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Proofpoint Inc. (NASDAQ:PFPT)

Q4 2013 Earnings Call

January 31, 2014 4:30 PM ET

Executives

Paul Auvil – CFO

Gary Steele – CEO

Analysts

Phil Winslow – Credit Suisse

Rob Owens – Pacific Crest

Nandan Amladi – Deutsche Bank

Matthew Hedberg – RBC Capital Markets

Craig Nankervis – First Analysis

Jonathan Ruykhaver – Stephens

Tim Klasell – Northland Securities

Sanjit Singh – Wedbush

Michael Kim – Imperial Capital

Jonathan Ho – William Blair

Operator

Good day ladies and gentlemen. Welcome to the Proofpoint Fourth Quarter and Full Year 2013 Financial Results Conference. Just a reminder that today’s program is being recorded. At this time, I would like to hand things over to Mr. Paul Auvil, Chief Financial Officer. You may begin.

Paul Auvil

Thank you. Good afternoon and welcome to Proofpoint’s fourth quarter and full year 2013 earnings call. Today, we will be discussing the results announced in our press release that was issued after the market closed today. I am Paul Auvil, Chief Financial Officer of Proofpoint and with me on the call is Gary Steele, Proofpoint’s Chief Executive Officer. During the course of this call, we will make forward-looking statements regarding future events and the future financial performance of the company. These forward-looking statements are subject to material risks and uncertainties that could cause actual results to differ materially from those in the forward-looking statements. We caution you to consider the important risk factors that could cause actual results to differ materially from those in the forward-looking statements, contained in the press release and this conference call. These risk factors are described in our press release and more fully detailed under the caption Risk Factors in Proofpoint’s most recent Form 10-K and Form 10-Q filed with the SEC and the company’s other filings with the SEC.

During this call, we will present both GAAP and non-GAAP financial measures. These non-GAAP measures may exclude stock-based compensation expenses, acquisition related costs, accretion of the debt discounts and amortization of the debt issuance costs associated with our convertible debt, additions to deferred revenue from acquisitions as well as the amortization of intangibles related to acquisitions or other components of GAAP metrics. 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 fourth quarter and full year 2013 results, which can be found in the Investors Relations section of our website. In addition, please note that the date of this conference call is January 30, 2014 and any forward-looking statements that we make today are based on assumptions that we believe to be reasonable as of this date. We undertake no obligation to update these statements as a result of new information or future events.

So with that said, I will turn the call over to Gary.

Gary Steele

Thanks Paul. I’d like to thank everyone for joining us on the call today. We are once again very pleased with our execution during the fourth quarter which led to a strong finish to the year with record billings, recurring revenue and free cash flow. Proofpoint had a very exciting 2013 completing several acquisitions, experiencing significant momentum across all our solutions and growing market shares as the competitive landscape dramatically shifted in our favor. During the year, we witnessed both a decline in terms of the quality and capability in many of our competitor solutions as well as notable weakening in many of our competitor go-to-market initiative and overall participation in the marketplace. Proofpoint’s market share continue to expand as evidenced by our ongoing penetration to the Fortune 1000, ending the year with 180 of these very important customers each of whom have a significant enterprise scale deployment. This is up over 50% from the 119 we had at the end of 2012, demonstrating the tremendous traction we have with these large accounts. It’s important to note however, that this only represents 18% of the Fortune 1000, leaving us with substantial opportunity to further grow within this key account base as we upgrade them to our best in class security and governance solutions. It is also important to note that we ended 2013 with 38 customers in the Fortune 100, up from 26 at the time of our IPO in April of 2012, further highlighting our success in gain share from the largest enterprises in the world.

In addition, we’re very pleased with our success in driving additional sales to our existing customers, as evidenced by the fact that at the end of 2013, 33% of our customers were using two or more of our solutions, up from 30% at the end of 2012 and 26% in 2011. We are also pleased to say that at year end 2013, 6% of our customers had more than two products, up from 2% in 2012. This is a demonstration of the strong execution of major accounts team and add-on special two sole role to drive the sale of additional solutions to our existing customers. And yet with 67% still riding on Proofpoint product, there is a substantial opportunity for us to drive revenue growth to continue add-on sale.

Looking to 2014, Proofpoint is in position to maintain momentum, as we entered the year with a world class set of security, archiving and governance solutions that we believe are unmatched in the industry. This coupled with strong supporting operations that enable us to deliver superior product and service capabilities, have consistently resulted in world class renewal rates. In addition with the ongoing traction of our highly differentiated Targeted Attack Protection solution which acts as a new and rapidly growing market, we believe that we have tremendous potential above and beyond the approximate $5 billion total addressable market of our other product lines. As a result and confidence that the combination of product and service excellence, market opportunity and go-to-market leadership as well as a significantly strengthened balance sheet, positions the company for furthermore market share gains in the coming year and beyond.

Taking a look at our financial results for the fourth quarter, total revenue increased 43% year-over-year to 40.8 million and was driven by a 43% increase in subscription revenue. This represented our 42nd consecutive quarter of sequential revenue growth. We also recorded billings of 48.9 million, up 33% on a year-over-year basis. Both revenue and billings exceeded our fourth quarter guidance ranges even excluding the benefits from the Sendmail acquisition for which Paul will provide further detail in his remarks. Now turning to some of our key accomplishments during the fourth quarter. We are very pleased to report that we had another strong quarter with Proofpoint Targeted Attack Protection as we grew the TAP business over 100% year-over-year in Q4 and end of the year with hundreds of customers using the product.

As a reminder, these customers are protected by this unique and revolutionary approach which not only detects blocks, advance threats across any corporate or BYOD resource accessed by the end user via email, something that no other advanced threat solutions provides today. Some of the noteworthy winds during the quarter included, a leading U.S. regional healthcare and medical services providers which deployed TAP for 26,000 users. One of the US’s leading urban public education systems which added TAP for 25,000 users. A premiere provider of insurance services in North America, which deployed TAP for 10,000 users and a leading financial services and information technology company which added TAP for 20,000 users. We remain confident about our ability to maintain the momentum with TAP as we continue to leverage the technology from our recent acquisition of Armorize. We have a number of new product and capabilities under development and in beta, the first of which will be introduced at the upcoming RSA Conference in the end of February.

In addition, we had a strong quarter in our cloud-based archiving business, as evidenced by our ability to win deals with a leading global marketing company that purchased our archiving solutions for 11,000 users, where we replaced an on-premise solution from Symantec, a large U.S. regional financial services company that purchased our archiving solution for 8,000 replacing HP/Autonomy, a leading financial services and information technology company which purchased archiving as well as TAP for 20,000 users, that I just mentioned, and a large European-based financial services that purchased our archiving solutions taking out HP/Autonomy. With regard to our social media archiving solution, we continue to see traction there as well as evidenced by a win with our leading investment services company. We believe that our social media compliance capability continues to strengthen our competitive advantage and provide a must have feature for regulated organizations that employ social media in their business practices.

We also continue to benefit from Google’s decision to end-of-life its Postini infrastructure and expect this opportunity to persist the remainder of this year and into 2015. Some examples of significant wins during the fourth quarter were Proofpoint’s solutions replaced Postini include one of the world’s largest global industrial and technology companies with over 350,000 users; a global resources and energy company with over 50,000 users; one of the largest independent securities regulators in the U.S. which also purchased our privacy and TAP solutions; a large global semiconductor manufacture with 16,000 users; and a large mutual fund company that also purchased our social media archiving solutions that I mentioned earlier.

Furthermore, we saw good momentum in the Postini channel, as Postini distributors and resellers continue to sign up for Proofpoint’s Essentials, our security and governance offerings that target smaller enterprises worldwide. In addition to Postini, we also saw ongoing weakness with our other competitors particularly Cisco IronPort, where we saw a number of conversions approximately doubled sequentially compared to the third quarter of 2013. This resulted in an additional new customer wins during the fourth quarter including a globally renowned research university which purchased our protection solution for over 65,000 users and a leading U.S. regional grocery retail company which also purchased our protection solution.

Further, our privacy solution has also seen increased momentum as the trend towards more stringent industry and government regulations that mandate stricter privacy policies has created a need for increased data security compliance for enterprises. During the quarter, we won deals with a large insurance company for 25,000 users, which also purchased our protection solutions, a large North American financial institution for 15,000 users and one of the largest independent securities regulators in the U.S. which also purchased our TAP solution that I mentioned earlier. Finally, we saw solid progress with our international operations and international revenues for 2013 accounted for 17% of total revenues. We continue to make progress as we build the foundation to drive our efforts in Europe.

In the fourth quarter, we were particularly pleased with the Sendmail team’s contribution to this effort as they were able to sell our solutions to two of the largest European accounts in less than 90 days, both of which were customers with over 100,000 users. Specifically, one of the largest insurance companies brought our protection solutions that have been approximately110,000 users and one of the world’s largest software companies purchased our protection solutions to safeguard their 120,000 employees across their global operations. The addressable market outside the United States in both AMEA and Asia-Pacific continues to represent an ongoing growth opportunity for Proofpoint and we plan to further expand our sales and marketing teams and add new channel partners to grow market share in these regions. With the key addition to the sales leadership team over the last year combined with the solid installed base account in AMEA and Japan, they came to us through the Sendmail acquisition, we believe we can develop meaningful traction in our overseas operation in 2014.

Before wrapping up, I want to touch briefly on our acquisition activity. During 2013, we closed five separate transactions bringing with them a variety of exciting new technology, a very talented group of new people and a compelling set of customers. The integration efforts have met or exceeded our original expectations in all cases and the associated benefits are now incorporated into the fabric of our company as we move forward. As we look to 2014, we will continue to consider the overall business plans and potential opportunities to broaden our business and product portfolio through these types of activities. So in summary, I’m very pleased with our strong execution which resulted in a great finish to the year. We entered 2014 with strong momentum, a positive competitive environment and a significantly strengthened balance sheet. In addition, with all the integrations from recent acquisitions substantially complete, we are already benefiting from a product developer perspective as well as improvements in cross-sell opportunities and global reach. As a result, I believe that Proofpoint continues to be well positioned to grow share and extend its technology leadership positions.

With that, let me turn it back over to Paul.

Paul Auvil

Thanks, Gary. We were very pleased with our ability to meet or exceed expectations, revenue, billings, adjusted EBITDA and cash flow on both a quarterly and annual basis. The combination of very 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%, drove these outstanding results. Please note that I will be discussing both GAAP and non-GAAP measures and unless stated otherwise, all non-GAAP measures excludes stock-based compensation, acquisition related costs, accretion of the debt discounts and amortization of the debt issuance costs associated with our convertible debt, additions to deferred revenue from acquisitions and the amortization of intangibles associated with acquisitions.

Before getting into the details, it is important to highlight the revenue guidance provided during our earnings call in October of 2013, was built upon the assumption that Proofpoint would retain none of the deferred revenue that Sendmail carried on its balance sheet prior to the acquisition. After completing our evaluation analysis associated with the Sendmail acquisition, we have determined that 14.5 million of deferred revenue from Sendmail’s closing balance sheet should be retained and added to Proofpoint’s balance sheet as of the close of the merger in early October. Driven by Proofpoint’s obligation to assume responsibility to provide ongoing support, maintenance and service to Sendmail’s installed base customers. Of this initial balance of 14.5 million, 2.8 million was recognized during the fourth quarter in the form of subscription revenue. The remaining 11.7 million is reflected in Proofpoint’s deferred revenue balance as of December 31, 2013 all of which will be recognized as subscription revenues in future periods, with approximately 7 million to be recognized during 2014 and approximately 3 million to be recognized during 2015, with the remainder spread across 2016 and 2017. With that noted I will now provide additional details on our performance for the fourth quarter and full year 2013 and then conclude with our outlook for the first quarter and full year 2014.

During the fourth quarter, total revenue was 40.8 million, up 43% year-over-year and above our previously announced guidance range of 35 million to 36 million. I would like to highlight that even without the benefit from the Sendmail’s deferred revenue during the quarter, we would have recorded 38 million in revenue for the quarter, still exceeding the high end of our guidance range and delivering a year-over-year growth rate of 33%. These strong results were driven by a 43% year-over-year growth rate in our subscription revenue even when adjusting the revenue results to exclude the benefit of the 2.8 million contributions to subscription revenue from the Sendmail deferred revenue. We also saw a 27% growth in hardware and services driven by billings and revenue activity associated with the legacy Sendmail business model, as it continues to work its way through the pipeline. We do not currently expect this level of revenue in hardware and services to continue going forward and hence the overall hardware services revenue should decline sequentially by approximately 0.5 million, recurring to levels closer to our historical range of 1 million to 1.2 million per quarter going forward.

From a geographic perspective our growth continues to be largely driven by our strength in the U.S. market, where revenue grew by 32% year-over-year and accounted for 83% of total revenue as compared to 82% last year. Billings for the fourth quarter totaled 48.9 million, reflecting growth of 33% on a year-over-year basis and nicely exceeding the high-end of our previously announced guidance range of 44 million to 46 million. As a reminder, we calculate quarterly billings as revenue recorded during the quarter, plus the net change in deferred revenue during the quarter and is intended to serve as a representation of the overall business invoiced to customers and partners during the quarter.

With this in mind, it is important to note that we specifically excluded from the billings calculation the 11.7 million contribution to the growth in deferred revenue during the fourth quarter, associated with the balance that was brought over from Sendmail’s closing balance sheet. If [inaudible] was a one-time benefit resulting from an acquisition accounting entry and hence not driven by amounts invoiced to customers during the period. Consistent with the past several quarters, approximately one half of the net new subscription business that we closed during the fourth quarter was driven by sales of new solutions to our existing customers. We remain very pleased with this statistics as it demonstrates our ability to leverage our extensive and growing customer base by selling them additional solutions and expanding their number of users, hence providing a meaningful important contribution to our long-term revenue growth.

In addition, our strategic partners and resellers continue to account for approximately one half of our billings activity during the quarter, reflecting our ongoing ability to leverage external sales resources to further drive growth and market share gains in a cost effective manner. Turning to expenses and profitability for the fourth quarter, on a non-GAAP basis, our total gross margins was 72% during the fourth quarter, which is in line with our prior guidance. 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 fourth quarter, non-GAAP sales and marketing expense increased 31% over the prior year period to 19.1 million, representing 47% of total revenue. This growth in expense was primarily driven by the addition of sales personnel, as well as the investment in key marketing and regeneration programs and a modest contribution from the acquisitions. Research and development expenses increased 49% year-over-year to 8.9 million accounting for 22% of total revenue and reflecting our continued focus on enhancing and expanding our solutions and platform, particularly driven by the incorporation of the development teams that have joint Proofpoint through our recent acquisitions.

General and administrative expense was 3.6 million compared to 3.4 million last year, primarily driven by our larger scale as well as the resources needed to accommodate the integration of these recent acquisitions. Non-GAAP operating loss was 2.1 million for the quarter, compared to a non-GAAP operating loss of 3 million during the fourth quarter of 2012. Non-GAAP net loss was $2.5 million or $0.07 per share based on $36 million weighted average shares outstanding and was better than our guidance range of a loss of $0.14 to a $0.11 per share. We were very pleased with this result, particularly since the loss includes the full impact to operating costs from our recent acquisitions. This compares to a non-GAAP net loss of $3.1 million or $0.10 per share based on $32.4 million weighted average shares outstanding in the year ago period.

Fourth quarter 2013 adjusted EBITDA was negative 0.4 million, compared to negative 1.7 million during the same period last year and was better than our original guidance range of negative 3 million to negative 2 million, primarily driven by the benefit of the Sendmail deferred revenue recorded during the quarter. On a GAAP basis, GAAP net loss for the fourth quarter totaled $12.6 million or $0.35 per share, based on $36 million weighted average shares outstanding. And this compares to a GAAP net loss of $5.5 million or $0.17 per share based on $32.4 million weighted average shares outstanding in the prior year period. A reconciliation of GAAP to non-GAAP financial measures has been provided in the financial statement tables included in our press release.

Turning to a quick summary of our financial results for the full year 2013, total revenue was 137.9 million, an increase of 30% compared to 2012. This growth was driven by the 30% increase in subscription revenue which accounted from 96% of total revenue during the year consistent with 2012. The 2.8 million contribution from Sendmail deferred revenue recorded during the fourth quarter, contributed approximately 2.5% to the full year results. Even adjusted for this effect, revenue came in above our prior guidance range. Billings for the full year of 2013 were 160.5 million, up 37% year-over-year and well above our final guidance for the year. Non-GAAP gross margin was 72%, contributing to our improved adjusted EBITDA loss of 4.3 million in the year, a modest improvement over 2012. Non-GAAP net loss which excludes stock-based compensation expense, debt discount accretion expense and amortization and intangibles associated with acquisitions was $11.3 million or $0.32 per share, based on $34.9 million weighted average shares outstanding. And this compares to a non-GAAP loss of $9.8 million or $0.31 per share on $31.8 million weighted average shares outstanding in 2012. In terms of cash flow, we just generated 5.3 million in operating cash flow in the quarter and invested 3.1 million in capital expenditures in support of our ongoing build-out infrastructure for our global SaaS platform. This resulted in positive free cash flow of 2.2 million for the quarter. On a full year basis, we generated 12.6 million in operating cash flow and invested 7.6 million in capital expenditures, resulting in free cash flow generation of 5 million for the year compared to 0.9 million in 2012. This was in line with our guidance. So overall, Gary and I are both very pleased with our performance in 2013, delivering results that met or exceed the guidance over the course of the year starting with our initial outlook provided in October of 2012, as well as the subsequent updates provided during our earnings call each quarter.

Turning to the balance sheet, we ended the fourth quarter with 251.8 million in cash and short-term investments and 155.3 million in debt, compared to 71.6 million in cash and short-term investments and 2.8 million in debt as of September 30, 2013. This sequential increase in cash during the quarter was driven by the combination of cash flow generated from operations to 194 million in net proceeds from a recently completed convertible debt offering, ongoing stock option exercises and the contributions to capital for our employee stock purchase plan, partially offset by the cash disbursement associated with the purchase of Sendmail. We ended the fourth quarter with an accounts receivable balance of 26.2 million, resulting in DSOs of 50 days during the quarter, consistent with third quarter as we continued to have strong collections during the fourth quarter. Total deferred revenue increased 37.1 million year-over-year to 124 million during the fourth quarter, up from 86.9 million in the year ago period. Compared to the third quarter of 2013, deferred revenues increased 22.7 million. And as I mentioned earlier, this year ending deferred revenue balance includes the benefit of the additional 11.7 million contributed from the Sendmail acquisition.

During the fourth quarter, the overall duration of our contract terms was up slightly from our third quarter results, but still finished below our historical range of 20 months to 25 months, highlighting our continued focus to shortened contract duration across our customer base where possible. Before turning to our guidance, we plan to continue to provide a handful of metrics that we update once annual each year. And with that in mind, here are our annual updates to those metrics that were not already covered by Gary earlier in the call. Regarding overall customer growth, we now have approximately 3,100 customers as of the end of the year adding over 400 net new accounts on top of the roughly 2,700 onboard as of the end of 2012. Note that this customer account excludes the SMB customers contributed from our Proofpoint Essentials product line launched earlier this year in conjunction with our Maildistiller acquisition.

In terms of revenue mix for the year, our protection products continue to grow rates well in excess of the underlying markets, propelled by the strong growth for our Targeted Attack Protection solution during its first full year of sales, resulting in roughly 55% of revenues coming from our protection product category. We were also quite pleased with the ongoing success for archiving and governance solutions, with this category growing just higher than our overall average for the year, representing just under 30% of total revenues for the full year. Privacy delivered yet another solid result for the company, growing in rates fast than the underlying market but slower than our other solutions, a solid result given the healthy internal competition for attention with our sales team from these other product lines. We believe that this breath of revenue engagement with our new and existing customers not only helps us to improve our rate of capture of perspective new accounts, but also positions us to further improve on our already world class retention rates with our existing customers.

Now turning to financial outlook starting with the full year 2014. We entered the year with excellent momentum as the competitive landscape shifted dramatically in our favor. We believe we are in the position to increase market share and extend our technology leadership position as we continue to invest in new product development and expand our sales and marketing resources worldwide, while we benefit from our significantly improved balance sheet. As a result, we are increasing our outlook for the full year 2014 as compared to the initial views that we shared on last quarter’s call. From a full year perspective, we expect billings to be in the range of 203 million to 205 million at the midpoint of this range. This represents an annual growth of approximately 27% and is above the preliminary guidance that we provided at the end of October. With this billings performance, we would expect total revenue of 174.5 million to 176.5 million, reflecting an annual growth rate of 27% at the midpoint range and again above our preliminary guidance. Subscription revenues should continue to account for approximately 95% of our total revenue for the year.

As I noted earlier in the call, the deferred revenues balances brought over by the Sendmail balance sheet will contribute approximately 7 million to the overall revenues 2014, all of which will be reported as subscription revenue, with the amounts recognized across the four quarters as approximately 2.4 million, 1.8 million, 1.5 million and 1.3 million respectively. Even at the absence of $7 million benefit for 2014, the total revenue guidance for the year is $167.5 million to $169.5 million above our preliminary guidance and reflecting an annual growth rate of 25% at the midpoint of the range. Note that in order to provide a consistent comparison between the two periods, this 25% growth rate, that I just mentioned, is derived by excluding the contributions from Sendmail deferred revenue in both 2013 and 2014.

As a final point, note that the Sendmail contribution to deferred revenue in the fourth quarter of 2013 is 2.8 million, whereas that contribution deferred revenue in the fourth quarter of 2014 will only be 1.3 million and overall decline of 1.5 million, which will create a year-over-year headwind to revenue growth of approximately 3.5% for the Q4 ‘14 outlook. We expect full year 2014 non-GAAP gross margins to be approximately 71%, slightly lower than our past several quarters as the initial cost associated with the build out of infrastructure associated with our newest Targeted Attack Protection products, apply modest pressure to our margins this year.

Adjusted EBITDA for full year of 2014 are expected to be in the range of negative 5 million to negative 7 million, achieving breakeven results during the fourth quarter as the company assimilates the Armorize and Sendmail acquisitions, which together are expected to create a drag on 2014 EBITDA of approximately $5 million across the course of the year. Also, we mentioned on the October earnings call, that we plan to modestly accelerate our investment in sales and capital to capitalize on the weakening competitive environment and the rapidly expanding opportunity in the new landscape of advanced persistent threats. And we’ll continue to expand our investment in research and development to support our ongoing slate of key product development initiatives.

As a result, we continue to expect our EBITDA loss to increase in the first quarter of 2014 as compared to the fourth quarter of 2013, with the gradual improvement over the course of the full year and the goal of achieving breakeven in the fourth quarter of 2014. We expect full year 2014 non-GAAP net loss to be $18 million to $20 million or a loss of $0.48 to $0.53 per share based on approximately $37.6 million weighted average shares outstanding. This assumes depreciation of approximately 9 million, up 50% from 2013 and cash interest expense associated with convertible debt of roughly 2.5million, the new item for 2014. As for the income tax provision, exclusive of potential discrete items is suspected to be approximately 0.9 million to 1.1 million for 2014. I would like to highlight again that we’re currently generating net loss and as such our weighted average share account 32.4 million for the fourth quarter, did not include the entire impact of vested stock options. If we were profitable today, our fully diluted share account would have been approximately 39.8 million shares when applying the treasury stock method to these vested options. In addition, if our convertible note had been issued and in the money at the beginning of the quarter, it would add approximately 5.2 million shares.

Finally, we are reiterating our free cash flow of guidance of roughly $10 million for the full year 2014, which is an increase of almost 100% from 2013. This cash flow guidance assumes capital expenditures of 13 million to 15 million for the full year, as we continue to build out our cloud infrastructure to support the rapid rescaling aspects of the business and our latest product introductions. For the first quarter specifically, we would expect free cash flow to be roughly breakeven driven by the payout of the annual bonus pool, the payout of commissions associated with our strong billings performance in the fourth quarter and the high cost associated with payroll taxes and sales kickoff here at the start of the year. Note that as in past periods, to the extent that we can deliver upside revenues as outlined in our guidance, we do expect to reinvest most or all of that upside back into the company in the form of initiatives that we believe will deliver differentiated solutions for our customers and improve long-term growth to the overall business.

Turning to the first quarter 2014 outlook, we currently expect billings to be 43 million to 45 million resulting in a year-over-year growth of 25% of the midpoint of the range. As we mentioned on the earnings call last quarter, the billings growth rate in the first quarter of 2014 is expected to be a bit lower than later in the year, due to the seven figure full year add-on deal that we closed during the first quarter of 2013, which by definition will not recur in 2014. Note that given the strength of our billings in the fourth quarter of 2013, we do expect the billings growth rate in the fourth quarter of 2014 to face a bit of a headwind as a result of this tough compare. Regarding revenue for the first quarter, we are targeting total revenue of 40 million to 41 million or 31% growth year-over-year at the midpoint of the range. This revenue range includes a $2.4 million contribution to subscription revenue from the Sendmail deferred revenue balance and assumes that hardware and services revenues will return to their historical range of approximately $1 million. I would like to highlight that even if we exclude the benefit of the Sendmail deferred revenues, this guidance reflects a subscription growth rate of 30% of the midpoint range. Note that this guidance suggests that total revenues may slightly decline sequentially from the fourth quarter, driven by the expected $0.5 million sequential decline from hardware and services revenue that I mentioned earlier, as well as $0.4 million sequential decline in the contribution to subscription revenue from the Sendmail deferred revenue between the two periods. Adjusted for these two effects, the midpoint of the guidance reflects a sequential increase in total revenues of approximately 0.5 million.

We expect first quarter non-GAAP gross margins to be approximately 71% consistent with our full year guidance. With regards to our adjusted EBITDA, we’re currently targeting negative 3.5 to negative 4.5 million in the first quarter, given our typical increase in cost earlier in the year associated with payroll taxes, sales kickoff and initial sales and marketing investments for the year has juxtaposed with our relatively flat sequential revenue guidance. We expect first quarter non-GAAP net loss to be negative $6.5 million to negative $7.5 million or a loss of $0.18 to $0.21 per share, based on approximately $36.5 million weighted average shares outstanding. And this assumes an income tax provision exclusive of discrete items of 0.2 million to 0.3 million during the quarter. So in summary, we had a very strong fourth quarter and full year 2013 and believe that Proofpoint remains to be well positioned to maintain momentum throughout 2014 as the worldwide demand for integrated cloud solutions remain strong. Before turning it over to the operator for questions, I wanted to mention that we are planning to host an Investor Day in New York City on Tuesday May 20th and we’ll be providing additional details as we get closer to that date.

With that, I want to thank everyone for taking the time for joining us on the call today and we’d be happy to take your questions now. Operator?

Question-and-Answer Session

Operator

Thank you. [Operator Instructions]. From Credit Suisse, we’ll go to Phil Winslow.

Phil Winslow – Credit Suisse

Hi thanks guys and congrats on another great quarter. One of the things that jumped out of me again was the annual breakdown of the revenue was just the protection number and the growth you continue to see there. I guess my question is I mean outside obviously just for the success that you saw on TAP, what are you seeing just on that core messaging security business and particularly, just competitively some of your competitors just recently as of yesterday were talking about some weaknesses in messaging security you are not seeing that. Just what are you seeing from the competition out there and why are you clearly outpacing them? Thanks.

Gary Steele

Hi Phil, it’s Gary. So what we see today is continued weakness on the competitive landscape that is playing in our favor specifically, the tailwind effect of the Google Positini announcement clearly is playing to our strength. Secondly, as we indicated in the script, we are seeing a significant amount of weakness in the Cisco IronPort business. We saw a number of takeout sequentially double between Q3 and Q4 and on top of that as we mentioned Symantec indicated on their earnings call that their mail business had declined in the quarter and so there’s weakness there as well. So, collectively across the competitive landscape, we do not see active participation from a lot of those various companies and it allows us with a superior set of products and capabilities to go out and win business.

Paul Auvil

Yeah I think the only thing I would add is, we see the market as very healthy. So the weakness with that these other players are seeing is essentially caused by ongoing process taking market share from them.

Phil Winslow – Credit Suisse

And then just one quick follow-up question on TAP, obviously you’re seeing a lot of success there. When you think about the competitive landscape and a lot of people Targeted Attack Protection and with FireEye may be you could just also again describe for us where you fit in versus the competition sort of what your focus is there versus others in the market?

Gary Steele

Yeah so great question. So we’re really focused on Targeted Attack coming into the organization and so we thought to dedicate the capabilities within TAP to enable people to find those targeted attacks that come in through attack in email. Competitively people who have solutions that may look somewhere folks like the FireEye who operate web solution and email solution and file solutions, we would compete against their email solution. The capabilities in our products differ from FireEye’s, our approach differs and we have been well differentiated when we go head to head competitively. The other competitors that we see in this broader advanced threat world, often times are taking very different approach. So it’s more share of wallet competition versus feature by feature comparison. Today, I would say FireEye is the closest capabilities that look like ours but there’s lots of noise in the advanced threat market and customers are pursuing defense and depth strategy to try to eliminate as much of these threats they possibly can.

Phil Winslow – Credit Suisse

Great. Thanks, guys and congrats again.

Gary Steele

Thanks Phil.

Paul Auvil

Thanks Phil.

Operator

Our next question comes from Rob Owens, Pacific Crest.

Rob Owens – Pacific Crest

Great. Thank you very much. I’m curious around your channel strategy and I think you mentioned that it was 50% of revenue came from or 50% billings came from partners in the quarter. And given the competitive disarray that is out and given the momentum just curious why that number is not more at this point?

Paul Auvil

Yeah I think Rob I would describe it as follows and Gary might have a few things to add. We have a balanced go-to-market strategy where we build out both field sales people that operate in the territories as well as inside sales folks that dial the phones. And they then work in partnership with resellers and various partnership networks that we’ve built. And so as we continue to scale up those resources, there is sort of this inherit competition in terms of the rate at which they are building up their business book of business that they go out and find on their own versus business that are ultimately around also working in conjunction with the partner. So we’re actually pleased with the rate at which we’re seeing growth from the partnership channel as well as the productivity that we’re seeing from our sales team. So the nice thing is that they are growing roughly in a lock [ph] step which we think is a positive. Now, I think there is a potential out there for at some point in the future, partners that may be historically have directed a bit more of their business to one of our competitors to get more aggressive about directing some of that business to us, particularly in those renewal cycles. So, I think that’s a potential source of upside for us down the road, but for now we’re actually happy with the rate of production that we’re seeing from the partners that we’ve got engaged in the go-to-market channel along with what we’re seeing from our direct sales team.

Gary Steele

And one other comment there, one of the places where we’ve had great success and it has been due to the leadership of Tracey Newell, our new VP of sales. She’s really been putting her focus and investment around major camp selling and that investment and focusing major camp selling is pushing us up to the highest levels of the pyramid in terms of customer size and in those particular deals customers are looking to buy direct typically. And so I think that as a lot of our growth has been from very, very large accounts and it’s threw a lot of that focus major account selling activity.

Rob Owens – Pacific Crest

Okay, great. And then second just around pricing just curious, I know you don’t talk a lot about units in pricing, but given the competitive landscape has been in such disarray, are you seeing any firmer or better pricing today than you were say a couple quarters ago?

Gary Steele

Prices have been very stable. We sometimes see struggle with competitors and try to do low ball pricing, but they really have had nominal impact on our business. We’ve actually seen very solid price stability in the last couple of quarters.

Paul Auvil

I think what I would add to that is while I think there are opportunities for prices to ultimately move up a bit as the competitive environment continues to evolve in our favor, I think we’re still some points of market share away from having that sort of influence on pricing in the market, but I think there is certainly an opportunity for that over time.

Rob Owens – Pacific Crest

Great. Fair enough. Thank you.

Paul Auvil

Thanks

Gary Steele

Thanks, Rob.

Operator

Our next question today comes from Nandan Amladi, Deutsche Bank.

Nandan Amladi – Deutsche Bank

Hi Gary and Paul. Thanks for taking my questions. So first question on the international expansion I know you brought Tracey to do that perhaps it’s a little bit early to say anything. But I just wanted to get a sense of where things are? Are you happy with the pores so far? And how should we think about the remainder of this year say exiting the first half of ‘14, how should we think about the international revenues?

Gary Steele

So as we indicated in the script, we’re very pleased with the early results. So Tracey joined in August of this year, subsequent to that we hired Rich Turner who is heading up our European operations. One of the great things if you combine that new leadership with the Sendmail acquisitions, we have some good early traction with some of the largest Sendmail customers. We referenced two in the script. We think there is a lot more opportunity out there that looks exactly like that. So we feel well positioned as we move into ‘14 in terms of the opportunity. As we indicated 17% of our business came from international operations in ‘13 and we do think there is upside on that as we exit the year.

Nandan Amladi – Deutsche Bank

Okay, thank you. And then this go-to-market change in anyway relative to partnerships versus going direct. I know in one of the earlier questions you said larger enterprises typically preferred to buy direct from you. So in the wane of international expansion, what does that look like?

Gary Steele

Yeah, I think that’s good question and I think likely as Europe starts to become a larger percentage of our business, you’ll see that mix of business partners increase a bit because Europe really is primarily delivered through the channel. And so while we’re following a simpler model where we are putting people in the field to go and engage directly with the customers and joint with partners, we think the majority of the fulfillment whether we find the opportunity on our own or whether the partner brings it to us, we’ll ultimately be through with the partner channel in Europe and that will then drive the mix a little bit as a result. In the U.S., I think the mix is likely to stay relatively similar to where it is today although there are couple of things that can change that.

Nandan Amladi – Deutsche Bank

Thank you.

Gary Steele

Thanks.

Paul Auvil

Thanks.

Operator

From RBC Capital Markets, Matt Hedberg is next.

Matthew Hedberg – RBC Capital Markets

Yeah thanks for taking my questions guys I’ll offer my congratulations as well. I have a question is about the Microsoft relationship may be talk a little bit more about I guess even more Office 365 channel relationship there.

Paul Auvil

Yeah so what we start and Gary will have sure have couple of things to add. As we talked about in our last call, we’re in the phase of a relationship with Microsoft where all the net new accounts they are purposely pushing through the channel to leverage the channel as they with Office 365 need to go out and compete with Google Apps. So as a result, the business that we built up under the original strategic partnership is now starting to slowly kind of asymptotically taper off in terms of its growth rate. And so as we shared again in the last call, we do expect while that business will continue to be healthy, it will grow very slowly on a going forward basis and will ultimately become less than 10% in revenues. Now the flipside to that switch is that, we now have been introduced to working aggressively with a number of their largest Office 365 partners to go out and cooperate, develop and close business in conjunction with them. And we don’t split out that data specifically, but I can tell you that we’re pleased with how those partnerships are developing and it’s certainly close some business with that channel since that introduction and evolution over the last I guess it’s probably four to six months now since that first started to take root.

Gary Steele

And as one other final comment there, so we are seeing as we’ve indicated before we are seeing demand from Office 365 customers for more capability than archive. And so as Office 365 gets more market traction more customers, we see those customers looking to help provide instead of security and compliance capability is beyond what Microsoft delivers.

Matthew Hedberg – RBC Capital Markets

That’s great. And then I’m curious you guys seemed in the earlier – quarter and is that something that’s a one-time thing in the last quarter should we expect that to come up again in 2014?

Paul Auvil

You broke up right at the start of your question, can you just quickly ask that again?

Matthew Hedberg – RBC Capital Markets

Sure yes. I was curious if fourth quarter saw any early renewals? I think you had some of those in the third quarter I was wondering should we expect more of those in 2014.

Paul Auvil

Yeah the reason I called it out in the third quarter is that we had well above average pace of them. We always have a few in any given quarter that are just naturally derived from add on cycles that we engage in etcetera. In fourth quarter, I would say it returned to what we would say is normal levels. So it’s out of our total billings it’s… I couldn’t give you an exact characterization but it’s well under 10% of billings in any given quarter.

Matthew Hedberg – RBC Capital Markets

Great. Thanks guys.

Paul Auvil

Yes.

Gary Steele

Thank you.

Operator

Our next question is from Craig Nankervis from First Analysis.

Craig Nankervis – First Analysis

Thanks. Nice job. Great quarter. Gary may be with the influx of cash that you have, can you sketch a little bit how your acquisition profile might change and may be little bit around [inaudible]?

Gary Steele

Yeah so good question. So as we indicated in the script, I don’t think anything from our acquisition strategy changes just because we have more cash. I think we’re always going to be out looking for opportunities where we can expand the capabilities, we deliver to customers within the categories we serve, where we can get great teams of people, where there is great revenue and customers we like those kinds of opportunities. But we don’t have anything planned today, but we’re actively looking to see if we can do acquisitions similar to what we have done in the past. But I don’t think that profile changes Craig.

Craig Nankervis – First Analysis

Okay. On TAP well selling it alone versus selling it along and getting in an account with the core protection offering also, can you just talk may be have you seen any trends starting to develop how TAP is helping you with the core email security business and any color there would be interesting?

Gary Steele

Yeah so as we indicated in our Q3 call, half of our TAP business went to new customers half went to the existing. As we look at Q4 it was more like 60-40, 60% to new and 40% to existing customers. And then if you look at those new customers, we had a reasonable attach rate over half of the customers brought half with the core protection. So we are seeing leverage and strength in our ability to take the message of TAP, combine that with a message of protection and win the deal. And so I think it’s a very interesting lever point where weakens down differentiator they are very differentiated from our competitors and often times disrupt customers who is actually happy with their existing protection solution we have the opportunity to actually disrupt that by telling the story about TAP.

Craig Nankervis – First Analysis

Right. So that seems to be firming as a trend you’re comfortable could likely continue?

Gary Steele

Yes.

Craig Nankervis – First Analysis

And then Paul, I guess sort of asked on this question but it sounds like there were no anomalous dynamics in the billings result for the quarter?

Paul Auvil

That’s correct. That’s right.

Craig Nankervis – First Analysis

That’s all here. Thank you.

Gary Steele

Thanks Craig.

Paul Auvil

Thanks Craig.

Operator

Our next question comes from Jonathan Ruykhaver, Stephens.

Jonathan Ruykhaver – Stephens

Hey guys congrats on the performance once again. I’m just curious with some cost consolidation that we’ve seen, specifically around the events threat prevention markets. Do you guys sense that there is any need for Proofpoint to react and deliver technologies around Internet response, remediation or other end point detection technologies?

Paul Auvil

We don’t and I’m sure you’re referring to Mandiant acquisition by FireEye. Mandiant is a really interesting company it has had its great reputation but it’s only a services business. And if you look at our financials as a starting point, we are not a professional services company. We do think there are interesting capabilities that can simplify and automate some of the remediation capabilities, but we think about that from a technology standpoint than a services standpoint. So, as we operate over the course of the coming years you will see there is some capabilities from us that help with remediation that we will not take a services perspective to that.

Jonathan Ruykhaver – Stephens

Okay.

Paul Auvil

And we do not feel the need from kneejerk reaction standpoint to go do something to response to the Mandiant acquisition. We feel like the capabilities that we’re delivering with TAP are well differentiated, they have nothing to do with what Mandiant does and we don’t think that remediation is the starting point it’s blocking thing coming in as opposed to helping people clean up the mess after the pack[ph].

Jonathan Ruykhaver – Stephens

Right. Okay. I guess somewhat of a similar question, just your thoughts on the opportunity to build out your broader cloud platform for advanced threat prevention across webgate. I know in the past you’ve maintained its focus on email as the best strategy for Proofpoint. But is there any change in your thought process around the markets you could serve?

Paul Auvil

So there is – we’ve had no change in strategic thinking in terms of where we want to play today. Having said that though, we do believe there are more capabilities that can help customers deal with the advanced threats and the challenges associated with it. As we indicated you will see additional capabilities coming from us that these are incremental types of capabilities that create more value for customers, drives higher economic value and as we build out a roadmap over the coming quarters, you will see additional capabilities that expand our overall product footprint.

Jonathan Ruykhaver – Stephens

So will these capabilities broaden the market outside of traditional email?

Paul Auvil

Yes, but don’t conclude that as immediate web don’t think that.

Jonathan Ruykhaver – Stephens

Okay. Okay. Then my final question

Paul Auvil

I want to be careful that if you’re asking me are we doing web this year what question, we have no announced plans to do that. We don’t feel like we need that and we have a very good opportunity with TAP as it is today.

Jonathan Ruykhaver – Stephens

Okay, good. My final question is have you seen any change out of FireEye since they introduced their cloud-based offering for email threat prevention I think it was back in November of last year?

Paul Auvil

We have not seen that and we’ve not run into competitively in the marketplace with those clients.

Jonathan Ruykhaver – Stephens

Okay. Alright good. Thanks guys.

Paul Auvil

Thanks, Jonathan.

Gary Steele

Thanks, Jonathan.

Operator

Up next from Northland Securities, is Tim Klasell

Tim Klasell – Northland Securities

Hey, I throw out my congratulation as well. My question has to do with IronPort and competitive displacements there. When you are going after current or former Postini customers it’s a cloud-based solution displaying another cloud, how does that change with IronPort because that’s an appliance space, there are customer different, the sales methodology different. Can you sort of walk us through the differences there?

Paul Auvil

Yeah, interesting question, Tim. So what we’re seeing actually is the customers that are running Cisco IronPort on-premise are typically frustrated with the effectiveness that they are seeing with that solution. They are willing to do something different and they are actually willing to consider cloud. So good example I referenced a leading research university with 65,000 users that was an on-premise IronPort customer that went to the cloud at Proofpoint. And so we’re finding that this greater acceptance to cloud today and so taking someone that is traditionally been on-premise and moving to the cloud is pretty much what’s happening. Its difference in the Postini world but it’s not harder sale cycle because you are transitioning from on-prem to cloud. And as you are aware someone wants to do private cloud on-premise we can still do that we don’t see that as the dominant deployment platform, we see people moving from on-premise to cloud.

Tim Klasell – Northland Securities

Okay, great. And then one quick follow up I know may be a quarter ago you are beginning to get a lot of questions from your European customers or potential customers around buying from U.S. based customer because while they say eyes out there has that dissipated or increased, how should we think about that?

Gary Steele

I think there is still a lot of questions being asked by the European customers around how [inaudible] managing the cloud and because of the technological choices we’ve made we have a very good story and manage our way through those objections, but there is a lot of questions being asked today.

Tim Klasell – Northland Securities

Okay, great. Thank you.

Operator

Sanjit Singh from Wedbush is up next.

Sanjit Singh – Wedbush

Congrats Paul and Gary. Thanks taking my questions. I wanted to see from 2014 whether you see any potential opportunities from specific vertical markets I think the SEC announced that they’re looking at asset managers to make sure that they are well protected against cyber-attacks, whether it’s financial services or government or some hi-tech is there any particular vertical that standout as potential incremental growth driver as you’re heading to the next calendar year?

Gary Steele

Yeah interesting question. So if you look historically we’ve got very well on regulated industry so financial services and healthcare been the two dominant industries. I think that will continue to play out in the same way, I think we’ve traditionally done well in retail given the big breach exposure that target another places, we are seeing more activity in the retail sector. Government overall for us has been relatively small segment, but we are investing more there. We do see future opportunity in the government sector given the investments that are being made. So that’s where I suspect we will see the most opportunity. Having said that, I spend a lot of time on a road with customers and it doesn’t matter what sector I visit, customers are concerned about these advanced threats and trying to figure out what to do. So I suspect we will continue to play where the broadest set of capabilities we offer apply well in those verticals. I wouldn’t suspect we will see a radical change to that, but the advanced threats that are happening today are forcing organizations across all vertical to figure out what their security posture will be and how they’re going to defend themselves.

Sanjit Singh – Wedbush

Right. And just a follow up on that given the recent attacks on target and even markets, are you seeing more inbound inquires? Are you seeing a new level of interest for TAP and if you kind of map that the $200 million debt offering, where you’re going to – how should we think about allocating that extra cash in terms of your investment? Is it just going to be just in sales coverage or there are new products coming out? How are you going to map the extra cash with the kind of urgent need that the customers have?

Paul Auvil

Yeah so let me make a comment on the cash and then Gary can talk a little about the couple other dimensions. So having raised the cash and the convertible debt, given the fact we are running cash flow positive, we don’t plan to invest any of that in a way to sort of operating elements of the business. It’s there potentially serve among other things as a level to help with future M&A activity, but that’s it. But as we think about investment elements for 2014 while also doubling our free cash flow to about $10 million, you will see some ongoing expense investments in sales and marketing both further accelerate some of the work that we have done in Europe as well just to put more core capacity in U.S. even though we’re not sitting at close to 200 for Fortune 1000 that still means that 80% of the Fortune 1000 still don’t have a single product from us. So we have – we are still under distributed versus the U.S. market opportunity. So you will see that as well as I think Gary mentioned some ongoing investments in R&D, to further accelerate the work we’re doing in TAP. But also we have a very interesting product roadmap in the archiving area, it may be not quite front and center if you will with the investment community the way targeted attack and advanced threat issues are right now. But it’s a huge market with a tremendous opportunity and lot of money being spent on really third rate solutions that people are looking to get out from under and move to next generation areas. So there is a lot to be done there and there lot of opportunities. So that’s where you’ll see the bulk of our investment. In terms of kind of lead flow, I can say anecdotally from the CFO perspective, I’ve definitely seen an uptick in inbound activity where people are contacting pool point directly, but I wouldn’t describe it is sea change but Gary I don’t know whether you have anything else to add there.

Gary Steele

Yeah, I would just reiterate the point that is we move into ‘14, we are extremely excited about our overall roadmap and our roadmap encompasses all of our products. You are going to see significant releases with new capabilities across TAP, across protection, across privacy and as Paul indicated archiving. And all of the capabilities continue to distance ourselves from the competition. So we feel really good about the R&D and innovation capabilities coming out of the last year.

Sanjit Singh – Wedbush

Appreciate the time guys, thank you.

Operator

And next is Michael Kim from Imperial Capital.

Michael Kim – Imperial Capital

Hi, good afternoon guys. I think you call out pretty significant sequential step up in the Cisco IronPort conversions. As we look out to the balance of 2014 and into 2015 what do you think the potential would be contribution from these versions to be on par with what you might see from Postini?

Paul Auvil

The one comment I’d make and again I’m sure Gary has additional color here. We estimate the total opportunity in terms of the current business that is over at Cisco that’s the IronPort businesses somewhere in the mid-300s in terms of the recurring revenue. So there is a big opportunity to convert that base over time. Obviously we’ve got our hands full taking all the opportunities as they come flooding in as people move up the Postini platform, but in spite of dealing with that, we have a flood of interesting opportunities that we are developing on the IronPort site as well. How that kind of play out is transitions a little hard to say but we are certainly seeing a very interesting pipeline of our IronPort businesses developing as the pipeline of Postini will start to wane here a little bit as that effect winds up over the course of the year.

Michael Kim – Imperial Capital

And with respect to the Postini conversion, do you feel that you guys are getting more than your fair share of the opportunities out there and where – how do you see that playing out in the balance of the year?

Paul Auvil

Yeah, we do feel that we’re getting more than our fair share. As we indicated earlier in the call, Symantec mentions specifically in their earnings call that their email business has declined. And if your subscription business is declining you’re currently losing lots of customers and not closing any new. So I feel like we are definitely taking our fair share that I do believe that the Postini effect works its way well into ‘15. We’re not – we are still a long way from being done with that sort of conversions. So we feel very good about this combination of Postini lasting into ‘15 as well as the opportunities especially with IronPort.

Michael Kim – Imperial Capital

Okay, great. And then switching to archiving and I think you called out some sizable wins and displacement against HP and Symantec. Are you seeing sort of an acceleration towards the cloud based solution and may be more [inaudible] that you are seeing at this point is there an inflexion point?

Paul Auvil

It’s an interesting question, it sure feels like we are moving towards an inflexion point. There is a lot more people raising their hands saying I want to figure out what I’m going to do next, I want to get up front. I think the cloud is the way to go and we’re getting incorporated into those discussions. It’s always hard to know when you are in the exact inflexion of the curve but it does feel very different than it did a year ago.

Michael Kim – Imperial Capital

Great. Thank you very much.

Operator

Our next question comes from Daniel Ives, FBR Capital Markets.

Unidentified Analyst

Hey guys great quarter. This is Jim Moran for Dan Ives. Just wondered if you can talk a little bit about the privacy business and may be expand a little bit on you’re saying it’s growing slower than the overall business. And just wondering can you expand a little bit on efforts here you’re making there to help drive growth?

Paul Auvil

One comment I kind of covered in the script but we were pleased in that privacy business still grew nicely above the overall market growth rate of privacy. So we felt good about the results. As you could imagine with our sales team and at the end of the day, we operate with some of the great limited marketing budgets. We’ve got a lot of activity around Targeted Attack Protection around protection with the conversion of the Postini customer base and things starting to open up a bit with IronPort among other things and then of course archiving. And so, privacy ultimately competes for the share of interest if you will, from our sales people we’re out engaging in new opportunities. And so we’re actually pretty pleased with how the privacy product lines performed given these other attended interest that are center of the sales team. The net of it is that we think that there is a big market opportunity there and we’re continuing to chip away at it. And all things kind of flow in cycles and it could be very well be cycles of all the earlier question about some of the mandates from the SEC, we could see a significant uptick in acceleration in the ray of growth and the opportunity and privacy 2014. But in the meantime it’s a very meaningful contributor just under 20% of revenues to revenue profitability and we think we’ll continue to be on a go forward basis.

Unidentified Analyst

Great. Thanks very much for the color.

Paul Auvil

Thanks.

Operator

From William Blair, we’ll take a question from Jonathan Ho.

Jonathan Ho – William Blair

Hey guys great quarter. Just wondering to start out can you may be quantify for us how your win rates may be have been changing over the course of the year? I know you’ve talked about it getting a lot better here but if you were winning two out of 10 deals you were winning three out of 10 deals just wanted to get a sense of whether you can quantify that a little bit better for us?

Paul Auvil

We don’t quantify win rates per se, I can tell you that for us we’re very pleased that the rate at which when we engage in an opportunity and go through the process of evaluating or demonstrating our solution, we’re pleased that the rate at which we’re converting a customers over, may be importantly – the important fact is that we’ve grown our sales organization and engaged more with the channel. We’re seeing a larger number of opportunities in our conversion rate on those opportunities continues to be from our perspective compelling. We’re always looking ways to sharpen the blade and improve the win rate, but I would say the win rate is in the level we think is consistent with sort of world class execution when in fact we do have other people out there in the market. And so people like Intel security and Cisco and others are certainly waning in terms of the participation of the market. They do still show up on net new opportunities and we do have to compete with them and there are various attributes that people consider when buying a product, it’s not just product excellence that we think we can consistently demonstrate that we’re superior to those solutions. There are notions of share of wall like consolidating to single vendor strategies etcetera we have to compete with all of those in the mix.

Jonathan Ho – William Blair

Got it. Can you talk a little bit about sort of the competition with the distribution channel itself? I mean a lot of that we talked to you they saw multiple products that fit into a single category and so lot of the battle is shifted to get the mind share with these guys. Can you may be talk a little bit about that and the progress that you’ve seen in that channel from that perspective?

Paul Auvil

Yeah great question. So the one thing that we’ve focused on is the top security resellers around the globe and making sure that we have good relations with those. As you described, you’re obviously competing for share a mind with resell or rap etcetera so as you look at our channel today, we focus on the top guys like the Accuvance, [inaudible] of the world those kinds of players. And I think we take it on our approach where we’re very targeted and focus on the specific names we work with. We’re not going for volume we’re doing single tier pretty much across the globe the small exceptions where we’ll do multi-tier and we think that direct touch to the reseller is an effective way to ensure that we’re getting the mind chart.

Jonathan Ho – William Blair

Got it, got it. And just lastly one question around additional investments. I mean as you look at the opportunity ahead of you in terms of competitors that are may be losing focus, how do you balance the decision whether to spend a lot of money and sort of try and chase this opportunities versus may be potentially having more discipline on the profitability side? Just wanted to hear philosophically how you think about that?

Paul Auvil

That’s a very good question and obviously there is a whole range of philosophies and how people are currently executing in the market. I would say Gary and I both have experiences work at Proofpoint and earlier our career where we think of a balanced approach where you drive both in this case, for our business cash flow and growth is important. I think the notion of relying on spending and giving amounts of money raised you want to convertible debt or IPO or secondary to actually fund the operating investments in the company. It’s just generally not a good discipline. And I know it has examples of success out there but our view is that as we see the market evolve, we see players and often in these markets as they mature players once they drop out or fade to the back they don’t come back. And so we think that there is plenty of opportunity and time to aggregate this market share over time and build a significant business while also delivering modest but improving cash flow over time and then ultimately profitability. And so what we try to look to serve both of those opportunity as we build a business. The other thing to consider is from our perspective there is this notion that as you look at the markets, we in existing large markets whether you look at the protection market, privacy or archiving. When you are looking at more of a Greenfield opportunity there is a bit of a tendency to have that land rush you want to invest, you want to be the first to each customer because if you don’t get there first, you may lose that account and never be able to convert them. Our whole life is about getting out there and taking the pick axe and breaking the rocks and converting the customers one by one. We’ve done a very good job over the years and what confidence that is the market environment continues to evolve in our favor. We’ll just be able to do that hopefully more and more efficient matter over time. So again that just tells us this is the right balanced approach for us that is generating cash and driving growth at the same time. That’s the model we think has worked historically and is the right model to run the business going forward.

Jonathan Ho – William Blair

Great. Thank you.

Paul Auvil

Thanks.

Operator

And at this time, there are no further questions. I’ll hand the conference back to management for any additional or closing remarks.

Paul Auvil

We just want to take a moment and thank everybody for joining us today. We’re excited about the prospects in 2014 and look forward to talking to you next quarter. Thanks so much.

Operator

Ladies and gentlemen, that does conclude today’s conference. Thank you all for your participation.

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