Proofpoint, Inc.
Q2 2020 Earnings Call Transcript

Published: 30 Jul 2020

[Operator:]

Good day, ladies and gentlemen, and welcome to the Proofpoint Second Quarter 2020 Earnings Results Conference Call. This call is being recorded. At this time, I would like to hand the conference over to Mr. Jason Starr, Vice President, Investor Relations. Please go ahead.

[Jason Starr:]

Thanks, Lisa. Good afternoon, and welcome to Proofpoint's second quarter 2020 earnings call. Today we'll be discussing our results for the second quarter, detailed in the press release that we issued after the market close this afternoon, a copy of which is available on the Investor Relations section of our website. Joining me on the call are Gary Steele, Proofpoint's Chief Executive Officer and Chairman of the Board; and Paul Auvil, Proofpoint's Chief Financial Officer. During the course of this call, we will make forward-looking statements regarding future events and future financial performance of the company, which are subject to material risks and uncertainties that could cause actual results to differ materially. Of note, we believe that the COVID-19 crisis creates additional complexity when it comes to providing a forward-looking view of the business and we are providing our guidance on a good faith basis for recent SEC recommendations. We caution you to consider the important risk factors contained in the press release and on this conference call. These risk factors are also more fully detailed under the caption Risk Factors in Proofpoint's filings with the SEC including our most recent Form 10-Q. These forward-looking statements are based on assumptions that we believe to be reasonable as of today's date, July 30, 2020. We undertake no obligation to update these statements as a result of new information or future events. Also it is Proofpoint's policy to neither reiterate nor adjust the financial guidance provided on today's call unless it is done through a public disclosure such as a press release or through the filing of a Form 8-K. We will present both GAAP and non-GAAP financial measures on today's call. These non-GAAP measures exclude a number of items as set forth in our release. These non-GAAP measures are not intended to be considered in isolation from, a substitute for or superior to our GAAP results and we encourage you to consider all measures when analyzing Proofpoint's performance. A reconciliation of GAAP to non-GAAP measures and a list of the reasons why the company uses these non-GAAP measures are included in today's press release. Finally in addition to reading our press releases and SEC filings, we encourage investors to also monitor the Investors section of our website at investors.proofpoint.com as we routinely post investor-oriented information such as news and events, financial filings, webcasts, presentations and other relevant materials to it.

[Gary Steele:]

Thanks, Jason. I'd like to thank everyone for joining us on the call today. We are very pleased with our second quarter results, which came in above our expectations on all metrics and we are excited to raise guidance for the year as Paul will detail shortly. The current work-from-home environment mandates and our unique visibility into an increasingly active threat landscape continue to highlight the importance of Proofpoint's people-centric security and compliance services. Overall demand for our services was quite strong in the quarter with continued momentum in our e-mail security offerings as well as strong performance from emerging services like our Email Fraud Defense or EFD Cloud App Security Broker or CASB, Security Awareness Training or PSAT and Insider Threat Management or ITM solutions. We were also pleased to maintain our ARR renewal rate at over 90%. The competitive environment remains favorable and our people-centric approach to cybersecurity and compliance is resonating with our customers and prospects alike as evidenced by our continued high win rates, robust demand for our emerging products and the ongoing traction with our product bundles. During the COVID-19 crisis, our top priority remains the health and safety of our employees, while maintaining our world-class operational readiness to continue to support and protect our customers. I'm pleased to report that our overall productivity levels remain high and our overall engagement with our customer base has never been better. I'd like to thank our teams around the world for their continued dedication and hard work throughout this challenging time. As enterprises around the world remain in a work-from-home environment and employees often beyond the reach of traditional on-premise security controls many security teams are increasingly realizing that the traditional enterprise perimeter has effectively shifted from the network to their individual employees. In other words, people not infrastructure are the new perimeter making Proofpoint's unique people-centric approach to cybersecurity and compliance even more relevant for security team's efforts to protect their end users and safeguard the sensitive data they interact with. While e-mail remains the primary method of attack in the last 12 months, we've seen them more aggressively -- we see them move more aggressively towards account takeovers including e-mail account compromise and also spook e-mail impersonation also known as business e-mail compromise as the basis for launching and hosting sophisticated attacks.

[Paul Auvil:]

Thanks, Gary. We are quite pleased with our operating results this quarter, which beat our updated guidance on all metrics. Revenue totaled $258 million, up 21% year-over-year and above our guidance range of $251 million to $255 million. Note that our revenue for the quarter benefited from approximately $3 million of accelerated revenue under ASC 606, it was not expected at the time that we provided guidance in May, driven by the sale of solutions that were deployed on-premises by our customers and hence triggering the requirement to recognize the majority of the subscription revenue at the time of sale. That said, all of this business was based on our standard subscription contract structure and as such, will renew in future periods, similar to our other recurring revenue business. We believe that these results are particularly compelling when considering that approximately 98% of this revenue is recurring, which sets us apart as a leader on this metric across all publicly traded SaaS companies. While we no longer provide guidance on billings, our Q2 result of $250 million was solid, particularly given the headwinds we continue to face from sectors more significantly impacted by the current crisis, such as retail, travel, energy and parts of the healthcare industry, which collectively represent just over 20% of our balance. In particular, I would like to highlight that we were pleased that our ARR renewal rate remained above 90% during the quarter. A very good result, given that a number of our renewals were impacted by layoffs and furloughs across our customer base, which ultimately serve to lower the ARR value of those particular renewals. As we look to the second half of 2020, as discussed during our call of May, we continue to see the potential for this metric to dip modestly below 90% in future quarters due to impacts related to COVID. As we stated last quarter, we expect that the overall employment rates at these impacted customers will improve over time, similar to the recovery from the Great Recession back in 2009, enabling an eventual return to growth for these customers as the crisis eventually abates. As a final point regarding billings, I would like to note that while we saw a modest increase in duration during the quarter, when compared to Q1, we expect this will likely remain under pressure for the remainder of the year, as companies try to preserve cash, given the current economic environment around the world. Turning to expenses and profitability for the second quarter. On a non-GAAP basis, our total gross margin was 80%, above our expectations driven primarily by our strong revenue performance. This gross margin performance puts us in the top quartile of all publicly traded SaaS companies and stands as a testament to the efficiency with which we operate our global cloud operations. During the second quarter, total non-GAAP operating expenses increased 18% over the prior year period to $167 million, representing 64% of total revenue. Moving down the income statement. On a GAAP basis, we recorded a net loss for the second quarter totaling $23 million or $0.39 per share based on 57 million outstanding shares. This result included a non-cash gain of $14 million resulting from the reversal of stock compensation expense related to performance-based stock awards. These amounts have been accrued in prior periods based on progress towards the target metrics associated with these performance grants. But based on the impact of the crisis as reflected in our updated guidance we no longer believe that likely that these targets will be achieved and hence these accruals have been reversed accordingly. We reported non-GAAP net income of $33 million, well above our guidance range of $24 million to $26 million. Moving on to EPS. Non-GAAP earnings per share for the quarter was $0.51 per fully diluted share above our guidance range of $0.38 to $0.41 based on 65 million shares. The EPS calculation applies the if-converted method to our convertible notes due in 2024 and as such assumes the conversion of approximately six million shares and adds back just under $0.5 million in cash interest associated with this debt instrument. In terms of cash flow, we generated $31 million in operating cash flow which included a $4 million reimbursement for tenant improvements associated with our corporate headquarters project. We invested $12 million in capital expenditures of which $7 million was associated with our new headquarters resulting in free cash flow for the quarter of $19 million, well above the high end of our guidance range of breakeven to $10 million. This upside was principally driven by the strong billings linearity during the second quarter which helped to accelerate some cash collections into Q2 that otherwise would have been collected in Q3. So with that let's move on to guidance for 2020. Recall that back in May of this year, as a result of the COVID-19 pandemic, we opted to take a very different approach to our guidance. As such instead of providing our traditional guidance range for the year, we chose to outline two very different scenarios based on potential directions that the pandemic could take and how that might impact our business. In the first scenario where the COVID-19 crisis peaked during the second quarter with a gradual return to normalcy over the rest of the year, we modeled revenues of $1.03 billion absorbing the impact of a 5% reduction in our new add-on business as compared to 2019. In the second scenario where the pandemic continued to meaningfully impact the global economy over the entire year, we model revenues of $1.005 billion absorbing the impact of a 40% reduction potentially in our new and add-on business as compared to the prior year. As Gary already noted, our business remains well-positioned despite the continued uncertainty regarding the recovery from the COVID-19 pandemic and the resulting impact to the global economy. While the overall operating environment remains challenging compared to normative standards and the current crisis has yet to stabilize in many of our markets around the world given our stronger-than-expected Q2 operating results. Our solid pipeline and our good linearity here in July we no longer view the second more dire scenario is likely. And as such we are suspending that aspect of our outlook for the year. We are also pleased to be able to raise the top end of our guidance range on all metrics with a return to a more traditional approach to guidance for the year though we are being particularly thoughtful given the current environment in how we provide this guidance. In terms of revenue guidance for 2020, we are increasing our range to $1.035 billion to $1.037 billion with a midpoint that implies an annual growth rate of approximately 17% for the year. We expect full year 2020 non-GAAP gross margins to be approximately 80% modestly improved when compared to our prior guidance of 79%. In terms of non-GAAP net income, we are raising our guidance to a range of $106 million to $110 million from our prior range of $91 million to $101 million. This new range translates to approximately $1.64 to $1.70 per share using 66 million shares outstanding. In terms of tax rate under CNDI for 2020, we expect a rate of approximately 17%. This guidance also assumes depreciation for the year of roughly $37 million to $39 million and $4 million in net cash interest income. In terms of cash flow for the year, we are raising our free cash flow estimate to an updated range of $130 million to $140 million. This guidance assumes capital spending of approximately $75 million down from our prior expectations of $95 million. This is comprised of approximately $40 million in capital spending associated with the build-out of our new headquarters and partially offset by approximately $16 million in the form of tenant allowance reimbursements that we have negotiated with the landlord. And as a reminder this reimbursement runs through the operating cash line the cash flow statement as opposed to netting against capital expense. This cash flow guidance for the year also includes the tax payment for the transfer of intellectual property associated with our acquisition of ObserveIT which we now estimate to be no more than $15 million, down from our prior estimate of $20 million. Now, let's discuss our financial outlook specifically for the third quarter. We expect revenue to range between $260 million and $262 million, reflecting 15% growth at the midpoint. I would like to note that this outlook when viewed in conjunction with our guidance for the full year implies Q4 revenue of approximately $267 million for the fourth quarter and hence a year-over-year growth rate of 10% for the final quarter of the year. As I noted earlier, for 2020, we are currently modeling an actual decline in new and add-on business of roughly 5% as compared to the prior year as precipitated by the COVID-19 crisis and its general impact on the global economy and more specifically, the relatively stifling effect it has had on the roughly 20% of our customers operating in highly impacted industries in particular. This decline in new and add-on business by definition creates some pressure on relative revenue growth for the year. Assuming an improved operating environment in 2021 where our new and add-on business returns to growth year-over-year, we would expect that the fourth quarter of 2020 will mark a low point for our revenue growth with a reacceleration playing out across the arc of 2021. For third quarter, we expect non-GAAP gross margin to be roughly 80%. We expect non-GAAP net income to be $24 million to $26 million or $0.37 to $0.40 per share. This assumes depreciation of approximately $10 million and less than $1 million in net cash interest income and a share count of 66 million fully diluted shares outstanding. We expect free cash flow to be $16 million to $21 million for the third quarter which includes capital expenditures of roughly $25 million of which $16 million is associated with spending on the new headquarters. This being partially offset by $10 million in expected leasehold improvement reimbursement that will flow through the operating cash flow line. Note that given some of the construction delays associated with the shelter-in-place orders here in California that occurred earlier in the year a larger percentage of CapEx for this project approximately $16 million in total will fall into the fourth quarter. Though note that our reimbursement allowance is expected to be fully used during the third quarter. And as a result, the final phase of spending on the new headquarters will impact Q4 free cash flow by a full $16 million which is a significant step-up as compared to the $6 million of net impact during Q3. Our Q3 free cash flow guidance also includes the aforementioned cash payment associated with the ObserveIT intellectual property transfer. As a final note on guidance, while we have been pleased to be able to continue to provide our quarterly and full year guidance despite the crisis, I would like to note that we do not expect to provide an initial outlook for the fiscal year 2021 on our third quarter earnings call later this year given the pandemic and its impact on our ability measured over the somewhat longer time horizons have visibility into the business. In conclusion, despite a challenging operating environment, we continue to execute well delivering strong top and bottom-line results in the second quarter and we believe that we remain well positioned to drive disciplined growth with increasing free cash flow margins in the years ahead, built on our proven ability to defend enterprises against today's advanced security and compliance threats. We are well-positioned to weather the COVID-19 crisis over the coming quarters with a 98% or better portion of our revenues coming from recurring business, a cash balance of nearly $1 billion, healthy free cash flow generation, strong secular drivers, a favorable competitive environment, and our broad people-centric product set. We continue our targeted investments with discipline and we expect fees to help us emerge from this uncertain period stronger than ever with the goal of returning to our rule of 40 operating paradigm targeting a score of 40 better as the crisis eventually resolves and we return to a more normal operating environment at some point in the future. I will now turn it over to Jason to review our upcoming Investor Relations schedule for the quarter before taking questions from the sell-side.

[Jason Starr:]

Thanks Paul. Before I get into that just wanted to mention I've heard that the webcast service provider for today's call had an issue with multiple companies' calls today. So, from a transparency standpoint, we're going to try to post the transcript or the language from the script to the investor website as soon as we can just as a quick heads up for everybody. From a marketing standpoint in the third quarter Proofpoint's management team will be presenting at D.A. Davidson's Software and Internet Virtual Conference on September 9th and Citi's Global Technology Conference on September 10. A webcast of these presentations will be made available on the Investor Relations page at investors.proofpoint.com and hopefully today's call will be too. We will now take questions from our sell-side analysts. Thank you for taking the time to join us on our call today. And with that we'll be happy to take your questions now. Lisa?

[Operator:]

Thank you, sir. We'll go first to Rob Owens, Piper Sandler.

[Rob Owens:]

Good afternoon guys. It's a good thing I can ask multipart question. So Gary, I wanted to touch a little bit on the enterprise DLP products and effectively what that brings. I know that that's been kind of a legacy market where some historical vendors of Symantec is dominated there. And does that go hand in glove with email security? Or is it honestly viewed separately? And as you're engaging with some of those Symantec customers, is this a type of solution that can potentially shake more of them through? Thanks.

[Gary Steele:]

Yes. We're very excited about the opportunity around enterprise DLP and helping customers think about this differently taking a people-centric approach where we believe we can fundamentally deliver a whole different category of time to value in terms of implementation and that's been one of the historical issues. Where we find that there's incredible leverage is many customers already use us for single vector DLP. So e-mail DLP is something that we've always had very good success on. But we're seeing with the momentum broadly in our CASB solution and the early indications that are super positive on ObserveIT. We believe that bringing all this together into a complete enterprise solution really positions us uniquely in the market. It's big and I think that market is being underserved and I think it creates a tremendous opportunity for us.

[Rob Owens:]

Great. Thank you.

[Operator:]

Next up is Jonathan Ruykhaver, Baird.

[Jonathan Ruykhaver:]

Yeah. Good afternoon guys. Regarding the solution bundles, can you just talk about your expectations? You mentioned potentially larger enterprise adoption around P2 and P3 as we move into the second half. So I'm just wondering in particular, what you are expecting? And any color on what's driving that expected adoption from a modular use-case perspective would be helpful?

[Gary Steele:]

Yes. I mean I would say -- hey, Jonathan good to hear you. I would say first and foremost, there's a definite focus on vendor consolidation. So people looking for a way to operate with fewer vendors, see if they can get some savings, particularly from internal efficiencies associated with operating with fewer vendors, fewer people having to manage different solutions. But the other side of this of course is that when you look at Proofpoint's broader people-centric security and compliance framework there are incredible benefits from having all these capabilities delivered by a single vendor in this case Proofpoint and having a single pane of glass to manage and essentially remediate compliance issues, but also see the threat landscape broadly beyond just the aperture of e-mail, but looking broadly across all of these different cloud properties where you're being attacked. And understand who your VIPs and your very intact people are being able to manage and be responsive to that and understand who the threat actors are and what they're after. So it's a combination of all these things that are very much playing in a favorable way toward our opportunities to sell these larger P2 and P3 bundles.

[Paul Auvil:]

And I think it became much more pronounced in the COVID where CSOs are really thinking about who their strategic partners are, how many vendors they really want to deal with and that's been a key catalyst for us to help drive bundle sales.

[Jonathan Ruykhaver:]

Okay. Helpful. Thanks guys.

[Operator:]

We'll take the next question today from Andrew Nowinski D.A. Davidson.

[Andrew Nowinski:]

Thank you and congrats on a great quarter. So I just wanted to ask on our e-mail tracker that we published, we picked up on more wins for Proofpoint this quarter than maybe we've seen in the past. So I'm wondering if you could provide any color on the rate of new local acquisition this quarter relative to last quarter and perhaps how it compared to your internal expectation? Thanks.

[Gary Steele:]

I'll start and Paul maybe has a comment. One of the things that we saw was -- and we mentioned this in the prepared remarks that our core protection and TAP business had a really good quarter. And we've referenced some very large deals with large financial services firm. That was a customer actually coming off of Symantec. And so I think broadly speaking, we see tailwind from -- in our core simply because we're seeing -- this e-mail being such a high priority and people are rethinking what they've traditionally done. So I think we've been well positioned and that's why – I think that's why it's showing up the way it is in your tracker.

[Paul Auvil:]

Yes. I don't have anything to add. I agree with that.

[Andrew Nowinski:]

Thank you very much, guys. Keep up the good work.

[Operator:]

Walter Pritchard of Citi has the next question.

[Walter Pritchard:]

Hi. Wondering if you could give us a little bit more color around. You're seeing some consolidation into bundles which makes sense given the environment. What areas are you seeing the most benefit there especially as you talk P2 and P3? And what areas are – other areas of the market that are kind of stand-alone that are seeing a consolidation into that? Thanks.

[Gary Steele:]

Yes. Walter I would say, one of the primary areas would CASB. Yes that market is very fluid requirements have moved around and we've made significant investments. And so it just is a natural part to think about – it's a natural component to include in that broader bundle.

[Walter Pritchard:]

Got it. Any others?

[Gary Steele:]

I would highlight that as the primary one. And then obviously in the lower bundles you have our Security Awareness Training that has been a natural adder and all the integration work that we've done there make it very compelling to buy it with the rest of the solution.

[Walter Pritchard:]

Thank you.

[Operator:]

Next up is Jonathan Ho, William Blair.

[Jonathan Ho:]

Hi, good afternoon. I guess, one thing I wanted to understand a little bit better was sort of the dynamic that you're seeing around some of the net expansion and some of the headwinds there, particularly given headcounts and do you see that potentially bouncing back if we see recovery? Just helping us understand maybe the pace of that and what those headwinds look like in the back half of the year might be helpful. Thanks.

[A – Paul Auvil:]

Yes. I think Jonathan, I'll start and then Gary probably has a few things to add. I would say that within our installed base, the highly impacted industries, definitely you've got the furloughs and the layoffs that are then impacting our renewals accordingly. Gary and I were both here leading the company back during a great recession so we know what this pattern looks like. Most of these businesses will eventually recover their former level of output and success. It just takes some time and as they do, they'll hire folks back and then we'll move our subscription levels back up to those original levels of employment in the subscription values accordingly. So with all that said, with regards to specifically the second half of the year, it's a little hard to tell but I would say we all have sort of our own anecdotal experience here. But as I look at travel-related services for example, it doesn't feel like there's going to be much of a recovery for those industries in the second half of the year. But let's all hope that sometimes as we work our way through 2021, there'll be a better recovery. Some parts of retail may be a little more successful here in the second half of the year depending on how things come together. Healthcare was already starting to see a bit of a rebound but now with kind of resumed lockdown, a lot of elective surgeries been put on hold. But let's hope with the new lockdowns that you've seen in different states they seem to be getting the better of case count increases. Maybe we get back to an increase in elective activity. Again maybe mid to late Q3, which then brings headcount back into those healthcare providers. So I think it's going to depend industry by industry. But the good news is it then kind of bakes in some uplift in terms of new and add-on recurring if you will that will pick up over the next I would guess probably 12 to 18 months as those companies all come back online to their former levels of employment.

[Gary Steele:]

Yes. And the only thing I'd add to that is what I feel really good about is these companies that had maybe done temporary reductions in headcount, we do believe they come back, because these are large enterprise companies that have long-term sustainability. These are not companies in the SMB world that may not ever come back. So we feel very good given the segments that we serve that we will see a rebound. And as Paul said, it will be naturally sort of basically be built into ARR uplift over time versus a company that just fundamentally are going away, which I think people will see in the SMB world.

[Jonathan Ho:]

Thank you.

[Operator:]

Next up from Wells Fargo is Phil Winslow.

[Richard Hilliker:]

Hey, team. This is Rich Hilliker on for Phil. Thanks for taking my question. We talked a little bit earlier in your prepared remarks and in the Q&A about vendor consolidation and some new logo acquisition. I was wondering if we can double-click there a little bit on your competitive win rates. Specifically, if you can against some recently acquired vendors. Thanks.

[Gary Steele:]

When you said recently acquired vendors, can you elaborate a little bit more? I want to make sure we're answering your question.

[Paul Auvil:]

You're referring to Symantec?

[Richard Hilliker:]

Yes, exactly. Yes.

[Gary Steele:]

Yes. No our win rates have been extremely high. We've referenced that in our prepared remarks. And our win rates I would say were steady to increasing frankly over the course of Q2 and so we feel very good about our positioning and our market momentum. And I think frankly one of the things that we saw when we referenced a little bit of this in the prepared remarks as well in the COVID world, we've seen that threat landscape move. And if you didn't demonstrate agility you have a hard time keeping up with the threat environment. And I think our technical team did a really good job of ensuring that our customers were well protected. And I can't say that necessarily across the other -- the competitors that we saw in the market.

[Richard Hilliker:]

Great. Thanks guys and congrats.

[Operator:]

Brian Essex of Goldman Sachs is next.

[Brian Essex:]

Hi, good afternoon. Thank you very much for taking the question. I was wondering if maybe you could comment a little bit on contract duration. Is there any way to quantify the impact of that in the quarter? And then with regard to contracts that come up for renewal on a more frequent basis, have you been able to quantify any potential lift in attach rates as that's an opportunity obviously for upsell when they count renewal on a more frequent basis?

[Gary Steele:]

Yes. It's hard to quantify. We haven't put specific numbers out there, but obviously contraction and duration does put a little bit of a headwind into the billings number. And hence we were pleased with the $250 million we recorded as a result of that. Clearly with a somewhat longer gration, you would have seen a higher billings number by definition, but it's hard to put an exact number on what that otherwise might have looked like. But to your point, we've always been advocates for shorter duration go back and look at any of our transcripts for the last eight years. Our compensation plan's actually focus on the sales team doing shorter not longer duration contracts. And the reason for that is twofold. First, on a shorter duration contract you get less of a discount or said differently if you do a three-year prepaid contract, we do give you a typically 10% discount which is kind of the industry standard. I'd rather not give you that 10% discount I'd rather have it be a one-year deal because we generate more revenue profitability, net income and ultimately cash flow by renewing the same customer year after year on those single-year terms. And as well to your point, those shorter duration contracts just create one more touch point where you can go in and drive an add-on sale whether it's upgrading the customer to one of our new or larger bundles or just simply selling a third or fourth or fifth product. And so, we like moving to shorter duration. There obviously is some near-term impact to billings but in the long run it actually creates a more significant cash flow stream for shareholders over time.

[Brian Essex:]

That makes a lot sense. Thanks very much.

[Gary Steele:]

Thanks.

[Operator:]

The next questioner is Alex Henderson, Needham.

[Alex Henderson:]

Thank you, very much. I was hoping you could give us a little bit of more granularity around the personnel training security training side of the business. What kind of scale has it gotten up to? And what kind of growth rate are you seeing within that particular segment of your business? Thanks.

[Paul Auvil:]

Yes. I'll start and Gary may want to chime in. We've seen really good success with our Security Awareness Training product. As you probably are familiar, we picked it up through an acquisition back in 2018 of a company called Wombat. We've now rebranded it to Proofpoint Security Awareness Training but it continues consistently each quarter to be one of the top contributors to new and add-on recurring revenue that we bring into the company each quarter. We were really pleased last quarter. We closed a small acquisition in Europe called The Defence Works which added some additional content and capability to the platform. So it's nearly where we continue to invest both organically with a large team of developers primarily in the Pittsburgh area as well as the most recent acquisition and who knows there may be another acquisition or two at some point down the road. We think it's a really important area it's a critical part of how you build out your overall strategy for defending the enterprise, educating your employees and making sure they understand what threats look like and know-how to identify them is an important part of the overall defense paradigm that all companies need to adopt large or small. So with all that said I think, we've been pleased with the performance. The business has grown a reasonable scale. We don't break it out separately as a specific division with externally reported revenues. And part of which is it's frequently sold as a bundle with other products naturally as you can imagine. If you're buying our protection and advanced threat capability buying our Security Awareness Training is a natural third piece of that equation if you will. But I would say that generally we see that our customers are really pleased with the capability and it fits very nicely together in our portfolio.

[Gary Steele:]

Yes. I would just add that strategically, we feel like we're well differentiated from the independent companies in this sector and our differentiation has come from the fact that we've done some very interesting integration bringing together our core with the Pishing Simulation and Security Awareness Training. Then there's a lot of very demonstrable benefits of having these two products together. And so we think we're really well positioned relative to independent players in this particular market.

[Alex Henderson:]

Thank you very much. Its very helpful.

[Operator:]

Next we'll go to Sarah Hindlian-Bowler Macquarie.

[Sarah Hindlian-Bowler:]

Great. Thank you so much Gary and Paul. I appreciate it. Paul can you drill down a little bit more on the duration comments you were just going over. I know they were up this quarter which is a bit of a surprise to me, but you're guiding for them to continue to come down. And then Gary just a follow-up for you on international. What is it that you guys think you need to do there to really move the needle?

[Paul Auvil:]

Yes. So I'll start Sarah. I would say that the fact that we had a modest uptick in duration this quarter was a surprise to me as well. But as I look at it in retrospect the one thing that's clear is, it was primarily companies in the financial services space where we were seeing this. And I think as you can imagine in the current interest rate environment and the degree to which the Fed's basically shoveling money into the vaults of the banks and daring them to do something useful with it. One of the useful things to do is to get your 10% discount and do a 3-year prepay with Proofpoint. And so as a result financial services in particular which as you know is one of the important segments for Proofpoint proved to have somewhat higher duration than I ever would have anticipated going into the quarter. With that said it's hard to say exactly what behaviors will be week-to-week month-to-month quarter-to-quarter. And so for modeling purposes for now we're assuming that the duration for the second half of the year is more consistent with what we saw in Q1. And then, we'll see maybe we'll be positively surprised and see an uptick in third and fourth quarter. But for now I just want to set expectations that at a lower level until we see how third quarter plays out.

[Gary Steele:]

And Sarah with respect to international we were very pleased with the results. So 28% growth in the quarter we were very happy with and we feel like that momentum carries through the second half. The one thing that was interesting in Q2 we're seeing broader participation out of our APAC team which we think could be -- as that business begins to grow we think that could be a catalyst over the next several years as well. So we feel really good about international. We feel like we're on the right track.

[Sarah Hindlian-Bowler:]

Awesome guys. Thank you very much appreciate it.

[Operator:]

Up next is Gray Powell, BTIG.

[Gray Powell:]

Okay, great. Thanks for taking the question. Maybe just a follow-up on Symantec, so it sounds like the pace of wins against Symantec is picking up. I just want to make absolutely certain that I'm hearing that correctly. And then when a customer does switch over, what's sort of like a typical price uplift that you see? Like if they're spending $100 per user -- or they spending $100 with Symantec how much did they end up spending with Proofpoint? Or what sort of does the product uplift?

[Gary Steele:]

Yes. Great question. No we've definitely seen an uptick in Symantec. We feel really good about the kinds of customers we're winning. We've referenced to Fortune 500 companies in the script. But obviously, we had very good momentum in sort of across the broad customer base. When someone switches, it's very much like what happened in the McAfee transition, where we see the core email security dollars transferring sort of dollar for dollar and then our sales team will work hard to put them into a bundle which will ultimately get us two or three or 4x what they had traditionally been paying. So how do we do that? Well we're trying to move them into a bundle like a P1 bundle or even a P2 bundle. So we're including things like Security Awareness Training that bring the price up and adding other products.

[Gray Powell:]

Got, actually very helpful. Thank you very much.

[Operator:]

Next up is Erik Suppiger JMP Securities.

[Erik Suppiger:]

First off, I'm just curious can you talk a little bit about whether you've seen any acceleration in business coming from Office 365? Do you think that just the pandemic has accelerated any business to them and therefore creating additional opportunities for you? And then secondly have you -- do you anticipate any efficiencies realized during the pandemic that you can continue once pandemic passes which might create upside to long-term margin targets?

[Gary Steele:]

I'll start and then Paul probably has a couple of comments. So with respect to Office 365 we've just seen continued momentum of movement to Office 365 and that's been a contributor of growth for us pre-pandemic, during pandemic and I think it will be with us for a long time as more and more customers finally get to the cloud. I do believe that COVID has put more pressure on people to rethink what their cloud strategy is and I think there will be continued momentum in that direction. We've also seen as we noted this in the script there are a number of things that I think are -- raise the visibility and the importance of our capabilities in a work-from-home environment. I think with users sitting at home it's everything you -- the customers know that they need to protect their employees with respect to a good e-mail solution. So I think that's been a positive. We've also seen as we noted more interest in our Insider Threat Management solution because again you have a whole set of users at home, off the corporate network, companies want to understand what those users are doing, how they're managing data. And so we've seen uptick in interest. And frankly, I think, even as COVID subsides, I think, we continue to see this momentum because people are seeing the value of what we can deliver and the importance it is in the overall security posture. So I don't anticipate a slowdown in demand. I think we're just raising the visibility of the kind of work that we do for customers during this period. Would you add any to that Paul?

[Paul Auvil:]

No. I think just to the other part of the question which is related to other things that we are doing in terms of how we're operating the business today in the middle of the pandemic that as we emerge from the pandemic will it change the operating profile of how we run as a business. I would say that in our case, I don't believe so. Obviously, pretty much everyone is working from home at this stage. I expect that to continue for the foreseeable future. But with that said, we very much believe in the power of having people working together in offices. And so while the productivity of the teams has remained remarkably high over this stretch where people have been working from home. We very much look forward to bringing everyone back into the office when it's safe and get the power of heading teams working together and just the benefits of the camaraderie of people working under the same roof as well while travel budgets obviously, are roughly running at zero right now. Unless we see a behavior change in our customers themselves where for whatever reason they've decided that they no longer want to meet with our executives or salespeople and we'll continue to just make decisions via Zoom and virtual meetings. Unless that were to happen, I think we'll be back to our normal travel activities when we come back around. Again I suspect that's still a ways out. But that's what I see. So again, I don't see any changes to our business model in the long-term as a result of this. But obviously there have been some short-term impacts to our spending profile.

[Erik Suppiger:]

Very good. Thank you.

[Operator:]

We'll now go to Matt Hedberg, RBC Capital Markets.

[Matt Hedberg:]

Good morning, guys. Thanks for taking my questions. Paul you noted good linearity, which was really good to hear. I'm wondering if you can expand on that a bit in terms of the pace of business. And also comment on the pipeline build through this uncertainty and I assume it's probably the pipeline it's strong, but maybe the close rate assumptions are sort of what we're all watching.

[Paul Auvil:]

Yes. I think linearity was very, very good in the second quarter and linearity so far here in Q3 has been good as well. It's hard for me to attribute specifically what that might be related to. I do think there is a heightened understanding and concern on the part of both customers and prospects about the threat environment with people working from home, the need to make sure that they are properly protected. So that obviously tips things on the margin in our favor. But I wouldn't call it a C change in buying behavior, but it probably maybe creates a little more vigilance and a little more urgency on the part of our customers on average. So with all that said, I think that the pipeline entering the quarter, I think we felt good about obviously, in the context of the guidance that we provided. We haven't changed any assumptions around close rates though. I think our close rates are kind of following our traditional pattern or at least that's what we've seen thus far in the second quarter and what we would expect to see in Q3. So it's a little bit business as usual other than of course the sales team doesn't get to go out and actually see the customers in person. So almost all of our interactions are virtual at this stage. But our solid paradigm seems to have transitioned fairly effectively to that. And again, we were really pleased with how Q2 came together and hopeful for some good results here in the second half.

[Matt Hedberg:]

Excellent. Thanks.

[Operator:]

Next up is Hamza Fodderwala, Morgan Stanley.

[Hamza Fodderwala:]

Hi, guys. Thanks for taking my question. Just had a quick one on the recent partnership that you guys made with Okta, CrowdStrike and Netskope to secure remote work. Can you give a little bit more color as to what that involves from an additional integration standpoint, as well as a go-to-market standpoint, with some of the benefits that you foresee there.

[Gary Steele:]

Yeah. We've been – we've been on this mission to do technical integrations with critical partners and we've had very good success most recently with CrowdStrike and with Okta. And so when the opportunity came along to bring together all of this in a zero trust framework it just made a ton of sense. And so again, we're leveraging the technical work that we've been doing with these vendors. And bringing then – bringing it out to the market with channel partners as well as joint marketing activities with each of these organizations. Then, we think this that broad power across these vendors give us some lift in the market.

[Hamza Fodderwala:]

Thank you.

[Operator:]

Nehal Chokshi of Northland Capital Markets is next.

[Nehal Chokshi:]

Yeah. Thank you. Paul at the beginning of your script you talked about an ASC 606 acceleration. Can you just double-click on what happened there? And then just clarify that the – forward guidance does that include a benefit from the ASC 606 acceleration?

[Paul Auvil:]

Yeah. I'm sure you're familiar for – under the new accounting standard, it's not actually new at this stage, but relatively new over the last couple of years. Even, if you have a recurring subscription business, if the product can be deployed on-premise and is in fact deployed on-premise by the customer and it doesn't require regular updates and upgrades from the vendor in order to enable that capability then you end up accelerating roughly 80% of the value of that subscription into the period of time, when that deal actually closes. And of course, when it renews a year later, you'll see that same effect again. And so because we did have some customers who chose to deploy some of the TAC on-premise unexpectedly, which is fine we don't mind what – if you want to build your own little private cloud and run it in your data center we're perfectly happy to do that. It ended up creating some more accelerated revenue in period. So while we were really pleased with the overall subscription business we closed, a larger amount of it got recognized in period than we would normally expect, because as you can imagine, if I close a 12-month contract near the end of the month of June and it's a subscription business very little of that revenue gets taken in June and ultimately then in the second quarter. But under ASC 606, even if that deal closes on the last day of June, I'll end up with 80% of it being recognized in the month of June and ultimately in the second quarter. So the result of that of course is that we had that $3 million unexpected step-up in revenues for the second quarter. And that then pulls revenue out of future period. So again, if you think of $3 million and divide it by four, it's a negative impact actually of about $750,000 a quarter to our revenues for the subsequent periods, which would be Q3 and Q4 of this year and Q1 and Q2 next year, and again our guidance reflects all of that. So 606 created a nominal benefit here in Q2, and it actually is a bit of a nominal takeaway then in the next four quarters as a result.

[Nehal Chokshi:]

Excellent. Thank you very much.

[Operator:]

Next up from Stifel is Gur Talpaz.

[Gur Talpaz:]

Okay. Great. Thanks for taking my question. Gary, can you talk about the appetite for M&A in the current environment and ultimately where you might be looking?

[Gary Steele:]

Sure. We continue to explore the M&A market looking for interesting opportunities that extend the value that we currently have with customers, where we can – basically, there finding a tight adjacency where we can create more value drive more economic value for us with customers or something that extends this current solution. And our focus really is everything that fits in that people-centric view. And so we look at all M&A opportunities through that lens. And while we had thought we would see a more significant decline in private company values we haven't seen that. And so we will continue to be, super disciplined in how we look at opportunities, and continue to explore it and see what we find. But we're going to continue to be super disciplined.

[Gur Talpaz:]

Great. Thank you.

[Operator:]

Our next question is from Taz Koujalgi, Guggenheim Partners.

[Taz Koujalgi:]

Hey, guys. Thanks for taking my question. Paul, I have a question about the new and add-on business you said that it should be down 5% for the year that's what you're expecting. Can you give some more color on what it was down for Q2 and Q1? And is your full year guide implying that the momentum improves in the macro?

[Paul Auvil:]

Yeah. I didn't break that out. So it's just – overall for the year, it's down about 5%. The timing for the quarters obviously has a little bit of an impact on revenue, but you see that reflected in the guide. So, obviously, we're hopeful that we not only deliver on that number, but with luck maybe we get that NARR number back to even from the prior year. Yes, we'll see how the second half of the year plays out. But I think with current pandemic and the fact that 20% of our installed base, a little bit more is in this highly impacted industry, where as you can imagine, we're getting the renewals albeit often at somewhat lower value, because of either furloughs or layoffs. Those customers have no dollars to spend for add-on product almost uniformly, and as well because we have sales teams that focus on those markets. There's not much in the way of new business that we're closing for new account acquisition in those impacted industries. So I'm actually quite pleased that we're able to deliver a NARR number at this level. Given the affected industries and the dynamics we see in those businesses right now.

[Taz Koujalgi:]

Got it. Thanks.

[Operator:]

We'll now go to Daniel Bartusm Bank of America.

[Daniel Bartus:]

Hey, guys. Thanks for squeezing me in here. I'm just curious how Meta Networks is doing. Gary maybe you can discuss which of your products it might integrate well with and if it has indeed been replacing existing VPNs recently. And then Paul if there's any sense you can give us for the size or growth rate that would be great too. Thank you.

[Gary Steele:]

Yes. No great question. We focused Meta on integration with a CASB solution providing interesting access capabilities and this really fits within that broader SASE framework that Gartner talks about. There's a reasonable amount of development work to do there, but we're seeing some good early interest and early demand and we feel good about how that really augments our overall CASB solution and overall competitive position.

[Paul Auvil:]

We haven't broken out any kind of stats explicitly on the revenues or things like that within the emerging cohort of products.

[Daniel Bartus:]

Got you. Thanks guys.

[Operator:]

And our last question today comes from Yi Fu Lee, Oppenheimer.

[Yi Fu Lee:]

Thank you for taking questions gents. And congrats on the sale execution in light of the pandemic. My one quick question is about alliance. Seen some great wins, because of these alliances. I was wondering Gary or Paul if you could explain how the economics split when you guys go-to-market together with other vendors? Thanks.

[Gary Steele:]

Yes. So in terms of the economics, we don't resell their products, they don't resell ours. It's very much -- the good news is we share all the same channel partners. So the channel partners will kit together the solutions and put together often a bundled quote that includes some combination of Proofpoint and the other solutions to the customer in question. And then, of course, we sell our piece to the reseller or the distributor accordingly. And so obviously, there's a lot of benefit for all of us cooperating. So if we find an opportunity where we think one or more of the other partners involved could benefit we'll bring them in, and we'll encourage the channel partner to do that as well and vice versa. So there's a lot of value in working and collaborating. And it's very similar to how the Palo Alto Networks relationship work, which is our first big foray in this area years ago. When you have a common enemy, there's a lot of power in working together arm-in-arm to go win business jointly. And so I think we're pleased with the early results we've seen from some of these newer partnerships. And I think that could potentially play a pretty meaningful role in helping to drive business for us down the road.

[Yi Fu Lee:]

Thank you for the color. And again congrats on the solid contribution.

[Gary Steele:]

Thanks.

[Operator:]

And that does conclude the question-and-answer session today. I'll hand the conference back to Gary Steele for any additional or closing remarks.

[Gary Steele:]

Great. I want to take a moment and thank everyone for joining us on the call today. We're very pleased with our Q2 results and our continued progress with our people-centric approach to cybersecurity compliance while also supporting the health and safety of our employees and customers. We believe we've remained well positioned to drive attractive returns for our shareholders, and we look forward to talking to you on our next call and to seeing many of you virtually on the conference circuit this quarter. We wish you all good health, as we press forward through this crisis. Thank you so much.

[Operator:]

And once again, ladies and gentlemen, that does conclude today's conference. Thank you all for your participation today. You may now disconnect.