Good day, and welcome to the Palo Alto Networks First Quarter 2015 Earnings Conference Call. Today's conference At this time, I would like to turn the conference over to Kelsey call is being recorded. 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 Q1 2015 is being broadcast live over the web and can be accessed on the Investors section of our website at investors.paloaltonetworks.com. With me on today's call are Mark McLaughlin, our Chairman, President and Chief Executive Officer and Stefan Tomlinson, our Chief Financial This afternoon, we issued a press release announcing our results for the 1st fiscal quarter ended October 31, is 2014.
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 revenue and earnings per share guidance for our fiscal 2nd quarter, continued strength in our business, our expectations regarding our gross margins, seasonality, revenue growth, future investment in Traps, is our ability to accelerate growth in 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 ks filed with the SEC on September 18, 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 will be posted on the financial
measures in the
supplemental financial information that can be found in the Investors section of our website located at investors.paloaltonetwork.com. Before I turn the call over to Mark, we'd like to inform you that we will be presenting at the Credit Suisse 18th Annual Technology Conference on Wednesday, December 3, in Phoenix. Conference is the Raymond James 2014 Systems Semiconductor Software and Supply Chain Conference on Tuesday, December 9 in New York City and the Barclays Global Technology ends on Wednesday, December 10, in San Francisco. And with that, I'll turn the call over to Mark.
Thank you, Kelsey, and 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 Palatin Networks team for their contributions and call is recorded. 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 expectations and I'm especially pleased that we were able to demonstrate strong sequential growth off of our record 4th quarter.
In Q1 billings and revenue reached records again with billings growing 52% year over year to $240,000,000 and revenue growing 50% year over And delivered Q1 non GAAP EPS of $0.15 per share. Our growth is primarily being driven by 3 things. Is spent. 2nd, in the security battle, prevention is the ultimate objective and Palo Alto Networks integrated and automated next generation security platform is unique and delivers unparalleled prevention capabilities in this $16,000,000,000 addressable market opportunity. And third, we believe is a very important subject matter experts that are best in class both before and after an order.
Our Q1 results reflect these long term factors is a very strong quarter and 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
is a priority at a Fortune 10
company replacing Check Point and Cisco in an enterprise wide global deployment in 1 of Asia's largest financial institutions and replacing Check Point and Cisco as the primary data center firewall for 1 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 has spent a minimum of $6,100,000 in lifetime value, up from $5,600,000 last quarter, and almost all of those customers made a purchase in the quarter will 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 is expected to be a key driver 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 is a very strong quarter for 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 expanded the current deployment with 8 additional chassis. Also, they continues to provide the world's best prevention capabilities at all points in the network, 2 weeks ago we launched our newest appliance, the PA-three thousand and sixty for our midsize enterprise customers' data center call is available for the Q1 of 2019. In the Advanced Persistent Threat Solutions space, we believe we are now the largest provider by customer count with approximately 4,000 is repaying for Wildfire's integrated and automated prevention capabilities. And in late September, we made real time exploit and malware is mentioned that both the network and the endpoint are 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 New product announcements like the PA-three thousand and sixty 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 Palatin Networks addition for NSX and are engaged in a large number of is also in October, we expanded our partnership with VMware to provide our advanced security to VMware's public is the cloud platform vCloudAir. Enterprises can now apply the same rich set of security services available through VMware NSX
is a very strong quarter
for the quarter and conference is helping organizations control access to enterprise applications and data based on key policy criteria such as application, user and device. And we announced the latest release of our VM series with support for Amazon, AWS and KVM. Our customers can now take advantage call is now available at the same time delivering bottom line results and cash flow generation that continue to demonstrate the leverage we have in the business and the ability to expand it over time. Is a 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 is a top IT spending priority across organizations of all sizes and 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 is superior security at a superior total cost of ownership. With that, I'll wrap it up and turn it over to Stephen.
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 Q1, we built upon the record billings and revenue we delivered in Q4 FY 2014, demonstrates the continued traction we have in the market with our powerful platform. And we continue to drive leverage with both operating margin and free cash flow increasing on a sequential components of our business model.
Once again, we saw new customer acquisition and expansion at existing customers will 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 is in our favor. Now let me turn to the numbers. In Q1, total revenue grew 50% over the prior year and is 8% sequentially to reach a new record of $192,300,000 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% in 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 3 components of our hybrid SaaS model product, subscription and support all grew very well in Q1. Q1 product revenue of $101,500,000 increased 34% over the prior year and 2% sequentially. We saw particular strength in the contribution from our highest end appliances, including the PA-seven thousand and fifty, which continues to provide greater opportunity in the data center market.
Our recurring services revenue of $90,900,000 increased 72% over the prior year and is 16% sequentially and accounted for a 47% share of total revenue. Looking at the 2 components of recurring service revenue, The first component is our SaaS based subscription revenue of $43,700,000 which increased 76% over the prior year and is 16% sequentially. Support and maintenance revenue, the second component of recurring services was 47,200,000 in the prior year and 15% sequentially. Billings in Q1 were 240,500,000 increased 52% year over year and 3% sequentially. Growth in recurring services billings positively impacts deferred revenue.
Total deferred revenue in Q1 was $470,700,000 an increase of 69% year over year and eleven is now open. Short term deferred revenue increased to $286,700,000 an increase of is 27% year over year and 10% sequentially. Total gross margin for Q1 was 76 point increased by $1,000,000 an increase of 180 basis points compared to last year and 10 basis points sequentially. Product gross margin was 75.1%, a 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 is 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 percent of revenue, increasing approximately $2,100,000 sequentially to $22,800,000 This was primarily due to headcount growth. Sales and marketing expense for Q1 was 46.8 percent of revenue, is decreasing approximately $2,500,000 sequentially to $90,100,000 This was primarily due to a decrease in sales commissions related to our strong fiscal
is a record year
14 year end performance. General and administrative expense for Q1 was 7.5 percent of revenue, Increasing approximately $5,400,000 sequentially to $14,400,000 This was driven in part by consulting and outside services related to projects in the G and A organization. Total headcount at the end of the quarter was 1900, up from 1722
is at the end of Q4 fiscal 2014.
In total, Q1 operating expenses were $127,300,000 or 66 point is 2% of revenue. Operating margin grew 310 basis points year over year to 10.6% and increased sequentially 250 basis Net income for the quarter was $12,800,000 or $0.15 per diluted share using 84,700,000 shares is a conference call, compared with net income of $6,200,000 or $0.08 per diluted share in Q1 2014. On a GAAP basis for the Q1, net loss was $30,100,000 or $0.38 per basic and diluted share. This compares with a Q1 2014 GAAP net loss of $7,900,000 or $0.11 per basic and diluted share. For Q1 were $74,900,000 $69,000,000 and 35.9 percent respectively.
Capital expenditures in the quarter totaled $5,900,000 Consistent with the strength we saw in the quarter, linearity in Q1 tracked better than the prior year period. Our accounts receivable balance was $116,200,000 for this quarter, down from 135,500,000 is Q4. DSOs decreased sequentially and year over year by 4 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 conference in Q2 2015, we expect revenue to be in the range of $200,000,000 to $204,000,000 call, which represents 42% to 45% growth year over year.
We expect non GAAP EPS to be in the range of $0.16 to $0.17 per share using 85,000,000 to 87,000,000 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 is $25,000,000 or $0.18 to $0.19 per share in Traps, our advanced endpoint protection offering with the level of investments 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 $45,000,000 to $50,000,000 for the year.
And as we said previously, we continue to expect to exit is Q4 2015 with a low teens non GAAP operating margin and to exit Q4 fiscal 2016 at a is a range of 82% to
25% non GAAP operating margin.
With that, I'll turn the call back over to the operator for Q and A.
Thank you. 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 is And how the sales force is able to upsell and cross sell that? Thank you.
Yes. Hey, Maram, it's Mark. Thanks for joining us. Yes, we're very excited about Traps. As you know, we You brought that back to market in late September.
So we had it in the market for about 6 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 and also one that I just wanted to note just because it was a good sized deal, mid 6 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 work. And 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 So I think it's a great completion to the platform concept that we've been talking about and selling for a while. And it's primarily geared toward is prevention and now we can demonstrate that on the endpoint as we said the early indications seem very positive.
Perfect. Thank you.
Thank you for taking the question. Just a little more broadly, I want to just have a question on customer activity. Can you talk about whether you're seeing any pull forward of demand
calendar year. Thanks. Yes, sure, Matthew. I think it's a little difficult to say if there's a pull in. The security market is very strong right now.
You can see that And our results, other folks' results. So it's a good market to be in. We span the end of the year in this quarter, so we don't have an impact of folks trying to pull spending in. But as a general matter, what we're seeing is increased attention, increased spending from folks and is definitely a desire to have prevention capabilities, and I think that's why we're selling so well.
Got it. And then just one follow-up is on international. Any color you can provide on what's driving the acceleration in growth in EMEA and APAC
this quarter? Yes. 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, very healthy conference is being recorded. And 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. And I think some of 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 Westcom before In a previous call where we expanded our relationship globally and the real focus of that to start off was in Europe and early indications conference call is on that a really great growth of well in excess of 300% in just a short period of time on a year over year basis. So we're happy with that relationship and other major global players like that that we're working with on a global basis.
Yes. 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, and we feel like we're still in the very early innings of getting to that growth.
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, I have 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 to take on more product, whether it be more subscriptions like wildfire or maybe using a virtualized appliance like we have VMware. And then question number 2, as you guys start to get more mature and start to actually refresh is 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 is already within your customer base.
Yes, sure Keith. Yes, they're somewhat related. On the first point, I'll call that the wallet share question, we're seeing a couple and the value of using everything that the platform brings to bear in the battle for security. So really healthy, as you can see from our subscription services business. Is the 3,000,000 and fifty.
At the high end selling well, we just introduced is 30.60 for data center use cases for midsize enterprises and then the addition of Traps as well to complete The platform. So I think that's all taking effect. But 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 conference call.
Today's conference call is now growing in lifetime value over time.
And in the earlier ones, which we look at in 2,009, 2010, we can see call. 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 AccuVance recent teaming up, How does that impact your business?
Sure. Yes. I think there will continue has increased their business over time. A combination brings more to bear from what they can do for us as a large vendor in the market. So I think that's Probably a good thing.
Got it. And Stefan, thanks for reaffirming the operating margin targets as you exit fiscal 2016. But 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
Well, currently we have a static non GAAP tax rate of 38%. What we've done over the past couple of years is we've committed to an international cost sharing structure for our IP and 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. And 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, now that we've and at that point, we'll have had that static tax rate for about 2 years.
And 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 is a little bit out of the street. I'm curious what you're seeing there as it relates to the service side?
And 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 is early, but there's a big opportunity for you in that segment of the business. Yes, sure, Brent. On the product services side, we came off of is a screaming 4th quarter, as you may recall, and very happy to see sequential growth across the board, Q4 to Q1, so we're 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.
Of the services show stickiness with the customers and has higher margins. So we really like that trend. And at the same time, we continue to grow the product revenue at a very high rate as well. So 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 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.
Thank you, Stefan. I've got a question about the cash flow performance, which was extraordinary in the quarter and the operating cash flow margin is way above what your non GAAP operating margin was. So I'm just wondering if you could give us a little bit of guidance on how to model cash flow. What kind of sort of if you look out a year, let's say fiscal 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. Well, first of all, our cash flow has benefited this quarter by a great billing cycle in Q4 and very good linearity in Q1. So the fact that we drove is 35.9 percent free cash flow margin and the quarter was great. Longer term, we've been giving folks a guideline around is at our target model of 22% to 25% non GAAP operating margin. Free cash flows, we estimate should be 5% to 8% above.
We'll continue to refine that down the road, but that's something that where we believe free cash flow margin will be above operating margins, mainly because operating margins candidly are a lagging indicator of profitability, is 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. So 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 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. And 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?
Yes. So we reported overall tax rates every 6 months. The last time we talked about this Last quarter, we said on an overall basis, it's 2.1%, up from 1.9%, the previous time we had spoken about 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 that are prevention are in the 80 something is a 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 and 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 Where do you guys think the budget is coming from? What other areas are seeing less spend at this point?
Rob, it's hard is 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 is going to spend
money here and it
sounds like they're going to continue to do that in the future with security being 1 or 2 of the top priorities. I don't actually track All the other stuff close enough to know who might be being shorted for that, but somehow people are figuring out how to spend here.
And then as we Look at your strong customer acquisition numbers the last couple of quarters showing some acceleration here. Who do you 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.
Conference call is open. It really hasn't changed in quite some time. I know everybody has jumped on the marketing bandwagon for next generation, but there's Few things that I think are become increasingly evident in the market. The first is when it's time to show up and conference really proved that to folks. We've consistently been the only ones who've been able to show true next generation firewall capabilities.
And even more importantly now is the is a concept of next generation security platform that does prevention. So just not only just next gen firewall, but really, really distancing ourselves from everybody else in the market 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. And that looks like that will continue for quite some time.
Thanks. Thanks, Rob.
Our next question comes from Philip Winslow with is Credit Suisse.
Hi. Thanks guys and congrats on another great quarter. You guys talked about just pretty good success in is 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 though 1.8 to 2.1 that you guys talked about last quarter. You always said you have a high end appliance, so you can actually go into more and more data center deals. Or how do you think about And then just one quick follow-up.
Yes, sure. Congratulations on your baby fella, by the way.
Thank you.
Yes, 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 is the enterprise security market and understanding that platform capability set as having end to end protection prevention capabilities. So as a general matter, people are more inclined to just buy more from us in size and scope and do it on an earlier basis than they have in the past. And then 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. So it's really a combination of those two Things that are driving higher more times at that, higher initial sales and then increasing the ability to sell subscriptions in there, so the lifetime value continues to go up.
Great. And then just one quick follow-up for Stefan. The exit rate for fiscal 2016 that you talked about, maybe if you could just remind us about sort of what that model looks like, sales and marketing as a percentage of revenue, gross margin, etcetera, so we kind of have an
range exiting Q4 of fiscal 2016 is 73% to 76%. Sales and marketing as a percentage of revenue is is 33% to 36%. R and D is 13% to 14% and G and A is 5% to is leading to a range of 22% to 25% non GAAP operating margin. And 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. And as practitioners of the business, we constantly evaluate growth versus profitability.
And the fact that we're growing committed to delivering profitability over time, but we don't want to strive to get to be as profitable as possible because we would be leaving a great opportunity is on the table. So that's our viewpoint on it and we've been pretty consistent. 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 kind of do the math on wildfire. As we think about other wildfire and other subscriptions that you have, could they approach the 80% or how should we Think about the potential peak of attach on those.
Hey, Walter, it's Mark. Yes, I think that particularly wildfire as is an example is a close cousin, 1st cousin to threat prevention when you kind of think about what it does. And then particularly when those two things work together. So I think we could see The other ones are already selling very well and at very high attach rates. And then we have GlobalProtect, which is doing nicely.
It's still our smallest one as I think the market swerves through what mobile security is going to look like in the future. We like that one a lot because I think it's going to take some time for folks to come to the understanding of how mobile security should be done. And then on top of that, we have Traps as well, which is is not an attach rate, as you know, but I think of it as our 5th service from a financial perspective and we have great expectations for that.
And just a follow-up to that Mark is should we think about Traps as kind of the next driver here in terms of attach so to speak? Or do Do you have in your back pocket other subscription services that might start to become meaningful that we don't have released or maybe sort of fledgling in beta, something like that over
the next couple of years. I think about Traps as a 5th service here even though it won't have an attach rate concept to it. And we're always evaluating additional subscription services and we have a high bar in those, meaning things that folks have added value in, in the past, is a deal that you delivered with hardware can be subsumed into our platform in a very elegant, graceful and highly integrated way. So we're constantly evaluating things that could is really 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. So maybe starting off with a bigger picture question. I think in about 4, maybe 5 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?
Great. Yes. So we're still single digit players in the close to $19,000,000,000 addressable market If you look out a couple of years from today as far as the size of the market is, and 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 2 things going for us there. The first is that Traps itself is
highly disruptive. It is truly doing prevention
on endpoint, something nobody is really disruptive. It is truly doing prevention on endpoint, something nobody has seen before, and it's very, very effective. And in addition to that, when it's is working with the rest of the network security platform. It really gives you end to end protection prevention across the entire network. So we think it's a combination of is those two things that will help us drive penetration into the endpoint market and be able to do so at high growth rates.
Is a great benefit to our existing customers or folks who would look at us just for network security. So we think that it's also going to benefit us from is a sales perspective on the network side of the business. So those two things working in tandem are very nice for us.
Got it. And 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? So on the console or the management platform itself, which we call is very, very scalable. I think a few years ago, some of our petition 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 and then also we introduced A hardware platform that Panorama can run on as well, the M100, so that we can have lots of scalability around that. I have not heard a customer in They can manage thousands of devices right now and deployments out there today are 500 plus is usually running on Panorama.
So 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 and 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? And if you do see that an opportunity, does that
To hearing the word cybersecurity used, generally hearing it used by C Suite executives on the technology side, so CIO, CISO, is the ISO conversations, but at the same time dealing with people who are actually rolling through sleeves in operating technology, 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 network down to the endpoint, then we've got the answer to that. When they bring the operating guys 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. So when we're going to talk about the firewall, We can talk about the firewall, we can talk about the endpoint, we can talk about IPS, we can talk about all the capabilities set to that both at a C suite executive level as well as people who actually have will run stuff at the end of the day, so it's working well.
Thank you.
Our next question comes from Andrew is now
open for questions.
Okay. Good afternoon. I think last quarter you had about 3,000 Wild Player paying customers. Is just curious to know what that changed to this quarter and whether Traps could be driving some of that demand for wildfire? And I just have a quick follow-up.
Sure, Andrew. We are just shy of about 4 paying customers, so a great quarter for us and customer addition on paid wildfire. I think it's Traps has not been in the market long is not enough to be influencing wildfire sales, probably the opposite as there are some of the deals that we saw around Traps in the quarter, but those two things work in conjunction should help
Okay. And then can you just talk about
whether Wildfire is predominantly having success when the customers are already a Palo Alto 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 found that if you're an existing Palo Alto Networks customer not yet using wildfire, the idea that you can do real time and malware prevention for known threats and then very, very fast detection and downstream kill chain impacts for malware that is totally set, so you should use wildfire. In addition to that, we go into new opportunities and nobody they're not using our technology at all yet. We very much talk to the platform and the prevention capabilities of the platform. And 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 is a first purchase because they want that advanced persistent threat protection right upfront.
Thanks. Thank you.
Will hear next from Aaron Schwartz with Macquarie.
Good afternoon. Thank you. On the is the target operating margins. I know you just mentioned and you 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 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
There are definitely 2 things at play there, 2 of which you just said. The first is, we are is continuing to build out our channel infrastructure. We have a great partner ecosystem. And as we invest in the channel, train the channel, in the model. We will be getting more revenue growth by virtue of having more channel partners out there.
We've always described is our sales model is a high touch indirect fulfillment type model. So 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. So what we've done in the past, under Mark Anderson's leadership is we've done account segmentation with looking at Global 2,000 accounts and major accounts. And in those instances, we have very nice high touch direct sales folks, sometimes working in concert with the channel partners as well 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.
And 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 installed base, those repeat sales that happen come at a lower cost of sale to the company. So 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 and
is. Good evening and thank you for taking my questions. A question for Stefan. Your R and D was 11.9% in Q1 and 12.3% in is fiscal year 2014 with or below your midterm target of 13% to 15%. Could you give some insight on operates in service business that we can expect to continue?
Thanks.
Well, for R and D, we keep the filter very tight around the folks we're bringing to the company and we are committed to making the best investments that we can. And our commitment to innovation within R and D has translated very well to 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, is 14% -ish. So there's going
to be some
lumpiness as we get there. Additionally, on R and D, we're starting to really build out the Crafts team in Tel Aviv that was a product of our Cyvera acquisition. So we are going to be seeing more investments in that business as well. So I can't really comment on the specific near term, but we feel good about our target model and we feel like to adequately Increasing attach rates to the subscriptions and remember subscriptions are software type gross margins. So 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 like early days of getting some scale in that group. And you can imagine with the amount the sheer number of customers we've acquired, we've been adding well over 1,000 customers
Our next question will come from Eric Suppiger with JMP Securities.
Yes, good afternoon. Congratulations. Thanks, Kurt. On Traps, I was wondering, can you give us a sense for how that might scale and maybe give us a comes relative to wildfire. You've talked about that market size as being significantly bigger, but I think you have a different sales is a model for that.
So you've seen you started to see the elements there. When could we see Traps maybe start to exceed The customer base that you have for wildfire.
Yes, sure. So a couple of thoughts around that. The first is that By having Traps in the 1st place and entering into the endpoint security market, the addition to the addressable market opportunity is is anywhere between $4,000,000,000 to $5,000,000,000 depending on news numbers you look at. So the endpoint security market is a larger market than what we've seen folks conference who've tried to triangulate on this the market called STAP where wildfires specifically may fall into which I've seen anywhere from $1,000,000,000 to 2,000,000,000 as far as what the market looks like is in terms of size. Given that, we like that market a lot.
And 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 is a very, very fast turnaround for unknown threats, both at the network and the enterprise. So we're thinking about those two is being recorded. As far as the what we expect to see from Traps, we like the early interest in the market. We like We think given the subscription model and the time we'll take the ramp of sales and a few other things that we'll see meaningful revenue contribution in fiscal 2016 and our sales building throughout the back half of fiscal 2015.
But we're very excited about this opportunity.
We'll take
the next question from Michael Turits with Raymond James.
Hey, guys. Good morning, Wildfire and Traps. Thanks for taking the question.
1st of all, in each
of those with each of those two products, who are you specifically who are you going up against in deals with each
So on the wildfire situation, it's when people think about that, they usually think about advanced persistent And there's some folks who would position themselves in the market as more comprehensive so that we all the standard network competitors we've seen Cisco, Juniper, Checkpoint, who have offerings in that space as well. So that's more of And we see, as far as the standalone player there will be firing.
And then what about
on Traps?
Yes, I'm sorry. I'm sorry, I'm sorry. On Traps, the The big players in that market are the legacy folks in NASDAQ Trend and McAfee. And 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 Nextu as complement to some of those legacy guys is the first step.
So we're competing in both cases, legacy, but probably today more and more on the next gen guys, who are competing for the is based on the endpoint to do something new.
Our next question will come from Jeff Kvaal with Northland.
Yes. Thank you. I have two questions and Stefan they may both be for you actually. I'm wondering if you could comment on 1, the linearity in the quarter, it looks like it was great. Could you talk about why linearity is improving?
And should we expect it to revert to, let's say, last year's level at some point? And then secondarily, Stefan, if you wouldn't mind, Could you tell us more about what was in the consulting element of the G and A uptick and particularly if it's going to be recurring? Thanks.
All right. So, 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 and the close rates have been very robust. So we're able to close deals earlier because of the technological differentiation and the power of the platform that we have is in addition to great sales execution. So, we've had the differentiation that we've always had, but now we have more feet on the street, more firepower and 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, but certainly in our fiscal Q2, one of the interesting things about a company like that has a quarter end in January is December typically is a strong month because of calendar year on budget flush. So we'd is expected to do a very good portion of our business through month 2. And 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. This in Q1 we had some come back on.
And 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. And then also we have 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. So So think about finance and accounting projects as well in order to get more future leverage. So there's a little bit of quarterly perturbations around projects rolling off in 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% to 6% for G and A.
So directionally over time it should come down, but there will be quarterly perturbations.
And ladies and gentlemen, that does conclude our question and answer session. I'll now turn the call back over to Mark McLaughlin for and closing comments.
Great. Thanks everybody for being on the call this afternoon. We had a great start to the year and we're really energized with the opportunity we see as we move into fiscal 'fifteen 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 Palatinetworks' team for all their hard work and support for all of our customers and partners as we continues our march to be the leading enterprise security provider in the world, and I wish everyone a happy and healthy Thanksgiving holiday.
Thanks for being with us.