Proofpoint, Inc.
Q2 2015 Earnings Call Transcript

Published: 24 Jul 2015

[Operator:]

Good day and welcome to Proofpoint Second Quarter 2015 Financial Results Conference Call. Today's conference is being recorded. At this time, I'd like to turn the call over to Mr. Paul Auvil, Chief Financial Officer. Please go ahead.

[Paul R. Auvil:]

Thank you and good afternoon and welcome to Proofpoint's second 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 today is Gary Steele, Proofpoint's Chief Executive Officer. During the course of this call, we will make forward-looking statements regarding future events and 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, costs associated with litigation, as well as the amortization of intangibles related to acquisitions, non-recurring income tax benefits, other income and other 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 second quarter of 2015 results, which can be found in the Investor Relations section of our website. In addition, please note that the date of this conference call is July 23, 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, let me turn the call over to Gary.

[Gary L. Steele:]

Thanks, Paul. I'd like to thank everyone for joining us on the call today. The second quarter of 2015 marked another strong quarter for Proofpoint. Our ability to meet or exceed the high end of our billings, revenue and profitability guidance during the quarter was driven by a combination of strong demand for our advanced treat protection solutions, high competitive win rates, robust add-on activity, and consistently high renewal rates. I want to take a moment here at the start of the call to step back and provide some observations regarding the security industry. Now, more than ever, today's threat landscape poses significant risk to enterprises worldwide, as their legacy security infrastructure is failing to protect them from the latest generation of highly sophisticated attacks, which includes dynamic and zero-day malware, weaponized documents, malicious embedded URLs, and other advanced exploits. In particular, phishing attacks delivered through email have become the most pervasive and prevalent way in which individual employees are being targeted and attacked. As an example, in the past 90 days, we've seen an increasing frequency of weaponized documents containing the Dridex Trojan delivered as part of email-based phishing campaigns. These attacks are not being detected and blocked by traditional antivirus systems. In recent sampling of customer environments, we saw a large number of email messages containing Dridex with the antivirus systems catching less than 1% of the messages, which stands in marked contrast with our Targeted Attack Protection solution, which captured 99.9% of the malware. Our unique approach has proven to be extremely effective with this advanced form of malware and as such has created a positive tailwind in our business. Against this backdrop, anecdotally we see customers operating with modestly larger budget today for security solutions as compared to prior years and as such needing to make informed and judicious decisions about how to spend these additional dollars to best protect their enterprise. Hence, our ability to quickly and effectively demonstrate in a real-time production environment that our solution can deliver tangible additional protection is a critical advantage when it comes to winning in this environment and something that Proofpoint has done particularly well as evidenced by our results over the past several quarters. On a related note, in June, Gartner released its 2015 Magic Quadrant for Secure Email Gateways and Proofpoint was, once again, positioned as the leader for the seventh consecutive year. We are particularly pleased that Proofpoint was again positioned as having the most completeness of vision amongst all of the vendors included in the analysis. We view this as further confirmation of the company's proven ability to execute in the email security market and our ongoing innovation in using the cloud and big data technologies to protect enterprises from today's most advanced targeted attacks. Taking a quick look at our financial results for the second quarter, total revenue increased 37% year-over-year to $63.5 million. This represented our 48th consecutive quarter of sequential revenue growth. We also reported record billings of $75.5 million, up 51% on a year-over-year basis. And finally, we delivered positive adjusted EBITDA of $0.5 million, which exceeded the high-end of our guidance range. Now, turning to some of the key accomplishments during the second quarter, we had another very strong quarter with Targeted Attack Protection as we once again grew the TAP business by over 100% year-over-year in Q2. Demand is being driven by TAP's next generation capabilities, which uniquely combines the use of big data systems and dynamic malware analysis to identify and block zero-day and polymorphic malware. Also as a cloud-based service, we protect the mobile user wherever they are, in the office or on the road even when they are not operating on the corporate network. This particular feature is becoming increasingly important as organizations embrace a BYOD strategy to meet the needs of their mobile workforces. In addition, the advantage of leveraging our broad threat intelligence 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 global financial services company that added TAP for 320,000 users; a defense department from one of the largest countries in Europe which added TAP for 200,000 users; one of the largest healthcare systems in the U.S. which added TAP for 160,000 users; one of the nation's largest insurance companies, which added TAP for 80,000 users; and a leading U.S. financial advisors organization which added TAP for over 30,000 users. As part of our ongoing momentum of TAP, we are also seeing growing demand for our threat intelligence and remediation solutions. As a reminder, during Q1, our threat intelligence capabilities were significantly enhanced by the acquisition of Emerging Threats, which provides what we believe to be most effective and detailed threat intelligence across the entire TAP chain. During the second quarter, we closed a number of deals for these new solutions including two of the largest technology companies in the world, including one from the Fortune 100, which added our threat intelligence solution; a Fortune 50 global retailer, which purchased our threat intelligence solution; and a leading worldwide media company, which added Threat Response for 12,000 users. Demand is being driven by our ability to provide threat verification and containment capabilities via an open platform that unifies alert data from Proofpoint along with inputs from a wide variety of other leading security vendors. Further, Proofpoint is able to automatically validate, filter and prioritize malware samples into actionable threat intelligence for detecting, blocking and remediating advanced cyber-attacks. These threat intelligence capabilities also provide enterprises with additional insight into business risk since they help the customer to understand where the malware originated from, if it is associated with a broader campaign, and/or if the enterprise is specifically being targeted. In addition, these solutions are natural add-on to TAP, creating what we believe can be the most timely actionable end-to-end attack intelligence and protection solution in the industry. In our core protection business, momentum continued as strong demand and our high win rates versus the competition, again resulted in many new and add-on customer additions. A few examples of protection wins during the quarter include one of the world's largest telecommunications companies, which added our protection solution for 325,000 users; one of the largest U.S. insurance companies, which purchased protection for 45,000 users; one of the largest U.S. university systems, which purchased protection for nearly 60,000 users and a large European-based global retailer, which bought protection for 33,000 users. During the second quarter, the transition to Microsoft Office 365 continued to be a compelling catalyst for Proofpoint. Enterprise customers moving to Office 365 are looking for additional security capability to complement and enhance the baseline solutions provided by Microsoft. In addition, the need to replace the existing on-premise compliance infrastructure that had been deployed in support of the legacy exchange environment creates a catalyst that drives demand for our broader cloud-based compliance capabilities. This is evidenced by deals with one of the world's largest media and entertainment companies, which purchased TAP for 14,000 users; a leading international beverage producer and marketer, which purchased Protection and TAP; and a large university which purchased Protection, Privacy and TAP. We also had another strong quarter with our cloud-based archiving business. As we continue to see organizations moving to the cloud, replacing their aging on-premise archiving infrastructure. Some of the key wins during Q2 included one of the world's largest credit card companies with 70,000 users and one of the largest global retailers with over 14,000 users. I am also pleased to report that during the second quarter, we saw ongoing demand for our social media security and compliance solutions. With our acquisition of Nexgate at the end of last year, Proofpoint's unique set of capabilities including our ability to identify and block advanced malware coming through social media resulted in a number of key new and add-on wins during the quarter, including a Fortune 500 bank seeking to stop security fraud and compliance issues on their social accounts; a Fortune 500 technology company, which purchased social media security to scan their broader users and accounts; a large U.S. retailer, seeking to track and scan retail store social accounts for regulated data security and fraud risks; and a Fortune 500 diversified healthcare company which purchased social media security through our partner, Hootsuite, to identify, track and scan social users and accounts for fraud, security and compliance issues. While it is still early, we believe that Proofpoint is well positioned to take advantage of this growing opportunity, particularly given the increasing number of highly visible social media attacks. In addition, Proofpoint's partner ecosystem for social, most notably with Hootsuite and Percolate, is also beginning to yield results. In regards to selling additional products to our expanding customer base, our focus initiative continued to gain traction during the second quarter. We further increased the number and size of add-on deals booked as roughly half of our growth was driven by add-on in Q2. Examples of key add-on wins include a leading global hospitality company, which added 16,000 users for Protection and Privacy; a large university which added TAP for 25,000 users; and a large U.S. bank which also added TAP for 17,000 users. As a reminder, only 40% of our customers had more than one Proofpoint product at the end of 2014. As we mentioned at the Analyst and Investor Day last month, we believe that we have an opportunity of roughly triple the size of our business based on add-on sales alone. And hence, add-on represents a significant ongoing growth opportunity for the company. In summary, I am very pleased with our strong first half of the year, and the broad based momentum we are seeing across the entire business. While budgets aren't unlimited, we continue to experience a tailwind from the large and growing advanced threat problem. 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 R. Auvil:]

Thanks, Gary. We were very pleased with our ability to once again meet or exceed expectations for revenue, billings, adjusted EBITDA, and non-GAAP EPS during the second quarter. Proofpoint continued 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 the second quarter, total revenue was $63.5 million, up 37% year-over-year and above our previously announced guidance range of $60 million to $61 million. These strong results were driven by a 37% year-over-year growth in our subscription revenue. Looking at the revenue breakdown by solution, during the second quarter, our Protection and Privacy solutions comprised 79% of total revenues, growing 42% annually, while our archiving and governance solutions made up the remaining 21%, growing 21% year-over-year. In addition, during Q2, our international revenues grew 29% year-over-year and accounted for 17% of total revenues. Billings for the second quarter totaled $75.5 million, reflecting growth of 51% on a year-over-year basis and exceeding the high end of our previously announced guidance range of $65 million to $67 million. During the second quarter, billings benefited from a number of early renewals that were originally scheduled to be renewed during the second half of 2015, adding over $5 million of build activity to the quarter as compared to our typical baseline of activity. It is important to highlight that many of these early renewals were driven by customers purchasing an add-on solution during the quarter and hence choosing to combine that new purchase with their pending renewal. In the absence of these early renewals, we would have recorded billings of approximately $71 million or roughly 42% growth year-over-year, still well ahead of our guidance for the quarter, reflecting the positive demand environment we are currently seeing for the Proofpoint product suite. With regards to duration, it was consistent with the last quarter and at the low end of our historical range of 16 months to 22 months. Turning to expenses and profitability for the second quarter, on a non-GAAP basis, our total gross margin was 74%, which was above our expectations primarily due to the strong revenue performance as measured against our cloud spending on infrastructure. While we are very pleased with the improved leverage in Q2, which clearly demonstrated our ability to hit the low end of our long-term gross margin target range, we do expect margins for the remainder of the year to trend down by few percentage points as we continue to build out the infrastructure to support the growing demand for our TAP and threat intelligent solutions. In terms of our operating expenses, we continue to invest in sales and marketing as well as research and development to support future growth. During the second quarter, total non-GAAP operating expenses increased 41% of the prior year to $49.3 million, representing 78% of total revenue, up from 75% in the same period last year, primarily due to an increase in sales commission's expense, driven by the strong bookings activity during the quarter. As a reminder, Proofpoint follows the conservative approach of expensing commissions during the period in which they are incurred rather than amortizing them over the term of the revenue contract. Note that many SaaS companies amortize their commissions over the term of the subscription agreement rather than expensing them in period. Non-GAAP net loss was $3.4 million or $0.09 per share based on $39.6 million weighted average shares outstanding and was at the favorable end of our guidance range. Non-GAAP net loss during Q2 2015 included a favorable impact from foreign exchange currency translation related to our cash held in local currencies of approximately $0.1 million. Second quarter 2015 adjusted EBITDA was $0.5 million, making it our fifth consecutive quarter of profitability on adjusted EBITDA basis, and was slightly above our original guidance range of $0.1 million to $0.03 million, primarily driven by the upside to revenue during the quarter. On a GAAP basis, GAAP net loss for the second quarter totaled $25 million, or $0.63 per share based on 39.6 million weighted average shares outstanding. In terms of cash flow, during the second quarter, we generated $1.7 million in operating cash flow and invested $5.8 million in capital expenditures, resulting in negative free cash flow for the quarter of $4.2 million, below our guidance of roughly breakeven primarily due to the timing of deals closing a bit later in the quarter than originally expected. Turning to the balance sheet, we ended the second quarter with $411 million in cash and short-term investments and $336 million in debt, compared to $194 million in cash and short-term investments and $164 million in debt as of March 31, 2015. This sequential increase in cash during the quarter was primarily driven by the convertible notes offering that we closed in June. And to a lesser extent, the cash flow generated from operations, the ongoing stock option exercises, and the contributions to capital from our employee stock purchase plan. I'd like to note that we carry two series in convertible notes now on our balance sheet that are due in 2018 and 2020 respectively. The first series due in 2018 pays an annual interest of $2.5 million in two equal installments during the second quarter and the fourth quarter and the conversion price on the notes is $39.02 and if converted, 5.2 million shares would be issued. The second series due in 2020 pays annual interest of $1.7 million also in two equal installments during the second quarter and the fourth quarter. The conversion price on these notes is $81.23 and if converted, 2.8 million shares would be issued. I would also like to highlight that we are currently generating a net loss and as such our weighted share count of 39.6 million shares for Q2 2015 does not include the impact of vested stock options. If we were profitable today, our fully diluted share count would have been approximately 43 million shares when applying the treasury stock method to these vested options. We ended the second quarter with an accounts receivable balance of $44.3 million, resulting in DSOs of 52 days, a modest increase from the prior quarter due to some deals closing later in the quarter as compared to the first quarter. Total deferred revenue increased to $52.4 million or 40% year-over-year to $183.9 million during the second quarter, up from $131.6 million in the year ago period. Now, turning to the financial outlook, starting with the third quarter. We currently expect billings to be $76 million to $78 million, resulting in year-over-year growth of approximately 24% at the midpoint of the range. Now, note that these figures reflect the impact of the $5 million in renewals that were pulled into the second quarter that otherwise would have been recognized as billings during the third quarter. Absent this effect, the year-over-year growth rate considered in this guidance would be approximately 32% at the midpoint of the range. Regarding revenue for the third quarter, we are targeting a range of $65 million to $66 million or 30% growth year-over-year at the midpoint. We expect third quarter non-GAAP gross margin to be approximately 72%, down a few percentage points from the prior quarter. And with regards to adjusted EBITDA, we are currently targeting positive $0.1 million to $0.3 million for the third quarter. We expect third quarter non-GAAP net loss to be $4.4 million to $4.2 million or a loss of $0.12 to $0.11 per share based on approximately 40.2 million weighted average shares outstanding, and this includes the added interest expense from the recent convertible offering and assumes an income tax provision exclusive of discrete items of approximately $0.2 million to $0.3 million for the quarter. From a full-year perspective, we are increasing our guidance above and beyond the top-line of our performance just reported for Q2, driven by the anticipated strength of the business. Specifically, we now expect billings to be in the range of $303 million to $307 million, which represents an annual growth rate of 31% at the midpoint, and this compares to our previous guidance of $292 million to $296 million. Keep in mind that during the fourth quarter of 2014, we recorded over $5 million in early renewals pulled in from the first quarter of 2015, which creates approximately three full percentage points of headwind on the measurement of our full year numbers, and more specifically closer to eight full percentage points of headwind against our fourth quarter billings, in particular. As well, I would like to remind everyone that our year-over-year billings growth rate includes a headwind from foreign exchange due to the strengthening of the U.S. dollar as compared to 2014. With this billings performance, we are also increasing our total revenue guidance to a range of $255.5 million to $257.5 million, reflecting an annual growth rate of 31% at the midpoint. This compares to our previous revenue guidance of $250 million to $252 million. Subscription revenue should continue to account for approximately 95% of our total revenue for the year. Now, as a reminder, when we set our 2015 guidance in January, we were assuming an exchange rate for the euro of 1.15. As of today, that rate has dropped to approximately 1.10 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 five to six full percentage points, due to a combination of the ever strengthening U.S. dollar as well as the decline in legacy deferred revenue recognized from the Sendmail acquisition in 2015 as compared to the prior year. The impact from foreign exchange will be felt most greatly in the revenue stream during the fourth quarter of the year as our international customers renew their subscriptions at these new less favorable exchange rates over the course of 2015. Also recall that in the fourth quarter of 2014, we had a spike in hardware revenue of roughly $1 million over our typical run rate, driven by several large Sendmail customers who chose to refresh their MTA appliance infrastructure. As we noted at that time, we do not expect to see a recurrence of these sorts of purchases in future periods and this effect creates an additional headwind to revenue growth of approximately two full percentage points for our fourth quarter 2015 outlook. Given our strong performance in the second quarter, we are raising our expectations for full year 2015 non-GAAP gross margins to be approximately 72%, which includes the costs associated with the build-out of infrastructure for our newest platform solutions associated with Nexgate and Emerging Threats acquisitions, along with our ongoing investments in threat intelligence 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. We are also nominally raising our expectations for adjusted EBITDA for the full year 2015, with the range now expected to be positive $2 million to positive $2.5 million as we continue to plan and reinvest any additional contributions from revenue upsides back into the business to drive future growth. We expect full year 2015 non-GAAP net loss to be $16 million to $15.5 million, or a loss of $0.40 to $0.39 per share based on approximately 39.9 million weighted average shares outstanding. This assumes depreciation of approximately $12.5 million, up 39% from 2014, and cash interest expense associated with the convertible debt of roughly $3.4 million. As well, the income tax provision exclusive of potential discrete items is expected to be approximately $0.8 million to $0.9 million for 2015. In terms of our free cash flow guidance, given the additional capital investment required to support the strong demand for our products, we are raising our capital expense outlook by roughly $4 million for the year, with a new range being $22 million to $24 million. Accordingly, with this higher capital spending, we now expect our overall free cash flow to be $16 million to $21 million or 6% to 8% of revenues, representing a range of $0.40 to $0.53 per share. We continue to believe that this guidance, which pairs compelling top-line growth with meaningful free cash flow generation puts Proofpoint in an elite category within the SaaS industry matched by only a few other subscription businesses of our size and scale. So, in summary, we had a very strong second quarter and believe that Proofpoint remains well positioned to maintain momentum for the remainder of the year as the worldwide demand for our integrated cloud based data protection solutions remain strong. With that, I wanted to thank everyone for taking the time to join us on the call today, and we'd be happy to take your questions at this point. Operator?

[Operator:]

Thank you. And our first question comes from Rob Owens with Pacific Crest.

[Rob Owens:]

Great and thank you for taking my questions. Want to drill down on the comment that you made about half the growth was add-on in the quarter. And was curious, is this attached to the renewal cycle? Is this why you're seeing more early renewals as they're trying to make those contracts coterminous or are you seeing a lot of these somewhat out of phase in terms of people adding on?

[Gary L. Steele:]

Yeah. I'll jump in. Thanks, Rob. So, what we do see is we are driving independent add-on sales cycles outside of their renewal timing. And when it gets tied to renewals where the customer just happens to be engaged in the sales cycle where they're ready to close and their renewal is coming up in the forthcoming quarter. So, we drive independent of the renewal activity.

[Paul R. Auvil:]

And I think the one thing I would add to that is, Rob, as you know, since you've known the company for quite some time now, we've been driving our duration down, which has a number of benefits to the company and for shareholders. As that duration has come down, I think it's increasing the number of cases where an add-on opportunity that happens to be within sort of reach of that pending renewal, back when we did a very large number of our contracts on three-year deals, an add-on deal that would be halfway through a three-year deal, no one would do an early renewal at that point in time. But if you're on an annual contract cycle and you close an add-on piece of business, there's a higher likelihood now if you're on a one-year deal that you're within 30 to 60 days, maybe 90 days of that next renewal and so it just makes sense to co-term all of it. So, I think that maybe part of the reason we're starting to see an increasing frequency of these larger pull-in activities related to renewals that tie into the add-on cycle.

[Rob Owens:]

So, you talked about the impact there in Q3 and helped us normalize billings, thanks for that, but is there an expectation that you may see pull-in then again in Q4 as well?

[Gary L. Steele:]

Yeah, so all of the guidance we provide assumes that we're not seeing any material pull-in activity. So, obviously, there's always prospect for it, but as you can imagine, it's extremely hard to forecast. So whenever we provide our outlook and our guidance, we're assuming that there isn't any pull-in activity in future periods as we book net new business as well as that renewal activity.

[Rob Owens:]

Great. And if I can sneak one in on the Ingram relationship, just what that brings to the table, when you guys would hope to see leverage from that as well?

[Gary L. Steele:]

Yeah, so we closed our first handful of deals with Ingram. We were very encouraged by the fact that we got something done at such a short period of time. I think that if there's just this natural maturity process that will evolve with them, and so I would suspect we'll see a higher velocity of deals in Q3 and then more deals in Q4, but it will take us probably six months before we see any significant contribution from Ingram. And fundamentally, the thing we're excited about with Ingram and the potential there is driving more activity with regional partners who have great relationships in particular areas of the country are with particular verticals and customers and so we'll have broader reach as that Ingram relationship matures.

[Rob Owens:]

Thank you very much.

[Gary L. Steele:]

Thanks, Rob.

[Operator:]

And next will be Phil Winslow with Credit Suisse. Philip Alan Winslow - Credit Suisse Securities (USA) LLC (Broker) Thanks, guys, and congrats on another great quarter. Just wanted to hone in on TAP for a moment. Obviously, at the Analyst Day, you gave us a lot more details on TAP and just sort of the potential, just in the customer base and sort of just net new customer acquisition there. Just wondering if you could just update us, what you saw this quarter and particularly what you see just in the pipeline going forward? And then obviously, one of the next areas you've talked about is on the social side. Just give us any sort of update there, just early feedback you're getting from customers, et cetera?

[Gary L. Steele:]

Sure. So, with respect to TAP as we've talked about on our previous calls, roughly half of our TAP business goes to new customers, roughly half goes to the installed base. And I think what was more impactful in Q2, when you reference this in the script, is there's just more and more malware coming in that the traditional antivirus systems aren't catching; and as a result of that, it's driving buying for advanced malware solutions like TAP and frankly organizations can't really survive without some form of protection. So that's what's really driving that broader demand, both in our customer base as well as with new accounts. On the social side, while it's still early, we're getting very good interest and traction with larger customers. Many of these deals that we start with are for a smaller percentage of their overall social media presence, so they get going with some form of security and compliance and then we have the opportunity to grow that over time. There's this broad recognition that we see today when we talk to those customers that they understand that they have to do something about security and compliance, but it's relatively new. And so we're very encouraged about the longer-term opportunity and we were happy with the performance that we saw in Q2. We believe that this will be an interesting growth driver for us in the coming quarters. Philip Alan Winslow - Credit Suisse Securities (USA) LLC (Broker) Great. Thanks, guys.

[Paul R. Auvil:]

Thanks.

[Gary L. Steele:]

Thanks, Phil.

[Operator:]

And next will be Matt Hedberg with RBC Capital Markets.

[Matthew Hedberg:]

Yeah. Thanks, guys, for taking my questions and congrats from me as well on the quarter. I had a question on the federal side. Are you guys seeing a benefit from either the OPM breach or the government's 30-day sprint to really shore up their systems that they announced a month or so ago?

[Gary L. Steele:]

Yeah, great question. If you look overall, federal's a relatively small percentage of our business. It's been – all government business has been in the sort of the mid-single digits for a while. We are making more investments, specifically in federal. We do think there is an opportunity there. But I would say the maturity of our presence in federal is early, and so we're encouraged by what we've seen to date, but I don't think that we're going to see any short-term pop if that's what you're asking for.

[Matthew Hedberg:]

That's great. And then, Paul, the color around your free cash flow margins was helpful on the added CapEx spending. I think at your Analyst Day, you mentioned that 2016 had the opportunity to be up, I believe you said meaningfully, from at the time was an 8% to 10% range. Is there – and I know you're not at the point to guide to 2016 yet, but do you still feel that there's an opportunity to expand these free cash flow margins in the out year?

[Paul R. Auvil:]

I do. And as you know, we'll do an early guide on 2016 in the October call, so obviously we're really just getting started on a more detailed formative plan for 2016. We always have kind of a three-year rolling out look at the business, but we're really just starting to dig into it, but I continue to feel good about the prospect of expanding the free cash flow for the company as we move our way into 2016.

[Matthew Hedberg:]

Great. Thanks a lot, guys.

[Paul R. Auvil:]

Yeah.

[Operator:]

And next question will come from Tiaz Koujalgi with Deutsche Bank.

[Imtiaz Koujalgi:]

Hey, guys. Thanks for taking my question. I have two questions; one is generally on the industry landscape. If you look at the results from all the security vendors, most of them have had good numbers in the good results. Has that impacted your sales promotion or your sales cycle at all and any impact on pricing as a result of the demand uptick in security?

[Gary L. Steele:]

I think a couple things. So one is there's a definite demand profile and urgency given the kinds of threats coming into folks environments today. I think we benefited from the fact that we can demonstrate in the live eval (evaluation) the kinds of malware that we can catch in a relatively short period of time. Pricing for us has remained relatively stable. We haven't seen wide fluctuations in that. The one thing that is always concerning to organizations because they only have limited staff to deploy – they obviously have limited budgets, but they also have limited staff, and so our benefit and what has created tailwind for us is our ability to actually demonstrate in the live eval the kinds of malware we can catch, and I think that has driven conclusive proof on behalf of the buyer that they should buy from Proofpoint.

[Imtiaz Koujalgi:]

Has that resulted in a faster selling motion, have your sales cycles been impacted because of that urgency in buying security products?

[Gary L. Steele:]

I think we will at times see more urgent situations where people buy quicker, but again, if you think about our customer and the kinds of examples I referenced, there is a natural buying cadence in an organization that is a Fortune 1000 or Fortune 100 company, they can only move so fast.

[Imtiaz Koujalgi:]

Got it. And then if I heard you correctly, your international revenues, I thought grew 29%, which was a bit slower than what we've heard in the last few quarters, did I hear that correctly, 29%?

[Paul R. Auvil:]

Yeah, yeah. That's right. And I think overall, we felt good about how Europe developed – maybe part of what's really going on as well that growth rate is solid, there's a heightened level of awareness, understanding and urgency amongst the U.S. buyers around these advanced threats. And so we're just naturally seeing more acceleration there than we see across European customer base, but we're – we feel good about the customers we close. Gary referenced closing one of the largest European defense departments in the world last quarter. We're getting traction with important and large scale customers in Europe.

[Imtiaz Koujalgi:]

Got it. Thank you. That's it from me. Thanks.

[Paul R. Auvil:]

Thanks.

[Operator:]

And moving on to Walter Pritchard with Citi.

[Walter H. Pritchard:]

Hi. Paul, I'm wondering if you could expand upon – you talked about deal timing being later in the quarter and I'm wondering, I guess, I might think that with the environment out there that you might actually see deals closing earlier in the quarter, I'm wondering what drove that factor?

[Paul R. Auvil:]

Yeah. It's hard to really characterize it. I would say that at the end of the day, as I put my plan together each quarter ahead of the earnings call, I have a certain assumption in terms of the linearity of the business that I think will close in the first month, second month and third month of the quarter and in this particular case, April, May and June. And so as you can imagine because we do a lot of business during the quarter, the timing, especially the business that gets closed in this particular case, April, which we then collect fully by the end of the quarter ends up being an important part of what drives operating cash flow and ultimately free cash flow for the quarter. And so my personal estimates of April, we were a little overly optimistic, I would describe. So as we look at it, we do look at larger deals and the timing when we think they will close and so as you can imagine larger deals just literally closing 5 days or 10 days later. So instead of the end of April closing in the middle of May then often we'll triple payment cycle outside of the quarter and so that's really what's going on. There wasn't any big shift where suddenly a whole bunch of business didn't show up until the end of June, for example. It was just that some of the stuff that we thought we would close in April closed into May during the timeframe when we then were unable to collect within the quarter.

[Walter H. Pritchard:]

Got it. And then, Paul, on the – you went through all the factors like an early renewals in hardware and other things that are impacting your comps. Could you just make sure you quantify for us the FX impact sort of – I know to just step up there from Q2 to Q3, what that impact is on revenue in billings?

[Paul R. Auvil:]

Yeah. So with FX, as you can imagine for us, it's complicated because it rolls through and accumulates over time.

[Walter H. Pritchard:]

Yeah.

[Paul R. Auvil:]

You see it relatively upfront in the billings numbers, but as all the legacy deferred revenue is rolling off, it was done at $1.3 to the $1 or so being replaced by deals that are renewing now at $1.1 to the $1, it accumulates this effect. So the five points to six points of headwind that I described that we really see predominantly accumulated into the fourth quarter, think of that number in the fourth quarter as being on the order of five points to six points of impact on a revenue basis.

[Walter H. Pritchard:]

Okay.

[Paul R. Auvil:]

Yeah.

[Walter H. Pritchard:]

Okay, got it. And then it sort of fades as we go into next year again as we...

[Paul R. Auvil:]

Right.

[Walter H. Pritchard:]

... anniversary these comps, but in the later basis than you would see with most companies because of the delays.

[Paul R. Auvil:]

Right. Yeah. And to your point because our average duration is over 12 months, it will continue to be a drag for us as we work our way through the first part of 2016 and then it will normalize in late 2016 going into 2017.

[Walter H. Pritchard:]

Okay, great. Thank you.

[Paul R. Auvil:]

Yeah.

[Operator:]

And next will be Jonathan Ho with William Blair.

[Jonathan F. Ho:]

Hey, guys, congratulations on the strong quarter. Just wanted to start out – just given the $200 million that you raised in terms of capital, like where do you see sort of the opportunity to invest – how do we think about how you're going to deploy that capital?

[Paul R. Auvil:]

I think I'd just – at a high-level and then Gary, I'm sure, will have some things to add. As you've seen from the acquisitions we've done in the past, we're very thoughtful about how we deploy capital around M&A activity. We have a specific thought about what we think reasonable value is for various assets that we might acquire and integrate with Proofpoint. And so we're going to stick to that paradigm. And so as things get a little more hectic and valuations go up, I think that there may be deals that we look at that historically could have been interesting, but valuations don't make sense and we'll just continue to evaluate that. But beyond kind of M&A activity that we don't have any other plans for that capital. We're very happy with our current datacenter strategy where we work with third parties and essentially buy capital in the form of servers and storage to put into third-party datacenters, but we leave that datacenter space. We'll continue to do that, so we won't have a large capital project associated with building our own datacenter. For example, that's not something, in any sort of projection that we can see over the next several years. As well, we're happy with the campus we have. I don't see a significant tentative improvement spend associated with moving into a new campus or something like that as part of how we would deploy that capital anytime in the near future. So it's really cash that's available for strategic M&A and I think you'll continue to see us execute going forward in a manner similar to what you've seen of us in the past and, Gary, I don't know whether you have anything else you want to add there.

[Gary L. Steele:]

No, I think that's good.

[Jonathan F. Ho:]

Okay. And then just in terms of Nexgate and the pricing around social, now that you guys have signed several deals, can you give us maybe a flavor or a sense of how you're pricing the product at this point?

[Paul R. Auvil:]

Yeah. So, we're still evolving that pricing, but with the social products, there are a few different elements, right? There's an element related to enabling people to use the product to surveil all the various properties out there to make sure that their brand isn't being compromised. So that's – think of that as more sort of licensed based on the size of the company; small, medium or large. Separately then we do specifically protect accounts, whether they might be Twitter accounts, LinkedIn accounts, what have you, and so that pricing really sort of depends a little bit on the relative size and scope of the number of accounts that you are going to protect. And so if you're doing a relatively small number of accounts, they're typically accounts that have large numbers of followers or very strategic like the Twitter feed for your CEO or what have you. So the price per account can be quite, quite high. Separately, if you're looking to protect all of your users who are accessing Facebook or LinkedIn for work purposes, then that price per user will be low. Think of it as sort of in the same realm as what we would charge otherwise for security product like email security and the pricing we historically talked about there. So that kind of gives you a range of the dimensions, but we're still sort of evolving this at this point. And I think maybe in October, we'll be able to provide a little bit better set of paradigms on how pricing actually rolls in. It's still relatively small revenue influence for the business. Gary talked about some exciting accounts that we closed, but as compared to the scale of TAP or even our historical protection or our archiving businesses, it's a very small contributor, but we expected to be a meaningful contributor as we work our way into 2016.

[Gary L. Steele:]

Yeah. And the one fundamental difference, Jonathan, is typically on the social side, people sign up for a small number of accounts initially. And then there is opportunity to grow that over time. You contrast that to what we're doing with TAP. You sell to the whole enterprise all at one time. So it's a little bit different selling motion in terms of the land and expand strategy that exists for social.

[Jonathan F. Ho:]

Got it. Thank you.

[Paul R. Auvil:]

Thanks.

[Operator:]

And next will be Jonathan Ruykhaver with Stephens.

[Jonathan B. Ruykhaver:]

Yeah. Hi, guys. Congratulations on the quarter.

[Gary L. Steele:]

Thanks.

[Jonathan B. Ruykhaver:]

My question relates to the competitive landscape. What if your email competitors likes to highlight a broad platform approach for advanced threat protection which encompasses web, email, file and endpoint. And I'm just wondering, given the possibility of growing vendor consolidation in the enterprise, did you see a need for Proofpoint longer term to extend its capabilities to – address more of an end-to-end threat protection environment including the web gateway?

[Gary L. Steele:]

We obviously hear that as a competitive position from some of our competitors out there. But the reality is customers continue to buy best-of-breed and we continue to win against those competitors that are touting the value of the broader advanced threat solution. And in particular, I think that at the end of the day, what people are looking for is something that works extremely well and that you can demonstrate the overall effectiveness and our selling strategy has been really simple. We'll go into an eval and we'll prove that we're better than anybody that shows up on the block. And so, I think that in the environment we're in where people are so concerned about the threat landscape, they're not looking for – they're not actually looking for less vendors, they're actually looking for products that work extremely well.

[Jonathan B. Ruykhaver:]

Okay. All right, I mean I guess, I was curious on, Gary, what your thoughts are regarding this kind of platform positioning versus best-of-breed. It seems to me like for best – for platform to work, it's going to take a CIO or CISO pushing that down to the security teams and I do hear that, but I don't know if it's actually being undertaken within organizations today. It seems like the best-of-breed mentality is still what's driving a lot of the purchasing behavior?

[Gary L. Steele:]

No, that's absolutely right. I think, aspirationally, I think all companies want less vendors to deal with. I don't think there's any question about that; and if you're going to talk to a CIO or CISO, they would all agree that they would like to deal with less vendors, but no company is willing to compromise their overall security by just saying, well, we have less vendors. They want to know that they're more secure. And so I believe that given the threat landscape that we're operating in, we will continue to see best-of-breed buying behavior for a very long time and I think we're uniquely positioned given our detection rates and our ability to demonstrate that with our customers.

[Jonathan B. Ruykhaver:]

Right. Okay.

[Paul R. Auvil:]

Yeah. And I think the one thing I would add to that is what's interesting is that even before people became hyper aware of the threat environment, so you can go back to, say, 2010, we saw that selling strategy being tried and even then before people had this hyper level of concern, it wasn't proven to be an effective selling tactic because again it's easy to compare the production efficacy of our solution against other alternatives and if you're going to spend the same amount of money, you want the best solution to protect your email infrastructure.

[Gary L. Steele:]

Yeah. And one another factor that is probably important to point out is we're winning deals today because of our deployment model as well. So, what we're seeing is boxes, advanced threat boxes sitting outside datacenters all over the globe where they can be deployed and we'll go and deploy in just a phenomenally short period of time. So, getting people up and running with something that works incredibly well is more important than less vendors that struggle getting deployed.

[Jonathan B. Ruykhaver:]

Right. Okay. The other question I had was around Threat Response 3.0 just in the context of the integration with the Proofpoint core intelligence and the TAP, what is the broader value proposition and is there a pricing enhancement opportunity with that integration?

[Gary L. Steele:]

So, the core value there is to bring together end-to-end a TAP chain intelligence with the ability to automate and orchestrate the remediation process. And frankly, it's pretty compelling where you can understand what it is that's come into the environment and then take the appropriate actions as required from a remediation strategy. We haven't announced any pricing or price changes to Proofpoint Threat Response at this point. So, we'll provide an update when the product goes GA, but we're excited about the early feedback that we've gotten from customers that have had an early look, but we still have more work to do.

[Jonathan B. Ruykhaver:]

So, you still need to validate it essentially with the enterprise or is it more just the integration work that needs to be done?

[Gary L. Steele:]

It's just the integration work that needs to be done. We've gotten very strong validation from the customer set already.

[Jonathan B. Ruykhaver:]

Okay. All right. Good enough. Thanks, guys.

[Gary L. Steele:]

Thank you.

[Paul R. Auvil:]

Thanks.

[Operator:]

Moving on to Tim Klasell with Northland Securities.

[Tim E. Klasell:]

Hey, throwing my congratulations as well. I have a question on the sort of partnerships' last competitive landscape. Do you know what percentage of your new bookings are coming from Office 365 customers, because it's very popular with the small to medium-size business, but not as much for a larger enterprises and we're just trying to get our arms around how that's evolving?

[Paul R. Auvil:]

Yeah. To exactly your point, it's still a relatively small effect compared to sources of opportunities that we get from elsewhere, but it is meaningful and it is growing. And so to your point, Office 365 really like Google app, started off in the low end of the SMB realm, worked its way up into mid – kind of mainstream SMB, and is now working its way up into kind of mid enterprise accounts, and ultimately we're starting to see evidence of some larger customers, I think tens of thousands, if not 50,000 seats looking to consider that move as well. We're tracking along with that quite nicely and see pipeline of opportunities coming along. But at the end of the day, it is a relatively small percentage of the new and add-on business that we're closing each quarter, but it's large enough and it's worth talking about on the calls which is why we do. I think that we'll probably not actually break that percentage out in the near future, but we'll continue to talk about it as a concept.

[Tim E. Klasell:]

Okay.

[Gary L. Steele:]

And the other thing I would add – the other thing I would add, Tim, is that when we go out and talk to the prospect base, many, many customers that are in the, let's call it, 10,000 seat to 20,000 seat range, have a plan for Office 365. It might not have made that decision to move yet, but they're all putting it in their plans in terms of a future IT activity for the organization. So I think we'll see broader and broader adoption of larger and larger organizations as we move through the next 24 months.

[Tim E. Klasell:]

Okay, great. And then Microsoft introduced one GA, I guess, with their ATP product about a month ago. Have you guys analyzed that and what are you – what's your thoughts around how applicable that is to your customer base?

[Gary L. Steele:]

Yeah. I think we may have seen it once in the field in Q2. We didn't see it as particularly effective in solving the customer's problem. So it'll be interesting to see how much adoption it actually gets. The one thing I would say is the kind of attacks coming in today are extremely difficult to catch, because the bad guys have continued to innovate at a rapid rate. And so I suspect it will take some time for Microsoft's product to mature before it's very effective. And we're seeing – again, we've referenced some number for customers, but we continue to see customers using Office 365 testing us and adopting our solution.

[Tim E. Klasell:]

Perfect, perfect. And then there was one little accounting question. Of the $5 million that was early renewals, was that the renewal amount or was that the renewal amount plus the upsell if they were taking additional product?

[Paul R. Auvil:]

Good question. That was the renewal value, the add-on or upsell value was above and beyond that.

[Tim E. Klasell:]

Okay, great. Thank you.

[Paul R. Auvil:]

Okay. Thanks, Tim.

[Operator:]

And moving on to Erik Suppiger with JMP Securities.

[Erik L. Suppiger:]

Yeah, congratulations. Back on the Office 365 topic, what competition are you seeing for that business and do you have – as you look at the larger enterprise accounts, do you have a sense for what portion of those accounts are using the Microsoft security or are the large majority of them using third party?

[Gary L. Steele:]

Great question. So if you think about the Office 365 opportunity, you really need to have a cloud based solution, it would be very unusual to take email routed into your corporate network and then routed back to Office 365. So given that scenario, then you need to have a cloud based advanced threat solution. There aren't a lot of those out there as you are probably well aware of the competitive landscape. FireEye has a early cloud based solution. We frankly haven't seen that frequently out in the marketplace. Symantec claims to have something, but we frankly don't see that much either. So, we've been quite happy with the broader competitive landscape and our ability to go in and show value and win. And we think that this will continue – this opportunity continues in front of us and as customers drive that plan and the migration to Office 365, it forces that displacement of the on-premise security and clients capabilities into the cloud and that gives us a unique opportunity. We don't know – we have no way of knowing, Erik, how many of those Office 365 customers are using the Microsoft capabilities, but it is not uncommon for customers to choose this at one or two points; one where they're beginning their migration and they're in the planning process and they look at us and we work on a transaction with them. Secondly, we'll oftentimes get a customer after they moved to Office 365 and they find that they want additional security capability. So, we get them in those – in both of those scenarios, but it's really difficult to quantify how many customers are using the Microsoft solutions only.

[Erik L. Suppiger:]

And is it fair to say that you are seeing the volume of customers accelerate?

[Gary L. Steele:]

In Office 365?

[Erik L. Suppiger:]

Yes.

[Gary L. Steele:]

Yes, that's a fair statement.

[Erik L. Suppiger:]

Okay. Thank you very much.

[Paul R. Auvil:]

Thanks.

[Gary L. Steele:]

Thanks, Erik.

[Operator:]

And next will be Robert Brous with Wunderlich Securities.

[Robert J. Brous:]

Hi. First, congratulations, guys. Wondering if you could talk a little bit more back on previous question about international growth. Do you see yourself investing more there to drive growth, let's say, equal to the corporate average? How do you think about that market? Do you need to discount, given the strength of U.S. dollar, just curious to get your overall perceptions, Gary, on the European/international market?

[Paul R. Auvil:]

Let me start with a couple of items and then Gary can jump in. So, we've got a solid team there, new leader – actually, not so new anymore – been there running the corner on a year. But nevertheless, he's built out an infrastructure, a team of leaders across several different major geographies and built a very good team of individuals that then staff and drive that organization. I think one of the things that we're still investing in is putting in place the right channel and marketing infrastructure to support them as well. I think we're most of the way there. So the net of it is, as we kind of refine and fine-tune that investment level, I don't see another major uptick beyond where we are currently until we see that performance start to move closer to the U.S. averages, which we're anticipating, hopefully, will happen sooner rather than later. But in any case, as we look at our pricing in the market, one thing that's important here is we price in local currency and have for many years now. So the change in the value of the dollar versus the euro to the European customers, pricing doesn't appear to have changed. We're charging a certain number of euros per user per year for our products. We obviously on our end are getting something less for that. But keep in mind that we also have a separate European cloud whose cost also move in association with the change in the value of the euro versus the dollar. So overall, our European pricing is isolated from the dollar/euro move other than, of course, the way it then gets reflected in how we bill and recognize on our income statement in U.S. currency as that rate fluctuates.

[Gary L. Steele:]

Yeah. And Rob, I would add one other point of view from a market standpoint. We've seen more concerned paranoia, urgency on behalf of the U.S. buyer than on the European buyer. We have seen a change over the last six months and part of this is related to the broad exposure that happens in the U.S. when there's a breach or some disclosure of private information. There is less breach notification requirements in Europe and so there's just been less fear, paranoia and concern. That's starting to improve. We saw improvement actually in Q2 over where it was in Q1. But there is still a very different perspective that lives with the European buyer. I think that, that all catches up because we're living in a global economy where the European customer will be equally attacked. But I think the point of view is slightly different today in Europe than it is in the U.S., and as Paul described earlier, I think our U.S. business has just done extremely well given the market backdrop that we're living in.

[Robert J. Brous:]

Great. Maybe just a quick follow-up, Gary, a question that I get a lot of times is why is Proofpoint so effective more than the competition. And my answer has always been it's the backend analytics, the algorithms that sit on top of that new back-end that you use. Is there any way to quantitatively or qualify how much more data or how much bigger of a data analytics set that you have relative to the competition, at least maybe form some third party industry person I spoke to?

[Gary L. Steele:]

Yeah, it's a really good question. We don't have hard analytics in the comparison of our effectiveness versus our competitors. I think there's probably three factors that influence our overall effectiveness. So because we deploy in the cloud, our rate of innovation is incredibly fast. So, our product release cycles are every six weeks. You couple that then with the broad big data analytics that we do and our ability to assimilate billions of points of information coupled with the hundreds of thousand unique pieces of malware we see on a single day. And I think the secret sauce, frankly, is our ability to correlate all this information and we're using big data analytics to drive correlation that, frankly, we would not be able to see the things that we see if we weren't able to do that. And because our mentality, our deployment, our technologies are cloud-centric, we're doing things that no one else is doing today. And that's what drives that effectiveness. We don't have – it's really hard to even to with a customer to provide hardcore numbers. And so we're always in a deal getting a customer to eval and we'll prove it every single day in their environment because everyone's threat environment's very different. And so it's hard to even give universal numbers because what one customer sees will be very, very different than what another customer sees.

[Robert J. Brous:]

Perfect. Nice quarter, guys.

[Gary L. Steele:]

Thank you.

[Paul R. Auvil:]

Thanks, Rob.

[Operator:]

And next will be Gray Powell with Wells Fargo.

[Gray W. Powell:]

Great. Thank you very much. Just a couple of questions. So I think you guys have disclosed that your TAP penetration is around 30% of your email customer base. I'm just curious what kind of attach rate have you seen on new sales and where do you think that a tax rate can go over time?

[Paul R. Auvil:]

Yeah. So I would say that we're definitely seeing TAP as the leading indicator of driving net new opportunity. So as we look at the broader landscape and the opportunity, lots and lots of our demand opportunity now is being driven by TAP as the first conversation. And then with that as the way in the door, often will drive it to a larger conversation around the protection platform. Now, that's not to say that we don't sell protection independently, but the attach rate on net new accounts of selling TAP and protection together is quite compelling. It's not a number that we actually specifically share externally, but the two definitely go hand-in-hand. But back to kind of our core installed base, the 30% number I think is a bit high where the current attach rate against our entire installed base of protection and archiving and privacy customers is actually well under 30% which is where the big add-on numbers that we talked about at Analyst Day come from. There's a big opportunity to sell additional TAP products, for example, to the installed base as well as privacy and archiving and our social products. But anyway long way of saying there isn't a lot of data that we provide here, but I can tell you anecdotally protection and TAP do sell very well together for net new accounts and obviously TAP is a very strong add-on seller to existing protection customers that don't currently run a second solution.

[Gray W. Powell:]

Got it, got it. Okay. And then my bet on the 30% number that was something that I tried to back in to from the Analyst Day disclosures.

[Paul R. Auvil:]

Yeah.

[Gray W. Powell:]

But just one other question, just more of a modeling one. I'm just trying to think about the normalized billings growth implied by your Q3 guidance and you gave us a couple of the components for Q3 of 2015. Roughly speaking, though, what is the headwind for foreign exchange year-over-year on billings for Q3 of 2015? And then, I believe, also in Q3 of 2014 you had some sort of one-time benefits or early renewals. So I just want to make sure that I'm looking at Q3 2014 versus Q3 2015 on an apples-to-apples basis?

[Paul R. Auvil:]

Sure. Yeah. So, since foreign exchange hits billings directly, whereas it takes time to roll through on revenue. Think of it as this which is our overall international revenues are high-teens, most of which is Europe and so the euro, some of which is done in pounds. And so then think of the euro as having depreciated from the low 1.3s down to currently 1.1, so think of that as depreciation, let's say, on the – getting close to, but not quite 20%. You put those two things together and you'll come up with a billings headwind in and of itself of somewhere in the kind of 4%-ish range plus or minus. And then, again, as we talked about in terms of revenue and this was a little bit the question that Rob had asked about, that does accumulate a little bit. So it becomes a higher impact depending on the quarter ago forward, which is why I talked about that 5% plus number in terms of the impact on our fourth quarter revenue numbers. But you can see that FX impact in the billings number directly as you're trying to think about what our normalized year-over-year billings growth rate is, think of it as adjusting it for about four points for FX.

[Gray W. Powell:]

Okay. And then, in Q3 of 2014, you had some early renewals pulled into that quarter, is that correct?

[Paul R. Auvil:]

No, Q4 of 2014 where we pulled in about $5 million of renewals from the first quarter of 2015.

[Gray W. Powell:]

Okay.

[Paul R. Auvil:]

Yeah.

[Operator:]

And next will be Michael Kim with Imperial Capital.

[Michael Wonchoon Kim:]

Good afternoon, guys. Just touching on the archiving side, are you starting to see a shift especially by the larger enterprises towards archiving, are they sort of overcoming some of their security concerns? And was the growth in the quarter primarily driven by cross-sell with some of the existing base or are these net new customers?

[Gary L. Steele:]

We saw a mix of both. So the larger customers that we referenced were new, but we saw some reasonable add-on production as well, so it was a mix. I think the one thing that's going on at a market level though that's important is the only innovation happening across the industry is cloud based. And so as organizations get to a point where their on-premise environment is not performing to expectation, that's when they look to the market, you look to the market the only real choice is to go cloud and so we continue to fundamentally believe that this is a classic on-prem to SaaS opportunity where the broader market moves from on-premise to cloud. We know this will take time, but we continue to see these organizations that are just struggling with on-premise old legacy environment that want to do something fundamentally different and there are only real choices to go cloud.

[Michael Wonchoon Kim:]

And are you starting to see deal sizes expand over time or are they – is it typically a toehold and then over time you'll build out with that customer?

[Gary L. Steele:]

No, when customers decide to go, they pretty much go all the way.

[Michael Wonchoon Kim:]

Okay.

[Gary L. Steele:]

And it's not – archiving is not a land and expand model because of the level of investment required.

[Michael Wonchoon Kim:]

Got it. Okay. And then just on privacy, are you seeing some displacement opportunities especially with Cisco IronPort or other legacy vendors out there. Is the lead gen coming primarily in the regulated verticals or are you actually starting to see some non-regulated customers that take a closer look at privacy?

[Gary L. Steele:]

Most of the privacy customers are working to reduce their overall attack service, protect PCI related information or PII related information. And so highest density of customers would be in regulated, but we are seeing broader interest today, given the concern about reducing overall attack surface. And from a competitive point of view, competitive landscape has not shifted at all. We're taking out legacy incumbent players like a Cisco or Symantec.

[Michael Wonchoon Kim:]

Got it. Great. Thank you very much.

[Gary L. Steele:]

Thank you.

[Paul R. Auvil:]

Thanks.

[Operator:]

And our next question comes from Mike Cikos with Macquarie. Mike Cikos - Macquarie Capital (USA), Inc. Hi, guys. Just a quick question for you on the social media solutions you currently have there. I know that this market is still young especially for you guys, and I'm just interested in what market feedback has been like, would you say that there is still a fair amount of evangelizing that needs to take place on, on the social solutions? And second question regarding the social solutions is where is the spending coming from out of customer budgets?

[Gary L. Steele:]

Yeah. Good question. So there is still a fair amount of evangelizing that goes on. We raise the visibility in regard to the security issues that can happen as a result of some particular attack on social. I think that honestly, I really do believe that there is broader awareness and understanding today than ever before, and almost everybody we talk to that has a reasonable social presence has had some issue they've had to deal with. So it's not like we're explaining that, oh, my God, there's a security issue related to social, they know. And so, in terms of the – where budget comes from, it's typically a collaboration between the head of security, so the CISO and individual within marketing that owns the social presence. So that could be the head of digital marketing or someone in that group that owns social presence for the enterprise. And it's typically a collaboration between those two groups. Marketing oftentimes has more dollars to spend and so dollars can be generally funded or come from marketing only. Mike Cikos - Macquarie Capital (USA), Inc. Okay. Okay. And then just another quick question for you on the – I just want to make sure I got it right. So was it 50% of new business signed in the quarter was driven by add-ons, first? And then second, how does that 50% compare to the last few quarters?

[Gary L. Steele:]

Yeah. So, yeah. It was 50% that was – that's correct. And it's pretty typical for us in any given quarter. We're about 50/50 these days. And it's not surprising because we have a very significant team of sales reps that do nothing but wake up every day and drive add-on sales to the installed base and then a separate team that drives nothing but going out and hunting and taking down net new accounts. And so, we kind of designed it to have a balance that's roughly 50/50. We think that's the right way to grow the business going forward. In some quarters it's a little bit more one way, in some quarters it's a little bit more the other, but it operates kind of within a 60/40, 40/60 boundary, but this quarter it was kind of roughly 50/50 spot on. Mike Cikos - Macquarie Capital (USA), Inc. Okay. Are the add-ons going mainly to newer products or is it mainly customers just extending seats?

[Gary L. Steele:]

It's almost never customers expanding seats. With the exception of the social product, almost all of our products when you first buy them, you buy for the entire enterprise. And so it's mostly people who started with, say, Protection and they're buying TAP or they have TAP and they buy Protection or they have TAP and Protection and now they're buying Privacy and it will be again full deployments across the entire company and this is truly even for our largest customers, customers that have 300,000 users. Mike Cikos - Macquarie Capital (USA), Inc. Okay. Excellent. Thank you, guys.

[Gary L. Steele:]

Thanks.

[Paul R. Auvil:]

Thank you.

[Operator:]

And next question comes from Srini Nandury with Summit Research.

[Srini S. Nandury:]

All right. Thank you, guys. A couple of questions actually. Following up on Robert's question on the international front, can you comment on the privacy restrictions and so forth rules and regulations moving into cloud play into the – your investments into CapEx and sales and how that's impacting your revenue growth?

[Paul R. Auvil:]

Yeah. So we've had datacenters in Europe for a number of years now and to your point, we found that it's been important even before it's become a more publicized issue in terms of having capabilities in countries that enable us to meet the data privacy requirements that exists within the EU. So we haven't found it to be a specific impediment, although we do sometimes find customers who even though we're running the European cloud and you're a U.S. company, geez, you know, I know it's European cloud, they've got still a little bit nervousness around that. And so we do have the ability to enable people to build their own little private cloud. So for larger companies they might actually build our own cloud with our solution running within their datacenters, we don't see that very often, but we have that as an alternative for folks who really are very concerned about it and don't want to run in, in our European datacenters. And so I think we've got that problem pretty well covered off.

[Srini S. Nandury:]

Okay. One last question from me. You mentioned in the last call that you're in the process of opening Australia and Asia-Pacific, are you operating in those areas now and can you update on how the insured traction has been?

[Gary L. Steele:]

Yeah. We're operating there. We do have a small amount of business there. It's very, very early right now, though. So I would describe it as something that we felt we wanted to get up and running, we want to put the brand into that region and get going. But it probably won't be something that we talk about in terms of really meaningful business contribution, I would guess for another year, but we're happy with how it's progressing here in the first stages.

[Srini S. Nandury:]

All right. Congratulations on a good quarter.

[Gary L. Steele:]

Thank you.

[Operator:]

And next will be Steve Koenig with Wedbush Securities.

[Steve R. Koenig:]

Hi, gentlemen. I'll leave it to just one question since it's getting late and congrats on the excellent quarter as usual. I wanted to just focus on the buyer and in particular, I'm interested on your thoughts on how your relative focus evolves over time as you move more into more sales of the threat protection and the intelligence product and future products down the road. How do you see that evolving from the email buyer, certainly in conjunction with the CISO to other security buyers or other functions in the company and how that might evolve over time?

[Gary L. Steele:]

Yes. Steve, that's a good question. So our two primary buying constituencies have been the email buyer and the CISO. If you look back at the last few quarters, that's really transitioned from email buyer to CISO predominantly, because the CISO is extremely concerned about the kinds of threats coming in into the email environment and therefore putting the individuals within the organization at risk. So we've really shifted hard to the CISO and that has been a very effective shift for us. I think primarily our success there has been again going back to what I said earlier is just our ability to demonstrate the value that we deliver in the form of a production eval. If you look at additional product capabilities and you think about where they fit, so you look at things like threat intelligence and Threat Response, those fits squarely underneath the CISO. They fit into the security operation center most frequently. Security operation centers continue to mature in terms of process, how they're staffed, the way they operate and we're having very good success and traction and talking to those organizations and showing them the value that we can deliver, but we are typically entering at the CISO level and pushing down into those groups versus going the other way around. And the only exception as we talk about earlier is the social products do sell to the CSO, but they also sell to the marketing department, because marketing own social, but the concern and accountability around security is still owned with the CISO and that's where our communication is focused.

[Steve R. Koenig:]

Perfect. Great. Thanks a lot, guys.

[Gary L. Steele:]

Yep, thanks, Steve.

[Operator:]

And that does conclude the question-and-answer session. I'll now turn the conference back over to management for any additional remarks.

[Gary L. Steele:]

Well, I just want to take a moment and thank everyone for joining us on the call today. We were excited about our Q2 results and we look forward to speaking to you at the close of Q3. Thanks so much, everyone.

[Operator:]

Well, thank you. And that does conclude today's conference. Again, thank you for your participation today.