10-Q 1 d238283d10q.htm FORM 10-Q Form 10-Q
Table of Contents

 

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

 

FORM 10-Q

 

 

(Mark One)

x Quarterly report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934

For the quarterly period ended October 31, 2011

OR

 

¨ Transition report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934

Commission File Number: 001-32224

 

 

salesforce.com, inc.

(Exact name of registrant as specified in its charter)

 

 

 

Delaware   94-3320693

(State or other jurisdiction of

incorporation or organization)

 

(IRS Employer

Identification No.)

The Landmark @ One Market, Suite 300

San Francisco, California 94105

(Address of principal executive offices)

Telephone Number (415) 901-7000

(Registrant’s telephone number, including area code)

Indicate by check mark whether the Registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 (the “Exchange Act”) during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days:    Yes  x    No  ¨

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).    Yes  x    No  ¨

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.

 

Large accelerated filer  x    Accelerated filer  ¨
Non-accelerated filer  ¨  (Do not check if a smaller reporting company)    Smaller reporting company  ¨

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).    Yes  ¨    No  x

As of October 31, 2011, there were approximately 136.0 million shares of the Registrant’s Common Stock outstanding.

 

 

 


Table of Contents

salesforce.com, inc.

INDEX

 

          Page No.
   PART I. FINANCIAL INFORMATION   

Item 1.

  

Financial Statements:

  
  

Condensed Consolidated Balance Sheets as of October 31, 2011 and January 31, 2011

   3
  

Condensed Consolidated Statements of Operations for the three and nine months ended October 31, 2011 and 2010

   4
  

Condensed Consolidated Statements of Cash Flows for the three and nine months ended October 31, 2011 and 2010

   5
  

Notes to Condensed Consolidated Financial Statements

   6

Item 2.

  

Management’s Discussion and Analysis of Financial Condition and Results of Operations

   33

Item 3.

  

Quantitative and Qualitative Disclosures About Market Risk

   54

Item 4.

  

Controls and Procedures

   55
   PART II. OTHER INFORMATION   

Item 1.

  

Legal Proceedings

   56

Item 1A.

  

Risk Factors

   56

Item 2.

  

Unregistered Sales of Equity Securities and Use of Proceeds

   71

Item 3.

  

Defaults Upon Senior Securities

   71

Item 4.

  

Removed and Reserved

   71

Item 5.

  

Other Information

   71

Item 6.

  

Exhibits

   71

 

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PART I. FINANCIAL INFORMATION

 

ITEM 1. FINANCIAL STATEMENTS

salesforce.com, inc.

Condensed Consolidated Balance Sheets

(in thousands)

 

     October 31,
2011
     January 31,
2011
 
     (unaudited)         

Assets

     

Current assets:

     

Cash and cash equivalents

   $ 502,987       $ 424,292   

Short-term marketable securities

     142,861         72,678   

Accounts receivable, net

     312,331         426,943   

Deferred commissions

     71,799         67,774   

Deferred income taxes

     38,834         27,516   

Prepaid expenses and other current assets

     79,428         55,721   
  

 

 

    

 

 

 

Total current assets

     1,148,240         1,074,924   

Marketable securities, noncurrent

     650,845         910,587   

Property and equipment, net

     504,827         387,174   

Deferred commissions, noncurrent

     48,616         48,842   

Deferred income taxes, noncurrent

     70,857         41,199   

Capitalized software, net

     199,413         127,987   

Goodwill

     732,062         396,081   

Other assets, net

     156,418         104,371   
  

 

 

    

 

 

 

Total assets

   $ 3,511,278       $ 3,091,165   
  

 

 

    

 

 

 

Liabilities, temporary equity and stockholders’ equity

     

Current liabilities:

     

Accounts payable

   $ 28,265       $ 18,106   

Accrued expenses and other liabilities

     409,150         345,121   

Deferred revenue

     905,055         913,239   

Convertible senior notes, net (Note 2)

     490,119         0   
  

 

 

    

 

 

 

Total current liabilities

     1,832,589         1,276,466   

Convertible senior notes, net

     0         472,538   

Income taxes payable, noncurrent

     30,204         18,481   

Long-term lease liabilities and other

     52,559         25,487   

Deferred revenue, noncurrent

     12,766         21,702   
  

 

 

    

 

 

 

Total liabilities

     1,928,118         1,814,674   
  

 

 

    

 

 

 

Temporary equity (Note 2)

     84,771         0   
  

 

 

    

 

 

 

Stockholders’ equity:

     

Common stock

     136         133   

Additional paid-in capital

     1,330,735         1,098,604   

Accumulated other comprehensive income

     3,977         6,719   

Retained earnings

     163,541         171,035   
  

 

 

    

 

 

 

Total stockholders’ equity

     1,498,389         1,276,491   
  

 

 

    

 

 

 

Total liabilities, temporary equity and stockholders’ equity

   $ 3,511,278       $ 3,091,165   
  

 

 

    

 

 

 

See accompanying Notes.

 

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Table of Contents

salesforce.com, inc.

Condensed Consolidated Statements of Operations

(in thousands, except per share data)

(unaudited)

 

     Three Months Ended
October 31,
    Nine Months Ended
October 31,
 
     2011     2010     2011     2010  

Revenues:

        

Subscription and support

   $ 549,182      $ 402,948      $ 1,531,965      $ 1,122,611   

Professional services and other

     35,078        26,139        102,661        77,661   
  

 

 

   

 

 

   

 

 

   

 

 

 

Total revenues

     584,260        429,087        1,634,626        1,200,272   

Cost of revenues (1):

        

Subscription and support

     96,306        54,089        260,693        147,127   

Professional services and other

     32,259        28,042        91,848        84,375   
  

 

 

   

 

 

   

 

 

   

 

 

 

Total cost of revenues

     128,565        82,131        352,541        231,502   
  

 

 

   

 

 

   

 

 

   

 

 

 

Gross profit

     455,695        346,956        1,282,085        968,770   

Operating expenses (1):

        

Research and development

     76,049        47,305        214,734        130,357   

Marketing and sales

     304,571        200,544        842,043        558,812   

General and administrative

     85,232        63,951        254,016        181,713   
  

 

 

   

 

 

   

 

 

   

 

 

 

Total operating expenses

     465,852        311,800        1,310,793        870,882   

Income (loss) from operations

     (10,157     35,156        (28,708     97,888   

Investment income

     5,136        11,699        18,303        28,309   

Interest expense

     (3,859     (7,374     (11,376     (21,619

Other income (expense)

     30        (921     (4,001     (4,659
  

 

 

   

 

 

   

 

 

   

 

 

 

Income (loss) before benefit (provision) for income taxes and noncontrolling interest

     (8,850     38,560        (25,782     99,919   

Benefit (provision) for income taxes

     5,094        (16,192     18,288        (41,092
  

 

 

   

 

 

   

 

 

   

 

 

 

Consolidated net income (loss)

     (3,756     22,368        (7,494     58,827   

Less: Net income attributable to noncontrolling interest

     0        (1,296     0        (5,266
  

 

 

   

 

 

   

 

 

   

 

 

 

Net income (loss) attributable to salesforce.com

   $ (3,756   $ 21,072      $ (7,494   $ 53,561   
  

 

 

   

 

 

   

 

 

   

 

 

 

Earnings per share- basic and diluted:

        

Basic net income (loss) per share attributable to salesforce.com common shareholders

   $ (0.03   $ 0.16      $ (0.06   $ 0.41   

Diluted net income (loss) per share attributable to salesforce.com common shareholders

   $ (0.03   $ 0.15      $ (0.06   $ 0.40   

Shares used in computing basic net income per share

     135,847        130,888        134,824        129,461   

Shares used in computing diluted net income per share

     135,847        137,044        134,824        135,007   

 

(1)    Amounts include stock-based expenses, as follows:

        

Cost of revenues

   $ 4,138      $ 2,357      $ 12,168      $ 8,617   

Research and development

     12,197        3,976        31,224        12,119   

Marketing and sales

     29,123        11,969        80,024        36,496   

General and administrative

     11,548        7,330        35,742        21,483   

See accompanying Notes.

 

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salesforce.com, inc.

Condensed Consolidated Statements of Cash Flows

(in thousands)

(unaudited)

 

     Three Months Ended
October 31,
    Nine Months Ended
October 31,
 
     2011     2010     2011     2010  

Operating activities

        

Consolidated net income (loss)

   $ (3,756   $ 22,368      $ (7,494   $ 58,827   

Adjustments to reconcile net income (loss) to net cash provided by operating activities:

        

Depreciation and amortization

     41,553        19,710        111,385        52,008   

Amortization of debt discount and transaction costs

     2,138        6,655        6,470        17,639   

Amortization of deferred commissions

     26,862        19,959        76,453        57,554   

Expenses related to stock-based awards

     57,006        25,632        159,158        78,715   

Excess tax benefits from employee stock plans

     (6,892     (14,578     (11,012     (46,768

Changes in assets and liabilities:

        

Accounts receivable, net

     30,101        (30,212     120,152        67,326   

Deferred commissions

     (33,611     (25,687     (80,252     (65,243

Prepaid expenses and other current assets

     9,035        (16,583     (9,959     (6,463

Other assets

     4,693        (5,263     67        (9,405

Accounts payable

     5,944        2,575        8,928        6,500   

Accrued expenses and other current liabilities

     13,081        57,926        (4,936     95,320   

Deferred revenue

     (17,445     11,538        (17,800     (12,691
  

 

 

   

 

 

   

 

 

   

 

 

 

Net cash provided by operating activities

     128,709        74,040        351,160        293,319   
  

 

 

   

 

 

   

 

 

   

 

 

 

Investing activities

        

Business combinations, net of cash acquired

     (66,115     (3,834     (364,785     (155,337

Land activity and building improvements

     (6,654     (8,000     (13,090     (8,000

Strategic investments

     (21,508     (4,000     (34,723     (6,500

Purchase of marketable securities

     (100,664     (296,557     (408,228     (1,518,996

Sales of marketable securities

     126,672        518,641        563,621        868,595   

Maturities of marketable securities

     13,159        58,256        31,894        200,768   

Capital expenditures

     (34,678     (20,790     (107,043     (60,311
  

 

 

   

 

 

   

 

 

   

 

 

 

Net cash provided by (used in) investing activities

     (89,788     243,716        (332,354     (679,781
  

 

 

   

 

 

   

 

 

   

 

 

 

Financing activities

        

Purchase of subsidiary stock

     0        (150,970     0        (152,243

Proceeds from the exercise of stock options

     15,794        44,353        90,362        115,996   

Excess tax benefits from employee stock plans

     6,892        14,578        11,012        46,768   

Contingent consideration payments related to prior business combinations

     0        0        (16,200     0   

Principal payments on capital lease obligations

     (7,685     (3,116     (21,796     (7,157
  

 

 

   

 

 

   

 

 

   

 

 

 

Net cash provided by (used in) financing activities

     15,001        (95,155     63,378        3,364   
  

 

 

   

 

 

   

 

 

   

 

 

 

Effect of exchange rate changes

     (729     (2,223     (3,489     2,095   
  

 

 

   

 

 

   

 

 

   

 

 

 

Net increase (decrease) in cash and cash equivalents

     53,193        220,378        78,695        (381,003

Cash and cash equivalents, beginning of period

     449,794        409,925        424,292        1,011,306   
  

 

 

   

 

 

   

 

 

   

 

 

 

Cash and cash equivalents, end of period

   $ 502,987      $ 630,303      $ 502,987      $ 630,303   
  

 

 

   

 

 

   

 

 

   

 

 

 

Supplemental cash flow disclosure:

        

Cash paid (received) during the period for:

        

Interest, net

   $ 632      $ 1,378      $ 3,718      $ 3,980   

Income taxes, net of tax refunds

     7,858        4,260        19,864        (530

Non-cash financing and investing activities:

        

Fixed assets acquired under capital leases

     18,600        6,765        65,803        12,929   

Fair value of stock options assumed (Note 4)

     1,043        0        5,772        0   

See accompanying Notes.

 

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salesforce.com, inc.

Notes to Condensed Consolidated Financial Statements

1. Summary of Business and Significant Accounting Policies

Description of Business

Salesforce.com, inc. (the “Company”) is a leading provider of enterprise cloud computing applications. The Company provides a comprehensive customer and collaboration relationship management (“CRM”) service to businesses of all sizes and industries worldwide and provides a technology platform for customers and developers to build and run applications. The Company offers its enterprise cloud computing services on a subscription basis.

Fiscal Year

The Company’s fiscal year ends on January 31. References to fiscal 2012, for example, refer to the fiscal year ending January 31, 2012.

Basis of Presentation

The accompanying condensed consolidated balance sheet as of October 31, 2011 and the condensed consolidated statements of operations and the condensed consolidated statements of cash flows for the three and nine months ended October 31, 2011 and 2010, respectively, are unaudited. The condensed consolidated balance sheet data as of January 31, 2011 was derived from the audited consolidated financial statements which are included in the Company’s Form 10-K for the fiscal year ended January 31, 2011, which was filed with the Securities and Exchange Commission (the “SEC”) on March 23, 2011. The accompanying statements should be read in conjunction with the audited consolidated financial statements and related notes contained in the Company’s fiscal 2011 Form 10-K.

The accompanying condensed consolidated financial statements have been prepared in accordance with U.S. generally accepted accounting principles (“U.S. GAAP”) for interim financial information. Accordingly, they do not include all of the financial information and footnotes required by U.S. GAAP for complete financial statements. In the opinion of the Company’s management, the unaudited condensed consolidated financial statements have been prepared on the same basis as the audited consolidated financial statements in the Form 10-K, and include all adjustments necessary for the fair presentation of the Company’s statement of financial position as of October 31, 2011, and its results of operations and its cash flows for the three and nine months ended October 31, 2011 and 2010. All adjustments are of a normal recurring nature. The results for the three and nine months ended October 31, 2011 are not necessarily indicative of the results to be expected for any subsequent quarter or for the fiscal year ending January 31, 2012.

On February 1, 2011, the Company adopted on a prospective basis Accounting Standards Update No. 2009-13, Revenue Recognition (Topic 605), “Multiple-Deliverable Revenue Arrangements—a consensus of the FASB Emerging Issues Task Force” (“ASU 2009-13”). As a result of the adoption of ASU 2009-13, the Company has updated its accounting policy for revenue recognition related to multiple-deliverable arrangements.

Use of Estimates

The preparation of financial statements in conformity with U.S. GAAP requires management to make estimates and assumptions in the Company’s consolidated financial statements and notes thereto.

Significant estimates and assumptions made by management include the determination of:

 

   

the best estimate of selling price of the deliverables included in multiple-deliverable revenue arrangements,

 

   

the fair value of assets acquired and liabilities assumed for business combinations,

 

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recognition and measurement of current and deferred income taxes,

 

   

the fair value of stock awards issued and

 

   

the valuation of strategic investments and the determination of other-than-temporary impairments.

Actual results could differ materially from those estimates.

Principles of Consolidation

The consolidated financial statements include the accounts of the Company and its wholly owned subsidiaries. All significant intercompany balances and transactions have been eliminated in consolidation.

Segments

The Company operates in one reportable segment. Operating segments are defined as components of an enterprise about which separate financial information is evaluated regularly by the chief operating decision maker, or decision making group, in deciding how to allocate resources and assessing performance. Since the Company operates in one operating segment, all required financial segment information can be found in the consolidated financial statements.

Foreign Currency Translation

The functional currency of the Company’s major foreign subsidiaries is generally the local currency. Adjustments resulting from translating foreign functional currency financial statements into U.S. dollars are recorded as part of a separate component of stockholders’ equity. Foreign currency transaction gains and losses are included in net income (loss) for the period. All assets and liabilities denominated in a foreign currency are translated into U.S. dollars at the exchange rate on the balance sheet date. Revenues and expenses are translated at the average exchange rate during the period. Equity transactions are translated using historical exchange rates.

Concentrations of Credit Risk and Significant Customers

The Company’s financial instruments that are exposed to concentrations of credit risk consist primarily of cash and cash equivalents, marketable securities and trade accounts receivable. Although the Company deposits its cash with multiple financial institutions, its deposits, at times, may exceed federally insured limits. Collateral is not required for accounts receivable. The Company maintains an allowance for doubtful accounts receivable balances. The allowance is based upon historical loss patterns, the number of days that billings are past due and an evaluation of the potential risk of loss associated with delinquent accounts.

No customer accounted for more than five percent of accounts receivable at October 31, 2011 and January 31, 2011. No single customer accounted for five percent or more of total revenue in the three and nine months ended October 31, 2011 and 2010.

As of October 31, 2011 and January 31, 2011, assets located outside the Americas were 17 percent and 16 percent of total assets, respectively.

Revenues by geographical region are as follows (in thousands):

 

     Three Months Ended
October 31,
     Nine Months Ended
October 31,
 
     2011      2010      2011      2010  

Americas

   $ 397,118       $ 292,540       $ 1,104,052       $ 826,493   

Europe

     103,864         76,464         300,315         208,851   

Asia Pacific

     83,278         60,083         230,259         164,928   
  

 

 

    

 

 

    

 

 

    

 

 

 
   $ 584,260       $ 429,087       $ 1,634,626       $ 1,200,272   
  

 

 

    

 

 

    

 

 

    

 

 

 

 

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Cash and Cash Equivalents

The Company considers all highly liquid investments purchased with an original maturity of three months or less to be cash equivalents. Cash and cash equivalents are stated at fair value.

Marketable Securities

Management determines the appropriate classification of marketable securities at the time of purchase and reevaluates such determination at each balance sheet date. Securities are classified as available for sale and are carried at fair value, with the unrealized gains and losses, net of tax, reported as a separate component of stockholders’ equity. Fair value is determined based on quoted market rates when observable or utilizing data points that are observable, such as quoted prices, interest rates and yield curves. Declines in fair value judged to be other-than-temporary on securities available for sale are included as a component of investment income. In order to determine whether a decline in value is other-than-temporary, the Company evaluates, among other factors: the duration and extent to which the fair value has been less than the carrying value and its intent and ability to retain the investment for a period of time sufficient to allow for any anticipated recovery in fair market value. The cost of securities sold is based on the specific-identification method. Interest on securities classified as available for sale is also included as a component of investment income.

Fair Value Measurement

The Company reports its financial and non-financial assets and liabilities that are re-measured and reported at fair value at each reporting period. The Company uses a three-tier fair value hierarchy, which prioritizes the inputs used in the valuation methodologies in measuring fair value:

 

Level 1.

   Observable inputs that reflect quoted prices (unadjusted) for identical assets or liabilities in active markets.

Level 2.

   Include other inputs that are directly or indirectly observable in the marketplace.

Level 3.

   Unobservable inputs which are supported by little or no market activity.

All of the Company’s cash equivalents, marketable securities and foreign currency derivative contracts are classified within Level 1 or Level 2 because the Company’s cash equivalents, marketable securities and foreign currency derivative contracts are valued using quoted market prices or alternative pricing sources and models utilizing market observable inputs. The Company’s contingent considerations related to acquisitions are classified within Level 3 because the liabilities are valued using significant unobservable inputs.

 

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The following table presents information about the Company’s assets and liabilities that are measured at fair value as of October 31, 2011 and indicates the fair value hierarchy of the valuation (in thousands):

 

Description

   Quoted Prices in
Active Markets
for Identical Assets
(Level 1)
     Significant Other
Observable
Inputs

(Level 2)
     Significant
Unobservable
Inputs

(Level 3)
     Balances as of
October 31, 2011
 

Cash equivalents (1):

           

Time deposits

   $ 27,032       $ 0       $ 0       $ 27,032   

Money market mutual funds

     148,878         0         0         148,878   

Marketable securities:

           

Corporate notes and obligations

     0         518,726         0         518,726   

U.S. treasury securities

     46,580         0         0         46,580   

Mortgage backed securities

     0         26,985         0         26,985   

Government obligations

     6,562         0         0         6,562   

Municipal securities

     0         14,803         0         14,803   

Collateralized mortgage obligations

     0         102,560         0         102,560   

U.S. agency obligations

     0         77,490         0         77,490   

Foreign currency derivative contracts (2)

     0         852         0         852   
  

 

 

    

 

 

    

 

 

    

 

 

 

Total Assets

   $ 229,052       $ 741,416       $ 0       $ 970,468   
  

 

 

    

 

 

    

 

 

    

 

 

 

Liabilities

           

Foreign currency derivative contracts (3)

   $ 0       $ 7,261       $ 0       $ 7,261   
  

 

 

    

 

 

    

 

 

    

 

 

 

Total Liabilities

   $ 0       $ 7,261       $ 0       $ 7,261   
  

 

 

    

 

 

    

 

 

    

 

 

 

 

(1) Included in “cash and cash equivalents” in the accompanying condensed consolidated balance sheet as of October 31, 2011, in addition to $327.1 million of cash.
(2) Included in “prepaid expenses and other current assets” in the accompanying condensed consolidated balance sheet as of October 31, 2011.
(3) Included in “accrued expenses and other current liabilities” in the accompanying condensed consolidated balance sheet as of October 31, 2011.

The following table presents the Company’s liabilities that were measured at fair value using significant unobservable inputs (Level 3) during the nine month period ended October 31, 2011. These consisted of the Company’s contingent consideration liabilities related to acquisitions (in thousands):

 

Balance at February 1, 2011

   $ 17,138   

Changes in fair value

     262   

Payments

     (17,400 )
  

 

 

 

Balance at October 31, 2011

   $ 0   
  

 

 

 

 

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The following table presents information about the Company’s assets and liabilities that are measured at fair value as of January 31, 2011 and indicates the fair value hierarchy of the valuation (in thousands):

 

Description

   Quoted Prices in
Active Markets
for Identical Assets
(Level 1)
     Significant Other
Observable
Inputs

(Level 2)
     Significant
Unobservable
Inputs

(Level 3)
     Balances as of
January 31, 2011
 

Cash equivalents (1):

           

Time deposits

   $ 26,565       $ 0       $ 0       $ 26,565   

Money market mutual funds

     122,516         0         0         122,516   

Marketable securities:

           

Corporate notes and obligations

     0         707,613         0         707,613   

U.S. treasury securities

     22,706         0         0         22,706   

Mortgage backed securities

     0         38,886         0         38,886   

Government obligations

     6,532         0         0         6,532   

Municipal securities

     0         23,081         0         23,081   

Collateralized mortgage obligations

     0         105,039         0         105,039   

U.S. agency obligations

     0         79,408         0         79,408   

Foreign currency derivative contracts (2)

     0         1,539         0         1,539   
  

 

 

    

 

 

    

 

 

    

 

 

 

Total Assets

   $ 178,319       $ 955,566       $ 0       $ 1,133,885   
  

 

 

    

 

 

    

 

 

    

 

 

 

Liabilities

           

Foreign currency derivative contracts (3)

   $ 0       $ 2,863       $ 0       $ 2,863   

Contingent consideration (related to acquisitions, see Note 4) (3)

     0         0         17,138         17,138   
  

 

 

    

 

 

    

 

 

    

 

 

 

Total Liabilities

   $ 0       $ 2,863       $ 17,138       $ 20,001   
  

 

 

    

 

 

    

 

 

    

 

 

 

 

(1) Included in “cash and cash equivalents” in the accompanying condensed consolidated balance sheet as of January 31, 2011, in addition to $275.2 million of cash.
(2) Included in “prepaid expenses and other current assets” in the accompanying condensed consolidated balance sheet as of January 31, 2011.
(3) Included in “accrued expenses and other current liabilities” in the accompanying condensed consolidated balance sheet as of January 31, 2011.

The following table presents the Company’s liabilities that were measured at fair value using significant unobservable inputs (Level 3) at January 31, 2011. These consisted of the Company’s contingent consideration liabilities related to acquisitions and the fair value was determined using a discounted cash flow model (in thousands):

 

Balance at February 1, 2010

   $ 0   

Additions and changes in fair value

     17,138   
  

 

 

 

Balance at January 31, 2011

   $ 17,138   
  

 

 

 

 

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Strategic Investments

The Company has two investments in marketable equity securities measured using quoted prices in their respective active markets and certain interests in non-marketable equity and debt securities. As of October 31, 2011, the fair value of the Company’s marketable equity securities of $6.5 million includes an unrealized gain of $4.3 million. As of January 31, 2011, the fair value of the Company’s marketable equity security of $6.0 million includes an unrealized gain of $5.2 million. These investments are recorded in other Assets, net on the condensed consolidated balance sheets.

The Company’s interest in non-marketable equity and debt securities consists of noncontrolling equity and debt investments in privately-held companies. The Company’s investments in these privately-held companies are reported at cost or marked down to fair value when an event or circumstance indicates an other-than-temporary decline in value has occurred. These investments are valued using significant unobservable inputs or data in an inactive market and the valuation requires the Company’s management judgment due to the absence of market price and inherent lack of liquidity. During the three months ended October 31, 2011 the Company recorded a net gain of $1.2 million primarily resulting from the acquisition of Assistly, Inc. (“Assistly”). This net gain is recorded in other income (expense) on the condensed consolidated statement of operations.

As of October 31, 2011 and January 31, 2011 the carrying value that approximates the fair value of the Company’s investments in privately-held companies was $48.5 million and $21.1 million, respectively. These investments are recorded in other assets, net on the condensed consolidated balance sheets.

Derivative Financial Instruments

The Company enters into foreign currency derivative contracts with financial institutions to reduce the risk that its cash flows and earnings will be adversely affected by foreign currency exchange rate fluctuations. The Company uses forward currency derivative contracts to minimize the Company’s exposure of balances denominated in Euros, Canadian dollars, Swiss francs, Australian dollars, Singapore dollars, Japanese yen and British pounds. The Company’s foreign currency derivative contracts which are not designated as hedging instruments are used to reduce the exchange rate risk associated primarily with intercompany receivables and payables. The Company’s program is not designated for trading or speculative purposes. As of October 31, 2011 and January 31, 2011 the foreign currency derivative contracts that were not settled are recorded at fair value on the condensed consolidated balance sheets.

Foreign currency derivative contracts are marked-to-market at the end of each reporting period with gains and losses recognized as other income (expense) to offset the gains or losses resulting from the settlement or remeasurement of the underlying foreign currency denominated receivables and payables. While the contract or notional amount is often used to express the volume of foreign currency derivative contracts, the amounts potentially subject to credit risk are generally limited to the amounts, if any, by which the counterparties’ obligations under the agreements exceed the obligations of the Company to the counterparties.

Details on outstanding foreign currency derivative contracts related primarily to intercompany receivables and payables are presented below (in thousands):

 

     October 31,
2011
    January 31,
2011
 

Notional amount of foreign currency derivative contracts

   $ 347,686      $ 202,491   

Fair value of foreign currency derivative contracts

   $ (6,409   $ (1,324

 

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The Company’s fair value of its outstanding derivative instruments are summarized below (in thousands):

 

          Fair Value of  Derivative
Instruments
 
     Balance Sheet Location    October 31,
2011
     January 31,
2011
 

Derivative Assets

        

Derivatives not designated as hedging instruments:

        

Foreign currency derivative contracts

   Prepaid expenses and
other current assets
   $ 852       $ 1,539   
     

 

 

    

 

 

 

Derivative Liabilities

        

Derivatives not designated as hedging instruments:

        

Foreign currency derivative contracts

   Accrued expenses and
other current liabilities
   $ 7,261       $ 2,863   
     

 

 

    

 

 

 

The effect of the derivative instruments not designated as hedging instruments on the condensed consolidated statements of operations for the three and nine months ended October 31, 2011 and 2010, respectively are summarized below (in thousands):

 

Derivatives Not Designated as Hedging

Instruments

       

Gains (Losses) on Derivative Instruments
Recognized in Income

 
              Three months ended
October 31,
 
        

Location

       2011             2010      

Foreign currency derivative contracts

  

Other income (expense)

   $ (2,977   $ (6,638
       

 

 

   

 

 

 

 

Derivatives Not Designated as Hedging

Instruments

       

Gains (Losses) on Derivative Instruments
Recognized in Income

 
              Nine months ended
October 31,
 
        

Location

       2011             2010      

Foreign currency derivative contracts

  

Other income (expense)

   $ (3,937   $ (3,308
       

 

 

   

 

 

 

Investment Income

Investment income consists of interest income, realized gains and realized losses on the Company’s cash, cash equivalents and marketable securities. The components of investment income are presented below:

 

     Three Months Ended
October 31,
    Nine Months Ended
October 31,
 

(In thousands)

   2011     2010     2011     2010  

Interest income

   $ 5,093      $ 8,447      $ 16,611      $ 21,597   

Realized gains

     601        4,333        4,374        8,986   

Realized losses

     (558     (1,081     (2,682     (2,274
  

 

 

   

 

 

   

 

 

   

 

 

 

Total investment income

   $ 5,136      $ 11,699      $ 18,303      $ 28,309   
  

 

 

   

 

 

   

 

 

   

 

 

 

 

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Comprehensive Income (Loss)

Comprehensive income (loss) consists of the following, net of tax: net income (loss), net foreign currency translation gains and losses and net change in unrealized gains and losses on marketable securities. The following table sets forth the components of comprehensive income (loss) (in thousands):

 

     Three Months Ended
October 31,
    Nine Months Ended
October 31,
 
     2011     2010     2011     2010  

Consolidated net income (loss)

   $ (3,756   $ 22,368      $ (7,494   $ 58,827   

Less: net income attributable to noncontrolling interest

     0        (1,296     0        (5,266

Translation and other adjustments

     1,666        (2,299     447        3,698   

Net change in unrealized gain (loss) on marketable securities

     (4,908     3,474        (3,189     6,762   
  

 

 

   

 

 

   

 

 

   

 

 

 

Comprehensive income (loss) attributable to salesforce.com

   $ (6,998   $ 22,247      $ (10,236   $ 64,021   
  

 

 

   

 

 

   

 

 

   

 

 

 

Earnings/Loss Per Share

Basic earnings/loss per share attributable to salesforce.com is computed by dividing net income (loss) attributable to salesforce.com by the weighted-average number of common shares outstanding for the fiscal period. Diluted earnings/loss per share attributable to salesforce.com is computed giving effect to all potential weighted average dilutive common stock, including options, restricted stock units, warrants and the convertible senior notes. The dilutive effect of outstanding awards and convertible securities is reflected in diluted earnings per share by application of the treasury stock method. Diluted earnings/loss per share for the three and nine months ended October 31, 2011 is the same as basic earnings/loss per share as there is a net loss in those periods and inclusion of potentially issuable shares would be anti-dilutive.

A reconciliation of the denominator used in the calculation of basic and diluted earnings/loss per share attributable to salesforce.com is as follows (in thousands):

 

     Three Months Ended
October 31,
     Nine Months Ended
October 31,
 
     2011     2010      2011     2010  

Numerator:

         

Net income (loss) attributable to salesforce.com

   $ (3,756   $ 21,072       $ (7,494   $ 53,561   

Denominator:

         

Weighted-average shares outstanding for basic earnings per share

     135,847        130,888         134,824        129,461   

Effect of dilutive securities:

         

Convertible senior notes

     0        1,513         0        993   

Employee stock awards

     0        4,643         0        4,553   
  

 

 

   

 

 

    

 

 

   

 

 

 

Adjusted weighted-average shares outstanding and assumed conversions for diluted earnings per share

     135,847        137,044         134,824        135,007   
  

 

 

   

 

 

    

 

 

   

 

 

 

The weighted average number of shares outstanding used in the computation of basic and diluted earnings/loss per share does not include the effect of the following potential outstanding common stock. The effects of these potentially outstanding shares were not included in the calculation of diluted earnings/loss per share because the effect would have been anti-dilutive (in thousands):

 

     Three Months Ended
October 31,
     Nine Months Ended
October 31,
 
         2011              2010              2011              2010      

Stock awards

     7,204         164         7,332         514   

Warrants

     6,736         6,736         6,736         6,736   

Convertible senior notes

     6,735         0         6,735         0   

 

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Income Taxes

The Company uses the liability method of accounting for income taxes. Under this method, deferred tax assets and liabilities are determined based on temporary differences between the financial statement and tax basis of assets and liabilities and net operating loss and credit carryforwards using enacted tax rates in effect for the year in which the differences are expected to reverse. The effect on deferred tax assets and liabilities of a change in tax rates is recognized in income in the period that includes the enactment date. Valuation allowances are established when necessary to reduce deferred tax assets to the amounts more likely than not expected to be realized.

The total income tax benefit recognized in the accompanying condensed consolidated statements of operations related to stock-based awards was $53.9 million and $28.7 million for the nine months ended October 31, 2011 and 2010, respectively.

Effective Tax Rate

The Company computes its provision for income taxes by applying the estimated annual effective tax rate to income from recurring operations and adjusts the provision for discrete tax items recorded in the period. The Company’s effective tax rate for the nine months ended October 31, 2011 was 71 percent, which was higher than the federal statutory tax rate of 35 percent. The higher tax rate was attributable to a detrimental foreign tax differential and non-deductible acquisition expenses, offset by state income taxes, Federal and California tax credits and the tax benefit from the May 2011 acquisition of Radian6 Technologies, Inc. (“Radian6”). The combined effect of these items on a small loss before income taxes was significant resulting in a high effective tax rate.

The Company’s effective tax rate of 41 percent for the nine months ended October 31, 2010 was higher than the federal statutory rate of 35 percent primarily due to state income taxes, a detrimental foreign tax rate differential, non-deductible acquisition expenses and the unfavorable impact of a change in California tax law, which was partially offset by California tax credits.

Unrecognized Tax Benefits and Other Considerations

The Company records liabilities related to its uncertain tax positions. During the three months ended July 31, 2011, as a result of the Radian6 acquisition, the Company recorded $13.1 million of unrecognized tax benefits, of which $6.6 million was recognized in the three months ended October 31, 2011 following the remeasurement of an uncertain tax position due to new information received. This item is reflected in the Company’s condensed consolidated balance sheets.

The Company’s existing tax positions will continue to generate an increase in tax liabilities or unrecognized tax benefits. The Company does not believe that it is reasonably possible that there will be a significant increase or decrease in unrecognized tax benefits over the next twelve months.

Tax positions for the Company and its subsidiaries are subject to income tax audits by multiple tax jurisdictions throughout the world. The Company does not believe that it is reasonably possible that the estimates of unrecognized tax benefits will change significantly in the next twelve months. However, an adverse resolution of one or more uncertain tax positions in any period could have a material impact on the results of operations for that period.

Revenue Recognition

The Company derives its revenues from two sources: (1) subscription revenues, which are comprised of subscription fees from customers accessing the Company’s enterprise cloud computing application service and from customers purchasing additional support beyond the standard support that is included in the basic subscription fee; and (2) related professional services such as process mapping, project management, implementation services and other revenue. “Other revenue” consists primarily of training fees.

The Company commences revenue recognition when all of the following conditions are satisfied:

 

   

There is persuasive evidence of an arrangement;

 

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The service has been or is being provided to the customer;

 

   

The collection of the fees is reasonably assured; and

 

   

The amount of fees to be paid by the customer is fixed or determinable.

The Company’s subscription service arrangements are non-cancelable and do not contain refund-type provisions.

Subscription and Support Revenues

Subscription and support revenues are recognized ratably over the contract terms beginning on the commencement date of each contract, which is the date the Company’s service is made available to customers. Amounts that have been invoiced are recorded in accounts receivable and in deferred revenue or revenue, depending on whether the revenue recognition criteria have been met.

Professional Services and Other Revenues

The majority of the Company’s professional services contracts are on a time and material basis. When these services are not combined with subscription revenues as a single unit of accounting, as discussed below, these revenues are recognized as the services are rendered for time and material contracts, and when the milestones are achieved and accepted by the customer for fixed price contracts. Training revenues are recognized as the services are performed.

Multiple-Deliverable Arrangements

The Company enters into arrangements with multiple-deliverables that generally include subscription, premium support and professional services.

Prior to February 1, 2011, the deliverables in multiple-deliverable arrangements were accounted for separately if the delivered items had standalone value and there was objective and reliable evidence of fair value for the undelivered items. If the deliverables in a multiple-deliverable arrangement could not be accounted for separately, the total arrangement fee was recognized ratably as a single unit of accounting over the contracted term of the subscription agreement. A significant portion of the Company’s multiple-deliverable arrangements were accounted for as a single unit of accounting because the Company did not have objective and reliable evidence of fair value for certain of its deliverables. Additionally, in these situations, the Company deferred the direct costs of a related professional services arrangement and amortized those costs over the same period as the professional services revenue was recognized.

In October 2009, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update No. 2009-13, “Revenue Recognition (Topic 605), Multiple-Deliverable Revenue Arrangements—a consensus of the FASB Emerging Issues Task Force” (“ASU 2009-13”) which amended the previous multiple-deliverable arrangements accounting guidance. Pursuant to the updated guidance, objective and reliable evidence of fair value of the deliverables to be delivered is no longer required in order to account for deliverables in a multiple-deliverable arrangement separately. Instead, arrangement consideration is allocated to deliverables based on their relative selling price.

In the first quarter of fiscal 2012, the Company adopted this updated accounting guidance on a prospective basis. The Company applied the new accounting guidance to those multiple-deliverable arrangements entered into or materially modified on or after February 1, 2011, which is the beginning of the Company’s fiscal year.

The adoption of this updated accounting guidance did not have a material impact on the Company’s financial condition, results of operations or cash flows. As of October 31, 2011, the deferred professional services revenue and deferred costs under the previous accounting guidance are $41.0 million and $19.3 million, respectively, which will continue to be recognized over the related remaining subscription period.

 

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Under the updated accounting guidance, in order to treat deliverables in a multiple-deliverable arrangement as separate units of accounting, the deliverables must have standalone value upon delivery. If the deliverables have standalone value upon delivery, the Company accounts for each deliverable separately. Subscription services have standalone value as such services are often sold separately. In determining whether professional services have standalone value, the Company considers the following factors for each professional services agreement: availability of the services from other vendors, the nature of the professional services, the timing of when the professional services contract was signed in comparison to the subscription service start date and the contractual dependence of the subscription service on the customer’s satisfaction with the professional services work. To date, the Company has concluded that all of the professional services included in multiple-deliverable arrangements executed have standalone value.

Under the updated accounting guidance, when multiple-deliverables included in an arrangement are separated into different units of accounting, the arrangement consideration is allocated to the identified separate units based on a relative selling price hierarchy. The Company determines the relative selling price for a deliverable based on its vendor-specific objective evidence of selling price (“VSOE”), if available, or its best estimate of selling price (“BESP”), if VSOE is not available. The Company has determined that third-party evidence of selling price (“TPE”) is not a practical alternative due to differences in its service offerings compared to other parties and the availability of relevant third-party pricing information. The amount of revenue allocated to delivered items is limited by contingent revenue.

For certain professional services, the Company has established VSOE as a consistent number of standalone sales of this deliverable have been priced within a reasonably narrow range. The Company has not established VSOE for its subscription services due to lack of pricing consistency, the introduction of new services and other factors. Accordingly, the Company uses its BESP to determine the relative selling price.

The Company determined BESP by considering its overall pricing objectives and market conditions. Significant pricing practices taken into consideration include the Company’s discounting practices, the size and volume of the Company’s transactions, the customer demographic, the geographic area where services are sold, price lists, its go-to-market strategy, historical standalone sales and contract prices. The determination of BESP is made through consultation with and approval by the Company’s management, taking into consideration the go-to-market strategy. As the Company’s go-to-market strategies evolve, the Company may modify its pricing practices in the future, which could result in changes in relative selling prices, including both VSOE and BESP.

Deferred Revenue

The deferred revenue balance does not represent the total contract value of annual or multi-year, non-cancelable subscription agreements. Deferred revenue primarily consists of billings or payments received in advance of revenue recognition from subscription services described above and is recognized as the revenue recognition criteria are met. The Company generally invoices customers in annual or quarterly installments. Deferred revenue is influenced by several factors, including seasonality, the compounding effects of renewals, invoice duration, invoice timing and new business linearity within the quarter.

Billings against professional services arrangements entered into prior to February 1, 2011 will generally be added to deferred revenue and recognized over the remaining related subscription contract term.

Deferred revenue that will be recognized during the succeeding twelve month period is recorded as current deferred revenue and the remaining portion is recorded as noncurrent.

Deferred Commissions

Deferred commissions are the incremental costs that are directly associated with non-cancelable subscription contracts with customers and consist of sales commissions paid to the Company’s direct sales force.

 

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The commissions are deferred and amortized over the non-cancelable terms of the related customer contracts, which are typically 12 to 24 months. The commission payments are paid in full the month after the customer’s service commences. The deferred commission amounts are recoverable through the future revenue streams under the non-cancelable customer contracts. The Company believes this is the preferable method of accounting as the commission charges are so closely related to the revenue from the non-cancelable customer contracts that they should be recorded as an asset and charged to expense over the same period that the subscription revenue is recognized. Amortization of deferred commissions is included in marketing and sales expense in the accompanying condensed consolidated statements of operations.

Business Combinations

Goodwill represents the excess of the purchase consideration of an acquired business over the fair value of the underlying net tangible and intangible assets acquired and liabilities assumed. While the Company uses its best estimates and assumptions to accurately assign fair value to the tangible assets and intangible assets acquired and liabilities assumed at the acquisition date, the Company’s estimates are inherently uncertain and subject to refinement. As a result, during the measurement period, which may be up to one year from the acquisition date, the Company may record adjustments to the fair value of assets acquired and liabilities assumed, with the corresponding offset to goodwill. Upon the conclusion of the measurement period or final determination of the fair value of assets acquired or liabilities assumed, whichever comes first, any subsequent adjustments are recorded to the Company’s condensed consolidated statements of operations.

In addition, uncertain tax positions and tax related valuation allowances assumed in connection with a business combination are initially estimated as of the acquisition date. The Company reevaluates these items quarterly and records any adjustments to the Company’s preliminary estimates to goodwill provided that the Company is within the measurement period and the Company continues to collect information in order to determine their estimated fair values as of the date of acquisition. Subsequent to the measurement period or the Company’s final determination of the tax allowances’ or contingencies’ estimated value, changes to these uncertain tax positions and tax related valuation allowances will affect the Company’s provision for income taxes in the Company’s condensed consolidated statements of operations.

Accounting for Stock-Based Compensation

The Company recognizes stock-based expenses on a straight-line basis over the requisite service period of the awards, which is the vesting term of four years. Stock-based expenses are recognized net of estimated forfeiture activity.

The fair value of each option grant was estimated on the date of grant using the Black-Scholes option pricing model with the following assumptions and fair value per share:

 

     Three Months Ended October 31,     Nine Months Ended October 31,  
             2011                     2010                     2011                     2010          

Volatility

     47     45-50     47-50     45-50

Estimated life

     3.7 years        3.8 years        3.7 years        3.8 years   

Risk-free interest rate

     0.68-0.79     0.98-1.08     0.68-1.77     0.98-2.11

Dividend yield

     0        0        0        0   

Weighted-average fair value per share of grants

   $ 49.89      $ 40.89      $ 57.90      $ 31.36   

The estimated life was based on an actual analysis of expected life. The risk free interest rate is based on the rate for a four-year U.S. government security at the time of the option grant.

The Company estimated its future stock price volatility considering both its observed option-implied volatilities and its historical volatility calculations. Management believes this is the best estimate of the expected volatility over the expected life of its option grants.

 

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During the three months ended October 31, 2011 and 2010, the Company capitalized $0.6 million and $0.8 million, respectively, of stock-based expenses related to capitalized internal-use software development and deferred professional services costs and capitalized $1.7 million and $2.1 million for the nine months ended October 31, 2011 and 2010, respectively.

During the nine months ended October 31, 2011, the Company recognized stock-based expense of $159.2 million. As of October 31, 2011, the aggregate stock compensation remaining to be amortized to costs and expenses was $582.3 million. The Company expects this stock compensation balance to be amortized as follows: $58.4 million during the remaining three months of fiscal 2012; $208.9 million during fiscal 2013; $179.0 million during fiscal 2014; $121.2 million during fiscal 2015 and $14.8 million during fiscal 2016. The expected amortization reflects only outstanding stock awards as of October 31, 2011 and assumes no forfeiture activity. The Company expects to continue to issue stock-based awards to its employees in future periods.

Goodwill, Intangible Assets and Impairment Assessments

Goodwill represents the excess of the purchase price of an acquired business over the fair value of the underlying net tangible and intangible assets. Goodwill is tested for impairment at least annually during the fourth quarter (more frequently if certain indicators are present). In the event that the Company determines that the carrying value of goodwill is less than fair value, the Company will incur an impairment charge for the amount of the difference during the quarter in which the determination is made.

Intangible assets are amortized over their useful lives. Each period the Company evaluates the estimated remaining useful life of its intangible assets and whether events or changes in circumstances warrant a revision to the remaining period of amortization. The carrying amounts of these assets are periodically reviewed for impairment whenever events or changes in circumstances indicate that the carrying value of these assets may not be recoverable. Recoverability of these assets is measured by comparison of the carrying amount of each asset to the future undiscounted cash flows the asset is expected to generate. In the event that the Company determines certain assets are not fully recoverable, the Company will incur an impairment charge for those assets or portion thereof during the quarter in which the determination is made.

Warranties and Indemnification

The Company’s enterprise cloud computing application service is typically warranted to perform in a manner consistent with general industry standards that are reasonably applicable and materially in accordance with the Company’s online help documentation under normal use and circumstances.

The Company’s arrangements generally include certain provisions for indemnifying customers against liabilities if its products or services infringe a third-party’s intellectual property rights. To date, the Company has not incurred any material costs as a result of such obligations and has not accrued any liabilities related to such obligations in the accompanying condensed consolidated financial statements.

The Company has also agreed to indemnify its directors and executive officers for costs associated with any fees, expenses, judgments, fines and settlement amounts incurred by any of these persons in any action or proceeding to which any of those persons is, or is threatened to be, made a party by reason of the person’s service as a director or officer, including any action by the Company, arising out of that person’s services as the Company’s director or officer or that person’s services provided to any other company or enterprise at the Company’s request. The Company maintains director and officer insurance coverage that would generally enable the Company to recover a portion of any future amounts paid. The Company may also be subject to indemnification obligations by law with respect to the actions of its employees under certain circumstances and in certain jurisdictions.

 

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Subsequent Events

The Company evaluated subsequent events through the date this Quarterly Report on Form 10-Q was filed with the SEC.

On November 14, 2011 the Company entered into a definitive agreement to acquire Model Metrics, Inc. (“Model Metrics”), a privately-held mobile and social cloud consulting services company, for an estimated purchase consideration of approximately $57.6 million in cash, net of cash acquired. This transaction is expected to close in this fiscal fourth quarter, subject to customary closing conditions.

New Accounting Pronouncements

In December 2010, the FASB issued Accounting Standards Update No. 2010-29, Disclosure of Supplementary Pro Forma Information for Business Combinations (Topic 805)Business Combinations (“ASU 2010-29”), to improve consistency in how the pro forma disclosures are calculated. Additionally, ASU 2010-29 enhances the disclosure requirements and requires description of the nature and amount of any material, nonrecurring pro forma adjustments directly attributable to a business combination. ASU 2010-29 is effective for the Company in fiscal 2013 and should be applied prospectively to business combinations for which the acquisition date is after the effective date. The Company does not believe the impact of the pending adoption of ASU 2010-29 will have a significant effect on the consolidated financial statements.

In June 2011, the FASB issued Accounting Standards Update No. 2011-05, Comprehensive Income (Topic 220)—Presentation of Comprehensive Income (“ASU 2011-05”), to require an entity to present the total of comprehensive income, the components of net income, and the components of other comprehensive income either in a single continuous statement of comprehensive income or in two separate but consecutive statements. ASU 2011-05 eliminates the option to present the components of other comprehensive income as part of the statement of equity. ASU 2011-05 is effective for the Company in fiscal 2013 and should be applied retrospectively. The Company is currently evaluating the impact of the pending adoption of ASU 2011-05 on the consolidated financial statements.

2. Balance Sheet Accounts

Marketable Securities

At October 31, 2011, marketable securities consisted of the following (in thousands):

 

Investments classified as Marketable Securities

   Amortized
Cost
     Unrealized
Gains
     Unrealized
Losses
    Fair Value  

Corporate notes and obligations

   $ 516,341       $ 4,521       $ (2,136   $ 518,726   

U.S. treasury securities

     46,530         68         (18     46,580   

Mortgage backed securities

     26,511         673         (199     26,985   

Government obligations

     6,320         242         0        6,562   

Municipal securities

     14,726         106         (29     14,803   

Collateralized mortgage obligations

     101,588         1,544         (572     102,560   

U.S. agency obligations

     77,214         281         (5     77,490   
  

 

 

    

 

 

    

 

 

   

 

 

 
   $ 789,230       $ 7,435       $ (2,959   $ 793,706   
  

 

 

    

 

 

    

 

 

   

 

 

 

 

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At January 31, 2011, marketable securities consisted of the following (in thousands):

 

Investments classified as Marketable Securities

   Amortized
Cost
     Unrealized
Gains
     Unrealized
Losses
    Fair Value  

Corporate notes and obligations

   $ 701,047       $ 7,356       $ (790 )   $ 707,613   

U.S. treasury securities

     22,631         85         (10 )     22,706   

Mortgage backed securities

     38,348         656         (118 )     38,886   

Government obligations

     6,414         118         0        6,532   

Municipal securities

     23,121         79         (119 )     23,081   

Collateralized mortgage obligations

     104,285         1,098         (344 )     105,039   

U.S. agency obligations

     79,242         190         (24 )     79,408   
  

 

 

    

 

 

    

 

 

   

 

 

 
   $ 975,088       $ 9,582       $ (1,405 )   $ 983,265   
  

 

 

    

 

 

    

 

 

   

 

 

 

The duration of the investments classified as marketable securities is as follows (in thousands):

 

     October 31,
2011
     January 31,
2011
 

Recorded as follows:

     

Short-term (due in one year or less)

   $ 142,861       $ 72,678   

Long-term (due between one and 3 years)

     650,845         910,587   
  

 

 

    

 

 

 
   $ 793,706       $ 983,265   
  

 

 

    

 

 

 

As of October 31, 2011, the following marketable securities were in an unrealized loss position (in thousands):

 

     Less than 12 Months     12 Months or Greater     Total  
     Fair Value      Unrealized
Losses
    Fair Value      Unrealized
Losses
    Fair Value      Unrealized
Losses
 

Corporate notes and obligations

   $ 172,329       $ (2,126   $ 4,717       $ (10   $ 177,046       $ (2,136

U.S. treasury securities

     29,986         (18     0         0        29,986         (18

Mortgage backed securities

     2,397         (112     5,800         (87     8,197         (199

Municipal securities

     589         (1     1,673         (28     2,262         (29

Collateralized mortgage obligations

     32,408         (253     9,391         (319     41,799         (572

U.S. agency obligations

     7,171         (5     0         0        7,171         (5
  

 

 

    

 

 

   

 

 

    

 

 

   

 

 

    

 

 

 
   $ 244,880       $ (2,515   $ 21,581       $ (444   $ 266,461       $ (2,959
  

 

 

    

 

 

   

 

 

    

 

 

   

 

 

    

 

 

 

The unrealized loss for each of these fixed rate marketable securities ranged from less than $1,000 to $231,000. The Company does not believe any of the unrealized losses represent an other-than-temporary impairment based on its evaluation of available evidence as of October 31, 2011. The Company expects to receive the full principal and interest on all of these marketable securities.

Prepaid Expenses and Other Current Assets

Prepaid expenses and other current assets consisted of the following (in thousands):

 

     October 31,
2011
     January 31,
2011
 

Deferred professional services costs

   $ 13,563       $ 17,908   

Prepaid income taxes

     13,137         720   

Prepaid expenses and other current assets

     52,728         37,093   
  

 

 

    

 

 

 
   $ 79,428       $ 55,721   
  

 

 

    

 

 

 

 

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Table of Contents

Property and Equipment, net

Property and equipment consisted of the following (in thousands):

 

     October 31,
2011
    January 31,
2011
 

Land

   $ 248,263      $ 248,263   

Building improvements

     34,974        10,115   

Computers, equipment and software

     223,288        115,736   

Furniture and fixtures

     24,622        20,462   

Leasehold improvements

     125,838        100,380   
  

 

 

   

 

 

 
     656,985        494,956   

Less accumulated depreciation and amortization

     (152,158     (107,782
  

 

 

   

 

 

 
   $ 504,827      $ 387,174   
  

 

 

   

 

 

 

Depreciation and amortization expense totaled $17.9 million and $11.0 million for the three months ended October 31, 2011 and 2010, respectively, and $49.4 million and $28.9 million for the nine months ended October 31, 2011 and 2010, respectively.

Computers, equipment and software at October 31, 2011 and January 31, 2011 included a total of $107.2 million and $38.8 million acquired under capital lease agreements, respectively. Accumulated amortization relating to computers, equipment and software under capital lease agreements totaled $32.6 million and $18.5 million, respectively, at October 31, 2011 and January 31, 2011. Amortization of assets under capital lease agreements is included in depreciation and amortization expense.

Capitalized Interest Cost

Interest costs related to construction projects, specifically the Company’s development of its global headquarters (“campus project”), and capitalized internal-use software development costs, are capitalized until the underlying asset is placed into service. Capitalized interest is calculated by multiplying the effective interest rate of the convertible senior notes by the qualifying costs. When the qualifying asset is placed into service, the qualifying asset and the related capitalized interest are amortized over the useful life of the related asset. Interest costs related to the buildings and improvements of $4.1 million and $0 were capitalized during the three months ended October 31, 2011 and 2010, respectively, and $11.8 million and $0 were capitalized during the nine months ended October 31, 2011 and 2010, respectively. Interest costs related to the Company’s capitalized internal-use software development efforts of $0.1 million and $0 were capitalized during the three months ended October 31, 2011 and 2010, respectively, and $0.3 million and $0 were capitalized during the nine months ended October 31, 2011 and 2010, respectively.

Capitalized Software

Capitalized software consisted of the following (in thousands):

 

     October 31,
2011
     January 31,
2011
 

Capitalized internal-use software development costs, net of accumulated amortization of $46,008 and $34,513, respectively

   $ 35,475       $ 29,154   

Acquired developed technology, net of accumulated amortization of $82,157 and $37,818, respectively

     163,938         98,833   
  

 

 

    

 

 

 
   $ 199,413       $ 127,987   
  

 

 

    

 

 

 

 

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Capitalized internal-use software amortization expense totaled $4.0 million and $3.3 million for the three months ended October 31, 2011 and 2010, respectively. Acquired developed technology amortization expense totaled $17.4 million and $4.9 million for the three months ended October 31, 2011 and 2010, respectively. Capitalized internal-use software amortization expense totaled $11.5 million and $9.5 million for the nine months ended October 31, 2011 and 2010, respectively. Acquired developed technology amortization expense totaled $44.3 million and $10.4 million for the nine months ended October 31, 2011 and 2010, respectively.

As described in Note 4 “Business Combinations” the Company acquired Radian6 in May 2011. Approximately $84.2 million of the purchase consideration was allocated to acquired developed technology.

Other Assets, net

Other assets consisted of the following (in thousands):

 

     October 31,
2011
     January 31,
2011
 

Deferred professional services costs, noncurrent portion

   $ 5,707       $ 10,201   

Long-term deposits

     13,887         12,114   

Purchased intangible assets, net of accumulated amortization of $15,117 and $9,868, respectively

     45,410         31,660   

Aquired intellectual property, net of accumulated amortization of $2,300 and $746, respectively.

     13,895         5,874   

Strategic investments

     55,035         27,065   

Other

     22,484         17,457   
  

 

 

    

 

 

 
   $ 156,418       $ 104,371   
  

 

 

    

 

 

 

As described in Note 4 “Business Combinations” the Company acquired Radian6 in May 2011. Approximately $18.8 million of the purchase consideration was allocated to purchased intangible assets.

Purchased intangible assets amortization expense for the three months ended October 31, 2011 and 2010, was $1.7 million and $1.0 million, respectively, and for the nine months ended October 31, 2011 and 2010, was $5.2 million and $3.0 million, respectively.

Goodwill

Goodwill represents the excess of the purchase price in a business combination over the fair value of net tangible and intangible assets acquired. Goodwill amounts are not amortized, but rather tested for impairment at least annually during the fourth quarter. There was no impairment of goodwill for the nine months ended October 31, 2011.

Goodwill consisted of the following (in thousands):

 

Balance as of January 31, 2011

   $  396,081   

Manymoon Corporation

     10,493   

Radian6 Technologies, Inc.

     262,637   

Assistly, Inc.

     47,205   

Other acquisitions and adjustments

     15,646   
  

 

 

 

Balance as of October 31, 2011

   $ 732,062   
  

 

 

 

 

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Accrued Expenses and Other Current Liabilities

Accrued expenses and other current liabilities consisted of the following (in thousands):

 

     October 31,
2011
     January 31,
2011
 

Accrued compensation

   $ 145,116       $ 148,275   

Accrued other liabilities

     134,741         112,840   

Accrued income and other taxes payable

     78,819         49,135   

Accrued professional costs

     22,836         12,548   

Accrued rent

     27,638         22,323   
  

 

 

    

 

 

 
   $ 409,150       $ 345,121   
  

 

 

    

 

 

 

Convertible Senior Notes

In January 2010, the Company issued at par value $575.0 million of 0.75% convertible senior notes (“the Notes”) due January 15, 2015. Interest is payable semi-annually in arrears on January 15 and July 15 of each year, which commenced July 15, 2010.

The Notes are governed by an Indenture dated as of January 19, 2010, between the Company, as issuer, and U.S. Bank National Association, as trustee. The Notes do not contain any financial covenants or any restrictions on the payment of dividends, the incurrence of senior debt or other indebtedness, or the issuance or repurchase of securities by the Company. The Notes are unsecured and rank senior in right of payment to the Company’s future indebtedness that is expressly subordinated in right of payment to the Notes and rank equal in right of payment to the Company’s existing and future unsecured indebtedness that is not so subordinated and are effectively subordinated in right of payment to any of the Company’s cash equal to the principal amount of the Notes, and secured indebtedness to the extent of the value of the assets securing such indebtedness and are structurally subordinated to all existing and future indebtedness and liabilities incurred by the Company’s subsidiaries, including trade payables.

If converted, holders will receive cash equal to the principal amount of the Notes, and at the Company’s election, cash and/or shares of the Company’s common stock for any amounts in excess of the principal amounts.

The initial conversion rate is 11.7147 shares of common stock per $1,000 principal amount of Notes, subject to anti-dilution adjustments. The initial conversion price is $85.36 per share of common stock. Throughout the term of the Notes, the conversion rate may be adjusted upon the occurrence of certain events, including for any cash dividends. Holders of the Notes will not receive any cash payment representing accrued and unpaid interest upon conversion of a Note. Accrued but unpaid interest will be deemed to be paid in full upon conversion rather than cancelled, extinguished or forfeited. Holders may convert their Notes under the following circumstances:

 

   

during any fiscal quarter, if, for at least 20 trading days during the 30 consecutive trading day period ending on the last trading day of the immediately preceding fiscal quarter, the last reported sales price of the Company’s common stock for such trading day is greater than or equal to 130 percent of the applicable conversion price on such trading day share of common stock on such last trading day;

 

   

in certain situations, when the trading price of the Notes is less than 98 percent of the product of the sale price of the Company’s common stock and the conversion rate;

 

   

upon the occurrence of specified corporate transactions described under the Notes Indenture, such as a consolidation, merger or binding share exchange; or

 

   

at any time on or after October 15, 2014.

During the fiscal quarter ended July 31, 2011, the closing stock price conversion right was triggered therefore the Notes were convertible at the option of the holder up to 6.7 million of the Company’s common shares for the Company’s entire third fiscal quarter. As of October 31, 2011 the Notes are classified as a current

 

23


Table of Contents

liability on the Company’s condensed consolidated balance sheet. Additionally, a portion of the equity component of the Notes attributable to the conversion feature of the Notes is classified in temporary stockholders’ equity equal to the difference between the principal amount and carrying value of the Notes. The closing stock price conversion right also was triggered during the fiscal quarter ended October 31, 2011, therefore the liability and equity components of the Notes will remain classified as current and temporary, respectively, for the quarter ended January 31, 2012.

Holders of the Notes have the right to require the Company to purchase with cash all or a portion of the Notes upon the occurrence of a fundamental change, such as a change of control at a purchase price equal to 100 percent of the principal amount of the Notes plus accrued and unpaid interest. Following certain corporate transactions that constitute a change of control, the Company will increase the conversion rate for a holder who elects to convert the Notes in connection with such change of control in certain circumstances.

In accounting for the issuance of the Notes, the Company separated the Notes into liability and equity components. The carrying amount of the liability component was calculated by measuring the fair value of a similar liability that does not have an associated convertible feature. The carrying amount of the equity component representing the conversion option was determined by deducting the fair value of the liability component from the par value of the Notes as a whole. The excess of the principal amount of the liability component over its carrying amount is amortized to interest expense over the term of the Note. The equity component is not re-measured as long as it continues to meet the conditions for equity classification.

In accounting for the transaction costs related to the Note issuance, the Company allocated the total amount incurred to the liability and equity components based on their relative values. Transaction costs attributable to the liability component are being amortized to expense over the term of the Notes, and transaction costs attributable to the equity component were netted with the equity components in temporary stockholders’ equity and stockholders’ equity. Additionally, the Company initially recorded a deferred tax liability of $51.1 million in connection with the Notes.

The Notes consisted of the following (in thousands):

 

     October 31,
2011
    January 31,
2011
 

Liability component :

    

Principal

   $ 574,890      $ 575,000   

Less: debt discount, net (1)

     (84,771     (102,462
  

 

 

   

 

 

 

Net carrying amount

   $ 490,119      $ 472,538   
  

 

 

   

 

 

 

 

(1) Included in the condensed consolidated balance sheets within convertible senior notes and is amortized over the remaining life of the Notes using the effective interest rate method.

As of October 31, 2011, the remaining contractual life of the Notes is approximately 3.3 years.

The following table sets forth total interest expense recognized related to the Notes prior to capitalization of interest (in thousands):

 

     Three months ended
October 31,
    Nine months ended
October 31,
 
     2011     2010     2011     2010  

Contractual interest expense

   $ 1,078      $ 1,078      $ 3,234      $ 3,234   

Amortization of debt issuance costs

     331        331        992        990   

Amortization of debt discount

     6,000        5,665        17,690        16,649   
  

 

 

   

 

 

   

 

 

   

 

 

 
   $ 7,409      $ 7,074      $ 21,916      $ 20,873   
  

 

 

   

 

 

   

 

 

   

 

 

 

Effective interest rate of the liability component

     5.86 %     5.86 %     5.86 %     5.86 %

 

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Table of Contents

Note Hedges

To minimize the impact of potential economic dilution upon conversion of the Notes, the Company entered into convertible note hedge transactions with respect to its common stock (the “Note Hedges”). The Company paid, in January 2010, an aggregate amount of $126.5 million for the Note Hedges. The Note Hedges cover approximately 6.7 million shares of the Company’s common stock at a strike price that corresponds to the initial conversion price of the Notes, also subject to adjustment, and are exercisable upon conversion of the Notes. The Note Hedges will expire upon the maturity of the Notes. The Note Hedges are intended to reduce the potential economic dilution upon conversion of the Notes in the event that the market value per share of the Company’s common stock, as measured under the Notes, at the time of exercise is greater than the conversion price of the Notes. The Note Hedges are separate transactions and are not part of the terms of the Notes. Holders of the Notes will not have any rights with respect to the Note Hedges. The Company initially recorded a deferred tax asset of $51.4 million in connection with these Note Hedges.

Warrants

Separately, the Company in January 2010 also entered into warrant transactions (the “Warrants”), whereby the Company sold warrants to acquire, subject to anti-dilution adjustments, up to 6.7 million shares of the Company’s common stock at a strike price of $119.51 per share. The Company received aggregate proceeds of $59.2 million from the sale of the Warrants. As the weighted average market value per share of the Company’s common stock for the three and nine months ended October 31, 2011 exceeds the strike price of the Warrants, the Warrants would have had a dilutive effect on the Company’s earnings/loss per share for the three and nine months ended October 31, 2011. The Warrants were anti-dilutive for the three and nine months ended October 31, 2011 based on the Company’s net loss for the three and nine months ended October 31, 2011. The Warrants are separate transactions, entered into by the Company and are not part of the terms of the Notes or Note Hedges. Holders of the Notes and Note Hedges will not have any rights with respect to the Warrants.

3. Stockholders’ Equity

Stock Options Issued to Employees

The Company maintains the following stock plans: the 2004 Equity Incentive Plan, 2004 Employee Stock Purchase Plan and the 2004 Outside Directors Stock Plan. These plans, other than the 2004 Outside Directors Stock Plan, provide for annual automatic increases on February 1 to the shares reserved for issuance. The expiration of the 1999 Stock Option Plan in fiscal 2010 did not affect awards outstanding, which continue to be governed by the terms and conditions of the 1999 Stock Option Plan.

On February 1, 2011, 3.5 million additional shares were reserved under the 2004 Equity Incentive Plan pursuant to the automatic increase.

On May 2, 2011, as part of the share purchase agreement entered into with Radian6, the Company assumed Radian6’s existing stock option plan and all unvested options thereunder, which converted into options to purchase 239,519 shares of the Company’s common stock after giving effect to the closing of the Radian6 transaction.

On September 20, 2011, as part of the share purchase agreement entered into with Assistly, the Company assumed Assistly’s existing stock option plan and all unvested options thereunder, which converted into options to purchase 49,379 shares of the Company’s common stock after giving effect to the closing of the Assistly transaction.

In September 2011, the Company’s Board of Directors amended and restated the 2004 Employee Stock Purchase Plan (the “ESPP”). Initially, the ESPP was established in 2004, but the Company’s Board of Directors authorization was required for the commencement of one or more offerings. In conjunction with the amendment of the ESPP, the Company’s Board of Directors determined that the offerings under the ESPP would commence, beginning with a twelve month offering period starting in December 2011. As of October 31, 2011, the Company has 1,000,000 shares of its common stock reserved for future issuance under this plan.

 

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Table of Contents

In April 2006, the Company’s Board of Directors approved the 2006 Inducement Equity Incentive Plan (the “Inducement Plan”) that allows for stock option and other equity incentive grants to employees in connection with merger or acquisition activity. In September 2011, the Company’s Board of Directors amended and restated the Inducement Plan to increase the number of shares of its common stock reserved for issuance under the plan by an additional 400,000 shares.

Prior to February 1, 2006, options issued under the Company’s stock option plans generally had a term of 10 years. After February 1, 2006, options issued have a term of five years.

Stock activity is as follows:

 

     Shares
Available
for Grant
    Options Outstanding  
       Outstanding
Stock
Options
    Weighted-
Average
Exercise Price
     Aggregate
Intrinsic Value
(in thousands)
 

Balance as of January 31, 2011

     4,095,460        11,783,159      $ 65.35      

Increase in shares authorized:

         

2004 Equity Incentive Plan

     3,500,000        0        0.00      

2006 Equity Inducement Plan

     400,000        0        0.00      

Radian6 Technologies Inc. Stock Option Plan

     239,519        0        0.00      

Assistly Option Plan

     49,379        0        0.00      

Options granted under all plans

     (1,239,742     1,239,742        118.46      

Restricted stock activity

     (683,447     0        0.00      

Stock grants to board and advisory board members

     (32,575     0        0.00      

Exercised

     0        (2,097,476     43.08      

1999 Plan shares expired

     (49,733     0        0.00      

Cancelled

     569,874        (569,874     89.42      
  

 

 

   

 

 

   

 

 

    

Balance as of October 31, 2011

     6,848,735        10,355,551      $ 74.90       $ 630,921   
  

 

 

   

 

 

   

 

 

    

 

 

 

Vested or expected to vest

       10,053,987      $ 73.92       $ 621,713   
    

 

 

   

 

 

    

 

 

 

Exercisable as of October 31, 2011

       4,188,956      $ 39.92       $ 390,617   
    

 

 

   

 

 

    

 

 

 

The total intrinsic value of the options exercised during the nine months ended October 31, 2011 and 2010 was $198.0 million and $222.9 million, respectively. The intrinsic value is the difference between the current market value of the stock and the exercise price of the stock option.

The weighted-average remaining contractual life of vested and expected to vest options is approximately 3 years.

As of October 31, 2011, options to purchase 4,188,956 shares were vested at a weighted average exercise price of $39.92 per share and a remaining weighted-average remaining contractual life of approximately 2.1 years. The total intrinsic value of these vested options as of October 31, 2011 was $390.6 million.

 

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Table of Contents

The following table summarizes information about stock options outstanding as of October 31, 2011:

 

     Options Outstanding      Options Exercisable  

Range of Exercise

Prices

   Number
Outstanding
     Weighted-
Average
Remaining
Contractual Life
(Years)
     Weighted-
Average
Exercise
Price
     Number of
Shares
     Weighted-
Average
Exercise
Price
 

$1.10 to $25.19

     1,019,400         3.3       $ 10.63         858,222       $ 10.56   

$25.97

     1,748,760         2.1         25.97         1,004,324         25.97   

$27.40 to $52.76

     1,601,575         1.4         48.07         1,304,213         48.40   

$54.22 to $65.41

     264,435         2.1         59.30         154,438         59.53   

$65.44

     1,885,639         3.0         65.44         646,232         65.44   

$65.68 to $140.28

     1,367,887         4.1         108.93         221,527         78.93   

$142.50 to $151.75

     2,467,855         4.1         143.57         0         0   
  

 

 

          

 

 

    
     10,355,551         3.0       $ 74.90         4,188,956       $ 39.92   
  

 

 

          

 

 

    

Restricted stock activity is as follows:

 

     Restricted Stock Outstanding  
     Outstanding     Weighted-
Average
Exercise Price
     Aggregate
Intrinsic
Value
(in thousands)
 

Balance as of January 31, 2011

     3,216,103      $ 0.001      

Granted

     918,621        0.001      

Cancelled

     (202,599     0.001      

Vested and converted to shares

     (634,499     0.001      
  

 

 

   

 

 

    

Balance as of October 31, 2011

     3,297,626      $ 0.001       $ 439,145   
  

 

 

   

 

 

    

 

 

 

Expected to vest

     3,111,692         $ 414,384   
  

 

 

      

 

 

 

The restricted stock, which upon vesting entitles the holder to one share of common stock for each share of restricted stock, has an exercise price of $0.001 per share, which is equal to the par value of the Company’s common stock, and generally vests over four years.

The weighted-average fair value of the restricted stock issued for the nine months ended October 31, 2011 and 2010 was $135.19 and $87.37, respectively.

Common Stock

The following numbers of shares of common stock were reserved and available for future issuance at October 31, 2011:

 

Options outstanding

     10,355,551   

Restricted stock awards and units outstanding

     3,297,626   

Stock available for future grant:

  

2004 Equity Incentive Plan

     5,739,066   

2006 Inducement Equity Incentive Plan

     529,069   

2004 Employee Stock Purchase Plan

     1,000,000   

2004 Outside Directors Stock Plan

     580,600   

0.75% Convertible senior notes

     6,734,664   

Warrants

     6,735,953   
  

 

 

 
     34,972,529   
  

 

 

 

 

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Table of Contents

4. Business Combinations

Radian6 Technologies Inc.

In May 2011, the Company acquired the outstanding stock of Radian6 for cash and the Company’s common stock. Radian6 is a cloud application vendor based in Canada that provides customers with social media monitoring, measurement and engagement solutions. The Company acquired Radian6 to, among other things, expand its social enterprise market opportunities. The Company has included the financial results of Radian6 in the condensed consolidated financial statements from the date of acquisition, which have not been material to date. The total consideration for Radian6 was approximately $336.6 million, of which $282.6 million was cash, $49.3 million in shares of the Company’s common stock and $4.7 million for the fair value of stock options of Radian6 assumed by the Company. The value of the share consideration for the Company’s common stock was based on the closing price of $136.19 on the day of the acquisition. The fair value of the stock options assumed by the Company was determined using the Black-Scholes option pricing model and the share conversion ratio of 0.196 Radian6 options to the Company’s options.

The excess of purchase consideration over the fair value of net tangible and identifiable intangible assets acquired was recorded as goodwill. The fair values assigned to tangible and identifiable intangible assets acquired and liabilities assumed are based on management’s estimates and assumptions. The estimated fair values of assets acquired and liabilities assumed are considered preliminary and are based on the information that was available as of the date of the acquisition. The Company believes that the information provides a reasonable basis for assigning the fair values of assets acquired and liabilities assumed, but it is waiting for additional information, primarily related to noncurrent income taxes payable and deferred taxes which are subject to change, pending the finalization of certain tax returns. Thus the provisional measurements of fair value set forth below are subject to change. The Company expects to finalize the valuation as soon as practicable, but not later than one-year from the acquisition date. The following table summarizes the consideration transferred to acquire Radian6 and the assets acquired and liabilities assumed as of the date of acquisition:

 

(in thousands)

      

Tangible assets

   $ 11,754   

Current and noncurrent liabilities

     (12,757 )

Deferred revenue

     (680 )

Deferred tax liability

     (27,306 )

Intangible assets

     103,000   

Goodwill

     262,637   
  

 

 

 

Total purchase price

   $ 336,648   
  

 

 

 

The following table sets forth the components of identifiable intangible assets acquired and their estimated useful lives as of the date of acquisition:

 

(in thousands)

   Fair value      Useful Life  

Developed technology

   $ 84,200         3 years   

Customer relationships

     15,000         5 years   

Trade name and trademark

     3,800         3 years   
  

 

 

    

Total intangible assets subject to amortization

   $ 103,000      
  

 

 

    

Developed technology represents the fair value of the Radian6 monitoring technology. Customer relationships represent the fair values of the underlying relationships and agreements with Radian6 customers. Trade name and trademark represents the fair value of brand and name recognition associated with the marketing of Radian6 service offerings. The goodwill balance is primarily attributed to the assembled workforce, expected synergies and expanded market opportunities when integrating Radian6’s social solution media technology with the Company’s current product offerings. The goodwill balance is deductible for tax purposes.

 

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The Company assumed unvested options with a fair value of $23.9 million. Of the total consideration, $4.7 million was allocated to the purchase consideration and $19.2 million was allocated to future services and will be expensed over the remaining service periods on a straight-line basis.

Assistly, Inc.

On September 20, 2011, the Company acquired for cash the outstanding stock of Assistly, a cloud provider of customer service solutions. The Company acquired Assistly to, among other things, extend its commitment to small and emerging businesses in customer service help desk application offerings. The Company has included the financial results of Assistly in the condensed consolidated financial statements from the date of acquisition, which have not been material to date. The total consideration for Assistly was approximately $58.7 million, of which $53.9 million was cash, $1.1 million for the fair value of stock options assumed by the Company and $3.7 million for the fair value of the Company’s previously held noncontrolling interest in Assistly. The fair value of the stock options assumed by the Company was determined using the Black-Scholes option pricing model and the share conversion ratio of 0.031 Assistly options to the Company’s options.

The Company had a $1.0 million, or approximately seven percent, noncontrolling equity investment in Assistly prior to the acquisition. The acquisition date fair value of the Company’s previous equity interest was $3.7 million and is included in the measurement of the consideration transferred. The Company recognized a gain of $2.7 million as a result of remeasuring its prior equity interest in Assistly held before the business combination. The gain has been recognized in Other income (expense) on the condensed consolidated statement of operations.

The excess of purchase consideration over the fair value of net tangible and identifiable intangible assets acquired was recorded as goodwill. The fair values assigned to tangible and identifiable intangible assets acquired and liabilities assumed are based on management’s estimates and assumptions. The estimated fair values of assets acquired and liabilities assumed are considered preliminary and are based on the information that was available as of the date of the acquisition. The Company believes that the information provides a reasonable basis for estimating the fair values of assets acquired and liabilities assumed, but it is waiting for additional information, primarily related to estimated values of certain intangible assets, current and noncurrent income taxes payable and deferred taxes which are subject to change, pending the finalization of certain tax returns. Thus the provisional measurements of fair value set forth below are subject to change. The Company expects to finalize the valuation of the net tangible and intangible assets as soon as practicable, but not later than one-year from the acquisition date.

 

(in thousands)

      

Net tangible assets

   $ 1,576   

Deferred tax liability

     (2,606

Developed technology

     12,500   

Goodwill

     47,205   
  

 

 

 

Total purchase price

   $ 58,675   
  

 

 

 

Developed technology represents the estimated fair value of Assistly’s customer service solution technology. The Company determined the useful life of the developed technology to be three years. The goodwill balance is primarily attributed to the assembled workforce and expanded market opportunities for small and emerging businesses when integrating Assistly’s customer service technology with the Company’s other product offerings. The goodwill balance is not deductible for tax purposes.

The Company assumed unvested options with a fair value of $5.1 million. Of the total consideration, $1.1 million was allocated to the purchase consideration and $4.0 million was allocated to future services and will be expensed over the remaining service periods on a straight-line basis.

 

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Other Business Combinations

On February 1, 2011 the Company acquired the stock of Manymoon Corporation (“Manymoon”) for $13.6 million in cash. The Company accounted for this transaction as a business combination. In allocating the purchase price based on estimated fair values, the Company preliminarily recorded $4.7 million of acquired intangible assets with useful lives of one to three years, $10.5 million of goodwill, and $1.6 million of deferred tax liabilities. The goodwill balance is not deductible for tax purposes. This transaction is not material to the Company.

Additionally, during the nine months ended October 31, 2011, the Company acquired multiple companies for $21.2 million in cash and has included the financial results of these companies in its condensed consolidated financial statements from the date of each respective acquisition. These transactions, individually or in aggregate, are not material to the Company.

Fiscal year 2011

Jigsaw Data Corporation

On May 7, 2010 the Company acquired for cash the stock of Jigsaw Data Corporation (“Jigsaw”), a cloud provider of crowd-sourced data services. The Company acquired Jigsaw to, among other things, combine the Company’s CRM applications and enterprise cloud platform with Jigsaw’s cloud-based model for the automation of acquiring, completing and cleansing business contact data. The Company has included the financial results of Jigsaw in the condensed consolidated financial statements from the date of acquisition.

The total cash consideration for Jigsaw was approximately $148.5 million. In addition, the Company made additional payments (“contingent consideration”) of $14.4 million in cash, based on the achievement of certain billings targets related to Jigsaw’s services for the one-year period ended May 7, 2011. The estimated fair value using a discounted cash flow model of the contingent consideration at May 7, 2010 was $13.4 million and is included in the total purchase price. The Company recorded and paid the full amount of the contingent consideration during the fiscal quarter ended July 31, 2011 based on Jigsaw’s achievement of meeting its billing targets as it relates to the contingent consideration. The total purchase price and the fair value of the contingent consideration were allocated to the net tangible and intangible assets and liabilities based upon their fair values as of the acquisition date. In the final purchase price allocation which was based on fair values, the Company recorded approximately $133.9 million of goodwill, $28.1 million of identifiable intangible assets, $4.4 million of deferred tax liabilities and $4.3 million of net tangible assets.

Heroku, Inc.

On January 3, 2011 the Company acquired for cash the stock of Heroku, Inc. (“Heroku”), a platform-as-a-service cloud vendor, built to work in an open environment and take advantage of the Ruby language. Ruby has become one of the leading development languages used for applications that are social and collaborative and that deliver real-time access to information across mobile devices. The Company acquired Heroku to, among other things, access a large community of developers and independent software vendors (“ISVs”) who are building applications in the cloud. The Company has included the financial results of Heroku in the condensed consolidated financial statements from the date of acquisition.

The total cash consideration for Heroku was approximately $216.7 million. The total preliminary purchase price was allocated to the net tangible and intangible assets and liabilities based upon their fair values as of the acquisition date. In allocating the purchase price based on estimated fair values, the Company preliminarily recorded approximately $181.5 million of goodwill, $40.1 million of identifiable intangible assets, $10.1 million of deferred tax liabilities and $5.2 million of net tangible assets. The preliminary allocation of the purchase price was based upon a preliminary valuation. The Company’s estimates and assumptions are subject to change within the measurement period of one year from the acquisition date. The primary areas of the preliminary purchase price allocation that are not yet finalized relate to both current and noncurrent deferred taxes which are subject to change, pending the finalization of certain tax returns. The Company expects to continue to obtain information to finalize these preliminary valuations during the measurement period.

 

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DimDim, Inc.

On January 6, 2011 the Company acquired for cash the stock of DimDim, Inc. (“DimDim”), a provider of online meeting solutions for business collaboration. The Company acquired DimDim to, among other things, expand its market leadership opportunities when integrating DimDim’s online meeting solution technology with the Company’s collaboration cloud offering. The Company has included the financial results of DimDim in the condensed consolidated financial statements from the date of acquisition.

The total cash consideration for DimDim was approximately $37.1 million. The total preliminary purchase price was allocated to the net tangible and intangible assets and liabilities based upon their fair values as of acquisition date. In allocating the purchase price which was based on estimated fair values, the Company preliminarily recorded approximately $23.4 million of goodwill, $14.4 million of identifiable intangible assets, $2.6 million of deferred tax liabilities and $1.9 million of net tangible assets. The preliminary allocation of the purchase price was based upon a preliminary valuation. The Company’s estimates and assumptions are subject to change within the measurement period of one year from the acquisition date. The primary areas of the preliminary purchase price allocation that are not yet finalized relate to both current and noncurrent deferred taxes which are subject to change, pending the finalization of certain tax returns. The Company expects to continue to obtain information to finalize these preliminary valuations during the measurement period.

5. Commitments

Letters of Credit

As of October 31, 2011, the Company had a total of $11.2 million in letters of credit outstanding substantially in favor of certain landlords for office space. These letters of credit renew annually and mature at various dates through September 2021.

Leases

The Company leases facilities space and certain fixed assets under non-cancelable operating and capital leases with various expiration dates.

As of October 31, 2011, the future minimum lease payments under non-cancelable operating and capital leases are as follows (in thousands):

 

     Capital
Leases
    Operating
Leases
 

Fiscal Period:

    

Remaining three months of fiscal 2012

   $ 7,564      $ 30,484   

Fiscal 2013

     28,922        119,782   

Fiscal 2014

     24,505        95,830   

Fiscal 2015

     4,496        56,846   

Fiscal 2016

     1,925        49,727   

Thereafter

     1,123        125,190   
  

 

 

   

 

 

 

Total minimum lease payments

     68,535      $ 477,859   
    

 

 

 

Less: amount representing interest

     (3,554  
  

 

 

   

Present value of capital lease obligations

   $ 64,981     
  

 

 

   

The Company’s agreements for the facilities and certain services provide the Company with the option to renew. The Company’s future contractual obligations would change if the Company exercised these options.

 

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6. Legal Proceedings

In the ordinary course of business, the Company is involved in various legal proceedings and claims related to alleged infringement of third-party patents and other intellectual property rights, commercial, employment, wage and hour, and other claims.

On June 7, 2011, the Company entered into a preliminary settlement agreement with respect to a California state wage and hour lawsuit that had been filed against the Company early in 2011 in the Superior Court of California, County of San Francisco. The settlement agreement is subject to approval of the court, which is expected to rule by late 2011 or early 2012. The Company’s current estimate of the expense charge for the settlement is approximately $0.04 per diluted share. This charge is reflected in the Company’s financial results for the nine months ending October 31, 2011.

In general, the resolution of a legal matter could prevent the Company from offering its service to others, could be material to the Company’s financial condition or cash flows, or both, or could otherwise adversely affect the Company’s operating results.

The Company makes a provision for a liability relating to legal matters when it is both probable that a liability has been incurred and the amount of the loss can be reasonably estimated. These provisions are reviewed at least quarterly and adjusted to reflect the impacts of negotiations, settlements, rulings, advice of legal counsel and other information and events pertaining to a particular matter. In management’s opinion, resolution of these matters is not expected to have a material adverse impact on the Company’s consolidated results of operations, cash flows or financial position. However, depending on the nature and timing of any such dispute, an unfavorable resolution of a matter could materially affect the Company’s future results of operations or cash flows, or both, of a particular quarter.

7. Related-Party Transactions

In January 1999, the salesforce.com/foundation, also referred to as the Foundation, a non-profit public charity, was chartered to build philanthropic programs that are focused on youth and technology. The Company’s chairman is the chairman of the Foundation. He, one of the Company’s employees and one of the Company’s board members hold three of the Foundation’s seven board seats. The Company is not the primary beneficiary of the Foundation’s activities, and accordingly, the Company does not consolidate the Foundation’s statement of activities with its financial results.

Since the Foundation’s inception, the Company has provided at no charge certain resources to Foundation employees such as office space. The value of these items was in excess of $90,000 for the quarter ending October 31, 2011.

In addition to the resource sharing with the Foundation, the Company issued to the Foundation warrants in August 2002 to purchase shares of the Company’s common stock. All of the warrants were exercised in prior years. As of October 31, 2011, the Foundation held 103,500 shares of salesforce.com common stock. Additionally, the Company has donated subscriptions to the Company’s services to other qualified non-profit organizations. The Company also allows an affiliate of the Foundation to resell the Company’s services to large non-profit organizations. The Company does not charge the affiliate for the subscriptions. The fair value of the subscriptions were in excess of $3.6 million for the quarter ended October 31, 2011. The Company plans to continue these programs.

 

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ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

The following discussion in “Management’s Discussion and Analysis of Financial Condition and Results of Operations” (“MD&A”) contains forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended (the “Securities Act”) and Section 21E of the Securities Exchange Act of 1934, as amended (the “Exchange Act”). Forward-looking statements consist of, among other things, trend analyses, statements regarding future events, future financial performance, our business strategy and our plans to build our business, including our strategy to be the leading provider of enterprise cloud computing applications and to lead the industry shift to the social enterprise, our service performance and security, the expenses associated with new data centers and expanding our data center capacity, our operating results, our anticipated growth, trends in our business, new application service features, our strategy of acquiring or making investments in complementary companies, services and technologies, and intellectual property rights, our ability to successfully integrate acquired businesses and technologies, the effect of general economic and market conditions including sudden declines in the fair value of our investments in cash equivalents and marketable securities, our ability to protect our intellectual property rights, our ability to develop our brands, the effect of evolving government regulations, the effect of foreign currency exchange rate and interest rate fluctuations on our financial results, the potential availability of additional tax assets in the future and related matters, the impact of expensing stock options, the sufficiency of our capital resources, potential litigation involving us and our plan to build our new global headquarters in San Francisco, all of which are based on current expectations, estimates, and forecasts, and the beliefs and assumptions of our management. Words such as “expects,” “anticipates,” “aims,” “projects,” “intends,” “plans,” “believes,” “estimates,” “seeks,” variations of such words, and similar expressions are also intended to identify such forward-looking statements. These forward-looking statements are subject to risks, uncertainties and assumptions that are difficult to predict. Therefore, actual results may differ materially and adversely from those expressed in any forward-looking statements. Readers are directed to risks and uncertainties identified below, under “Risk Factors” and elsewhere in this report, for factors that may cause actual results to be different than those expressed in these forward-looking statements. Except as required by law, we undertake no obligation to revise or update publicly any forward-looking statements for any reason.

Overview

We are a leading provider of enterprise cloud computing applications. We provide a comprehensive customer and collaboration relationship management, or CRM, service to businesses of all sizes and industries worldwide and we provide a technology platform for customers and developers to build and run business applications.

We were founded in February 1999 and began offering our enterprise CRM application service in February 2000. Since then, we have augmented our CRM service with new editions and enhanced features. We introduced our Force.com platform to customers and developers so they can build complementary applications to extend beyond CRM. In 2010, we introduced our AppExchange directory of enterprise cloud computing applications that are integrated with our CRM service and, in most cases, have been developed on our platform by third parties. We also introduced Chatter, a collaboration application for the enterprise to connect and share information securely and in real-time. In fiscal 2012, we introduced our vision of a social enterprise, which is a company that leverages social, mobile and open technologies to place its customers at the center of its business.

Our objective is to be the leading provider of enterprise cloud computing applications and to lead the industry shift to the social enterprise. Key elements of our strategy include:

 

   

Strengthening our existing CRM applications and extending into new functional areas within CRM;

 

   

Pursuing new customers and new territories aggressively;

 

   

Deepening relationships with our existing customer base;

 

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Continuing to lead the industry transformation to the next phase of cloud computing; and

 

   

Encouraging the development of third-party applications on our cloud computing platform.

We believe the factors that will influence our ability to achieve our objectives include our prospective customers’ willingness to migrate to an enterprise cloud computing application service; the performance and security of our service; our ability to continue to release, and gain customer acceptance of, new and improved features; our ability to successfully integrate acquired businesses and technologies; successful customer adoption and utilization of our service; acceptance of our service in markets where we have few customers; the emergence of additional competitors in our market and improved product offerings by existing and new competitors; the location of new data centers; third-party developers’ willingness to develop applications on our platform; and general economic conditions which could affect our customers’ ability and willingness to purchase our application service, delay the customers’ purchasing decision or affect renewal rates.

To address these factors, we will need to, among other things, continue to add substantial numbers of paying subscriptions, upgrade our customers to fully featured versions such as our Unlimited Edition or arrangements such as a social enterprise license agreement, provide high quality technical support to our customers and encourage the development of third-party applications on our platform. Our plans to invest for future growth include the continuation of the expansion of our data center capacity. We also plan to continue to hire additional personnel, particularly in direct sales, other customer-related areas and research and development. As part of our growth plans, we intend to continue to focus on retaining customers at the time of renewal. Additionally, we plan to: expand our domestic and international selling and marketing activities; continue to develop our brands; add additional distribution channels; increase our research and development activities to upgrade and extend our service offerings; develop new services and technologies and integrate acquired technologies; and add to our global infrastructure to support our growth. We also regularly evaluate acquisitions or investment opportunities in complementary businesses, joint ventures, services and technologies, and intellectual property rights in an effort to expand our service offerings. We expect to continue to make such investments and acquisitions in the future. As such, we plan to reinvest a significant portion of our incremental revenue to grow our business and continue our leadership role in the cloud computing industry. As a result of these investments, we expect diluted earnings per share in fiscal 2012 to be significantly lower than diluted earnings per share in fiscal 2011.

Over the past two years, we acquired several businesses and technologies such as Jigsaw and Heroku. In May 2011, we acquired Radian6 for a total purchase price consideration of approximately $336.6 million, net of cash acquired. Radian6 is a cloud application vendor that provides customers with social media monitoring, measurement and engagement solutions. We acquired Radian6 for its developed technology, assembled workforce, expected synergies and expanded market opportunities when integrating Radian6’s social solution technology with our current product offerings. In September 2011, we acquired Assistly for a total purchase price consideration of approximately $58.7 million. Assistly is a cloud-based provider of customer service solutions. We acquired Assistly for its developed help desk application technology in order to expand our customer service market opportunities in the small and emerging business market. We also entered into a definitive agreement to acquire Model Metrics to expand our mobile and social consulting services.

In fiscal 2010, we issued at par value $575.0 million of 0.75% convertible senior notes due on January 15, 2015 (the “Notes”). For 20 trading days during the 30 consecutive trading days ended January 31, 2011, April 30, 2011, July 31, 2011 and October 31, 2011, our common stock traded at a price exceeding 130 percent of the conversion price of $85.36 per share applicable to the Notes. Accordingly, based on the terms of the Notes, since February 1, 2011, the Notes were convertible at the option of the holder and continue to be convertible at the holders’ option for the quarter ending January 31, 2012. Upon conversion of any Notes, we will deliver cash up to the principal amount of the Notes and, with respect to any excess conversion value greater than the principal amount of the Notes, shares of our common stock, cash, or a combination of both. Therefore, for the quarter ending January 31, 2012, the Notes will remain classified as a current liability on our condensed consolidated balance sheet.

 

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We expect marketing and sales costs, which were 52 percent of our total revenues for the nine months ended October 31, 2011 and 47 percent for the same period a year ago, to continue to represent a substantial portion of total revenues in the future as we seek to add more paying subscribers, build greater brand awareness and attract new customers.

Fiscal Year

Our fiscal year ends on January 31. References to fiscal 2012, for example, refer to the fiscal year ended January 31, 2012.

Segments

We have made several acquisitions to expand our business and offerings. For example in fiscal 2012, we acquired Radian6 to provide cloud based social media monitoring, measurement and engagement solutions. This and other acquisitions made over the past two years have allowed us to expand our offerings, presence and reach in various segments of the enterprise cloud computing market. While we have offerings in multiple enterprise cloud computing market segments, our business operates in one reportable segment because our decision making group evaluates our financial information and resources and assesses the performance of these resources on a consolidated basis only. Since we operate in one operating segment, all required financial segment information can be found in the consolidated financial statements.

Sources of Revenues

We derive our revenues from: (1) subscriptions fees from customers accessing our enterprise cloud computing application service; (2) support revenues from customers purchasing additional support beyond the standard support that is included in the basic subscription fee; (3) professional services, which include consulting services such as process mapping and project management, and implementation services including systems integration, technical architecture and development, and data conversion; and (4) other revenue, which consists primarily of training fees. Subscription and support revenues accounted for approximately 94 percent of our total revenues during the nine months ended October 31, 2011. Subscription revenues are driven primarily by the number of paying subscribers, varying service types, the price of our service and service renewal rates. We define a “customer” as a separate and distinct buying entity (e.g., a company, a distinct business unit of a large corporation, a partnership, etc.) that has entered into a contract to access our enterprise cloud computing service. We define a “subscription” as a unique user account purchased by a customer for use by its employees or other customer-authorized users, and we refer to each such user as a “subscriber.” The number of paying subscriptions at each of our customers ranges from one to tens of thousands. None of our customers accounted for more than five percent of our revenues during the three and nine months ended October 31, 2011 and 2010, respectively.

Subscription and support revenues are recognized ratably over the contract terms beginning on the commencement dates of each contract. The typical subscription and support term is 12 to 24 months, although terms range from one to 60 months. Our subscription and support contracts are non-cancelable, though customers typically have the right to terminate their contracts for cause if we materially fail to perform. We generally invoice our customers in advance, in annual or quarterly installments, and typical payment terms provide that our customers pay us within 30 days of invoice. Amounts that have been invoiced are recorded in accounts receivable and in deferred revenue, or in revenue depending on whether the revenue recognition criteria have been met. In general, we collect our billings in advance of the subscription service period.

Professional services and other revenues consist of fees associated with consulting and implementation services and training. Our consulting and implementation engagements are typically billed on a time and materials basis. We also offer a number of training classes on implementing, using and administering our service that are billed on a per person, per class basis. Our typical professional services payment terms provide that our customers pay us within 30 days of invoice.

 

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In determining whether professional services can be accounted for separately from subscription and support revenues, we consider a number of factors, which are described in “Critical Accounting Policies and Estimates—Revenue Recognition” below. Prior to February 1, 2011, the deliverables in multiple-deliverable arrangements were accounted for separately if the delivered items had standalone value and there was objective and reliable evidence of fair value for the undelivered items. If the deliverables in a multiple-deliverable arrangement could not be accounted for separately, the total arrangement fee was recognized ratably as a single unit of accounting over the contracted term of the subscription agreement. A significant portion of our multiple-deliverable arrangements were accounted for as a single unit of accounting because we did not have objective and reliable evidence of fair value for certain of our deliverables. Additionally, in these situations, we deferred the direct costs of a related professional service arrangement and amortized those costs over the same period as the professional services revenue was recognized.

In October 2009, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update No. 2009-13, “Revenue Recognition (Topic 605), Multiple-Deliverable Revenue Arrangements—a consensus of the FASB Emerging Issues Task Force” (“ASU 2009-13”) which amended the previous multiple-deliverable arrangements accounting guidance. Pursuant to the new guidance, objective and reliable evidence of fair value of the deliverables to be delivered is no longer required in order to account for deliverables in a multiple-deliverable arrangement separately. Instead, arrangement consideration is allocated to deliverables based on their relative selling price. In the first quarter of fiscal 2012, we adopted this new accounting guidance on a prospective basis. We applied the new accounting guidance to those multiple-deliverable arrangements entered into or materially modified on or after February 1, 2011 which is the beginning of our fiscal year.

Seasonal Nature of Deferred Revenue and Accounts Receivable

Deferred revenue primarily consists of billings to customers for our subscription service. Over 90 percent of the value of our billings to customers is for our subscription and support service. We generally invoice our customers in either quarterly or annual cycles, with a disproportionate weighting towards annual billings in the fourth quarter, primarily as a result of large enterprise account buying patterns. Additionally, our fourth quarter has historically been our strongest quarter for new business and renewals. The year on year compounding effect of this seasonality in both billing patterns and overall new and renewal business causes the value of invoices that we generate in the fourth quarter for both new and existing customers to increase as a proportion of our total annual billings.

Accordingly, the sequential quarterly changes in accounts receivable and the related deferred revenue during the first three quarters of our fiscal year are not necessarily indicative of the billing activity that occurs in the fourth quarter as displayed below:

 

$1,426,943 $1,426,943 $1,426,943 $1,426,943

(in thousands)

   April 30,
2011
     July 31,
2011
     October 31,
2011
    

                      

Fiscal 2012

           

Accounts receivable, net

   $ 270,816       $ 342,397       $ 312,331      

Deferred revenue, current and noncurrent

     915,133         935,266         917,821      

 

$1,426,943 $1,426,943 $1,426,943 $1,426,943
      April 30,
2010
     July 31,
2010
     October 31,
2010
     January 31,
2011
 

Fiscal 2011

           

Accounts receivable, net

   $ 183,612       $ 228,550       $ 258,764       $ 426,943   

Deferred revenue, current and noncurrent

     664,529         683,019         694,557         934,941   

 

$1,426,943 $1,426,943 $1,426,943 $1,426,943
      April 30,
2009
     July 31,
2009
     October 31,
2009
     January 31,
2010
 

Fiscal 2010

           

Accounts receivable, net

   $ 145,869       $ 168,842       $ 191,297       $ 320,956   

Deferred revenue, current and noncurrent

     549,373         549,010         545,435         704,348   

 

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Cost of Revenues and Operating Expenses

Cost of Revenues. Cost of subscription and support revenues primarily consists of expenses related to hosting our service and providing support, the costs of data center capacity, depreciation or operating lease expense associated with computer equipment and software, allocated overhead and amortization expense associated with capitalized software related to our application service and acquired developed technologies. We allocate overhead such as rent and occupancy charges based on headcount. Employee benefit costs and taxes are allocated based upon a percentage of total compensation expense. As such, general overhead expenses are reflected in each cost of revenue and operating expense category. Cost of professional services and other revenues consists primarily of employee-related costs associated with these services, including stock-based expenses, the cost of subcontractors and allocated overhead. The cost of providing professional services is significantly higher as a percentage of the related revenue than for our enterprise cloud computing subscription service due to the direct labor costs and costs of subcontractors.

We intend to continue to invest additional resources in our enterprise cloud computing application service. For example, we plan to open additional data centers in the future. Additionally, as we acquire new businesses and technologies, the amortization expense associated with this activity will be included in cost of revenues. The timing of these additional expenses will affect our cost of revenues, both in terms of absolute dollars and as a percentage of revenues, in the affected periods.

Research and Development. Research and development expenses consist primarily of salaries and related expenses, including stock-based expenses, the costs of our development and test data center and allocated overhead. We continue to focus our research and development efforts on adding new features and services, integrating acquired technologies, increasing the functionality and enhancing the ease of use of our enterprise cloud computing application service. Our proprietary, scalable and secure multi-tenant architecture enables us to provide all of our customers with a service based on a single version of our application. As a result, we do not have to maintain multiple versions, which enables us to have relatively lower research and development expenses as compared to traditional enterprise software companies. We expect that in the future, research and development expenses will increase in absolute dollars as we improve and extend our service offerings, develop new technologies and integrate acquired businesses and technologies.

Marketing and Sales. Marketing and sales expenses are our largest cost and consist primarily of salaries and related expenses, including stock-based expenses, for our sales and marketing staff, including commissions, payments to partners, marketing programs and allocated overhead. Marketing programs consist of advertising, events, corporate communications, brand building and product marketing activities.

We plan to continue to invest in marketing and sales by expanding our domestic and international selling and marketing activities, building brand awareness, attracting new customers and sponsoring additional marketing events. The timing of these marketing events, such as our annual and largest event, Dreamforce, will affect our marketing costs in a particular quarter. We expect that in the future, marketing and sales expenses will increase in absolute dollars and continue to be our largest cost.

General and Administrative. General and administrative expenses consist of salaries and related expenses, including stock-based expenses, for finance and accounting, legal, internal audit, human resources and management information systems personnel, legal costs, professional fees, other corporate expenses and allocated overhead. We expect that in the future, general and administrative expenses will increase in absolute dollars as we invest in our infrastructure and we incur additional employee related costs, professional fees and insurance costs related to the growth of our business and international expansion. We expect general and administrative costs as a percentage of total revenues to remain flat for the next several quarters.

Stock-Based Expenses. Our cost of revenues and operating expenses include stock-based expenses related to option and stock awards to employees and non-employee directors. We recognize our stock-based payments as an expense in the statement of operations based on their fair values and vesting periods. If our grant activity

 

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remains consistent and our stock price increases in the future, stock-based expenses will rise. These charges have been significant in the past and we expect that they will increase as we hire more employees and seek to retain existing employees.

Critical Accounting Policies and Estimates

Our consolidated financial statements are prepared in accordance with accounting principles generally accepted in the United States. The preparation of these consolidated financial statements requires us to make estimates and assumptions that affect the reported amounts of assets, liabilities, revenues, costs and expenses, and related disclosures. On an ongoing basis, we evaluate our estimates and assumptions. Our actual results may differ from these estimates under different assumptions or conditions.

We believe that of our significant accounting policies, which are described in Note 1 to our condensed consolidated financial statements, the following accounting policies involve a greater degree of judgment and complexity. Accordingly, these are the policies we believe are the most critical to aid in fully understanding and evaluating our condensed consolidated financial condition and results of operations.

Revenue Recognition. We derive our revenues from two sources: (1) subscription revenues, which are comprised of subscription fees from customers accessing our enterprise cloud computing application service and from customers purchasing additional support beyond the standard support that is included in the basic subscription fee; and (2) related professional services such as process mapping, project management, implementation services and other revenue. “Other revenue” consists primarily of training fees.

We commence revenue recognition when all of the following conditions are satisfied:

 

   

There is persuasive evidence of an arrangement;

 

   

The service has been or is being provided to the customer;

 

   

The collection of the fees is reasonably assured; and

 

   

The amount of fees to be paid by the customer is fixed or determinable.

Our subscription service arrangements are non-cancelable and do not contain refund-type provisions.

Subscription and Support Revenues

Subscription and support revenues are recognized ratably over the contract terms beginning on the commencement date of each contract, which is the date our service is made available to customers. Amounts that have been invoiced are recorded in accounts receivable and in deferred revenue or revenue, depending on whether the revenue recognition criteria have been met.

Professional Services and Other Revenues

The majority of our professional services contracts are on a time and material basis. When these services are not combined with subscription revenues as a single unit of accounting, as discussed below, these revenues are recognized as the services are rendered for time and material contracts, and when the milestones are achieved and accepted by the customer for fixed price contracts. Training revenues are recognized after the services are performed.

Multiple-Deliverable Arrangements

We enter into arrangements with multiple-deliverables that generally include subscription, premium support, and professional services.

Prior to February 1, 2011, the deliverables in multiple-deliverable arrangements were accounted for separately if the delivered items had standalone value and there was objective and reliable evidence of fair value

 

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for the undelivered items. If the deliverables in a multiple-deliverable arrangement could not be accounted for separately, the total arrangement fee was recognized ratably as a single unit of accounting over the contracted term of the subscription agreement. A significant portion of our multiple-deliverable arrangements were accounted for as a single unit of accounting because we did not have objective and reliable evidence of fair value for certain of our deliverables. Additionally, in these situations, we deferred the direct costs of a professional services arrangement and amortized those costs over the same period as the professional services revenue is recognized.

In October 2009, the FASB issued Accounting Standards Update No. 2009-13, “Revenue Recognition (Topic 605), Multiple-Deliverable Revenue Arrangements—a consensus of the FASB Emerging Issues Task Force” (“ASU 2009-13”) which amended the previous multiple-deliverable arrangements accounting guidance. Pursuant to the updated guidance, objective and reliable evidence of fair value of the deliverables to be delivered is no longer required in order to account for deliverables in a multiple-deliverable arrangement separately. Instead, arrangement consideration is allocated to deliverables based on their relative selling price.

In the first quarter of fiscal 2012, we adopted this updated accounting guidance on a prospective basis. We have applied the new accounting guidance to those multiple-deliverable arrangements entered into or materially modified on or after February 1, 2011 which is the beginning of our fiscal year.

The adoption of this updated accounting guidance did not have a material impact on our financial condition, results of operations or cash flows. As of October 31, 2011, the deferred professional services revenue and deferred costs under the previous accounting guidance are $41.0 million and $19.3 million, respectively, which will continue to be recognized over the related remaining subscription period.

Under the updated accounting guidance, in order to treat deliverables in a multiple-deliverable arrangement as separate units of accounting, the deliverables must have standalone value upon delivery. If the deliverables have standalone value upon delivery, we account for each deliverable separately. Subscription services have standalone value as such services are often sold separately. In determining whether professional services have standalone value, we consider the following factors for each professional services agreement: availability of the services from other vendors, the nature of the professional services, the timing of when the professional services contract was signed in comparison to the subscription service start date, and the contractual dependence of the subscription service on the customer’s satisfaction with the professional services work. To date, we have concluded that all of the professional services included in multiple-deliverable arrangements executed have standalone value.

Under the updated accounting guidance, when multiple-deliverables included in an arrangement are separated into different units of accounting, the arrangement consideration is allocated to the identified separate units based on a relative selling price hierarchy. We determine the relative selling price for a deliverable based on its vendor-specific objective evidence of selling price (“VSOE”), if available, or our best estimate of selling price (“BESP”), if VSOE is not available. We have determined that third-party evidence (“TPE”) is not a practical alternative due to differences in our service offerings compared to other parties and the availability of relevant third-party pricing information. The amount of revenue allocated to delivered items is limited by contingent revenue, if any.

For certain professional services, we have established VSOE as a consistent number of standalone sales of this deliverable have been priced within a reasonably narrow range. We have not established VSOE for our subscription services due to lack of pricing consistency, the introduction of new services and other factors. Accordingly, we use our BESP to determine the relative selling price.

We determined BESP by considering our overall pricing objectives and market conditions. Significant pricing practices taken into consideration include our discounting practices, the size and volume of our transactions, the customer demographic, the geographic area where our services are sold, our price lists, our go-to-market strategy, historical standalone sales and contract prices. The determination of BESP is made through consultation with and approval by management, taking into consideration the go-to-market strategy. As our go-to-market strategies evolve, we may modify our pricing practices in the future, which could result in changes in relative selling prices, including both VSOE and BESP.

 

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Deferred Revenue. The deferred revenue balance does not represent the total contract value of annual or multi-year, non-cancelable subscription agreements. Deferred revenue primarily consists of billings or payments received in advance of revenue recognition from subscription service described above and is recognized as the revenue recognition criteria are met. We generally invoice customers in annual or quarterly installments. Deferred revenue is influenced by several factors, including seasonality, the compounding effects of renewals, invoice duration, invoice timing and new business linearity within the quarter.

Billings against professional services arrangements entered into prior to February 1, 2011 will generally be added to deferred revenue and recognized over the remaining related subscription contract term.

Deferred revenue that will be recognized during the succeeding twelve month period is recorded as current deferred revenue and the remaining portion is recorded as noncurrent.

Deferred Commissions. We defer commission payments to our direct sales force. The commissions are deferred and amortized to sales expense over the non-cancelable terms of the related subscription contracts with our customers, which are typically 12 to 24 months. The commission payments, which are paid in full the month after the customer’s service commences, are a direct and incremental cost of the revenue arrangements. The deferred commission amounts are recoverable through the future revenue streams under the non-cancelable customer contracts. We believe this is the preferable method of accounting as the commission charges are so closely related to the revenue from the non-cancelable customer contracts that they should be recorded as an asset and charged to expense over the same period that the subscription revenue is recognized.

During the nine months ended October 31, 2011, we deferred $80.3 million of commission expenditures and we amortized $76.5 million to sales expense. During the same period a year ago, we deferred $65.2 million of commission expenditures and we amortized $57.6 million to sales expense. Deferred commissions on our condensed consolidated balance sheets totaled $120.4 million at October 31, 2011 and $116.6 million at January 31, 2011.

Business Combinations. We recognize separately from goodwill the fair value of assets acquired and liabilities assumed. Goodwill as of the acquisition date represents the excess of the purchase consideration of an acquired business over the fair value of the underlying net tangible and intangible assets acquired and liabilities assumed. We use our best estimates and assumptions to accurately assign fair value to the tangible and intangible assets acquired and liabilities assumed at the acquisition date. Our estimates are inherently uncertain and subject to refinement. As a result, during the measurement period, which may be up to one year from the acquisition date, we may record adjustments to the fair value of assets acquired and liabilities assumed, with the corresponding offset to goodwill. Upon the conclusion of the measurement period or final determination of the fair value of assets acquired or liabilities assumed, whichever comes first, any subsequent adjustments are recorded to our condensed consolidated statements of operations.

In addition, uncertain tax positions and tax related valuation allowances assumed in connection with a business combination are initially estimated as of the acquisition date. We reevaluate these items quarterly and record any adjustments to the preliminary estimates to goodwill provided that we are within the measurement period and we continue to collect information in order to determine their estimated fair values as of the date of acquisition. Subsequent to the measurement period or our final determination of the estimated value of the tax allowance or contingency, changes to these uncertain tax positions and tax related valuation allowances will affect our provision for income taxes in the condensed consolidated statements of operations.

Stock-Based Awards. We recognize the fair value of our stock awards on a straight-line basis over the requisite service period of the award which is the vesting term of generally four years.

We recognized stock-based expense of $159.2 million during the nine months ended October 31, 2011. The requirement to expense stock-based awards will continue to materially reduce our reported results of operations.

 

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As of October 31, 2011, we had an aggregate of $582.3 million of stock compensation remaining to be amortized to expense over the remaining requisite service period of the underlying awards. We currently expect this stock compensation balance to be amortized as follows: $58.4 million during the remaining three months of fiscal 2012; $208.9 million during fiscal 2013; $179.0 million during fiscal 2014; $121.2 million during fiscal 2015 and $14.8 million during fiscal 2016. These amounts reflect only outstanding stock awards as of October 31, 2011 and assume no forfeiture activity. We expect to continue to issue stock-based awards to our employees in future periods, which will increase the stock compensation amortization in such future periods.

We recognize as an operating expense the payroll and social tax costs, as applicable by jurisdiction, when stock options are exercised. The impact of stock-based expense in the future is dependent upon, among other things, the timing of when we hire additional employees, the effect of long-term incentive strategies involving stock awards in order to continue to attract and retain employees, the total number of stock awards granted, the fair value of the stock awards at the time of grant, changes in estimated forfeiture assumption rates and the tax benefit that we may or may not receive from stock-based expenses. Additionally, we are required to use an option-pricing model to determine the fair value of stock option awards. This determination of fair value is affected by our stock price as well as assumptions regarding a number of highly complex and subjective variables. These variables include, but are not limited to, our expected stock price volatility over the term of the awards.

As of October 31, 2011, there were 3.3 million restricted stock awards and units outstanding. We plan to continue awarding restricted stock to our employees in the future. The restricted stock, which upon vesting entitles the holder to one share of common stock for each restricted stock, has an exercise price of $0.001 per share, which is equal to the par value of our common stock, and vests over four years. The fair value of the restricted stock is based on our closing stock price on the date of grant, and compensation expense, net of estimated forfeitures, is recognized on a straight-line basis over the vesting period.

Income Taxes. We account for income taxes using the liability method, which requires the recognition of deferred tax assets or liabilities for the tax-effected temporary differences between the financial reporting and tax basis of our assets and liabilities and for net operating loss and tax credit carryforwards. The tax expense or benefit for unusual items, or certain adjustments to the valuation allowance are treated as discrete items in the interim period in which the events occur.

Our effective tax rate could be adversely affected by changes in the mix of earnings and losses in countries with differing statutory tax rates, certain non-deductible expenses as a result of acquisitions, the calculation of deferred tax assets and liabilities, and changes in tax laws and accounting principles.

Strategic Investments. We report our investments in marketable equity securities at fair market value using the quoted prices in their respective active markets. We report our investments in non-marketable equity and debt securities, which consist of minority equity and debt investments in privately-held companies, at cost or fair value when an event or circumstance indicates an other-than-temporary decline in value has occurred. Management evaluates financial results, earnings trends, technology milestones and subsequent financing of these companies, as well as the general market conditions to identify indicators of other-than temporary impairment.

 

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Results of Operations

The following tables set forth selected data for each of the periods indicated (in thousands, unaudited).

 

     Three Months Ended
October 31,
    Nine Months Ended
October 31,
 
     2011     2010     2011     2010  

Revenues:

        

Subscription and support

   $ 549,182      $ 402,948      $ 1,531,965      $ 1,122,611   

Professional services and other

     35,078        26,139        102,661        77,661   
  

 

 

   

 

 

   

 

 

   

 

 

 

Total revenues

     584,260        429,087        1,634,626        1,200,272   

Cost of revenues:

        

Subscription and support

     96,306        54,089        260,693        147,127   

Professional services and other

     32,259        28,042        91,848        84,375   
  

 

 

   

 

 

   

 

 

   

 

 

 

Total cost of revenues

     128,565        82,131        352,541        231,502   
  

 

 

   

 

 

   

 

 

   

 

 

 

Gross profit

     455,695        346,956        1,282,085        968,770   

Operating expenses:

        

Research and development

     76,049        47,305        214,734        130,357   

Marketing and sales

     304,571        200,544        842,043        558,812   

General and administrative

     85,232        63,951        254,016        181,713   
  

 

 

   

 

 

   

 

 

   

 

 

 

Total operating expenses

     465,852        311,800        1,310,793        870,882   

Income (loss) from operations

     (10,157     35,156        (28,708     97,888   

Investment income

     5,136        11,699        18,303        28,309   

Interest expense

     (3,859     (7,374     (11,376     (21,619

Other income (expense)

     30        (921     (4,001     (4,659
  

 

 

   

 

 

   

 

 

   

 

 

 

Income (loss) before benefit (provision) for income taxes and noncontrolling interest

     (8,850     38,560        (25,782     99,919   

Benefit (provision) for income taxes

     5,094        (16,192     18,288        (41,092
  

 

 

   

 

 

   

 

 

   

 

 

 

Consolidated net income (loss)

     (3,756     22,368        (7,494     58,827   

Less: Net income attributable to noncontrolling interest

     0        (1,296     0        (5,266
  

 

 

   

 

 

   

 

 

   

 

 

 

Net income (loss) attributable to salesforce.com

   $ (3,756   $ 21,072      $ (7,494   $ 53,561   
  

 

 

   

 

 

   

 

 

   

 

 

 

 

     As of  
     October 31,
2011
     January 31,
2011
     October 31,
2010
 

Balance Sheet Data:

        

Cash, cash equivalents and marketable securities

   $ 1,296,693       $ 1,407,557       $ 1,802,440   

Deferred revenue, current and noncurrent

     917,821         934,941         694,557   

 

     Three Months Ended
October 31,
     Nine Months Ended
October 31,
 
     2011      2010      2011      2010  

Revenues by geography:

           

Americas

   $ 397,118       $ 292,540       $ 1,104,052       $ 826,493   

Europe

     103,864         76,464         300,315         208,851   

Asia Pacific

     83,278         60,083         230,259         164,928   
  

 

 

    

 

 

    

 

 

    

 

 

 
   $ 584,260       $ 429,087       $ 1,634,626       $ 1,200,272   
  

 

 

    

 

 

    

 

 

    

 

 

 

 

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Cost of revenues and operating expenses include the following amounts related to stock-based awards (in thousands).

 

     Three Months Ended
October 31,
     Nine Months Ended
October 31,
 
     2011      2010      2011      2010  

Cost of revenues

   $ 4,138       $ 2,357       $ 12,168       $ 8,617   

Research and development

     12,197         3,976         31,224         12,119   

Marketing and sales

     29,123         11,969         80,024         36,496   

General and administrative

     11,548         7,330         35,742         21,483   

Cost of revenues and marketing and sales expenses include the following amounts related to amortization of purchased intangibles (in thousands).

 

     Three Months  Ended
October 31,
     Nine Months Ended
October 31,
 
     2011      2010      2011      2010  

Amortization of purchased intangibles:

           

Cost of revenues

   $ 17,469       $ 4,168       $ 42,937       $ 9,738   

Marketing and sales

     953         1,013         4,499         3,063   

The following tables set forth selected consolidated statements of operations data for each of the periods indicated as a percentage of total revenues.

 

     Three Months Ended
October 31,
    Nine Months Ended
October 31,
 
     2011     2010     2011     2010  

Revenues:

        

Subscription and support

     94     94     94     94

Professional services and other

     6        6        6        6   
  

 

 

   

 

 

   

 

 

   

 

 

 

Total revenues

     100        100        100        100   
  

 

 

   

 

 

   

 

 

   

 

 

 

Cost of revenues:

        

Subscription and support

     16        13        16        12   

Professional services and other

     6        6        6        7   
  

 

 

   

 

 

   

 

 

   

 

 

 

Total cost of revenues

     22        19        22        19   
  

 

 

   

 

 

   

 

 

   

 

 

 

Gross profit

     78        81        78        81   

Operating expenses:

        

Research and development

     13        11        13        11   

Marketing and sales

     52        47        52        47   

General and administrative

     15        15        15        15   
  

 

 

   

 

 

   

 

 

   

 

 

 

Total operating expenses

     80        73        80        73   

Income (loss) from operations

     (2     8        (2     8   

Investment income

     1        3        1        2   

Interest expense

     (1     (2     (1     (2

Other income (expense)

     0        0        0        0   
  

 

 

   

 

 

   

 

 

   

 

 

 

Income (loss) before benefit (provision) for income taxes and noncontrolling interest

     (2     9        (2     8   

Benefit (provision) for income taxes

     1        (4     1        (3
  

 

 

   

 

 

   

 

 

   

 

 

 

Consolidated net income (loss)

     (1     5        (1     5   

Less: Net income attributable to noncontrolling interest

     0        0        0        (1
  

 

 

   

 

 

   

 

 

   

 

 

 

Net income (loss) attributable to salesforce.com

     (1 )%      5     (1 )%      4
  

 

 

   

 

 

   

 

 

   

 

 

 

 

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Table of Contents
     Three Months  Ended
October 31,
    Nine Months Ended
October  31,
 
      2011     2010     2011     2010  

Revenues by geography:

        

Americas

     68     68     68     69

Europe

     18        18        18        17   

Asia Pacific

     14        14        14        14   
  

 

 

   

 

 

   

 

 

   

 

 

 
     100     100     100     100
  

 

 

   

 

 

   

 

 

   

 

 

 

 

     Three Months  Ended
October 31,
    Nine Months Ended
October 31,
 
     2011     2010     2011     2010  

Stock-based awards:

        

Cost of revenues

     1     0     1     1

Research and development

     2        1        2        1   

Marketing and sales

     5        3        5        3   

General and administrative

     2        2        2        2   

Three Months Ended October 31, 2011 and 2010

Revenues.

 

      Three Months Ended
October 31,
     Variance  

(In thousands)

   2011      2010      Dollars      Percent  

Subscription and support

   $ 549,182       $ 402,948       $ 146,234         36 %

Professional services and other

     35,078         26,139         8,939         34 %
  

 

 

    

 

 

    

 

 

    

 

 

 

Total revenues

   $ 584,260       $ 429,087       $ 155,173         36 %
  

 

 

    

 

 

    

 

 

    

 

 

 

Total revenues were $584.3 million for the three months ended October 31, 2011, compared to $429.1 million during the same period a year ago, an increase of $155.2 million, or 36 percent. Subscription and support revenues were $549.2 million, or 94 percent of total revenues, for the three months ended October 31, 2011, compared to $402.9 million, or 94 percent of total revenues, during the same period a year ago. The increase in subscription and support revenues was due primarily to new customers, upgrades and additional subscriptions from existing customers and improved renewal rates as compared to a year ago. The price per user per month for our three primary offerings, Professional Edition, Enterprise Edition and Unlimited Edition, in the quarter ended October 31, 2011 has remained substantially consistent relative to prior periods. Professional services and other revenues were $35.1 million, or six percent of total revenues, for the three months ended October 31, 2011, compared to $26.1 million, or six percent of total revenues, for the same period a year ago. The increase in professional services and other revenues was due primarily to the improved utilization of existing headcount and a small benefit from the prospective adoption of the new revenue accounting guidance for multiple-deliverable arrangements.

Revenues in Europe and Asia Pacific accounted for $187.1 million, or 32 percent of total revenues, for the three months ended October 31, 2011, compared to $136.5 million, or 32 percent of total revenues, during the same period a year ago, an increase of $50.6 million, or 37 percent. The increase in revenues outside of the Americas was the result of the increasing acceptance of our service, our focus on marketing our service internationally and improved renewal rates. Additionally, the value of the U.S. dollar relative to foreign currencies contributed to an increase in U.S. dollar revenues outside of the Americas for the three months ended October 31, 2011 as compared to the same period a year ago. The foreign currency impact had the effect of increasing our aggregate revenues by $9.3 million compared to the same period a year ago. As part of our overall growth, we expect the percentage of our revenue generated outside of the Americas to increase as a percentage of our total revenues worldwide.

 

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Cost of Revenues.

 

     Three Months Ended
October 31,
    Variance  

(In thousands)

   2011     2010     Dollars  

Subscription and support

   $ 96,306      $ 54,089      $ 42,217   

Professional services and other

     32,259        28,042        4,217   
  

 

 

   

 

 

   

 

 

 

Total cost of revenues

   $ 128,565      $ 82,131      $ 46,434   
  

 

 

   

 

 

   

 

 

 

Percent of total revenues

     22 %     19 %  

Cost of revenues was $128.6 million, or 22 percent of total revenues, for the three months ended October 31, 2011, compared to $82.1 million, or 19 percent of total revenues, during the same period a year ago, an increase of $46.4 million. The increase in absolute dollars was primarily due to an increase of $6.3 million in employee-related costs, an increase of $11.2 million in service delivery costs, primarily due to our efforts to increase data center capacity, an increase of $19.2 million in depreciation and amortization expenses, $13.3 million of which related to the amortization of acquired developed technology, an increase of $6.2 million in outside subcontractor and other service costs, an increase of $1.1 million in allocated overhead and an increase of $1.8 million in stock-based expenses. Gross profit margins for professional services and other improved over the same period a year ago primarily due to the improved utilization of existing headcount, a reduction in non-billable headcount since October 31, 2010 and a small benefit from the prospective adoption of the new revenue accounting guidance for multiple-deliverable arrangements.

We intend to continue to invest additional resources in our enterprise cloud computing application service and data center capacity. Additionally, the amortization of acquired developed technology will increase as we acquire additional businesses and technologies. The timing of these expenses will affect our cost of revenues, both in terms of absolute dollars and as a percentage of revenues in future periods.

Research and Development.

 

     Three Months Ended
October 31,
    Variance  

(In thousands)

   2011     2010     Dollars  

Research and development

   $ 76,049      $ 47,305      $ 28,744   

Percent of total revenues

     13 %     11 %  

Research and development expenses were $76.0 million, or 13 percent of total revenues, for the three months ended October 31, 2011, compared to $47.3 million, or 11 percent of total revenues, during the same period a year ago, an increase of $28.7 million. The increase in absolute dollars was primarily due to an increase of $16.6 million in employee-related costs, an increase of $8.2 million in stock-based expenses and an increase of $2.2 million in allocated overhead. We increased our research and development headcount by 65 percent since October 31, 2010 in order to improve and extend our service offerings and develop new technologies. Some of the increase in headcount was due to acquired businesses.

Marketing and Sales.

 

     Three Months Ended
October 31,
    Variance  

(In thousands)

   2011     2010     Dollars  

Marketing and sales

   $ 304,571      $ 200,544      $ 104,027   

Percent of total revenues

     52 %     47 %  

 

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Marketing and sales expenses were $304.6 million, or 52 percent of total revenues, for the three months ended October 31, 2011, compared to $200.5 million, or 47 percent of total revenues, during the same period a year ago, an increase of $104.0 million. The increase in absolute dollars was primarily due to increases of $67.0 million in employee-related costs, $17.2 million in stock-based expenses, $13.3 million in advertising, marketing and event costs and $4.0 million in allocated overhead. Our largest annual marketing event, Dreamforce, occurred during the third quarter of fiscal 2012 and was held in the fourth quarter of the prior fiscal year. The costs associated with this event are reflected in the three months ended October 31, 2011 results. Our marketing and sales headcount increased by 43 percent since October 31, 2010 as we hired additional sales personnel to focus on adding new customers and increasing penetration within our existing customer base. Some of the increase in headcount was due to acquired businesses.

General and Administrative.

 

     Three Months Ended
October 31,
    Variance  

(In thousands)

   2011     2010     Dollars  

General and administrative

   $ 85,232      $ 63,951      $ 21,281   

Percent of total revenues

     15 %     15 %  

General and administrative expenses were $85.2 million, or 15 percent of total revenues, for the three months ended October 31, 2011, compared to $64.0 million, or 15 percent of total revenues, during the same period a year ago, an increase of $21.3 million. The increase was due to an increase of $14.4 million in employee-related costs, an increase of $4.2 million in stock-based expenses and an increase of $2.7 million in professional and outside service costs. Our general and administrative headcount increased by 46 percent since October 31, 2010 as we added personnel to support our growth.

Income (loss) from operations.

 

     Three Months Ended
October 31,
    Variance  

(In thousands)

   2011     2010     Dollars  

Income (loss) from operations

   $ (10,157   $ 35,156      $ (45,313

Percent of total revenues

     (2 )%     8 %  

Loss from operations for the three months ended October 31, 2011 was $10.2 million and included $57.0 million of stock-based expenses and $18.4 million of amortization of purchased intangibles. During the same period a year ago, operating income was $35.2 million and included $25.6 million of stock-based expenses and $5.2 million of amortization of purchased intangibles.

Investment income.

 

     Three Months Ended
October 31,
    Variance  

(In thousands)

   2011     2010     Dollars  

Investment income

   $ 5,136      $ 11,699      $ (6,563

Percent of total revenues

     1 %     3 %  

Investment income consists of income on cash and marketable securities balances. Investment income was $5.1 million for the three months ended October 31, 2011 and was $11.7 million during the same period a year ago. The decrease was primarily due to a reduction in realized gains from sales of marketable securities, the decrease in marketable securities balances and lower interest rates.

 

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Interest expense.

 

     Three Months Ended
October 31,
    Variance  

(In thousands)

   2011     2010     Dollars  

Interest expense

   $ (3,859   $ (7,374   $ 3,515   

Percent of total revenues

     (1 )%     (2 )%  

Interest expense consists primarily of interest on our Notes and capital leases. Interest expense was $3.9 million, net of interest costs capitalized, for the three months ended October 31, 2011 and was $7.4 million during the same period a year ago. During the three months ended October 31, 2011, we capitalized $4.2 million of interest costs related to major construction projects, specifically our campus project, which began during the fourth quarter of fiscal 2011, and our capitalized internal-use software development costs. Capitalized interest during the same period a year ago was immaterial. We will continue to capitalize interest on these projects until these assets are ready for service.

Other income (expense).

 

     Three Months Ended
October 31,
    Variance  

(In thousands)

      2011            2010        Dollars  

Other income (expense)

   $ 30       $ (921   $ 951   

Other income (expense) primarily consists of realized gains and losses resulting from strategic investment activity and foreign currency transaction gains and losses. Other income (expense) increased primarily due to the net gain of $1.2 million from activity within our portfolio of noncontrolling equity and debt investments in privately-held companies offset by realized and unrealized losses on foreign currency transactions for the three months ended October 31, 2011 compared to the same period a year ago.

Benefit (provision) for Income Taxes.

 

     Three Months Ended
October 31,
    Variance  

(In thousands)

   2011     2010     Dollars  

Benefit (provision) for income taxes

   $ 5,094      $ (16,192   $ 21,286   

Effective tax rate

     58 %     42 %  

The benefit for income taxes was $5.1 million for the three months ended October 31, 2011, compared to an income tax provision of $16.2 million during the same period a year ago.

Our effective tax rate for the three months ended October 31, 2011 was 58 percent, which was higher than the federal statutory rate of 35 percent. The higher tax rate was attributable to a detrimental foreign tax differential and non-deductible acquisition expenses, offset by state income taxes and Federal and California tax credits and the tax benefit from the May 2011 acquisition of Radian6. The combined effect of these tax items on a small net loss before income taxes was significant resulting in a high effective tax rate.

Our effective tax rate of 42 percent for the three months ended October 31, 2010 was higher than the federal statutory rate of 35 percent primarily due to state income taxes, a detrimental foreign tax rate differential, non-deductible acquisition expenses and the unfavorable impact of a change in California tax law, which was partially offset by California tax credits.

 

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Nine Months Ended October 31, 2011 and 2010

Revenues.

 

     Nine Months Ended
October 31,
     Variance  

(In thousands)

   2011      2010      Dollars      Percent  

Subscription and support

   $ 1,531,965       $ 1,122,611       $ 409,354         36 %

Professional services and other

     102,661         77,661         25,000         32 %
  

 

 

    

 

 

    

 

 

    

 

 

 

Total revenues

   $ 1,634,626       $ 1,200,272       $ 434,354         36 %
  

 

 

    

 

 

    

 

 

    

 

 

 

Total revenues were $1.6 billion for the nine months ended October 31, 2011, compared to $1.2 billion during the same period a year ago, an increase of $434.4 million, or 36 percent. Subscription and support revenues were $1.5 billion, or 94 percent of total revenues, for the nine months ended October 31, 2011, compared to $1.1 billion, or 94 percent of total revenues, during the same period a year ago. The increase in subscription and support revenues was due primarily to new customers, upgrades and additional subscriptions from existing customers and improved renewal rates as compared to a year ago. The price per user per month for our three primary offerings, Professional Edition, Enterprise Edition and Unlimited Edition, in the nine months ended October 31, 2011 has remained substantially consistent relative to prior periods. Professional services and other revenues were $102.7 million, or six percent of total revenues, for the nine months ended October 31, 2011, compared to $77.7 million, or six percent of total revenues, for the same period a year ago. The increase in professional services and other revenues was due primarily to the improved utilization of existing headcount, and a small benefit from the prospective adoption of the new revenue accounting guidance for multiple-deliverable arrangements.

Revenues in Europe and Asia Pacific accounted for $530.6 million, or 32 percent of total revenues, for the nine months ended October 31, 2011, compared to $373.8 million, or 31 percent of total revenues, during the same period a year ago, an increase of $156.8 million, or 42 percent. The increase in revenues outside of the Americas was the result of the increasing acceptance of our service, our focus on marketing our service internationally and improved renewal rates. Additionally, the value of the U.S. dollar relative to foreign currencies contributed to an increase in U.S. dollar revenues outside of the Americas for the nine months ended October 31, 2011 as compared to the same period a year ago. The foreign currency impact had the effect of increasing our aggregate revenues by $35.0 million compared to the same period a year ago. As part of our overall growth, we expect the percentage of our revenue generated outside of the Americas to increase as a percentage of our total revenues worldwide.

Cost of Revenues.

 

     Nine Months Ended
October 31,
    Variance  

(In thousands)

   2011     2010     Dollars  

Subscription and support

   $ 260,693      $ 147,127      $ 113,566   

Professional services and other

     91,848        84,375        7,473   
  

 

 

   

 

 

   

 

 

 

Total cost of revenues

   $ 352,541      $ 231,502      $ 121,039   
  

 

 

   

 

 

   

 

 

 

Percent of total revenues

     22 %     19 %  

Cost of revenues was $352.5 million, or 22 percent of total revenues, for the nine months ended October 31, 2011, compared to $231.5 million, or 19 percent of total revenues, during the same period a year ago, an increase of $121.0 million. The increase in absolute dollars was primarily due to an increase of $11.4 million in employee-related costs, an increase of $29.8 million in service delivery costs, primarily due to our efforts in increasing data center capacity, an increase of $50.8 million in depreciation and amortization expenses, $33.2 million of which related to the amortization of acquired developed technology, an increase of $20.0 million in

 

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outside subcontractor and other service costs, an increase of $4.2 million in allocated overhead and an increase of $3.6 million in stock-based expenses. Gross profit margins for professional services and other improved over the same period a year ago primarily due to the improved utilization of existing headcount, a reduction in non-billable headcount since October 31, 2010 and a small benefit from the prospective adoption of the new revenue accounting guidance for multiple-deliverable arrangements.

We intend to continue to invest additional resources in our enterprise cloud computing application service and data center capacity. Additionally, the amortization of acquired developed technology will increase as we acquire additional businesses and technologies. The timing of these expenses will affect our cost of revenues, both in terms of absolute dollars and as a percentage of revenues in future periods.

Research and Development.

 

     Nine Months Ended
October 31,
    Variance  

(In thousands)

   2011     2010     Dollars  

Research and development

   $ 214,734      $ 130,357      $ 84,377   

Percent of total revenues

     13 %     11 %  

Research and development expenses were $214.7 million, or 13 percent of total revenues, for the nine months ended October 31, 2011, compared to $130.4 million, or 11 percent of total revenues, during the same period a year ago, an increase of $84.4 million. The increase in absolute dollars was primarily due to an increase of $52.5 million in employee-related costs, an increase of $19.1 million in stock-based expenses, an increase of $7.8 million in allocated overhead, an increase of $2.4 million in test data lab costs and an increase of $1.2 million in outside subcontractor and other service costs. We increased our research and development headcount by 65 percent since October 31, 2010 in order to improve and extend our service offerings and develop new technologies. Some of the increase in headcount was due to acquired businesses.

Marketing and Sales.

 

     Nine Months Ended
October 31,
    Variance  

(In thousands)

   2011     2010     Dollars  

Marketing and sales

   $ 842,043      $ 558,812      $ 283,231   

Percent of total revenues

     52 %     47 %  

Marketing and sales expenses were $842.0 million, or 52 percent of total revenues, for the nine months ended October 31, 2011, compared to $558.8 million, or 47 percent of total revenues, during the same period a year ago, an increase of $283.2 million. The increase in absolute dollars was primarily due to increases of $183.2 million in employee-related costs, $43.5 million in stock-based expenses, $26.1 million in advertising, marketing and event costs, $17.1 million in allocated overhead and the preliminary settlement of the California wage and hour case discussed in Note 6. Our largest annual marketing event, Dreamforce, occurred during the third quarter of fiscal 2012 and was held in the fourth quarter of the prior fiscal year. The costs associated with this event are reflected in the nine months ended October 31, 2011 results. Our marketing and sales headcount increased by 43 percent since October 31, 2010 as we hired additional sales personnel to focus on adding new customers and increasing penetration within our existing customer base. Some of the increase in headcount was due to acquired businesses.

General and Administrative.

 

     Nine Months Ended
October 31,
    Variance  

(In thousands)

   2011     2010     Dollars  

General and administrative

   $ 254,016      $ 181,713      $ 72,303   

Percent of total revenues

     15 %     15 %  

 

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General and administrative expenses were $254.0 million, or 15 percent of total revenues, for the nine months ended October 31, 2011, compared to $181.7 million, or 15 percent of total revenues, during the same period a year ago, an increase of $72.3 million. The increase was primarily due to an increase of $40.0 million in employee-related costs, an increase of $14.3 million in stock-based expenses, an increase of $1.5 million in depreciation and amortization and an increase of $15.4 million of professional and outside service costs. Our general and administrative headcount increased by 46 percent since October 31, 2010 as we added personnel to support our growth.

Income (loss) from operations.

 

     Nine Months Ended
October 31,
    Variance  

(In thousands)

   2011     2010     Dollars  

Income (loss) from operations

   $ (28,708   $ 97,888      $ (126,596

Percent of total revenues

     (2 )%     8 %  

Loss from operations for the nine months ended October 31, 2011 was $28.7 million and included $159.2 million of stock-based expenses and $47.4 million of amortization of purchased intangibles. During the same period a year ago, operating income was $97.9 million and included $78.7 million of stock-based expenses and $12.8 million of amortization of purchased intangibles.

Investment income.

 

     Nine Months Ended
October 31,
    Variance  

(In thousands)

   2011     2010     Dollars  

Investment income

   $ 18,303      $ 28,309      $ (10,006

Percent of total revenues

     1 %     2 %  

Investment income consists of income on cash and marketable securities balances. Investment income was $18.3 million for the nine months ended October 31, 2011 and was $28.3 million during the same period a year ago. The decrease was primarily due to a reduction in realized gains from sales of marketable securities, the decrease in marketable securities balances and lower interest rates.

Interest expense.

 

     Nine Months Ended
October 31,
    Variance  

(In thousands)

   2011     2010     Dollars  

Interest expense

   $ (11,376   $ (21,619   $ 10,243   

Percent of total revenues

     (1 )%     (2 )%  

Interest expense consists primarily of interest on our Notes and capital leases. Interest expense was $11.4 million, net of interest costs capitalized, for the nine months ended October 31, 2011 and was $21.6 million during the same period a year ago. During the nine months ended October 31, 2011, we capitalized $12.1 million of interest costs related to major construction projects, specifically our campus project, which began during the fourth quarter of fiscal 2011, and our capitalized internal-use software development costs. Capitalized interest during the same period a year ago was immaterial. We will continue to capitalize interest on these projects until these assets are ready for service.

 

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Other income (expense).

 

     Nine Months Ended
October 31,
    Variance  

(In thousands)

   2011     2010     Dollars  

Other income (expense)

   $ (4,001   $ (4,659   $ 658   

Other income (expense) primarily consists of realized gains and losses resulting from strategic investment activity and foreign currency transaction gains and losses. The decrease is primarily due to the net gain of $1.2 million from activity within our portfolio of noncontrolling equity and debt investments in privately-held companies offset by realized and unrealized losses on foreign currency transactions for the nine months ended October 31, 2011 compared to the same period a year ago.

Benefit (provision) for Income Taxes.

 

     Nine Months Ended
October 31,
    Variance  

(In thousands)

   2011     2010     Dollars  

Benefit (provision) for income taxes

   $ 18,288      $ (41,092   $ 59,380   

Effective tax rate

     71 %     41 %  

The benefit for income taxes was $18.3 million for the nine months ended October 31, 2011, compared to an income tax provision of $41.1 million during the same period a year ago.

Our effective tax rate for the nine months ended October 31, 2011 was 71 percent, which was higher than the federal statutory tax rate of 35 percent. The higher tax rate was attributable to a detrimental foreign tax differential and non-deductible acquisition expenses, offset by state income taxes, Federal and California tax credits and the tax benefit from the May 2011 acquisition of Radian6. The combined effect of these tax items on a small net loss before income taxes was significant resulting in a high effective tax rate.

Our effective tax rate of 41 percent for the nine months ended October 31, 2010 was higher than the federal statutory rate of 35 percent primarily due to state income taxes, a detrimental foreign tax rate differential, non-deductible acquisition expenses and the unfavorable impact of a change in California tax law, which was partially offset by California tax credits.

New Accounting Pronouncements

In December 2010, the FASB issued Accounting Standards Update No. 2010-29, Disclosure of Supplementary Pro Forma Information for Business Combinations (Topic 805)Business Combinations (“ASU 2010-29”), to improve consistency in how the pro forma disclosures are calculated. Additionally, ASU 2010-29 enhances the disclosure requirements and requires description of the nature and amount of any material, nonrecurring pro forma adjustments directly attributable to a business combination. ASU 2010-29 is effective for us in fiscal 2013 and should be applied prospectively to business combinations for which the acquisition date is after the effective date. We do not believe the impact of the pending adoption of ASU 2010-29 will have a significant effect on our consolidated financial statements.

In June 2011, the FASB issued Accounting Standards Update No. 2011-05, Comprehensive Income (Topic 220)—Presentation of Comprehensive Income (“ASU 2011-05”), to require an entity to present the total of comprehensive income, the components of net income, and the components of other comprehensive income either in a single continuous statement of comprehensive income or in two separate but consecutive statements.

 

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ASU 2011-05 eliminates the option to present the components of other comprehensive income as part of the statement of equity. ASU 2011-05 is effective for us in fiscal 2013 and should be applied retrospectively. We are currently evaluating the impact of our pending adoption of ASU 2011-05 on our consolidated financial statements.

Liquidity and Capital Resources

At October 31, 2011, our principal sources of liquidity were cash, cash equivalents and marketable securities totaling $1.3 billion and accounts receivable of $312.3 million.

Net cash provided by operating activities was $351.2 million during the nine months ended October 31, 2011 and $293.3 million during the same period a year ago. Cash provided by operating activities has historically been affected by: the amount of net income (loss); sales of subscriptions, support and professional services; changes in working capital accounts, particularly increases and seasonality in accounts receivable and deferred revenue as described above, the timing of commission and bonus payments, and the timing of collections from large enterprise customers; and add-backs of non-cash expense items such as depreciation and amortization, amortization of debt discount and the expense associated with stock-based awards.

Net cash used in investing activities was $332.4 million during the nine months ended October 31, 2011 and $679.8 million during the same period a year ago. The net cash used in investing activities during the nine months ended October 31, 2011 primarily related to the purchase of Assistly in September 2011, the purchase of Radian6 in May 2011, the purchase of Manymoon in February 2011, investment of cash balances, capital expenditures and strategic investments offset by proceeds from sales and maturities of marketable securities.

Net cash provided by financing activities was $63.4 million during the nine months ended October 31, 2011 and $3.4 million during the same period a year ago. Net cash provided by financing activities during the nine months ended October 31, 2011 consisted primarily of $90.4 million of proceeds from the exercise of employee stock options and $11.0 million of excess tax benefits from employee stock plans, offset by $21.8 million of principal payments on capital leases and $16.2 million of contingent consideration payments.

In January 2010, we issued the Notes and concurrently entered into convertible notes hedges (the “Note Hedges”) and separate warrant transactions (the “Warrants”). The Notes will mature on January 15, 2015, unless converted earlier.

For 20 trading days during the 30 consecutive trading days ended July 31, 2011 and October 31, 2011, our common stock traded at a price exceeding 130 percent of the conversion price of $85.36 per share applicable to the Notes. Accordingly, based on the terms of the Notes, the Notes were convertible at the option of the holder as of October 31, 2011 and continue to be convertible at the holders’ option for the quarter ending January 31, 2012. Upon conversion of any Notes, we will deliver cash up to the principal amount of the Notes and, with respect to any excess conversion value greater than the principal amount of the Notes, shares of our common stock, cash or a combination of both. Therefore, for the quarter ending January 31, 2012, the Notes will remain classified as a current liability on our condensed consolidated balance sheet.

Our cash, cash equivalents and marketable securities are comprised primarily of corporate notes and obligations, U.S. agency obligations, U.S. treasury securities, mortgage backed securities, collateralized mortgage obligations, time deposits, money market mutual funds, government obligations and municipal securities.

As of October 31, 2011, we have a total of $11.2 million in letters of credit outstanding in favor of certain landlords for office space. To date, no amounts have been drawn against the letters of credit, which renew annually and mature at various dates through September 2021.

 

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We do not have any special purpose entities, and other than operating leases we do not engage in off-balance sheet financing arrangements. Additionally, we currently do not have a bank line of credit. We may in the future raise additional funds for general corporate purposes.

Our principal commitments consist of obligations under leases for office space and co-location facilities for data center capacity and our development and test data center, and computer equipment and certain fixed assets. At October 31, 2011, the future non-cancelable minimum payments under these commitments were as follows (in thousands):

 

     Capital
Leases
    Operating
Leases
 

Fiscal Period:

    

Remaining three months of fiscal 2012

   $ 7,564      $ 30,484   

Fiscal 2013

     28,922        119,782   

Fiscal 2014

     24,505        95,830   

Fiscal 2015

     4,496        56,846   

Fiscal 2016

     1,925        49,727   

Thereafter

     1,123        125,190   
  

 

 

   

 

 

 

Total minimum lease payments

     68,535      $ 477,859   
    

 

 

 

Less: amount representing interest

     (3,554  
  

 

 

   

Present value of capital lease obligations

   $ 64,981     
  

 

 

   

Our lease agreements provide us with the option to renew. Our future operating lease obligations would change if we exercised these options and if we entered into additional operating lease agreements as we expand our operations.

We entered into a definitive agreement to acquire Model Metrics to expand our mobile and social consulting services for an estimated purchase consideration of approximately $57.6 million in cash, net of cash acquired. This transaction is expected to close in this fiscal fourth quarter, subject to customary closing conditions.

We anticipate making a tax payment of approximately $40.0 million during the first quarter of fiscal 2013 as a result of the Radian6 transaction.

We believe our existing cash, cash equivalents and short-term marketable securities and cash provided by operating activities will be sufficient to meet our working capital and capital expenditure needs over the next 12 months.

We may in the future enter into arrangements to acquire or invest in complementary businesses, joint ventures, services and technologies, and intellectual property rights. While we believe we have sufficient financial resources to do so, we may be required to seek additional equity or debt financing. Additional funds may not be available on terms favorable to us or at all.

 

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ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

Foreign currency exchange risk

Our results of operations and cash flows are subject to fluctuations due to changes in foreign currency exchange rates, particularly changes in the Euro, British Pound Sterling, Canadian dollar, Swiss franc, Singapore dollar, Japanese Yen and Australian dollar. We seek to minimize the impact of certain foreign currency fluctuations by hedging certain balance sheet exposures with foreign currency forward contracts. Any gain or loss from settling these contracts is offset by the loss or gain derived from the underlying balance sheet exposures. In accordance with our policy, the hedging contracts we enter into have maturities of less than three months. Additionally, by policy, we do not enter into any hedging contracts for trading or speculative purposes.

Interest rate sensitivity

We had cash, cash equivalents and marketable securities totaling $1.3 billion at October 31, 2011. This amount was invested primarily in money market funds, time deposits, corporate notes and bonds, government securities and other debt securities with credit ratings of at least single A or better. The cash, cash equivalents and short-term marketable securities are held for working capital purposes. Our investments are made for capital preservation purposes. We do not enter into investments for trading or speculative purposes.

Our cash equivalents and our portfolio of marketable securities are subject to market risk due to changes in interest rates. Fixed rate securities may have their market value adversely impacted due to a rise in interest rates, while floating rate securities may produce less income than expected if interest rates fall. Due in part to these factors, our future investment income may fall short of expectation due to changes in interest rates or we may suffer losses in principal if we are forced to sell securities that decline in market value due to changes in interest rates. However because we classify our debt securities as “available for sale,” no gains or losses are recognized due to changes in interest rates unless such securities are sold prior to maturity or declines in fair value are determined to be other-than-temporary. Our fixed-income portfolio is subject to interest rate risk.

An immediate increase or decrease in interest rates of 100-basis points at October 31, 2011 could result in a $21.0 million market value increase or reduction of the same amount. This estimate is based on a sensitivity model that measures market value changes when changes in interest rates occur. Fluctuations in the value of our investment securities caused by a change in interest rates (gains or losses on the carrying value) are recorded in other comprehensive income, and are realized only if we sell the underlying securities.

At January 31, 2011, we had cash, cash equivalents and marketable securities totaling $1.4 billion. The fixed-income portfolio was also subject to interest rate risk. Changes in interest rates of 100-basis points would have resulted in market value changes of $27.7 million.

Market Risk and Market Interest Risk

In January 2010, we issued at par value $575.0 million of 0.75% Notes. Holders may convert their Notes prior to maturity upon the occurrence of certain circumstances. Upon conversion, we would pay the holder an amount of cash equal to the principal amount of the Notes. Amounts in excess of the principal amount, if any, may be paid in cash or stock at our option. Concurrent with the issuance of the Notes, we entered into separate note hedging transactions and the sale of warrants. These separate transactions were completed to reduce the potential economic dilution from the conversion of the Notes.

For 20 trading days during the 30 consecutive trading days ended July 31, 2011 and October 31, 2011, our common stock traded at a price exceeding 130 percent of the conversion price of $85.36 per share applicable to the Notes. Accordingly, based on the terms of the Notes, the Notes were convertible at the option of the holder as of October 31, 2011 and continue to be convertible at the holders’ option for the quarter ending January 31, 2012. Upon conversion of any Notes, we will deliver cash up to the principal amount of the Notes and, with respect to

 

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any excess conversion value greater than the principal amount of the Notes, shares of our common stock, cash or a combination of both. Therefore, for the quarter ending January 31, 2012, the Notes will remain classified as a current liability on our condensed consolidated balance sheet.

The Notes have a fixed annual interest rate of 0.75% and therefore, we do not have economic interest rate exposure on the Notes. However, the value of the Notes is exposed to interest rate risk. Generally, the fair market value of our fixed interest rate Notes will increase as interest rates fall and decrease as interest rates rise. In addition, the fair value of our Notes is affected by our stock price. The total estimated fair value of our Notes at October 31, 2011 was $961.7 million and the fair value was determined based on the closing trading price per $100 of the Notes as of the last day of trading for the third quarter of fiscal 2012, which was $167.29.

We have an investment portfolio that includes strategic investments in public and privately-held companies, many of which are in the development stage. When our ownership interests are less than 20 percent and we do not have the ability to exert significant influence, we account for investments in non-marketable equity and debt securities of the privately-held companies using the cost method of accounting. Otherwise, we account for the investments using the equity method of accounting. At October 31, 2011, the fair value of these investments was $55.0 million.

 

ITEM 4. CONTROLS AND PROCEDURES

(a) Evaluation of disclosure controls and procedures

Under the supervision and with the participation of our management, including our principal executive officer and principal financial officer, we conducted an evaluation of the effectiveness of the design and operation of our disclosure controls and procedures, as defined in Rules 13a-15(e) and 15d-15(e) under the Exchange Act, as of the end of the period covered by this report (the “Evaluation Date”).

In designing and evaluating our disclosure controls and procedures, management recognizes that any disclosure controls and procedures, no matter how well designed and operated, can provide only reasonable assurance of achieving the desired control objectives. In addition, the design of disclosure controls and procedures must reflect the fact that there are resource constraints and that management is required to apply its judgment in evaluating the benefits of possible controls and procedures relative to their costs.

Based on management’s evaluation, our principal executive officer and principal financial officer concluded that our disclosure controls and procedures are designed to, and are effective to, provide assurance at a reasonable level that the information we are required to disclose in reports that we file or submit under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in Securities and Exchange Commission rules and forms, and that such information is accumulated and communicated to our management, including our chief executive officer and chief financial officer, as appropriate, to allow timely decisions regarding required disclosures.

(b) Management’s Report on Internal Control Over Financial Reporting

Under the supervision and with the participation of our management, including our principal executive officer and principal financial officer, we conducted an evaluation of any changes in our internal control over financial reporting (as such term is defined in Rules 13a-15(f) and 15d-15(f) under the Exchange Act) that occurred during our most recently completed fiscal quarter. Based on that evaluation, our principal executive officer and principal financial officer concluded that there has not been any material change in our internal control over financial reporting during the quarter covered by this report that materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.

 

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PART II. OTHER INFORMATION

 

ITEM 1. LEGAL PROCEEDINGS

In the ordinary course of business, we are involved in various legal proceedings and claims related to alleged infringement of third-party patents and other intellectual property rights, commercial, employment, wage and hour, and other claims.

We have been, and may in the future be, put on notice and/or sued by third parties for alleged infringement of their proprietary rights, including patent infringement. We evaluate these claims and lawsuits with respect to their potential merits, our potential defenses and counter claims, and the expected effect on us. Our technologies may be subject to injunction if they are found to infringe the rights of a third party. In addition, many of our subscription agreements r