PROOFPOINT INC - 10-K - MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

(Edgar Glimpses Via Acquire Media NewsEdge) The following discussion and analysis of our financial condition and results of operations should be read in conjunction with our "Selected Consolidated Financial Data" and our consolidated financial statements and related notes included elsewhere in this Annual Report on Form 10-K. This discussion contains forward-looking statements that involve risks and uncertainties. Our actual results could differ materially from those forward-looking statements below.

Factors that could cause or contribute to those differences include, but are not limited to, those identified below and those discussed in the section entitled "Risk Factors" included elsewhere in this Annual Report on Form 10-K. This Annual Report on Form 10-K contains "forward-looking statements" within the meaning of Section 21E of the Securities Exchange Act of 1934, as amended (the "Exchange Act"). These statements are often identified by the use of words such as "may," "will," "expect," "believe," "anticipate," "intend," "could," "estimate," or "continue," and similar expressions or variations. Such forward-looking statements are subject to risks, uncertainties and other factors that could cause actual results and the timing of certain events to differ materially from future results expressed or implied by such forward-looking statements. Factors that could cause or contribute to such differences include, but are not limited to, those identified herein, and those discussed in the section titled "Risk Factors", set forth in Part I, Item 1A of this Form 10-K.

Except as required by law, we disclaim any obligation to update any forward-looking statements to reflect events or circumstances after the date of such statements.

Overview Proofpoint is a pioneering security-as-a-service vendor that enables large and mid-sized organizations worldwide to defend, protect, archive and govern their most sensitive data. Our security-as-a-service platform is comprised of an integrated suite of on-demand data protection solutions, including threat protection, regulatory compliance, archiving and governance, and secure communication.

We were founded in 2002 to provide a unified solution to help enterprises address their growing data security requirements. Our first solution was commercially released in 2003 to combat the burgeoning problem of spam and viruses and their impact on corporate email systems. As the threat environment has continued to evolve, we have dedicated significant resources to meet the ongoing challenges that this highly dynamic environment creates for our customers. In addition, we have invested significantly to expand the breadth of our data protection platform: • In 2004, we launched our Regulatory Compliance and Digital Asset Security solutions, designed to prevent the loss of critical data.

These Data Loss Prevention, or DLP, solutions apply ourproprietary machine learning and deep content inspection technologies to screen outbound email to prevent the theft or inadvertent loss of sensitive or confidential information.

• In 2005, we launched Proofpoint Secure Messaging, our first email encryption solution.

• In 2006, we combined our email encryption and DLPtechnologies to develop a new solution for policy-based encryption, enabling each outgoing message to be inspected for confidential content and automatically encrypted accordingly.

35-------------------------------------------------------------------------------- Table of Contents • In 2007, we began selling our software-based virtual appliance, enabling our customers to deploy our solutions in a private cloud configuration. We also invested in international expansion by establishing a team in the United Kingdom as a precursor to the build out of our data center infrastructure, and launching operations in Germany and the Netherlands to support ourcustomers outside of the United States.

• In 2008, we introduced Proofpoint Enterprise Archive, acloud-based email archiving solution that enables businesses to securely archive both their email and instant message conversations while enabling real-time access to the entire repository for quick and easy electronic discovery, or eDiscovery.

• In 2009, we launched Proofpoint Encryption, a proprietary email encryption solution that improved the level of integration across our data protection suite and allowed us to phase outtechnology licensed from a third party. We also introduced a cloud-based email messaging service.

• In 2010, we evolved our solutions to address new forms ofmessaging and information sharing in the enterprise such as social media and Internet-based collaboration and file sharing applications.

• In 2011, we achieved FISMA certification for our cloud-based archiving and governance solution, enabling us to serve therigorous security requirements of U.S. Federal agencies. We alsointroduced an integrated security offering in conjunction with VMware for its Zimbra Collaboration Server.

• In 2012, we introduced Proofpoint Enterprise Governance, an information governance solution that provides organizations the ability to monitor and apply governance policies tounstructured information across the enterprise. We also introduced Proofpoint Targeted Attack Protection along with Proofpoint Secure Share.

Proofpoint Target Attack Protection is a solution that uses big data analysis techniques to identify and apply additional security controls to suspicious messages. Proofpoint Secure Share allows enterprises to securely exchange large files with ease in a cloud-based environment.

Our business is based on a recurring revenue model. Our customers pay a subscription fee to license the various components of our security-as-a-service platform for a contract term that is typically one to three years. At the end of the license term, customers may renew their subscription and in each year since the launch of our first solution in 2003, we have retained over 90% of our customers. We derive this retention rate by calculating the total annually recurring subscription revenue from customers currently using our security-as-a-service platform and dividing it by the total annually recurring subscription revenue from both these current customers as well as all business lost through non-renewal. A growing number of our customers increase their annual subscription fees after their initial purchase by broadening their use of our platform or by adding more users, as evidenced by the fact that these sales consistently represent 15% or more of our billings each year since 2008. As our business has grown, our subscription revenue has increased as a percentage of our total revenue, from 89% of total revenue in 2010 to 95% in 2012.

We market and sell our solutions to large and mid-sized customers both directly through our field and inside sales teams and indirectly through a hybrid model where our sales organization actively assists our network of distributors and resellers. We also derive a lesser portion of our revenue from the license of our solutions to strategic partners who offer our solutions in conjunction with one or more of their own products or services.

Our sales and marketing operation consists of sales people and associated marketing resources, each of whom are assigned to a specific geographic territory. Their mission is to grow additional revenue within their respective territory in whatever manner is most efficient, either by obtaining new customers or by working with existing customers to expand their use of our solutions. Our sales teams are compensated equally for sales to new customers or sales of additional solutions to existing customers, and we do not allocate sales and marketing resources between activities related to the acquisition of new customers and activities associated with the sale of additional solutions to existing customers.

We invoice our customers for the entire contract amount at the start of the term. The majority of these invoiced amounts is treated as deferred revenue on our consolidated balance sheet and is recognized ratably over the term of the contract. We invoice our strategic partners on a monthly basis, and the associated fees vary based upon the level of usage during the month by their customers. These amounts are recognized as revenue at the time of invoice.

Our deferred revenue balance on our consolidated balance sheet does not represent the total contract value of annual or multi-year, non-cancelable subscription agreements. Unbilled deferred revenue was approximately $7.6 million and $7.3 million as of December 31, 2012 and 2011, respectively.

Unbilled deferred revenue represents future billings under our subscription agreements that have not been invoiced and, accordingly, are not recorded in deferred revenue. We expect that the 36-------------------------------------------------------------------------------- Table of Contents amount of unbilled deferred revenue will change depending upon the timing and duration of large customer subscription agreements, billing cycles and the timing of when unbilled deferred revenue is to be recognized as revenue.

Additionally, the unbilled deferred revenue for multi-year subscription agreements that billed annually is typically high at the beginning of the contract period, low prior to renewal and increases when the agreement is renewed. Such fluctuations are not a reliable indicator of future revenues.

Our solutions are designed to be implemented, configured and operated without the need for any training or professional services. For those customers that seek to develop deeper expertise in the use of our solutions or would like assistance with complex configurations or the importing of data, we offer various training and professional services. In some cases, we provide a hardware appliance to those customers that elect to host elements of our solution behind their firewall. Increasing adoption of virtualization in the data center has led to a decline in the sales of our hardware appliances and a shift towards our software-based virtual appliances, which are delivered as a download via the Internet. Our hardware and services offerings carry lower margins and are provided as a courtesy to our customers. The revenue derived from these offerings has declined from11% of total revenue in 2010 to 5% of total revenue in 2012. We view this trend as favorable to our business and expect the overall proportion of total revenue derived from these offerings to continue to gradually decline.

The substantial majority of our revenue is derived from our customers in the United States. We believe the markets outside of the United States offer an opportunity for growth and we intend to make additional investments in sales and marketing to expand in these markets. Customers from outside of the United States represented 18%, 21% and 20% of total revenue for 2012, 2011 and 2010, respectively. As of December 31, 2012, we had approximately 2,700 customers around the world, including 27 of the Fortune 100. No single partner or customer accounted for more than 10% of our total revenue in 2011 or 2010, one customer accounted for 14% of our total revenue in 2012.

We have not been profitable to date and will need to grow revenue at a rate faster than our investments in cost of revenue and operating expenses in order to achieve profitability, as discussed in more detail below.

Key Opportunities and Challenges The majority of costs associated with generating customer agreements are incurred up front. These upfront costs include direct incremental sales commissions, which are recognized upon the billing of the contract. The costs associated with the teams tasked with closing business with new customers and additional business with our existing customers have represented more than 90% of our total sales and marketing costs since 2008. Although we expect customers to be profitable over the duration of the customer relationship, these upfront costs typically exceed related revenue during the earlier periods of a contract.

As a result, while our practice of invoicing our customers for the entire amount of the contract at the start of the term provides us with a relatively immediate contribution to cash flow, the revenue is recognized ratably over the term of the contract, and hence contributions toward operating income are limited in the period where these sales and marketing costs are incurred. Accordingly, an increase in the mix of new customers as a percentage of total customers would likely negatively impact our near-term operating results. On the other hand, we expect that an increase in the mix of existing customers as a percentage of total customers would positively impact our operating results over time. As we accumulate customers that continue to renew their contracts, we anticipate that our mix of existing customers will increase, contributing to a decrease in our sales and marketing costs as a percentage of total revenue and a commensurate improvement in our operating income.

As part of maintaining our security-as-a-service platform, we provide ongoing updates and enhancements to the platform services both in terms of the software as well as the underlying hardware and data center infrastructure. These updates and enhancements are provided to our customers at no additional charge as part of the subscription fees paid for the use of our platform. While more traditional products eventually become obsolete and require replacement, we are constantly updating and maintaining our cloud-based services and as such they operate with a continuous product life cycle. Much of this work is designed to both maintain and enhance the customers' experience over time while also lowering our costs to deliver the service, as evidenced by our improvements in gross profit over the past three years. Our security-as-a-service platform is a shared infrastructure that is used by all of our approximately 2,700 customers.

Accordingly, the costs of the platform are spread in a relatively uniform manner across the entire customer base and no specific infrastructure elements are directly attached to any particular customer. As such, in the event that a customer chooses to not renew its subscription, the underlying resources are reallocated either to new customers or to accommodate the expanding needs of our existing customers and, as a result, we do not believe that the loss of any particular customer has a meaningful impact on our gross profit as long as we continue to grow our customer base.

To date, our customers have primarily used our solutions in conjunction with email messaging content. We have developed solutions to address the new and evolving messaging solutions such as social media and file sharing applications, but these solutions are relatively nascent. If customers increase their use of these new messaging solutions in the future, we 37-------------------------------------------------------------------------------- Table of Contents anticipate that our growth in revenue associated with email messaging solutions may slow over time. Although revenue associated with our social media and file sharing applications has not been material to date, we believe that our ability to provide security, archiving, governance and discovery for these new solutions will be viewed as valuable by our existing customers, enabling us to derive revenue from these new forms of messaging and communication.

While the majority of our current and prospective customers run their email systems on premise, we believe that there is a trend for large and mid-sized enterprises to migrate these systems to the cloud. While our current revenue derived from customers using cloud-based email systems continues to grow as a percentage of our total revenue, many of these cloud-based email solutions offer some form of threat protection and governance services, potentially mitigating the need for customers to buy these capabilities from third parties such as ourselves. We believe that we can continue to provide security, archiving, governance, and discovery solutions that are differentiated from the services offered by cloud-based email providers, and as such our platform will continue to be viewed as valuable to enterprises once they have migrated their email services to the cloud, enabling us to continue to derive revenue from this new trend toward cloud-based email deployment models.

We are currently in the midst of a significant investment cycle in which we have taken steps designed to drive future revenue growth and profitability. For example, we plan to build out our infrastructure, develop our technology, offer additional security-as-a-service solutions, and expand our sales and marketing personnel both in North America and internationally. Accordingly, we expect that our total cost of revenue and operating expenses will continue to increase in absolute dollars, limiting our ability to achieve and maintain positive operating cash flow and profitability in the near term.

With the majority of our business, we invoice our customers for the entire contract amount at the start of the term and these amounts are recorded as deferred revenue on our balance sheet, with the dollar weighted average duration of these contracts for any given period over the past three years typically ranging from 18 to 23 months. As a result, while our practice of invoicing customers for the entire amount of the contract at the start of the term provides us with a relatively immediate contribution to cash flow, the revenue is recognized ratably over the term of the contract, and hence contributions toward operating income are realized over an extended period. Accordingly, when comparing 2012 with 2009, our cash flow related to operating activities improved by $10.5 million while our operating loss increased by $0.3 million. As such, our efforts to improve our profitability require us to invest far less in operating expenses than the cash flow generated by our business might otherwise allow. As we strive to invest in an effort to continue to increase the size and scale of our business, we expect that the level of investment afforded by our growth in revenue should be sufficient to fund the investments needed to drive revenue growth and broaden our product line.

Considering all of these factors, we do not expect to be profitable on a GAAP basis in the near term and in order to achieve profitability we will need to grow revenue at a rate faster than our investments in operating expenses and cost of revenue.

We intend to grow our revenue through acquiring new customers by investing in our sales and marketing activities. We believe that an increase in new customers in the near term will result in a larger base of renewal customers, which, over time we expect to be more profitable for us.

Sales and marketing is our greatest expense and hence a significant contributing factor to our operating losses. Given that our costs to acquire new revenue sources, either in the form of new customers or the sale of additional solutions to existing customers, often exceed the actual revenue recognized in the initial periods, we believe that our opportunity to improve our return on investment on sales and marketing costs relies primarily on our ongoing ability to cost effectively renew our business with existing customers, thereby lowering our overall sales and marketing costs as a percentage of revenue as the mix of revenue derived from this more profitable renewal activity increases over time.

Therefore, we anticipate that our initial significant investments in sales and marketing activities will over time generate a larger base of more profitable customers. Cost of subscription revenue is also a significant expense for us, and we expect to continue to build on the improvements over the past three years, such as in replacing third-party technology with our proprietary technology and improving the utilization of our fixed investments in equipment and infrastructure, in order to provide the opportunity for improved subscription gross margins over time. Although we plan to continue enhancing our solutions, we intend to lower our rate of investment in research and development as a percentage of revenue over time by deriving additional revenue from our existing platform of solutions rather than by adding entirely new categories of solutions. In addition, as personnel costs are one of the primary drivers of the increases in our operating expenses, we plan to reduce our historical rate of headcount growth over time.

Key Metrics We regularly review a number of metrics, including the following key metrics presented in the unaudited table below, to evaluate our business, measure our performance, identify trends in our business, prepare financial projections and make 38-------------------------------------------------------------------------------- Table of Contents strategic decisions. Many of these key metrics, such as adjusted subscription gross profit, billings and adjusted EBITDA, are non-GAAP measures. This non-GAAP information is not necessarily comparable to non-GAAP information of other companies. Non-GAAP information should not be viewed as a substitute for, or superior to, net loss prepared in accordance with GAAP as a measure of our profitability or liquidity. Users of this financial information should consider the types of events and transactions for which adjustments have been made.

Year Ended December 31, 2012 2011 2010 (in thousands) Total revenue $ 106,295 $ 81,838 $ 64,790 Growth 30 % 26 % 34 % Subscription revenue $ 101,470 $ 73,896 $ 57,657 Growth 37 % 28 % 37 % Adjusted subscription gross profit $ 76,666 $ 53,841 $ 37,236 % of subscription revenue 76 % 73 % 65 % Billings $ 116,914 $ 88,977 $ 76,545 Growth 31 % 16 % 32 % Adjusted EBITA $ (4,543 ) $ (7,227 ) $ (9,016 ) Subscription revenue.

Subscription revenue represents the recurring subscription fees paid by our customers and recognized as revenue during the period for the use of our security-as-a-service platform, typically licensed for one to three years at a time. We consider subscription revenue to be a key business metric because it reflects the recurring aspect of our business model and is the primary driver of growth for our business over time. The consistent growth in subscription revenue over the past several years has resulted from our ongoing investment in sales and marketing personnel, our efforts to expand our customer base, and our efforts to broaden the use of our platform with existing customers.

Adjusted subscription gross profit.

We have included adjusted subscription gross profit, a non GAAP financial measure, in this report because it is a key measure used by our management and board of directors to understand and evaluate our operating results, core operating performance, and trends to prepare and approve our annual budget and to develop short and long-term operational plans. We have provided a reconciliation between subscription gross profit, the most directly comparable GAAP financial measure, and adjusted subscription gross profit. We believe that adjusted subscription gross profit provides useful information to investors and others in understanding and evaluating our operating results in the same manner as our management and board of directors.

Our use of adjusted subscription gross profit has limitations as an analytical tool, and you should not consider it in isolation or as a substitute for analysis of our results as reported under GAAP. Because of these limitations, you should consider adjusted subscription gross profit alongside other financial performance measures, including subscription gross profit and our other GAAP results.

The following unaudited table presents the reconciliation of subscription gross profit to adjusted subscription gross profit for the years ended December 31, 2012, 2011 and 2010: 39-------------------------------------------------------------------------------- Table of Contents Year Ended December 31, 2012 2011 2010 (in thousands) Subscription revenue $ 101,470 $ 73,896 $ 57,657 Cost of subscription revenue 28,246 24,193 24,523 Subscription gross profit $ 73,224 $ 49,703 $ 33,134 Add back: Stock based compensation 657 366 357Amortization of intangible assets 2,785 3,772 3,745 Adjusted subscription gross profit $ 76,666 $ 53,841 $ 37,236 Billings.

We have included billings, a non GAAP financial measure, in this report because it is a key measure used by our management and board of directors to manage our business and monitor our near term cash flows. We have provided a reconciliation between total revenue, the most directly comparable GAAP financial measure, and billings. Accordingly, we believe that billings provides useful information to investors and others in understanding and evaluating our operating results in the same manner as our management and board of directors.

Our use of billings as a non-GAAP measure has limitations as an analytical tool, and you should not consider it in isolation or as a substitute for revenue or an analysis of our results as reported under GAAP. Some of these limitations are: • Billings is not a substitute for revenue, as trends in billings are not directly correlated to trends in revenue except when measured over longer periods of time; • Billings is affected by a combination of factors including the timing of renewals, the sales of our solutions to both new and existing customers, the relative duration of contracts sold, and the relative amount of business derived from strategic partners. As each of these elements has unique characteristics in the relationship between billings and revenue, our billings activity is not closely correlated to revenue except over longer periods of time; and • Other companies, including companies in our industry, may not use billings, may calculate billings differently, or may use other financial measures to evaluate their performance all of which reduce the usefulness of billings as a comparative measure.

The following unaudited table presents the reconciliation of total revenue to billings for the years ended December 31, 2012, 2011 and 2010: Year Ended December 31, 2012 2011 2012 (in thousands) Total revenue $ 106,295 $ 81,838 $ 64,790 Deferred revenue Ending 86,859 76,240 69,101 Beginning 76,240 69,101 57,346 Net change 10,619 7,139 11,755 Billings $ 116,914 $ 88,977 $ 76,545 Adjusted EBITA.

40-------------------------------------------------------------------------------- Table of Contents We define adjusted EBITDA as net loss, adjusted to exclude: depreciation, amortization of intangibles, interest income (expense), net, provision for income taxes, stock based compensation, acquisition related expense, other income, and other expense. We believe that adjusted EBITDA is useful to investors and other users of our financial statements in evaluating our operating performance because it provides them with an additional tool to compare business performance across companies and across periods. We believe that: • Adjusted EBITDA provides investors and other users of our financial information consistency and comparability with our past financial performance, facilitates period-to-period comparisons of operations and facilitates comparisons with our peer companies, many of which use similar non-GAAP financial measures to supplement their GAAP results; and • It is useful to exclude certain non-cash charges, such as depreciation, amortization of intangible assets and stock based compensation and non-core operational charges, such as acquisition related expenses, from adjusted EBITDA because the amount of such expenses in any specific period may not be directly correlated to the underlying performance of our business operations and these expenses can vary significantly between periods as a result of new acquisitions, full amortization of previously acquired tangible and intangible assets or the timing of new stock based awards, as the case may be.

We use adjusted EBITDA in conjunction with traditional GAAP operating performance measures as part of our overall assessment of our performance, for planning purposes, including the preparation of our annual operating budget, to evaluate the effectiveness of our business strategies and to communicate with our board of directors concerning our financial performance.

We do not place undue reliance on adjusted EBITDA as our only measures of operating performance. Adjusted EBITDA should not be considered as a substitute for other measures of financial performance reported in accordance with GAAP.

There are limitations to using non-GAAP financial measures, including that other companies may calculate these measures differently than we do, that they do not reflect our capital expenditures or future requirements for capital expenditures and that they do not reflect changes in, or cash requirements for, our working capital.

The following unaudited table presents the reconciliation of net loss to adjusted EBITDA for the years ended December 31, 2012, 2011 and 2010: Year Ended December 31, 2012 2011 2010 (in thousands) Net loss $ (20,360 ) $ (20,141 ) $ (20,865 ) Depreciation 4,434 3,142 3,261Amortization of intangible assets 3,276 4,542 4,382 Interest expense, net 108 300 340 Provision for income taxes 521 370 243 EBITDA (12,021 ) (11,787 ) (12,639 ) Stock based compensation expense 7,321 4,548 3,365 Acquisition related expense 3 125 - Other income (18 ) (141 ) (20 ) Other expense 172 28 278 Adjusted EBITDA $ (4,543 ) $ (7,227 ) $ (9,016 ) Components of Our Results of Operations Revenue 41-------------------------------------------------------------------------------- Table of Contents We derive our revenue primarily through the license of various solutions and services on our security-as-a-service platform on a subscription basis, supplemented by the sales of training, professional services and hardware depending upon our customers' requirements.

Subscription. We license our platform and its associated solutions and services on a subscription basis. The fees are charged on a per user, per year basis.

Subscriptions are typically one to three years in duration. We invoice our customers upon signing for the entire term of the contract. The invoiced amounts billed in advance are treated as deferred revenue on the balance sheet and are recognized ratably, in accordance with the appropriate revenue recognition guidelines, over the term of the contract (see -Critical Accounting Policies).

We also derive a portion of our subscription revenue from the license of our solutions to strategic partners. We bill these strategic partners monthly. As our business has grown, our subscription revenue has increased as a percentage of our total revenue, from 89% of total revenue in 2010 to 95% in 2012.

Hardware and services. We provide hardware appliances as a convenience to our customers and as such it represents a small part of our business. Our solutions are designed to be implemented, configured and operated without the need for any training or professional services. For those customers that seek to develop deeper expertise in the use of our solutions or would like assistance with complex configurations or the importing of data, we offer various training and professional services. We typically invoice the customer for hardware at the time of shipment. Effective January 1, 2011, we adopted the revenue recognition guidance of Accounting Standards Update (ASU) 2009-13 and ASU 2009-14, which mandate that our revenue derived from the sale of hardware be recognized at the time of shipment. Prior to the adoption of this new accounting guidance, hardware revenue was recognized ratably over the duration of the contract. We typically invoice customers for services at the time the order is placed and recognize this revenue ratably over the term of the contract. On occasion, customers may retain us for special projects such as archiving import and export services; these types of services are recognized upon completion of the project.

The revenue derived from these hardware and services offerings has declined from 11% of total revenue in 2010 to 5% of total revenue in 2012. We view this trend as favorable to our business and expect the overall proportion of revenue derived from these offerings to continue to decline gradually.

Total Cost of Revenue Cost of Revenue Cost of Subscription Revenue. Cost of subscription revenue primarily includes personnel costs, consisting of salaries, benefits, bonuses, and stock-based compensation, for employees who provide support services to our customers and operate our data centers. Other costs include fees paid to contractors who supplement our support and data center personnel; expenses related to the use of third-party data centers in both the United States and internationally; depreciation of data center equipment; amortization of licensing fees and royalties paid for the use of third-party technology; amortization of capitalized research and development costs; and the amortization of intangible assets related to prior acquisitions. Growth in subscription revenue generally consumes production resources, requiring us to gradually increase our cost of subscription revenue in absolute dollars as we expand our investment in data center equipment, the third party data center space required to house this equipment, and the personnel needed to manage this higher level of activity.

However, our cost of subscription revenue has declined in recent periods as a percentage of its associated revenue as we have replaced third-party licensed technology with our proprietary technology, and we expect the benefit of these initiatives to continue in future periods.

Cost of Hardware and Services Revenue. Cost of hardware and services revenue includes personnel costs for employees who provide training and professional services to our customers as well as the cost of server hardware shipped to our customers that we procure from third parties and configure with our software solutions. Effective January 1, 2012, in conjunction with the adoption of the new revenue recognition guidance, the cost of hardware is expensed at the time of shipment. Prior to the adoption of this new guidance, these hardware costs were recognized ratably over the duration of the contract with which they were sold. Our cost of hardware and services as a percentage of its associated revenue has been relatively consistent from period to period in the past, but with the adoption of our new accounting guidance we expect that it may gradually increase as a percentage of hardware and services revenue in future periods.

Operating Expenses Our operating expenses consist of research and development, sales and marketing, and general and administrative expenses. Personnel costs, which consist of salaries, benefits, bonuses, and stock-based compensation, are the most significant component of our operating expenses. Our headcount increased from 239 employees as of January 1, 2010 to 449 employees as of December 31, 2012. As a result of this growth in headcount, operating expenses have increased significantly over these 42-------------------------------------------------------------------------------- Table of Contents periods. We expect personnel costs to continue to increase in absolute dollars as we hire new employees to continue to grow our business, however, we do not anticipate that our historical rates of headcount growth will continue over the longer term.

Research and Development. Research and development expenses include personnel costs, consulting services and depreciation. Our research and development headcount increase reflects our ongoing investment in solutions developed internally as well as those added through acquisitions. We believe that these investments have played an important role in broadening the capabilities of our platform over the course of our operating history, enhancing the relevance of our solutions in the market in general and helping us to retain our customers over time. We expect to continue to devote substantial resources to research and development in an effort to continuously improve our existing solutions as well as to develop new offerings. We believe that these investments are necessary to maintain and improve our competitive position, however, over the longer term, we intend to monitor these costs so as to decrease this spending as a percentage of total revenue. Our research efforts include both software developed for our internal use on behalf of our customers as well as software elements to be used by our customers in their own facilities. To date, for software developed for internal use on behalf of our customers, we have capitalized costs of approximately $0.4 million, all of which was incurred during 2011, and is being amortized as cost of subscription revenue over a two-year period. For the software developed for use on our customers' premises, the costs associated with the development work between technological feasibility and the general availability has not been material and as such we have not capitalized any of these development costs to date.

Sales and Marketing. Sales and marketing expenses include personnel costs, sales commissions, and other costs including travel and entertainment, marketing and promotional events, public relations and marketing activities. All of these costs are expensed as incurred, including sales commissions. These costs also include amortization of intangible assets as a result of our past acquisitions.

We plan to continue to invest in growing our sales and marketing operations, both domestically and internationally. Our sales personnel are typically not immediately productive, and therefore the increase in sales and marketing expenses we incur when we add new sales representatives is not immediately offset by increased revenue and may not result in increased revenue over the long-term if these new sales people fail to become productive. The timing of our hiring of new sales personnel and the rate at which they generate incremental revenue will affect our future financial performance. We expect that sales and marketing expenses will continue to increase in absolute dollars and be among the most significant components of our operating expenses.

General and Administrative. General and administrative expenses include personnel costs, consulting services, audit fees, tax services, legal expenses and other general corporate items. We expect our general and administrative expenses to increase in absolute dollars in future periods as we continue to expand our operations, hire additional personnel and transition from being a private company to a public company, although we expect these expenses to decrease as a percentage of total revenue.

Total Other Income (Expense), Net Total other income (expense), net, consists of interest income (expense), net and other income (expense), net. Interest income (expense), net, consists primarily of interest income earned on our cash and cash equivalents offset by the interest expense for our capital lease payments and borrowings under our equipment loans. Other income (expense), net, consists primarily of the net effect of foreign currency transaction gain or loss.

Provision for Income Taxes The provision for income taxes is related to certain state and foreign income taxes. As we have incurred operating losses in all periods to date and recorded a full valuation allowance against our deferred tax assets, we have not historically recorded a provision for federal income taxes. Realization of any of our deferred tax assets depends upon future earnings, the timing and amount of which are uncertain. Utilization of our net operating losses may be subject to substantial annual limitation due to the ownership change limitations provided by the Internal Revenue Code and similar state provisions.

Analyses have been conducted to determine whether an ownership change had occurred since inception. The analyses have indicated that although an ownership change occurred in a prior year, the net operating losses and research and development credits would not expire before utilization as a result of the ownership change. In the event the Company has subsequent changes in ownership, net operating losses and research and development credit carryovers could be limited and may expire unutilized as a result of the subsequent ownership change.

Results of Operations The following table is a summary of our consolidated statements of operations.

43-------------------------------------------------------------------------------- Table of Contents Year Ended December 31, 2012 2011 2010 (in thousands) Revenue: Subscription $ 101,470 $ 73,896 $ 57,657 Hardware and services 4,825 7,942 7,133 Total revenue 106,295 81,838 64,790 Cost of revenue:(1) Subscription 28,246 24,193 24,523 Hardware and services 4,867 5,537 4,082 Total cost of revenue 33,113 29,730 28,605 Gross profit 73,182 52,108 36,185 Operating expense:(1) Research and development 24,827 19,779 17,583 Sales and marketing 55,239 42,676 31,161 General and administrative 12,693 9,237 7,465 Total operating expense 92,759 71,692 56,209 Operating loss (19,577 ) (19,584 ) (20,024 ) Interest income (expense), net (108 ) (300 ) (340 ) Other income (expense), net (154 ) 113 (258 ) Loss before provision for income taxes (19,839 ) (19,771 ) (20,622 ) Provision for income taxes (521 ) (370 ) (243 ) Net loss $ (20,360 ) $ (20,141 ) $ (20,865 ) The following table sets forth our consolidated results of operations for the specified periods as a percentage of our total revenue for those periods.

44-------------------------------------------------------------------------------- Table of Contents Year Ended December 31, 2012 2011 2010 Revenue: Subscription 95 % 90 % 89 % Hardware and services 5 10 11 Total revenue 100 100 100 Cost of revenue:(1) Subscription 27 30 38 Hardware and services 4 6 6 Total cost of revenue 31 36 44 Gross profit 69 64 56 Operating expense:(1) Research and development 23 24 27 Sales and marketing 52 52 48 General and administrative 12 12 12 Total operating expense 87 88 87 Operating loss (18 ) (24 ) (31 ) Interest income (expense), net - - (1 ) Other income (expense), net - - - Loss before provision for income taxes (18 ) (24 ) (32 ) Provision for income taxes (1 ) (1 ) - Net loss (19 )% (25 )% (32 )% _______________________________________________________________________________ (1) Includes stock-based compensation and amortization of intangible assets as follows: Year Ended December 31, 2012 2011 2010 (in thousands)Stock-based compensation Cost of subscription revenue $ 657 $ 366 $ 357 Cost of hardware and services revenue 70 29 17 Research and development 1,869 1,247 1,010 Sales and marketing 3,103 1,976 1,113 General and administrative 1,622 930 868 Amortization of intangible assets Cost of subscription revenue $ 2,785 $ 3,772 $ 3,745 Research and development 30 1 - Sales and marketing 461 769 637 Revenue Year Ended Year Ended December 31, Change December 31, Change 2012 2011 $ % 2011 2010 $ % (in thousands) (in thousands) Revenue Subscription $ 101,470 $ 73,896 $ 27,574 37 % $ 73,896 $ 57,657 $ 16,239 28 % Hardware and services 4,825 7,942 (3,117 ) (39 )% 7,942 7,133 809 11 % Total revenue $ 106,295 $ 81,838 $ 24,457 30 % $ 81,838 $ 64,790 $ 17,048 26 % 45-------------------------------------------------------------------------------- Table of Contents Subscription revenue increased $27.6 million and $16.2 million, or 37% and 28%, for 2012 and 2011. These increases were primarily due to a $24.3 million and $12.7 million increase in revenue from the United States and, to a lesser extent, a $3.2 million and $3.5 million increase from our international operations for 2012 and 2011, respectively. We increased personnel in the sales and marketing organization, which represented a 24% and 30% increase for 2012 and 2011, respectively in the size of the team from the prior year. These new resources directly contributed to the further growth in the sales capacity of our field sales organization and were the primary reason for the 30% and 26% overall growth in revenue for 2012 and 2011 from the previous years. We believe that the fundamental shift in the overall threat landscape, the growth of business-to-business collaboration as well as the consumerization of IT, coupled with an ongoing improvement in economic conditions, led to the increase in demand for data protection and governance solutions.

Hardware and services revenue decreased $3.1 million and increased $0.8 million or (39%) and 11% for 2012 and 2011, respectively. Revenue from the United States contributed $2.7 million and international business accounted for $0.4 million of the decrease for 2012. Revenue from the United States contributed $0.7 million and international business accounted for $0.1 million of the increase for 2011. The fluctuation was attributable to our adoption of new revenue recognition guidance (as more fully described in our Critical Accounting Policies) effective January 1, 2011 under which revenue from sales of hardware appliances began to be recognized when sold.

Cost of Revenue Year Ended Year Ended December 31, Change December 31, Change 2012 2011 $ % 2011 2010 $ % (in thousands) Cost of revenue Subscription $ 28,246 $ 24,193 $ 4,053 17 % $ 24,193 $ 24,523 $ (330 ) (1 )% Hardware and services 4,867 5,537 (670 ) (12 )% 5,537 4,082 1,455 36 Total cost of revenue $ 33,113 $ 29,730 $ 3,383 11 % $ 29,730 $ 28,605 $ 1,125 4 % Cost of subscription revenue increased $4.1 million and decreased $0.3 million or 17% and (1%) for 2012 and 2011, respectively. The changes in 2012 and 2011 were primarily due to increased data center costs of $0.9 million and $0.4 million associated with ongoing growth in usage by new and existing customers.

Additionally depreciation increased $0.9 million and $0.2 million in 2012 and 2011 in support of the ongoing growth. An increase in personnel related expenses of $2.4 million and $0.8 million in 2012 and 2011 attributed to both operations and customer support, due to overall growth of our business. Royalty expense decreased $.4 million and $1.8 million in 2012 and 2011, driven by the replacement of third-party licensed technology, as well as improved economic terms associated with our ongoing licensing agreements.

Cost of hardware and services revenue decreased $0.7 million and increased $1.5 million, or (12%) and 36% for 2012 and 2011, respectively. The changes in 2012 and 2011 were primarily due to the adoption of the new revenue recognition guidance effective January 1, 2011 under which costs from sales of hardware appliances were recognized when the associated hardware revenue is recognized resulted in higher hardware costs in 2011. Accordingly, a decrease of $0.4 million and an increase of $1.5 million of these costs were a result of the change in revenue recognition guidance in 2011. Additionally, a decrease of $0.9 million and $0.2 million in 2012 and 2011 in appliance costs was attributable to a decrease in corresponding revenue, offset by an increase in services expense of $0.6 million and $0.2 million in 2012 and 2011 directly correlated to an increase in services revenue during the fiscal year.

Operating Expenses Year Ended Year Ended December 31, Change December 31, Change 2012 2011 $ % 2011 2010 $ % (in thousands) (in thousands) Research and development $ 24,827 $ 19,779 $ 5,048 26 % $ 19,779 $ 17,583 $ 2,196 12 % Percent of total revenue 23 % 24 % 24 % 27 % 46-------------------------------------------------------------------------------- Table of Contents Research and development expenses increased $5.1 million and 2.2 million, or 26% and 12% for 2012 and 2011, respectively. The increases were primarily due to personnel related costs of $3.5 million and $2.0 million for 2012 and 2011.

Additionally, facilities costs and corporate fees both increased $0.6 million in 2012 and no such increase in 2011 primary due to the acquisition related activities in 2011.

Year Ended Year Ended December 31, Change December 31, Change 2012 2011 $ % 2011 2010 $ % (in thousands) Sales and marketing $ 55,239 $ 42,676 $ 12,563 29 % $ 42,676 $ 31,161 $ 11,515 37 %Percent of total revenue 52 % 52 % 52 % 48 % Sales and marketing expenses increased $12.6 million and 11.5 million, or 29% and 37%, for 2012 and 2011, respectively. The increase in headcount on a worldwide basis resulted in increased personnel related costs of $7.6 million and $6.5 million, as well as an increase in travel expenses of $1.1 million and $1.0 million in 2012 and 2011, respectively. Additionally, as our business grew, commission expense increased by $2.6 million and $1.8 million for 2012 and 2011.

Marketing program spending increased $0.5 million and $1.4 million in 2012 and 2011, respectively, as a result of our continued investment in lead generation programs, tradeshows and our corporate branding programs.

Year Ended Year Ended December 31, Change December 31, Change 2012 2011 $ % 2011 2010 $ % (in thousands) (in thousands) General and administrative $ 12,693 $ 9,237 $ 3,456 37 % $ 9,237 $ 7,465 $ 1,772 24 % Percent of total revenue 12 % 11 % 11 % 12 % General and administrative expenses increased $3.5 million and $1.8 million, or 37% and 24%, for 2012 and 2011, respectively. Personnel-related costs increased $2.6 million and $0.9 million for 2012 and 2011, respectively, in our transition to being a public company. Additionally, an increase of $0.8 million in both 2012 and 2011was related to external consulting fees and legal expenses.

Total Interest Income (Expense), Net Year Ended Year Ended December 31, Change December 31, Change 2012 2011 $ % 2011 2010 $ % (in thousands) (in thousands) Total interest income (expense), net (108 ) (300 ) 192 (64 )% (300 ) (340 ) 40 (12 )% Total interest income (expense), net increased $0.2 million for 2012. The change for 2012 was primarily due to an increase of $0.1 million in interest income related to investments purchased subsequent to the IPO in April 2012.

Additionally, interest expense decreased $0.1 million for 2012 as we continue to pay down our capital equipment loans. The change for 2011 was immaterial.

Total Other Income (Expense), Net Year Ended Year Ended December 31, Change December 31, Change 2012 2011 $ % 2011 2010 $ % (in thousands) (in thousands) Total other income (expense), net $ (154 ) $ 113 $ (267 ) (236 )% $ 113 $ (258 ) $ 371 (144 )% 47-------------------------------------------------------------------------------- Table of Contents Total other income (expense), net decreased $0.3 million and increased $0.4 million for 2012 and 2011, respectively. The change was primarily related to an increase in other expense due to loss sustained from foreign currency translation and a decrease in other income related to revaluation of Series B warrant in 2011.

Provision for Income Taxes Year Ended Year Ended December 31, Change December 31, Change 2012 2011 $ % 2011 2010 $ % (in thousands) (in thousands) Provision for income taxes $ 521 $ 370 $ 151 41 % 370 243 $ 127 52 % Total income tax expense increased $0.2 million and $0.1 million, or 41% and 52% for 2012 and 2011, respectively. The 2012 change was primarily related to an increase in interest and penalties on uncertain tax positions as a result of the completion of a transfer pricing analysis. The 2011 change was primarily related to an increase in uncertain tax positions.

As of December 31, 2012, due to recent net cumulative losses and other negative evidence, a valuation allowance of approximately $4.2 million remains on certain non-U.S. deferred tax assets that are not more-likely-than-not to be realized. We evaluate our deferred tax asset valuation allowance position on a quarterly basis. As a result, management believes a reversal of a significant portion of the Company's valuation allowance on non-U.S. deferred tax assets is possible in the next 12 months.

Quarterly Results of Operations The following table sets forth our unaudited quarterly consolidated statements of operations data for each of the eight quarters in the period ended December 31, 2012. We have prepared the quarterly data on a basis consistent with our audited annual financial statements, including, in the opinion of management, all normal recurring adjustments necessary for the fair statement of the financial information contained in these statements. The historical results are not necessarily indicative of future results and should be read in conjunction with our consolidated financial statements and the related notes included elsewhere in this Annual Report on Form 10-K.

48-------------------------------------------------------------------------------- Table of Contents Three Months Ended Dec. 31, Sept. 30, June 30, Mar. 31, Dec.31, Sept. 30, June 30, Mar. 31, 2012 2012 2012 2012 2011 2011 2011 2011 (in thousands, except per share data) Consolidated Statements of Operations Data: Revenue: Subscription $ 27,460 $ 25,991 $ 24,750 $ 23,269 $ 21,363 $ 18,793 $ 17,663 $ 16,077 Hardware and services 1,189 1,093 1,193 1,350 1,328 1,693 2,217 2,704 Total revenue 28,649 27,084 25,943 24,619 22,691 20,486 19,880 18,781 Cost of revenue:(1) Subscription 6,832 6,967 7,236 7,211 6,640 5,936 5,801 5,816 Hardware and services 1,401 1,163 1,134 1,169 1,111 1,313 1,530 1,583 Total cost of revenue 8,233 8,130 8,370 8,380 7,751 7,249 7,331 7,399 Gross profit 20,416 18,954 17,573 16,239 14,940 13,237 12,549 11,382 Operating expense:(1) Research and development 6,460 6,262 6,224 5,881 5,363 4,594 4,881 4,941 Sales and marketing 15,488 14,126 13,450 12,175 12,606 10,779 9,846 9,445 General and administrative 3,822 3,141 2,964 2,766 3,054 2,043 2,092 2,048 Total operating expense 25,770 23,529 22,638 20,822 21,023 17,416 16,819 16,434 Operating loss (5,354 ) (4,575 ) (5,065 ) (4,583 ) (6,083 ) (4,179 ) (4,270 ) (5,052 ) Interest income (expense), net 2 (7 ) (43 ) (60 ) (42 ) (70 ) (112 ) (76 ) Other income (expense), net (54 ) 109 (178 ) (31 ) (99 ) (31 ) 94 149 Loss before provision for income taxes (5,406 ) (4,473 ) (5,286 ) (4,674 ) (6,224 ) (4,280 ) (4,288 ) (4,979 ) Provision for income taxes (91 ) (119 ) (232 ) (79 ) (201 ) (33 ) (30 ) (106 ) Net loss $ (5,497 ) $ (4,592 ) $ (5,518 ) $ (4,753 ) $ (6,425 ) $ (4,313 ) $ (4,318 ) $ (5,085 ) _______________________________________________________________________________ (1) Includes stock-based compensation expense and amortization of intangible assets as follows: Three Months Ended Dec. 31, Sept. 30, June 30, Mar. 31, Dec. 31, Sept. 30, June 30, Mar. 31, 2012 2012 2012 2012 2011 2011 2011 2011 (in thousands) Stock-based compensation: Cost of subscription revenue $ 214 $ 205 $ 109 $ 129 $ 85 $ 76 $ 107 $ 98 Cost of hardware and services revenue 24 20 15 11 9 7 6 7 Research and development 460 502 485 422 379 307 283 278 Sales and marketing 801 830 820 651 558 511 478 429 General and administrative 439 390 506 288 226 220 239 245 Total stock based compensation expenses $ 1,938 $ 1,947 $ 1,935 $ 1,501 $ 1,257 $ 1,121 $ 1,113 $ 1,057 Amortization of intangible assets: Cost of subscription revenue $ 333 $ 333 $ 1,019 $ 1,100 $ 963 $ 949 $ 935 $ 925 Research and development 7 8 7 8 1 - - - Sales and marketing 72 72 146 171 143 142 141 343 Total amortization of intangible assets $ 412 $ 413 $ 1,172 $ 1,279 $ 1,107 $ 1,091 $ 1,076 $ 1,268 The following unaudited table sets forth our consolidated results of operations data as a percentage of total revenue.

49-------------------------------------------------------------------------------- Table of Contents Three Months Ended Dec. 31, Sept. 30, June 30, Mar. 31, Dec. 31, Sept. 30, June 30, Mar. 31, 2012 2012 2012 2012 2011 2011 2011 2011 Consolidated Statements of Operations Data: Revenue: Subscription 96 % 96 % 95 % 95 % 94 % 92 % 89 % 86 % Hardware and services 4 4 5 5 6 8 11 14 Total revenue 100 100 100 100 100 100 100 100 Cost of revenue: Subscription 24 26 28 29 29 29 29 31 Hardware and services 5 4 4 5 5 7 8 8 Total cost of revenue 29 30 32 34 34 36 37 39 Gross profit 71 70 68 66 66 64 63 61 Operating expense: Research and development 23 23 24 24 24 22 25 26 Sales and marketing 54 52 52 50 56 53 50 51 General and administrative 13 12 11 11 13 10 10 11 Total operating expense 90 87 87 85 93 85 85 88 Operating loss (19 ) (17 ) (19 ) (19 ) (27 ) (21 ) (22 ) (27 ) Interest income (expense), net - - - - - - - - Other income (expense), net - - (1 ) - - - - 1 Loss before provision for income taxes (19 ) (17 ) (20 ) (19 ) (27 ) (21 ) (22 ) (26 ) Provision for income taxes - - (1 ) - (1 ) - - (1 ) Net loss (19 )% (17 )% (21 )% (19 )% (28 )% (21 )% (22 )% (27 )% Liquidity and Capital Resources Since our inception, we have relied principally on sales of our preferred stock to fund our operating activities. To date, we have raised $92.8 million from the sale of preferred stock. Additionally, we have utilized equipment lines to fund capital purchases and in April and May 2012, we raised net proceeds of $68.3 million in our initial public offering including proceeds from the underwriters' partial exercise of their over-allotment option.

We entered into a new equipment loan agreement with Silicon Valley Bank in April 2011 for an aggregate loan principal amount of $6.0 million. Interest on the advances is equal to the prime rate plus 0.50%. As of December 31, 2012, the interest rate on the outstanding advances was 4.50%. We had the ability to draw down on this equipment line through April 19, 2012 and no longer have the ability to draw on this equipment line. Each drawn amount is due 48 months after funding. Borrowings outstanding under the equipment loan at December 31, 2012 were $4.0 million. Equipment financed under this loan arrangement is collateralized by the respective assets underlying the loan. The terms of the loan restrict our ability to pay dividends. The loan includes a covenant that requires us to maintain cash and cash equivalents plus net accounts receivables of at least two times the amount of all outstanding indebtedness. As of December 31, 2012, we were in compliance with this financial covenant. See the notes to our consolidated financial statements for a description of our prior equipment loan.

We plan to grow our customer base by continuing to emphasize investments in sales and marketing to add new customers, expand our customers' use of our platform, and maintain high renewal rates. We also expect to incur additional cost of subscription revenue in accordance with the resulting growth in our customer base. We believe that the combination of our ongoing improvements in gross margins, the benefits of lower sales and marketing costs associated with our renewal activity, and the fact that our contracts are structured to bill our customers in advance should enable us to improve our cash flow from operations as we grow. Based on our current level of operations and anticipated growth, both of which are expected to be consistent with recent quarters, we believe that our existing sources of liquidity will be sufficient to fund our operations for at least the next 12 months. Our future capital requirements will depend on many factors, including our rate of revenue growth, the expansion of our sales and marketing activities, and the timing and extent of spending to support product development efforts and expansion into new territories, and the timing of introductions of new features and enhancements to our solutions. To the extent that existing cash and cash equivalents and cash from operations are insufficient to fund our future activities, we may need to raise additional funds through public or private equity or debt financing. We may also seek to invest in or acquire 50-------------------------------------------------------------------------------- Table of Contents complementary businesses, applications or technologies, any of which could also require us to seek additional equity or debt financing. Additional funds may not be available on terms favorable to us or at all.

Cash Flows The following table sets forth a summary of our consolidated cash flows for the periods indicated: Years Ended December 31, 2012 2011 2010 (in thousands)Net cash provided by (used in) operating activities $ 6,836 $ (168 ) $ 3,409 Net cash provided by (used in) investing activities (50,735 ) (7,353 ) 306 Net cash provided by financing activities 73,386 5,201 1,445 Net Cash Flows Provided by (Used in) Operating Activities Our net loss and cash flows from operating activities are significantly influenced by our investments in headcount and data center operations to support anticipated growth. Our cash flows are also influenced by cash payments from customers. We invoice customers for the entire contract amount at the start of the term, and as such our cash flow from operations is also affected by the length of a customer contract.

We generated $6.8 million of cash in operating activities in 2012. The generation of cash was the result of a net loss of $20.4 million, offset by non-cash expenditures of $15.6 million, which included depreciation, amortization, provision for allowance of bad debt and stock-based compensation expense. These non-cash expenditures increased due to capital expenditure and headcount growth, primarily related to continued investment in our business.

Cash used in operations was further offset by an increase in deferred revenue of $10.6 million due to sales growth and a decrease in deferred product costs of $1.3 million. The remaining use of funds was due to the net change in working capital items, most notably an increase in accounts receivable of $2.4 million due to strong sales growth, an increase of $0.9 million in prepaid expenses and other current assets, and an increase in accrued liabilities of $3.5 million related to timing of compensation, employee stock purchase plan contribution and increase in tax liability.

We used $0.2 million of cash in operating activities in 2011. This use of cash was the result of a net loss of $20.1 million, offset by non-cash expenditures of $12.4 million million, which included depreciation, amortization and stock-based compensation expense. These non-cash expenditures increased due to capital expenditure and headcount growth, primarily related to continued investment in our business. Cash used in operations was further offset by an increase in deferred revenue of $7.1 million due to sales growth and a decrease in deferred product costs of $2.8 million. The remaining use of funds was due to the net change in working capital items, most notably an increase in accounts receivable of $2.7 million due to strong sales efforts during the last quarter of the fiscal year, an increase of $0.8 million in prepaid expenses and other current assets, and an increase in accrued liabilities of $0.7 million related to timing of compensation and capital expenditures.

Cash provided by operating activities in 2010 of $3.4 million was the result of a net loss of $20.9 million, offset by non-cash expenditures of $11.4 million, which included depreciation, amortization and stock-based compensation expense, due to headcount growth and investment in the business. This was further offset by an increase in deferred revenue of $11.8 million and a decrease in deferred product costs of $1.6 million as a result of our increased sales activity. The remaining use of funds of $0.5 million was from the net change in working capital items, most notably an increase in accounts receivable of $3.1 million due to growth and timing of increased sales, and increases in accounts payable and accrued liabilities of $1.0 million and $1.8 million respectively, related to timing of royalty, inventory, data center obligations, and employee compensation accruals.

Net Cash Flows Provided by (Used in) Investing Activities Our primary investing activities have consisted of capital expenditures in support of expanding our infrastructure and workforce and the purchase and sale of short-term investments. As our business grows, we expect our capital expenditures and our investment activity to continue to increase.

51-------------------------------------------------------------------------------- Table of Contents We used $50.7 million of cash in investing activities during 2012. This was primarily due to purchases of short term investments of $60.1 million with proceeds generated from our initial public offering, offset by net proceeds of $15.3 million from sales and maturities of short-term investments. In addition, we used $5.9 million to purchase equipment for infrastructure expansion. These expenditures were primarily for replacement and upgrade of equipment to lower the cost of deployment as well as to improve the efficiency for our cloud based architecture.

We used $7.4 million of cash in investing activities during 2011. This was primarily from the net purchase of $2.3 million in short-term investments. In addition, we used $4.9 million to purchase equipment for infrastructure expansion. These expenditures were primarily for replacement and upgrade of equipment to lower the cost of deployment as well as to improve the efficiency for our cloud-based architecture.

Investing activities in 2010 resulted in net proceeds of $0.3 million. This was primarily from $3.7 million of net proceeds from short-term investments, offset by $3.4 million of equipment purchases used for infrastructure expansion and other fixed assets.

Net Cash Flows Provided by (Used in) Financing Activities Cash provided by financing activities in 2012 was $73.4 million. This was primarily related to proceeds from our initial public offering, net of offering costs, of $68.3 million. Contributions also included $6.1 million of proceeds from the exercise of stock options, partially offset by $1.0 million in repayments under our equipment financing loans.

Cash provided by financing activities in 2011 was $5.2 million. This consisted of $1.2 million of proceeds from the exercise of stock options and borrowings under our new equipment line of $4.9 million during this period, partially offset by repayments under our equipment financing loans of $0.2 million and $0.7 million in earn-out payments.

Cash provided by financing activities in 2010 was $1.4 million. This consisted of proceeds from sales our Series F preferred stock financing of $1.5 million along with $1.2 million from the exercise of employee stock options, partially offset by repayment of equipment financing loans of $0.5 million and $0.8 million towards earn-out payments.

Contractual Obligations and Commitments Our principal commitments consist of obligations under our outstanding leases for our office space and third-party data centers as well as equipment leases and loans for certain computer and office equipment. The following table summarizes our contractual obligations as of December 31, 2012 (in thousands): Payment Due By Period Less Than More Than Contractual Obligations Total 1 Year 1-3 Years 3-5 Years 5 Years Debt obligations(1) $ 3,968 $ 1,642 $ 2,326 $ - $ - Interest expense payments(2) 226 146 80 - - Capital and operating lease obligations(3) 4,234 1,818 1,980 436 - Purchase obligations(4) 2,256 1,924 332 - - Total $ 10,684 $ 5,530 $ 4,718 $ 436 $ - _______________________________________________________________________________ (1) Represents our outstanding debt under our equipment loan, including the loan and equipment agreement commencing April 2011.

(2) Represents interest payments on our outstanding debt under our equipment loan, including the loan and equipment agreement commencing April 2011.

(3) Consists of capital leases and contractual obligations under operating leases for office space, including the new facility lease commencing December 2012 and June 2013.

(4) Consists of purchase obligations for servers and similar equipment to support our third-party data centers.

We entered into a new equipment loan agreement with Silicon Valley Bank in April 2011 for an aggregate loan principal amount of $6.0 million. For more information about our equipment loan agreement please see "Liquidity and Capital Resources." 52-------------------------------------------------------------------------------- Table of Contents In March 2011, we entered into a lease agreement to occupy an additional 23,121 square feet of office space at our headquarters facility. The lease term is 39 months for 74,338 square feet in the aggregate, with a monthly rental of $74,338 commencing on April 1, 2011, and expiring on June 30, 2014.

In November 2012, we entered into a lease agreement to occupy 22,216 square feet of office space at our Canada facility. The lease term is 36 months with a monthly rental approximately $37,000 commencing on December 1, 2012, and expiring on November 30, 2015.

In December 2012, we entered into an amendment to the lease agreement to occupy an additional 3,202 square feet of office space at our Utah facility. The lease is 48 months for 18,532 square feet in the aggregate, with a monthly rent approximately $24,000 commencing on June 1, 2013 and expiring on May 31, 2017.

We have recorded a liability for sales and use taxes. A variety of factors could affect the liability, which factors include recovery of amounts from customers and any changes in relevant statutes in the various states in which we have done business. To the extent that the actual amount of our liabilities for sales and use taxes materially differs from the amount we have recorded on our consolidated balance sheet, our future results of operations and cash flows could be negatively affected.

As of December 31, 2012, the amount of cash and cash equivalents held by our foreign subsidiaries was $11.7 million, including intercompany receivable balances. If these funds were needed for our operations in the United States, we would be required to withhold foreign taxes on the funds repatriated of approximately $0.5 million. We have provided an insignificant amount (less than $0.1 million) for these taxes in accordance with ASC 740-30-25, as it is our intention that these funds are permanently reinvested outside the United States and our current plans do not demonstrate a need to repatriate these funds to our United States operations.

Under the indemnification provisions of our standard customer agreements, we agree to indemnify, defend and hold harmless our customers against, among other things, infringement of any patents, trademarks or copyrights under any country's laws or the misappropriation of any trade secrets arising from the customer's legal use of our solutions. Certain indemnification provisions potentially expose us to losses in excess of the aggregate amount paid to us by the customer under the applicable customer agreement. No material claims have been made against us pursuant to these indemnification provisions to date.

Off-Balance Sheet Arrangements During the periods presented, we did not have, nor do we currently have, any relationships with unconsolidated entities or financial partnerships, such as entities often referred to as structured finance or special purpose entities, which would have been established for the purpose of facilitating off-balance sheet arrangements or other contractually narrow or limited purposes. We are therefore not exposed to any financing, liquidity, market or credit risk that could arise if we had engaged in those types of relationships.

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