Proofpoint, Inc.
Q4 2016 Earnings Call Transcript

Published: 27 Jan 2017

Operator:

Good day, ladies and gentlemen, and welcome to the Proofpoint's Fourth Quarter 2016 Earnings Results Conference Call. Today's conference is being recorded. At this time, I'd like to turn the conference over to Mr. Jason Starr, Vice President of Investor Relations. Please go ahead, sir.
Jason Starr:

Thanks. Good afternoon, and welcome to Proofpoint's fourth quarter and full year 2016 earnings call. With us today are Gary Steele, Proofpoint's Chief Executive Officer; and Paul Auvil, Proof's Chief Financial Officer. We will be discussing the results announced in our press release that was issued after the market closed today, and a copy of this is available on the Investor Relations section of our Web site. 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 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 also based on assumptions that believe to be reasonable as of today's date, January 26, 2017. 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 with the SEC on 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. 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 were very pleased with our strong fourth quarter results, which capped off another excellent year for the company. For the full year 2016, we delivered billings growth of 43%, revenue growth of 41%, and nearly tripled free cash flow to $60 million. I think it is important to note that this represents one of the highest annual growth rates that we have ever recorded in our five years as a public company, underscoring not only the scope of our opportunity, but also the remarkable execution delivered by our teams over the course of the year. Throughout 2016 we benefited from a combination of a healthy growth rate of new customers, a strong cycle of add-on sales to our install-base, and a world-class renewal rate that exceeds 90%. I believe that Proofpoint remains well-positioned to maintain its momentum over the course of 2017. Hackers continue to target individuals, not infrastructure through sophisticated attacks using social engineering, perpetrated across email, social and mobile. Attacks today, which include ransomware and other forms of malware as well as highly-targeted business email compromise or email spoofing campaigns are driving ongoing demand for advanced resolutions and increasing momentum for our emerging products. Throughout Q4 we continue to experience a healthy macro environment as we have not seen any changes in buying behavior from enterprises global, and linearity remain consistent with our historically norms. Also from an international perspective, we have not seen any impact from Brexit. Now, turning to some of our key accomplishments during the fourth quarter; we were very pleased with the ongoing traction of our advanced threat product suite as it again represented roughly half of the company's new and add-on business for the quarter. We entered 2016 with a little over 2,100 active paying Targeted Attack Protection or TAP customers, up more than 90% over the prior year. Some of the noteworthy cap wins during the quarter included a Fortune 50 telecommunications provider that purchased Protection, TAP, and Privacy for 175,000 users. One of the world's largest medical technology companies that purchased protection and TAP for 90,000 users, and a Fortune 500 global beverage company that executed a mid-seven figure multiyear booking adding Protection, Privacy, and TAP for 65,000 users. We expected the overall transition to the cloud will remain a long-term catalyst that drive demand for Proofpoint's broader security and compliance solutions as enterprises need to replace their existing on-premise solutions with cloud-based alternatives as they migrate their IT infrastructure to the cloud. In particular, during Q4, the shift to Microsoft Office 365 was another key growth driver as customers look for additional security capabilities to complement and enhance the base line solutions provided by Microsoft. In fact, our largest deal for the quarter was the billings value in the mid-seven figure range was a Fortune 50 retailer that purchased a three-year subscription for not only archiving, but also our broad suite of advance threat solutions including Protection, TAP, Threat Intelligence, Threat Response, email fraud defense, and a social product suite. We are particularly pleased with this win since the sale cycle for our advanced threat solution was less than three months, driven by the fact that the customer's experience with the Microsoft solutions fell well short of their requirements. Other examples of Office 365 wins during the quarter included a Fortune 50 consulting company that added TAP after increasing their user count to over 400,000. This is our largest TAP deployment in Q4, and was yet another example of an enterprise bolstering the basic security capabilities that get with Microsoft. A Fortune 500 services company that purchased Protection and TAP for 50,000 users, and the Fortune 500 company manufacturer that purchase Protection for 35,000 users. During the fourth quarter, our strong results were also driven by our high win rates versus the competition as large and midsized organizations are switching to Proofpoint's cloud-based solution and away from legacy providers. In particular, a key driver for our Protection business was the ongoing demand by enterprises protect against attack from what the FBI refers to as Business Email Compromise or BEC. As a reminder, our core protection offering includes unique detection capabilities that leverage our machine learning classifier to identify and catch BEC messages at the email gateway. We also provide a more comprehensive set of enterprise class capabilities built around email authentication as part of our email fraud defense solution enabling customers to directly address the growing threat of domain spoofing. Given the ongoing challenges that our customers are having in terms of finding and blocking these BEC messages, we expect this attack factor to remain a catalyst that drives demand for Proofpoint security solutions for the foreseeable future. A few examples of protection wins during Q4 included a large airline that purchased Protection and TAP for 70,000 users, a Fortune 50 retailer that purchased Protection and TAP for 60,000 users, and the large national retail chain that bought Protection and TAP for 43,000 users. With regards to our partnership with Intel McAfee, we continue to be very excited about this opportunity. During the fourth quarter, we saw a pipeline from this partnership continue to grow. That said, given the strength of business that we closed during the quarter coming from all of the other incumbent players in the industry, the new business involving McAfee replacements was similar to our activity during the first half of the year running at the high-end of our historical averages. As such, our strong fourth quarter result underscore the ongoing success we continue to have in displacing all of the existing legacy vendors as McAfee is only one element of this particular growth factor. As we look towards 2017, we believe that the Intel McAfee transition will likely provide a tailwind as large and midsize customers continue to migrate to our platform over the course of their remaining four-year wind down period granted by Intel. Turning to our emerging products, these new offerings are proving to be an excellent source of growth to complement our ongoing success with our TAP product line. These new solutions, which include our social, mobile, threat response, threat intelligence, and email fraud defense capabilities grew over 100% year-over-year and represented more than 10% of the new and add-on business closed during the quarter. In particular, our newly introduced email fraud defense product based on core technology that was acquired from Return Path in August of last year had an excellent debut during its first full quarter of availability with the sales team closing a few dozen new and add-on transactions around the world. A few of the key wins included a Fortune 1000 financial services company, one of the largest European-based home furnishing retailers in the world, and a large diversified European bank. We also continue to see significant traction of our social product suite, recording our largest quarter ever in terms of new and add-on business. As enterprises increase their engagement and social channel, they are beginning to fully appreciate the securities that are posed by unknown secured social media communication, and as such, are looking to secure those channels. A few of the key wins included a global 50 bank in Europe which purchased our solution to address their digital fraud risk, including a wave of angler fishing that was exploiting their customers over social media. And the top five global sports entertainment league which deployed our solution to protect their marquee social accounts from malicious content and hacks. Our success in engaging with customers over our ever broadening product line can be seen in the progress we are making in driving additional sales to our existing customers, specifically at the end of 2016, 50% of our customers were using two or more products, up from 44% at the end of 2015 and within that set of multi product customers almost half or 24% of our total customer base had three or more products at the end of the year up from 17% in 2015. This is even more compelling when viewed in light of our growth in total customer account which now stands at 5,300 customers at the end of 2016 up over 32% from just over 4,000 a year ago. These customer counts exclude essential customers sold to our MSFP partners. Rounding out our annual statistics, we ended 2016 with 344 customers in the Fortune 1000 each of whom has a significant enterprise scale of deployment it is important to note however that this represents only 34% of the Fortune 1000 leaving us with substantial opportunity to further grow our revenues through our best in glass security and compliance solutions. Note that we now have nine distinct product offering, not counting the TAP for SaaS solution that we expect to release later this year and as such, we have the significant opportunity to continue to expand our revenue footprint, within our existing customer base. This growing portfolio of security solutions also provide a significant opportunity to capture additional share from legacy providers and to expand our revenue footprint within our existing customer base particularly the 50% of our customers that still only have a single product. During the fourth quarter the growth rate of our cloud based archiving privacy and governance results improved to 31% on a year-over-year basis consistent with our guidance last quarter. In addition to the Fortune 50 retailer that I mentioned earlier, some of the key deals closed during Q4 included a Fortune 500 healthcare provider which added privacy for 65,000 users, a large healthcare provider that added archiving for over 20,000 users and a Fortune 500 financial services company that added archiving for 12,000 users. Additionally as we announced earlier this month, we are quite pleased to be positioned in the leader's quadrant in Gartner's 2016 Magic Quadrant for Enterprise Information Archiving for the fifth consecutive year. We view this as further confirmation of the company's proven ability to executing the archiving market enabling organizations to significantly reduce cost comply with regulations and streaming discovery for our regulatory and compliance purposes. In terms of our ecosystem partnerships with Palo Alto Networks, CyberArk, Imperva, and Splunk, we remain very excited about these relationships as all of the partners continue to be very engaged during Q4. Notable deals closed during the quarter that were influenced by our ecosystem partnerships included a large national retail change that bought Protection and TAP for 10,000, a large national energy company that purchased Protection, Privacy and TAP for 10,000 users and a large national distributor that purchased Protection and TAP for 40,000 users. I would also like to point out that during the quarter we were pleased with the momentum of the channel, as it once again accounted for over half of the new and add-on business closed for the quarter. Finally, we continue to make progress towards further expansion abroad with our international business representing 16% of total revenue and growing 35% year-over-year consistent with last quarter's performance, notable international deals closed during the quarter included a large European pharmaceutical company that added TAP for 170,000 users. A large European financial services company which bought TAP for 50,000 users and a large trading house in Asia Pacific that brought Protection and TAP for 25,000 users. The addressable markets outside of the United States in both EMEA and Asia Pacific represents the compelling future growth opportunity for Proofpoint and we plan to continue to increase market share in these regions. Before I hand it over to Paul, I want to share with everyone that Anthony Bettencourt has decided to resign from the Proofpoint Board of Directors effective immediately in order to further focus his efforts in his role as the CEO of Imperva. Anthony joined as a Director in March of 2012, just ahead of our initial public offering and has provided great counsel to myself and the company during his tenure. I want to thank him for his years of service to Proofpoint and our shareholders and wish him well in the years ahead. So in summary, our strong fourth quarter performance contributed to yet another record year for Proofpoint. Looking to 2017 the company is well-positioned to maintain momentum as Enterprises continue to select Proofpoint's cloud based advanced threat protection solution over legacy all alternatives given our proven capability in handling today's advanced security threats. Combining these elements with our superior go to market strategy strong balance sheet and proven ability to generate cash, positions the company for further market share gains in the over $10 billion total addressable market. With that, let me turn it over to Paul.
Paul Auvil:

Thanks, Gary. We were very pleased with our ability to once again exceed expectations across all of our key financial metrics during the quarter. Fourth quarter revenue totaled $106.8 million up 43% year-over-year and above our previously announced guidance range of $103 million to $105 million. Billings for the fourth quarter were $138.4 million reflecting growth of 42% on a year-over-year basis and exceeding the high-end of our previously announced guidance range of $133.5 million to $135.5 million. In terms of billings duration, we did see a modest uptick during the quarter as some customers were determined to commit upfront multiyear purchases despite our incentives to the contrary underscoring the Greenwich customers view Proofpoint's market-leading cloud platform as a fundamental cornerstone of their security and compliance architecture. This trend is reflected in our deferred revenue balances where short-term deferred revenue grew sequentially by $20 million over the prior quarter and long-term deferred revenue grew by $11.6 million. Turning to expenses and profitability for the fourth quarter; on a non-GAAP basis our total gross margin was 77% which was above our expectations driven by the revenue upside delivered during the quarter coupled with our ongoing improvements in efficiency of our cloud operations. In terms of our operating expenses we continue to invest in sales and marketing as well as research and development to support our future growth. During the fourth quarter total non-GAAP operating expenses increased 34% of the prior year period to $72.4 million representing 68% of total revenue improved from 72% during the same period last year. 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 to drive both new customer acquisition, as well as add-on sales to existing customers. Fourth quarter 2016 adjusted EBITDA was $14.8 million well above our guidance range of $11 million to $12.5 million primarily driven by the upside to revenue coupled with focused spending discipline across our businesses around the world. I would like to note that during the earnings call last quarter I had indicated that our move to deferred commission accounting in 2016 will have a favorable impact to our profitability for the fourth quarter of approximately $3.5 million in our guidance for the quarter reflected that benefit. In fact the actual impact was slightly less favorable than expected at $3.2 million. In terms of profitability for the quarter we reported positive non-GAAP net income of $8.5 million or $0.18 per diluted share based on $54.4 million fully diluted shares outstanding and adding back the $1.06 million in cash interest expense associated with convertible debt is prescribed by the converted method for calculating earnings per share. This result is well above our guidance range of $0.10 to $0.14 a share driven by the revenue upside delivered during the quarter without a commensurate increase in spending and marched our third consecutive quarter of non-GAAP profitability. On a GAAP basis we reported a net loss for the fourth quarter totaling $22.9 million or $0.54 a share based on $42.6 million shares outstanding. As a reminder we are now using two different share counts for our EPS calculations here on the call. In cases where reporting a loss we're calculating EPS using the basic EPS methodology with a share count is equal to the weighted average number of shares of common stock outstanding for the quarter resulting in a figure of 42.6 million shares for the fourth quarter and 41.9 million shares for the full year of 2016. We expect the first quarter 2017 share count to be $43.2 million in full year number to be approximately $44 million. In cases where we're reporting a profit we're calculating EPS using the diluted EPS methodology. The diluted EPS share count begins with the basic EPS share count and then adds two elements. The first element is to apply the treasury stock method to assess the dilutive impact of all stock options and other forms of outstanding equity awards that would serve to dilute the basic EPS figure. This first element adds 3.8 million shares to the basic figure for the current quarter. The second element is to apply the if converted method to our convertible notes the application of this method adds 8 million shares from both the 2018 and 2020 notes and hence the fully diluted share count for the fourth quarter is determined by adding a total of 11.8 million shares to the basic share count of 42.6 million resulting in a fully diluted share count of 54.4 million shares. We expect the fully diluted share count to be approximately 54.7 million for the first quarter of 2017 and approximately 55.7 million for the full year 2017. As a reminder, since we again trigger the if converted method, not only the shares associated with convertible notes included in the diluted share count but also the cash interest expense associated with the notes of 1.06 million is added back to net income as part of calculating EPS. As an important point when calculating the enterprise value per point keep in mind that when using the fully diluted share count associated with the if converted method, you must also eliminate the debt from the balance sheet since the share count is based on the premise that both series of convertible notes has been fully converted from debt to equity. Accordingly this means that the cash and equivalents on the balance sheet are entirely for the benefit of shareholders, enhance any calculation enterprise value should take this favorable unencumbered cash balance into account. So as an example with our closing stock price today of $82.63 and $54.4 million fully diluted shares outstanding the total market capitalization for Proofpoint would represent $4.5 billion adjusting the unencumbered cash balance of $397 million that suggests and enterprise value of $4.1 billion. 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. In terms of cash flow during the fourth quarter we generated $41.2 million in operating cash flow and invested $8.9 million in capital expenditures resulting in record free cash flow for the quarter of $32.4 million or 30% of revenue due primarily strong balance and collection trends. With this result we delivered a 24% free cash flow margin for the second half of 2016, a full year ahead of our original commitment four years ago which was deliver free cash flow margin of at least 20% in the second half of 2017. Turning to a quick summary of financial results for the full year 2016; total revenue was $375.5 million an increase of 41% compared to 2015 and Billings for the full-year of 2016 were $462.8 million up 43% year-over-year and above our final guidance for the year. For 2016 our adjusted EBITDA was $38.7 million and was a significant improvement over 2015. Note that during the call in January of 2016, we had indicated that we expected the full-year impact of our move to deferred commission accounting to be a benefit to EBITDA of approximately $4 million. Based on results recorded for the year the actual impact was only $3 million and for 2017 we don't plan to provide this relative comparison between the current policies given that both 2016 and 2017 are recorded using the same methodology. As a reminder with respect to our quarterly filings during 2016 this change in commissions accounting was applied retrospectively all four quarters of 2015 so that the results could be properly compared across the reporting periods as required of course by FASB. Non-GAAP net income for the year was $16.9 million or $0.37 per share based on $45.8 million weighted average diluted shares outstanding and represented a full-year of positive non-GAAP EPS in the company's history. Note that for the full year 2016 we did not trigger the if converted threshold for either the two series of convertible notes and hence the fully diluted share count is only adjusted to include the shares associated with stock options and other forms of outstanding equity awards based on the treasury stock method. On a full year basis, we generated $94.2 million in operating cash flow and invested $34.4 million in capital expenditures resulting in free cash flow generation of $59.8 million for the full year or 16% of total revenue. This new crippling of free cash flow over 2015 highlights the company's ability to generate strong free cash flow while at the same time delivering compelling top line results. Turning to the balance sheet, we ended the fourth quarter with $397 million in cash and short-term investments and $367 million in debt compared to $412 million in cash and short-term investments and $361 million in debt as of September 30, 2016. This sequential decrease in cash during the quarter was driven primarily by cash used for the acquisition of fire layers which was partially offset by the free cash flow generated, as well as contributions to capital from stock option exercises and our employee stock purchase plan. We ended for the quarter with an accounts receivable balance of $73 million resulting in DSOs of 49 days. Total deferred revenue for the fourth quarter was $312 million an increase of $88 million or 40% on a year-over-year basis. Now, turning to our financial outlook; we entered the year with good momentum and believe that we are in a position to increase market share and extend our technology leadership as we continue to invest in new product development and expand our sales and marketing resources throughout the world. As a result, we are increasing our outlook for the full year 2017 as compared to use that we shared on last quarter's call. Starting with the first quarter we currently expect billings to be $133 million to $135 million resulting in year-over-year growth of approximately 36% at the midpoint of the range. This guidance assumes that our duration returns to the mid teens consistent with the first three quarters of 2016. Note that in the first quarter of 2016 we benefited from roughly 5 million in early renewals pulled in from future periods and as such Q1 2017 billings guidance actually implies an effective growth rate of just over 40%. And as a reminder, our billings tend to be relatively flat from the fourth quarter to the first two quarters of the following year given the cyclical nature of demand inherent across the tech industry, as well as the timing of our renewal activity across the four quarters of the year. Regarding revenue for the first quarter, we are targeting a range of $109 million to $111 million or 39% growth year-over-year at the midpoint. As a reminder revenue growth tends to be a bit lower sequentially from the fourth quarter to the first quarter given that we employ a daily revenue recognition methodology with respect to releasing subscription revenue from our deferred revenue accounts. More specifically given the Q1 has only 90 days of revenue to recognize as compared to 92 in Q4, the result is a sequential decline in subscription revenue from the existing business of approximately 2% which equates to roughly 2.3 million at our current size and scale, which works as a headwind against the net new and add-on business that we closed over the course of the fourth quarter. Also note that this revenue outlook includes no material contributions to revenues from legacy business associate with either the acquisitions of return layers or fire layers or return path since their prior revenues were immaterial in the context of Proofpoint's current revenue run rate. Our plan going forward is to drive organic growth opportunities for Proofpoint by using these newly acquired technologies to introduce new products into the market. We expect first quarter non-GAAP gross margin to be approximately 76%, a modest decline from the 77% recorded in Q4 as our spending begins to catch up with the accelerated revenue delivered during the second half of 2016. Now that we are generating positive net income on a non-GAAP basis, we will no longer be providing guidance with respect to adjusted EBITDA and instead focus our non-GAAP net income guidance instead. We expect first quarter non-GAAP net income to be 3 million to 4 million or $0.07 to $0.09 rather per share, a decline from Q4 as our level of spending in R&D, cloud infrastructure services and sales catches up with our accelerated level of revenue. This assumes an income tax provision exclusive of discrete items of 0.9 to 1 million during the quarter, depreciation of approximately 5 million and the share count of 54.7 million fully diluted shares outstanding. And as a reminder, in applying the if converted method to each of the four quarters of the year, the quarterly interest expense associated with the notes of $1.06 million should be added back to net income for each of the quarters when calculating EPS. In terms of free cash flow expect to generate 15 million to 20 million during the first quarter which marks a strong start to the year coming on the heels of an exceptional result in the fourth quarter. This guidance includes capital expenditures of roughly $13 million, a $4 million increase from Q4 of '16. Most of the sequential increase is driven by a modest investment to remodel the third and final building understanding of campus which we leased during the fourth quarter. The completion of this project will give us exclusive access to all of the space across the three buildings in our complex enabling us to maintain a tight knit and cohesive work environment as we grow and importantly to remain in our current location through 2020 without the need for a significant campus investment. Note that first quarter is always a step backwards in terms of profitability and free cash flow when compared to fourth quarter as our operating expenses include our typical increase in costs associated with payroll taxes, sales kickoff, and initial sales and marketing investments for the year, and cash flow includes the payout of the company's annual bonus program as well as the accelerated commissions earned by the sales team during the month of December. From a full year perspective, we are raising our revenue guidance to a new range of 30 to 31% of $488 to $492 million, a full percentage point above the guidance range that we provided in October and consistent with our guidance in terms of growth rate at the same time last year. We continue to expect billings to grow at a rate that is a few percentage point higher than revenue for the year with the initial range of $611 to $615 million and a reasonable step-up from our initial guidance in October due to our performance during the fourth quarter of 2016. We believe that this guidance is a strong starting point for the year, given the high growth rates delivered over the course of 2016 particularly Q2 and Q3 which were driven by unique circumstances in terms of linearity and churn that were much better than our historical norms, something that we don't expect to recur in 2017 as a result we do faced challenging year-over-year comparisons throughout 2017 in these quarters in particular. We expect full year 2017 non-GAAP gross margin to be approximately 76.5% demonstrating ongoing progress toward our 2020 target range of 77% to 79%. We expect full year 2017 non-GAAP net income to be in the range of $23 million to $25 million $0.49 to $0.52 per share using 55.7 million fully diluted shares outstanding and adding back 4.2 million in cash interest expense as prescribed under the if-converted method. This is up from our previous guidance of $21 million to $23 million or $0.45 to $0.49 per share on a fully diluted basis. We believe that this marks a very strong outlook at the start of the year, keeping in mind that our 2016 profitability benefited from very strong revenue performances delivered throughout the year, outpacing the rate at which we could productively invest in R&D, cloud infrastructure services and sales and hence guidance reflects the fact that we do expect some degree of catch-up in terms of our rate of spending over the arc of 2017. Finally in terms of cash flow, given the strong performance during the fourth quarter we are raising our 2017 free cash flow guidance by $5 million to $95 million to $105 million or just over 20% of revenue at the midpoint with the majority of cash flow delivered in the second half of the year based on a pattern similar to our results in 2016. We believe that this outlook is particularly compelling given our commitment to innovation and ongoing investments to pursue the key opportunities in the market and an excellent step towards the target patient 24% to 26% that we outlined as part of our 2020 model, during our Analyst Day in June of last year. Also I would like to highlight that we are producing this cash flow with an average build contract duration in the mid-teens which highlights the high quality of the recurring cash flow that our business can create as it scales. This 2017 guidance assumes capital expenditures of $40 to $42 million, depreciation of roughly $24 to $25 million, cash interest expense associated with the convertible debt of approximately $4.2 million and an income tax provision exclusive of potential discrete items of approximately $3.5 to $4 million, a reconciliation of our non-GAAP guidance for both the fourth quarter and the full year 2016 to GAAP can be found in our release that we issued this afternoon. And in fact, what I meant there is our guidance as compared to 2017. In summary, we continue to experience strong execution during the fourth quarter and believe that Proofpoint remains well positioned to maintain momentum through 2017 and beyond, given our proven capability to defend enterprises against today's advance security threats. Before turning it over to the operator for questions, I wanted to mention that we are planning to host our Investor Day in New York on Thursday September 7, and we will be providing additional details as we get closer to that date. In addition, given the increase coverage of company, we would appreciate if you would each ask just one question and a follow-up and get back into the queue, in order to allow everyone time to ask their questions. So, with that, I want to thank you for taking the time to join us on our call today, and we would be happy to take your questions now. Operator?
Operator:

Thank you. [Operator Instructions] We will drill first to Phil Winslow with Wells Fargo.
Phil Winslow:

Hey, thanks guys for taking my question. Just wanted to double-click on partnerships and at least some of the relationships that you talked about in 2016, you had the McAfee and Palo Alto Networks, if you kind of think about how those contribute over the course of the year, how do those trend versus your expectations, and as you are now looking into '17 versus where you all came out in '16, I mean how are you all thinking about it, you know, what sort of deltas you are expecting?
Gary Steele:

Yes, good question. So we were -- as we indicated in the prepared remarks, we are really pleased with the results across the partnerships we have. In particular, what we saw over the course of the year is phenomenally good feedback from customers as we discussed the technical integration work that we had done with each of these partners, and as you recall the cadence of introduction that we made with each of them. So Palo Alto got introduced as part of our earnings call in January. We subsequently introduced CyberArk and Imperva and Splunk at our Analyst Day in June. And so, Palo Alto has a full year. So we had just gotten started. We had outstanding start a year ago at this time. And so, I would suspect in '17, we will continue to see momentum across all these partnerships in a much more mature way. We continue to -- with each of these relationships look for additional opportunity where we can do more technical integration work to create more value with customers. We think what comes with that is additional interest and momentum. And I suspect that the number of deals influenced by these partnerships continues to grow as we move through 2017. And I think if you look across the security industry, the security industry has really not done much in terms of cross vendor integration, and I think that's why we are getting the positive feedback that we are. And so, not only does the technical integration will play a role, but we are getting good sales in the field engagement between reps, and that ultimately is something that is benefiting us.
Phil Winslow:

Great. And then just also one follow-up, I mean you had -- you know, Microsoft talking about spending a lot more on security, and you all talk obviously about the tailwind from migrations to Office 365, you know, I'm not sure if you have seen any see sort of change yet from Microsoft or have any conversations with them? Just sort of how do you think about sort of the potential, sort of the platform vendor, so to speak also providing incremental security?
Gary Steele:

Yes, I think that every customer that makes a decision to go to Office 365 evaluates the capabilities that Microsoft offers as part of their platform. And what we have seen though as organizations make that move from an on-premise environment to the cloud, there is a heightened concern about security. They typically when they make the decision to go with us they actually test us against the base capabilities offered by Microsoft, and that's how those decisions are getting made. We did not see any fundamental change in the competitive landscape as it relates to how our product would operate relative to Microsoft. And so, we were quite pleased with the momentum that was built in -- that we just saw over the course of the year as customers evaluated us versus Microsoft, we have seen absolutely no change, and we continue to believe that the move to Microsoft Office 365 or Google G Suite will continue momentum for us and our business.
Operator:

Our next question comes from Rob Owens with Pacific Crest Securities.
Rob Owens:

Great. Thank you for taking my question. Paul, you talked in your prepared comments about confidence in consumer concern, I wonder [indiscernible] a little bit in partnerships, external partnerships, and it seemed like through your prepared remarks that general contribution to add-on and new remained fairly consistent. And then you rationalized go-to-market there in terms of personnel. So, maybe strategically can you talk about some of the moves you guys have had in anticipation what you expect for the channel in the coming year?
Paul Auvil:

Yes. So we were pleased with the results that we saw in the channel in Q4, and if you go back in time, we really started initially with just a few national players. We had very good success with those national players. We then complemented that with two tier distribution [indiscernible]. And over the course of the last six months or so we continue to grow into the regional as well as additional national, international player. So, we are making a -- we are taking a very pragmatic approach to this. We are seeing very good uptake given the success we are having in the market channel partners signing on, and then you combine with that the work that we have done with the ecosystem partners that makes us that much more compelling. So for example, we had a good number of Palo Alto partners come to us, because they want to sell both products. So, broadly speaking, we are actually seeing a lot of demand from the channel to want to sell our products, and we think the channel continues to place increasing role in '17 as we continue to grow our channel presence.
Gary Steele:

Yes. And the other thing I think I would add to that just for everybody's benefit, and Rob, I know you are very familiar with this, but for everyone on the call, the way we operate with the channel is we have folks, both inside sales team members as well as people deployed in the field, and sort of depending on the size of the account it's either inside or field resources that work on the customers. And they are paid equally independent of whether the deal is closed by the channel or whether it's a deal that we find and close on our own. And so, we are finding an increase benefit of just partnering that goes on between our field sales people and the variety of partners that we have in each of the territories both in the U.S. as well as internationally. So, we don't have kind of that classic channel conflict that some companies will develop where the sales people might fight with channel partners over developing the business. Our field resources are really increasingly operating for the benefit of our channel partners to help accelerate their ability to be successful in the market and we are finding that program is scaling quite nicely.
Rob Owens:

Great. And then secondarily, can you talk a little bit about the centrals, how meaningful is it to revenue at this point, how has it grown, and do you see the same dynamic in the lower end of the market, where it usually outpaced Microsoft or is it more kind of bare knuckle spike down given a lot of those customers are probably looking at for more nimble functionality? Thanks.
Gary Steele:

That's a very good question. So, Essentials is a platform that we acquired several years ago originally built on non Proofpoint technology and we bought the Proofpoint capabilities into that cloud fabric, and it's designed to work with partners who serve that very low end of the market, primarily MSSPs. And so, really what we see in the dynamics of that market, and to be clear, Essentials is a immaterial part of our overall business, it's I think well under 10% of total revenue, in fact under 5%. And we find it -- it's a great place for us to develop and try out new technology, but importantly it is a way to serve this set of partners that we otherwise wouldn't be able to productively and efficiently serve with our classic enterprise class cloud infrastructure. So with all that said, I think we are seeing is that, it really very much depends on the nature of the relationship between the MSSP and the other resellers and each one of the end customers, and that relationship drives very much from what we can tell the decisions that these end customers will ultimately make and what security platform they want. So I think in some cases where those relationships are quite as valued, ultimately maybe people move over to Office 365 and just use the Microsoft offering, or actually finding that the other business has grown nicely over the last year. And there are we think a number of people in that low-end category, who value the recommendations that they get from there MSSP partners and ultimately want to move over and have a unique and differentiated security offering like Proofpoint. With that said, we don't view that low-end market as a place for us to go aggressively attack, because I think there is a lot of inconsistency in terms of how people value technology for literally customers that have five, 10, 15, users on their mail system, but with Essentials and the relationship with the MSSP partners we are excited to continue to explore that market opportunity going forward.
Rob Owens:

Thank you.
Operator:

Our next question comes from Walter Pritchard with Citi.
Jim Fish:

Hey, guys. This is actually Jim Fish on for Walter. Thanks for the question. Just around archiving, it looks like it continued to accelerate again this quarter; can you discuss what tailwinds are coming on right now versus the last few quarters and who you are mainly replacing?
Gary Steele:

Yes, and a great question. So we definitely have seen acceleration in pipeline, acceleration in customer engagement, and what's driving that is there has been a number of shift in the industry that are forcing customers to rethink what their strategy is specifically with the move of the HP autonomy assets to micro focus, I think customers are just fundamentally trying to figure out what's going to happen to the investment they have made relative to autonomy, that's one and two with the spinout of Enterprise Vault which stocked part of Symantec it went with the VERITAS Carlyle asset, went to it with VERITAS asset under Carlyle I think those customers are trying to understand what the overall commitment is there and so, what is driven is just this customer just trying to understand what's going to happen and that's creating a lot of market movement today. We do think that continues to play out over the course of 2017, we are seeing pipeline increase, we are seeing a lot of interest there and I think it plays as well in the move to the cloud and to Office 365 or Google G Suite, people want to move their archives when they move their email and so as part of this, I think you have got a couple of drivers both the competitive or incumbent landscape as well as what's happenings with respect to infrastructure.
Jim Fish:

Got it. And then just one more for me, with FireLayers now close and I get it, it's a smaller deal and pretty early on, but how are the early days look especially within the sales force understanding the differentiation of this product versus competitors?
Gary Steele:

Yes, I will take this and Paul may add a comment as well. So with the FireLayers acquisition we have been very clear we are not going after the CASB market, what we are doing is we are extending our targeted TAP and Protection solution to be able to protect SaaS users from malicious content. So think about a malicious resume where they basically a piece of malware in a resume that got it uploaded to what Leyo [ph] or someone using One Drive and Office 365 and there is malicious content uploaded that way. We are basically allowing our customers, the extension of TAP to be able to look for that malicious content in those particular SaaS application, this is something that is different than what the traditional CASB guys have been doing and so we are steering clear the broader competitive dynamics that are happening in CASB itself. As I indicated in my script, we expect to have those capabilities generally available in the first half of the year. Our early customer engagement from a early access point of view has been very, very positive, but I would say it's very early in that product life cycle.
Jim Fish:

Got it, thanks guys.
Gary Steele:

You bet.
Operator:

We will now hear from Melissa Gorham with Morgan Stanley.
Melissa Gorham:

Great, thanks for taking my question. So I just wanted dwell a little bit deeper into the drivers for 2017. So Gary and Paul, you both talked how McAfee potentially or likely be a tailwind in 2017, it sounds like the emerging solutions are starting to ramp, I am wondering what that means for the core email protection and specifically how much more of a runway do you think, you have aside from the McAfee share gains but how much more you have to go, in terms of winning share in that market?
Gary Steele:

Yes, I think we have a long way to go and I think specifically the thing that I continue to be really excited about is broad movement to the cloud is forcing people to rethink all of that on-premise appliance and software infrastructure that they bought, we are replacing people every day as a result of this and so there is this natural catalyst as Office 365 becomes more prevalent and as newer organization think about Google G Suite, we believe we are at the very beginning stages of that opportunity with core protection. So we don't see that fundamentally slowing down as we get into 2017, we are as you indicated, we are really excited about the emerging product we had a phenomenal quarter across a range of product that growing 100% now representing roughly 10% of new add-on business in the quarter. We think this is a great complement, we continue to take share in the protection market of which we still have reasonably small market share, but long ways to go and you complement that with the broad product line where we can drive incremental value. We feel very good about the opportunity and drivers for 2017.
Melissa Gorham:

Okay, that's helpful. And then just one quick follow-up, in terms of guidance for '17 are you assuming any acceleration in McAfee share gains or you assuming just in line with or maybe the top end of the historical norm?
Gary Steele:

Yes, I would say the top end of historical norms plus or minus is sort of our view right now. So to the extent that there is an opportunity and we see some acceleration from McAfee conversions that obviously is an area that can produce some upside for the business.
Melissa Gorham:

Okay, thank you.
Operator:

Matt Hedberg with RBC Capital Markets. Please go ahead.
Dan Bergstrom:

Yes. Hi, it's Dan Bergstrom for Matt Hedberg, thanks for taking my question. So just to build on the 365 topic that's been touched on a few times here, could you talk more broadly about the relative level of upsell within that customer base, is there a higher catch rate of TAP or archiving versus the non 365 customers?
Gary Steele:

What's interesting, Dan, in your question is that as customers make the move to the cloud, they are forced to rethink sitting around their mail environment and so I think longer term and the opportunity for broader penetration is there because it kind of makes no sense to leave stuff behind on-prem, so contrast that to someone that we take out, that's an on-prem customer not going to Office 365, there is not that natural catalyst to make those other changes. So I think we have more opportunity frankly for broader penetration of all of our products when someone goes to the cloud because it simply doesn't make a lot of sense to leave something on-prem, it creates a hell of a hassle for the customer.
Dan Bergstrom:

Great, thanks
Gary Steele:

You bet.
Operator:

And we will take our next question from Gabriela Borges with Goldman Sachs. Please go ahead.
Chelsea Jurman:

Hi, this is Chelsea Jurman on behalf of Gabriela; thanks for taking my question. In the past you talked about the portfolio having the potential of $95 to $100 per seat. So now that you had these different nine products out there, can you give us any sort of update on what you see as being the total dollar opportunity?
Gary Steele:

Yes, that's a good question. That $95 to $100 is essentially build around those core nine products. That said I think as we introduce the TAP for SaaS product and FairLayers that will be an opportunity to further add to that and of course we do have other product in the works that we will help build that revenue per user opportunity over time. So we are actually really excited being at about that $100 today as we continue to sell add-on business into our existing customers and we do expect to grow that revenue per user opportunity through additional products that we introduce down the road.
Chelsea Jurman:

Great, thank you. And then as a follow-up; can you talk any more about what you are seeing in terms of customer budgeting priorities for 2017 since the past year, for email and are you seeing any shift in emails as being a top priority any detail you can talk about?
Gary Steele:

Yes, I think the one thing that happened it started happening really in 2015 we saw strong in 2016 and we will see it in 2017 is this there is a broader understanding and acceptance of the fact that, what is vulnerable today in the enterprise is the individual and as hackers move away from targeting vulnerability and infrastructure they are focusing using sophisticated forms of social engineering to go after individuals on either mobile and social. So frankly what we see is a higher priority towards our types of capabilities today than some of the other things that people maybe considering. The other factor in this to consider is when the decision is made to go to Microsoft Office 365 they have to decide what to do it about all of these about on-premise capabilities that lived in that broad email ecosystem and so that also is a catalyst to drive higher priority for some of the thing that we sell from some of the other security capabilities that they might consider buying. So it's almost a force prioritization in our favor and we fundamentally believe we will see that broad catalyst of movement to the cloud through 2017 and into 2018 and beyond.
Paul Auvil:

I think the only thing I would add as well as with our social and mobile products we are seeing the exploits now starting to move beyond email and into social and mobile. We have very unique capabilities both in terms of those products as well as the degree to which its integrated with this big data fabric that we build for many years around email itself and so our ability to go to customers and be able to provide one stop shop for dealing with people who would seek to exploit your employees not only through email as well as through social and mobile is very unique thing that we can offer compared to anybody else in the market.
Chelsea Jurman:

Great, thank you.
Operator:

And Jonathan Ho with William Blair.
Jonathan Ho:

Hi, good afternoon. I just wanted to start out with your comments around duration. Can you talk a little bit about maybe what drove the duration to be higher this quarter and maybe why you expect that to potentially revert back in 2017?
Gary Steele:

Yes it's a good question, I wish I knew honestly Jonathan, because all the incentive programs that we have in place both with our reps as well as pricing it very much drives customers to one year deals but all canters as I included in the prepared remarks, I would say what we found was some of the very large multi-year deals that happened in this quarter, these are customers actually many of them Office 365, who is part of looking at their plan realize look I valuated Proofpoint it's a perfect solution, it's got great capabilities and tremendous reputation in the industry and as a result, I am making a -- I am just going to make this commitment and write this check, I am not going to be coming back to this for the next several years, I got other things I need to work on and thinking about, reconsidering my email security posture and something I am going to be doing in the next year or two and so it just drives this spending behavior which we pleased to take cash early and the discounts we offer from multi-year now are very nominal and so it's actually finding beneficial for shareholders. But with that said, as I look to Q1 2017, for my planning assumptions, I just assume that we will operate in the mid teens historical norm. So if we do see this activity again in Q1, we will albeit it will probably drive some upside for us again in terms of helping to push cash flow, if not in Q1, Q2 depending on the timing of those deals and that will be fine.
Chelsea Jurman:

Got it. And then just a follow up in terms of the growth rates that you guys are seeing and sort of the new technologies, do you need to accelerate investments in spending on specifically in the areas like social and some of the newer opportunities that are out there, just want to understand sort of the dynamics around that piece of the business?
Gary Steele:

I think we're really pleased with the investment we've made in engineering over the years, right now our engineering spend as a percentage of revenue runs just over 20% and we do intend to continue to invest there on an absolute basis as we go forward although as a percentage of revenue, we expect it to decline modestly over the next several years toward our 2020 goals, with that said, I think we have plenty of capability based on what we have today and our current plans considering the guidance that we just provided for the year. And one of the things to keep in mind is that we credit some very important core intellectual property around machine learning, around big data technology and a few other core intellectual property components which we then use as a shared resource across both email and social and mobile and so it's not like we have to replicate that investment three times as we do that, we have a core team of engineers that run those systems and then you modestly tweak them to accommodate those three different venues and so we get this economy to scale as we build out to cover off those other factors that will be very unique compared to people who might want to only be in the social business or only in the mobile business, we leveraged this significant proprietary and actual property investment we made over the year and bring it to bear on these new venues.
Chelsea Jurman:

Great, thank you.
Operator:

Thank you. Our next question comes from Andrew Nowinski with Piper Jaffray.
Andrew Nowinski:

Well, thanks. I think you mentioned that you now have nine products and the SaaS product coming out later this year, you also continue to gain market share at the expense of your competition but you still have a very small footprint internationally, so I'm given your market leading position, I guess do you feel like you are appropriately balancing profitability and revenue growth this time or as opposed to increasing investments trying and accelerate revenue growth?
Gary Steele:

Yes, I think we got the right balance and it is something that Gary and I actually spend quite a bit of time thinking about quarter-to-quarter, how much do we invest for driving growth and footprint both in the U.S. where Canada was still fairly under distributed in terms of the footprint of sales team members that we have compared to that opportunity and then the investments internationally to your point, I think that as we look to build a world class enterprise, this trade off driving growth, driving cash flow, driving ongoing evolution of profitability all three of those I think are hallmarks of great companies as you look at businesses in the SaaS world across that $0.5 billion threshold that we are looking to drive over the course of this year, that current guidance at $490 million at the midpoint. Companies that have then gone on to do great things have generated this level of cash flow and profitability, so we think we can follow in the footsteps of others who did this before and do it same kind of long-term.
Andrew Nowinski:

Got it. Okay. And then on Q4 historically been a strong quarter on the magnitude of upside in Q4, it has been little bit higher in prior years, so I'm just wondering if you can tell us any larger deals may slipped out of the quarter and how your pipeline is compared to either last quarter or last year at this point, thanks.
Gary Steele:

Yes, nothing slipped out, it was a great quarter, deals we expected to close closed, we had a nice let's just call it backlog of opportunity that was the pipeline going into Q1 that we thought was compelling and allowed us to deliver the guidance we just provided for the first quarter and for the full year 2017 where we raised guidance and the guidance for 2017 now at 30% to 31% for revenue is spot on with the guidance we provided a year ago in terms of growth rates for 2016 in January. So I think as we looked at the business overall, Q4 was a great quarter, I would say that we are as we get bigger getting better at forecasting and providing guidance it is a little more refined and hence the magnitude of the upside of the beats will probably be a little more refined as well as we get bigger. Remember that in both Q2 and Q3 we had extraordinary linearity in the new business that closed and churn that was well below our normal averages and so we had some pretty big beats in Q2 and Q3 driven by those dynamics, Q4 was a return in normalcy if you will which I then expect as we go into 2017, so I think our fourth quarter beat was within the normal parameters what we would hope for back out October when we had our call, and we are pleased with what we delivered and excited about that guidance we provided for 2017.
Andrew Nowinski:

Got it. Keep up the good work. Thanks.
Gary Steele:

Thanks.
Operator:

And our next question comes from Imtiaz Koujalgi with Deutsche Bank.
Imtiaz Koujalgi:

Hey guys. Thanks for taking my question again I want to ask about the makes opportunity given that the end of flash that is already happened in 2017 shouldn't you expect the dollar pipeline from McAfee customers will be aggressive I think in 2016?
Gary Steele:

Yes, one thing to just put point on is that McAfee had cloud system that was mostly in SMB solution that end of life sort of final line in the -- is literally happening here in January. We serve that with our central platform that Brad Olens asked about little bit earlier so were picking up some business there, but it's not really a focus. The vast majority of the opportunity that's relevant to prove point is actually the legacy on-premise business that have been the original McAfee customers on-premise product as well as secure computing in cyber trust products that were acquired over the years that lined in the sand actually isn't all the way out until 2021 were all customers required to get off the platform. And so, there is a lot of run way here and you could see that in our Q4 results were, we're at the high end of our historical norms in terms of the percentage of new business coming from McAfee but not over it, because again we have some great business we took a lot of business from other competitors in the space in Q4 and I think again you got a number of McAfee accounts that they've got year literally before they need to move over and while we are working with them to see about accelerating the turning of that, each customers different in terms of how they think about that problem.
Imtiaz Koujalgi:

Got it, you guys have move from McAfee to Proofpoint so far can guys give us a sense of how many of those guys went to versus Proofpoint enterprise.
Gary Steele:

The vast majorities as measure on the revenue basis were customers that moved over to either our Proofpoint on demand product or do keep in mind we've a legacy on-premise product that for customers who had just transition moving to the cloud were happy to accommodate them and let them run either physical or virtual appliances but again from a revenue perspective, the vast majority of the McAfee conversions have been Proofpoint on demand the enterprise cloud solution or virtual physical on-premise appliances essentials is a very small part of that overall business.
Imtiaz Koujalgi:

Got it. Thank you.
Operator:

We continue on to Michael Kim with Imperial Capital.
Michael Kim:

Hi, good afternoon guys. Here with the fed rep certification of the archiving solution have you also received sort it operate from many federal agency, it may take roughly about a year or so give or take curious if you incorporating any contract order opportunities in '17?
Gary Steele:

Yes, well in terms of guidance in '17 I would say that we're still developing our federal business so well we are pleased to have fed rep certification and do have some customers running obviously under that certification as business that we developed over the years and I wouldn't say there any specific federal opportunities that when I think about the guidance we just provided are assumed to close in the year but we do think that there is a big opportunity there over time.
Michael Kim:

Okay, great. Thank you very much.
Gary Steele:

Thanks.
Operator:

And Ken Talanian with Evercore ISI.
Ken Talanian:

Hi guys thanks for taking my question so first you mentioned Google G Suite to couple times during the call I'm just wondering what your growth did on that platform in the quarter what your expectation over '17?
Gary Steele:

Sort of interesting if you look at 2016 as a whole we really didn't see much Google G Suite at all in the first half. We started to see, customers starting to talk about in the second half and we did have some number of customers that were Google G Suite customers come to us clearly the momentum has been with Microsoft Office 365 as we get all the prepared remarks we really talk about, simply just talk about Office 365 and so it will be interesting to see how Google does relative to Microsoft over the coming year but we, we're agnostic we can support customers to going up as 365 if Google G Suite becomes more of a place more of a row, we've got great references, great McAfee customers in that - as well but today the bulk of what we're seeing is Microsoft.
Ken Talanian:

Okay, great and just a follow-up question on the federal business what your current estimate on that opportunity and is that tied to either adoption of Office 365 but the government or Google G Suite?
Gary Steele:

Yes, I would say that federal opportunities is very large and we have very little of that business currently. And we've -- something that we've been investing in here and I think we're positioned to start to take some nice share there over the coming year too. With that said, what we do find is that a lot of the agencies still run on-premise and we do have an advantage that we have on on-premise solutions again both physical and virtual appliances, so we can serve the market that way. We also do see agencies that are starting to look at and move to Office 365 and as part of that move we are well-positioned to take business there in a manner no different than the manner that we can do that as the commercial customer moves over. We just need to continue to invest in the sales infrastructure to make we can develop those relationships and ultimately close that business.
Ken Talanian:

Great. Thanks very much.
Operator:

And we will go to Jason Nolan with Robert W. Baird.
Jason Nolan:

Okay, great. Thank you. I wanted to ask on customers with two plus and three plus products. Could you talk a little bit about the benefit they see, is it ease of use or integration or lower price points or maybe all of the above?
Gary Steele:

I would say that the real benefit is the fact that we have world-class products across all nine of these capabilities. And so, people pick the second to third to fourth product, because they love the first to the second product they bought, and they are looking to consolidate their spending around fewer providers who have you know, truly world-class capabilities that can really protect and defend their enterprise. And so, we do provide very modest price benefits if you buy a second product, but you know, as an example it's not if you buy three products you get 75% off or something crazy like that. It's a very, very small discount for putting the second to third or fourth product on top of the existing purchases that you have for us.
Jason Nolan:

Do you see common combinations across the portfolio?
Gary Steele:

We do. Many customers who have protection nationally will buy TAP, and often people will buy protection and TAP together. We also see that people are increasingly who are protection and TAP customers are buying privacy not just because they want to deal with the data loss prevention issue of employee setting up confidential information, but it's a very nice add-on to deal with the business email compromise problem to make sure people aren't accidentally sending out W2s or other confidential information to people outside of the company, it's just a way to confirm and insure that data will be trapped rather than accidentally forwarded outside of the enterprise. And obviously one of the things I was super-encouraged in the quarter was our ability to include email fraud defense on newest product that came through the acquisition to be able to slot that into either the initial sales cycle, where we would include it as part of our overall offering or add it on to an existing protection TAP customer. I was also super-excited about. And so, that's what gives us a reasonably high level of confidence that we're going to have a good year with EFD in '17.
Jason Nolan:

That's great. Thank you.
Operator:

Thank you. And we will go to Patrick Crowell with RE [ph] Research.
Unidentified Analyst:

Hi, there. Good quarter guys. So it makes -- points out that it seems like your cash flow margin implying guidance for next year is coming on quite considerably. Do you want to just kind of talk around that, please?
Gary Steele:

To be clear, our free cash flow margin for 2016 was 16%, and our current guidance is 20%. So it's actually up nicely. Now to your point, our fourth quarter of free cash flow margin was 30%, but it's you know, again like many things and for many companies fourth quarter can produce some exceptional metrics but then don't recur until some point in the future. So, we are actually really pleased with the free cash flow margins we delivered for the year, this year 2016 and our current guide for 2017. And as I talked about in the prepared remarks when we went public we told people that by the second half of '17 we deliver a free cash flow margin of at least 20% for that six-month period. We delivered a 24% free cash flow margin for the second half of '16, so we delivered more than that 20% commitment we did a year earlier, which is consistent with pretty much everything we have done since we have been public in terms of meeting or exceeding the expectations that we said at the timing of the public offering.
Unidentified Analyst:

Okay. I've got a quick follow-up on the TAP product. I think clearly you guys are way ahead of Microsoft in terms of email -- in terms of protection -- prevention; sorry, I mean is that both on the kind of the Miller product and the TAP or is it the TAP which is the kind of where you guys are much ahead?
Gary Steele:

Honestly it's across the board, it's anything from basic spam and a virus blocking to what TAP is designed to do which is deal with targeted attacks for URLs and attachments as well as business email compromise on all of those dimensions we are measurably better and it's for us to prove that by just simply running a production evaluation as part of the sales cycle, where again since all email traffic is coming from outside your enterprise, it's easy for us to put our cloud in front of that traffic, run some of that traffic and show you the measurable difference between what we can do and what you get as part of the Microsoft offering.
Unidentified Analyst:

Cool, cheers. Thank you very much.
Gary Steele:

Thank you.
Operator:

We will now hear from Steve Koenig with Wedbush Securities.
Steve Koenig:

Hi guys, I will skip the follow-up just ask an in depth question hear. So it sounds like fraud defense is doing pretty well, Gary, you spoke to it and for that emerging products, you really grew well in the quarter and it sounds like fraud defense was a big part of that. So just a couple of questions about fraud defense; first, can you talk to what additive in the skew versus the bundle functionality and the Protection offering and do you sell fraud defense to non Proofpoint customers like you do for TAP and then just lastly maybe can you give us some color on momentum or penetration rate considering that you are expecting as you go through 2017
Gary Steele:

Yes, so couple of things. So one is fraud defense is not part of the Protection and TAP bundle so that is just added on in the sales cycle. We have the ability to sell it to anybody, so we could sell it to someone who is not running our product today, having said that I suspect that won't be the situation because we are seeing such great affinity between ESP and Protection and TAP that I suspect our sales team will either be added into deals that they have going or they will be adding it on to existing customer accounts and again email fraud defense simply is helping organization drive authentication of email, creating the visibility reporting and assistance necessary to make this auth actually happen and given the world that we are living in with increasing domain spoofing is a very common tactic and organizations struggling with this. There is broad acceptance and understanding that auth needs to happen and so without tools it's almost impossible to do it and so we believe that there is a lot of opportunity. As we look at the success that we had in Q4, we suspect that momentum continues into 2017, we are still early when it comes to things like pricing and having some maturity there. But we do feel good about the opportunity how many customers in theory should buy EFD, it's really large customers or midsize customers that have big brands, that's the simple way to think about it and those are most likely candidates with the 100% of our installed base buy this I would say the answer to that is no. But it's a reasonably high percentage.
Steve Koenig:

Sounds good, thank you very much.
Gary Steele:

You bet.
Operator:

Srini Nandury with Summit Redstone Partners.
Srini Nandury:

Thank you for taking my question. Can you talk about the sales cycle are they lengthening or shortening over the last couple of years relating to sales cycle could short note, the next couple of years as more people adopt the cloud? Thank you.
Gary Steele:

Yes, that's a really good question. I would say over the course of 2016, I would say sales cycle remained relatively constant, we do see customer who basically wake up one day and realize how much exposure they have, they can actually move relatively quickly as we indicated in the prepared remarks the Fortune 50 retailer that we discussed, they moved very, very fast with respect to our advance protection suite. So I don't think that the cloud is the driving factor to accelerate sales cycle, I actually think the threat landscape is the thing that will drive more aggressive sales cycle as we thought about planning for 2017 and build our guidance, we assume sales cycle will remain consistent with what we have seen historically.
Operator:

And we will go now to Bill Choi with Wunderlich.
Bill Choi:

Thank you, I also dispense with the follow-up, just wanted to get some perspective around the increase pipeline and archival, when you go back to your Analyst Day I think the CAGR on archive versus Protection was modestly lower, does that change in relative growth rate over the next one to two years now that you are seeing the attach rate go you up and can you just discuss how well you are prepared to be able to convert these into business obviously a little bit of a different selling motion versus Protection. So do you need to for example get closer to Office 365 consultants or channel partner that do more of a back-up infrastructure type of work? Thanks.
Gary Steele:

I will answer the first part -- last part first. The ecosystem around archiving we have the relationships that we need there we -- what's interesting is that because of the customer relationships we have, we have very good access to the decision markers associated with the archiving projects and that's how -- that's certainly has given us confidence in this growing pipeline that we have seen. I do think that there is opportunity for improvements in growth rate over the course of 2017. One of the things we talked about on previous calls is that because there has been such a high demand for security that our sales team has just gone where it's been easier honestly and we have to see how that plays out in 2017 whether there is increase in level of archiving and demand and we just see a broader uplift in growth rate there. But we do feel very good about the opportunity in front of us as I indicated I think it's two fundamental drivers one is the competitive landscape and two is moving to the cloud bot of those things play a role in helping drive demand.
Bill Choi:

And the relative growth rates?
Gary Steele:

When you say relative growth rates you mean just -- as we look at growth rates over the next couple of years, where do we see those going.
Bill Choi:

Yes because I think if you go back to financial analyst meeting just looking at the CAGR of 2020 targets, it feels like Protection advance threat was modestly higher growth rate, has that changed in your view over the last six months as you have seen the pipeline pickup in archive?
Gary Steele:

No, not at all, yes again I think we stick with what we talked about it at the Analyst Day back in June with regards to relatively proportions of how the various major product line contribute to revenue as we look over the next several years with that said, I do think there is certainly room for archiving to execute at a level that's above what was comprehended there. But I think it's a little early for us to make an official proclamation along those lines.
Bill Choi:

Fair enough. Thank you.
Operator:

And we will hear from Erik Suppiger with JMP Securities.
Erik Suppiger:

Yes, thanks for taking my question. Couple, one can you give us a sense for what kind of exposure you have through Office 365 at this point, maybe talk about what proportion of new customers are coming from there or can you give any metrics on that front.
Gary Steele:

Yes, we don't actually have any metrics I can share with you, it's very anecdotally when we look at it it's hard to note for sure and I think we may have shared this on other calls in the past, many customers when we work and engage with them, we they are initially prospects have Office 365 in their mind as part of how they are thinking about retooling their security and compliance architectures, that said it's hard to know exactly which ones have moved already, which ones are in the process of moving and which ones are going to move at some point in the future and by the way that point in the future can be in a few months of can literally be years out and so we are not overly focused on measuring it because you know, canter doesn't matter to us. We sit in the cloud in front of whatever email system you are running, whether it's on-premise, exchange whether its Office 365, G Suite you can be running notes, lotus notes, we don't care and so it's not a metric we track all that closely because we kind of agonistic to it.
Erik Suppiger:

Okay. Can you give us a sense for how much of an impact the increase duration had on your billings in the quarter?
Gary Steele:

Yes, it was modest, but measured in kind of single digit million but it was measurable enough to be worth talking about.
Erik Suppiger:

Okay, and last one, can you give us a sense for what kind of engagement you are having with Palo Alto at this point, how that in particular is ramping for you?
Gary Steele:

Yes, I think the -- we continue to be really encouraged there, we had good work on the engineering side for our initial release, we constantly look for other opportunities for technical collaboration and I feel very good about the cooperation of a go-to-market standpoint, where our marketing teams are working collaboratively, our sales reps and sales management are working collaboratively driving engagement of particular accounts and it's just worked pretty much at all levels and so we feel very encourage by where we are and again this has been, we have been at it basically 12 months now. We are still in the very early stages of capitalizing on that opportunity.
Erik Suppiger:

Very good, thank you.
Gary Steele:

Thanks.
Operator:

And Catharine Trebnick with Dougherty. Your line is open.
Catharine Trebnick:

Okay, thank you for taking my question, Office 365, Paul, is there like a magnitude of the opportunity that you could possibly give us on Office 365 and then do you have an idea of how many or what percent of the customers do evaluate Microsoft third party supplier such as Proofpoint?
Paul Auvil:

Yes, those are both difficult questions to answer Microsoft themselves and press release when it came over the wire, they continue to be very thoughtful about how they provide some information about Office 365 without giving any specific characteristics around components of customers that are actually running on the email platforms that is part of the Office 365 suite of capabilities that you get depending on what you are buying from them. So it's for us to actually have a lot of insider visibility into that ourselves, I can tell you that our anecdotally it would appear that the vast majority of customers as they moving to Office 365 understand that they need some other Protection capability beyond what's offered from Microsoft and so we see lots of proactive engagements. We also don't do close customers who have moved over to Office 365 thinking that they can do without and find that they end up with the breach or some other significant issue which creates an escalation or requires them to reach out to find a solution to run and find the Office 365 solution.
Catharine Trebnick:

Thank you. And then one quick question on -- congratulations on fed ramp I see you guys were certified for the archiving last November any idea on when you will have Protection certified?
Paul Auvil:

No, it's clearly a focus for us, we haven't announced any availability date on that but it's clearly a focus and a priority for us to get that done.
Catharine Trebnick:

All right, thank you.
Operator:

And we will hear from Tim Klasell with Northland.
Tim Klasell:

Just two questions here. First on a high level probably for Gary or Paul as I take a look at some of these new products, particularly the ones that you acquired from FireLayers and what have you. How do you determine what is going to be charged for as an add-on product and what is going to be sort of new features that you would maybe normally rollout to an existing customer.
Gary Steele:

I will start. Paul may have a couple of comments. Typically what we do is we look for, we look at the industry competitive landscape and determine what things we think competitively need to be included in the product and we will be differentiators that will drive adoption of our solution over competitive incumbents and then we look at where there is traditionally been a market, some market history where the customer has paid for some of these incremental capability and so that's pretty much how we look at it and to see we don't want to compromise the economic opportunity when we can charge for something but we also don't want to be egregious and we also always put ourselves in a position, where we can competitively add our innovation, drive value to our existing install base, while being competitive against incumbents and things like EFD its been email fraud defense, it's something that where our customers are paying to and so we felt like that we could charge for it.
Paul Auvil:

Yes, I don't think I have a lot to add to that, other than maybe just to reinforce one of the messages Gary has touched on which is we really focused on creating a meaningful lifelong relationship with our customers and so getting into the business of grouching them on pricing and charging for things that they feel rightfully perhaps should be included as features or capabilities the product is always a real hot buttons for these folks. And so, we are very focused on as we create innovation, trying to create an innovation that the customer will absolutely will view as incrementally different as what they believe they are already paying for and hence we can go and ask for more money for it. But when we innovate in areas that are part of a product line, where again the customers already paid for a capability and they might reasonably expect something would be included, we will often include it because as you can imagine, if you got a million dollar of your customer, there is a huge difference between keeping them for $3 million and collecting $3 million for those services and keeping them for 10 years and collecting 10 million particularly given the fact we pay almost no sales costs, whatsoever on the renewals for year or two forward. And so, as a result, it's hugely lucrative to keep that customer over an extended period of time, and so that's a key milestone that we think about as we navigate that miss.
Tim Klasell:

Good, good, and then just a quick minor follow-up. Beginning of last year you talked about the change in how you would account for sales commissions, and it looks like you overestimated that despite overachieving on the top line on the sales front, so I would actually expect that maybe you underestimated rather than overestimated on the holdback. How should we -- did something change in there or was there something fundamental, or are you just being too conservative?
Gary Steele:

Just being too conservative, and so purposely picking a figure where we were overestimating the benefit that we would see, because I want to make sure that particularly because accounting changes are always sensitive with the investment community. I want to make sure that I -- if nothing overstated what that benefit would be in our initial guidance a year ago. We are feeling fairly confident that even if we overachieved with the overall business then that benefit wouldn't be even higher that would then make people feel like that, you know, while that accounting benefit really is part of what's propelling your success in the business, which of course it isn't, so…
Tim Klasell:

Okay, great. Thank you very much.
Gary Steele:

Thanks.
Operator:

And we will take our final question from Gur Talpaz with Stifel. And sir, your line is open, please go ahead. And hearing no response, I would like to turn the floor back over to Mr. Gary Steele.
Gary Steele:

Great, thank you. I just want to take a moment and thank everyone for joining us on the call today. We are very happy with the results of Q4 and we look forward to talking to you at the close of Q1. Thank you so much.
Operator:

Thank you. Ladies and gentlemen, again that does conclude today's conference; thank you all again for your participation.

Proofpoint, Inc. Q4 2016 Earnings Call Transcript

Other Proofpoint, Inc. earnings call transcripts:

Proofpoint, Inc.
Q4 2016 Earnings Call Transcript