Proofpoint, Inc.
Q2 2018 Earnings Call Transcript

Published: 27 Jul 2018

[Operator:]

Good day, ladies and gentlemen. Thank you for standing by. Welcome to Proofpoint's Second Quarter 2018 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-Investor Relations. Please go ahead.

[Jason Starr:]

Thanks. Good afternoon and welcome to Proofpoint's second quarter 2018 earnings call. Joining me on the call today are Gary Steele, Proofpoint's Chief Executive Officer and Chairman of the Board; Klaus Oestermann, Proofpoint's President and Chief Operating Officer; and Paul Auvil, Proofpoint's Chief Financial Officer. We'll be discussing the results announced in our press release that was issued after the market close today, 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, July 26, 2018. 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 not reiterate or 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'll 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. Also, I would also like to remind everyone that we have adopted ASC 606 as of January 1, 2018, under the full retrospective method. And as such, all of the comparisons to prior financial periods as discussed on today's earnings call and outlined in today's press release are made in reference to our retrospective financials as revised in accordance with the ASC 606 accounting standard. So with that said, I'll turn the call over to Gary.

[Gary L. Steele:]

Thanks, Jason. I'd like to thank everyone for joining us on the call today. I'd like to start by welcoming Klaus Oestermann, our recently announced President and Chief Operating Officer. As the company continues to grow towards $1 billion in revenue and beyond, the board and I saw an opportunity to add an experienced executive to expand leadership capacity in support of our overall long-term growth objectives. In particular, Klaus brings a rich combination of international experience, channel knowledge and product aptitude, all of which will contribute to extending our leadership and driving overall growth in the business. I'd like to quickly turn the call over to Klaus to make some initial comments before I review our key Q2 results.

[Klaus Oestermann:]

Thanks, Gary, and good afternoon, everyone. While I'm still in my first month in the role, I'm excited to be here and it's been a true pleasure to meet the team, get a better sense of our capabilities throughout the organization. Proofpoint's seen tremendous success in the marketplace. And while our strategy is clearly working, I see a great opportunity to help amplify that momentum, particularly when we look at potential in how we scale out international business, channel operations, drive product innovation and expand our customer footprint around the globe. I look forward to meeting many of you in the investment community in the months ahead.

[Gary L. Steele:]

Thanks, Klaus. I'm looking forward to working with you to continue to drive growth and innovation in the business. It's great to have you on the team. So with that, let's turn back to the quarter. I'm pleased to report that we had another strong quarter, beating on all key metrics, driven again by the continuing demand for our next-generation SaaS-based security and compliance platform, the ongoing migration to the cloud and the rapidly evolving threat landscape. While the threat landscape is constantly changing, the motivations behind cyber attacks remain largely the same. Cyber criminals follow the money, which today is readily accessible through human factor exploits such as credential phishing and email spoofing, as opposed to infrastructure-based vulnerabilities. These attacks are often socially engineered and don't require expensive malware or advanced techniques to compromise individuals. And while the barrier to entry to launch these exploits can be quite low, the cost to breached organizations can be extremely high. In fact, the FBI recently reported that since late 2013, over $12 billion has been stolen globally through business email compromise and email account compromise attacks alone. Given this attractive financial model, bad actors are highly motivated to continue to invest in, innovate and execute these targeted attacks, often slipping through security defenses that are largely network and endpoint focused. As the traditional enterprise perimeter continues to blur and enterprises increasingly migrate compute workloads and applications to the cloud, this exposure to new methods of business compromise is only expected to grow. In fact, cyber criminals because have pioneered yet another way to compromise corporate email systems and employees, this time by hacking Office 365 login credentials and then masquerading as a legitimate employee. With that point of entry established, the attacker then has nearly unlimited opportunity to cause financial harm and further data loss for the affected company by tricking employees into fulfilling fraudulent and malicious requests. Note that even companies who have deployed single sign-on and/or multifactor authentication systems are often vulnerable. To defeat this new attack tactic, we recently announced the availability of our Cloud Account Defense service, which was internally developed through a combination of Proofpoint's rich threat intelligence paired with the CASB technologies attained through our FireLayers acquisition. This innovative and timely solution helps organizations detect and remediate these Office 365 account compromises. This is another great example of Proofpoint's unique people-centric vision of cybersecurity, which enables enterprises to gain visibility across all forms of business communications, including email, social media and cloud applications. With this unprecedented visibility, enterprises now have insight into who in their organization is being targeted, by which threat actor, in what manner, and how that compares to their industry peers. And while most companies know their very important people, or VIPs, very few realize who their very attacked people are, or VAPs. And, in fact, the VIPs aren't always an organization's VAPs. But the latter can be far more important to protect and monitor because of the sensitive content that they have access to and the risk that they pose to the organization. VAPs aren't the people who receive the most threats, but rather the ones that receive the most critical threats. Proofpoint has developed data science based models to score threats and then cover these prime targets within an organization and help our customers better protect their employees. Armed with this visibility, a security team can now take additional steps to increase the protection and controls for these highly targeted individuals. Now, turning to some of our key operating results during the second quarter. Our suite of Advanced Threat solutions, including Targeted Attack Protection, or TAP offering, continue to be an important contributor to the growth of our business. We had a number of noteworthy TAP and Protection wins this quarter including

[Paul R. Auvil:]

Thanks, Gary. First, I'd like to remind everyone that these results and comparisons are being reported under the new ASC 606 accounting standard, which we adopted in January this year under the full retrospective method. Please refer to my comments from last quarter for greater detail on some of the impacts of differences in our reporting under this new accounting standard. With that said, let's talk about our results for the quarter. We're very pleased with our operating results this quarter which represented our 60th quarter of growth since our founding back in 2002. Second quarter revenue totaled $171.9 million, up 40% year-over-year and above our updated guidance range of $168 million to $170 million. Note that adjusting for the impact of our recent acquisitions, as well as the effects related to ASC 606, the underlying organic growth rate was approximately 32% for the quarter. Billings for the second quarter were $197.9 million, an increase of 35% year-over-year and above the high-end of our updated guidance range of $194 million to $196 million. As explained in detail on last quarter's call, under ASC 606, the derivation of our billings metric now requires adjustments to reflect unbilled accounts receivable activity during the quarter, as well as any right of refund liability. For Q2, the adjustment related to these two items was a positive impact of $0.8 million in total. Contract duration across our new, add-on and renewal business was nominally higher than Q1 and still operating at the low-end of our historical range of 14 to 20 months. This trend in terms of duration is again reflected in our deferred revenue balances which ended the quarter at $491.2 million, up $25.2 million sequentially, with short-term growing by $21.5 million and long-term increasing by only $3.7 million. During the second quarter, our Advanced Threat segment grew 46% year-over-year and represented 75% of revenue. Our compliance segment grew 26% year-over-year, consistent with the growth expectations that we outlined during past earnings calls and represented 25% of revenue. We're particularly pleased with these results, given that this segment faced a difficult comparison on a year-over-year basis given some one-time professional services revenues that we recorded in this segment during the second quarter of last year coupled with the impacts under ASC 606. We expect growth in this latter segment to remain at these levels in the near term as the larger deals in the pipeline continue to mature. Turning to expenses and profitability for the second quarter, on a non-GAAP basis, our total gross margin was 77%, which was above our expectations, primarily driven by our strong revenue performance. During the second quarter, total non-GAAP operating expenses increased 42% over the prior-year period to $117.4 million, representing 68% of total revenue. Growth in spending was primarily driven by hiring both in R&D and sales as we added talent to both broaden and deepen the capabilities of our product offerings along with sales resources to build core capacity. And note that this was our first full quarter carrying the operating expense contributed from our acquisition of Wombat, which served to amplify our spending growth here in Q2. In terms of profitability for the quarter, we reported non-GAAP net income of $14.1 million, well above our guidance range of $8 million to $9 million, driven by revenue outperformance and our continued operating discipline during the quarter. Moving onto EPS, non-GAAP earnings per share for the quarter was $0.26 per fully diluted share, above our guidance range of $0.15 to $0.17. Note that the EPS calculation applies the "If-Converted" method to our convertible notes and, as such, adds back $431,000 in cash interest associated with the convertible debt and uses 56.8 million fully diluted shares for the quarter. We've included a section in our press release entitled computational guidance on earnings per share estimates, which is intended to provide additional details on this topic and to explain the resulting differences in share count used in these calculations based on the results. On a GAAP basis, we recorded net loss for the second quarter totaling $34.3 million or $0.67 per share based on 50.9 million shares outstanding. In terms of cash flow, we generated $30.1 million in operating cash flow and invested $8.1 million in capital expenditures, resulting in free cash flow for the quarter of $22 million above our guidance range of $15 million to $17 million. Now turning to our financial outlook starting with the third quarter; we currently expect billings to be $218 million to $220 million, resulting in year-over-year growth of 32% at the midpoint. Regarding our revenue outlook, we expect a range of $180 million to $182 million or 34% growth year-over-year at the midpoint. We expect recent acquisitions to contribute roughly 800 basis points for our growth during the third quarter and, with that said, as mentioned on previous calls, ASC 606 creates a headwind to our results this year and adjusted for the impact of the new accounting standard, effective underlying growth rate of our business based on this guidance is roughly 28% in the third quarter. We expect third quarter non-GAAP gross margin to be approximately 77.5%, reflecting ongoing operating discipline and cost synergies gained from the recent migration to our next-generation SaaS cloud system. We expect third quarter non-GAAP net income to be $14 million to $16 million or $0.25 to $0.29 per share. This guidance assumes an income tax provision, exclusive of discrete items, of approximately $0.1 million during the quarter, depreciation of approximately $8.5 million, and a share count of 57 million fully diluted shares outstanding, and of course, adding back the $431,000 in quarterly cash interest expense for our convertible notes as prescribed by the "If-Converted" method. In terms of free cash flow, we expect free cash flow of $45 million to $47 million. This third quarter guidance includes capital expenditures of roughly $10 million. From a full year perspective, we're now increasing our billings guidance for the full year and expect billings to be in the range of $870 million to $874 million, which represents an annual growth rate of 37% at the midpoint of the range, up from our previous guidance of $866 million to $870 million. Note that the timing of the actual billings recorded in the first two quarters of the year when combined with the guidance provided here for the third and fourth quarter suggest that our billings linearity across the four quarters of 2018 will be almost identical to our 2017 linearity. In terms of revenue guidance, we're raising our estimates to a new range of $705 million to $709 million, an annual growth rate of 36% at the midpoint as compared to our most recent guidance of $702 million to $706 million. When taking into account the impact of our recent acquisitions for the full year in conjunction with the headwinds from the transition to the ASC 606 accounting standard, the underlying organic growth rate associated with this guidance is roughly 29%. Note that this full year guidance when viewed in the context of our guidance for the third quarter implies revenues of a bit over $191 million at the midpoint of the range for Q4, an absolute growth rate of roughly 31% and an organic growth rate of roughly 27% when adjusted for acquisitions and the impact of ASC 606, the latter of which creates a particularly difficult compare here at the end of the year. As we mentioned on last quarter's call, under the new standard, we have some greater variability in terms of growth rates quarter to quarter under the new accounting standard based on the amounts of accelerated revenues recognized and recorded in any given period. And as a reminder, recall that we've changed certain elements of the Cloudmark business model by terminating certain OEM agreements and discontinuing their practice of perpetual licensing, which creates a downward trend on these revenues over the arc of 2018. We expect full year 2018 non-GAAP gross margins to be just over 77% and within our 2020 target range of 77% to 79%. As a result, we expect full year 2018 non-GAAP net income to be $62.5 million to $66.5 million or $1.12 to $1.19 per share, an improvement from our previous guidance of $55 million to $60 million or $0.91 to $1 per share. This full year guidance assumes an income tax provision, exclusive of discrete items, of approximately $2 million to $2.5 million, depreciation of approximately $33 million to $34 million and a share count of approximately 57.1 million fully diluted shares outstanding, and adding back the $1.7 million in cash interest expense as prescribed under the "If-Converted" method. For 2018 cash flow, we're raising our free cash flow guidance for the full year to the range of $148 million to $150 million or 21% of revenue. This assumes capital expenditures of roughly $40 million for the full year. Note that this guidance suggests a free cash flow margin of 27% for the second half of the year. It is important to note that we're producing this cash flow with an average billed contract duration in the low-teens based on the model with over 95% recurring revenues and renewal rates over 90%, which highlights the high quality of the recurring cash flow that our business generates. The quality of our business model is effectively highlighted in the context of the Rule of 40 methodology, an approach increasingly used by investors to evaluate SaaS businesses. This metric considers the classic trade-off between revenue growth rates and cash flow margins by adding the two together with the notion that the sum of these two figures should be 40% or greater for a well-run SaaS business. Proofpoint continues to execute well above this threshold of 40%, demonstrating our ability to drive the combination of attractive revenue growth and cash flow in a way that separates us not only from the majority of security companies, but also the broader set of publically-traded SaaS companies, and further demonstrates our commitment to drive attractive and disciplined top line growth with strong free cash flow margins as we continue to deliver compelling returns for our shareholders. A reconciliation of our GAAP to non-GAAP guidance for both the third quarter and full year 2018 can be found in our release that we issued this afternoon. 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 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 go to Andrew Nowinski with Piper Jaffray.

[Andrew James Nowinski:]

Thanks. And congrats on a nice quarter. Over the last four years, you've made about 10 acquisitions and you've launched many new add-on solutions. So I'm just wondering if you could give us an idea of what the average spend per user is now across your installed base and what it was back in 2014 before all the acquisitions that you made.

[Paul R. Auvil:]

Yeah, we don't actually put those numbers out. And part of the reason is that, as you can imagine, there is a broad variety in terms of what that price per user on average is depending on whether you're a Fortune 100 bank with hundreds of thousands of users or whether you're a small regional bank that's got maybe a couple of hundred users in the state of Oklahoma, for example. And so, those price per user comparisons aren't all that effective even across a vertical like that and, of course, then when you start thinking about a retailer or healthcare institution or what have you. And so, quite frankly, we don't actually track that data because we haven't found it to be particularly helpful. Now, what I can tell you is that we've seen a nice improvement, we've talked about this at past analyst days, in terms of the number of customers that have one, two, three or more products. And so, whereas when we first went public, literally, almost 75% of our customers only had a single product. We made significant headway and now well over half of our customers have two or more products with roughly little over 25% of the customers having three or more. So, to your point, Andrew, we've got a very broad product line and it's really helpful for us both in driving add-on business with customers as well as having yet another way in the door when we're looking to acquire a net new account. And I will tell you, as is a typical of many quarters, this quarter, if you look at the total new and add-on business that we closed that drove growth quarter-to-quarter sequentially, about half of the business came from new and about half from add-on. And this is very typical. In fact, for 2017, if you look at that stat, it was almost spot-on at 50/50 in terms of new and add-on from the recurring revenue that we closed. And for the first half of the year, we're right on top of that metric. So, we purposely look to execute where about half of our business comes from add-on sales to the installed base and about half comes from new.

[Andrew James Nowinski:]

That's great. Thanks, Paul. Keep up the good work.

[Paul R. Auvil:]

Thanks.

[Operator:]

Thank you. We'll continue on to Philip Winslow with Wells Fargo.

[Philip Winslow:]

Hey. Thanks a lot for taking my question. And Klaus, also very excited to start working with you again. Just wanted to focus in on pricing and competition; anything that you'd call out this quarter from a pricing and competitive perspective or even if you just sort of look at the first half of this year versus last year?

[Gary L. Steele:]

Hey, Phil. It's Gary. No, I think consistency was pretty much the same as last year when we look at the large incumbents. And as customers migrate to the cloud, they are thinking about taking out their on-premise capabilities. And so that was really very consistent. Yes. So, no fundamental changes from this year from last year.

[Paul R. Auvil:]

And I think the one thing I'd add is we look pretty carefully at a bunch of analytics every quarter. And what's interesting is that if you look across the bands of kind of average deal sizes and then measure that across the number of deals that we're doing in each of those categories, the numbers here in the second quarter were very consistent with what we've seen as our historical averages.

[Philip Winslow:]

Got it. Thanks, guys.

[Operator:]

Thank you. Anne Meisner with Susquehanna Financial Group has our question.

[Anne M. Meisner:]

Hi. Thanks for taking my question. Paul, a quick question for you. Last quarter, we saw invoice durations contract a bit and it sounds like that normalized a bit this quarter. Can you just talk about the assumptions that are underpinning your billings guidance both for Q3 and the year as it relates to invoice direct durations? Anything different, I guess, from the assumption that you made in Q1?

[Paul R. Auvil:]

Yeah. That's a good question. So, durations were an all-time low in Q1 and, in Q2, we saw them come up only nominally. And so, as we look at the second half of the year, we're assuming that durations continue to stay at kind of the low end of our range when I think about the guidance that I just provided for both the third and fourth quarter.

[Anne M. Meisner:]

Okay, perfect. Thank you.

[Operator:]

Thank you. Alex Henderson with Needham. Please go ahead.

[Alex Henderson:]

Great. Thank you very much. I was hoping you could talk a little bit about the fed segment in the marketplace, particularly as we're going into the third quarter. You've just gotten approval on the FedRAMP, so how long does it take for that to play out and when do you think that that will show up as a meaningful contribution to growth? Thanks.

[Gary L. Steele:]

Yeah. Great question. We do see the fundamental trends that have created success for us in the commercial markets to be playing out in fed as well. There is broad adoption or beginning broad adoption of cloud and, obviously, the threat landscape is quite complex. We started making investments here about a year ago and part of our product line is FedRAMP certified today. The remainder of the product line we have work that we're doing, so specifically with our Protection and TAP solutions. Those are not yet FedRAMP certified. And so while we've got a lot of investments going, we do not believe that Q3 will be a huge threat quarter for us. We think that the investments we're making will play out more in the next federal fiscal, not in the current federal fiscal. The one other thing I would say is we do see government broadly as an important vertical where we've had some good success in state and local across the U.S. We see that opportunity internationally as well. And so we think, over time, government will be an important vertical for us, but don't expect a big huge Q3 fiscal close.

[Alex Henderson:]

Would TAP be done by the next turn, the next year's?

[Gary L. Steele:]

Yes, yes.

[Alex Henderson:]

Great. Thank you.

[Gary L. Steele:]

Thanks.

[Operator:]

Thank you. We'll go to Ken Talanian with Evercore ISI.

[Kenneth Talanian:]

Hi, guys. Thanks for taking the question. Could you give us a sense for the scale and associated progress from the larger archiving deals in your pipeline for the remainder of the year?

[Gary L. Steele:]

Sure. As we've indicated on prior calls, we continue to see the pipeline build and, in Q2, as we noted in our prepared remarks, we saw a couple of nice deals close. That market continues to evolve favorably for us. We don't see a lot of innovation happening across the incumbent vendors, the non-cloud vendors. And we think there is a great long-term opportunity. So, I think we remain very optimistic about this particular segment. It is very difficult, however, to forecast exactly when those deals will close, but we feel very good about the long-term opportunity.

[Kenneth Talanian:]

Great. Thank you.

[Operator:]

Our next question comes from Melissa Franchi with Morgan Stanley.

[Melissa Franchi:]

Great. Thanks for taking my question. I guess just a high level question for Gary. Gary, I'm just wondering if you could maybe give a little bit more color on the rationale for creating the COO role now at this scale, and then given that you effectively have sort of new sales leadership, just wondering if you could talk about any expectations or any changes in the go-to-market motion.

[Gary L. Steele:]

Yeah, no, as I indicated in the prepared remarks, we viewed the opportunity to bring on additional leadership capacity as something that would help drive growth and scale in the business over the course of the next 3, 5, 10 years. And Klaus brings just a wealth of experience that we think is critical for the next leg of growth in the business. If you didn't notice, Klaus grew up in Europe, has a great perspective on the international market, and I think brings a lot of perspective and will be instrumental in helping us drove that next leg of growth outside the U.S. So, we're excited about that. From a sales point of view, we have extremely strong theater leaders running APAC, U.S. and EMEA. Those individuals work for Klaus today and we – obviously, we had a very strong Q2 and we feel very well aligned to have a great second half. We will continue to look for a worldwide VP of Sales. There is a search that's underway looking at both internal and external candidates. But we feel well-positioned given the strength of the theater leaders that we have.

[Melissa Franchi:]

Okay. Thank you very much.

[Operator:]

We'll continue on to Catharine Trebnick with Dougherty.

[Catharine Trebnick:]

Oh, thanks for taking the question. Gary, could you talk about your opportunities with the carriers and the MSSPs? Thanks.

[Gary L. Steele:]

You bet. So, as you are all well aware, through the Cloudmark acquisition, we have the opportunity to continue to grow footprint within the carrier community. That market has been growing somewhat slower, obviously, as we've talked about with the Cloudmark business. What is interesting though, to your point, is there is a lot of interest from MSSPs, oftentimes those MSSPs are owned by or led by carriers. And we've had some good early relationships and we're optimistic about what MSSPs can do for the company over time. I would say it's relatively early now, but it just represents a yet another element of channel and channel opportunity.

[Catharine Trebnick:]

All right, thanks.

[Gary L. Steele:]

You bet.

[Operator:]

Our next question comes from Walter Pritchard with Citi.

[Walter H. Pritchard:]

Hi, a question for Paul. Just on billings seasonality, it feels like your Q3 is maybe a little lighter than a typical year would be and the Q4 seems a little stronger. Is there anything in your pipeline or in the market that might be driving that?

[Paul R. Auvil:]

Not really. I noted in the script just because I thought it just beared highlighting. Given the guidance that I just provided for third quarter and then for the full year, which then obviously by definition implies the fourth quarter number, if you look at our linearity by quarter on billings for 2017, this linearity literally plus or minus 100 basis points is the same in each quarter for the four quarters of 2017. And it just speaks to the nature of the fact that, even in a subscription model, there is an emphasis and a focus amongst the broader customer base of buying in the fourth quarter. And, of course, that just continues because, as a subscription business, customers renew every year basically on the same date that they brought originally. And so, it just drives this really significant spike in fourth quarter activity compared to the activity across the other three quarters of the year. So, again, the numbers as you see them laid out now based on what we delivered in Q1 and Q2, the guide for Q3 and the implied guide for Q4 lineup right on top of the linearity for the prior year and absent anything outside expected, as we work our way into 2019, it will likely look very similar.

[Walter H. Pritchard:]

Great. Thank you.

[Operator:]

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

[Matthew George Hedberg:]

Thanks for taking my question. Gary, in terms of it acting as a catalyst, where are we in the deployment of Office 365 in your base? And have you noticed anything in terms of a change from Microsoft as a competitor?

[Gary L. Steele:]

Yeah. No, great questions. A couple of things. So, one, there's lot – it's really interesting, from an Office 365 perspective, we see lots of customers in motion, meaning, they're either in a stage of planning or they are in a stage of implementing. There is very few customers that we've seen that are all the way there. And so it's hard to really estimate and untangle those three categories. But I would say the vast majority of customers have some form of plan to get to the cloud at some point. And even the highly regulated financial institutions are building plans today. And I think those plans come to provision more like in a five-year timeframe. So this broad catalyst of move to the cloud is going to last for us for a long, long period of time. And I think that has a five-plus-year window of opportunity for us. In terms of the second part of your question, in terms of competitiveness of Microsoft, as we noted in our script, we saw a very high uptake for customers going to Office 365 and selecting our capabilities over the base capabilities provided by Microsoft. In the period, we saw no change in the overall efficacy or uptake on Microsoft solution. And so we feel quite good, again, that this broad catalyst will continue to drive growth in our business for the foreseeable future.

[Matthew George Hedberg:]

Thanks, Gary.

[Gary L. Steele:]

You bet.

[Operator:]

And Gabriela Borges with Goldman Sachs. Please go ahead.

[Gabriela Borges:]

Great. Good afternoon. Thanks for taking my question. Either for Gary or Paul, always some good detail on Office 365 and some of the specific displacements that you guys have won. Can you remind us, at a higher level, how do you benchmark and measure your share gain on the land piece of the email security stack? And maybe give us an update on how you think about the runway you have there. Thanks.

[Paul R. Auvil:]

Yeah, it's a little hard to – we don't actually have a stat where we track that. I would say that, generally speaking, as Gary described earlier, it's hard to understand exactly how many customers are running Office 365 across both our installed base as well as the customers that we choose to go after. What I think I continue to see as a real positive is that even for customers who having made the decision to move to Office 365 then want to come back and revisit their email security solution, we're seeing very high win rates and we articulate some of those in the prepared remarks every quarter. So, overall, we view the setup with migration to the cloud as something that works very much in our favor either directly when people first move and decide to bring in Proofpoint or later when they realize that the capabilities that they get from Microsoft don't really meet the measure of what they need to properly protect the enterprise.

[Gary L. Steele:]

Yeah, and just one other point here. We view every customer that goes to Office 365 as an incredible opportunity. So, whether we get them in migration or we get them after the fact, they're raising their hands aggressively to get help. And as we noted in our script, this new area of compromised accounts is putting us right in the middle of opportunity every single day. I spend a lot of time on the road with customers and, literally over the last 90 days, every single Office 365 customer that I met had compromised accounts and they did not know what to do. And that means that there is basically attackers in their email system using that against them every day, and those customers have to do something. And it's just creating yet more opportunity for Proofpoint.

[Gabriela Borges:]

Makes sense. Thank you.

[Gary L. Steele:]

Thanks.

[Operator:]

We'll continue to Steve Koenig with Wedbush.

[Steve R. Koenig:]

Hi, gentlemen. Thanks for taking my question. Just on the product side, so you're already winning some CASB deals and (42

[Gary L. Steele:]

Steve, that market is relatively young, so it's a little bit of everything. So what I would say, over the course of the last 90 days in particular is the deals that we noted are all customers that likely had some form of compromised accounts that allowed us to then drive the broader CASB opportunity. And so, it created unique differentiation, it created acceleration in the sales cycle and it created rapid adoption because people needed help to solve that problem, and we were uniquely able to do so. So I do think we have seen some amount of turnover where people might have made an early decision and weren't fully committed to what they purchased. But there's still a lot of folks that have yet to make a decision. And we're incredibly enthusiastic about this Cloud Account Defense solution simply because it's urgent; people have a problem, they are trying to fix it.

[Steve R. Koenig:]

Got it. Great. Thanks, Gary.

[Gary L. Steele:]

Sure. Thanks, Steve.

[Operator:]

Sarah Hindlian with Macquarie. Please go ahead. Sarah Hindlian - Macquarie Capital (USA), Inc. Great. Thank you very much. I would love to get an update from you guys in terms of what you're seeing from Mimecast in the market given they do seem to be more desirous of moving upstream. And then just another one really quickly, where are we in terms of the Wombat sales team integration with the Proofpoint team? Thanks.

[Gary L. Steele:]

Yeah, two great questions. So with Mimecast, it's been pretty much the same. I think aspirationally they'd love to move up-market. We still see there – if you look at their prepared remarks, their average deal size is still around $10,000 and obviously ours is much, much larger. We do see them attempting to win bigger deals, but it's nothing really different than we've seen in prior quarters. With respect to Wombat, sales integration has gone quite well. We have a pretty well oiled machine now, and we're pretty optimistic about pipeline. Still early. We'll have to see. We've had one quarter of operating together. And so, we'll have to see how that all plays out, but we feel really good about that opportunity with Wombat. And we see that the value of the technical integration to be of high value to customers. So the value proposition is working. Sarah Hindlian - Macquarie Capital (USA), Inc. Awesome. Thank you.

[Gary L. Steele:]

Thanks.

[Operator:]

Our next question comes from Erik Suppiger with JMP Securities.

[Erik L. Suppiger:]

Yes. Thanks for taking the question. Your emerging products, the newer products, you said they were over 20% of your business, of your new and add-on business. I think that was a consistent amount with last quarter. Can you comment a little bit in terms of what you're seeing? Is that just a rounding issue or is that continuing to grow as a contributor?

[Gary L. Steele:]

It's continuing to grow as a contributor. We just felt like the over 20% was a good benchmark to speak to. We'll probably provide additional color on it, if not later in the year, certainly for our full year stats that we talk about in our January call once we've completed our full fiscal year. But needless to say, we're really pleased with how the emerging products are executing. When you look at that performance, it's not just one or two products that's helping to drive that business; we really are seeing nice contributions from the entire cohort of emerging products. And every quarter, it's a little different in terms of some being a little more stand out than others. But the great news is that all these different offerings that we have for the sales team to work with, the sales team is fully up to speed doing a very nice job of getting those to customers, both in terms of add-on sales and the installed base, as well as including them in net new deals, both as differentiation as well as expanding deal size. And then, of course, just as a net new way of getting into an account where maybe the company – customer or prospect, if you will, is not quite ready to make a decision around their email security platform. Great, let me solve your CASB problem and let me get you some Wombat compliance training. Yeah, you name it, the list goes on. There are plenty of other ways for us to add value at that prospect in that initial sale and then engage in add-on sales downstream. So we're really pleased with how the emerging products category is executing.

[Erik L. Suppiger:]

Can you share which ones? If there's one two or three that are standing out in terms of contribution within that?

[Gary L. Steele:]

Yeah, I think two that I would note and you could actually see it in our prepared remarks. Two of the solutions are Email Fraud Defense, or EFD. Just the amount of email spoofing going on is really driving people to find a solution for email authentication. We're helping customers through that journey. So that's been incredibly popular. And then our Threat Response solution, where we're really delivering a set of automation that is very important to security teams these days, I think those two have resonated highly and we see a high level of attach in the deals that we're doing. You can just see it in the remarks that we made and the customer examples. You'll see those often noted as part of the transaction.

[Erik L. Suppiger:]

Very good. Thank you.

[Operator:]

Patrick Colville with Arete Research. Please go ahead.

[Patrick E. Colville:]

Hi, there. Klaus, welcome aboard. Can I ask you, if possible, what the levers that you are likely to pull on to keep up the momentum in Europe and in Asia or even maybe accelerate it?

[Klaus Oestermann:]

Yes. I think if you look at Europe, you heard last quarter that we opened up Italy and the Nordics. And I think as we start opening up more markets, that will definitely give us leverage and add more capacity in existing markets like the UK and Germany where we've been successful for a long time. And if you look at APAC, it's a continuation of the efforts there, strong presence in ANZ and growing in Japan. And there's plenty of room for expanding in that geo as well.

[Patrick E. Colville:]

Got it. Okay, thank you so much.

[Klaus Oestermann:]

Thanks, Patrick.

[Operator:]

We'll continue to Jonathan Ho with William Blair.

[Jonathan F. Ho:]

Hi, good afternoon. I just wanted to understand, now that you've broadened some of the product set offering, like how much of a difference is that making when you're engaging with customers to be able to offer sort of the fuller suite relative to maybe just the core solutions in the past. Just want to get a sense around your thought process there?

[Gary L. Steele:]

Yeah, a couple of things, Jonathan. So one is, it's making us more strategic. So we're capturing more spend and making it more strategic. It's basically elevating us as one of the critical security vendors in many of those Fortune 1000 customers. And one of the things that we're seeing today is we're seeing this theme of consolidation and consolidating spend towards us, and we think that is a great long-term theme to continue to help us drive growth in the business. So the breadth of the product line has been a significant strategic advantage for us.

[Paul R. Auvil:]

Yeah. And I think the thing that I'd add, and this is just a reflection on all the different data points I pick up across the enterprises, this evolution toward being able to really provide truly people-centric security to our customers is something that really resonates with them. And it's not that having world-class email security isn't first and foremost something that's important to every enterprise, but increasingly people are understanding that their problem is much broader than that. They need to be able to provide security and compliance for all the content that exists beyond the firewall, whether it's sitting in repositories like box or Dropbox, whether it's content that out on social that employees are engaging with, or whether it's very SaaS applications, whether it's your service cloud, Workday, what have you, all those things are points of entry into the enterprise for the threat actors and also points of compliance violation for the company overall. And so, being able to help people see that broader opportunity combined with this idea of going after, not just the notion of helping an enterprise understand who the VIPs are, but as Gary talked about in his prepared remarks, the VAPs or the very attacked people so that they can be particularly focused on understanding how to manage that population. That all really resonates with the customers that we serve in the marketplace. So I think this investment that we've made in R&D traded off against still, quite frankly, a very tight spend that we have in G&A. It has really helped drive this evolution of a really unique platform that we think is already resonating with customers and will make a big difference as we think about our execution over the next couple of years.

[Operator:]

We'll continue to Gary (sic) [Gray] Powell with Deutsche Bank.

[Gray Wilson Powell:]

Great. Thanks for taking the question. So I just want to follow-up on Walter's question from a few minutes ago because I'm not sure I fully understood the answer. So the full year guidance implies that billings growth accelerates by a decent amount in Q4 from Q3. I understand like linearity and seasonality, but just what would be main driver for the year-over-year growth rates accelerating in Q4? Thanks.

[Gary L. Steele:]

Yes, it's a combination of the things, but it's both – remember that historical we've had multiyear deals, right? So if you go back several years ago, we did deals that were three years, we did deals that were two years, and of course we do lots of deals that are one year. So you've got a combination of some multiyear renewals that are coming up in the fourth quarter that kind of stacks on to that renewal base in Q4 of this year compared to Q4 of last year. And, of course, then just our natural planning around what we would expect to see in terms of the new and add-on business that we close in the fourth quarter where you've got budget flush and all the other kind of normal spending behaviors that enterprises engage in at the end of the year. So it's a combination of all those things.

[Gray Wilson Powell:]

Okay, that's helpful. Thank you.

[Operator:]

We'll go to Shaul Eyal with Oppenheimer.

[Shaul Eyal:]

Thank you. Hi. Good afternoon, guys. Congrats on the quarter and thanks for taking my question. High level one. You guys were actually amongst the first security companies, I'm heading back to the second half of 2017 or the third quarter of 2017, that actually saw some positive GDPR, I would imagine, spending impact. What can you tell us about the state of affairs about GDPR and do you see that as some sort of a tailwind for the next few quarters? Thank you.

[Paul R. Auvil:]

Yeah. I'll let Gary chime in. But the one thing I want to make sure, if I go back and think about everything that we talked about regarding GDPR, since it became a notional issue broadly within Europe, we would've actually been pretty consistent in letting people know that while we think GDPR could potentially be an opportunity in the longer term, we've actually never in any of our reported quarters seen business that we felt was a direct result of the GDPR mandate. So while we do think that GDPR would suggest that you should buy world-class security compliance capabilities, and we do think that with GDPR placed, there could be a possibility that it could accelerate business for us, we have yet to see anything that we think are specific signs of that. So with that said, Gary, you want to add a little bit?

[Gary L. Steele:]

Yes, the only thing that I would reiterate on that front is, I do believe that GDPR is highlighting the need for European organizations to take a much stronger security posture. And we think that over the course of the next several years, we will benefit from that. And as Paul described, it hasn't been some episodic thing where we've seen any short-term response. But we do believe fundamentally that the capabilities that we're offering are critical to a solid security posture, and we do think that we'll benefit over time. So we think it will be a tailwind as the coming quarters unfold, but nothing in the short-term.

[Shaul Eyal:]

Thank you.

[Operator:]

And we'll go to Gur Talpaz with Stifel.

[Gur Yehudah Talpaz:]

Great. Thanks for taking my question. Paul or Gary, can you talk about the appetite for M&A going forward here? And I guess the question is, do you still see yourself kind of firmly in the digestive phase here or would you be more near term opportunistic if something did pop up that you liked?

[Paul R. Auvil:]

We actually let Manish take a vacation, which is why he is not on the call today. But you shouldn't take that as an indication that we're not always thinking about and pondering M&A possibilities. I think as we've shared with people when we announced that kind of rapid succession of three deals like last year and early this year, we told people that we want to take some time to digest those and make sure we integrated them and we were getting full value from them. So with that in mind, we continue to survey the landscape and there was a possibility that we might do something in the second half of the year. I can tell you, we don't have anything planned in the near term here, but we do continue to look at companies kind of small and even moderately sized opportunities, but don't have anything in kind of the near term planning horizon. But we continue to believe, and it's one of the things that I think is a very strong element of Proofpoint culture, whereas many successful tech companies, their engineering teams feel like, hey, if it were worth doing, we'd be doing it. So it's very much a not invented here philosophy. What's great about our engineering culture is that people get the fact that there are all sorts of really interesting things that other companies have been founded to work on and that there is great innovation going on, that we just don't have the bandwidth and the cycles to pursue. And so, to the extent that we can find one of those teams doing something that we think is really interesting and relevant to what we're delivering in our cloud platform, people are excited to see that acquisition get executed and welcome those people to the team. And so, we are continuing to look for those opportunities. And so, we'll see how things play out here between now and the end of the year. Gary, anything you want to add there?

[Gary L. Steele:]

No.

[Gur Yehudah Talpaz:]

That's helpful. Thanks, guys.

[Paul R. Auvil:]

Yes, thanks.

[Operator:]

Thank you. Ladies and gentlemen, our final question comes from Tim Klasell with Northland Securities.

[Tyler Wood:]

Yeah, this is Tyler Wood on for Tim actually. Thanks for taking our question. Post-acquisition, how commonly are you specifically seeing existing Wombat customers taking on other Proofpoint products?

[Gary L. Steele:]

Yeah, that's a great question. It's too early to answer that. So while we noted an example of a Wombat customer buying Proofpoint capabilities in Q2, it's only our first full quarter of selling. So we remain optimistic about that, but we don't have a ton of proof yet. So stay tuned, we'll keep you updated on that one.

[Operator:]

Thank you. And at this time, I'd like to turn the conference back over to Gary Steele for any additional or closing remarks.

[Gary L. Steele:]

Great. Thanks so much. I want to just take a moment and thank everyone for joining us on the call today. We're excited about our progress, and we believe we're well-positioned as we enter the second half of 2018. We look forward to talking to you on the next call and seeing many of you on the conference circuits in the coming months. Thanks so much for joining us today.

[Operator:]

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