Proofpoint, Inc.
Q3 2015 Earnings Call Transcript

Published: 22 Oct 2015

[Operator:]

Good day and welcome to the Proofpoint Third 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 R. Auvil:]

Thanks. Good afternoon and welcome to Proofpoint's third 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.f 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, costs 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 third quarter 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 October 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, I'll turn the call over to Gary.

[Gary L. Steele:]

Thanks, Paul. I'd like to thank everyone for joining us on the call today. We are very pleased with our strong execution during the third quarter, which resulted in our ability to exceed expectations across all key operating metrics. During the quarter, we continued to benefit from strong demand for advanced threat protection solution, ongoing high competitive win rates, robust add-on activity and consistently high renewal rates. The overall demand environment for security solutions that can identify and block advanced malware continues to be strong. Strategies of attacks continually change as cyber criminals are always looking for the easiest way into organizations. However, the one tactic that is constant with today's cyber criminals is email-based phishing. E-mail is the number one threat factor for organizations because it only takes one click or one download by an individual and the entire organization's security is compromised. These attacks had become so sophisticated that they enticed even the most senior executives at companies. For example, we're seeing highly personalized phishing attacks focused on wire fraud. These attacks look like directives from management to wire fund somewhere, and the people following those instructions wire money into the hands of hackers. While many think targeted attacks are typically focused on financial services companies, no industry is safe today. For example, we've seen the classic Dyre malware revamped and re-released and re-targeted at supply chains in attacks on major fulfillment and warehousing entities. Such attacks have the potential not only for direct cash theft, but false storefront creation, artificial invoicing and even shipment redirection. These kinds of targeted attacks are forcing organizations across all industries to rethink their security infrastructure. As organizations look to solve these types of challenges, Proofpoint's Targeted Attack Protection solution is ideally suited to address these threats given its proven ability to be extremely effective with advanced forms of malware and attacks. As a result, we feel very good about the momentum of TAP going forward. Taking a quick look at our financial results for the third quarter, total revenue increased 37% year-over-year to $69.1 million. This represented our 49 consecutive quarter of sequential revenue growth. We also reported record billings of $85 million, up 37% on a year-over-year basis. And finally, we achieved record-adjusted EBITDA of $2.4 million and free cash flow of $16.2 million for the quarter, both of which significantly exceeded third quarter guidance ranges. Now, turning to some of our key accomplishments during the third 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. This is the 8 consecutive quarter of achieving this growth with the ongoing demand being driven by TAP's next generation capabilities, which uniquely combines the application of big data analytics and dynamic malware analysis to identify and block zero-day and polymorphic malware. Given the increasing scale of the TAP business, while we expect revenues from the business to continue to produce meaningful growth on an absolute basis, the year-over-year growth when measured on a percentage basis will begin to moderate as these absolute comparisons become more difficult. Some of the noteworthy TAP wins during the quarter included, a Fortune 50 global conglomerate that added TAP for 185,000 users, a Fortune 100 insurance company which added TAP for 45,000 users, and a leading financial services company that added TAP for over 30,000 users. As the demand for our TAP solution continues, we are seeing growing interest for our complementary offerings in threat intelligence and remediation. This is evidenced by a deal we won with a Fortune 100 food distribution company that bought TAP earlier in the year and came back and added Threat Response and our threat intelligence solutions for over 30,000 users. As a reminder, these solutions are natural add-ons to TAP, creating what we believe to be the most timely, actionable, end-to-end attack intelligence and remediation solution in the industry. During the quarter, we were very excited to announce the availability of TAP Mobile Defense, which expanded our capabilities for the mobile market. According to a recent survey, more than 30% of Android apps are capable of leaking users' private data, and many iOS apps are also vulnerable. In addition, many apps, even in legitimate app stores, are mining private data and sending the information to unauthorized servers around the world. TAP Mobile Defense provides security teams with the ability to stop malicious Android and iOS mobile apps before they steal sensitive data stored on mobile phones. In addition, TAP Mobile Defense can also proactively remove malicious apps by leveraging its tight integration with the leading enterprise mobility management platforms, including MobileIron and AirWatch by VMware. In regards to the momentum with our Social Media Security Solutions, we were very pleased with the ongoing demand during the third quarter, and some of the key wins included a global professional services company seeking to protect our high-value user accounts from account takeovers, malware, and other malicious activities; a Fortune 100 pharmaceutical company seeking to protect themselves from fraud and brand damage, as well as securing their social properties, and a Fortune 100 bank, which was seeking to identify fraudulent phishing accounts. We also see a large market opportunity for social media compliance solutions as enterprises, particularly financial institutions, increase their use of social media in a compliant manner for various sales, marketing and customer services initiatives. Given that the adoption of social media as a tool in enterprises continue to be relatively nascent, we expect our demand to track the overall development of this market. As a result, we believe that Proofpoint remains very well-positioned to take advantage of this growing opportunity, particularly given the increasing number of highly visible social media hacks. In our core protection business, momentum continued as strong demand and our high win rates versus the competition once again resulted in many new customer additions. A few examples of protection wins during the quarter include; a large operator of hospitals and healthcare facilities that purchased Protection, TAP and Privacy for 25,000 users; a large domestic retail chain which purchased Protection and TAP for over 25,000 users; two regional healthcare service providers, one of which purchased Protection and TAP for 20,000 users, and the other that purchased Protection and Privacy for 17,000 users; and a Fortune 500 commercial real estate services firm, which purchased Protection for 60,000 users as part of their transition to Office 365. This win further highlights the fact that enterprise customers moving to Office 365 continue to look for additional security capabilities to complement and enhance the baseline solutions provided by Microsoft. In addition, the need to replace the existing compliance infrastructure that has been deployed on premise in support of the legacy exchange infrastructure creates a catalyst that drives demand for our broader cloud-based compliance capabilities as part of this migration to Office 365. As a result, during Q3, the transition to Microsoft Office 365 continue to be a compelling catalyst for Proofpoint and some additional deals included a Fortune 100 healthcare services company which purchased Protection and TAP for 50,000 users, a Fortune 500 energy company which purchased Protection, Privacy and TAP for 7,000 users and a large regional hospital, which also purchased Protection, Privacy and TAP for 7,000 users. We also had another solid quarter with our cloud-based archiving business as we continue to see organizations move into the cloud to replace their aging on-premise archiving infrastructure. Some of the key wins during Q3 included a Fortune 1000 medical device company, a large municipal entity and a broad expansion for a leading Internet brand. In regards to selling additional products to our expanding customer base, we continue to gain momentum during the third quarter. Specifically, we further increased the number and size of add-on deals booked during the quarter with over half of our growth driven by add-on in Q3. As a reminder, at the start of the year, only 40% of our customers had more than one Proofpoint product. As a result, we continue to believe that we have the opportunity to roughly triple the size of our business based on add-on sales alone which represents an ongoing growth opportunity for the company. I wanted to also point out that during the quarter, we were pleased with the momentum of the channel as we saw a greater percentage of deals going through resellers highlighting the diversity of our go-to-market strategy. Finally, we also start growing momentum in our international operations during the quarter as we made progress toward further expansion abroad. During Q3, international revenues grew 29% year-over-year, representing another solid performance particularly in Europe. Some of the international deals won include one of the world's largest professional services firms which added TAP for over 170,000 users; a leading European aerospace company which also added TAP for 20,000 users; and one of Europe's largest industrial companies which bought TAP for over 8,000 users. The addressable market outside of United States in both EMEA and Asia Pacific continues to represent future growth opportunity for Proofpoint as we plan to further grow market share in these regions going forward. In summary, I am very pleased with our strong third quarter results and ongoing broad-based momentum we are seeing across our entire business. Given our proven ability in defending enterprises against today's advanced security threats, we believe the company remains well-positioned to gain market share in the over $9 billion total addressable market. Before I turn it back over to Paul, I want to share with everyone that Intel Security and Proofpoint have entered into a broad commercial agreement covering Intel Security's use of Proofpoint's threat intelligence information in a joint go-to-market collaboration. The expected impact of this strategic relationship is already considered in the upcoming financial guidance that Paul will provide you. With that, let me turn it back over to Paul.

[Paul R. Auvil:]

Thanks, Gary. We were very pleased with our ability to exceed expectations for revenue, billings, adjusted EBITDA, and non-GAAP EPS during the third quarter. Proofpoint continued to benefit from 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 third quarter, total revenue was $69.1 million, up 37% year-over-year and above our previously announced guidance range of $65 million to $66 million. These strong results were driven by a 39% year-over-year growth rate in our subscription revenue. Looking at the revenue breakdown by solution, during the third quarter, our Protection and Privacy solutions comprised 80% of total revenues, growing 43% annually, while our archiving and governance solutions made up the remaining 20%, growing 18% over the prior year. Billings in the third quarter totaled $85 million, reflecting growth of 37% on a year-over-year basis and exceeding the high-end of our previously announced guidance range of $76 million to $78 million. With regards to duration, it was consistent with the last quarter and at the low-end of our historical range of 15 months to 22 months. Turning to expenses and profitability for the third quarter, on a non-GAAP basis, our total gross margin was 75%, which was above our expectations and right in the middle of our long-term target of 74% to 76%. While we were very pleased with our ability to meet or exceed our long-term target earlier than expected, this quarter's results were bolstered by a strong growth in the subscription business ahead of our underlying investment in cloud infrastructure, and hence we expect our margins to decline going into Q4 as spending catches up with revenues. 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 third quarter, total non-GAAP operating expenses increased 41% over the prior year to $52.6 million, representing 76% of total revenue, up from 74% during the same period last year, primarily due to an increase in sales commission expense, driven by the strong bookings activity during the quarter. As a reminder, Proofpoint currently follows the approach of expensing commissions during the period in which they were incurred rather than amortizing them over the term of the revenue contract. Note that many SaaS companies amortized their (15

[Operator:]

Thank you. And we'll take our first question from Rob Owens with Pacific Crest Securities.

[Rob Owens:]

Great. Thank you very much and good afternoon, guys. I want to talk a little bit about the shift to the channel that you mentioned in your prepared remarks. What is your current channel mix? Is this business that you're sending the way of the channel, is the channel actually doing the origination at this point? And maybe talk a little about the programs that are helping to incentivize and drive this?

[Paul R. Auvil:]

Yes. Thanks, Rob. That's a good question. So, right now, we're seeing a bit over 50% of our overall business coming through the channel and it is a combination of what we call push business where we have deals that are more easily fulfilled through the channels so we give them to the channel. And, of course, the channel earns fewer points on those deals versus pull business where they originate the opportunity and then ultimately drive the business over the line themselves. So, we're happy with that mix. We don't disclose that push-pull ratio externally, but we think given where we are with the channel that ratio is sort of right in line with where we'd expect to be. And quite frankly, the momentum in the channel – we've had some very nice wins and some nice deals and all channel partners each in their own way are playing an important role and helping to continue to drive the momentum for the business. And Gary, I don't know if you want to add any additional color on that.

[Gary L. Steele:]

Yes. Just two points. I think it's reflective of the strategy that Tracy put in place when she got here where we initially focused on just a few direct relationships with national partners. We then obviously introduced two-tier distribution in the U.S. midyear with the announcement of Ingram and we are starting to see some momentum build there as we build out relationships with regional partners. So, our overall channel strategy is really working as architected and we feel very good about that momentum.

[Rob Owens:]

Great. And then as an unrelated follow-up around the DSO number, you mentioned couple of large deals that paid early. Were those just closed earlier in the quarter and is that indicative of a mix shift towards more large deals in your business, which I think we've seen over the last couple of quarters? I'm just trying to understand, I guess, linearity and then mix of large deals.

[Paul R. Auvil:]

Yeah. That was good question. So, I would just roughly say there was on the order of $10 million of collections that we otherwise would have expected to be here in Q4 that came in Q3 and there were a couple of customers in particular that were the drivers of that. One just pay a little bit earlier than expected. The other, I think, as a matter of convenience, it was deal that we closed in late September but for whatever reason, they just wanted to essentially get the disbursement done. And so we were of course pleased to take that payment before the end of the month. So I don't think it's indicative of any accelerated payment behavior on the part of our customers overall. It was a little bit of a quirk which is why I thought it was important to call out. So, it kind of accelerates some cash flow into Q3 that we otherwise wouldn't have expected and engrained a little bit of cash flow out of Q4 that otherwise would have naturally been sitting there. But the DSO behavior outside of that was basically kind of right on where we normally see the number, so I think mid-40s.

[Rob Owens:]

Great. Thank you.

[Gary L. Steele:]

Yeah. Thanks, Rob.

[Operator:]

We'll take our next question from Philip Winslow with Credit Suisse. Philip A. Winslow - Credit Suisse Securities (USA) LLC (Broker) Hi. Thanks, guys, and congrats on just another great quarter. Two questions here sort of related. From just a competitive standpoint, we've heard some of the legacy vendors talk about new products in e-mail and messaging such as APT that could be released or are in the process of being released. Any sort of change from your perspective on the competitive landscape and what you're seeing from some of the legacy vendors? And then, similarly, within that, pricing, I wonder if you can give us some comments about just sort of what you're seeing in the pricing environment?

[Gary L. Steele:]

So, on the competitive front, we really did not see a fundamental shift in the competitive landscape as it relates to APT or Advanced Threat. We continue to see the vendors that we have been seeing in the market, people like FireEye and others but our win rates maintain their very high rate, and we didn't see new entrants coming in and affecting that in any way. To your point earlier, there is knowledge in the market that some of these vendors may have solutions. We just haven't frankly seen them on a day-to-day basis out in the marketplace. Philip A. Winslow - Credit Suisse Securities (USA) LLC (Broker) Yeah.

[Gary L. Steele:]

And I'll let Paul comment on pricing.

[Paul R. Auvil:]

Yeah. On pricing, we – I think I've shared this in past calls. We look pretty carefully at both the 5 and 12 quarter trailing average pricing for all of our products broken down by customer size, et cetera. Things continue to be stable. So I wouldn't say that the pricing environment is improving, but it certainly continues to be solid. So the price competition that happened earlier in the space of the market as it evolved years ago now has stabilized. And so pricing continues to be consistent with our reasonably recent past periods. I would say that with the TAP product in particular, that product, as Gary alluded to in his prepared remarks, is selling quite well, and we see a very solid pricing behavior in that part of the market. And I think part of it – we offer a tremendous value. When you look at the combination of the technology, our ability to identify but also block threats – the majority of the threats that come into the enterprise coming through email, and to do all of that in the cloud at the price points that we offer, quite frankly, it's a real value to the customer.

[Operator:]

And we'll take our next question Matt Hedberg with RBC Capital Markets.

[Matthew Hedberg:]

Yeah. Thanks for taking my questions, guys, and congrats on the quarter from me as well. Gary, you guys offered very strong revenue in building the guidance for 2016. I'm wondering if you can give us a few more details on the Intel partnership that you referenced. And maybe without pre-announcing some of the others, I'm wondering if you could give us an overview or some of the characteristics of what some of these other partnerships might look like.

[Gary L. Steele:]

Yeah. So, with respect to the Intel Security partnership, as we indicated, it involves Threat Intel and a prior go-to-market relationship. There's not a lot more that we can share at this point about that, but we are very excited about that. And as we indicated, the opportunity there was reflected in the guidance that Paul provided. There are some other relationships that we're working on that are broader ecosystem relationships that we do think will play key role as we continue to broaden our overall distribution footprint. Nothing really specifically more that we can say about those today but we're enthusiastic about the opportunity in announcing those relationships over the next several months.

[Matthew Hedberg:]

That's great. Stay tuned. And, Paul, certainly appreciate you normalizing your Q4 billings growth rate to 30%, absent some of those early renewals last year. Now you talked about some early payments this quarter, but did you guys see any other early renewals this quarter similar to last year?

[Paul R. Auvil:]

Yeah. So, we had what I would describe as kind of more of a normal cadence of early renewal activity. So we call it out when it's kind of exceptional. This quarter we had some, but nothing that I thought was overly noteworthy so I didn't bother to call it out specifically.

[Matthew Hedberg:]

Okay. And, maybe if I could, just one last quick one on the archiving. Obviously, you've talked about some nice wins there, certainly a higher price point for these archiving solutions. What is it going to take to see higher attach there? It seems like a great product to sell into the base to core protection. Are there some things you're going to be working on in 2016 that drive even higher adoption there?

[Gary L. Steele:]

Yes. We're very much focused on driving adoption of that capability, both with new customers and in the installed base. And I think the – we're now at a time when many of the legacy on-premise archive solutions are getting to the point where they're not very functional. And the opportunity to move those systems to the cloud is becoming clearer and clearer and I think we will benefit from that broader move from on-premise to the cloud as we move probably through 2016. And we're working on marketing and sales initiatives that allow us to capitalize on that.

[Matthew Hedberg:]

Thanks, guys.

[Operator:]

We'll take our next question from Walter Pritchard with Citi.

[Walter H. Pritchard:]

Hi. Paul, I'm wondering if you could talk, or Gary, talk a little about on the social side and on Ingram Micro. Those are kind of two earlier things in your business. What sort of traction you're seeing right now and how we should expect those to sort of unfold in terms of driving traction over the next few quarters?

[Gary L. Steele:]

Yeah. Great, Walter. So, on social, what we continue to see is a very high level of interest from some of the world's largest organizations. We're getting good interest. And what we find, though, as we indicated in the prepared remarks, is that people are just getting started with their broader social program. So they want security but they're not fully deployed on social so they don't buy for the whole enterprise, for example. So, while we're seeing great demand, we're still at the earlier stages of that market given the maturity of overall social adoption in selling and marketing within the enterprise, really enthusiastic about the long term opportunity. I think we're early in market right now. Your follow-up question was regarding Ingram. We announced Ingram in the middle of the year, I guess, it was in July. We continue to be very excited about the relationship. We're working hard and working hand in hand with the Ingram team to enable these regional partners. We are seeing very good reception and demand from those regional partners and the relationship with Ingram. We're at the very early stages of that. I think it's a couple of quarters to get really enabled with those partners and begin to drive benefit. We did see deals go through Ingram once again and some good early momentum, but we're at the very early stage of that relationship and we're optimistic that that could play a role in 2016 as we get there.

[Walter H. Pritchard:]

Great. Thanks.

[Gary L. Steele:]

Thanks, Walter.

[Operator:]

We'll take our next question from Melissa Gorham with Morgan Stanley.

[Melissa A. Gorham:]

Great. Thanks for taking my question. I'd like to touch on Office 365. Gary, can you maybe talk about what percent of your new business is maybe coinciding with the transition to Office 365 and have you implemented any notable initiatives in terms of go-to-market or sales strategy to maybe take advantage of that opportunity?

[Gary L. Steele:]

Yeah. So as we noted in the prepared remarks, Office 365 continues to be a compelling catalyst for our business. As those organizations shift their Exchange environment to the cloud, they have to rethink their whole security and compliance infrastructure. We have not published any specific numbers in terms of what percentage of our business is related to Office 365, but it is – it's meaningful in the context what we've noted it now for the past four quarters in our earnings calls. As we think about 2016, we do believe that Office 365 continues to be an important growth driver for us. And as a result of that, we're aligning marketing and sales initiatives to capitalize on that. And so, specifically, working closely with the Office 365 partners, that's a very important element of our strategy. So those individual partners that work in the Microsoft ecosystem that are driving this transition, those are critical partners for us. A good example of that is CDW, which is an existing partner of ours. They also have a very large Office 365 practice. That's an example where we get good crossover and benefit. And then we're doing a lot of sales enablement, driving our sales team to go, search out those particular Office 365 customers that are moving and engaging early in that dialogue. And as you're probably aware, many customers have a plan for Office 365. That doesn't mean they're doing today, but they have a stated timeframe, and they're thinking about in their overall IT infrastructure planning where Office 365 plays a role. An interesting thing there is we can dovetail on that and work with them on that planning process. So we continue to see that for the next several years, frankly, as being interesting and compelling for us and our business.

[Melissa A. Gorham:]

Okay. Thank you. And then just one follow-up. You talked about how Threat Response is very complementary to TAP. Can you maybe talk about the extent to which those solutions are getting bundled together and then any sort of context in what the price uplift is when you bundle Threat Response to TAP?

[Gary L. Steele:]

Yeah. No, great question. So I'll cover the selling motion and I'll let Paul cover the pricing. From a selling motion perspective, when we're going in and talking about advanced threat, which is our primary sales motion today, we're showing customers the value of these complementary solutions, which includes Threat Response and all of our threat intelligence. What we're typically finding, though, is customers buying TAP first and then coming back and buying threat intelligence and Threat Response. And that was the example that we provided, the one customer that we cited in that particular script. That's a pretty common sales motion where we win the TAP business and then go back and win the remediation and intelligence capabilities after the fact. Typically, though, through the sales motion that we have, customers are thinking about that and budgeting for that separately, so it becomes a discrete add-on sales process after the fact. I'll let Paul comment a little bit on pricing.

[Paul R. Auvil:]

Yeah. So the pricing we're seeing, it's still early because we haven't sold nearly as many instances, obviously, of Threat Response as TAP. But early indications would indicate that if price is at or close to the price of the TAP solution when sold either after the fact or at the same time, if you buy them altogether, we might give you a little bit more of a discount to buy the two pieces coincident, but that's kind of roughly what we're seeing. Now, over time, as we scale that, will that pricing hold? It's not entirely clear right now.

[Melissa A. Gorham:]

Okay. Great. Thank you.

[Gary L. Steele:]

Thanks.

[Operator:]

We'll take our next question from Imtiaz Koujalgi with Deutsche Bank.

[Imtiaz Koujalgi:]

Hey, guys. Thanks for taking my question. I have two questions. One is, I believe at the Analyst Day, you mentioned that you'll have some new products launching in Q3, I believe, TAP for Social and then Threat Response 3.0. Any initial feedback from those new products that you will launch in this quarter?

[Gary L. Steele:]

Yeah. So we've really – we launched a number of products. So one was TAP Mobile Defense. So that got announced at Black Hat in the beginning of August. We had basically five weeks of selling. We saw a very good early demand. We'll have to see now how that demand translates into bookings and revenue, but the feedback initially has been phenomenally good. With respect to the new version of Threat Response, that really integrates the value of our threat intel integrated into a remediation environment. That feedback has been good. And the example that we gave with the Fortune 500 foodservices company, that was a good example of capitalizing on that combination. And then TAP for Social, some good early feedback. I would say that's a little earlier in maturity at this point. But as I indicated earlier, Social continues to be something that is of high interest and high demand from the world's largest companies. So I just think we're a little bit early in converting that to revenue at this point.

[Imtiaz Koujalgi:]

Got it. And then secondly, if I look at the – I guess, international growth this quarter was 29%, which is similar to what you did in Q2. It looks like this is the second quarter in a row where your international growth was actually lower than your overall growth. Any disconnect between what's happening in the U.S. market versus outside the U.S.? Is it demand, or is it something more of an execution issue on your side?

[Paul R. Auvil:]

We're still early with Europe, as we talked about before. So we got a team on the ground there. They're doing good work, and they're closing some really good deals, right? So, overall, we're seeing good performance out of that team. The one thing that I think is important is, what you're seeing is the revenue result. And so, for example, this quarter, we actually had a particularly strong result from a bookings perspective. We didn't bother to call it out on the script, but since you called attention to it, I'll articulate this a little bit more. There were a number of kind of key wins and new deals that were closed in Europe, and Gary talked about a few of them in the script, and some nice add-on business as well. But it takes a while then for that to roll through given our deferred revenue model in that we're 97% subscription to see that as a benefit in revenue. So I would say we've heard other people talk about weak demand profiles in Europe. I wouldn't say that we would characterize it that way at all. I think there's compelling demand in Europe, and we're just driving our team to get up to consistent productivity across all the new members that we've added over the last year or so. And we have some very nice deals that we were happy to see close this quarter.

[Imtiaz Koujalgi:]

Thank you.

[Paul R. Auvil:]

Thanks.

[Operator:]

And we'll take our next question from Jonathan Ho with William Blair.

[Jonathan F. Ho:]

Hey, guys. Just wanted to start out with the decision to change the accounting. I just wanted to get a better sense from you guys why sort of now in terms of the change and what sort of impact should we be anticipating. I know you guys said it wasn't a big impact, but I just wanted to get a sense of what that could be.

[Gary L. Steele:]

Yeah. So, as we get bigger, what I'm increasingly realizing is that it's just – there's high value in having all of our accounting policies mark against the larger companies that people are familiar with in the SaaS industry. And this one in particular is the only one that I see is kind of a glaring disconnect is between how we do things versus how some of these bigger names like Salesforce and Workday and ServiceNow handle their accounting. And so it's one of those things that we dithered over before we took the company public in terms of changing. But since either methodology is fine and this is the one that we'd used prior to the public offering, we thought, all right, let's just use this. We got experience in forecasting around this. It's easy to understand for us, so we'll stick with it. I think this desire to have a methodology that's consistent with the larger players and get that done sooner rather than later, I think, is a value. As well, we're actually moving to a new revenue recognition system here at the end of the year, just upgrading our infrastructure. And so it's a natural time to make that change. To your question on impact, we've done some basic accounting around it and I think it's probably a few million, it may be more in terms of favorable benefit and there will be all those details provided in our 10-K filing, so that people will be able to essentially see the what-if, had we've been using this methodology in the past, what would be deferred balance and roll-through look like. So there won't be any obfuscation in this, I'll make sure it's very clear and probably as you all know me quite well by now, I'll probably spend too much time and too many paragraphs explaining all of them in the next earnings call.

[Jonathan F. Ho:]

Got it. Got it. And then your guidance for this year seems a bit more bullish than what we've seen in the past. And, I guess, I wanted to understand a little bit better what your environmental assumptions are. I know you guys talked about some of the upcoming partnership announcements, but just incrementally what you're seeing out in the environment for 2016 that could maybe support that higher level of confidence?

[Gary L. Steele:]

Yeah. So we've been building the sales force with quite a bit of rigor over the course of the year as you can see in our growth and sales marketing spend. And we've seen good uniform productivity out of the team numbers that we brought in. So as we look at that combined with the overall demand environment as we see it today, we feel very good about ongoing opportunities to drive sales of our TAP product, drive add-on sales with some of our newer products like TAP Mobile, Social, et cetera, as well as on growing compelling demand from our core product areas in what we call Protection and Privacy. And so, if you take all of those components and then look at some of these partnerships that we're working on that we talked about the one with Intel Security obviously today and there are several others that we're working on, we feel if you add all that up, we feel very good about how things look right now going into 2016. Also as I know everyone is aware, in the first couple of years as a public company, we were very thoughtful and quite conservative in how we thought about providing an outlook in the October timeframe. I think we've got a couple of years of operating as a public company under our belt now. And as a result, have better feeling for all the instrumentation around running the business, and hence, probably don't need to be quite as conservative as we have in the past in our October guidance as we look out to the coming year.

[Jonathan F. Ho:]

Great. Thank you.

[Gary L. Steele:]

Thanks.

[Operator:]

We'll take our next question from Gray Powell with Wells Fargo.

[Gray W. Powell:]

Hi, guys. Thanks for working me in. I appreciate it. Let me raise a couple of questions. At a macro level, do you think security can continue to take a higher share of IT budgets in 2016? And if so, when do you think share gains to level off if you see that at all?

[Gary L. Steele:]

Yeah. I think enterprises around the world today are woefully behind in building out the appropriate infrastructure to protect themselves from today's threat landscape. And I know there's been lots of speculation that people have overbought and they're going to slow down. I don't see that. I think we're still actually multiple years away from a moderated spending environment. As everyone on the call is aware, people struggle with finding staff to be able to implement things. And so there's been – there's still a lot of demand for capability that they just haven't had time to implement yet. And so, we are very positive about the ongoing demand environment, and we don't see that fundamentally changing over the course of the next couple of years.

[Gray W. Powell:]

Got it. Okay. That's very helpful. Then one more if I may. Obviously there's been a lot of discussion around increased federal spending. I know that the government is only 10% of your business. Just curious what you've seen on that front and if you have any plans to increase your focus on the vertical?

[Gary L. Steele:]

Yeah. Great question, Gray. So, we built our federal team roughly a year ago, and that team is now coming up to speed, driving productivity across all the individuals in the team. We did not – I'll repeat this, we did not have a federal fiscal budget/benefit in our Q3 results. What we do feel good about is the opportunity being created by our team and I think federal will play a bigger role for us in 2016. And as we grow that business, I think we'll start to see that 10% percentage increase over time. We do see a lot of opportunity there, and we think it is a key area of focus for the company and so we're excited about it, but it was not something we benefited from in the federal fiscal 2015 budget cycle.

[Gray W. Powell:]

Got it. Thank you very much.

[Gary L. Steele:]

You bet. Thanks.

[Operator:]

We'll take our next question from Craig Nankervis with First Analysis.

[Craig Nankervis:]

Thanks. It's great to hear about the ongoing exciting tone. My question I guess, Gary, is on the mid-market, how is the velocity there? I had understood that was picking up. Is that continuing or how are you looking at the mid-market specifically in your opportunities, and how much does Office 365 play into how you think about the mid-market?

[Gary L. Steele:]

So, Craig, for my benefit, when you say mid, define for me. So I'll make – I just want to make sure that I can answer your question.

[Craig Nankervis:]

The lower end of your market – the lower third or whatever of your market focus.

[Gary L. Steele:]

Okay. Because our mid is sometimes bigger than a lot of those mids. So when we think about mid, we think in the range of 500 employees up to, say, 4,000 employees, which is actually a pretty big midsized company. That has been a very fruitful area of investment for the company. We've had very good success selling a broad range of our product capabilities into those customers. We typically do, however, focus on industries that are highly regulated, so think financial services, healthcare, et cetera where those organizations fundamentally have the buying habits and the behavior of much larger organizations. But they operate under the rules and regulations of heavily regulated, and so that has been productive for us. As we look at Office 365, what's interesting today, and I wouldn't have said this a year ago is we're seeing Office 365 in all sizes of companies. And almost every company we go to, they have a very specific plan around Office 365. To the comments that we made to Melissa's question earlier, Office 365 is something that is being considered by organizations of all size today. It affects the mid guys that we're talking about now, but it also affects the larger enterprise. And as we cited in our prepared remarks, we had a good number of large enterprise customers going to Office 365 buyer capabilities because they needed it. And we don't see that any different in that midsize customer who is looking at Office 365. So, we think that's a compelling catalyst across both mid and large-sized companies.

[Craig Nankervis:]

And just one other while we're on Office 365 again. I mean, who do you see most as a competitor, and probably that varies depending on the segment of the market, but who are you most going up against for those opportunities?

[Gary L. Steele:]

Typically, what we're seeing today in a customer that's looking at Office 365, they are looking at the base capabilities that Microsoft offers, and they're trying to figure out whether those capabilities are good enough or do they need to buy something incremental. And so our number one challenge here is to make sure the customers actually spend the money and so we use the evaluation process as we talked about before to demonstrate the effectiveness and capability of our solution and get that customer compelled to buy. And so, competitively, there's not a lot of vendors in that particular space and it's much more about us showing the value to that customer that is going to the Microsoft environment.

[Craig Nankervis:]

Okay. Thanks.

[Operator:]

We'll take our next question from Tim Klasell with Northland Securities.

[Tim E. Klasell:]

Yeah. Hi. Most of my questions have been asked, but – and maybe I missed this. But Mimecast filed on Friday and they are sort of a competitor of yours, very strong in Europe and South Africa. How does that affect your ability to expand internationally and how often do you see them in a competitive environment?

[Gary L. Steele:]

Yeah. If you look at where we focus our marketing and sales energy, they very much play below from a market point of view from where we do and so we don't see them that frequently in our core business. We obviously run into them on the edges at the very low end of where we would play. And so we see them very much like we used to see Barracuda. So they kind of represent what Barracuda was on-premise, they represent that in the cloud. And so we just don't run into them much and I think if you were to talk to any of our sales people that's not on their minds at all.

[Tim E. Klasell:]

Okay.

[Gary L. Steele:]

So maybe just to round out your – answer your question, Tim. As we look at Europe and the business that we're booking there, I'm honestly not aware of them ever coming up in the context of the larger business that we're closing. Matter of fact I think I like the deals that we've won and the deals in our pipeline over the last several quarters.

[Tim E. Klasell:]

Okay. Great Thank you, very helpful.

[Operator:]

We'll take our next question from Erik Suppiger with JMP Securities.

[Erik L. Suppiger:]

Yeah. Congratulations. Two questions. One, on the Microsoft front, the Office 365 front, are you – you said you're working with Microsoft partners. How are you looking at Microsoft? They made an acquisition or announced an acquisition today. They bought Adallom a little bit back. Do you view them as becoming more competitive as we go forward, or are they pretty receptive to working with third party security?

[Gary L. Steele:]

Yeah. And a great question, Erik. So, we had been engaged with their field and their partners because at the end of the day what's most important is getting those customers Office 365. And we are a compelling catalyst to help those customers get over their security objections and help them solve those key problems. But customers – to be fair, customers do look at what Microsoft has and compare it to whether they need to buy something incremental. And I think that in working with the channel, working with the Microsoft reps, I think we're doing a good job of ensuring that we're telling that story. And given the threat landscape today, people don't want to be exposed given the risk associated with email and phishing. So we feel very good about this opportunity. And I think sometimes Microsoft looks like a partner, sometimes looks like a competitor. I think it will be that way for quite some time. But it's definitely helping drive our business today.

[Erik L. Suppiger:]

Okay. Then secondly, the FBI issued a warning or an announcement maybe a month ago about the wire fraud issues. They called it business email compromises. Did that make much of a difference in your business and does that play a much of a role in terms of your ability to get customers to revisit the TAP service?

[Gary L. Steele:]

Yeah. It's super interesting. So, the BEC, as people are calling it, which was the FBI warning, I think the reality is it's not the FBI warning itself that is driving demand, but I'm telling you, you could go out, talk to any customer, pick up the phone and everybody's feeling the effects of this. We were at a prospect literally a week ago where they had wired $3 million on accident due to one of these kinds of issues. These are big, they're meaningful, and they're far-reaching. So I think less so than the FBI warning, I think more so to the fact that you talk to anybody and they're seeing the effects of this. Finance departments everywhere are trying to figure out how not to let this happen and putting their own protocol and procedures in to ensure that you don't accidentally wire something based on one of these phishing attacks. It is definitely part of the dialogue everywhere we go, Erik. I think again, much more so from a customer demand standpoint versus just the FBI warning.

[Erik L. Suppiger:]

Great.

[Operator:]

And we'll take our next question from Daniel Ives with FBR. Daniel, your line is open.

[Daniel H. Ives:]

Yeah. Obviously a real strong outlook going to 2016. Can you maybe just talk about what do you think the biggest variable is that maybe you're being conservative on or from a new product area that could just put more fuel in the engine? Is it 365? Is it Social? Just maybe anecdotally talk about that going to 2016.

[Paul R. Auvil:]

Yeah. I mean, let me start and then Gary can add some color here. Just one of the things that I think is really sometimes underappreciated about Proofpoint is the breadth of our product line. And so to your point, as we think about 2016, both the baseline guidance and then areas to excel above that, there are a number of different elements that play a role there. So, Social certainly has a reasonable capability there, ongoing momentum from TAP, the new TAP Mobile product I think play a meaningful role as it comes together. The Threat Response product, we're seeing some good momentum developing there. There's a lot of levers there. And then as well our products in the aspects of how we actually help reduce the attack surface area in the enterprise and protect your data around what we historically have called our Privacy and Content Control products. We're starting to see kind of a nascent but growing area of interest in applying those products in that regard. So there are a number of different horses, if you will that you can ride as you think about that upside lever and how you pick one from another in terms of which is the best lever. On top of that, of course, the Office 365 trend is a little hard to say.

[Gary L. Steele:]

Yeah. And I would add to that, the competitive landscape has frankly never been better. And I believe that the lineup of products we have in combination with what's happening competitively is just a very strong position that we have as we round the corner in 2015 and move into 2016. And as we close out the year, we announce these broader strategic relationships. I think there is – it's a really good lineup for 2016.

[Daniel H. Ives:]

Thanks.

[Paul R. Auvil:]

Thanks.

[Gary L. Steele:]

Thanks.

[Operator:]

We'll take our next question from Mike Cikos with Macquarie. Michael Cikos - Macquarie Capital (USA), Inc. Hey, guys. Thanks for the time. Just a first question, wanted to come back to the Intel Security, I know details are still fuzzy right now and we'll get more on that later. But is any of that contributing to fourth quarter and the guidance that you gave there or can you give us an idea of the timing of when that will start impacting your P&L?

[Paul R. Auvil:]

Yeah. We don't really think it has any impact in the fourth quarter per se. It is certainly included in what we've outlined as part of our 2016 guidance. Couldn't really parse for you what portion of our numbers as we think of 2016 or related to that specifically as we don't disclose those kind of details externally. Michael Cikos - Macquarie Capital (USA), Inc. Okay. And regarding the change in accounting that you guys gave us an update on, so that few million that we'll see, is it fair that we'll be getting pro forma statements through calendar 2016? And is it 1Q 2017, the first time that this will actually flow through, or is it going to be towards the end of 2016?

[Paul R. Auvil:]

No. It will be in Q1 2016 where you see it. That will be the new methodology. And I'll provide some sort of elucidation as to what it means in the quarter as compared to prior methodology. The impact is more meaningful as you get out into the kind of second half of the year, just given the nature of how – as you think now, as we commission – as we expense commissions in period, the accelerators build over the year. And so, there's a more pronounced aspect of our sales and marketing spend that are related to commissions in the second half of the year. What deferring commissions does is it basically flattens it out more over the course of all four quarters for intents and purposes. And so, what you'll see is – I don't think it will actually have an adverse impact to Q1, but it will be muted to neutral in Q1. And you'll see more of a benefit in the latter half of 2016 under the new methodology. Michael Cikos - Macquarie Capital (USA), Inc. Okay. Thank you, guys.

[Paul R. Auvil:]

Just a few million at this point and I'll give you guys more color around this in the January call. Michael Cikos - Macquarie Capital (USA), Inc. Thank you.

[Operator:]

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

[Gur Talpaz:]

Great. Thanks for taking my question. I was hoping you could elaborate a bit more on the Intel partnership. Is this primarily the feeding of threat data into the respective products, or how far does it really extend from a product standpoint? And then going one step further, what does this mean with regards to potential endpoint tie-ins particularly in light of the (1

[Gary L. Steele:]

Great. So a couple of things. So one is, we're not in a position to comment beyond what we said in the prepared remarks that what we've announced today is simply a collaboration on the threat intel and go-to-market aspects. I can say that there is no contemplated relationship as it relates to endpoint as you've described the Tanium-Palo Alto relationship. So there is nothing that we're talking about that relates to that, that kind of relationship.

[Paul R. Auvil:]

Yeah. The one thing to keep in mind is that formerly McAfee, now Intel Security, has actually been a long time partner of Proofpoint's, in that we've been using, among other things, their AV technology in our solution for a number of years. And so this is kind of a natural additional step in the direction in a relationship that's been quite fruitful for both parties for quite some time.

[Gur Talpaz:]

Got it. That makes sense. And then with regards to TAP (1

[Gary L. Steele:]

Yeah. So, if you look at our go-to-market motion, we're definitely leading with advanced threat as our core story and core discussion we talked to customers. When customers buy initially, they either buy Protection and TAP together, or they buy Protection because that's what they have budget for and they come back and buy TAP later. That's pretty much the two variances there. It's rare that they buy TAP and then come back for Protection. That does happen. That's probably less likely. And then to your point about TAP AD versus TAP URL, a smart sales rep is always trying to sell the bundle which brings together those capabilities for a single price to the customer. What is the burning need today in the market is the issue associated with weaponized documents. So if a customer has a limited budget, they would purchase TAP AD standalone versus the bundle.

[Gur Talpaz:]

That's helpful. Thank you.

[Gary L. Steele:]

You bet.

[Operator:]

We'll take our next question from Steve Koenig with Wedbush.

[Steve R. Koenig:]

Hi, guys. Thanks for taking my question and congrats on the quarter as well. So, I just wanted to add another question on TAP here. Can you comment on maybe two aspects of it, kind of trends you're seeing in terms of penetration of the base with TAP; and secondly, trends you're seeing over the last few quarters when you look at the mix of TAP deals to new customers versus TAP deals that are an attached or a cross-sell?

[Gary L. Steele:]

Yeah. Great question. So we had a very productive quarter in Q3 as we indicated in our script doing a reasonable amount of add-ons. So traditionally, we've seen roughly half of our business of TAP going to new customers and roughly half going to the installed base, and we were a little more tilted toward the installed base in Q3. I suspect where we'll be in future quarters would be more 50-50, but we'll have to see how it pans out. I think, frankly, what's happening, Steve, is our sales team is getting much, much more effective in going back and mining the base and driving the penetration of TAP into the installed base because they're seeing the opportunity and the ease with which they can get those deals done. But from a management point of view, we like the half and half, bringing in new customers combined with continuing to further penetrate the base.

[Steve R. Koenig:]

And just one quick follow-up. Any commentary you can give us on kind of how that mix – like how long can the 50-50 last, assuming you can (1

[Gary L. Steele:]

Yeah. So we're still very underpenetrated in our base. We still have a long ways to go in terms of driving penetration overall of TAP into the base. We indicated at our Analyst Day, it was roughly 15% penetrated. So we have a long ways to go until we've filled out the base in terms of TAP.

[Steve R. Koenig:]

Great, fantastic. Hey, thanks a lot.

[Gary L. Steele:]

You bet.

[Operator:]

We'll take our next question from Srini Nandury with Summit Research.

[Srini S. Nandury:]

All right. Thank you for taking my call. Congratulations on a good quarter. I have a question on the archiving business. If you look at your traditional archiving rivals, the large OEMs, they're all shrinking and you guys grew very fast, in fact 18%, which is something pretty impressive. The question I have is that with much of the archiving going to the cloud, why shouldn't you be growing faster next year? And do you think that could happen in 2016?

[Gary L. Steele:]

Yeah. So it is interesting. I think, to your point, there is an opportunity for the archiving business to accelerate because there really is only one direction for people to go. It is from on-premise to the cloud. That is clearly where the market is headed. I think the challenge for us, frankly, is if you're a sales rep, it's easier to sell advanced threat today given the high, high demand. And so I think some of it's just a sales focus issue at this point in terms of driving higher growth. We're clearly looking at opportunities to ensure that we have balanced focus there. But some of it is just reality that selling TAP is frankly easier than selling archive given the broad market backdrop.

[Srini S. Nandury:]

All right. If I have one more question, please. You talked about mobile TAP in your prepared remarks, and I was not very sure if you started shipping the mobile TAP product out there. And if you look at your competition out there, the MDM providers such as AirWatch from VMware, are you guys complementary to them or are you guys in competition to them? And can you provide some color there, please?

[Gary L. Steele:]

You bet. So we started shipping when we announced at the beginning of August at BlackHat. So product's out and available. The cool thing and very interesting aspect of TAP Mobile Defense is that it sits on top of the MDM vendors. We referenced it in the script. We call them EMM vendors, Enterprise Mobility Management, but it's the same thing. And so we have relationships, for example, today with MobileIron, we also have relationships with AirWatch by VMware. And effectively, the way the product works is that if you have one of those solutions, there's no client agent required to sit on the mobile device that we can then manage and do the security assessments through those EMM vendors. So that's the really interesting thing. We're not competing against the AirWatches of the world. We are complementary, and we have go-to-market relationships with those folks, whereby we can frankly use those as the ability to reach in and take action on the device if we find something malicious.

[Srini S. Nandury:]

All right. Thank you for taking my call.

[Gary L. Steele:]

You bet.

[Paul R. Auvil:]

Okay. We've got time for two more.

[Operator:]

We'll take our next question from Michael Kim with Imperial Capital. n

[Michael Wonchoon Kim:]

Hi, guys. Good afternoon. Can you talk a little bit about the opportunity to accelerate your international growth, especially across the broader EMEA region? And what are some of the constraints around that? Is it data sovereignty? Do you need to extend your channel partnerships or some of the capital infrastructure investments you've referenced earlier?

[Gary L. Steele:]

Yeah. So let me start here. So we've got data centers in Europe already, so we don't have a data sovereignty problem. I think to your reference on channel, I think we've got a good team on the ground. They're closing some great deals. I think that developing the channel infrastructure is a key component of creating success, particularly in the European market. And so we're moderating investment in various international geographies against driving growth in geographies where we already have great momentum like the U.S. But we will definitely be making meaningful investments in Europe next year to drive acceleration in that footprint given the great constituent of customers that the team's closed over the last 12 months.

[Michael Wonchoon Kim:]

And then just based on your 2016 overall outlook, should we expect that the international side of your business has the opportunity to grow faster than the overall business next year?

[Gary L. Steele:]

I would for now assume that it just keeps pace with the U.S. operations, and I think an area for upside could be if Europe started to deliver a slightly stronger performance. But in the base line, we're expecting them to contribute roughly equally with their U.S. counterparts going into next year.

[Michael Wonchoon Kim:]

Okay, great. Thank you very much.

[Paul R. Auvil:]

Thank you.

[Operator:]

And we'll take our final question from Andrew Nowinski with Piper Jaffray.

[Andrew James Nowinski:]

Yeah, thanks. So your revenue guidance, you beat it about 5% but you beat your billing guidance by about 9%, and your DSOs were clearly better than expected. So I'm just wondering if there's any deals that came in that were larger than you were expecting and perhaps even deals that you weren't expecting in the quarter.

[Gary L. Steele:]

Yeah. Good question. We always run the business off of our pipeline reports and have expectations of business that we will close. And so, obviously, we handicap things accordingly. And so maybe the best way to characterize it is there were definitely some deals that were a little bit bigger than we had expected because the sales guys are always a little conservative when they put the numbers into the pipeline. And we closed a few of our larger deals that I think we were handicapping might close in Q4 actually closed in Q3, but my Q4 guidance that I provided comprehends that as well, so.

[Andrew James Nowinski:]

All right. And then is there any consistency between the customers that are purchasing multiple products versus the ones that are only purchasing one product? I'm just trying to understand why the percentage of customers that have purchased multiple products is not increasing.

[Gary L. Steele:]

So we don't share that statistic each quarter, right? We kind of just provide that annually. Clearly, with the strength of the add-on business that we're seeing, we're obviously improving our number which, at the start of the year, 40% of the customers had two or more products. We haven't disclosed an updated number there, but certainly expect that number to improve when we provide an update at the end of the year in January. We're also, along with that, seeing customers that are buying more than one product at a time and it's typically the combination of TAP and Protection that gets purchased together. And so that obviously is helping to drive that statistic as well. But there's nothing unique about one class of customer versus another. The product's very horizontal and we see success in selling multiple products in virtually every industry. And so it's part of the science that we're still perfecting is how to drive more multiple product customers, because obviously the more products the customer has from us, the stickier they are, and actually our overall margin profile improves a little bit depending on the mix of the products that they purchase.

[Andrew James Nowinski:]

Okay. Thanks. Keep up the good work.

[Gary L. Steele:]

All right. Good enough.

[Paul R. Auvil:]

Thank you.

[Gary L. Steele:]

Thank you.

[Operator:]

And I'd like to turn it back to management for any additional or closing remarks.

[Paul R. Auvil:]

Well, great. Thank you very much. I just want to take a moment and thank everyone for joining us on the call today and we look forward to talking to you again in January.

[Operator:]

And that does conclude today's conference. Thank you for your participation.