acquisition and expansion within our existing customers drove revenue growth of 25% to $431.8 million. Looking at the geographic mix of revenue, the Americas grew 22%, EMEA grew 32%, and APAC grew 33%. Product revenue of $164.2 million grew 1.3% compared to the prior year. Increasing adoption of our eight subscriptions and high renewal rates continue to drive sales in the recurring portion of our business. Q3 SaaS-based subscription revenue of $143.2 million, increased 55%. Support revenue of $124.4 million, increased 37%. In total, subscription and support revenue of $267.6 million, increased 46%, and accounted for a 62% share of total revenue. Billings of $544.1 million increased 12% and contract duration was unchanged compared to the prior year. Total deferred revenue of $1.6 billion, increased 51%. Moving on to margins. Q3 gross margin was 76.4%, a decrease of 150 basis points compared to last year, and within our target range of 75% to 78%. The decline was primarily attributable to the new products we introduced in the quarter. As we indicated on last quarter’s call, new products typically have a higher initial cost of goods sold, which will improve over time. Looking forward, we expect there will be fluctuations in product gross margin, particularly with the recent introduction of our new products, when we typically see a decline in product gross margin for a few quarter. And in the quarter, discounting decreased sequentially and was essentially flat year-over-year. Q3 operating expenses were $250.8 million, or 58% of revenue. Operating margin was 18.4% in Q3. Net income for the quarter grew 35% year-over-year to $57.1 million. EPS grew 33% to $0.61 per diluted share. On a GAAP basis for the third quarter, net loss was $60.9 million, or $0.67 per basic and diluted share. We finished April with cash, cash equivalents and investments of $2.1 billion. During the third quarter, we’ve purchased approximately 1.1 million shares of common stock at an average price of $113 per share, leaving a balance of approximately $705 million available for ongoing repurchases. Q3 cash flow from operations of $211.2 million increased 24%. Capital expenditures in the quarter were $48.6 million, including $32.8 million of CapEx related to our new headquarters. Free cash flow was $162.6 million, up 8% at a margin of 37.7%. Excluding CapEx related to our new headquarters, free cash flow was $195.4 million, up 29% at a margin of 45.3%. DSO was 78 days within the target range of 70 to 80 days. Turning now to guidance and modeling points. This guidance takes into account the type of forward-looking information that Kelsey referred to earlier, and also takes into account the work we still have to do on the go-to-market changes we introduced last quarter. For fiscal Q4 2017, we expect revenue to be in the range of $481 million to $491 million, an increase of 20% to 23%, and we expect non-GAAP EPS to be in the range of $0.78 to $0.80 using 93 million to 95 million shares. In addition, we expect the following modeling points for Q4 2017. Billings to be in the range of $625 million to $645 million; product revenue to be in the range of $188 million to $191 million;, and CapEx to be approximately $55 million, including $30 million related to our new headquarters. And for the fiscal year, we expect non-GAAP operating margins to be 19.5% to 19.6%, which is an increase of 220 to 230 basis points relative to FY 2016 non-GAAP operating margin of 17.3%, as reported. Included in that 220 to 230 basis point improvement is approximately 100 basis points of organic operating margin expansion and 180 to 190 basis points positive impact from the deferred commissions change, offset by an approximately 60 basis point headwind from LightCyber, and we expect fiscal 2017 free cash flow margin, excluding our headquarters investment to be, at least, 40%. With that, I’ll turn the call back over to the operator for questions.

Thank you, sir. [Operator Instructions] We’ll take our first question today from Gabriela Borges with Goldman Sachs.

Great. Good afternoon. Thanks for taking my question. May I just start off from, you mentioned in the prepared remarks a little bit on the progress you’ve made with the sales force and then there are still some work to do. Maybe you could just give us a little more detail there on what you feel you’ve accomplished thus far into the second-half of the fiscal year? And what are some of the milestones that you’re looking to achieve with the productivity and other internal metrics as we go through fiscal year into the next fiscal year? Thank you.

Sure, Gabriela. Yes, thanks for being on the call. Yes, as we mentioned last quarter with the reorganization, we are taking a four step approach to this. We needed to design what we wanted to do differently. We want to communicate that to everybody. We need to do account mapping exercises with the accounts in the right place coverage wise, and then we’ll make sure everybody’s in the chairs to cover that then we have to run it that way. So over the course of the last quarter, we got the design work finished, the communication work finished. We’ve met all the accounts, and now we need to make sure that the folks are in the chairs to cover the accounts and that other folks who have just picked up accounts are working as fast and as hard as possible with our help to build those relationships and those accounts as well, so that’s where we are. Right now, we’ll be continuing that through during the fourth quarter, for sure, hopefully, see a positive impact from this through fiscal 2018.

That’s helpful. And as a follow-up, if I could, just from a comment that discounting activity has moderated year-over-year, just your thoughts on what you think is driving that? Is that a function of some of the new products? Is it a function with competitive environment or effects, anything that would be helpful?

Well, the – different folks in the market have different go-to-market motions. Ours has always been to really focus upon security, reduction with complexity and, of course, we want to deliver that in a way that is within the cost envelope of what customers have, other folks have come out of it from the bottom of that stack, and really decided to go from a cost perspective and worked their way out, that’s not really been our go-to-market motion. So we believe there’s a lot of value in the problem. We train our salespeople and talk very consistently to the value proposition that’s going to provide for security, reduction and complexity and better total cost of ownership. And we think as a result of that, we’ve been able to maintain pretty good discounting discipline through the company’s history and you see that in this quarter as well.

And we’ll take our next question from Gregg Moskowitz with Cowen and Company.

Okay, thanks very much and congratulations on a nice bounce back quarter Mark, just to follow-on Gabriela’s first question. If we could apply the overused baseball analogy to the progress made with respect to your sales reorg, what inning would you say that we’re in right now?

I’d say, bottom of the second, top of the third.

Okay, that’s helpful. And then just for Steffan, any color that you can provide on the percentage of units roughly that were shipped this quarter that came from the new product family, and if you have any commentary just as it relates to ASPs for the new products sales vis-à-vis the other prior ones? Thanks.

Well, we’re very pleased with the adoption of our new products, they fill a need in the market and they also filled a need in our overall product line up. We don’t give exact percentages of how – of what percent of products were shipped coming from different units. I can tell you that the adoption was very strong. And as far as ASPs are concerned, it – the ASPs were very healthy kind of in line with what we thought. Anytime you have a new product introduction, you’re going to have a trade-up trade-down a new incremental opportunities presenting themselves, and we see – we saw all of that and overall it was a net positive for our business.

And we’ll take our next question from John DiFucci with Jefferies.

Thank you. I guess, my question is about the new products that came out. And do you think that, I mean, I know you’ve had talked a lot about the sales reorg, and it sounds like that’s going well. But there’s also seems like there’s most likely some pent-up demand sort of waiting for these new products. Do you think that had ended up and looking an on-site had an impact that was material on the results over the last couple of quarters?

Hey, John, it’s Mark. It’s always hard to tell right. When you have new product introductions, we have to assume that there would be some slippage from one quarter into the next as folks even see what their new products are about. So we assume, when we came out of the second quarter that we might have seen some of that fall into the third quarter, and have to assume that’s some of the overage in the third quarter is associated with that as well. I don’t think that that was the – I don’t think that was the majority of the over performance of what we guided there. But it’s – and it’s very difficult like to tell the exact amount one way or the other, but assume there’s some of that in there, of course.

Okay. Thanks a lot, Mark.

Thank you.

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

Great. Thanks, guys. Congrats on the quarter results from me. Growth in EMEA was particularly strong. I’m curious, is that more a function of easier compares, or our European customers starting to talk more about the breach notification going live next year?

Yes, Matt, it’s Mark. A couple of things in that. One is just as the size of market, EMEA is a large market. And when you look at the – just the dollars we’re doing in that market, we think we have a long way to go and grow in that market. So I would expect to be able to grow very hopefully in that market for some period of time. So we’d like to see three handles are better on the growth, so we’d like to see that in the quarter. For the GDPR, which is a legislation you’re talking about. There certainly a lot of attention and focus on it that basically is legislation that’s going to present companies with some pretty large fines, if they’re found to be lacking in their duties of using state-of-the-art technology, which is not a defined term in the legislation, but it talks about it that way state-of-the-art technology. So there’s a lot of focus from companies and Board of Directors to say, are we doing that right? And I think that’s really driving a lot of interest in getting off of legacy technology and it’s certainly a great opportunity for a platform provider like ourself.

Great. Thanks.

Thank you.

And we’ll take our next question from Philip Winslow with Wells Fargo.

Hey, thanks, guys, and congrats on a great bounce back quarter. I have a question about just the aging of your installed base. In the last Analyst Day, you all talked about just the potential wave of appliances coming up for renewal. Wonder if you can give some more detail to sort of what you saw this quarter, maybe compare that to the prior few quarters, if that wave starting to come on, or if that’s still on to come?

Hey, Phil, yes, it’s Mark. Yes, I think that the majority of what I would call that, the refresh potential for us is in the future and that’s just simple math. I’m looking at the classes, so we consider our classes as cohorts and doing by year. If you look at how that cohorts build over time, each year is getting a substantially bigger. So when we – if you think of like four to seven-year average refresh cycle somewhere in there, the big, big, big part of our customer base is going to be in refresh cycles and coming a couple of few years time versus the last couple of few years time. So we think that that’s something that should provided a tailwind for us go forward.

Got it. And then just one quick follow-up to that. I mean, in terms of just the new products we all launched in February. How do you think that influences, which way just the timing of people refreshing the installed base and considering you just have a new sort of virtual and physical appliances out?

So, yes, I think it would be helpful. And maybe an obvious point that, when you have new capability sets in a market, it gives the customers more choices. We like the lineup of technologies we had prior to the new products we launched. We just complemented them with a whole set of new products as well. So when customers are thinking about what their needs are, price performance needs are, throughput needs are that we’ve got a very, very full lineup now of capability sets and lots of upgrade for refresh when they’re so inclined when they reach that sweet spot in their refresh cycle.

We’ll take our next question from Saket Kalia with Barclays Capital.

Hey, guys, thanks for taking my questions here. First, maybe for you, Steffan. You said last quarter that billings should lag revenue growth by about 10 or 15 points, at least, for the back-half of this year. And it looks like that relationship will hold here in the fourth quarter as well, realizing that that you’re not ready to give us guidance for fiscal 2018 yet. Can you talk qualitatively if that relationship between billings and revenue should maybe be consistent, or perhaps widen? How do you think about that going forward?

I think, Saket, so last quarter we did say that the billings growth rate would trail the revenue growth rate by about 10 to 15 points, and in Q3, we came right about the midpoint of the range. Our Q4 guidance actually indicates that the range is improving and the range if you to – if you were to benchmark it off of the midpoint of our revenue guide, it’s about – billings growth rate is about 8.6% to 12.1% below revenue growth. So that that range is actually improving. And it’s too soon to call, what’s going to happen in 2018. But we’re definitely, we’re doing everything that we can to improve the growth profile of the company.

Got it. And then maybe for a follow-up here quickly for you, Mark, and maybe more philosophically. How do you think that last quarter’s experience is going to change that playbook in sales that’s been successful for so long in terms of splitting territories, allocating resources. How do you think about that playbook changing perhaps after last quarter’s experience?

I think that some of the chapters in the book are good and some of the chapters have to be modified, right? So the – we will continue to split territories. We wouldn’t do it at the rate and pace that we had done in the past. I think we talked about that on the last call, and then we will continue to do market segmentation, but we won’t be making assumptions about what the capability sets are from a sales team perspective one various customers that they could cover. So there’s – there are things that I would say will more or somewhat timeless when you think about sales playbooks and enters the execution based on which maybe unique to each company. So we’ve learned a lesson on that stuff, and we’re going to apply that fiscal 2018 and beyond.

We’ll take our next question from Jonathan Ho with William Blair.

Hey, guys, congratulations on the strong quarter. Can you just talk a little bit about maybe a shift, or acceleration of virtual appliances, and what you saw this quarter potentially relative to the public cloud?

Hey, Jonathan, it’s Mark. Yes, we continue to see a really nice adoption from the VM-Series and a lot of that’s being used in the public cloud environment, as well as private cloud, or NSX is doing very well. We’ve had that relationship for quite sometime. We’re seeing hundreds of customers in the public cloud environments using the VM-Series as well, and we would expect that to grow over time. There’s a lot of different angles on that that we look at, one is lead regeneration. We’re seeing some customers use us for the very first time, and AWS, for example. And then we get the lead in order to follow-up to see if we can ride additional security outside of just that public cloud infrastructure throughout their on-prem, through endpoints and things along those lines, see lots of people taking their own licenses up there and we see increasing sales in the marketplace just using AWS. We’re seeing that Azure, Google, other infrastructure providers as well. But it seems like it’s – it seems like it’s solid growth for us.

Got it. And then just relative to WannaCry, are you seeing any sort of impact from the increased attention around breaches, or do you think that that’s just more sort of support and removal or friction around the spending? Thank you.

Yes, sure. There are couple of things in that. The first is, WannaCry certainly got a lot of public attention. It’s – there’s going to be another attack like, I can’t say what it is, don’t know when it’s going to be right, but there’s always going to be the next one. I think, the WannaCry thing raised a lot of awareness and anxiety one, because it’s really kind of focused in the healthcare community first, it moved out of there. So further evidence of, I’ll call, critical aspects of our society that relying on the digital age of technology being at risk and certainly would capture folks attention. The other thing I think I highlighted for us as well as opportunity is the increasing need for platform. So, I think, WannaCry was looked at primarily as like an endpoint problem. But it – but it’s broader than that, once it gets in a – once it gets into an organization that moves around, it had the ability to spread. So platforms like ours are uniquely able to handle that stuff. So Traps, for example, would have stopped it on the endpoint. If it were in the network, WildFire would have picked it up. It was – if it was somebody was going to download it from a malicious URL and we would have stopped that. Threat Prevention would have stopped lateral movement and the internal spreading of the infection. So it really helps to have multiple ways to beat these attacks, and WannaCry is a great example of a good position you would be and if you had all those capability sets.

We’ll take our next question from Michael Turits with Raymond James.

Hey, guys, two questions. But first, you had talked in the past about the back-half of the calendar year getting some tailwinds both from the product refresh in general, as well as the new product cycle. Does that still looks like something that could be an accelerated growth at this point?

Hey, Michael, yes, as we talked about, we certainly talked about that at the beginning of the year and we had laid out a number of reasons why we believe that product growth would accelerate partly due to the ramping capabilities as sales force currently due to the assumption. There would be new product introductions service writer business, increasing productivity and lot of that holds true, but we have the crosscurrent of the sales force reorganization and things that we’re dealing with. So there’s puts and takes on both sides of that. We’re happy to see the product revenue in the Q – in the third quarter, but frankly, we’re not satisfied with where we are and we think we can do better and we aim to do better.

And then second question, a bit more specifically on the VM-Series. One of the important thing about the new release was the increase in throughput, or capacity for the new virtual. So what’s been – has there been a measurable impact from that both in terms of cloud adoption and the utilization and well – as well perhaps in the on-prem or in the private cloud that people thinking about it relative to other a trade-off of using virtual versus using physical box?

I think there’s – here’s how we think about, I think, a lot of customers are thinking this as well, which is, it’s really kind of a used case specific. So, your data is going to reside in different places, it’s going to be computed in different places, it’s going to move back and forth very, hopefully, very efficiently and without friction. And that’s really what we’re trying to do with the platform is providing the security in all those places. So when you talk about the cloud or in used cases or like East-West traffic in a highly virtualized data center. One of the things you’re going to see there, for sure, is just an ever-increasing amount of throughput requirements, because volume is growing from a number of applications, number of third parties applications being used for encryption, decryption capabilities or decryption needs, for example, so the throughout is going to continue to rise over time. So I think in the case just like we did with our hardware of having the much higher performance and same with the virtualized firewall as well as with the quadruple performance there, and we’re going to keep growing that performance, because as used cases, whether they’re physical or they’re cloud demand higher throughputs.

We’ll take our next question from Andrew Nowinski with Piper Jaffray.

All right. Thanks, guys. Just a question on the product guidance – product revenue guidance, you had great upside in the quarter, you had 1% year-over-year growth off of tough comp. I guess, why aren’t you expecting that momentum to continue in July quarter since your guidance suggests that product revenue will decline on a year-over-year basis? Is that just you being more conservative than usual?

Hi, Andrew. So when looking at the product side, we’re happy to see where we came in third quarter. Of course, like I said, we’re not satisfied big picture of where we are and we aim to be better than what we’re doing. When we look at the third to fourth quarter, we’re still looking at like a 15% sequential increase from the third and fourth quarter of the guide we gave, so that that’s a big increase. It’s a doable increase, for sure, we think and we expect it to get that done. But we’re kind of look at that on a relative basis sequentially and we’re looking at on a year-over-year basis while we’re coming off very, very high comp in the fourth quarter last year.

And we’re still in the midst of going through the sales force reorganization. So that also is a crosscurrent.

That’s right. Okay, I got it. And then on with regard to Traps, it’s still – you certainly continue to add more customers, but still has, I think a penetration rate of less than 3% on your installed base. When do you think, it’s going to start to gain a little bit more traction? When do you think we’ll start to see that penetration rate increasing at a faster clip?

Sure. That’s actually an area of an intentional focus for us, Andrew, which is given that we’ve been in the market for about three years now as one of the next gen providers after a replacement budgets like everybody else’s. We’ve been very intentional in targeting new customers, as well as our existing customer base for larger customers and larger deployment of endpoints, and that’s what we’re accomplishing. We’re very happy to have over 1,000 customers now, rate of customer growth is good. We would expect the penetration rate to go up faster later. But we’re – as we saw for all this referenceability that we’re getting now and increasing the technical capabilities like the 4.0 release. I think that with all that focus in mind, we’re getting where we want to go and when you think about the next gen AV providers in the market today, based on what we know about that we think we’re one of the biggest from a sales perspective.

We’ll take our next question from Michael Kim with Imperial Capital.

Yes, good afternoon, guys. Just a follow-up on Traps. Are you seeing an increase in head-to-head evals and any early feedback on when win rates? And out of that 1,000 customers, 1,000 of customers that you’ve accumulated are the majority of those existing or net new logos?

Yes, sure. So, yes, we’re doing lots of head-to-head, that’s actually what we’re trying to do right? We’re focused on trying to take the AV budgets from legacy providers when a lot of people are dissatisfied with them. So we’re certainly seeing them head-to-head and in a lot of the situations not surprisingly lot of the next gen folks are being evaluated, and kind of as a side note that, Michael, one of the interesting things that we’ve found with the customers that we’ve acquired so far when we survey them, that well more than half of those customers when asked why are you buying Traps from Palo Alto Networks. In addition to saying, it’s a great best-of-breed next gen endpoint security capability are saying, because it’s actually very well integrated with my network security capabilities and increasing with a cloud security capabilities, that consistency is very important and that approach where we’re driving is very important. Can you remind me your second part of your question?

Yes. So I was curious out of the 1,000 odd customers you have today, how much – how many of those were net new logos to Palo Alto versus existing customers? And I’m curious kind of what the initial uptake has been?

Yes, Mike, Mark Anderson here. It’s actually a pretty good balance that we have, I’d say close to 50-50. And the great thing is, our core sales team is getting better and better enabled each quarter at being able to integrate the Trap story into their next-generation network security story and prove the value of these two things working closely together. So whenever we do get a Traps customer, that’s a first-halftime buy. We’re able to go back and very seamlessly sell network security as well.

That’s great. Thank you very much.

We’ll take our next question from Pierre Ferragu with Bernstein.

Hi, thank you for taking my question. We talk a bit about like a refresh of opportunity and I even sure you got confused about how much refresh do you have in product revenues reported this quarter? Is that like am I right thinking, it’s still like a very, very negligible, very small part of your business and most firewalls, you’re selling today are still like adding up to your installed base, or is the fresh business already something fairly sizable and will you have an idea of what percentage of your product revenues would be refreshed already to-date? And then I had a – just like a very quick follow-up on sales cycle. We heard a lot over the last six to nine months in the industry that sales cycle were getting a bit longer. Plants were taking more time to figure out what they want in terms of network security. If you could give us like the latest update on that front as well?

Yes, Pierre, it’s Mark. I’ll take the first question, pass the second one to Mark Anderson. On the refreshed side of it, we don’t breakout the percentage of what portion of product is coming from new expand versus refreshed. But I can’t say in the refresh side is the – refresh for us has been strong in the past through our cohorts, which was great and kind of get a sense of that when you think about our renewal rates, our NPS scores, all these other externality that point to customers really like Palo Alto Networks and they can do refresh with us as well. Back to the cohort thing, I was talking about earlier. The percentage of the business is coming from the refresh has been increasing just kind of naturally mathematically as we gradually years, if you will, through those cohorts, and we would expect it to increase into the future.

Yes [Foreign Language] Pierre. So as far as the sales cycles go, I think, the new normal is that these sales cycles are taking longer. Clearly, security continues to be a Board level number one or number two priority for customers at every level. And there’s also copycats out there in the market that are mimicking the value proposition at Palo Alto Networks is going to pioneered. And really, that’s getting our sales teams trying to work hard to solve to a technical proof-of-concept, because when we get a chance to demonstrate in their live – with their live network traffic how differentiated we are. We typically win. So that does take a little extra time. We’ve sort of factored that into our forecast and guidance each quarter. And certainly, our sales teams have kind of factored that into their campaigns to win customers to really get to that technical proof-of-concept.

Thank you.

Yes.

We’ll take our next question from Shaul Eyal with Oppenheimer.

Thank you. Good afternoon, guys. Congrats on the solid execution quarterly performance. Mark, how is the LightCyber integration has been coming along so far? I don’t know if you can quantify or provide us with some color, they have some potential contribution this quarter?

Sure. Let me take that financially first and technically second. On the financial basis, the contribution was de minimus. From a top line perspective, when we gave some guidance last quarter from the impact from operating margin perspective, which as Steffan went over. On the technical basis, the integration is going, as planned. We’re on our project launch there, which is fantastic. We expect that will be a subscription-based service, like I said, before the end of the calendar year just as a kind of a side note on that, and you’ll hear more about this at Ignite if you just attend Ignite, that’s an example of capability, which is a really great technical capability, highly innovative for network behavioral analytics that when it is integrated in a platform, will take something that has historically been a product sale like by products and deployed everywhere to something that is a – as the software. So the subscription service without having to deploy additional hardware. So the feedback from the customer base on that model and what we’re demonstrating there with LightCyber has been very positive so far feedback wise. And they also like the service itself, it’s a very important service defined anomalies when somebody is moving through your network and they’re looking for just getting that best-of-breed capabilities on-site platform.

Yes, and if I can just add to that, Mark. I think from a people standpoint, we’re really impressed with the quality of the people that came over with LightCyber. They’ve co-located with our Tel-Aviv team in Israel and it’s a really good fit.

Got it. And then in the latter part of calendar 2016, if I’m not mistaken, you’ve established a telco-related type of activity, or maybe telco-related group. Just interested, Mark, around how the ramp-up has been coming along so far?

Sure. Yes, that’s the service provider group, we talked about that like a couple of years ago actually saying we wanted to be very focused on that more so than the past on the service provider, because it had been a couple years ago relatively untapped market for us right. The service provider market has some very specific technical needs capabilities. They also have some very specific go-to-market requirements, where you have to understand them, we have to talk – their talk. You have to know what their needs are and relationships really matter. So over the course of the last couple of years, we’ve building up the service provider team that has been built out very well, and they’re contributing very nicely the business we’d expect that business to grow over time for us.

We’ll take our next question from Catharine Trebnick with Dougherty.

Hello. Thank you for taking my question. Mark, I have a question regarded – regarding your virtual firewalls. It seems to me you said on earlier in your commentary several hundred this quarter. How – could you explain how differentiated you are with your virtual firewall versus Check Point in the AWS cloud or Azure? It seems to be rapid migration to cloud right now, and where do you see us fitting into this migration? And how fast is this possibly replacing some of your core – hardware products? Thanks.

let me comment on that backwards, Catharine, for a second, which is so far and we think obviously continue into the future, we’ve seen the cloud in general and then our VM-Series and other cloud aspects like Aperture to be additive. So we think that’s a lead provider for us and a growth provider for us in use cases. As far as differentiation relative to any of the competitors really kind of three things going on there. The first is that the – our VM-Series does exactly everything that our physical capabilities that would do. In the physical capabilities, as you know, the hardware capabilities are highly differentiated on what we do with Apple ID, content ID, user ID plus all the subscription services that you’re able to run on that. So we virtualized all that quite sometime ago. So that the difference is the customers really loved and appreciated in a physical world, they get all those in the virtual world as well. So that’s a starting point and very important point. The second part of that is just part of the platform. So you don’t have to give up, or accept a different, or lower security capabilities when you go to the cloud with all the networks, you get to have all those capabilities seamlessly from endpoints network to cloud to private cloud, third-party SaaS application, it’s exactly the same outcome. And customers really love the orchestration, the automation that you get as a result of that as well. So there’s – those are the fundamental two kind of differences on a competitive aspect that that people really appreciate when they look at our VM-Series.

Thank you.

We’ll take our next question from Ken Talanian with Evercore ISI.

Hi, guys. Thanks for taking the question. So, first off, have you seen any changes in the customer’s desire to do multi-year deals? and then can we – along with that, can we expect contract duration to remain relatively constant going forward?

Over the years we’ve seen a slight uptick in contract duration, and that’s really been customer led. And it’s indication of our – the value that we’re bringing to the table. And that customers want to standardize on us for a multi-year period and also renew at very high rates. Contract duration has been stable year-over-year. It’s hard to predict where contract duration is going to go. But at this point, from our own internal modeling standpoint, we’re not assuming any wide variation in contract duration on a go-forward basis. Time will tell.

Okay. And just a follow-up, I know we’ve sort of touched on this before with some of the prior questions. But I’m just curious what of – which of the new appliance families demonstrated the most traction in the quarter?

Well, we saw a great traction from the PA-5200 series and also the PA-220 and the 800 was also good too. So it was really kind of across the board. We saw really nice adoption.

And we’ll take our next question from Walter Pritchard with Citi.

A question on your product revenue. You’ve had pretty dramatic difference in growth rates over the last couple of years and your billings are growing probably in line with the industry, your product revenue probably growing below the industry, although, as many pointed out off of tough comps. I’m wondering how you think about that going forward just roughly, you generated a lot of of subscription attached, you have the unattached of subscription. And I’m wondering if we will continue to see a total business grow as long as excessive product, or if you think those will converge as things start to normalize here?

Hey, Walter, we have few thoughts around that. One is, like I said earlier, that we’re happy to see if we got a product revenue from third quarter perspective, the general matter, we think – yes, we plan to do better along these lines. When we think about the industry, it doesn’t look as though, people really breakout product or what hardware specific in the industry. One of the things that we look at is just how much money gets spent by everybody to report on the hardware side and we continue to take more than our fair share on that from a product perspective. We also know, of course, those relationships in the products of the hardware and the attach services as well. So as we work to improve the product revenue growth over time, and that would have some impact on the attach subscription service and we’re doing very well on the non-attach as well from a growth perspective that small part of the business are growing very quickly. So we’d expect that to do better for time as well. There’s a lot of things into the mix around that, which all comes out in the wash on. Billings growth and total revenue growth over time which is what we’re very focused on as part of the total platform.

And any comment on attach revenue this quarter, just any run rate, or anything to help us understand sort of traction collectively in that part of the subscription business?

Sure. Yes, we talked about the attach business on a semi-annual basis, but we can – we said last quarter was about 2.6, it’s outside and it went up.

And then on the unattached business, it was very good. We had – we referenced in our prepared remarks the number of new customers. So that’s an indication as well of the traction that we’re getting.

And ladies and gentlemen, our final question today comes from Keith Weiss with Morgan Stanley.

Thank you, guys, for sneaking me in. One of the things that I want to kind of drilldown into is or better understand. Is there dynamic on, are you able to like keep adding customers. So you had a really good, like a new customer add quarter just like, I would tell you, going through a sales reorg. And so one might, how does that dynamic sustain like? How do you guys sustain new customer adds so well, while you’re going through the sales reorg? And then on the flip side of the equation, while new customer adds look to be up pretty nicely on a year-on-year basis, product revenue was basically like flat on a year-on-year basis. Should we take away that sort of where the weakness reside just more in terms of sort of expanding existing customers, more so than getting new customers in the door?

That’s a great question, Keith. Well, a couple of thoughts in that. The first was, I think there’s a reverse, as we said last quarter, when you look at our business, it’s going to come from new customer acquisition and expansion of existing customers, about two-thirds of our business today is driven by expansion opportunities with customers we already acquired. So, of course, we want to continue to have higher rate of customer acquisition, I’ll come back to that thought in just a second. We’re very happy to see higher rates of customer acquisition. Then the trick is to expand the business side of this. Where we had some issues, we’re working through them with the reorg stuff was looking at the lifetime value expansion when you look at the segments in the market. So when we look at the highest end segment of the market, which is part of the Global 2000 and biggest customers, wallet share lifetime value expansion has done very nicely there and continues to be very nicely there, despite some of the issues that we’ve talked about before is really about getting the lifetime value expansion, where we wanted to be and where it had historically below that segment of the market. That’s where a lot of the reorg and alignment issues were and that’s what we’re really focused on that. We’re focused on fixing. And just from a new customer acquisition perspective, we’re getting new customers not only from our direct team as well, we’re also getting customer acquisition through the channel, or channel strongly grown over time. So we’re going to continue to get more customers from them. If I love the fact that we just had our second highest customer acquisition in the quarter history, I think we could do better, right? We get – the better we get from a got-to-market perspective, we should be able to continue acquire even more customers than that and we look forward to being able to do that.

Got it. And if I can sneak in follow-up. So while 1% product revenue growth was better than what we had anticipated. It’s still under growing the marketplace. But I’m assuming as both dynamics around sort of the new customer acquisition being able to like continue to get the customers to the door that give you guys the confidence that you’re not kind of losing share, if you will, that that opportunity remains just more of like untapped within these existing customers versus kind of net losing opportunity?

Hi, Keith. Yes, just on the year-over-year growth rate, we’re clearly coming off of – was it very high tough comparable product revenue last year 33% year-over-year. If you look at the dollar amount of product revenue that gets done in a particular quarter, as Mark mentioned earlier, we’re taking more than our fair share and there are some vendors that don’t even give out product revenue, and so like we’re shadow boxing with them a little bit. But we’re doing very well in the market. And the new products that we have that we’ve just introduced, the revenue customer acquisition,we feel like, there are crosscurrents that we’ve talked about around sales reorganization. But we’re laser focused on increasing the growth prospects of the company.

Yes, and that, of course, includes product revenue as well, so.

Ladies and gentlemen, that does conclude our question-and-answer session for today. Mr. McLaughlin, I’d like to turn the call back over to you for any closing remarks.

Thanks, operator, appreciate it. Before I close, I want to thank the Palo Alto Networks team for their dedication and our customers and partners for the opportunity to work with them. We hope to see everyone at Ignite in just a couple of weeks. Thanks for being on the call today. Bye.

Ladies and gentlemen, this does conclude today’s conference. We appreciate your participation.