Proofpoint, Inc.
Q1 2015 Earnings Call Transcript

Published: 22 Apr 2015

[Operator:]

Good day, and welcome to the Proofpoint First Quarter 2015 Financial Results Conference Call. Today’s conference is being recorded. At this time, I’d like to turn the conference over to Paul Auvil, Chief Financial Officer. You may begin.

[Paul Auvil:]

Thank you. Good afternoon and welcome to Proofpoint’s first quarter 2015 earnings call. Today, we will be discussing the results announced in our press release that was issued after the market closed today. I am Paul Auvil, Chief Financial Officer of Proofpoint. And with me on the call is Gary Steele, Proofpoint’s Chief Executive Officer. During the course of this call, we will make forward-looking statements regarding future events and the future financial performance of the Company. These forward-looking statements are subject to material risks and uncertainties that could cause actual results to differ materially from those in the forward-looking statements. We caution you to consider the important risk factors that could cause actual results to differ materially from those in the forward-looking statements, contained in the press release and this conference call. These risk factors are described in our press release and more fully detailed under the caption Risk Factors in Proofpoint’s most recent Form 10-K and Form 10-Q filed with the SEC and the Company’s other filings with the SEC. During this call, we will present both GAAP and non-GAAP financial measures. These non-GAAP measures exclude stock-based compensation expenses, acquisition-related costs, accretion of the debt discount and amortization of the debt issuance costs associated with our convertible debt, additions to deferred revenue from acquisitions, cost associated with litigation, as well as the amortization of intangibles related to acquisitions, non-recurring income tax benefits, other income and expense. 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 is included in today’s press release regarding our first quarter 2015 results, which can be found in the Investor Relations section of our Web site. In addition, please note that the date of this conference call is April 21, 2015 and any forward-looking statements that we make today are based on assumptions that we believe to be reasonable as of this date. We undertake no obligation to update these statements as a result of new information or future events. So, with that said, I will turn the call over to Gary.

[Gary Steele:]

Thanks, Paul. I’d like to thank everyone for joining us on the call today. The first quarter 2015 marked the strong start of the year for Proofpoint. Our ability to once again meet or exceed expectations was driven by the combination of strong demand for our advanced threat protection solution, combined with ongoing success with our existing product lines and a consistently high renewal rate. Similar to last quarter, we grew our targeted attack protection business by more than 100% year-over-year, highlighting the sustained momentum of the product due to increasing amounts, frequency and type of highly advanced persistent threats. In addition, new capabilities added through recent acquisitions are expanding Proofpoint’s overall market opportunity. Consequently, we believe the Company is well positioned to maintain the momentum and gain market share over the long-term. Taking a quick look at our financial results for the first quarter, total revenue increased 35% year-over-year to $57.8 million. This growth was driven by a 36% increase in subscription revenue, which accounted for 97% of total revenue. This represented our 47th consecutive quarter of sequential revenue growth. We also reported billings of $66.4 million, up 42% on a year-over-year basis. And finally, we recorded positive adjusted EBITDA of $1.2 million and free cash-flow of $7.3 million for the quarter, both of which exceeded first quarter guidance ranges. Now, turning to some of our key accomplishments during the first quarter. As I just mentioned, we had another strong quarter with targeted attack protection as we once again grew the TAP business by over a 100% year-over-year in Q1. Demand continued to be driven by the ongoing acceleration of sophisticated attacks by hackers who target high-value data within the enterprise. Companies around the world continue to recognize the vulnerability and increased risk associated with malware delivered through e-mail, similar to the recent breach at the Whitehouse. The incumbent solutions often some combination of traditional e-mail security and antivirus systems, that employ signature based detection techniques frequently fail to block these attacks, leading organizations exposed and vulnerable. Our cloud based TAP solution employs next generation capabilities that uniquely combined the use of big data systems and dynamic malware analysis to identify and block zero-day in polymorphic malware. In addition, as a cloud-based service, we can protect them over user wherever they are in the office, or on the road, even when they are not operating on their corporate network. As well, the advantage of leveraging our broad threat intelligence and big data analytics in the cloud continues to be a unique differentiator for Proofpoint and further drives the effectiveness of the product. Some of the noteworthy TAP wins during the quarter included a Fortune 50 industrial conglomerate that added TAP for over 350,000 users; one of the world’s largest grocery retailers, which purchased TAP and Protection for 120,000 users; a global financial services company, that had TAP for over 13,000 users; and a leading Internet company, which purchased TAP and Protection for over 12,000 users. While we remain very pleased with the ongoing market momentum at TAP, we're also seeing growing demand for Proofpoint Threat Response our threat remediation solution. During the first quarter, we closed a number of deals with this new solution, including a worldwide provider of medical imaging, a leading North American mining company and a large healthcare provider, that also for the containment capabilities via an open platform that unifies alert data from Proofpoint and a wide variety of other leading security vendors. In addition, Threat Response is a natural add-on to TAP. And while it is still early, we expect the requirements surrounding threat remediation to be a long-term growth driver for the Company. During Q1, we also executed on our commitment to invest in our threat analytics capabilities, highlighted by our acquisition of Emerging Threats, a leading threat intelligence company. Emerging Threats have built an expansive system for collecting and analyzing malware of all types using their array of global network sensors combined with a large stream of voluntary submissions from around the world, creating what we believe to be one of the world’s largest threat repositories. This repository is coupled with a proprietary big data analytics platform and a set of algorithms to automatically validate, filter and prioritize malware samples into actionable threat intelligence for detecting, blocking and remediating advanced cyber attacks. These threat analytics capabilities will also provide enterprises with additional insight into business risk, since they will help the customer to understand where the malware originated from, if it is associated with a broader campaign, or if the enterprise is specifically being targeted. We plan to integrate Emerging Threats’, advanced threat intelligence with our TAP and Threat Response solutions, creating what we believe to be the most timely actionable end-to-end attack intelligence and protection solution in the industry. Similar to prior acquisitions, Emerging Threats is the type of acquisition that Proofpoint has successfully completed in the past, a technology related purchase accompanied by a small focused team of developers, including industry renowned threat researchers who are excited to have their work incorporated into the Proofpoint SaaS platform. In our core protection business, momentum continued as our high win rates versus our competition, once again resulted in many new customer additions. A few examples of new protection accounts that moved to Proofpoint during the quarter; include, one of the largest media and entertainment companies, which purchased Protection for 40,000 users; a global medical device company, which purchased Protection, Privacy and TAP for 9,000 users; two different homebuilding companies, both of which purchased our Protection and TAP solutions for 6,000 users; and a leading investment service provider, which purchased our Protection and TAP solutions for 4,000 users. During the first quarter, the transition to the Microsoft office 365 cloud continue to be a compelling catalyst for Proofpoint, as enterprise customers start to replicate their former on-premises security and compliance infrastructure for their exchange deployments in the cloud. Some of the Office 365 deals we won this quarter; included, a global energy services company, which purchased Protection and TAP for over 35,000 users; and a large U.S. university, which purchased Protection, Privacy and TAP for 30,000 users. We also had another strong quarter in our cloud-based archiving business where a number of key wins; included, a national distributor of business products with 3500 users; one of the world’s most recognizable sports leagues with 2,500 users; a national auto finance company with approximately 2,000 users; and a U.S. professional services company with over 1,000 users. I am also pleased to report that during the first quarter we saw growing demand for our Social Media Security and Compliance Solutions. As a reminder, we completed our acquisition of Nexgate during Q4, which provided Proofpoint customers with the ability to protect their online brand presence and social media communication infrastructure by automatically identifying and immediately remediating fragile and social media accounts, social account hacks and social media content that contains malware, spam and abusive language. The solution also monitors authorized accounts and posts for compliance with a wide range of social media regulatory requirements. Some of the new customer wins during the quarter included a Fortune 100 global financial services company, a 4100 global food services company, and a global animal nutrition company. While it is still early, we believe that we have a unique set of capabilities, including our ability to identify and block advanced malware coming through social media. In our opinion Proofpoint is well position to take advantage of this growing opportunity, particularly given the increasing number of highly visible social media hacks. Finally, we also saw growing momentum in our international operations during the quarter, as we continued to make progress towards further expansion abroad. During Q1, international revenues grew 43% year-over-year and accounted for 19% of total revenues compared to 18% last year. Some of the international deals; one include a large European telecommunication service provider, which added protection for 60,000 users; a leading international real-estate services company, which bought TAP for 7,000 users; and a large European retail-store chain, which brought protection of TAP for 4,000 users. The addressable market, outside of the United States in both EMEA and Asia-Pacific, continues to represent an ongoing growth opportunity for Proofpoint and we plan to further grow market share in these regions going forward. So, in summary, I am very pleased with our strong start to the year and the momentum we are seeing with our advanced threat protection solutions. Enterprises continue, just like Proofpoint’s cloud based data protection solution over a legacy alternative, given our proven capability and handling today's advanced security threats. As a result, I believe we are well positioned to continue to drive momentum and grow market share. With that let me turn it back over to Paul.

[Paul Auvil:]

Thanks Gary. We are very pleased with our ability to meet or exceed expectations for revenue, billings, adjusted EBITDA, EPS and free cash-flow during the first quarter. Proofpoint continue to benefit from the combination of a healthy growth rate of new customers, a strong cycle of demand from existing customers buying additional solutions and a world-class renewal rate that remains well over 90%. During first quarter, total revenue was $57.8 million, up 35% year-over-year and above our previously announced guidance range of $56 million to $57 million. These strong results were driven by a 36% year-over-year growth rate in our subscription revenues. Looking at the revenue breakdown by solution, during the first quarter, our Protection and Privacy Solutions comprise 79% of total revenues, growing 39% annually, while our archiving and governance solutions made up the remaining 21%, growing 23% over the prior year. Regarding our international operations, we were pleased with the 43% year-over-year revenue growth rate that we recorded during the first quarter. This, despite the fact that our international revenues actually declined sequentially from the fourth quarter of 2014, as our international operations benefited disproportionally from the large one-time Sendmail appliance refresh during the fourth quarter, coupled with the fact that the international business bears the brunt of the revenue impacts from the legacy OEM partnership that was wound down at the end of last year. Note that we discussed both of these factors during the January call. Billings for the first quarter totaled $66.4 million, reflecting growth of 42% on a year-over-year basis and exceeding the high-end of our previously announced guidance range of $61 million to $63 million. During the first quarter, billings benefited from a strong cycle of renewal activity, based on a combination of one, two and three-year deals that were up for renewal during the quarter, pushing up billings growth rate from the mid 30's to the low 40% range. With regards to duration, it was modestly lower than last quarter, but still within our historical range of 17 to 22-months. Turning to expenses and profitability for the first quarter. On a non-GAAP basis, our total gross margin was 71%, which was slightly above our expectation. In terms of operating expenses, we continued our investments in sales and marketing as well as research and development to support future growth. During the first quarter, total non-GAAP operating expenses increased 27% over the prior year period to $42.8 million, representing 74% of total revenue, down from 79% during the same period last year, demonstrating our ability to drive continued growth while also creating leverage from these investments. Non-GAAP net loss was $3.6 million or $0.9 per share based on 39 million weighted average shares outstanding, and was in line with our guidance. Non-GAAP net loss during Q1 of 2015 includes an impact from foreign currency translation related to our cash held in local currencies of approximately $0.5 million. First quarter 2015 adjusted EBITDA was 1.2 million, marking our fourth consecutive quarter of profitability on adjusted EBITDA basis, and significantly better than our original guidance range of breakeven to the $0.5 million, primarily driven by our upside to revenue during the quarter, which outpaced the rate at which we were able to productively invest in operating expenses. On a GAAP basis, GAAP net loss for the first quarter totaled $21.7 million or $0.56 per share, based on 39 million weighted-average shares outstanding. In terms of cash flow, I am pleased to report that we again posted positive results for the quarter, as we generate $11.9 million in operating cash flow and invested $4.6 million in capital expenditures. This resulted in positive free cash flow for the quarter of $7.3 million, well above our guidance of $2 million to $4 million and a solid first step towards delivering against our full year guidance of $20 million to $25 million. Turning to the balance sheet. We ended the first quarter with $193.5 million in cash and short-term investments and a $164.2 million in debt, compared to $215 million in cash and short-term investments and a $162.3 million in debt as of December 31, 2014. This sequential decrease in cash during the quarter was driven by the cash disbursement associated with the purchase of Emerging Threats, offset in part by the cash flow generate from operations, ongoing stock option exercises and the contributions to capital from our employee stock purchase plan. We ended the first quarter with an accounts receivable balance of $32.1 million, resulting in DSOs of 43-days, consistent with the fourth quarter, as we continue to have strong collections during the first quarter. Total deferred revenue increased $44.1 million or 34% year-over-year to $172 million during the first quarter, up from a $127.9 million in the year ago period. Now turning to our financial outlook, starting with the second quarter. We currently expect billings to be $65 million to $67 million, resulting in a year-over-year growth of approximately 32% at the midpoint of the range. It should be noted that our year-over-year billings growth rate includes a headwind from foreign exchange, given the strengthening of the U.S. dollar and is up against a difficult comparison in the second quarter of 2014, where we had a number of early renewals. In addition, guidance is relatively flat sequentially, given that the first quarter included a relatively strong cycle of renewals, as I mentioned in my earlier remarks. Regarding revenue for the first quarter, we are targeting total revenue of $60 million to $61 million or 30% growth at that year-over-year midpoint of the range. We expect second quarter non-GAAP gross margin to be approximately 71%, consistent with the first quarter. With regards to adjusted EBITDA, we are currently targeting positive $0.1 million to $0.3 million for the second quarter, which notably includes the first period where we are carrying full 90-days of expenses for Emerging Threats. We expect second quarter non-GAAP net loss to be negative $3.7 million to $3.5 million or a loss of $0.10 to $0.09 per share, based on approximately $39.6 million of weighted average shares outstanding. And this assumes an income-tax provision, exclusive of discreet items, of approximately $0.2 million to $0.3 million during the quarter. As a final point, we expect free cash-flow during the second quarter to be approximately breakeven. From a full year perspective, we are increasing our guidance above the over-performance just reported for Q1, driven by the expected ongoing strength of the business. Specifically, we now expect billings to be in range of $292 million to $296 million, which represents an annual growth rate of 31% at the midpoint to the range, when adjusted reflects the $5 million in early renewals that were pulled into Q4 of 2014 from the first quarter of 2015. This compares to our previous guidance range of $288 million to $292 million. With this billings performance, we are also increasing our total revenue guidance to a range of $250 million to $252 million, reflecting an annual growth rate of 28% at the midpoint of the range. This compares to our previous total revenue guidance of $245 million to $247 million. Subscription revenues should continue to account for approximately 95% of our total revenue for the year. As a reminder, when we spend our 2015 guidance in January, we were assuming exchange rate for the euro of 1.15. As of today, that rate is dropped to approximately 1.08, and our current guidance reflects the impact of this new lower rate. The net result is that our overall results for 2015 include a headwind of approximately 5 to 6 -- 4 percentage points due to the ever-strengthening U.S. dollar, as well as the $4 million decline in legacy deferred revenue recognized from the Sendmail acquisition in 2015, as compared to the prior year. The impact from foreign exchange will felt more greatly in the revenue stream during the second half of the year, as our international customers renew their subscriptions at these new less favorable rates. We continue to expect full year 2015 non-GAAP gross margins to be approximately 70% to 71%, which includes the cost associated with the build-out of infrastructure for our newest platform solutions, associated with the Nexgate and Emerging Threats acquisitions, along with our ongoing investments in threat analytics and big data infrastructure that form the foundation of our efforts to find, analyze, and most importantly, block, these advanced threats from reaching our customers. Adjusted EBITDA for full year 2015 is expected to be in the range of positive $1.5 million to $2.5 million, a modest improvement over our guidance from last quarter, as we plan to reinvest any additional contributions from revenue upsides back into the business to drive growth. We expect full year 2015 non-GAAP net loss to be $15.8 million to $14.8 million, or a loss of $0.40 to $0.37 a share based on approximately 40 million weighted average shares outstanding. This assumes depreciation of approximately $12.5 million, up 39% from 2014 and cash interest expense associated with convertible debt of roughly $2.5 million. As well, the income tax provision, exclusive of potential discreet items, is expected to be approximately $0.9 million to $1 million for 2015, in total. I also wanted to note that the loss is slightly higher than our previous guidance range due to the impact of the ongoing strengthening of the U.S. dollar during the first quarter, as the euro fell from 1.15 at the start of the year to 1.08 today. I would like to highlight again that we are currently generating a net loss, and as such, our weighted average share count of 39 million for the first quarter of 2015, did not include the impact of vested stock options. If we were profitable today, our fully diluted share count would have been approximately 42.6 million shares, when applying the treasury stock method to these vested options. In addition, our convertible notes if converted would add approximately 5.2 million shares. Finally, we are reiterating our free cash-flow guidance for full year of $20 million to $25 million or 8% to 10% of revenues, representing over $0.50 per share. We continue to believe that this guidance, which pairs compelling top-line growth with meaningful free cash flow generation, puts Proofpoint in the lead category within the SaaS industry matched by only a few others subscription businesses of our size and scale. This cash-flow guidance still assumes capital expenditures of $18 million to $20 million for the full year. So, in summary, we had a very strong first quarter, and believe that Proofpoint remains well positioned to maintain momentum throughout 2015, as worldwide demand for our integrated cloud-based data protection solutions remain strong. Before turning it over to the operator for questions, I wanted to remind everyone that we are hosting an Investor Day in San Francisco on Thursday, June 4th. With that, I want to thank everyone for taking the time to join us on our call today. And we’d be happy to take your questions now. Operator?

[Operator:]

Thank you [Operator instructions]. And we go first to Phil Winslow with Credit Suisse.

[Phil Winslow:]

Just I was hoping the two questions here. First if you could maybe just comment on just the overall competitive environment, primarily on the protection side, just how that's trending and also just sort of the differentiation that you still have out there with TAP and how that’s resonating with existing and then also new customers? And then also just want to follow-up on archiving as well. Just sort of what trends you’ve been seeing there sort of when you look to your pipeline and toward this market opportunity. How do you think about that [23.59] lag in as well?

[Gary Steele:]

So, a number of things, so one in the core protection competitive landscape I would say it remained unchanged in Q1. We continue to see broader weakness across the on-premise incumbent solutions. We are winning deals today, based on the strength of our effectiveness and competitive head-to-head read-outs. With respect to targeted attack protection, the key differentiators for us continue to be our overall effectiveness. So the techniques that we’re capable of using in the cloud truly differentiate our solution. That combined with the fact that we can work on and off of corporate network to protect that mobile user that has been a compelling value proposition. And then as our solution has broadened, I think just overall our story continues to grow and create a compelling catalyst for people to move. I also would reiterate the point that we made in the script where organizations moving to Office 365. They are re-evaluating their whole security and compliance infrastructure. And as a result of that, it’s a forced change and it creates an opportunity, not only to sell protection but also to sell path. Onto archiving, the key catalyst there is that many organizations are struggling with their on-premise environment. There is very little innovation if any innovation happening from the on-premise archive vendors. And as a result, as organizations begin to look at that broader refresh, the real opportunity is to go the cloud. And so we continue to be very optimistic about the long-term opportunity there. We’re at the very beginning stages of that market moving from on-prem to cloud but we feel confident about that opportunity over the coming quarters.

[Operator:]

We go now to Matt Hedberg with RBC Capital Markets.

[Matt Hedberg:]

First on the billings, obviously, it was really nice to see the strength there. And I think you mentioned renewals as one of the big drivers there. I am curious, it sounds like customers are renewing early. And I’m curious what is driving that behavior right now?

[Gary Steele:]

So in this particular quarter, Matt, we actually didn't have any early renewals to speak up. We did have quite a few early renewals that were drawn into Q4 from Q1. And in fact if you take that $5 million effect in cascaded back-end of the first quarter, you’d see that our absolute billings growth rate, apples-to-apples, was just a little north of 50%. So very strong cycle of renewals but it gets back to this kind of legacy artifact associated with how Proofpoint operates where we have customers that are on one, two and three year deals. And so there is --in any given quarter, there is a historical combination of one, two and three year deals up for renewal. The Q1 of 2015 just happened to be a very strong renewal quarter for us. The underlying production on new and add-on business was obviously quite solid as well as you see it from the guidance that we just provided for the second quarter revenue numbers.

[Matt Hedberg:]

That’s helpful Paul. And then international growth was really nice to see as well. I'm wondering if you could talk about why you’re having such success there and may be the competitive environment internationally, does that defer from what we’re seeing here domestically?

[Gary Steele:]

Overall, the competitive environment internationally is relatively the same. We do see some smaller local vendors in specific countries. But it's predominantly the same environment that we have here in the U.S. I think the performance that we saw in Q1 was largely driven by the continued maturity and growth in our sales operation in Europe. We continue to grow and mature the teams that we have in the UK, France and Germany. And we feel good about the opportunity there to continue to scale that business in the coming quarters.

[Matt Hedberg:]

And maybe just a quick one for Paul just to clean up, I think you mentioned in your prepared remarks a 5% to 6% headwind for currency. Was that for both revenue and billings, or maybe just little clarification there?

[Paul Auvil:]

It is complicated in our model. And the 5% to 6% includes both the effects of currency as well as the effects of that $4 million year-over-year decline from Sendmail, which again measured against about $200 million of revenue on the order of a couple of points, all by itself, so currency, think of currency being for us in our world 3 to 4 points. And again remember only 20% of our business comes from international. And so, as a result, that's why the FX effects for us are a little bit less than what you see for other companies. But in any case, what's important here is just to get back to your primary question is that, you see the impacts of FX on a more immediate basis in our billings numbers, because ultimately that’s the rate at which we’re ultimately booking those renewals. It takes a while and then ultimately show-up cascaded for it in revenues because it has to essentially be this notion of replacing existing revenue streams with the renewals that are being renewed now at these lower, less favorable rates. And that’s why I talked about in the script the idea that the year-over-year growth rates from a revenue perspective will be more greatly impacted in the second-half of the year.

[Operator:]

And we’ll go now to Imtiaz Koujalgi with Deutsche Bank.

[Imtiaz Koujalgi:]

Again, back on the FX, I just need one clarification. So the 5 to 6 point headwind that Paul mentioned is that on the guidance or is that on the results for this quarter?

[Paul Auvil:]

No, I think about what's included in the guide, I didn’t actually provide a foreign currency neutral set of numbers for the quarter. Again, it's a relatively smaller impact for us. So, I didn’t think it really made sense to get into a currency neutral numbers, separate from the number that we're actually reporting. If foreign currencies continue to decline from here, I may start doing that in future periods. But again the key is that 5% to 6% year-over-year headwind, which is a combination of foreign currency effects as well as issues related to the Sendmail deferred revenue declines, are really going to more greatly felt in the second half of the year from a revenue perspective. And hence if you kind of piece together the revenue guide we gave for both Q2 as well as the overall guide for the full year, you get kind of a sense for that magnitude as it rolls through.

[Imtiaz Koujalgi:]

And how much of the 5 to 6 points headwind that’s coming in Q2? And the 5 to 6 points is the lower yield, fiscal '15. How much of that is in Q2?

[Gary Steele:]

Q2 has a pretty limited effect, so when you think about that 35% year-over-year revenue growth rate, there is may be a point of revenue growth that we would have otherwise reported. It's really if these contracts renew at these lower rates, you start to see a cumulative effect. And so, you don’t see it as much until you really get to the second half of the year.

[Imtiaz Koujalgi:]

And then on Threat Response, you’ve really got a momentum in Threat Response this quarter. Can you remind me of what the pricing is on an average, between Threat Responses, TAP and the core protection product?

[Gary Steele:]

From a pricing perspective, so Threat Response, really we do price that on kind of an end-point basis. But it's a little different than kind of our classic per user per year pricing. But we're still, at this point, kind of casting about trying to better understand exactly how we monetize that. So, we’ve seen -- it's like the early days of TAP, two years ago. We've put several different price-point out there and we're seeing what we think will work best with customers. We do nationally sell Threat Response along with the TAP product. But we think it will be measurable percentage of what you would otherwise pay for TAP on a per user per year basis, expect in this case again it's protecting end-points, which is a combination to users and other system that are being protected by the system. For Nexgate, it's a very different pricing model because it's more related to the properties that you're protecting, whether it's the company's Facebook page or access to other content in social media. So, again, it's a pricing model that’s still under development. And I think we’ll able to give people little bit more color as we work our way through the year. But we think it can be, on an enterprise basis, for enterprise that social more prolifically, it could be as financially compelling and lucrative as the monetization that we see for selling TAP for example to an enterprise. But again it’s not really is price per user per year, it's based more on the social properties that we’re protecting.

[Imtiaz Koujalgi:]

And one last one from me, Nexgate seems to have maybe different buyer and big enterprise versus your typical customer who buyers -- or even security products. So, how do you plan to sell that versus your core products? Are you taking it all on your sales force or would it be the social or same talent that you are selling your core products?

[Gary Steele:]

Yes there is really -- with respect to Nexgate, there is really two core buyers; one is the person whom we talk to everyday, which is the Chief Information Security Officer. Then that person fills accountable to the overall security posture at the organization, and so clearly cares about social. What we do see them very frequently is that person who runs digital marketing, that’s responsible for the social presence of the organization, that person is an integral part of the buying process. And so, from a go-to-market point of view, right now, we have a small specialist team that works with our journalist teams to target both that, digital marketing buyer as well as help tell the story to the SISA. And we think that that line-up of like combination of sales people puts us in a very good position to go leverage this into our core business.

[Operator:]

We go now to Walter Pritchard with Citi.

[Jim Pritchard:]

This is actually Jim Pritchard on for Walter, thanks for the question. So, I had a question first on, how much of the spend in R&D is really based more on the acquisitions versus kind of core Proofpoint? And then how should we think about the sales spends throughout the year in terms of build?

[Gary Steele:]

On the R&D side, Emerging Threats didn’t bring a lot of people to the overall organization, think of it is somewhere between 10 and 20, on the R&D front. So, while obviously on the margin does have an absolute impact on the numbers, the majority of our growth in R&D is coming from organic growth of hires around the world in the various places that we have development centers. So, we think about over the course of the year, one of the things that we're happy about is that even with the acquisition of ET and these additional heads, we’re not only not unfavorable changing guidance but we're actually improving our guidance on a EBITDA basis for the prepared remarks in the script. So, from a sales and marketing spend perspective, I would just say, expect more of the same in that as you think about how we're layering in and driving growth of the business, a key lever for garnering growth is that in more quota capacity to the Company and then the associated resources that are needed to support that. And so, again in the context of the overall guidance that we provided, both in terms of revenue, gross margin and then ultimately the implicit operating expenses based on the EBITDA guidance, you will see a balanced additional spend in both R&D and in sales and marketing as we scale up the Company. And normal contribution in G&A is we need to scale up G&A to support the growth for the rest of the Company.

[Jim Pritchard:]

And then I mean are you guys investing more so in the channel, are you seeing more out of it? And then I think my last one would be, what the -- it looked like productions were pretty good, what drove that?

[Gary Steele:]

I'll take the channel question, this is Gary. So we are seeing a lot of interest in the channel and through the initiatives driven by our VP of Sales, Tracy Newell, we've got a very good engagement model in place with the critical channel partners. It’s still early days. We feel like we're making good attraction there. But we're optimistic about the opportunity there to help us drive scale in our sales operations as we move through the reminder of the year. And I think, just in general, the channel is playing a bigger and bigger role given the breath of services capabilities that they can deliver. And we're well aligned with that given that we’re not competing with at all with the channel unlike some of the other vendors out there in the market place today.

[Paul Auvil:]

And on the other front, I think given today we have had very, very little bad debt expense over the life of the Company and part of it is just facing the nature of the mission critical products that we sell and the fact that ultimately I don't have collections issues because everybody is getting full value of the products that I sell, almost literally from today that we closed the order. And so while we occasionally have a few rough edges in getting dollars collected here and there, it’s a pretty smooth process overall. And we have a good partnership between the admin team and the sales organization to drive activity around collections as needed where we do have things that don't flow quite as smoothly as you might otherwise expect. And of course as we grow more business with the channel, the channel kind of operates like clockwork in terms of their payments. And so that really de-risks and, if you will, simplifies how the whole collections process works for us.

[Operator:]

We go now to Rob Owens with Pacific Crest Securities.

[Unidentified Analyst:]

It’s actually Liz on for Rob. I'm just wondering if you can give some more color on the product road-map and when you think your working threat technology is going to integrated?

[Gary Steele:]

So, there is really two points of integration for us, as we indicated in the script. So, one point of integration is leveraging that threat intelligence into TAP to drive incremental effectiveness in TAP. And the second is leveraging that broader threat intel into our threat response solution. So, with respect to TAP, that's actually already done. It's very easy to integrate this information to drive broader effectiveness. So we're extremely excited about that and our customers are already feeling the positive impacts of it. The work to be done with Threat Response is targeted for the second half of the year. And we’ve got a really good plan in place and we feel very optimistic about getting that out on-time. And in the meantime, we're also selling the Emerging Threat’s products standalone today. So for example, you can buy Emerging Threats’ query product, which is a very cool solution. It allows you to get intelligence related to specific forms of malware. So that's available through our sales force today. So, I feel really good about the early integration work we've already done and we’re making really good traction and headway on it.

[Operator:]

And we'll go now to Matt Niknam with Goldman Sachs.

[Matt Niknam:]

Just two if I could, one on international. So you talked about success you're seeing in Europe to-date. Just wondering what your latest thoughts are in expanding the international footprint beyond current markets? And then secondly, on M&A, you spoke about the acquisition of Emerging Threats, wondering, what you're seeing out there in terms of incremental opportunities in light of the run up and some private company evaluations? Thanks.

[Gary Steele:]

So, with respect to expanding our global footprint, there are some early efforts underway to look beyond Europe. So, for example, we’re in the process of opening Australia and some other territories in the Asia-Pacific. We’re taking a very prudent and practical approach there. But we’re continuing to look at how we can drive further penetration into the European market frankly right now. With respect to M&A and what we're seeing, we’ve proven to be very prudent buyers as we think about the kinds of acquisitions that we've an interest in. To your point, I think that the venture community has heated up the valuations of many of the security properties. Paul and I are actually sitting here at the RSA Conference in San Francisco doing the call locally here in San Francisco. And it is amazing what you see today on shared floor and the volume of venture money being popped into security. So I think it does, it does create somewhat of a challenge for us to find reasonable price properties. But we will continue to be disciplined. We’ll be continued to be thoughtful as we look at opportunities. And I think we've proven that we can execute with good discipline as it relates to values and we'll continue to do that. And we won't be influenced by the venture community.

[Operator:]

And we go now to Craig Nankervis with First Analysis.

[Craig Nankervis:]

Can you just remind us some of the go-to-market dynamics for Threats Response? It seems like you are starting to refer to it little bit more on the calls. And in terms of – you’d talked about pricing, I think early in the Q&A. But sales cycle, are you using a specialized team? Are you at the point where you are leading with this ever or you've mostly when with the just to base, just the landscape, if you don’t mind?

[Gary Steele:]

The way which we're approaching to right now, this is really part of our TAP sales cycle. So we’re often times leading with the broader advanced threat message and then we show the breadth and capabilities that we can offer to that customer, including Threat Response. We will offer it as a bundled solution with targeted TAP protection. So, you can kind of think of it as the McDonalds Meal where we’re thrown in the Apple Pie, there is a little of that going on. But we will also -- it's not uncommon to see a customer who is working on how they do remediation and they want a separate engagement post the TAP sale. And so, we work to sell it with TAP. We also work to sell it at the follow-on to TAP, that’s how I would summarize it.

[Craig Nankervis:]

And is it a specialized team or is anybody on the sales force?

[Gary Steele:]

So, the full Proofpoint sales team is out pushing targeted -- it's pushing Threat Response today.

[Craig Nankervis:]

And sales cycle is similar or different than say TAP?

[Gary Steele:]

I think it's different in that it's early the whole area of threat remediation is a relatively new segment. And so I would say it's longer than TAP when its standalone, simply because it's driving business process change and infrastructures change, it takes little bit more time.

[Craig Nankervis:]

Yes it makes sense. Okay I guess that’s all I’ll ask now for now. Thank you.

[Operator:]

And we'll now go to Tim Klasell with Northland Securities.

[Tim Klasell:]

Two quick questions on the channel, first, in past you've mentioned that you invested more heavily in U.S. sales force, the return was quicker. As you get scaled in Europe, do you think they are going to match or is that always going to be just a little bit longer of a channel to build-out?

[Paul Auvil:]

Tim it’s Paul. I think for the foreseeable future, I think our European team will continue to be a little less productive and the North American team is even as we get the channel moving. And it's a variety of factors, not the least so which is the U.S. team having had the benefit of many years of executing in the U.S. has a tremendous depth and breadth. The reference accounts were developing a brand that’s known in the U.S. Europe doesn’t have the benefit of those things for the foreseeable future. That said, we've got a good team there, I think again they executed well in the most recent quarters, you can see it from the numbers. And so, I think we will continue to invest there. And again, as we did in the early days where as you early highlighted, we tended to disproportionally put almost all the resources in the U.S. because that’s where the best return for the dollar was. At this point, there is higher strategic benefit to really cultivating and developing and getting the flywheel spinning in Europe. So, we will continue to invest and put resources there, even if the marginal return on the dollar is a little bit less than what we see in the U.S. market to continue to commit to and really build that into a meaningful market initiative that will someday rival the U.S operation.

[Tim Klasell:]

And then just one quick follow-up, you mentioned Office 365 is being obviously a nice tailwind. But I think of Microsoft and Office 365 resellers are being different group than the traditional security resellers. As you build both of your channels, which one do you think is going to be more important, the security resellers or the more general Office 365 type resellers?

[Gary Steele:]

I personally -- Tim, this is Gary. I personally think that the security resellers are going to play a bigger more relevant role there, simply because there is this broader review of security posture and that’s being driven in conjunction with the security resellers and whether people are running Office 365 or something else, that’s being taken into account because of the vulnerability associated with what happens as it relates to targeted fax and e-mail. And so I think that -- and if I look at, just anecdotally, if I look at the deals that we’ve done in Office 365, a good number of those have come through in the traditional security channel, almost more frequently today than what we've seen with the Office 365 channel interestingly.

[Operator:]

And we go now to Erik Suppiger with JMP Securities.

[John Lucia:]

This is John Lucia on for Eric. First question, what is the attached rate for TAP at this point?

[Paul Auvil:]

In terms of penetration of our installed base, it continues to be modest. We’ll probably share some specific statistics around that at the Analyst Day in June. But let me describe it differently which is, we're seeing very good uptake there. We talked in the fourth quarter call about having a meaningful number of customers that did moved over to TAP, also alongside our Protection customers. I think we talked about a number that was somewhere around 500 or so, little over. And then again we had a very good quarter, as Gary highlighted here in Q1. So the net of it is there's a big opportunity to sell into our install base. But interestingly, TAP continues to be the primary calling card for how we get into net new accounts as well.

[John Lucia:]

And for every Protection deal, I mean, do you typically sell TAP 50% at the time or 60% at the time, is it in that range? Or is it higher, or lower, or can you provide any commentary there?

[Paul Auvil:]

I don't have the exact statistics but I would say that certainly -- but just to add a little color. I would say just anecdotally, certainly, well over half the time when we sell Protection we sell TAP with it, if that's helpful.

[John Lucia:]

That's helpful. And then my follow up question, I’m sorry go ahead.

[Gary Steele:]

Go ahead, never mind.

[John Lucia:]

My follow up question would be related to Threat Response, do you think you can get Threat Response to that over 50% in the same period of time, or since it's a little earlier, do you think it'll take a little while for that to play-out?

[Gary Steele:]

I think it'll take a little more time, because again as I mentioned earlier it's a relatively new market segment. Threat remediation has been done often times with homegrown tools and very discrete processes that are -- that drive a manual remediation capability. And so it's -- because of the process rework, I think it'll take a little longer. But it's clearly a topic that everybody wants to talk about. It's one where organizations are investing. But I think there is market maturity that needs to happen.

[John Lucia:]

And last question on Office 365. Do you guys have a customer count, or how many customers do you have with Office 365? And then where we’re on that opportunity and how meaningful is it at this time in terms of billings or revenue?

[Paul Auvil:]

We haven't shared any specific stats around it. It continues to be an early contributor to pipeline opportunity. Office 365 in its first few years really was primarily the domain of S&B opportunity as you can imagine, if you're running a shop with 30 people why would you want to run your own exchange server if you can get that same capability in the cloud. It is now starting to push its way up, and we're seeing that and you can see that in our results and opportunities that we've closed that Gary's articulated, I think on our earnings calls now for the last four quarters. So it's a little hard to really say exactly how big an effect and how prolific it will be. But we're cautiously optimistic that it will be a growing factor in helping to drive business for us in the next couple of years.

[Operator:]

And we go now to Aaron Schwartz with Macquarie.

[Aaron Schwartz:]

Just had two quick questions, first on Emerging Threats, you talked about the integration work there. How do you monetize that? Does that result in a price increase when that is done, or do you view that more as just sort of a feature enhancement that will recruit new customer growth to monetize that?

[Gary Steele:]

It's a number of things, so one is the core threat intelligence we're selling that down one today. So customers find that that comes with an incremental price. The integration that we've done with TAP, that's just included in the core package. And then the -- as we do the integration with Threat Response that's still to be determined I suspect that will come with an incremental price.

[Aaron Schwartz:]

And then second question, I thought I heard, Paul you mentioned duration tick down just shortly a little bit. It looks like the deferred mix shifted a little bit to longer term. So I was just wondering if you could sort of reconcile that if I heard you correctly on the duration.

[Paul Auvil:]

Yes, and again remember, we talked about how we had a very strong cycle of renewals for one, two and three year deals in the quarter. So, well, when I was speaking to the duration ticking down, I was really speaking to what we saw with regards to new and add-on business. With renewals, again, since we’ve got a combination of one, two and three year deals that are cascading in for renewal and this was a particularly big quarter, as you can imagine that definitionally means we had a reasonable number of longer duration deals that came up for renewal but then got renewed again and then pushed forward. And so that's why if you look sequentially at our deferred revenue trends, you saw kind of disproportionate growth in the long-term deferred.

[Aaron Schwartz:]

So should I assume some of the three year deals that are still getting renewed sort of on that same three year deal or are you seeing any change in that?

[Paul Auvil:]

That's a good question, and it's good clarification for everyone's benefit. We typically -- if a customer's been a three year customer, and they tend to stay a three year customer one year customers tend to stay one year customers, it's just the nature of their buying mentalities. And that's fine. We don't -- we do generally try to sort of skew people down to shorter duration and the reason for that is we get more per use and per year because there's less discount associated with the multiyear deal. But again for existing customers that are multiyear, it can be often hard to get them to go to a shorter duration because why would they want to pay more when they're currently paying less, albeit writing a bigger check upfront. But if you're going to commit to that technology for a multiyear period, you may as well write the check, get the benefit of the discount and move on, so.

[Operator:]

And we go now to Andrew Nowinski with Piper Jaffray.

[Andrew Nowinski:]

Good afternoon, thanks for taking the question. Just a high level question, in light of the Whitehouse breach that you highlighted and the fact that more than 65% of breaches are initiated via phishing, just wondering if we’re actually seeing an increase in lead generation and request for pricing probably for those high-profile breaches?

[Gary Steele:]

There's been no specific breach that formed the catalyst that we could identify that from the catalyst for increased pipeline build or specific request for pricing. But to that point, what we have seen and we noticed it in the script that there is just a broader recognition today and it's really happened over the course of the last six to nine months that e-mail is a threat factor that carries these targeted attacks and more organizations want to talk to it because they realize the vulnerability and exposure that they have. So, I don’t think that there is anyone event, but collectively there is definitely a broader understanding and appreciation around it. And things like the Whitehouse breach just reinforce this broad message. So, we do think that it is beneficial to Proofpoint.

[Andrew Nowinski:]

And then last question, you called out a number of larger deals this quarter. You said you are not competing with the channel. But I'm just curious on how some those or most of those large deals were executed, whether it’s through channel or sold direct? And if you could just remind us what percent of your revenue in total went to the channel this quarter? Thanks.

[Gary Steele:]

So roughly half our business gets touched by the channel. We believe that that number will continue to decrease sequentially quarter-on-quarter, because we are engaging more broadly with the channel. Historically, some of our largest customer, so I think Fortune 100, many of those customers request specifically to engage with the vendor directly and we’ll do that at their request. But ideally, we would prefer more and more business of ours go to the channel if it's not inconsistent with way the customer wants to buy.

[Paul Auvil:]

And the one nuance there I think is worth mentioning is that in cases where channel partners brings us in and then for whatever reason the customer wants direct relationship with Proofpoint, we’ve ended up paying a referral fee to the channel partner. Obviously, they’d rather run it on their paper help to push their top line up. But at the end of the day, the margins that they earn, is a little bit less because they’re not carrying the risk and work associated with collection and what have you. But we are very focused on making sure that channel partners do work for us, get compensated in one way or another, even if the deal goes direct, if they're involved in the initial transaction and getting the project going.

[Operator:]

[Operator Instruction] And we'll go now to Srini Nandury with WR Hambrecht Summit Research.

[Jon Adlerman:]

This is Jon Adlerman speaking on behalf of Srini. Just to focus a little bit on some longer-term trends. Can you guys just comment a bit on the Emerging Threat acquisition with regards to trends and security information sharing alliances? And I guess that guides you a little bit, how do you see these new alliances affecting the advantage that you see with this acquisition with regards to identifying actionable threat intelligence over the long-term? Thank you.

[Gary Steele:]

Clearly, threat intelligence is a top of mind for many enterprise buyers today. And we hear consistently from customers that the broader level of insight that can be provided, the more beneficial and strategic you can be to the overall customer. And as part of Emerging Threats, one of the interesting things that we have as part of that is this large voluntary malware exchange. We think that that exchange runs across many vendors in the industry. We don’t publish participate in that exchange that is private today. But we do think that threat intel sharing is going to be an integral part of our overall strategy, and we're working hard to deliver more and more value there. Our ability to capture and see broad levels of malware and information has been critical up to this point and we think it will be critical to our success overall. So, we do think it's important. I think there is lots of people talking about threat intel, but have no ability to process the kinds of data that we see. And we've fundamentally differentiated ourselves being able to process this kind of information in the cloud with big data analytics and we think that is transformational, and the kinds of insights that we can and deliver to our customers. And we think that’s the critical thing in this. It's not just about the data, it's about how you process it.

[Jon Adlerman:]

And just I guess follow-up on that, have you guys maybe thought about internally if you would consider and to join one of these alliances or do you feel that it would you’re your competitive advantage?

[Gary Steele:]

We look at all those things on a case-by-case basis. And I think there are situations where we might join one and the other situations where we probably wouldn’t.

[Operator:]

And we'll now go to Mike Cikos with Macquarie.

[Mike Cikos:]

Just one quick question for you, on the European investments that you guys are making right now to expand internationally, I was just interested in spending environment and sales cycle, If you could comment on how that’s different from what you’re seeing in the states that’d be helpful?

[Gary Steele:]

I think that there is a little more urgency on behalf of the U.S. buyer today than there is internationally. The broader based breaches that have happened that have been communicated have come from U.S. based companies. And one of things that’s very different in Europe today as their breach notification laws are fundamentally different. So, things happen all the time. But European, the boarder European community does not know that it actually occurred, that will be changing over the course of the next coming years and I think that will create more urgency. But today, I would say sales cycles are shorter and there is more urgency on behalf of the U.S. buyers than there is a European buyer.

[Operator:]

And at this time, there are no further questions. I'll turn the call back to Mr. Gary Steele.

[Gary Steele:]

Thank you very much. I just like to take one moment and thank everyone for joining us on the call today. Again, we are very pleased with the results that we put-off to kick-off the year 2015. And we look forward to speaking with your all at the close of Q2. Thank you very much.

[Operator:]

This does conclude our conference. Thank you for your participation.