Proofpoint, Inc.
Q1 2019 Earnings Call Transcript

Published: 25 Apr 2019

[Operator:]

Good day, ladies and gentlemen and welcome to the Proofpoint First Quarter 2019 Earnings Results Conference Call. Today's conference is being recorded. At this time, I'd like to turn the conference over to Jason Starr, Vice President of Investor Relations. Please go ahead.

[Jason Starr:]

Thanks, Keith. Good afternoon, and welcome to Proofpoint's first quarter 2019 earnings call. 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. Today, we'll be discussing the results announced in our press release that was issued after the market closed this afternoon, a copy of which is available on the Investor Relations section of our website. During the course of this call, we'll 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. 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-K. These forward-looking statements are based on assumptions that we believe to be reasonable as of today's date, April 25, 2019. We undertake no obligation to update these statements as a result of new information or future events. Of note, it is Proofpoint's policy to neither reiterate nor adjust the financial guidance provided on today's call, unless it is also done through a public disclosure, such as a press release or through the filing of a Form 8-K. Additionally, 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 release and SEC filings, we encourage investors to also monitor the investors section of our [e-mail] as we routinely post investor oriented information such as news and events, financial filings, webcasts, presentations and other relevant materials to it. So, with that said, I'll turn the call over to Gary.

[Gary Steele:]

Thanks, Jason. I'd like to thank everyone for joining us on the call today. We're very pleased by the strong start to the year with our team delivering yet another quarter of exceptional top line and bottom line financial results.

[Paul Auvil:]

Thanks Gary. We were quite pleased with our operating results this quarter with many thanks to the hard work of our teams all around the world. Revenue totaled $202.9 million, up 25% year-over-year and above our guidance range of $198 million to $200 million. Billings for the first quarter were $215 million, an increase of 15% year-over-year and above the high end of our guidance range of $211.5 million to $213.5 million. We're pleased with these results, particularly when considering the Q1 represented a difficult compare, given the strong results recorded in Q1 of 2018. As noted on prior calls, under ASC 606, the derivation of our billings metric requires adjustments to reflect unbilled accounts receivable activity during the quarter, as well as any right of refund liability. For Q1, the adjustment related to these two items was immaterial. Our duration to the quarter was in the middle of our targeted range of 14 to 20 months consistent with the past few quarters and continues to underscore the high quality of our free cash flow generation. This trend in terms of duration is further reflected in our deferred revenue balances, which ended the quarter at $610 million, up $12 million sequentially with short-term growing by $8.7 million and long-term increasing by $3.4 million. In terms of a bit more detail on revenue during Q1. Revenues from our Advanced Threat segment grew 22% year-over-year and represented 75% of total revenue. And our Compliance segment grew 33% year-over-year and represented 25% of revenue. Please note that when analyzing our revenues sequentially from Q4 of 2018 to Q1 of 2019, it is important to keep in mind two factors that we highlighted on our call in January. First, revenue in Q4 benefited by $3 million, due to the acceleration of revenue under ASC 606, which did not recur again here in Q1. And second, note that our daily revenue recognition methodology resulted in the sequential decline in revenues of $4 million from Q4 to Q1 given the Q1 is two days shorter than Q4. Turning to expenses and profitability for the first quarter. On a non-GAAP basis, our total gross margin was 78.5%, above our expectations, primarily driven by our strong revenue performance. During the first quarter, total non-GAAP operating expenses increased 26% over the prior year period to $136.3 million, representing 67% of total revenue. Our non-GAAP operating income for the first quarter was $22.9 million, reflecting an operating margin of over 11%. Now moving on to net income. First, I'm very pleased to note that this quarter represents our 12th consecutive quarter of positive net income on a non-GAAP basis. In light of this milestone and in conjunction with what we believe to be a very promising outlook in the years to come, beginning January 1, 2019, we are now calculating non-GAAP net income in accordance with a directive issued by the SEC under their non-GAAP financial measures compliance and disclosure interpretations Section 102.11. Note that other successful businesses such as Palo Alto Networks, Splunk and Workday have all moved to follow the same reporting standard as they became consistently profitable on a non-GAAP basis over the past few years. Under this directive, companies generally apply a tax rate to their non-GAAP pretax income based on an estimated effective tax rate that is derived as if these earnings were actually GAAP pretax income. As such, we have calculated an effective non-GAAP tax expense commensurate with our level of non-GAAP profitability using an estimated tax rate applied to our non-GAAP pretax earnings. This additional non-GAAP tax expense is that included in the calculation of our non-GAAP net income, thereby reducing non-GAAP net income by a corresponding amount. It is of course important to note that this is a derivation solely for the purpose of applying a notional tax rate to non-GAAP pretax income and as such, these figures had no impact on our GAAP income statement, our balance sheet or our statement of cash flows. On a GAAP basis, we continue to expect that we will not incur any material tax expense for the foreseeable future, excluding any potential discrete items given our large balance of U.S. net operating loss carry forwards and our U.S. valuation allowance. We currently estimate for all of 2019 that our tax rate under this disclosure requirement will be approximately 17%. And looking beyond 2019, we estimate that this tax rate should range from 17% to 20% over the next several years. So with that as a backdrop in terms of our net income results for the quarter, we are quite pleased with our performance under our historical methodology and consistent with our guidance from last quarter. Net income for the first quarter was $23.1 million or $0.40 per share, significantly higher than our guidance range of $18 million to $20 million, driven by both the revenue outperformance as well as lower than expected spending in both sales, marketing and R&D. That said, comporting with the SEC's C&DI 102.11 standard, our estimated tax rate of 17% results in an additional noncash tax expense of $3.4 million for the quarter, resulting in a non-GAAP net income of $19.6 million under this calculation method. We've included a table in today's press release, which further highlights the differences under this standard, as it relates to both our Q1 results as well as our guidance. Moving on to EPS. Under our historical reporting methodology non-GAAP earnings per share for the quarter was $0.40 per fully diluted share nicely above the high end of our guidance range of $0.31 to $0.35 based on 57.6 million shares. Under 102.11 our non-GAAP earnings per share for the quarter was $0.34. On a GAAP basis, we recorded a net loss for the first quarter totaling $28.3 million or $0.51 per share based on $55.3 million shares outstanding. Moving to the balance sheet, we ended the quarter with $257 million in cash, cash equivalents and short-term investments. I'd like to take a moment to point out that beginning January 1 of this year, we have also implemented the new accounting standard known as ASC 842, which changed the recording of long-term operating leases in the financials. The most significant change with this new standard is that most leases, including most operating leases will now be capitalized on the balance sheet. Accordingly, we recorded assets of $60 million against liabilities, reflecting the value of these leases. Note that this new accounting standard has no impact on our income statement or our statement of cash flows. In terms of free cash flow, we generated $54.1 million in operating cash flow and invested $5.5 million in capital expenditures, resulting in free cash flow for the quarter of $48.6 million well above our guidance range of $38 million to $40 million and notably delivering 25% of our full year guidance during the first 90 days of the year. This strong result was partially driven by better than expected billings and collection in the quarter, which was then further bolstered by capital spending that was somewhat lower than expected, as we shifted some projects originally planned for Q1 to later in the year. And also chose to deploy some workloads with cloud service providers rather than deploying in our own data center infrastructure, particularly with regards to some of our newer product lines such as security training and phishing simulation. Now turning to our outlook, starting with billings guidance, we expect Q2 billings to be $228 million to $230 million, resulting in year-over-year growth of 16% at the midpoint. This represents an increase from our previous guide on our January call where we indicated that billings in Q2 would be approximately 21.5% of total billings guidance for the year, hence roughly $228 million at the mid point. As a reminder, here in 2019, we are shouldering the full impact of the wind down of Cloudmark's OEM business. For the full year, we are increasing the midpoint of our billings guidance by $4 million and now expect a range of $1.062 billion to $1.066 billion representing nearly 22% growth at the midpoint. For modeling purposes over the second half of the year, we continue to expect a pattern similar to past few years with roughly 26% of total billings occurring in Q3 or roughly $275 million and roughly 32.5% of total year billings occurring in Q4 or $345 million. Turning to revenue guidance. For the second quarter, we are increasing our range to $210 million to $212 million or nearly 23% growth at the midpoint above the guidance that we provided back in January where we expected a year-over-year growth rate in the second quarter of 21.5% to 22.5%. For the full year, we're increasing our revenue guidance by $4 million, which takes our range to $874 million to $878 million and represents 22% growth year-over-year at the midpoint or nearly 23% when adjusting for the ASC 606 revenue acceleration in Q4 2018 that I noted on our January call. In terms of modeling the second half of the year, we continue to expect our reported year-over-year revenue growth for the third quarter to be in the range of 21.5% to 22.5%. And for the fourth quarter, as I just mentioned, recall that the very strong performance in the fourth quarter of 2018 was driven by in part roughly $3 million in revenue acceleration under ASC 606 as we discussed in January, which creates a challenging baseline for the coming year. And absent a similar effect here in 2019, we continue to expect a growth rate of just over 20% in the fourth quarter of 2019 or roughly $238 million. In terms of gross margin guidance, we expect second quarter and annual non-GAAP gross margin to be just over 78%. Moving on to net income guidance. Under our historical methodology, in January, we guided the full year net income to be in the range of $94 million to $98 million. Today, we are effectively raising that guidance by $4 million to a range of $97.9 million to $101.9 million. That said, in adopting 102.11, we will now apply a 17% noncash tax expense to our reporting of non-GAAP net income, which equates to an additional noncash expense of approximately $14.7 million at the midpoint of the range. As such, in adjusting for this reporting methodology, our updated guidance for the year is $83.5 million to $87 million or $1.43 to $1.49 earnings per share based on 58.5 million fully diluted shares outstanding. Note that this guidance for the year assumes capital expenditures of $38 million, depreciation of roughly $32 million to $34 million and an income tax provision exclusive of potential discrete items of approximately $17.5 million, which includes $2.8 million of income tax computed under our historical method. And as noted $14.7 million of additional noncash income tax expense attributable to the 102.11 calculation. For the second quarter under our historical approach to reporting, we are guiding net income to a range of $23 million to $25 million. That said, in adopting 102.11, we will apply a 17% noncash tax expense to our reporting of non-GAAP net income, which equates to an additional noncash expense of $3.5 million. As such, in adjusting for this reporting methodology, our guidance for the second quarter is $19.5 million to $21.5 million or $0.34 to $0.37 earnings per share based on 57.7 million fully diluted shares outstanding. Note that this Q2 guidance assumes capital expenditures of $9 million, depreciation of approximately $8 million and an income tax provision exclusive of potential discrete items of approximately $4.2 million, which includes approximately $0.7 million of income tax computed under our historical method and approximately $3.5 million of additional noncash income tax expense attributable to 102.11. In terms of free cash flow, as discussed during our call in January, we had expected approximately 30% of our annual free cash flow to be delivered in the first half of the year or roughly $60 million. Given the strong start in Q1, we now expect to end the first half with approximately $75 million and hence a contribution of $25 million to $27 million during the second quarter. For the full year, we are also raising our free cash flow guidance to a range of $200 million to $204 million or 23% of revenue at the midpoint. For modeling free cash flow for the second half of the year, we expect approximately $15 million to be delivered in the third quarter. We believe that this outlook is particularly compelling, giving our commitment to innovation and ongoing investments to pursue the key opportunities in the market and demonstrates continued progress toward our 2020 target of 24% to 26% free cash flow margins. Also I would like to note that we are producing this cash flow with an average build contract duration in the mid-teens, which highlights the high quality of the recurring cash flow that our business can generate as it scales. As a final comment, I would like to highlight that this guidance for 2019 reflects our dual objectives of driving attractive growth in both revenue and free cash flow, which remains a hallmark of Proofpoint’s disciplined operating strategy and is further corroborated under the rule of 40 metric as discussed last quarter. When considering our outlook for 2019 of 22% revenue growth and 23% free cash flow margins, it results in a figure of 45 under the rule of 40 construct, which places us prominently in the top quartile of all publicly traded SaaS companies. We remain committed to our strategy of driving attractive growth in terms of revenue and free cash flow. So as we think about our opportunity over the next several years, given our significant opportunity to add new customers throughout the world while selling add-on into our ever-expanding installed base, combined with the strong secular trends regarding the ongoing migration of workloads and content to the cloud and the ongoing severity of the threat landscape. We believe that we can maintain a rule of 40 metric in the mid-40s by driving revenue growth in excess of 20%, while maintaining free cash flow margins in the mid-20s. In conclusion, we continue to execute well, delivering strong top line and bottom line operating results in the first quarter and believe the Proofpoint remains well positioned to continue to drive disciplined growth with increasing free cash flow margins built on our proven capability to defend enterprises against today's advanced security and compliance threats. Before turning it over to the operator for questions, I would like to request that everyone limit themselves to just one question to help reduce the duration of our call and to ensure that everyone has a chance to be included in today's discussion. Thank you very much for taking the time to join us on our call today. And with that, we would be happy to take your questions now. Operator?

[Operator:]

Thank you. We'll take our first question from Melissa Franchi with Morgan Stanley.

[Melissa Franchi:]

Great. Thanks for taking my question. A question to start with Paul. Paul, if you look at the sequential growth in billings this quarter, it was the sharpest Q1 quarter-on-quarter decline that we've seen in the business historically. And I know that you've talked about the business just becoming more backend loaded. And then you had Cloudmark that’s starting to roll off, but were there any other factors in Q1 that drove that sequential growth or just sequential decline. And then what are the factors that are driving the more backend loaded business?

[Paul Auvil:]

Yes. No, that's a great question. And what I'm pleased with is we'd beat the guidance that we provided for the first quarter as we always do. And I would say that as we look at the overall framework and I think we've discussed this in the past and a couple of other calls. As we scale there are a couple of things that are fundamentally true. First of all, like most businesses, in and around both SaaS and enterprise software, we do tend to close a majority of our new and add-on business in the second half of the year and particularly in the fourth quarter. And so as you can imagine, as that compounds year after year after year, the renewals space gets more and more concentrated in the second half of the year, in the fourth quarter in particular. So when you compare our fourth quarter billings performance with our first quarter billings performance, what you see is this big sequential change in the amount of renewable businesses actually being booked by the business. And so it has nothing to do with the actual overall health of the business, as Gary mentioned during his prepared remarks, our renewal rate continues to be well over 90%. It just has to do with the timing of the renewals. And of course, Q1 we do tend to close a lot less new and add-on business in that first quarter as compared to the fourth quarter. And so it's a combination of those two factors that caused this sequential decline in billings between the fourth quarter of one year and the first quarter of the next year.

[Melissa Franchi:]

Very helpful. Thank you so much.

[Paul Auvil:]

Thanks.

[Operator:]

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

[Andrew Nowinski:]

Great, thank you and congrats on a great quarter. I want to ask a question on the bundles. You mentioned that there was solid interest specifically in entry-level P1 bundle. And it looks like that actually contains a number of your products including Wombat. So I was wondering, did you see an increase in the average spend per user this quarter relative to prior quarters?

[Paul Auvil:]

Yes, there was a small modest increase in spend. And to your point that P1 bundle includes our basic advanced threat protection capabilities as well as we can't have good, better and best version of bundling that we offer with Wombat. And so the good version is included in the P1 bundle. So it did certainly help lift the ASPs just ever so modestly. Just to be clear, while we did see a nice uptick in the interest in bundles and the sale of the P1 bundle and Q1, it's still represents a fairly small amount of our overall business booked in terms of new and add-on during the quarter. So we feel like this initial starting point indicates that bundles are of interest to customers and we're seeing traction with our sales team channel and customers. And so it'll be interesting event to see how that evolves as a percentage of the overall new and add-on business that we close over the arc of the rest of the year.

[Andrew Nowinski:]

Great. Thank you.

[Paul Auvil:]

Thanks.

[Operator:]

We'll take our next question from Phil Winslow with Wells Fargo.

[Phil Winslow:]

Thanks for taking my question. Congrats on a strong start to the year. I just want to focus on sales productivity and also just international business. I wonder if you could provide just an update on how you're feeling about the trends in sales productivity and then the hiring in productivity, particularly in international? Thanks.

[Gary Steele:]

Yes, we feel good about the results that we posted from an international perspective. The overall growth rate was quite healthy, the deals that we closed we feel good about, we continued on our path of expansion within the EMEA region specifically. We've continued to open new territories when we will continue to do that. What we've seen is we've seen sales productivity very much come in align – in alignment with what we're seeing in North America. And so we feel like we've got a great path and great opportunity there.

[Paul Auvil:]

Yes. And I think, overall hiring, we had another good quarter of hiring new talent into the team. You're always looking to drive that growth curve as best you can. But we're pleased with where that hiring activity came in, both in Europe and as well as the rest of the international operations. And so as we think about where we're driving toward the later part of the year for now, we feel good about where we stand with the team globally.

[Phil Winslow:]

Great, thanks.

[Operator:]

We’ll take our next question from Matt Hedberg with RBC Capital Markets.

[Matt Hedberg:]

Hey guys, thanks for taking my question. Gary, you've been bullish on Office 365 for quite some time and you called it out in your prepared remarks again. I'm wondering can you help us with what percentage of new business comes from customers running Office 365, just some sort of curious as to how big of a funnel or a pipeline that is relative to sort of non-Office 365 customers.

[Gary Steele:]

Yes, it's interesting. I think that when you look across every single enterprise today, they're building some form of plan around Office 365 and everyone's at a different point or a different state. I would say probably 40% of our business or so is where they're actually in the process of migration, kind of in rough numbers. But we do see even with the most conservative organizations, they've got a plan and may be a year or two out but they're building plans to move. So we fundamentally believe that this continues to be an important catalyst for us over the course of the next several years. This is – we're still not even halfway there. There's lots of opportunity left here.

[Matt Hedberg:]

All right, thanks a lot.

[Operator:]

We'll go next to Rob Owens with KeyBanc Capital Markets.

[Rob Owens:]

Great. And thanks for taking my question guys. It would appear that the quarter’s off to a good start based on some of the federal reporting sites. So I think that begs the question. Number one, just highlight your federal opportunity. And number two, what you guys are seeing in the archiving market here? Thanks.

[Gary Steele:]

Sure. So, on the federal side, the one thing that continues to be encouraging to us is the broader move within federal agents to adopt cloud as a core platform. And while there's been discussion of this over the past several years, it's really becoming more of a hearing now kind of thing for federal agencies. And I think that creates opportunity for us. And then with respect to the archiving business, we continue as we noted in our prepared remarks, we continue to be really enthusiastic about that opportunity. The competitive landscape continues to move in a favorable way for us and we're seeing great opportunity out there with respect to the archiving business.

[Rob Owens:]

Great. Thanks. Hi Paul.

[Paul Auvil:]

Hi.

[Operator:]

We’ll go next to Jonathan Ho with William Blair.

[Jonathan Ho:]

Hi, good afternoon. I just wanted to understand a little bit better. What drove the outperformance in your cash flow and were you guys able to sort of invest at the level you were expecting to in Q1? Thanks.

[Gary Steele:]

Yes, there wasn't one particular effect. It was a combination of obviously collecting the large AR balance that we ended the year with, combined with some good productivity of collections within the quarter, a business that we build and collected. And then somewhat lower spending in a variety of different areas across sales, marketing, R&D, the first quarter is always kind of, everybody's kind of getting started and just start to drive the engine for the year. And so it wasn't that we had a deficit in spending areas that we think are an issue tactically or strategically to the business, just a little bit lower than what I had built-in in my as usual, fairly conservative planning. And then of course, our CapEx numbers were a bit lower because there are a couple of projects we decided to defer to later in the year. And then some of our newer capabilities, including compliance training and phishing simulation, we've decided to drive more of the build out in cloud service providers rather than build that out in our own data centers. And of course, that saves us some on CapEx, but it moves a little bit of that more into OpEx as part of that trade.

[Paul Auvil:]

Keith, you can go on to our next question.

[Operator:]

Next question is from Alex Henderson, Needham.

[Alex Henderson:]

Great. Thank you very much. I was hoping you could talk a little bit about what you're seeing on the competitive front, in terms of activities from Microsoft, MIME, Agari, Cisco or others, to give it some context around what their price action is looking like or what the competitive win rates look like or any other variable that would give us a sense of it. And if there's been any change as a result of change to packages in your go-to-market, how does that impact the selling timeline?

[Paul Auvil:]

Yes, I mean, I'll let Gary provide some color on the competitors in general. But what I can tell you is that as we've built out more and more value, you'll be on protection and TAP as we added Email Fraud Defense and a variety of other capabilities, our TRAP solution, the Wombat compliance training and phish simulation. What we're seeing overall is that values and deal sizes are actually moving up, further conversation a little bit earlier on the impact of the P1 bundles. And so we're not seeing competition change that those deal value is in fact, I would say that our average value of a new deal that we're closing is probably moving up a bit as compared to where we were over the last couple of years. We generally don't comment overly specifically on competitors but Gary, I don't know whether you want to provide any other color.

[Gary Steele:]

No. The one thing that I would reiterate and we noted this in our prepared remarks that our win rates continued to be very high when we look across the various folks that we run into in the market. We talk about Microsoft, we see Microsoft is in a very important catalyst for growth for us because this broad movement to the cloud, it continues to be fundamentally good for our business and we're able to very clearly demonstrate the value that we can deliver over the core basic capabilities that Microsoft delivers. And we saw no change in the efficacy of their solutions. As you are probably aware, they offer two core security capabilities

[Alex Henderson:]

Very helpful. Thank you very much.

[Operator:]

Go next to Walter Pritchard with Citi.

[Walter Pritchard:]

Thanks. My question is on the archiving. And it feels like in the past, you've had a little bit of fits and starts on getting that business really accelerating. It sounds like your commentary here is more bullish. I'm wondering what you attribute the increased traction there too, and how sustainable do you view that to be?

[Paul Auvil:]

Yes, I think our point of view on this is very positive because we have seen the continued diminished investment on behalf of the incumbent players there, whether it be Micro Focus or Veritas with Enterprise Vault. And I think many of the customers that have been longstanding, supporters of the solutions are just started giving up hope and they're looking for alternatives. And we're starting to see that market break and I think we'll see some nice consistency in that market and growth opportunity for Proofpoint on a sustained basis over a long period of time. So to summarize, we feel very bullish about the opportunities surrounding archiving.

[Operator:]

We'll take our next question from Gabriela Borges with Goldman Sachs.

[Gabriela Borges:]

Good afternoon and thank you. For Gary, how much do you think email security budgets are growing at the average Global 2000 customer or a company? And move towards the more people-centric approach on the messaging side, does that change how customers are thinking about budget or free up, different areas of budget for you guys to get access to? Thanks.

[Paul Auvil:]

Yes. With respect to budget, I think what are the things that has changed is there's broader awareness of the risk associated with these socially engineered targeted threats towards people. And so companies are not thinking about, I'm putting more dollars towards email security. They're thinking about how do I better defend my people. And so we are seeing increases in spend because they're taking different approaches to bring together a set of capabilities that better defend their people. I don't have a hard and fast number or what that looks like, but they're prioritizing these projects, they're spending more money and it's making a difference. On the people-centric side, what we're delivering today is helping organizations better understand who their targeted people are and then we're helping drive these adaptive controls and better secure those specific individuals. And I think the opportunity for Proofpoint is not only giving people that insight and visibility, but then also driving the maturity of their security posture by giving them more and more security controls. We noted that more training is an example of that. Well, that's working out exactly like we expected, but there's lots more that we can do in that area that will drive continued opportunity and demand for the company.

[Gabriela Borges:]

That’s helpful. Thank you.

[Operator:]

We’ll go next to Ken Talanian with Evercore ISI.

[Ken Talanian:]

Hi. Thanks for taking the question. I know you've talked about the renewal rate being above 90%, but I was wondering if you could comment on the trends you're seeing in your net retention rate and how that's compared versus previous quarters?

[Paul Auvil:]

Yes. We don't actually calculate that, so I literally couldn't tell you what that is. The way we run the business is we look at our renewal rate on the no-nonsense basis of what's the recurring revenue that's up for renewal this quarter and what percentage of it did we lose and what percentage of it did we keep. And then separately we run the sales team did this notion of new and add-on business that we assign out to them as quota and what we expect them to close. Obviously with the results we deliver this quarter, we delivered well on all of those metrics. So unfortunately I can't give you a number there. I literally don't know what the number is. We don't view it as a metric that's useful as we're sort of evaluating the operational health of the business.

[Ken Talanian:]

Okay. Thank you.

[Paul Auvil:]

Yes.

[Operator:]

We’ll go next to Sarah Hindlian with Macquarie.

[Sarah Hindlian:]

All right, great. Thank you so much for taking my question. Paul, I was really hoping you could help me drill down into the magnitude of the impact of the wind down of Cloudmark. Was it Q1 and on the remainder of the year and how that weighs into the confidence you expressed in back half guidance? Actually, let me ask you about a little bit more what's the mix of acceleration in the second half billings guidance. Can you just talk about renewal base, which I assume is the bulk of your guide?

[Paul Auvil:]

Yes. So again, from a revenue perspective, the impact of Cloudmark OEM is we see that impact more greatly in the first part of the year where we had more significant revenues associated with the Cloudmark OEM business because that was then tapering of course over the arc of the year. So the impact was more greatly felt in Q1 and Q2 here. Later in the year of, while we did still have some Cloudmark OEM revenue, it was already starting to wane. The biggest issue with regards to revenue and year-over-year growth in the fourth quarter is this ASC 606 acceleration that we mentioned on the prepared remarks both in January as well as again here on the call today, where you've got several million dollars of revenue that just because the customer's deployment methodology, even though it's a subscription business, we took the majority of the revenue in the period is prescribed under that accounting standard. From a billings perspective, really the Cloudmark OEM business is almost indiscernible in the scheme of the overall numbers. On the margin it impacts a little bit in the first part of the year. But by the time you get to the second half of the year with a much larger secular renewal trends driving through the Proofpoint installed base, it's really not a factor that affects that timing of billings by quarter as we've laid them out.

[Operator:]

We're going the next to Greg Moskovitch with Mizuho Securities.

[Mike Baroukh:]

Yeah. Hi Guys. This is Mike on for Greg. Thanks for taking the question. Can you just update us on how you're approaching M&A right now?

[Gary Steele:]

Sure. This is Gary. So, we continue to look for opportunities where we think we can create more value under the people centric framework. So, we think about opportunities that might extend our footprint and more adaptive controls, et cetera. We evaluate many, many opportunities. We're optimistic that at some point we'll find something, but, we will remain active and be thoughtful about a disciplined approach to M&A.

[Operator:]

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

[Shaul Eyal:]

Thank you. Good guys. Congrats on the solid set of results. Maybe big picture type of question. Historically the Proofpoint strategy has been, still is without a doubt, it was driven by both displacement of legacy providers on the one hand. On the other hand, plenty of Greenfield opportunities. Are you seeing any change in that respect, nowadays is it more of a Greenfield opportunities or rather, is it more displacement of those legacy providers? How could we be thinking about it?

[Gary Steele:]

Yes, no, I think that in the core Email Threat Protection, we're doing various forms of displacement, we’re either displacing on-premise appliances when organizations move to the cloud or we're taking out someone like Microsoft if they've moved to the cloud and haven't made the switch to a third party provider. And then in our emerging products, many of those are Greenfield markets where first for example, there are many organizations, for example, it hasn’t bought security awareness and training yet and that might be just a core Greenfield opportunity. So in the core it's 99% of the time a displacement in emerging products, it's oftentimes just Greenfield.

[Paul Auvil:]

Yes. I think the other thing I'd add is, we continue to see a good balance between new business and add-on business the drives the recurring revenue. So I should have mentioned this when Ken asked his question earlier. Well, again, we don't really have a net retention metric, which is a combination or the renewed value plus the add on value. We do see ongoing really good productivity of the sales team going in and selling more products to the existing installed customer base. Again, about half of the new business, new and add-on business comes add-on about from new. And one of the things, just as Gary touched on that I think is particularly interesting is as we've expanded into some of these new Greenfield markets, like our email fraud defense product in the Wombat security and awareness training capabilities. It creates new entry points into customers where for whatever reason, maybe they weren't ready to reconsider their email security posture. We can sell them something else as part of that initial engagement and then come back around and sell the broader product line later. So we really liked these additional features and the product line in that regard.

[Operator:]

We'll go next to Imtiaz Koujalgi with Guggenheim Partners.

[Imtiaz Koujalgi:]

Hey guys, thanks for taking my question. I had a question about the linearity of the quarter. It looks like your DSO went up quite a bit in this quarter. Any comment on if the quarter was a bit more back end loaded that usual.

[Paul Auvil:]

Actually I think the DSOs between Q4 and Q1 are roughly fattish. So, linearity within the quarter was fine. Nothing different from other quarters that we've seen. Like most tech companies, we do find that there's a much stronger buying cycle, in the last month of the quarter. And to your point, when you close deals in the month of March, for example, you won't collect that in the month of March. And hence that will drive your AR balance up accordingly. But I would say that the linearity in the first quarter was very similar to the linearity that we've seen in the past several quarters.

[Imtiaz Koujalgi:]

Thank you.

[Operator:]

We'll go next to Steve Koenig, Wedbush Securities.

[Steve Koenig:]

Hi Gentlemen, thanks for taking my question. Congrats on a good start to the year. So you guys are, have great visibility and are pretty steady Eddie while the market, alternatively gets manic depressive on your stock. Maybe just as you look at the short term and long term, short term execution wise kind of maybe just tell us about your confidence that some of the execution challenges you had in the middle of last year are behind you. And longer term, that guide for 20% revenue growth and mid, mid-20% free cash flow margin, is M&A additive on the revenue side or is M&A kind of built into that guide maybe help us understand that a little bit.

[Paul Auvil:]

Yeah. So a couple of things. One to your point about last year, the one thing I always liked to point out for people is that we consistently beat the guidance over the course of all four quarters of last year while delivering raises. So yes, we executed, right on top of everything that we put out for the street. That said, we did talk about a little bit of, an issue that we were running into with regards to productivity of our new hires in the Americas, which we feel like we're now, we put that behind us. And then we did get a bit of a slowdown in the hiring in the international teams, which we felt like we've made good progress against and you never quite exactly where you'd love to be on a hiring, but we feel like we're mostly where we'd like to be there. So anyway, so as we enter the year and as we look at where we stand here in April, I feel good about that set up. And to your question about this notion in the longer term of 20% or better top line growth with mid-20s free cash flow, which I think is a great model for the company to operate under. Certainly, we'd expect that we'll probably do some smaller acquisitions to compliment our R&D that will just be part of driving additional value we can deliver to customers that make those numbers a reality. If we were to do a larger acquisition that was – had meaningfully inorganic contribution, then obviously that would likely be additive. I don't in the near term foresee us doing any deals that would have in the context of our, this year, well over $800 million of revenue scale. I don't see us doing any deals that would be really material in the context of that from a revenue perspective. I'm not ruling it out, but it isn't kind of within the, the normal parameters of the sorts of businesses that we're looking at when we're considering M&A.

[Gary Steele:]

And Steve, one other point. The one thing that I feel very good about is in the change that happened last year is with new sales leadership under Blake. I really feel like we've put in place that structure that will enable us to get to a billion to 2 billion and beyond. And I think that longer term view of a scalable organization, that can continue to drive growth over a very long period. I think we've set that up so felt really good about the organization.

[Operator:]

We’ll good next to Catharine Trebnick, Dougherty.

[Catharine Trebnick:]

Thanks for taking my question, back to our archiving, you had mentioned, the legacy players not investing as much, but are you also seeing a trend with an Office 365 providers – that are moving to Office 365 looking to have a more online cloud based archiving system and that you're getting some of those opportunities there. Thank you.

[Gary Steele:]

Yes, that's a great point Catharine. The one thing is, it may sound obvious, but as organizations move from an on premise environment to Office 365, it really makes absolutely no sense to take all the data that's going into Office 365 and route it back to an on-premise archive. And so the cost and the management associated with that really makes no sense. So the broad disruption of Office 365 not only supports us in the security world, that creates a unique opportunity on the archiving side as well. So yeah, that's definitely part of the demand profile for what we're seeing on the archiving side.

[Operator:]

Well, go next to Gur Talpaz with Stifel.

[Gur Talpaz:]

Okay, great. Thanks for taking my question. Hey Gary a lot of talk of Threat Response in some of the deals you noted earlier in your program marks. Can you talk about that product in the space in general in like of some of the acquisitions that have happened, particularly Demisto by Palo Alto. How do you think about relevant differentiation for you and your approach versus what else is happening out there? Thank you. Yeah, no, great question. Where we have been focused and where we're winning business is we have taken the approach to automate very specific used cases. And these are used cases that are of extreme high value to security organizations. So, in the prepared remarks, we talked about something called clear. And it's really just think of it as abuse mailbox. So anytime someone reports something, how do you automate all the noise associated with that reporting of an event? And so what security organizations are I think are really focused on right now, given that they lack resources and anything that can automate these specific used cases that creates value for them, they're willing to pursue. So, our approach is not to be a broad based platform to go win every sore deal. Our approach is how do we create value for security organizations by giving them some key tools for security for automation, other specific used cases that drive the level of automation they haven't had in the past. So we're just, that's why we're winning and it fits very naturally with everything else we're selling. And that's why you've heard it included in so many examples.

[Operator:]

We’ll go next to Daniel Bartus with Bank of America Merrill Lynch.

[Daniel Bartus:]

Hey, guys. Thanks for turning me in and taking the question. I just want to go back to -- is there any slow precedence you guys would point to and then growing the average value of deals? Or this is really the new approach? And then is this still seems fully ramped under P2 and P3 bottles or should that be a source of upside as we move into second half? Thanks.

[Gary Steele:]

Yes. So, I would say that as we look at bundles, one thing to keep in mind is we've actually been bundling as I've said before for quite some time. Protection and TAP for example was its own bundle for years. And then when we introduced our TRAP product line, we had another bundle that included those three. So, it's not really new to the Proofpoint sales team, our channel or our customers. But what we decided to do is broaden the relevance of bundles by increasing the number of them to include products that really speak more to the broader people-centric vision as opposed to just things related to email security. And again, so far we're seeing that there's some good early indicators of interest. We do believe it will help ultimately over time drive larger deal sizes and inheritantly make customers stickier as a result. But it's very early right now. So, data points in Q1, we felt were good early promising indicator. But I think it'll be interesting to see over the next several quarters how things play out from there.

[Operator:]

We'll go next to Gray Powell with Deutsche Bank.

[Gray Powell:]

Great. Thanks for taking the question. So, I know there's some moving parts between Q4 and Q1 on the revenue side. If I look at the compliance piece, I guess, there just wasn't that much sequential growth in compliance revenue. So, how should we think about the organic growth in that business given that the year-over-year comparisons skewed by the Wombat acquisition? Thanks.

[Gary Steele:]

Yes. So, there are a couple things to keep in mind that I mentioned in the prepared remarks. You got both the ASC 606 revenue acceleration, which was partially in that compliance segment. And then, of course, you've got the $4 million quarter-over-quarter deceleration associated with having two fewer days in the quarter. And since we have daily revenue recognition, you've got that as a headwind. So overall, we feel good about the results and the way they come together. I think as we look at the guidance, we provided for the second quarter and the remainder of the year, we expect that you'll see ongoing healthy performance out of the compliance segment but also advanced threat. So, the net of it is, I'd like to always remind everybody from our perspective and I never bought the various development teams in the company to feel badly when I say this, but we really don't care what the sales team sells. They all have a recurring revenue target that we need them to hit. And whatever is resonating with customers is we want the sales team to go out and sell. So one quarter, Wombat might be a really important thing that is top of mind for customers. Another quarter it might be Email Fraud Defense. I suspect that CASB and browser isolation will increasingly come to the forefront of customers minds, of course, in addition to our ongoing Protection and TAP product line and the demand for those. So, the net of it is, while it's a result of us being a larger company, we're required to provide segment reporting and we always want to provide as much color around that as we can. The reality is that as we look at the relative growth between segments, it's not really that big a deal to us as long as we're meeting or exceeding our guidance and our own internal targets regarding delivering both billings, revenue growth, profitability and importantly, free cash flow margins as the business scales.

[Operator:]

We'll go next to Patrick Colville with Arete Research.

[Patrick Colville:]

Thank you very much for squeezing me in. Can I just pick apart your revenue guidance? So in the quarter, if I'm right, you beat by about $3 million versus the midpoint of your guidance. And for the year, you've lifted your revenue guidance by $3 million. So, given that you had a nice beat this quarter, a very healthy start to the year, how come you are being more confident about the second half?

[Paul Auvil:]

Sure. We actually raised full year by $4 million. So, we raised a little bit more than what you described. And I think for us, we're sitting here in April, we're driving now the business at higher scale. And actually we feel good in the core baseline in terms of that combination of revenue growth and free cash flow. Delivering rule of 40 metric is quite compelling. And so we want to work our way through another three months here, get some execution under our belt and then reevaluate the second half of the year as we get there.

[Operator:]

Our final question is from Erik Suppiger with JMP.

[Erik Suppiger:]

Yeah. Thanks for fitting me in. Just looking at the billings growth, you've given a few factors for being at the linearity through the year, but it looks here like your year-over-year billings growth in the first half of the year is in the mid-teens and the second half is, it gets you to the north of a 20% growth. Should we just think about that as the linearity of – or the seasonality of orders is causing that bifurcation? Or can you prioritize kind of what is making the year so back-end loaded?

[Gary Steele:]

Yes. So just as a reminder, if you look at the timing of the billings as delivered in Q1, Q2, Q3 and Q4 of last year, it's a relatively similar pattern here in 2019. And so, it is this notion of ongoing concentration of renewals in the back half of the year, combined with the natural fact that the new and add-on business that we close as a company in any given year tends to be higher as well. So, there's nothing really out of the ordinary. Just as we get bigger and higher and higher scale, we have a more and more distorted effect in terms of the billings being delivered in the second half of the year. You've got larger companies like Salesforce, for example, they have a similar pattern in their overall billings activity. So, it's really quite frankly nothing more than that.

[Operator:]

And ladies and gentlemen, this concludes today's question-and-answer session. For closing remarks, I'd like to turn the conference back over to Mr. Gary Steele. Please go ahead.

[Gary Steele:]

Great. I want to take a moment to thank, everyone, for joining us on the call today. We're very pleased with our Q1 results and excited about the continued progress with our people-centric approach to cybersecurity. We believe we remain well positioned to drive attractive returns for our shareholders, and look forward to talking to you on our next call and seeing many of you on the conference circuit this quarter. Thanks so much for joining us today.

[Operator:]

Ladies and gentlemen, this concludes today's conference. We appreciate your participation.