•         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 our proprietary
          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 DLP technologies to
          develop a new solution for policy?based encryption, enabling each
          outgoing message to be inspected for confidential content and
          automatically encrypted accordingly.


•         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 our customers outside of the
          United States..


•         In 2008, we introduced Proofpoint Enterprise Archive, a cloud?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 out technology licensed
          from a third party. We also introduced a cloud?based email messaging
          service.

•         In 2010, we evolved our solutions to address new forms of messaging 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 the rigorous security
          requirements of U.S. Federal agencies. We also introduced 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 to unstructured information across the
          enterprise. We also introduced Proofpoint Targeted Attack Protection, a
          solution that stops targeted attacks by combining previously disparate
          email security, Web security and malware analysis technologies into a
          single comprehensive cloud-based defense.

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 87% of total revenue in 2009, to 95% for the first half of fiscal 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 are treated as deferred revenue on our consolidated balance sheet and are 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 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 from 11.2% and 12.7% of total revenue in the three and six months ended June 30, 2011 to 4.6% and 5.0% of total revenue in the three and six months ended June 30, 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 18.1% and 18.3% for the three and six months ended June 30, 2012 and 20.8% and 21.2% of total revenue for the three and six months ended June 30, 2011,

respectively. As of June 30, 2012, we had in excess of 2,400 customers around the world, including 28 of the Fortune 100. There was one partner that accounted for more than 10% of our total revenue in the three and six months ended June 30, 2012, although the partner sold to a number of end user customers. There were no single partners or customers that accounted for more than 10% of our total revenue in the three and six months ended June 30, 2011.
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 greater than 2,400 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 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 the United States 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 20 to 25 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 the six months ended June 30, 2012 with the same period in 2011, our cash flow related to operating activities improved by $0.5 million, respectively while our operating loss improved by only $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 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.

                                             Three Months Ended June 30,           Six Months Ended June 30,
                                               2012               2011              2012               2011
                                                   (in thousands)                       (in thousands)
Total revenue                            $      25,943       $      19,880     $     50,562       $     38,661
Growth                                              30 %                29 %             31 %               28 %
Subscription revenue                     $      24,750       $      17,663     $     48,019       $     33,740
Growth                                              40 %                30 %             42 %               27 %
Adjusted subscription gross profit       $      18,642       $      12,904     $     35,982       $     24,188
% of subscription revenue                           75 %                73 %             75 %               72 %
Billings                                 $      26,346       $      21,578     $     50,228       $     40,730
Growth                                              22 %                20 %             23 %               17 %
Adjusted EBITDA                          $        (926 )     $      (1,296 )   $     (1,710 )     $     (3,336 )

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 three and six months ended June 30, 2012 and 2011:

                                           Three Months Ended June 30,       Six Months Ended June 30,
                                                2012            2011            2012            2011
                                                  (in thousands)                  (in thousands)
Subscription revenue                      $       24,750     $  17,663     $      48,019     $  33,740
Cost of subscription revenue                       7,236         5,801            14,447        11,617
Subscription gross profit                         17,514        11,862            33,572        22,123
Add back:
Stock?based compensation                             109           107               238           205
Amortization of intangible assets                  1,019           935             2,119         1,860
Adjusted subscription gross profit        $       18,642     $  12,904     $      35,929     $  24,188

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 three and six months ended June 30, 2012 and 2011:

                       Three Months Ended June 30,             Six Months Ended June 30,
                            2012                 2011            2012               2011
                             (in thousands)                          (in thousands)
Total revenue    $       25,943                $ 19,880    $      50,562       $      38,661
. . .