Today, welcome to the Palo Alto Networks first quarter 2015 earnings conference call. Today's conference is being recorded. If you would like to ask a question during today's call, please press star one on your touchtone telephone. At this time, I would like to turn the conference over to Kelsey Turcotte. Please go ahead, ma'am.
Great. Thank you. Good afternoon, and thank you for joining us on today's conference call to discuss Palo Alto Networks' fiscal first quarter 2015 financial results. This call is being broadcast live over the web and can be accessed on the investors section of our website at investors.paloaltonetworks.com. With me on today's call are Mark McLaughlin, our Chairman, President, and Chief Executive Officer, and Steffan Tomlinson, our Chief Financial Officer. This afternoon, we issued a press release announcing our results for the first fiscal quarter ended October 31st, 2014. If you would like a copy of the release, you can access it online on our website.
These forward-looking statements include statements regarding our revenue and earnings per share guidance for our fiscal second quarter, continued strength in our business, our expectations regarding our growth margins, seasonality, revenue growth, future investment in Traps, CapEx, and non-GAAP operating margin for Q4 of fiscal 2015 and Q4 of fiscal 2016, our ability to accelerate growth and our market share, demand for and adoption of our products and services, expected availability and efficacy of new products, and our competitive position. These forward-looking statements involve a number of risks and uncertainties, some of which are beyond our control, which could cause actual results to differ materially from those anticipated by these statements.
These forward-looking statements apply as of today, and you should not rely on them as representing our views in the future, and we undertake no obligation to update these statements after this call. For a more detailed description of these risks and uncertainties, please refer to our annual report on Form 10-K filed with the SEC on September 18th, 2014, and our earnings release posted a few minutes ago on our 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. 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.
Before I turn the call over to Mark McLaughlin, we'd like to inform you that we will be presenting at the Credit Suisse 18th Annual Technology Conference on Wednesday, December 3rd in Phoenix, the Raymond James 2014 Systems, Semiconductor, Software, and Supply Chain Conference on Tuesday, December 9th in New York City, the Barclays Global Technology Conference on Wednesday, December 10th in San Francisco. With that, I'll turn the call over to Mark McLaughlin.
Thank you, Kelsey Turcotte, thanks, everyone, for joining us this afternoon. I'm pleased to report that we had a very strong start to our fiscal year 2015. I'd like to thank our customers, partners, and the Palo Alto Networks team for their contributions and support. As a leading provider of end-to-end enterprise class protection and prevention, we are delivering growth rates well above the market and the competition by consistently demonstrating the differentiation and sustainability of our platform, the scalability of our model and our team, and our ongoing growth potential. This was evident in our Q1 results, which exceeded our own expectations, I'm especially pleased that we were able to demonstrate strong sequential growth off of our record fourth quarter. In Q1, billings and revenue reached records again, with billings growing 52% year-over-year to $240 million and revenue growing 50% year-over-year to $192 million.
In the quarter, we also expanded our non-GAAP operating margin to 10.6% delivered Q1 non-GAAP EPS of $0.15 per share. Our growth is primarily being driven by three things. First, at the most basic level, security continues to be a critical business imperative that must be addressed by every business in the world, this is driving increased security spend. Second, in the security battle, prevention is the ultimate objective, Palo Alto Networks' integrated and automated next-generation security platform is unique and delivers unparalleled prevention capabilities in this $16 billion addressable market opportunity. Third, we believe we successfully scaled a global sales coverage model with a powerful sales team and key distribution relationships in every geographic theater, providing our customers with security subject matter experts that are best in class, both before and after an order.
Our Q1 results reflect these long-term factors at work also reflect the power of our land and expand strategy. On the land side, we continue to acquire customers at a very fast pace and are now pleased to serve approximately 21,000 customers worldwide. Examples of new customer wins in the quarter included replacing Cisco, Blue Coat, and Websense for perimeter security at a Fortune 10 company, replacing Check Point and Cisco in an enterprise-wide global deployment in one of Asia's largest financial institutions, replacing Check Point and Cisco as the primary data center firewall for one of the nation's largest insurance companies. The expand side of the business also continues to grow quickly. To make our top 25 customer list in Q1, a customer had to have spent a minimum of $6.1 million in lifetime value, up from $5.6 million last quarter.
Almost all of those customers made a purchase in the quarter as we replaced legacy technology and point product solutions in favor of our next-generation enterprise platform. Customers are switching to us and continue to make repeat purchases at a rapid pace because of our technology. We believe our platform provides customers with the most comprehensive protection and prevention in the market for all their security use cases, while each individual aspect offers best-of-breed capabilities. For example, in the data center use case, we continue to see broad adoption of our high-end PA-7050 chassis. In the quarter, we saw sizable purchases, such as a global service provider buying more than a dozen chassis, and one of the world's largest oil and gas companies significantly expanding their current deployment with eight additional chassis.
To continue to provide the world's best prevention capabilities at all points in the network, two weeks ago, we launched our newest appliance, the PA-3060, for our mid-size enterprise customers' data center use cases. In the advanced persistent threat solutions space, we believe we are now the largest provider by customer account, with approximately 4,000 customers paying for WildFire's integrated and automated prevention capabilities. In late September, we made real-time exploit and malware prevention at both the network and the endpoint a reality with the integration of Traps and WildFire. This is extremely compelling for all customers who understand how vulnerable endpoints are to attack. While it will take time for Traps to ramp into a meaningful revenue contributor, we're off to a good start and closed multiple Traps deals in the quarter, including a mid-six-figure win in a highly competitive bake-off within a large U.S.-based energy company.
We are seeing a lot of enthusiasm for this disruptive offering. New product announcements like the PA-3060 and Traps place us at the forefront of solving some of our customers' most complex security needs, and we continue to innovate, helping them to safely and securely embrace technology trends like cloud and mobility. We continue to be pleased with the high degree of interest in the Palo Alto Networks addition for NSX and are engaged in a large number of POCs. In October, we expanded our partnership with VMware to provide our advanced security to VMware's public cloud platform, vCloud Air. Enterprises can now apply the same rich set of security services available through VMware NSX and Palo Alto Networks across both public and private cloud environments.
We enhanced our GlobalProtect mobility offering, helping organizations control access to enterprise applications and data based on key policy criteria such as application, user, and device. We announced the latest release of our VM-Series with support for Amazon AWS and KVM. Our customers can now take advantage of the productivity and cost benefits of the cloud without compromising their security. We were able to achieve all of this in the quarter while at the same time delivering bottom-line results in cash flow generation that continue to demonstrate the leverage we have in the business and the ability to expand it over time. Given the strong start to the year, we remain confident in our continued growth and our ability to gain market share at a rapid rate.
Security is the top IT spending priority across organizations of all sizes. Our solution to customer security problems is unique in the market. We believe our highly integrated next-generation firewall, subscription services, and advanced endpoint protection deliver best-in-class security at each point of the kill chain and when used together, provide superior security at a superior total cost of ownership. With that, I'll wrap it up and turn it 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'd like to note that except for revenue figures that are GAAP, all financial figures are non-GAAP unless stated otherwise. We're off to a strong start in our new fiscal year. In the first quarter, we built upon the record billings and revenue we delivered in Q4 FY 2014, demonstrating the continued traction we have in the market with our powerful platform. We continue to drive leverage with both operating margin and free cash flow increasing on a sequential basis. The power of our Hybrid SaaS revenue model, combined with our land, expand, and retain sales strategy, are key components of our business model.
Once again, we saw new customer acquisition and expansion at existing customers drive robust growth in both the product and services side of our business, which led to outperformance in billings, revenue, and deferred revenue. Existing and new products are performing well in the market as our enterprise security platform continues to drive market share shift in our favor. Now let me turn to the numbers. In Q1, total revenue grew 50% over the prior year and 8% sequentially to reach a new record of $192.3 million. The geographic mix of revenue for Q1 was 69% Americas, 20% EMEA, and 11% APAC. Compared to the prior year, the Americas grew 53%, EMEA grew 61%, and APAC grew 21%. As in previous quarters, we saw broad strength across a wide range of verticals. We did not have any end customer concentration.
The three components of our Hybrid SaaS model, product, subscription, and support, all grew very well in Q1. Q1 product revenue of $101.5 million increased 34% over the prior year and 2% sequentially. We saw particular strength in the contribution from our highest-end appliances, including the PA-7050, which continues to provide greater opportunity in the data center market. Our recurring services revenue of $90.9 million increased 72% over the prior year and 16% sequentially and accounted for a 47% share of total revenue. Looking at the two components of recurring service revenue, the first component is our SaaS-based subscription revenue of $43.7 million, which increased 76% over the prior year and 16% sequentially. Support and maintenance revenue, the second component of recurring services, was $47.2 million, an increase of 69% over the prior year and 15% sequentially.
Billings in Q1 were $240.5 million, an increase of 52% year-over-year and 3% sequentially. Growth in recurring services billings positively impacts deferred revenue. Total deferred revenue in Q1 was $470.7 million, an increase of 69% year-over-year and 11% sequentially. Short-term deferred revenue increased to $286.7 million, an increase of 67% year-over-year and 10% sequentially. Total gross margin for Q1 was 76.8%, an increase of 180 basis points compared to last year, and 10 basis points sequentially. Product gross margin was 75.1%, a decrease of 150 basis points year-over-year and 60 basis points sequentially. The sequential modest decline was due in part to investments we're making in manufacturing operations, and we expect there will be fluctuations in product gross margin, primarily due to product mix.
Services gross margin for Q1 was 78.6%, an increase of 580 basis points year-over-year and 60 basis points sequentially due in part to ongoing growth in the contribution from subscription services. For the quarter, research and development expense was 11.9% of revenue, increasing approximately $2.1 million sequentially to $22.8 million. This was primarily due to headcount growth. Sales and marketing expense for Q1 was 46.8% of revenue, decreasing approximately $2.5 million sequentially to $90.1 million. This was primarily due to a decrease in sales commissions related to our strong FY 2014 year-end performance. General and administrative expense for Q1 was 7.5% of revenue, increasing approximately $5.4 million sequentially to $14.4 million. This was driven in part by consulting and outside services related to projects in the G&A organization.
Total headcount at the end of the quarter was 1,900, up from 1,722 at the end of Q4 FY 2014. In total, Q1 operating expenses were $127.3 million, or 66.2% of revenue. Operating margin grew 310 basis points year-over-year to 10.6%, an increase sequentially 250 basis points. Net income for the quarter was $12.8 million, or $0.15 per diluted share, using 84.7 million shares, compared with net income of $6.2 million, or $0.08 per diluted share in Q1 2014. On a GAAP basis for the first quarter, net loss was $30.1 million, or $0.38 per basic and diluted share. This compares with a Q1 2014 GAAP net loss of $7.9 million, or $0.11 per basic and diluted share. We finished October with cash equivalents, and investments of $1.1 billion.
Cash flow from operations, free cash flow, and free cash flow margin for Q1 were $74.9 million, $69 million, and 35.9%, respectively. Capital expenditures in the quarter totaled $5.9 million. Consistent with the strength we saw in the quarter, linearity in Q1 tracked better than the prior year period. Our accounts receivable balance was $116.2 million for this quarter, down from $135.5 million in Q4. DSOs decreased sequentially and year-over-year by four days to 59 days. Turning to guidance, as we enter Q2, we feel good about the strength in our business and our ability to capitalize on expected year-end buying patterns. In Q2 2015, we expect revenue to be in the range of $200 million-$204 million, which represents 42%-45% growth year-over-year.
We expect non-GAAP EPS to be in the range of $0.16-$0.17 per share, using 85 million-87 million shares. Before I conclude, I'd like to highlight a few considerations for modeling purposes. Due to strong growth, seasonality has been difficult to forecast, but we believe that over the longer term, fiscal Q2 and Q4 may show our strongest revenue growth. As a reminder, in fiscal year 2015, we expect to invest approximately $25 million, or $0.18-$0.19 per share, in Traps, our advanced endpoint protection offering, with the level of investment skewed to the back half of the year. Consistent with what we said last quarter, we expect CapEx for fiscal year 2015 to be in the range of $45 million-$50 million for the year.
As we said previously, we continue to expect to exit Q4 2015 with a low teens non-GAAP operating margin and to exit Q4 fiscal 2016 at a 22%-25% non-GAAP operating margin. With that, I'll turn the call back over to the operator for Q&A.
Thank you. Ladies and gentlemen, if you would like to ask a question, please press star one on your touch-tone telephone. If you are using a speakerphone, please make sure your mute function is turned off to allow your signal equipment. Again, that is star one for questions. We'll go first to Raimo Lenschow with Barclays. Please go ahead.
Hey, thanks for taking my question, and congrats on a great start to the year. I just wanted to kind of talk a little bit about Traps. Can you talk a little bit about the You mentioned some early wins there. A little bit about the reception you got from the market and also the opportunity you do have then when you combine it with WildFire, and how the sales force is able to upsell and cross-sell that. Thank you.
Hey, Raimo, it's Mark. Thanks for joining. We're very excited about Traps. As you know, we brought that back to market in late September, so we had it in the market for about six weeks in the quarter, and the reception has been very strong. Just from an interest level, and like I said, we closed a number of deals in the quarter in October. Also one that I just wanted to note, just because it was a good-sized deal, mid-six-figure deal. It was highly competitive, where the customer had already given the PO to somebody else, took it back, and gave it to us once they saw it at work. That customer, to your point about WildFire integration, was an existing Palo Alto customer running WildFire. When they saw that work together with WildFire, they were extremely impressed with that.
I think it's a great completion to the platform concept that we've been talking about and selling for a while, that's primarily geared towards prevention, and now we can demonstrate that on the endpoint, as we said, the early indications seem very positive.
Perfect. Thank you.
Thank you.
We'll take our next question from Matthew Niknam with Goldman Sachs.
Hey, guys. Thank you for taking the question. A little more broadly, I want to have a question on customer activity. Can you talk about whether you're seeing any pull forward of demand from calendar 2015 into calendar 2014? Secondly, how you're starting to see demand among customers shape up as you head into the next calendar year. Thanks.
Yeah, sure, Matthew. I think it's a little difficult to say if there's a pull in. The security market's very strong right now. You can see that in our results, other folks' results. It's a good market to be in. We span the end of the year in this quarter, we don't have an impact of folks trying to pull spending in. As a general matter, what we're seeing is increased attention, increased spending from folks, and definitely a desire to have prevention capabilities, and I think that's why we're selling so well.
Got it. Just one follow-up on international. Any color you can provide on what's driving the acceleration in growth in EMEA and APAC this quarter?
Yeah. If you look at how our revenue breaks down across the theaters, you can see that North America, our most mature theater, continues to grow at a very healthy rate. As we've said in the past, we invested in the theaters outside of North America after North America, not surprisingly, as we grew and matured the company. I think some of those investments are paying off now over in Europe. We've done a lot of things there under Mark Anderson's leadership with major accounts, global accounts, all the playbook we've been running in North America, he's been running now in Europe with some good success. Also, just wanted to note as well, we had talked before about increasing our distribution relationships with some of the best folks in the world.
We mentioned Westcon before in a previous call where we expanded our relationship globally, the real focus of that to start off was in Europe. Early indications on that are really great growth of well in excess of 300% in just a short period of time on a year-over-year basis. We're happy with that relationship and other major global players like that that we're working with on a global basis.
One follow-on point, Matt, is with international being about a little bit over 30% of our business this quarter, we see that there's a very big continued growth opportunity across both EMEA and APAC, we feel like we're still in the very early innings of getting to that growth.
Once again, that is star 1 for questions. We do ask that you limit yourself to 1 question and 1 follow-up question. We'll go next to Keith Weiss with Morgan Stanley.
Excellent. Thank you guys for taking the question and very good quarter. I was hoping to jam 2 questions into 1, but if you could just talk about sort of how you're doing with sales into your existing customer base, in terms of going back and getting existing customers to take on more product, whether it be more subscriptions like WildFire or maybe using a virtualized appliance like we have VMware. Then question number 2, as you guys start to get more maturity and start to actually refresh your own customer base, maybe you could talk to us a little bit about how those refreshes are going, how well you're able to sustain value or add value on the refresh of guys already within your customer base.
Sure, Keith. They're somewhat related. On the first point, I'll call that the wallet share question, we're seeing a couple things there. The first is a continued increase in subscription rates and attach rates across the board as our customers continue to understand the value of using everything that the platform brings to bear in the battle for security. Really healthy, as you can see from our subscription services business. Attach rates continue to go up. In addition to that, we also are bringing to market, from a product perspective, things that can satisfy folks' need all up and down the chain, if you will, inside their enterprise. The PA-7050 at the high end selling well. We just introduced the PA-3060 for data center use cases for midsize enterprises. The addition of Traps as well to complete the platform.
I think that's all taking effect. At the end of the day, people are really buying into the platform concept and the prevention capabilities it brings. On the second portion of your question, the refresh opportunity, we watch our customer base very closely, and all of our customer cohorts are growing in lifetime value over time. In the earlier ones, which we look at in 2009, 2010, we can see the indications of our refresh cycles beginning there and the ability to upsell those folks as well when they're usually buying a bigger piece of hardware to upsell them on more subscription services because they're understanding that platform story. I think all that's working very well for us.
Excellent. Thank you, guys.
Thank you.
Our next question will come from Shaul Eyal with Oppenheimer. Please go ahead.
Thank you. Hi, good afternoon, guys. Great quarter. Congrats. Two quick questions on my end. Mark, just your thinking about FishNet and Accuvant recent teaming up, how does that impact your business?
Sure, yeah. I think we'll continue to see consolidation in that part of the industry. I don't think it's a bad thing for us. Both of those are very good partners of ours and have been increasing their business over time. Combination brings more to bear from what they can do for us as a large vendor in the market. I think that's probably a good thing.
Got it. Steffan, thanks for reaffirming the operating margin targets as you exit FY 2016. As we think about further means of lifting up EPS down the road, what's the current thinking about tax rate? How could that be maybe lower down and in turn lift up EPS?
Well, currently we have a static non-GAAP tax rate of 38%. We've done over the past couple of years is we've committed to an international cost-sharing structure for our IP. With that type of structure in place, as we become a full taxpayer longer-term down the road, we would expect to see our tax rate most likely be in the high 20% range, which would be a lift to EPS. As it relates to non-GAAP in the near term, over the next year or so, we'll evaluate the static tax rate of 38%, and we'll probably revisit that a year from now. At that point, we'll have had that static tax rate for about two years.
Our next question comes from Brent Thill with UBS.
Thanks. Just a question on the relationship between product and services there. You had good upside in services. On the product side, you were just a little bit ahead of the street. I'm curious what you're seeing there as it relates to the services side. There's another question as it relates to that is, you look at the managed defense as a service and how you think you'll benefit as that seems like it's early, but there's a big opportunity for you in that segment of the business.
Yeah, sure, Brent. On the product services side, we came off of a screaming fourth quarter, as you may recall, very happy to see sequential growth across the board. Q4 to Q1, very happy with how that turned out. The services side of our business, about 47% of our business right now, continues to grow over time. We like that a lot. The services show stickiness with the customers. It has higher margins, so we really like that trend. At the same time, we continue to grow the product revenue at a very high rate as well. I think both of those cylinders are firing very well on our hybrid model. On the services side, your managed services question, we love services, obviously. It's 47% of the business and growing.
We really like the idea of providing what used to be a hardware-based security as subscription services. We like that model a lot. We're not in the MSS business today. Lots of people are in that business and know how to run our products and provide it on a managed services basis, so we think we understand that segment of the market pretty well.
Our next question will come from Karl Keirstead with Deutsche Bank.
Thank you. Steffan, I've got a question about the cash flow performance, which was extraordinary in the quarter, the operating cash flow margin tracked way above what your non-GAAP operating margin was. I'm just wondering if you could give us a little bit of guidance in how to model cash flow. If you look out a year, let's say FY 2016, or you can pick the period, what should the relationship be between the operating cash flow margin and your non-GAAP operating margin? Thank you.
Good question. First of all, our cash flow has benefited this quarter by a great billing cycle in Q4 and very good linearity in Q1. The fact that we drove 35.9% free cash flow margin in the quarter was great. Longer term, we've been giving folks a guideline around at our target model of 22%-25% non-GAAP operating margin. Free cash flows, we estimate should be 5%-8% above. We'll continue to refine that down the road, but that's something where we believe free cash flow margin will be above operating margins, mainly because operating margins, candidly, are a lagging indicator of profitability because we have the hybrid SaaS revenue model where we take revenues ratably for a large swath of the business, but we also take in-period expenses for sales commissions. Free cash flow is a very meaningful indicator of profitability for us.
We believe it's a differentiating factor from a business model standpoint, and the fact that we're able to post great positive free cash flow while growing top-line revenue and billings way above market rate of growth, we feel very good about the power of the business model.
Great. That's helpful. If I could ask my follow-up on another metric, and that's the attach rate for the subscriptions. Obviously, that was a big growth engine in the October quarter. Are you able to bracket for us what the attach rates are for some of the more mature subscription modules?
Yeah. We reported overall attach rates every six months. The last time we talked about that in the last quarter, we said on an overall basis, it's 2.1 from 1.9 the previous time we had spoken about that. Attach rates continue to grow for us. That's because all the subscription services continue to grow very nicely. Some of the more mature ones, threat prevention, are in the 80-something% category of attach, and we think a number of these services can reach the high maturity rates.
We'll take the next question from Rob Owens with Pacific Crest Securities.
Great. Thanks. Good afternoon. Curious, as we're seeing security clearly accelerate here the last couple of quarters, not only for you guys, but the industry in general, where do you guys think the budget's coming from? What other areas are seeing less spend at this point?
Rob, it's hard to say what might not be getting funded. We definitely see an increase in security budgets across the board. That's on a global basis as well. The reports that I've looked at are pretty clearly indicating that people are figuring out that they have to spend money here. It sounds like they're going to continue to do that in the future with security being one or two of the top priorities. I don't actually track all the other stuff close enough to know who might be shorted for that. Somehow people are figuring out how to spend here.
As we look at your strong customer acquisition numbers the last couple of quarters showing some acceleration here, who are you seeing most from a displacement standpoint? With everyone kind of adopting a next-generation firewall marketing campaign, who are you seeing most competitively these days? Thanks.
It really hasn't changed in quite some time. I know everybody has jumped on the marketing bandwagon for next generation. There's a few things that I think have become increasingly evident in the market. The first is when it's time to show up and really prove that to folks, we've consistently been the only ones who've been able to show true next-generation firewall capabilities. Even more importantly now is the concept of next-generation security platform that does prevention. Not only just next-gen firewall, really distancing ourselves from everybody else in the market who don't even have that first capability set and continue to fall further behind on the whole platform concept and prevention. That is across the board.
When we look at our win rates across the board, we're taking business from everybody in the market today, that looks like that would continue for quite some time.
Thanks.
Thanks, Rob.
Our next question comes from Philip Winslow with Credit Suisse.
Hi. Thanks, guys, congrats on another great quarter. You guys talked about just pretty good success in just getting larger and larger deals. What's really driving that here? Is it really the attach rates of just more and more subscription services? You mentioned the 1.8-2.1 that you guys talked about last quarter. You always have a high-end appliance, so you can actually go into more and more data center deals, or how do you think about the mix of that? Just one quick follow-up.
Sure. Congratulations on your baby, Phil, by the way.
Thank you.
It's actually a mix of a number of things. The first, and probably the most important, is the acceptance of Palo Alto Networks as a major player in the enterprise security market and understanding that platform capability set as having end-to-end protection prevention capabilities. As a general matter, people are more inclined to just buy more from us on size and scope and do it on an earlier basis than they have in the past. For the existing customers who've been working with us for a while, the ability to march them up from an attach rate perspective has been demonstrated over time. It's really a combination of those two things that are just driving more times at bat, higher initial sales, and then increasing the ability to sell subscriptions in there so the lifetime value continues to go up.
Great. Just one quick follow-up for Steffan. The exit rate for fiscal 2016 that you talked about, maybe if you could just remind us about what that model looks like. Sales and marketing as a percentage of revenue, gross margins, et cetera, so we have an idea for how the model evolves in your mind.
Certainly. It starts with gross margin. Our forecasted range exiting Q4 of FY 2016 is 73%-76%. Sales and marketing as a percentage of revenue is 33%-36%. R&D is 13%-14%, G&A is 5%-6%, leading to a range of 22%-25% non-GAAP operating margin. When you look at where we are today as a business, we're either at or within sniffing distance of all of those line items, except for sales and marketing.
As practitioners of the business, we constantly evaluate growth versus profitability, the fact that we're growing at 10 times at the rate of the market and much faster than the rate of the competition, we are committed to delivering profitability over time, we don't want to strive to get to be as profitable as possible because we would be leaving a great opportunity on the table. That's our viewpoint on it, we've been very consistent since the time we went public around the target model exiting Q4 of FY 2016.
Our next question will come from Walter Pritchard with Citi.
Hi. Can you talk about on the attach of subscriptions, you mentioned the threat prevention, where it is in the approaching 80%. We can do the math on WildFire. As we think about WildFire and other subscriptions that you have, could they approach the 80%, how should we think about the potential peak of attach on those?
Hey, Walter. It's Mark. I think that particularly WildFire as an example is a close cousin, first cousin to threat prevention when you think about what it does, and then particularly when those two things work together. I think we could see pretty high attach rates on WildFire. The other ones are already selling very well and at very high attach rates. We have GlobalProtect, which is doing nicely. It's still our smallest one as I think the market sorts through what mobile security is going to look like in the future. We like that one a lot. We just think it's going to take some time for folks to come to the understanding of how mobile security should be done.
On top of that, we have Traps as well, which it's not an attach rate, as you know, but I think of it as our fifth service from a financial perspective, and have great expectations for that.
Just a follow-up to that, Mark, should we think about Traps as kind of the next driver here in terms of attach, so to speak, or do you have in your back pocket other subscription services that might start to become meaningful that we don't have released or are maybe sort of fledgling in beta, something like that, over the next couple of years?
I think about Traps as a fifth service here, even though it won't have an attach rate concept to it. We're always evaluating additional subscription services, and we have a high bar on those, meaning things that folks have had value in in the past, ideally are delivered with hardware, can be subsumed into our platform in a very elegant, graceful, and highly integrated way. We're constantly evaluating things that could fit that bill, and I would expect us to have more services in the future.
We'll go next to Gray Powell with Wells Fargo.
Great. Thanks for taking the questions. Just a couple, if I may. Maybe starting off with a bigger picture question. I think in about four, maybe five years, you've been able to take a high single-digit share of the network security market and a much higher flow share of new growth. How should we think about the opportunity in endpoint security, and what do you see as the gating factors of driving share gains in that market?
Hey, Gray. Yeah. We're still single-digit players in the close to $19 billion addressable market opportunity if you look out a couple years from today, as far as the size of the market is. That is for enterprise security, of which the endpoint is a portion of that. For us, that's a completely untapped portion of that addressable market opportunity, and I think we have two things going for us there. The first is that Traps itself is highly disruptive. It is truly doing prevention on endpoint, something nobody has seen before, and it's very effective. In addition to that, when it's working with the rest of the network security platform, it really gives you end-to-end protection and prevention across the entire network.
We think it's the combination of those two things that will help us drive penetration into the endpoint market and be able to do so at high growth rates. On the flip side, we love Traps as well, because it's a great benefit to our existing customers or folks who would look at us just for network security. We think that it's also going to benefit us from a sales perspective on the network side of the business. Those two things working in tandem are very nice for us.
Got it. One more, if I may. Can you help us just think about the scalability of Palo Alto's management console as we think about the potential for you guys to do larger deals? Along those lines, how many appliances can customers manage in some of your largest deployments today?
On the console or the management platform itself, which we call Panorama, is very scalable. I think a few years ago, some of our competition would like to say that that was somehow a limiting factor for us. We put a lot of time and attention to that over the last few years, both on the software side, then also we introduced a hardware platform that Panorama can run on as well, the M-100, that we can have lots of scalability around that. I have not heard a customer in years bring up management platform as any buying objections. As far as the capability set, they can manage thousands of devices right now, and deployments out there today are 500-plus devices easily running on Panorama. I don't think there's any limitation at all.
Excellent. Thank you very much.
Our next question will come from Scott Zeller with Needham & Company.
Hi, thanks. Just wanted to go back to the budget question from earlier. Could you tell us how often you're now seeing line items called out for cybersecurity when you're competing for deals? If you do see that an opportunity, does that typically mean a larger deal, I'm assuming?
Yeah. Hey, Scott. I think we're seeing the transition that is in play, and this will take some time, into hearing the word cybersecurity used, generally hearing it used by C-suite executives on the technology side, so CIO, CISO conversations. At the same time, dealing with people who are actually rolling their sleeves and operating technology, who talk in terms of the network and things that have to run in the network. That's an evolution of those two things over time. When people are talking about cybersecurity, we like that a lot, of course, because we say in cybersecurity, prevention should be your ultimate objective, and if you want to future-proof your organization in order to do protection and prevention all the way from the network down to the endpoint, then we've got the answer to that.
When they bring the operating guides into the room, right, to really dig into that, we're also able to have very fantastic conversations with them about each aspect of that. When they want to talk about the firewall, we can talk about the firewall. If they want to talk about the endpoint, we talk about the endpoint. We can talk about IPS. We can talk about all the capability sets of that, both at a C-suite executive level, as well as people who actually have to run stuff at the end of the day. It's working well.
Thank you.
Our next question comes from Andrew Nowinski with Piper Jaffray.
Okay. Good afternoon. I think last quarter, you had about 3,000 WildFire paying customers. Just curious to know what that changed to this quarter, and whether Traps could be driving some of that demand for WildFire. I just have a quick follow-up.
Sure, Andrew. We are just shy of 4,000 paying customers, so a great quarter for us in customer addition on paid WildFire. I think Traps has not been in the market long enough to be influencing WildFire sales. Probably the opposite. Some of the deals that we saw around Traps in the quarter, those two things working in conjunction should help each other out over a long-term basis.
Okay. Can you just talk about whether WildFire is predominantly having success when the customer's already a Palo Alto customer, or whether it's drawing you into some new deals, where the customer doesn't already have a Palo Alto firewall? Thanks.
It's both situations. We've found that if you're an existing Palo Alto Networks customer, not yet using WildFire, the idea that you can do real-time malware prevention for known threats and then very fast detection and downstream kill chain impacts for malware that is zero-day is a very compelling conversation. Of course, we also get to say, "You already bought the infrastructure to support that capability set, so you should use WildFire." In addition to that, when we go into new opportunities, and they're not using our technology at all yet, we very much talk to the platform and the prevention capabilities of the platform. When people hear that, if they're going to purchase Palo Alto Networks for the first time, they're inclined to buy WildFire along with that first purchase because they want that advanced persistent threat protection right up front.
Thanks.
Thank you.
We'll hear next from Aaron Schwartz with Macquarie.
Good afternoon. Thank you. On the target operating margins, I know you just mentioned, and you've talked about it before, the sales and marketing is really the area for leverage. The question I have is, how do you think about the mix between indirect and direct sales? Presumably indirect is going to play a part there in the greater leverage, and historically a lot of channel partners might be a little bit more network centric with security. Are there things or what are the milestones to continue to ramp the indirect side, get to your target margins, or are the target margins just a factor of top line growth, and you can get there independent of any mix in the channel?
There are definitely two things at play there, two of which what you just said. The first is, we are continuing to build out our channel infrastructure. We have a great partner ecosystem, and as we invest in the channel, train the channel, the percentage of deals that the channel can close with as little touch from Palo Alto Networks as possible, that will be more leverage for us in the model. We will be getting more revenue growth by virtue of having more channel partners out there. We've always described our sales model as a high touch indirect fulfillment type model. Literally close to 100% of deals get fulfilled through the channel, but we have a great direct touch sales force that sells side by side with the channel.
What we've done in the past under Mark Anderson's leadership is we've done account segmentation with looking at Global 2000 accounts and major accounts. In those instances, we have very nice high touch direct sales folks sometimes working in concert with the channel partners as well on doing those deals. For deals that are outside of the very large enterprises, we're going to be looking more towards our indirect partners to take more of that business from beginning to end. Additionally, how we get to that target sales and marketing line is we'll have more ramped salespeople than ramping salespeople over time. That's a key component.
The fact that we have such a great lifetime value concept where once we acquire a customer and we're able to sell more to the install base, those repeat sales that happen come at a lower cost of sale to the company. Strategically, we have the direct and indirect function, but we also have more ramped people than ramping and other elements that I just covered.
Terrific. Thank you.
Our next question comes from Hendi Susanto with Gabelli & Company.
Good evening. Thank you for taking my questions. A question for Steffan. Your R&D was 11.9% in Q1 and 12.3% in fiscal year 2014, which are below your midterm target of 13% to 15%. Could you give some insight on whether we can expect R&D as a percentage of revenue to be below that target in the near future? Additionally, services gross margin was very strong. I'm wondering whether we are seeing the uplift of favorable mix towards subscriptions and operating leverage in services business that we can expect to continue. Thanks.
Well, for R&D, we keep the filter very tight around the folks who we're bringing into the company, and we are committed to making the best investments that we can. Our commitment to innovation within R&D has translated very well into new product introductions, and really changing the game on the competition. Over time, we feel like in order to sustain the innovation engine, we should be around call it 13-ish, 14-ish%. There's going to be some lumpiness as we get there. Additionally, on R&D, we're starting to really build out the Traps team in Tel Aviv. That was a product of our Cyvera acquisition. We are going to be seeing more investments in that business as well.
I can't really comment on the specific near term, but we feel good about our target model, and we feel like to adequately be committed to innovation, you have to be in call it the 13% to 14% range. On the topic of services gross margins, there are two elements to services gross margins. The first is we are definitely getting the benefit of increasing attach rates to subscriptions. Remember, subscriptions are software type gross margins. As we get more subscription revenue, that will definitely translate into higher services gross margins. The other part of the services gross margins is the customer support organization, and that's really people and systems intensive. What we are starting to see are early days of getting some scale in that group.
You can imagine with the sheer number of customers we've acquired, we've been adding well over 1,000 customers per quarter for now 12 quarters in a row. We need to be investing in that customer support organization, we're doing it prudently. We believe pound for pound, we have the best customer support organization on the planet. Now we're starting to see some leverage. We're getting two positive tailwinds in services gross margin.
Our next question will come from Erik Suppiger with JMP Securities.
Yeah, good afternoon. Congratulations.
Thanks, Erik.
On Traps, I was wondering, can you give us a sense for how that might scale and maybe give us a sense relative to WildFire? You've talked about that market size as being significantly bigger, but I think you have a different sales model for that. You've started to see the elements there. When could we see Traps maybe start to exceed the size, the customer base that you have for WildFire?
Yes, sure. A couple thoughts around that. The first is that by having Traps in the first place and are entering into the endpoint security market, the addition to the addressable market opportunity is anywhere between $4 billion-$5 billion, depending on whose numbers you look at. The endpoint security market is a larger market than what we've seen folks who've tried to triangulate on this, the market called STAP, where WildFire specifically may fall into, which we've seen anywhere from $1 billion-$2 billion of market opportunity. They're just different addressable market opportunities in the first place, with Traps being a broader one, just as far as what the market looks like is in terms of size. Given that, we like that market a lot.
As I said a little earlier, when those two things are operating together, it's a killer offering for folks because you're getting real-time exploit prevention, you're getting real-time malware prevention for known threats, and you're getting very fast turnaround for unknown threats, both at the network and the enterprise. We're thinking about those two things together. As far as what we expect to see from Traps, we like the early interest in the market. We like the fact we're closing deals already. We think given the subscription model and the time it'll take to ramp the sales and a few other things, that we'll see a meaningful revenue contribution in fiscal 2016 and our sales building throughout the back half of fiscal 2015. We're very excited about this opportunity.
We'll take the next question from Michael Turits with Raymond James.
Hey, guys. One on WildFire and Traps, thanks for taking the question.
Thanks.
First of all, in each of those two products, who are you going up against in deals with each of those products?
On the WildFire situation, when people think about that, they usually think about advanced persistent threats. There's some folks who would position themselves in the market as more comprehensive, that would be all the standard network security competitors we've seen, Cisco, Juniper, Check Point, who have offerings in that space as well. That's more of our platform will beat them on a head-to-head basis relative to any of their point solutions that they have. The most direct competition we see as far as the standalone player there would be FireEye. On Traps-
What about on Traps?
I'm sorry, Michael. On Traps, the big players in that market are the legacy folks in Symantec, Trend Micro, and McAfee. Ultimately, a big part of the market opportunity is in that legacy space. There's a host of next-gen endpoint folks out there today as well that we're competing with who are trying to land next to as a complement to some of those legacy guys as the first step. We're competing in both cases, legacy, but probably today more and more on the next-gen guys who are competing for the space on the endpoint to do something new.
Our next question will come from Jeff Kvaal with Northland Capital Markets.
Thank you. I have two questions. Steffan, they may both be for you, actually. I'm wondering if you could comment on, number 1, the linearity in the quarter. It looks like it was great. Could you talk about why linearity is improving? Should we expect it to revert to, let's say, last year's level at some point? Secondarily, Steffan, if you wouldn't mind, could you tell us more about what was in the consulting element of the G&A uptick, and particularly if it's going to be recurring? Thanks.
Linearity in the quarter was very good. Why it's happening is we are getting a broader pipeline heading into each quarter, which is nice. The close rates have been very robust. We're able to close deals earlier because of the technological differentiation and the power of the platform that we have, in addition to great sales execution. We've had the differentiation that we've always had. Now we have more feet on the street, more firepower, and we're able to close deals earlier. It's too soon to tell whether or not the linearity will continue to be at these levels. Certainly, in our fiscal Q2, one of the interesting things about a company like ours that has a quarter end in January is December typically is a strong month because of calendar year-end budget flush.
We'd expect to do a very good portion of our business through month two. We'll see if that holds up this year, and there are no indications that it won't. As far as consulting services, at the end of the last fiscal year, we had a couple of consulting projects roll off. In Q1, we had some come back on, mainly in the tax area that we started to make some investments in. As we build out that organization, we're relying on some external consultants. Also we had some other, I'll call it discrete projects that we're working on, all with the intent of helping us get more scale going forward. Think of it as finance and accounting projects as well in order to get more future leverage.
There's a little bit of quarterly perturbations around projects rolling off and some projects starting, and that's what you really saw. As far as will it increase at the same rate? Certainly not over time because we're looking at a target model of 5%-6% for G&A, directionally over time, it should come down, but there will be quarterly perturbations.
Ladies and gentlemen, that does conclude our question and answer session. I'll now turn the call back over to Mark McLaughlin for closing comments.
Great. Thanks, everybody, for being on the call this afternoon. We had a great start to the year, we're really energized with the opportunity we see as we move into fiscal 2015 and beyond. We think we're at the right market at the right time with the market-leading protection and prevention technology. I'd really like to thank Palo Alto Networks team for all their hard work and support for all of our customers and partners as we continue our march to be the leading enterprise security provider in the world. I wish everyone a happy and healthy Thanksgiving holiday. Thanks for being with us.
Ladies and gentlemen, that does conclude today's conference, and we thank you for your participation.