Proofpoint, Inc.
Q3 2019 Earnings Call Transcript

Published: 24 Oct 2019

[Operator:]

Good day, and welcome to the Proofpoint Third Quarter 2019 Earnings Results Conference Call. Today's conference is being recorded. At this time, I would like to turn the conference over to Mr. Jason Starr, Vice President, Investor Relations. Please begin, sir.

[Jason Starr:]

Thanks, Aaron. Good afternoon, and welcome to Proofpoint's third 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 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. 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, October 24, 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 to 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 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. 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 are very pleased with our Q3 results with our team delivering yet another quarter of solid top line and bottom line financial results. Q3 revenues were $227.4 million, ahead of expectations and representing 23% annual growth.

[Paul Auvil:]

Thanks Gary. We were quite pleased with operating results this quarter, which exceeded our guidance across the board. Many thanks to the hard work of our teams around the world, who delivered these results. Before reviewing the numbers, I would like to provide a quick overview and some additional modeling points regarding our recent $920 million convertible bond offering, which we were pleased to have completed in August. In terms of some background, given the compelling pricing in the convertible bond market both our leadership team and our Board of Directors felt that it was a good time to access this funding resource, primarily to support future M&A projects. We closed the funding on August 23 structured as a five-year note. These notes are due in August of 2024 and carry annual cash interest expense of 0.25% or $2.3 million per year payable in equal biannual installments in February and August. The notes also carry a three-year provisional call that can be exercised anytime after August 2022 assuming certain conditions are met. The conversion price associated with these notes is $153.99, which represented a 37.5% premium at the time of issue and are convertible into approximately six million shares. Importantly, we took approximately 85 million of the net proceeds and entered into a cap call transaction with certain financial institutions. This enables the company to participate in any upside beyond the conversion price up to $223.98 which in turn reduces dilution by up to 1.9 million shares. Taking into account the cap call, the net proceeds from the financing were approximately $816 million. I would like to point out that just as we did with our previous two series in convertible notes that we retired in 2017 and 2018 respectively the shares associated with these new 2024 notes will now be included in our EPS calculations when they are dilutive. We have included a brief summary in today's press release outlining the associated accounting treatment for EPS under the, if converted, methodology to be applied going forward, the same methodology that we used for our previous series of convertible notes. Now turning to our financial results, revenue for the third quarter totaled $227.4 million up 23% year-over-year and above our guidance range of $223 million to $225 million. Billings for the third quarter were $277.8 million, an increase of 26% year-over-year and above the high-end of our guidance range of $274 million to $276 million. 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 writer refund liability. For Q3 the adjustment related to these two items was $4.3 million. Recall that from our many acquisitions, we’ve assume certain legacy customer contracts which include terms and conditions that require different accounting treatment that are typical Proofpoint customer agreements and this quarter we had one fairly large transaction, in particular that fell into this category. We saw a rebound in contract duration of roughly 10% this quarter a modest reversal from a relative low point recorded earlier in the year. This increase in duration was primarily driven by the two large archiving deals and also the significant P3 transaction, all three of which Gary mentioned earlier were all three of these organizations just execute multiyear prepaid contracts as part of locking in their commitment to deploy leverage our technology across their global operations. This kind of terms of duration is further reflected for revenue balances which ended the quarter at $674.6 million, up $46.1 million sequentially which short term growing by $27.4 million and long-term increasing by 18.7 million. Note that on a year over basis short-term deferred revenue grew by 22% from $440 million to $542 million. It is also worth noting that on a year-to-date basis, our total increase in long-term deferred revenue equals a modest 3.4% of total billings, up nominally as compared to the 3% and 3.2% recorded over the same period during the past two years. In terms of a bit more detail on revenue during Q3, revenues from our advanced threat segment grew 19% year-over-year and represented 72% of total revenue and our compliance segment grew 37% year-over-year and represented 28% of revenue. Turning to expenses and profitability for the third quarter, on a non-GAAP basis our total gross margin was 80% above our expectations, primarily driven by strong revenue performance. Note that this result was above our 2020 target range of 77% to 79% though the performance this quarter was also benefiting nominally for the slower than expected drop in our data center investments during the quarter. Total non-GAAP operating expenses during the quarter increased 21% over the prior year period to $147 million, representing 65% of total revenue. Our non-GAAP operating income for the third quarter was $33.9 million reflecting an operating margin of 15% bringing us into the high-end of our 2020 targeted range of 13% to 15% a full year ahead of schedule. Non-GAAP net income was $29.8 million nicely above our guidance range of $21.5 million to $23.5 million to $23.5 million driven by both the revenue outperformance as well as our lower-than-expected spending in sales, marketing, R&D and the aforementioned slower ramp in data center investments. Also it is important to note that $1 million of upside net income during the quarter was directly attributable to the convertible notes issued in late August with $1.4 million of additional interest expense, our income rather earned on the cash balances from funds raised, netted against $0.2 million of accrued interest expense payable to the note holders, and an adjusted for the 17% C&DI tax rate. As we discussed on our past two calls, beginning in January 1st of 2019, we are now calculating non-GAAP net income in accordance with the SEC's non-GAAP financial measures, compliance and disclosure interpretations Section 102.11. This quarter’s calculation include $6.1 million in tax expense under C&DI and an applied tax rate consistent with last quarter of 17%. Non-GAAP earnings per share for the quarter was $0.49 per fully diluted share. As I noted, the EPS calculation applies the if-converted method to newly issued convertible notes and as such as back $0.2 million in cash interest associated with the convertible debt. For Q3 specifically as the notes were issued on August 23rd only 2.5 million of these shares were included in the calculation as we use weighted share outstanding calculation, which represented a fully diluted share count of 61.2 million shares. Adjusting to eliminate the impacts from the converted transaction, which of course wasn't contemplated in our guidance back in July, the result for the quarter still otherwise would have been $0.49 per share, so still above the high end of our guidance range of $0.37 to $0.40. On a GAAP basis we recorded a net loss for the third quarter, totaling $44.3 million or $0.79 per share per based on 56 million shares outstanding. Of note, the expected Q3 tax payment for the repatriation of intellectual property from Israel to the United States associated with our acquisition of Meta Networks was in fact deferred until October. So as a result, while the repatriation did in fact impact Q3 current and deferred GAAP tax expense by $17.6 million, its impact on cash flow was delayed until the fourth quarter as I will discuss in more detail later in my prepared remarks. Moving to the balance sheet. We ended the quarter with $1.1 billion in cash, cash equivalents and short-term investments compared to $183 million in Q2. This significant increase was primarily driven by the convertible notes offering that we closed in August. In terms of cash flow, for the quarter we generated $68.6 million in operating cash flow and invested $10 million in capital expenditures, resulting in free cash flow of $58.6 million, well ahead of our guidance of $40 million to $42 million. While we had a very strong collection cycle within the quarter that helped to deliver this result, it's also important to note that our original guidance for the quarter assumed a one-time payment to repatriate intellectual property associated with our acquisition of Meta Networks of roughly $10 million. So for my earlier comment this did not get completed in the quarter and hence the equivalent guidance for the third quarter would have been $50 million to $52 million when adjusted for this effect. Given this context our $58.6 million in free cash flow recorded during the quarter was still a very good result and nicely ahead of our guidance, reflecting a free cash flow margin of nearly 26%. Moving on to guidance for the rest of the year. For the full year, we are maintaining our billings guidance range of $1.064 billion to $1.068 billion, representing nearly 22% growth at the midpoint. This guidance implies Q4 billings range of approximately $339 million to $343 million and also reflects a year-over-year growth rate of 26% for the fourth quarter at the midpoint. We are increasing our 2019 revenue guidance to $882.3 million to $884.3 million increasing the midpoint by $3.8 million, reflecting 23% growth year-over-year at the midpoint. This infers a range for the fourth quarter of $237.5 million to $239.5 million, representing 20% growth year-over-year for Q4. Now as a reminder, the very strong revenue performance in the fourth quarter of 2018 was driven in part by roughly $3 million in revenue acceleration under ASC 606 as we discussed back in our January call. And this creates a challenging baseline in Q4 absent a similar acceleration this year. And so adjusting for this effect, guidance implies 22% growth for the fourth quarter. In terms of gross margin guidance, we expect annual and fourth quarter non-GAAP gross margin to be approximately 79%. In terms of guidance for net income, for the fourth quarter, we expect non-GAAP net income of $30 million to $32 million or $0.47 to $0.50 in earnings per share based on 64.9 million fully diluted shares outstanding, as spending catches up to revenue and some expenses that were originally expected to be incurred in Q3 will now fall into Q4. Also it's important to note that this fourth quarter guidance includes $2 million of upside directly attributable to convertible notes issued in late August with $3 million of additional interest income earned on the cash balances from the funds raised netted against 0.6 million of accrued interest expense payable to the note holders and then adjusted for the 17% C&DI tax rate. Note that this Q4 guidance assumes capital expenditures of $14 million, depreciation of approximately $9 million and an income tax provision of approximately $6.3 million calculated in accordance with C&DI 102.11 and an effective rate of 17%. For the full year we are increasing our net income guidance by $9.5 million at the midpoint from our prior range of $94 million to $96 million to an updated range of $103.5 million to $105.5 million, which equates to $1.72 to $1.75 earnings per share based on 60.6 million fully diluted shares outstanding. As I just noted, this updated full year guidance includes a favorable impact from the issuance of the convertible notes of approximately $3 million across the third and fourth quarter. As such, of the $9.5 million increase in guidance just noted, $3 million is attributable to convertible notes and $6.5 million is attributable to our improved operational outlook. 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 of approximately $21.4 million calculated in accordance with C&DI 102.11. In terms of free cash flow, given the strong linearity during the third quarter, the cash collections that otherwise would have been expected in Q4 were actually accelerated into Q3. And with that in mind, in terms of free cash flow for the fourth quarter, we are now expecting this to range between $58.2 million and $60.2 million. Note that this now includes the onetime tax payments associated with the repatriation of intellectual property for Meta Networks, which we now expect to be $8.4 million, a bit lower than the original estimate of $10 million that we have provided last quarter. For the full year, we are increasing the range by $4.5 million with a new outlook for free cash flow of $200.5 million to $202.5 million. This represents a free cash flow margin of 23% or approximately 24% when excluding the $8.4 million IP transfer tax payment. Note that this updated range includes approximately $2 million in incremental interest income receipts from our increased cash balances resulting from our recent capital raise from the issuance of convertible notes. We believe that this outlook is particularly compelling given our commitment to innovation as well as our ongoing investments to pursue the key opportunities in the market. While we're still in the early stages of our planning process, I would now like to share a preliminary view regarding our 2020 financial outlook. I would like to highlight that this is a baseline target for modeling purposes with similar assumptions being made at this stage of our planning process as in prior years. As we complete our 2020 plan, we will provide more detailed outline of our operating assumptions on our next earnings call. Overall, our business remains well-positioned, the competitive environment favorable, and the strong secular drivers of the move to the cloud and active threat landscape are firmly in place. So with that as a backdrop, our preliminary view on 2020 is as follows. We are providing an initial revenue range of $1.05 billion to $1.0625 billion or a baseline revenue growth rate of approximately 20% when measured against the midpoint of our updated 2019 guidance. In terms of billings guidance, after seven years of beating our guidance on these metrics as a public company, as we look to the cadence of how we intend to operate the business now that our billing scale has exceeded $1 billion annually, we've decided that going forward we will end our practice of guiding on this particular metric. In terms of some background here, we concluded that it is the combination of revenue growth and the delivery of cash flow that drives how investors value our business and as such the actual timing of billings per se is not an important metric in how we run the business, particularly as the vast majority forward billings activity are renewals that are increasingly accumulating towards the end of each of our quarterly periods based on our customers buying patterns. With all that in mind, the timing of whether these renewals are build either additional wells are billed on the last release of one quarter as opposed to the first few days of the next has no relevant impact on either the recording of revenue or the timing of cash flows, particularly when viewed in the context of our operating model where over 95% of revenues are derived from recurring subscription contracts. So with that said, for those investors who still choose to model this metric, let me provide a few pointers. First, we'd expect billings growth to be equal to or slight less than revenue growth in 2020 depending on duration to build contracts, which we would continue to expect to remain somewhere in our stroke range of 14 to 20 months. Given the seasonal the seasonal timing of sales and customer renewal cycles, we would remind investors to expect a pattern similar to prior years were approximately 35% to 40% of our business is booked in the first half of the year. Drilling down as we intend to focus our efforts more on the timing of cash flow rather than billings, we would reasonably expect that a portion of Q1 renewal billings activity that would have traditionally closed at the end of Q1, will move into Q2 under our new protocol. This, of course, has no impact on revenue or cash flow that will be recorded in 2020 and simply reflects an easing of how we handle quarter end activity with some deals moving by handful of days from the end of March, early April. We would still expect approximately one-third of billings to occur in Q4 as we've seen over the past several years. For 2020 operating income modeling, we are expecting the low end of the target range that we have shared on the low prior calls of 13% to 15%. In terms of considerations for net income, keep in mind that with our recent node offering, our interest expense will be $2.3 million and offset by interest expense on our cash balances which are held in highly liquid assets, where we hope to hold interest rate of approximately 1% over the course of the year. Also note as well, the future M&A activity over the course of next year would serve to lower these cash balances and as such would have a nominal adverse impact on our net income and EPS accordingly. In terms of tax rate under C&DI, we expect tax rate for 2019 and for 2020 to both be consistently at 17%. Now, turning to free cash flow. As we shared in our Q3 call in 2018, we have outgrown our current Sunnyvale campus where we operated for over 12 years now and as noted on that call, we signed an 11-year lease renewal headquarters location just a few blocks away to accommodate our planned growth over the next decade. This project remains on schedule with a targeted opening in the fourth quarter of 2020. As part of this build out, we indicated that we plan to make modest investments in order to bring the building into compliance with our Office Standards and we currently expect an approximate investment of $25 million in onetime net tenant improvements at the lower end of our prior estimate of $25 million to $30 million. For modeling purposes, the capital expenditures in total that will be incurred for incurred for the project will be $43.5 million, so this will be offset by approximately $18.5 million in the form of a tenant allowance that we've negotiated with the landlord. Note that this offset will run through the operating cash line of the cash flow statement as opposed to netting directly against the capital expense. With this in mind, when excluding the onetime cost for our headquarters, we currently expect our free cash flow to grow by 24% year-over-year to approximately $250 million or roughly 24% of revenue, demonstrating the strong free cash flow characteristics of our financial model. On a reported basis, hence including the investments in our new headquarters, we expect free cash flow to be approximately $225 million or 21% of revenue. We believe that this outlook - this initial outlook is particularly compelling given our commitment to innovation as well as the ongoing investments we're making to pursue the key opportunities in the market. As in prior years, we expect the majority of this cash flow to be delivered in the second half of the year with just under 30% generated in the first half. This 2020 guidance assumes total capital expenditures of approximately $93.5 million including the just noted headquarters capital investment of $43.5 million which again will be partially offset by the $18.5 million dollar TI allowance that will run through operating cash flow. Similar to past year, we plan to further refine our 2020 forecast as we complete our planning process and gain additional insights from our extended network of partners and channel sales, but we believe that this is a thoughtful starting point. As a final comment, I would like to highlight that this guidance for 2020 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 initial 2020 outlook of 20% revenue growth and 24% free cash flow margins, when adjusted for the onetime headquarters investment these metrics would suggest a figure of 44 under the rule of 40 construct reflecting a very attractive financial model which continues to place us prominently in the top quartile of all publicly traded SaaS companies. In conclusion, we continue to execute well delivering strong top and bottom line operating results here in the third quarter and believe that Proofpoint remains well positioned to continue to drive disciplined growth with increasing free cash flow margins built on our improving 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 again 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:]

We'll go first to Jonathan Ho with William Blair.

[Jonathan Ho:]

Hi. Can you listen to me, okay?

[Gary Steele:]

Yes, we can.

[Jonathan Ho:]

Perfect. I just wanted to start out with a question around your billings guidance and particularly for the fourth quarter, just given the outperformance this year and maybe what you’re seeing in terms of puts and takes around that guidance.

[Gary Steele:]

Yes. Thanks Jonathan, that's a good question. As we look at the overall business and again with the billings number for the full year being over $1 billion, our focus is on essentially, as I talked about and the reason why we're suspending the billings guidance going forward, our focus really is on how do we deliver the revenue metric and how do we deliver the cash flow metric. And so we’re excited about raising both the revenue and the cash flow metrics for the year and we're excited about the guidance that we provide as a starting point for 2020. As we think about third quarter performance and where we see fourth quarter coming together, overall, we feel like that range that we've provided last quarter was the right range for us to be operating to. Keep in mind that it's delivering a 26% year-over-year growth rate in both the third and fourth quarter, so we think those numbers are compelling. So as we just looked at the outlook for the remainder of the year and how the pieces come together going in 2020, we felt that holding the overall billings guide for the full year was the right strategy at this stage.

[Jonathan Ho:]

Got it. Thank you.

[Gary Steele:]

We'll go to the next question.

[Operator:]

Yes, sir. We'll go next to Melissa Franchi with Morgan Stanley.

[Melissa Franchi:]

Great. Thanks for taking my question. Gary, I'd like to start with just maybe a high-level macro question, just given you're one of the first security companies to report this season. So there's obviously some concern about softening IT spending. I'm just wondering - it doesn't seem like you're seeing any of that, but just wondering if any of the customer conversations have changed? And then, Paul, as you're thinking about Q4 billings, was there any incremental conservatism embedded just given macro uncertainty?

[Gary Steele:]

Yes. Great question, Melissa. So throughout Q3, we did not any change in macro buying conditions. So we didn't see projects pushing out. We didn't see elongating sales cycles, and that's true really globally. And again, our footprint outside the U. S. is roughly 20% of revenue. So that would have less impact on it. So we were pretty consistent around the globe. Things were quite healthy for us.

[Paul Auvil:]

Yes. And your question specifically on Q4 and I probably should have touch on this with Jonathan's question from a minute ago. I mean, as we look at the fourth quarter, it's a very interesting timing in terms of the holiday calendars of when Christmas and New Year's come together. And we've already been made aware by a number of our customers that they're planning to have plant shutdowns to span a pretty meaningful period there's at the end of December. And given the fact that we have lots and lots of renewal business that's due in those last couple of weeks, it does add a little bit of complexity in working with those customers and getting all those over the line and that was another consideration as we were thinking about, should we raise billings guidance for the fourth quarter. Yes. Our view is, I can't control holiday schedules, I can't control when the CIO might be out on vacation and what have you. And given the fact a lot of contracts are quite large, they do - even when they're just for renewal require a fairly complex signoff process in order to get them processed. And so, just taking the holiday into account was part of how we thought about maintaining billings guide, because again the timing of -- as the pieces come together at the end of Q4 or early Q1, won't effect how we record cash flow or revenue as a business.

[Melissa Franchi:]

Helpful. Thank you.

[Operator:]

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

[Matt Hedberg:]

Hey, guys. Thanks for taking my questions. Gary, when you think of drivers for 2020, could you sort of summarize what you think the top three items could represent? Or that could represent upside to the initial 20% guide. And again, I guess, I wondering specifically to, if competitors share shift from legacy vendors, could be within one of those top three, kind of, given what's going on in the landscape?

[Gary Steele:]

Yes. I think, it's a combination of things. So, I think, that favorable competitive environment continues to play an interesting role for us. So that definitely factors in one of those top three. Second, for us would be, the early success we've experienced on bundles. So, as we noted in our prepared remarks we saw good early traction in Q3 with both our P0 and P1 bundles and some nice early traction with the larger P2 and P3 bundles, and some nice transactions noted in the prepared remarks. And then I think the third is we continue to invest in international a lot today as we reported 20% of our revenues coming from international. I think we've got interesting opportunity there as well. And then the final one and I would add number four which is our emerging product strength continues to be quite robust.

[Matt Hedberg:]

A bonus one, thanks.

[Gary Steele:]

You got it.

[Operator:]

We'll go next to Jonathan Ruykhaver with Baird.

[Jonathan Ruykhaver:]

Yes. Good morning. So regarding the bundle pack just curious on your view of the potential uplift the ACV on renewal, is it too early to identify any pattern? And then just in terms of a large enterprise opportunity for bundling when you think that would start to get more attraction?

[Gary Steele:]

Yes. It's a little hard to say. Obviously, customer pricing varies depending on vertical, depending on size of the customer what have you. The moving people to the lower end bundles like our P0 and P1. They represent some modest improvement in overall revenue, but small. I think 5% to 15% typically. But the P2 and P3 bundles are very, very significant step ups and as Gary noted in his prepared remarks it is large P3 transaction that we did with one of our long-time customers in financial services was a low 8 figure, 3 year transaction. So there is significant accretive value as we move people from kind of standard e-mail oriented threat deal frame work, to full P2 or a P3 deployment. So we’re quite encouraged given the early success that we're seeing here this year with the P2 and P3 upgrades in particular, in terms of the potential for them to help the meaningful secular driver of growth for us as we work our way into 2020 and beyond.

[Jonathan Ruykhaver:]

Helpful. Thank you.

[Operator:]

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

[Gray Powell:]

Great. Thanks for taking the question. Maybe just sort of a high-level one, so how do you feel about the potential to gain share against Symantec given their sales to Broadcom is there an incremental opportunity there? And then when you look at it do you have a sense as to how much of their e-mail business is maintenance revenue on a previously purchased appliance versus pure subscription that's sort of apples-to-apples with what you do? Thanks.

[Gary Steele:]

Yes. On that second question, Gray, we don't have any specifics on the exact breakdown as subscription versus maintenance. I think the one thing that is encouraging is there is a reasonable amount of recurring revenue there across there on-prem maintenance plus their cloud subscription. And then in terms of their overall opportunity, we've had good success over a long period moving customers from Symantec over to Proofpoint. And so with the changes that are occurring at Symantec, we think that's pretty interesting opportunity. We don't think those things happen overnight. We think that takes some time. But we are encouraged over the long-haul about customers who are on to Symantec and are looking for a next-generation product. We think we're a great alternative, and we think that can play out over the course of the next three years.

[Paul Auvil:]

Yes. I think the other thing, I'd add too, for those of who you have been following Proofpoint for a number of years. One of the things that was very interesting with McAfee formally exited the business. We found that for many of the opportunities we could go-in and sell our comparable offering to replace the existing McAfee capability. But in that sales engagement, sell additional products. And so might have been $1 that McAfee was receiving for every $1 they have been getting we might get $1.50 or $2 or more. And so given the breadth of our product line and our bundling strategy in particular, even for the customers that might be operating on a current maintenance renewal base. There is a significant opportunity for us to monetize that in a way that's well above beyond what Symantec was ever able to accomplish with that installed base of customers.

[Gray Powell:]

Got it. Okay, that’s very help. Thank you.

[Operator:]

We'll go next to Phil Winslow with Wells Fargo.

[Phil Winslow:]

Hey, guys. Thanks very much for taking my question. I just wanted to focus on the emerging products, how that again this quarter? Gary and Paul when you look out into next year, how you sort of factoring those in to 2020? And what are you sort of most optimistic on?

[Paul Auvil:]

Yes. So as we talked over the last few quarters, they have been over a third of the new and add-on recurring revenue that we booked and we definitely see ongoing momentum actually across a pretty broad set of those products. So we think it does give us a nice setup going into 2020, whether customers want to buy those individual emerging products on their own or whether they end up getting included in a P2 or P3 bundle. So, again, the set up for us going into 2020 with that broader product line and the emerging products in particular we think is pretty compelling. In terms of products that are kind of standouts, I don't know, Gary, whether do you want to provide some color there?

[Gary Steele:]

Yes. I would go back to some of the comments we made in the prepared remarks that we are seeing really high interest levels in our security awareness training, so they will want that business. I think we now have all of our sellers actively selling and prospecting on that. And because that market is relatively nascent and fast growing, I think we can actively participate in that growth. Second is EFD and Threat Response have been great staples and they represent opportunities as we think about bundling. And then, finally, we referenced CASB and the opportunities there associated with data loss prevention. I think with the changes, the broader structural changes happening within the industry I think we're well positioned there to go see nice growth in 2020.

[Phil Winslow:]

Great. Thanks, guys.

[Operator:]

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

[Ken Talanian:]

Hi, guys. Thanks for taking the question. I was wondering if you could comment on your M&A pipeline and where you think asset prices are relative to history?

[Gary Steele:]

Yes. That's a good question. I think overall the M&A landscape continues to be interesting to us. We continue to look at reasonable number of opportunities as we always have. It's hard to say whether overall pricing has meaningfully changed in the market, may be on the margin. I'm seeing a handful of people that are little more rational in their view of valuation of the enterprise that they built but I would say that we're still not quite there yet. But that doesn't keep us from looking and there's certainly some things that we're interested in and we continue on our march to look for great intellectual property developed by others that we think fits into our framework that we can add to bolster how we better defend and provide compliance for all of our customers in this people-centric security and compliance model.

[Paul Auvil:]

Yes, and I think our strategy has been where we have to build a very big and broad pipeline and so we have to be looking at a lot of things, because value is varied across that broad range of companies. So we just have a very active approach in how we evaluate and I think we will always maintain a very disciplined approach in what we are willing to pay for things.

[Ken Talanian:]

Great, thank you.

[Paul Auvil:]

Thanks, Ken.

[Operator:]

We'll take our next question from Gur Talpaz with Stifel.

[Gur Talpaz:]

Great. Thanks for taking my question. Just following up on Ken's question, given the size of the capital raised you just conducted, would you consider bigger M&A or perhaps larger acquisitions what you've done in the past? And then just one follow-up for Paul, given that you're calling the billings guidance, would you consider giving another metric something like ARR down the line as a way to gauge the business going forward? Thank you.

[Gary Steele:]

Yes, I think in terms of looking at bigger things, I think our -- we continue to really operate within the framework of our people-centric model and what M&A fits within that broad framework where we're either enhancing our ability to identify threats or we're providing additional adaptive control to better secure an enterprise. And with that, we're going to be extremely thoughtful about that size of deals that we can be successful with. We don't today see anything that is transformational, but we would go after that's not within our lens or things we're looking at. We just continue to operate within our broad framework of how do we extend people-centric, deliver more value to our customers, get great teams and then operate with a high level of price discipline.

[Paul Auvil:]

And to your question on metrics we are evaluating what we want to do going forward as we work our way to 2020. So, to your point having decided to suspend our practice of providing billings metric which is we looked across kind of all $1 billion plus SaaS companies, pretty much everyone moves away from that as they get to larger scale. Whether we would introduce ARR metric, RPO, something like that is something were currently considering, but haven't made a decision on that yet.

[Gur Talpaz:]

Hey, great. Thank you.

[Operator:]

Our next question comes from Sarah Hindlian with Macquarie.

[Sarah Hindlian:]

Great. Thank you so much. Thanks for taking my question. Gary I wanted to dig into you with the federal way that you noted in the quarter for 20,000 feet. And you talked about FedRAMP you talked about FedRAMP coming through across a coming through across a coming through across a coming through across a coming through across a number of areas. So, I think this is really important. And I'd like to hear a little bit more from you about how you're thinking about the timing and potential opportunity around the federal segments? And when we could expect to start to see the business become more meaningful for you?

[Gary Steele:]

Yes. So, in 2019, we continue to make federal investments both from a certification point of view, so getting FedRAMP obviously as you noted super- important and super-exciting to us and it became the catalyst for that large deal that we won in the quarter. We've also continued to build team and scale of team with respect Federal. So, we think that we have a great opportunity in 2020 to see more results from Federal and that I think will carry through the next 36 months. So, we feel good about that opportunity because we see this broader catalyst within the U.S. government to drive transition to cloud and we think we can be an active participant as organizations move to cloud to be part of their new security infrastructure. So, we're quite excited about that and I think we'll see this begin to play out in 2020.

[Sarah Hindlian:]

Terrific. Thank you so much. I appreciate that.

[Operator:]

We'll go next to Alex Henderson with Needham.

[Alex Henderson:]

Yes, just a clarification on the last one. Are you FedRAMP low, medium or high-end? The question I wanted to ask was really on the sale side for 2020? To what extent you are talking about accelerating you are talking about accelerating you are talking about accelerating you are talking about accelerating you are talking about accelerating you are talking about accelerating investments in sales hiring in order to penetrate international? How does the split between sales spend in the US versus international look? Thanks.

[Paul Auvil:]

Yes, so maybe just starting on that second question first. We've been making good baseline investments in our international over the last I'd call it 24 months now. And I think that we are pleased with the traction and progress. And you can see that of course reflected in the year-over-year growth rate of international versus domestic. So, I think as we're contemplating the numbers for that 2020 guide, there will be a disproportionate amount of hiring that will likely go on a year-over-year growth basis into international and likely Europe, in particular, where the team is definitely seeing some good momentum and some good success. So we will be investing in Asia-Pac. We're probably doing some work in and around Latin America as well. But I think Europe will be the biggest area of emphasis for us, given the fact that it's a security market that rivals the US market in terms of size and scale. It's kind of a natural place for us to focus. And, of course, all of these large enterprises and mid-sized enterprises that operate in Europe have the exact same security and compliance problems. Compliance could be a little bit different by country compared to the US, but all these enterprises have privacy issues they have to deal with in terms of mandates, both from the EU as well as often local country regulations that overlay on top of that. And so, we think it's an opportunity that's quite compelling. So we will be adding resources in the US. We think it's a great market and we're still, I would say, to some degree under distributed there, but there'll be more of a focus on growth in sales resources internationally, with Europe really being kind of first among equals.

[Gary Steele:]

And then with respect to your FedRAMP question with FedRAMP medium. That's what we're focused on, not FedRAMP High. We view that as the requirement across civilian and even DoD for most organizations.

[Alex Henderson:]

Thank you very much.

[Operator:]

We'll go next to Erik Suppiger with JMP.

[Erik Suppiger:]

Yes. Quick question on the emerging services, it's been about a third of your new and add-on business for last three quarters. You look out to fiscal 2020, where you think that could be as you exit this fiscal 2020?

[Paul Auvil:]

That's a good question. I would say that it's likely to expand. We don't specifically forecast emerging products as a segment, obviously, per se. But I think particularly as we see the P2 and P3 bundles take off, that will create further acceleration in the pull of how those products are deployed in the relative revenue allocation associated with them. So, I guess, I would say, likely to increase, but the thing I always like to remind people of is, for our sales team we pay them on recurring revenue, newer add-on recurring revenue and we have no bias in terms of what they sell. So we don't put any special space or accelerators or gates into the comp plan, because ultimately we want our salespeople to go out and sell whatever is easiest for them to go out and drive growth for the company, for shareholders with the idea that, well, get into account into account, once you're in the account, sell them more of what they want. Let's not be overly prescriptive refocus on product A versus product b versus product C. Growth is growth, cash flow is cash flow. And we do believe that the majority of our customers will want the breadth of our full product offering measured over time, but you never want to do anything where you're overly discounting a product just to try to hit the hurdle. And so, we avoid putting that into any of the competition plans for the sales team.

[Erik Suppiger:]

Would you be surprised to hit 40% by the end of fiscal 2020?

[Paul Auvil:]

No. I wouldn't be surprised if it got to that level.

[Erik Suppiger:]

Very good. Thank you.

[Paul Auvil:]

Yes.

[Operator:]

We'll take our next question from Gregg Moskowitz with Mizuho.

[Gregg Moskowitz:]

Hey. Thank you very much and good afternoon guys. Paul, I just wanted to follow up on Q4 billings commentary, if I could. If I think back to Q4 of last year, you had spoken about an increasing amount of business that was coming up for renewal. And you were right and we saw acceleration in billings growth. And, of course, every December we have a significant holiday season, right. So, I haven't had the chance to look at, but what I'm wondering is, calendar this year is set up to be logistically more challenging in terms of holidays than it was last year. Or are you just factoring in more conservatism around this, so to speak?

[Gary Steele:]

Yes. I would say that, again, it's scale, so now we're at a whole another level of scale as compared to last year. It adds logistical complexity. And then the holiday calendar just adds to that. So, for example, last year we had kind of a weekend to clean things up before we actually then ended up with the last day of the quarter. Here, there's no weekend. So, ending on a weekday and we have until midnight of that weekday to process whatever comes in and add to that the complexity of the timing of what we see as a lot of companies that are going to have extended vacation shutdown periods. It's a couple of different dimensions that I just want to be thoughtful about as the Chief Financial Officer for the company and the expectations we set for Wall Street. And again, as I shared in my prepared remarks, honestly, the timing of billings really is -- does not have much to do with anything in terms of how we deliver shareholder value because it doesn't affect the revenues I record in the quarter. And moving to billings a few days between the end of December and early January doesn't change the timing when that cash flow is going to be collected and delivered to the shareholders. And so it's, from our perspective, delivering a 26% year-over-year growth rate which is what the current guide is for the fourth quarter on billings is pretty substantial given our current scale and how we're operating. So, we feel good about that, didn’t see a need to move it.

[Gregg Moskowitz:]

Great. That's helpful. Thank you.

[Operator:]

We'll go next to Walter Pritchard with Citi.

[Walter Pritchard:]

HI thanks. I'm wondering Paul in terms of the way that you're guiding you've mentioned that your guidance -- the initial guidance for 2020 is very similar to what you've done in the past. I'm wondering if you compare to last year though, I think last year you were coming out of some uncertainty in the third quarter. Is it fair to say that your - you took a more conservative tact last year or are we thinking about - are you thinking about things similarly is how you guided that initial 2019 range I guess a year ago compared to what you're doing now?

[Paul Auvil:]

Yes, I’d say similarly and the difference is that as you say we were working through few issues with how people were ramping in the U.S. and some things with how we were scaling up international. In this case, well, I don't see those issues within the enterprise. We’re just operating at this next level of scale. And so we want to be thoughtful about how we're making assumptions about how all the pieces come together with the sales organization now operating at this next level over $1 billion, et cetera. And so I would say that the relative mechanics that I've gone through of thinking about the guide here in October for 2020 is similar to how we were thinking about the mechanics of the guide for 2019 and it's still early obviously at this point. We got quite ways between now and the end of 2020.

[Walter Pritchard:]

Okay. Thank you.

[Operator:]

We'll take our next question from Patrick Colville with Arete Research.

[Patrick Colville:]

Hi there. Thank you for taking my question. Can I switch slightly to a more strategic question around Meta Networks? And what the plan is for that company and the acquisition? And then also who you are going to be competing against in that market? Thank you.

[Gary Steele:]

Yes sure. So, again, just to refresh everybody's memory, Meta was acquisition that we did a very small - its Rio-based company, in May of this year. It falls in the zero-trans network access category. Our interest in Meta was to provide additional adaptive controls in our broader people-centric framework. We're very, very excited about this technology. It is early in its life and what we're focused on right now is early customer adoption. So while we’re seeing very good interest in the market with that particular product, we're really just working through the process of maturing the capabilities and better understanding how we can continue to drive interest and adoption of this new capability. It's a little early to call out who the competitors will be because we're one of the few companies that are focused on its people-centric view. We have seen the used cases that we're focused on of high interest for customers. So, for example, contract or access to network giving, again their contract represent a very risky group of individuals that if one of them were infected they could infect the whole corporate network. And so by providing access through Meta, organizations could put policies and controls around what systems and applications those individuals can see. And so that seems to be resonating quite well as the early use case. But I would say it's early and we're going to operate in this very early stage for the foreseeable future probably through the first half of 2020.

[Patrick Colville:]

Great. Thank you so much.

[Operator:]

We’ll go next to Taz Koujalgi with Guggenheim Partners.

[Taz Koujalgi:]

Hey guys, thanks for taking my question. I had a question on the pricing of bundles versus buying the products individual, can you comment on what the per seat pricing is to buy a bundle or supplying those products separately is lower than the product price would be, if you buy the product?

[Gary Steele:]

Yes, yes. If you buy a bundle especially P2, P3, you're realizing a modest discount, probably somewhere in the 10% to 15% range versus buying them individually. And for us the bundles are delivering some additional value at reasonable discount to customers, but more importantly it's way of really helping to frame for the customers this good, better, best concept of, hey I've seen this pricelist of 18 products, how do they fit together and what do I need to buy to deal with my broader people centric security compliant problem. And so the bundles are really about helping to frame that for our salespeople, for our channel partners, and ultimately for the customer.

[Taz Koujalgi:]

Got it. Thank you.

[Operator:]

We'll take our next question from Rob Owens with Piper Jaffray.

[Rob Owens:]

Good afternoon, guys.

[Gary Steele:]

Good afternoon.

[Rob Owens:]

Gary as you look at the success you've seen in archiving over the last couple of quarters. And I think if you look back at the story for the last five years this has always potentially been on the comment; it really feels like it's happening now. Maybe some of the puts and takes you're seeing around the market dynamics, what's happening, how pipelines are setting up? And as you look at 2020 and this being a potential catalyst over the next couple of years, just some of the puts and takes around how this markets involving? Thanks.

[Gary Steele:]

Yes, no. Thanks. Great question. So we're super enthusiastic and excited about the opportunity around archiving. And what we've seen is the larger incumbent players whether it be the Micro Focus, Autonomy Solution or the Enterprise Vault Solution under Veritas. There hasn't been a lot of innovation, and I think customers are beginning to look at what do they want to do next. And so we see great opportunities specifically in financial services and other regulated industries like health care to help those customers move to a next-generation solution. We continue to see very steady pipeline build in terms of those organizations basically reaching out and working on what their plan is to do -- what they want to do next. And I think the only trade-off here is that as we've noted in our prepared remarks is very difficult to forecast when these deals actually come to fruition. And so while, for example, we closed a very large deal that we noted in our Q2 remarks is actually a – one of the most significant deals we ever close in the company's history that was an archive deal. I think that they are just very difficult to forecast. So we feel like we've got a good setup for 2020 and 2021. And we're building pipeline nicely and we'll just – we want to be conservative about when we think those deals ultimately come to fruition.

[Rob Owens:]

Thanks.

[Operator:]

We'll go next to Daniel Bartus with Bank of America.

[Daniel Bartus:]

Hey thanks guys. I wanted to just zero in on CASB opportunity because it’s supposed to be such high growth market. So are you guys truly competing with and beating the leaders like the big CASB, SkyHigh or others? And is this a product that you can lead within 2020 or is it more of an add-on for existing customers? Thanks.

[Gary Steele:]

Yes. So we've made significant investments in this particular product area over the course of last 18. And what we saw in Q3 for example is some good early wins against all of the CASB players. We had wins both in existing Proofpoint customers as well as leading with that in new accounts. And so we feel like we're really well positioned as we enter 2020 to go attack that market and we're optimistic and hopeful that we'll see that to be an interesting contributor in this overall emerging product cohort.

[Daniel Bartus:]

Sounds good. Thanks

[Operator:]

We'll take our next question from Andrew King with Dougherty & Company.

[Andrew King:]

Hey guys, thanks for taking my question. I just wanted to focus on bundles a little bit. So in the past you guys might not seen the best win rates that you guys have expected in sub15000 mailbox space partially because of price competition. And it sounds like these bundles will sort of help you compete against those other competitors in that area. But how do you see that affecting the revenue contribution from the segment going forward?

[Gary Steele:]

Yes. So I would say that, just to clarify a couple of things. Sub 15000 -- we haven't really - if you think about that as sort of a framework, we haven't seen any sort of unique price competition in that space. Now if you want to get down to sub 1500 you get down some thousand it's a different realm and it's one that we sort of have always historically gone after more opportunistically. And so, it's a different level of value that you deliver there, when you have the likes of people like Barracuda and M1 cast operating there. It's a bit more of a commodity space because a lot of people outside of financial services and healthcare can't really differentiate between good and bad e-mail security. And so, we really focus on the verticals where we can get the most value as we look at those lower end markets. And then specifically for the people who don't value differentiated security, we have our essentials platform and we use that to serve the low end mostly through managed service providers and some of our channel partners. So the net of it is back to your question about bundles, we're excited that if bundles apply to all the people that we have historically looked at as enterprise customers whether it's 100 person bank in Oklahoma or whether it's a 100,000 person financial institutions located on the East Coast and everything in between. So the bundles are great way for us to bring our differentiated technology and increased deal sizes and improve how we enable our customers large and small to meaningfully change their security compliance posture, for all this contents that operates beyond the firewall. So hopefully that helps you see how the pieces fit together in terms of our model and how we think about serving the market

[Andrew King:]

Great. Thank you.

[Operator:]

We'll take our final question from Carson Sippel with Cowen.

[Carson Sippel:]

Hi. This is Carson Sippel on for Nick Yaho. I just wanted to circle back to the PSAT offering. Can you comment some point of differences in relative to other offerings in the market, particularly as more players entering the space? Thanks.

[Gary Steele:]

Sure. A couple of things that we focused on is one – we are leveraging our to inform the kind of simulations that actually happened because we fundamentally believe that you need to be training your users and rating awareness of your users on the actual threats that are happening as oppose to just made up phishing lures. That's one. Two is for customers who choose to purchase our broader protection suite, we've done very deep integration where when a user reports a particular phish, we can actually automate the holdback and process from grabbing the message, understanding whether based on our threat detection whether that is a malicious message. We cannot to do auto remediation, if it ultimately gotten delivered and that we can inform the user. This is what it's called clear. This is the integration that we talked about on previous calls. And so – and then the content that we built, we really focused on some key learning principles that have guided our path through, what kinds of content we want to deliver. And I think collectively those things differentiates us quite well in that market. And as I indicated in our prepared remarks, we continue to invest in pretty robust product road map. We release the whole set of new video content last quarter and there's additional customization capabilities that we announced in the quarter as well. So we've been on a very rapid to take advantage of the growth in the market. We feel really good about our positioning.

[Carson Sippel:]

Great. Thank you.

[Gary Steele:]

You bet.

[Operator:]

Ladies and gentlemen, this does conclude our question-and-answer session. I'll turn it back to Gary Steele for closing remarks.

[Gary Steele:]

Great. Thanks. I wanted to just take a moment and thank everyone for joining us on the call today. We are very pleased with Q3 results, our continued product innovation and excited about the continued progress with our people centric approach to cybersecurity and our path beyond the $1 billion in annual revenue. We believe we remain well positioned to drive attractive returns for our shareholders. And we look forward to talking to you on our next call and to see many of you on the conference over this quarter. Thanks so much for joining us today.

[Operator:]

Ladies and gentlemen, this does conclude today's conference. We thank you for your participation. You may now disconnect.