10-Q 1 d378216d10q.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 July 31, 2012

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 (§232.405 of this chapter) 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 July 31, 2012, there were approximately 139.0 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 July 31, 2012 and January 31, 2012

     1   
 

Condensed Consolidated Statements of Operations for the three and six months ended July 31, 2012 and 2011

     2   
 

Condensed Consolidated Statements of Comprehensive Income (Loss) for the three and six months ended July 31, 2012 and 2011

     3   
 

Condensed Consolidated Statements of Cash Flows for the three and six months ended July 31, 2012 and 2011

     4   
 

Notes to Condensed Consolidated Financial Statements

     5   

Item 2.

 

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

     28   

Item 3.

 

Quantitative and Qualitative Disclosures About Market Risk

     50   

Item 4.

 

Controls and Procedures

     51   
  PART II. OTHER INFORMATION   

Item 1.

 

Legal Proceedings

     52   

Item 1A.

 

Risk Factors

     53   

Item 2.

 

Unregistered Sales of Equity Securities and Use of Proceeds

     65   

Item 3.

 

Defaults Upon Senior Securities

     65   

Item 4.

 

Mine Safety Disclosures

     65   

Item 5.

 

Other Information

     65   

Item 6.

 

Exhibits

     65   


Table of Contents
PART I. FINANCIAL INFORMATION

 

ITEM 1. FINANCIAL STATEMENTS

salesforce.com, inc.

Condensed Consolidated Balance Sheets

(in thousands)

 

     July 31,
2012
     January 31,
2012
 
     (unaudited)         

Assets

     

Current assets:

     

Cash and cash equivalents

   $ 1,000,730       $ 607,284   

Short-term marketable securities

     106,933         170,582   

Accounts receivable, net

     446,917         683,745   

Deferred commissions

     94,921         98,471   

Deferred income taxes

     56,723         31,821   

Prepaid expenses and other current assets

     146,901         80,319   
  

 

 

    

 

 

 

Total current assets

     1,853,125         1,672,222   

Marketable securities, noncurrent

     696,602         669,308   

Property and equipment, net

     556,776         527,946   

Deferred commissions, noncurrent

     77,010         78,149   

Deferred income taxes, noncurrent

     108,031         87,587   

Capitalized software, net

     173,456         188,412   

Goodwill

     840,531         785,381   

Other assets, net

     148,039         155,149   
  

 

 

    

 

 

 

Total assets

   $ 4,453,570       $ 4,164,154   
  

 

 

    

 

 

 

Liabilities, temporary equity and stockholders’ equity

     

Current liabilities:

     

Accounts payable

   $ 69,339       $ 33,258   

Accrued expenses and other liabilities

     482,888         502,442   

Deferred revenue

     1,268,407         1,291,622   

Convertible senior notes, net

     508,533         496,149   
  

 

 

    

 

 

 

Total current liabilities

     2,329,167         2,323,471   

Income taxes payable, noncurrent

     47,165         37,258   

Long-term lease liabilities and other

     49,790         48,651   

Deferred revenue, noncurrent

     68,777         88,673   
  

 

 

    

 

 

 

Total liabilities

     2,494,899         2,498,053   
  

 

 

    

 

 

 

Temporary equity

     66,357         78,741   
  

 

 

    

 

 

 

Stockholders’ equity:

     

Common stock

     139         137   

Additional paid-in capital

     1,742,286         1,415,077   

Accumulated other comprehensive income

     19,730         12,683   

Retained earnings

     130,159         159,463   
  

 

 

    

 

 

 

Total stockholders’ equity

     1,892,314         1,587,360   
  

 

 

    

 

 

 

Total liabilities, temporary equity and stockholders’ equity

   $ 4,453,570       $ 4,164,154   
  

 

 

    

 

 

 

See accompanying Notes.

 

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salesforce.com, inc.

Condensed Consolidated Statements of Operations

(in thousands, except per share data)

(unaudited)

 

     Three Months Ended July 31,      Six Months Ended July 31,  
     2012      2011      2012      2011  

Revenues:

           

Subscription and support

   $ 687,493       $ 509,279       $ 1,342,713       $ 982,783   

Professional services and other

     44,156         36,723         84,403         67,583   
  

 

 

    

 

 

    

 

 

    

 

 

 

Total revenues

     731,649         546,002         1,427,116         1,050,366   

Cost of revenues (1)(2):

           

Subscription and support

     118,519         89,144         227,263         164,387   

Professional services and other

     43,899         31,766         86,706         59,589   
  

 

 

    

 

 

    

 

 

    

 

 

 

Total cost of revenues

     162,418         120,910         313,969         223,976   

Gross profit

     569,231         425,092         1,113,147         826,390   

Operating expenses (1)(2):

           

Research and development

     99,442         73,393         194,218         138,685   

Marketing and sales

     380,160         283,001         749,949         537,472   

General and administrative

     103,095         84,446         204,695         168,784   
  

 

 

    

 

 

    

 

 

    

 

 

 

Total operating expenses

     582,697         440,840         1,148,862         844,941   

Loss from operations

     (13,466      (15,748      (35,715      (18,551

Investment income

     7,173         5,112         11,634         13,167   

Interest expense

     (8,033      (3,846      (14,403      (7,517

Other income (expense)

     294         (3,231      (416      (4,031
  

 

 

    

 

 

    

 

 

    

 

 

 

Loss before benefit from income taxes

     (14,032      (17,713      (38,900      (16,932

Benefit from income taxes

     4,203         13,445         9,596         13,194   
  

 

 

    

 

 

    

 

 

    

 

 

 

Net loss

   $ (9,829    $ (4,268    $ (29,304    $ (3,738
  

 

 

    

 

 

    

 

 

    

 

 

 

Basic net loss per share

   $ (0.07    $ (0.03    $ (0.21    $ (0.03

Diluted net loss per share

   $ (0.07    $ (0.03    $ (0.21    $ (0.03

Shares used in computing basic net loss per share

     139,425         135,093         138,789         134,273   

Shares used in computing diluted net loss per share

     139,425         135,093         138,789         134,273   

 

           
(1)    Amounts include amortization of purchased intangibles from    Three Months Ended July 31,      Six Months Ended July 31,  
         business combinations, as follows:    2012      2011      2012      2011  

Cost of revenues

   $ 17,668       $ 16,373       $ 35,116       $ 25,468   

Marketing and sales

     2,407         2,306         5,834         3,546   
     Three Months Ended July 31,      Six Months Ended July 31,  
(2)    Amounts include stock-based expenses, as follows:    2012      2011      2012      2011  

Cost of revenues

   $ 7,864       $ 4,379       $ 15,117       $ 8,030   

Research and development

     16,089         11,188         31,756         19,027   

Marketing and sales

     44,781         27,114         86,768         50,901   

General and administrative

     16,683         11,913         33,042         24,194   

See accompanying Notes.

 

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salesforce.com, inc.

Condensed Consolidated Statements of Comprehensive Income (Loss)

(in thousands)

(unaudited)

 

     Three Months Ended
July 31,
    Six Months Ended
July 31,
 
     2012     2011     2012     2011  

Net loss

   $ (9,829   $ (4,268   $ (29,304   $ (3,738

Other comprehensive income, before tax and net of reclassification adjustments:

        

Foreign currency translation and other gains (losses)

     10,135        5,858        6,947        (1,219

Unrealized gains (losses) on investments

     (961     2,052        159        2,745   
  

 

 

   

 

 

   

 

 

   

 

 

 

Other comprehensive income, before tax

     9,174        7,910        7,106        1,526   

Tax effect

     359        (767     (59     (1,026
  

 

 

   

 

 

   

 

 

   

 

 

 

Other comprehensive income, net of tax

     9,533        7,143        7,047        500   
  

 

 

   

 

 

   

 

 

   

 

 

 

Comprehensive income (loss)

   $ (296   $ 2,875      $ (22,257   $ (3,238
  

 

 

   

 

 

   

 

 

   

 

 

 

See accompanying Notes.

 

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salesforce.com, inc.

Condensed Consolidated Statements of Cash Flows

(in thousands)

(unaudited)

 

     Three Months Ended
July 31,
    Six Months Ended
July 31,
 
     2012     2011     2012     2011  

Operating activities:

        

Net loss

   $ (9,829   $ (4,268   $ (29,304   $ (3,738

Adjustments to reconcile net loss to net cash provided by operating activities:

        

Depreciation and amortization

     49,999        40,239        99,440        69,832   

Amortization of debt discount and transaction costs

     6,371        2,077        11,040        4,332   

Amortization of deferred commissions

     35,783        24,916        72,029        49,591   

Expenses related to stock-based plans

     85,417        54,594        166,683        102,152   

Excess tax benefits from employee stock plans

     (14,702     (2,086     (25,745     (4,120

Changes in assets and liabilities:

        

Accounts receivable, net

     (75,522     (66,076     237,138        90,051   

Deferred commissions

     (35,222     (26,137     (67,340     (46,641

Prepaid expenses and other current assets

     (35,747     (9,611     (56,096     (18,994

Other assets

     (891     (1,913     864        (4,626

Accounts payable

     49,586        4,121        36,081        2,984   

Accrued expenses and other current liabilities

     78,485        47,624        (52,270     (18,017

Deferred revenue

     2,469        19,453        (43,111     (355
  

 

 

   

 

 

   

 

 

   

 

 

 

Net cash provided by operating activities

     136,197        82,933        349,409        222,451   
  

 

 

   

 

 

   

 

 

   

 

 

 

Investing activities:

        

Business combinations, net of cash acquired

     (10,078     (285,335     (58,991     (298,670

Land activity and building improvements

     0        (5,422     (4,106     (6,436

Strategic investments

     (1,129     (7,782     (3,794     (13,215

Purchases of marketable securities

     (107,101     (75,437     (594,904     (307,564

Sales of marketable securities

     472,710        84,879        548,232        436,949   

Maturities of marketable securities

     47,188        12,220        84,887        18,735   

Capital expenditures

     (29,304     (45,051     (74,025     (72,365
  

 

 

   

 

 

   

 

 

   

 

 

 

Net cash provided by (used in) investing activities

     372,286        (321,928     (102,701     (242,566
  

 

 

   

 

 

   

 

 

   

 

 

 

Financing activities:

        

Proceeds from equity plans

     33,824        42,282        127,391        74,568   

Excess tax benefits from employee stock plans

     14,702        2,086        25,745        4,120   

Contingent consideration payment related to prior business combinations

     0        (13,400     0        (16,200

Principal payments on capital lease obligations

     (7,479     (10,549     (15,053     (14,111
  

 

 

   

 

 

   

 

 

   

 

 

 

Net cash provided by financing activities

     41,047        20,419        138,083        48,377   
  

 

 

   

 

 

   

 

 

   

 

 

 

Effect of exchange rate changes

     10,415        3,758        8,655        (2,760
  

 

 

   

 

 

   

 

 

   

 

 

 

Net increase (decrease) in cash and cash equivalents

     559,945        (214,818     393,446        25,502   

Cash and cash equivalents, beginning of period

     440,785        664,612        607,284        424,292   
  

 

 

   

 

 

   

 

 

   

 

 

 

Cash and cash equivalents, end of period

   $ 1,000,730      $ 449,794      $ 1,000,730      $ 449,794   
  

 

 

   

 

 

   

 

 

   

 

 

 

Supplemental cash flow disclosure:

        

Cash paid during the period for:

        

Interest, net

   $ 2,766      $ 2,749      $ 3,390      $ 3,086   

Income taxes, net of tax refunds

   $ 3,506      $ 1,028      $ 45,467      $ 12,006   

Non-cash financing and investing activities:

        

Fixed assets acquired under capital leases

   $ 8,923      $ 0      $ 15,797      $ 47,203   

Fair value of stock options assumed

   $ 0      $ 4,729      $ 2,204      $ 4,729   

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 services. The Company is dedicated to helping customers of all sizes and industries worldwide transform themselves into social enterprises. Social enterprises leverage social, mobile and open technologies to place their customers and employees at the center of their business and to engage and collaborate with them in new and powerful ways.

Fiscal Year

The Company’s fiscal year ends on January 31. References to fiscal 2013, for example, refer to the fiscal year ending January 31, 2013.

Basis of Presentation

The accompanying condensed consolidated balance sheet as of July 31, 2012 and the condensed consolidated statements of operations, the condensed consolidated statement of comprehensive income (loss) and the condensed consolidated statements of cash flows for the three and six months ended July 31, 2012 and 2011, respectively, are unaudited. The condensed consolidated balance sheet data as of January 31, 2012 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, 2012, which was filed with the Securities and Exchange Commission (the “SEC”) on March 9, 2012. The accompanying statements should be read in conjunction with the audited consolidated financial statements and related notes contained in the Company’s fiscal 2012 Form 10-K. During the first quarter of fiscal 2013, the Company adopted the requirements of Accounting Standards Update No. 2011-05, Comprehensive Income (Topic 220)—Presentation of Comprehensive Income by presenting the total of comprehensive income (loss), the components of net loss, and the components of other comprehensive income in two separate but consecutive statements.

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 July 31, 2012, and its results of operations, including its comprehensive income (loss), and its cash flows for the three and six months ended July 31, 2012 and 2011. All adjustments are of a normal recurring nature. The results for the three and six months ended July 31, 2012 are not necessarily indicative of the results to be expected for any subsequent quarter or for the fiscal year ending January 31, 2013.

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 condensed 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,

 

   

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.

 

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Principles of Consolidation

The condensed 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 as one operating segment. Operating segments are defined as components of an enterprise for 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. Over the past few years, the Company has completed several acquisitions. These acquisitions have allowed the Company to expand its offerings, presence and reach in various segments of the enterprise cloud computing market. While the Company has offerings in multiple enterprise cloud computing market segments, the Company’s business operates in one operating segment because the Company’s decision making group evaluates the Company’s financial information and resources and assesses the performance of these resources on a consolidated basis. Since the Company operates in one operating segment, all required financial segment information can be found in the condensed consolidated financial statements.

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 July 31, 2012 and one customer accounted for six percent of accounts receivable at January 31, 2012. No single customer accounted for five percent or more of total revenue in the three and six months ended July 31, 2012 and 2011.

As of both July 31, 2012 and January 31, 2012, assets located outside the Americas were 12 percent and 13 percent of total assets, respectively.

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

 

     Three Months Ended
July  31,
     Six Months Ended
July 31,
 
     2012      2011      2012      2011  

Americas

   $ 507,974       $ 366,916       $ 992,927       $ 706,934   

Europe

     124,609         102,056         242,903         196,451   

Asia Pacific

     99,066         77,030         191,286         146,981   
  

 

 

    

 

 

    

 

 

    

 

 

 
   $ 731,649       $ 546,002       $ 1,427,116       $ 1,050,366   
  

 

 

    

 

 

    

 

 

    

 

 

 

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 services and from customers purchasing additional support beyond the standard support that is included in the basic subscription fees; 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;

 

   

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.

 

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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 updated accounting guidance to those multiple-deliverable arrangements entered into or materially modified on or after February 1, 2011, which was the beginning of the Company’s fiscal 2012.

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 for the fiscal year ended January 31, 2012. As of July 31, 2012, the deferred professional services revenue and deferred costs under the previous accounting guidance are $17.4 million and $9.9 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, 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.

 

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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.

As a result of the updated accounting guidance previously described, billings against professional services arrangements entered into prior to February 1, 2011 were generally 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.

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.

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.

 

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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 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 measures its cash equivalents, marketable securities and foreign currency derivative contracts at fair value.

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 additional disclosures regarding our fair value measurements are included in Note 2.

Property and Equipment

Property and equipment are stated at cost. Depreciation is calculated on a straight-line basis over the estimated useful lives of those assets.

Capitalized Software Costs

The Company capitalizes costs related to its enterprise cloud computing services and certain projects for internal use incurred during the application development stage. Costs related to preliminary project activities and post implementation activities are expensed as incurred. Internal-use software is amortized on a straight line basis over its estimated useful life, generally three years. Management evaluates the useful lives of these assets on an annual basis and tests for impairment whenever events or changes in circumstances occur that could impact the recoverability of these assets.

Goodwill, Intangible Assets, Long-Lived Assets and Impairment Assessments

The Company evaluates and tests the recoverability of its goodwill for impairment at least annually during the fourth quarter or more often if and when circumstances indicate that goodwill may not be recoverable.

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.

The Company evaluates the recoverability of its long-lived assets for possible impairment whenever events or circumstances indicate that the carrying amount of such assets may not be recoverable. If such review indicates that the carrying amount of long-lived assets is not recoverable, the carrying amount of such assets is reduced to fair value.

Business Combinations

The Company uses its best estimates and assumptions to accurately assign fair value to the tangible 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.

 

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In addition, income tax uncertainties and tax related valuation allowances assumed in connection with a business combination are initially estimated as of the acquisition date. The Company continues to collect information and 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. Subsequent to the measurement period, changes to these income tax uncertainties 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 related to stock options and restricted stock awards on a straight-line basis over the requisite service period of the awards, which is generally the vesting term of four years. The Company recognizes stock-based expenses related to shares issued pursuant to its Employee Stock Purchase Plan (“ESPP”) on a straight-line basis over the offering period, which is 12 months. Stock-based expenses are recognized net of estimated forfeiture activity.

The fair value of each stock option grant and stock purchase right granted under the ESPP 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
July  31,
    Six Months Ended
July 31,
 

Stock Options

   2012     2011     2012     2011  

Volatility

     47     47 - 50     47 - 51     47 - 50

Estimated life

     3.7 years        3.7 years        3.7 years        3.7 years   

Risk-free interest rate

     0.43 - 0.66     1.07 - 1.39     0.43 - 0.77     1.07 - 1.77

Dividend yield

     0        0        0        0   

Weighted-average fair value per share of grants

   $ 47.40      $ 62.64      $ 52.90      $ 61.13   
     Three Months Ended
July 31,
    Six Months Ended
July 31,
 

ESPP

   2012     2011     2012     2011  

Volatility

     42 - 46     n/a        42 - 46     n/a   

Estimated life

     0.75 years        n/a        0.75 years        n/a   

Risk-free interest rate

     0.12 - 0.13     n/a        0.12 - 0.13     n/a   

Dividend yield

     0        n/a        0        n/a   

Weighted-average fair value per share of grants

   $ 40.37        n/a      $ 40.37        n/a   

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 stock options and stock purchase rights.

The estimated life for the stock options was based on an actual analysis of expected life. The estimated life for the ESPP was based on the two purchase periods within each offering period. The risk free interest rate is based on the rate for a U.S. government security with the same estimated life at the time of the option grant and the stock purchase rights.

There was no stock-based expense in the three or six months ended July 31, 2011 because the Company did not commence the ESPP until December 2011.

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.

 

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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. During the quarter ended July 31, 2012, the Company modified its transfer pricing agreements which changed the functional currency of some of its foreign subsidiaries. As a result of this change, the balance of other comprehensive income on the Company’s condensed consolidated balance sheet as of the date prior to this change, will no longer revalue with fluctuations in foreign currency. All amounts recorded to other comprehensive income subsequent to the date of this change, will revalue with fluctuations in foreign currency.

Warranties and Indemnification

The Company’s enterprise cloud computing services are 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.

New Accounting Pronouncement

In September 2011, the FASB issued Accounting Standards Update No. 2011-08, Intangibles—Goodwill and Other (Topic 350)—Testing Goodwill for Impairment (ASU 2011-08), to allow entities to use a qualitative approach to test goodwill for impairment. ASU 2011-08 permits an entity to first perform a qualitative assessment to determine whether it is more likely than not that the fair value of a reporting unit is less than its carrying value. If it is concluded that this is the case, it is necessary to perform the currently prescribed two-step goodwill impairment test. Otherwise, the two-step goodwill impairment test is not required. The Company plans to adopt ASU 2011-08 by the fourth quarter of fiscal 2013 and does not believe that the adoption will have a material effect on the condensed consolidated financial statements.

2. Investments

Marketable Securities

At July 31, 2012, marketable securities consisted of the following (in thousands):

 

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Investments classified as Marketable Securities

   Amortized
Cost
     Unrealized
Gains
     Unrealized
Losses
    Fair Value  

Corporate notes and obligations

   $ 525,251       $ 4,764       $ (472   $ 529,543   

U.S. treasury securities

     32,623         32         0        32,655   

Mortgage backed securities

     15,740         390         (64     16,066   

Government obligations

     3,102         81         0        3,183   

Municipal securities

     2,864         1         (24     2,841   

Collateralized mortgage obligations

     133,628         1,914         (502     135,040   

U.S. agency obligations

     84,035         174         (2     84,207   
  

 

 

    

 

 

    

 

 

   

 

 

 

Total marketable securities

   $ 797,243       $ 7,356       $ (1,064   $ 803,535   
  

 

 

    

 

 

    

 

 

   

 

 

 

At January 31, 2012, 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

   $ 502,894       $ 3,485       $ (1,607   $ 504,772   

U.S. treasury securities

     79,290         70         (2     79,358   

Mortgage backed securities

     15,206         375         (155     15,426   

Government obligations

     3,132         78         0        3,210   

Municipal securities

     8,753         47         (11     8,789   

Collateralized mortgage obligations

     118,729         2,192         (426     120,495   

U.S. agency obligations

     107,515         331         (6     107,840   
  

 

 

    

 

 

    

 

 

   

 

 

 

Total marketable securities

   $ 835,519       $ 6,578       $ (2,207   $ 839,890   
  

 

 

    

 

 

    

 

 

   

 

 

 

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

 

     July 31,
2012
     January 31,
2012
 

Recorded as follows:

     

Short-term (due in one year or less)

   $ 106,933       $ 170,582   

Long-term (due between one and 3 years)

     696,602         669,308   
  

 

 

    

 

 

 
   $ 803,535       $ 839,890   
  

 

 

    

 

 

 

As of July 31, 2012, 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

   $ 53,393       $ (283   $ 13,374       $ (189   $ 66,767       $ (472

Mortgage backed securities

     1,632         (38     422         (26     2,054         (64

Municipal securities

     0         0        1,675         (24     1,675         (24

Collateralized mortgage obligations

     31,409         (184     17,096         (318     48,505         (502

U.S. agency obligations

     4,034         (2     0         0        4,034         (2
  

 

 

    

 

 

   

 

 

    

 

 

   

 

 

    

 

 

 
   $ 90,468       $ (507   $ 32,567       $ (557   $ 123,035       $ (1,064
  

 

 

    

 

 

   

 

 

    

 

 

   

 

 

    

 

 

 

The unrealized loss for each of these fixed rate marketable securities ranged from less than $1,000 to $121,000. 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 July 31, 2012. The Company expects to receive the full principal and interest on all of these marketable securities.

 

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Fair Value Measurement

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 uses a three-tier fair value hierarchy, which prioritizes the inputs used in the valuation methodologies in measuring fair value:

 

Level 1.

   Quoted prices (unadjusted) in active markets for identical assets or liabilities.

Level 2.

   Other inputs that are directly or indirectly observable in the marketplace.

Level 3.

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

The following table presents information about the Company’s assets and liabilities that are measured at fair value as of July 31, 2012 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
July 31, 2012
 

Cash equivalents (1):

           

Time deposits

   $ 27,901       $ 0       $ 0       $ 27,901   

Money market mutual funds

     693,059         0         0         693,059   

Marketable securities:

           

Corporate notes and other obligations

     0         529,543         0         529,543   

U.S. treasury securities

     32,655         0         0         32,655   

Mortgage backed securities

     0         16,066         0         16,066   

Government obligations

     3,183         0         0         3,183   

Municipal securities

     0         2,841         0         2,841   

Collateralized mortgage obligations

     0         135,040         0         135,040   

U.S. agency obligations

     0         84,207         0         84,207   

Foreign currency derivative contracts (2)

     0         1,817         0         1,817   
  

 

 

    

 

 

    

 

 

    

 

 

 

Total Assets

   $ 756,798       $ 769,514       $ 0       $ 1,526,312   
  

 

 

    

 

 

    

 

 

    

 

 

 

Liabilities

           

Foreign currency derivative contracts (3)

   $ 0       $ 2,236       $ 0       $ 2,236   
  

 

 

    

 

 

    

 

 

    

 

 

 

Total Liabilities

   $ 0       $ 2,236       $ 0       $ 2,236   
  

 

 

    

 

 

    

 

 

    

 

 

 

 

(1) Included in “cash and cash equivalents” in the accompanying Condensed Consolidated Balance Sheet as of July 31, 2012, in addition to $279.8 million of cash.
(2) Included in “prepaid expenses and other current assets” in the accompanying Condensed Consolidated Balance Sheet as of July 31, 2012.
(3) Included in “accrued expenses and other liabilities” in the accompanying Condensed Consolidated Balance Sheet as of July 31, 2012.

 

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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, 2012 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, 2012
 

Cash equivalents (1):

           

Time deposits

   $ 26,513       $ 0       $ 0       $ 26,513   

Money market mutual funds

     358,369         0         0         358,369   

Marketable securities:

           

Corporate notes and obligations

     0         504,772         0         504,772   

U.S. treasury securities

     79,358         0         0         79,358   

Mortgage backed securities

     0         15,426         0         15,426   

Government obligations

     3,210         0         0         3,210   

Municipal securities

     0         8,789         0         8,789   

Collateralized mortgage obligations

     0         120,495         0         120,495   

U.S. agency obligations

     0         107,840         0         107,840   

Foreign currency derivative contracts (2)

     0         621         0         621   
  

 

 

    

 

 

    

 

 

    

 

 

 

Total Assets

   $ 467,450       $ 757,943       $ 0       $ 1,225,393   
  

 

 

    

 

 

    

 

 

    

 

 

 

Liabilities

           

Foreign currency derivative contracts (3)

   $ 0       $ 2,551      $ 0       $ 2,551   
  

 

 

    

 

 

    

 

 

    

 

 

 

Total Liabilities

   $ 0       $ 2,551      $ 0       $ 2,551   
  

 

 

    

 

 

    

 

 

    

 

 

 

 

(1) Included in “cash and cash equivalents” in the accompanying Condensed Consolidated Balance Sheet as of January 31, 2012, in addition to $222.4 million of cash.
(2) Included in “prepaid expenses and other current assets” in the accompanying Condensed Consolidated Balance Sheet as of January 31, 2012.
(3) Included in “accrued expenses and other liabilities” in the accompanying Condensed Consolidated Balance Sheet as of January 31, 2012.

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 primarily denominated in Euros, 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 July 31, 2012 and January 31, 2012, 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):

 

     July 31,
2012
    January 31,
2012
 

Notional amount of foreign currency derivative contracts

   $ 417,890      $ 186,336   

Fair value of foreign currency derivative contracts

   $ (419   $ (1,930

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

 

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          Fair Value of Derivative Instruments  
     

Balance Sheet Location

   July 31,
2012
     January 31,
2012
 

Derivative Assets

        

Derivatives not designated as hedging instruments:

        

Foreign currency derivative contracts

  

Prepaid expenses and other current assets

   $ 1,817       $ 621   
     

 

 

    

 

 

 

Derivative Liabilities

        

Derivatives not designated as hedging instruments:

        

Foreign currency derivative contracts

  

Accrued expenses and other liabilities

   $ 2,236       $ 2,551   
     

 

 

    

 

 

 

The effect of the derivative instruments not designated as hedging instruments on the condensed consolidated statements of operations for the three and six months ended July 31, 2012 and 2011, respectively are summarized below (in thousands):

 

Derivatives Not Designated as Hedging

Instruments

      

Gains (Losses) on Derivative Instruments
Recognized in Income

 
              Three Months Ended
July 31,
 
        

Location

       2012              2011      

Foreign currency derivative contracts

  

Other income (expense)

   $ 2,054       $ (3,356
       

 

 

    

 

 

 

Derivatives Not Designated as Hedging

Instruments

      

Gains (Losses) on Derivative Instruments
Recognized in Income

 
              Six Months Ended
July 31,
 
        

Location

       2012              2011      

Foreign currency derivative contracts

  

Other income (expense)

   $ 1,132       $ (10,132
       

 

 

    

 

 

 

Strategic Investments

The Company has three investments in marketable equity securities measured using quoted prices in their respective active markets and certain interests in non-marketable equity and debt securities that are considered strategic investments. As of July 31, 2012, the fair value of the Company’s marketable equity securities of $4.4 million includes an unrealized gain of $1.6 million. As of January 31, 2012, the fair value of the Company’s marketable equity securities of $5.6 million included an unrealized gain of $3.4 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 judgment due to the absence of market price and inherent lack of liquidity.

As of July 31, 2012 and January 31, 2012, the carrying value that approximates the fair value of the Company’s investments in privately-held companies was $46.9 million and $48.3 million, respectively. These investments are recorded in other assets, net on the condensed consolidated balance sheets.

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 (in thousands):

 

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     Three Months Ended
July 31,
    Six Months Ended
July 31,
 
      2012     2011     2012     2011  

Interest income

   $ 4,915      $ 5,255      $ 9,664      $ 11,518   

Realized gains

     3,463        502        3,554        3,773   

Realized losses

     (1,205     (645     (1,584     (2,124
  

 

 

   

 

 

   

 

 

   

 

 

 

Total investment income

   $ 7,173      $ 5,112      $ 11,634      $ 13,167   
  

 

 

   

 

 

   

 

 

   

 

 

 

3. Property and Equipment

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

 

     July 31,
2012
    January 31,
2012
 

Land

   $ 248,263      $ 248,263   

Building improvements

     49,572        43,868   

Computers, equipment and software

     280,868        232,460   

Furniture and fixtures

     29,402        25,250   

Leasehold improvements

     148,470        137,587   
  

 

 

   

 

 

 
     756,575        687,428   

Less accumulated depreciation and amortization

     (199,799     (159,482
  

 

 

   

 

 

 
   $ 556,776      $ 527,946   
  

 

 

   

 

 

 

Depreciation and amortization expense totaled $23.3 million and $16.7 million for the three months ended July 31, 2012 and 2011, respectively, and $45.7 million and $31.5 million for the six months ended July 31, 2012 and 2011, respectively.

Computers, equipment and software at July 31, 2012 and January 31, 2012 included a total of $119.3 million and $105.1 million acquired under capital lease agreements, respectively. Accumulated amortization relating to computers, equipment and software under capital leases totaled $43.1 million and $31.7 million, respectively, at July 31, 2012 and January 31, 2012. Amortization of assets under capital leases is included in depreciation and amortization expense.

In November 2010, the Company purchased approximately 14 acres of undeveloped real estate in San Francisco, California, including entitlements and improvements associated with the land. In addition to the amounts reflected in the table above, the Company recorded $23.3 million related to the perpetual parking rights and classified such rights as a purchased intangible asset as it represents an intangible right to use the existing garage. The Company has capitalized pre-construction activities related to the development of the land, including interest costs and property taxes since the November 2010 purchase. The pre-construction costs capitalized for the six months ended July 31, 2012 were $5.7 million. During the first quarter of fiscal 2013, the Company suspended pre-construction activity. The total carrying value of the land, building improvements and perpetual parking rights was $321.1 million as of July 31, 2012. The Company is currently evaluating its future needs for office facilities space and its options for the undeveloped real estate.

4. Business Combinations

Rypple

On February 1, 2012, the Company acquired for cash the outstanding stock of 2Catalyze, Inc., (“Rypple”), a provider of social performance management applications. The Company acquired Rypple to, among other things, enable customers to engage and align their employees and teams with a social performance management solution, extending the employee social network to reach every employee. The Company has included the financial results of Rypple in the consolidated financial statements from the date of acquisition, which have not been material to date. The acquisition date fair value of the consideration transferred for Rypple was approximately $50.6 million, which consisted of the following:

 

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Fair value of consideration transferred (in thousands)

      

Cash

   $ 50,166   

Fair value of stock options assumed

     470   
  

 

 

 

Total

   $ 50,636   
  

 

 

 

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 0.011 was applied to convert Rypple options to the Company’s options.

The following table summarizes the estimated fair values of assets acquired and liabilities assumed as of the date of acquisition:

 

(in thousands)

      

Net tangible assets

   $ 758   

Deferred tax liability

     (1,671 )

Intangible assets

     5,970   

Goodwill

     45,579   
  

 

 

 

Net assets acquired

   $ 50,636   
  

 

 

 

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 certain items such as current and noncurrent income taxes payable and deferred taxes may be subject to change as additional information is received and certain tax returns are finalized. Thus the provisional measurements of fair value set forth above 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 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

   $ 4,970         3 years   

Customer relationships

     1,000         1 year   
  

 

 

    

Total intangible assets subject to amortization

   $ 5,970      
  

 

 

    

Developed technology represents the estimated fair value of Rypple’s social performance management technology. Customer relationships represent the fair values of the underlying relationships and agreements with Rypple customers. The goodwill balance is primarily attributed to the assembled workforce and expanded market opportunities when integrating Rypple’s social performance management technology with the Company’s other product offerings. The goodwill balance is deductible for U.S. income tax purposes.

The Company assumed unvested options with a fair value of $2.2 million. Of the total consideration, $0.5 million was allocated to the purchase consideration and $1.7 million was allocated to future services and will be expensed over the remaining service periods on a straight-line basis.

Other Business Combinations

Additionally, during the second quarter of fiscal 2013, the Company acquired four companies for $10.1 million in cash, net of cash acquired, and has included the financial results of these companies in its condensed consolidated financial statements from the date of each respective acquisition. The Company accounted for these transactions as business combinations. In allocating the purchase consideration based on estimated fair values, the Company recorded $4.1 million of acquired intangible assets with useful lives of one to three years, $7.3 million of goodwill, $0.3 million of net tangible liabilities and $1.0 million of deferred tax liabilities. The majority of this goodwill balance is deductible for U.S. income tax purposes. These transactions, individually and in aggregate, are not material to the Company.

 

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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.

Goodwill consisted of the following (in thousands):

 

Balance as of January 31, 2012

   $ 785,381   

Rypple

     45,579   

Other acquisitions and adjustments

     9,571   
  

 

 

 

Balance as of July 31, 2012

   $ 840,531   
  

 

 

 

There was no impairment of goodwill for the three or six months ended July 31, 2012.

5. Notes Payable

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, commencing 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 our 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% 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% of the product of the sale price of the Company’s common stock and the conversion rate;

 

 

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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.

For 20 trading days during the 30 consecutive trading days ended April 30, 2012, the Company’s common stock traded at a price exceeding 130% of the conversion price of $85.36 per share applicable to the Notes. Accordingly, the Notes were convertible at the option of the holder for the Company’s common shares as of July 31, 2012 and were classified as a current liability on the Company’s condensed consolidated balance sheet. For 20 trading days during the 30 consecutive trading days ended July 31, 2012, the Company’s common stock traded at a price exceeding 130% of the conversion price of $85.36 per share applicable to the Notes. Accordingly, the Notes will remain convertible at the holders’ option for the quarter ending October 31, 2012 and will remain classified as a current liability on the Company’s condensed consolidated balance sheet so long as the Notes are convertible.

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% 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 (“debt discount”) is amortized to interest expense over the term of the Notes. The equity component is not remeasured 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 component in temporary stockholders’ equity and stockholders’ equity. Additionally, the Company recorded a deferred tax liability of $51.1 million in connection with the Notes.

The Notes consisted of the following (in thousands):

 

     July 31,
2012
    January 31,
2012
 

Liability component:

    

Principal

   $ 574,890      $ 574,890   

Less: debt discount, net (1)

     (66,357     (78,741
  

 

 

   

 

 

 

Net carrying amount

   $ 508,533      $ 496,149   
  

 

 

   

 

 

 

 

(1) Included in the condensed consolidated balance sheets within 0.75% convertible senior notes and is amortized over the remaining life of the Notes using the effective interest rate method.

As of July 31, 2012, the remaining life of the Notes is approximately 2.5 years.

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

 

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     Three Months Ended
July 31,
    Six Months Ended
July 31,
 
         2012             2011         2012     2011  

Contractual interest expense

   $ 1,078      $ 1,078      $ 2,156      $ 2,156   

Amortization of debt issuance costs

     332        331        662        661   

Amortization of debt discount

     6,207        5,859        12,384        11,690   
  

 

 

   

 

 

   

 

 

   

 

 

 
   $ 7,617      $ 7,268      $ 15,202      $ 14,507   
  

 

 

   

 

 

   

 

 

   

 

 

 

Effective interest rate of the liability component

     5.86 %     5.86 %     5.86 %     5.86 %

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 $59.3 million from the sale of the Warrants. As the average market value per share of the Company’s common stock for the reporting period, as measured under the Warrants, exceeds the strike price of the Warrants, the Warrants would have a dilutive effect on the Company’s earnings/loss per share. The Warrants were anti-dilutive for the three and six months ended July 31, 2012 based on the Company’s net loss for the three and six months ended July 31, 2012. 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.

Interest Expense

Interest expense consists of interest on the Company’s capital lease commitments and the Notes, net of amounts capitalized. In accounting for the Notes at the time of issuance in January 2010, the carrying amount of the liability component was calculated by measuring the fair value of a similar liability that did not have an associated convertible feature. The excess of the principal amount of the liability component over its carrying amount is amortized, using an effective interest rate of 5.86%, to interest expense over the term of the Notes.

6. Other Balance Sheet Accounts

Prepaid Expenses and Other Current Assets

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

 

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     July 31,
2012
     January 31,
2012
 

Deferred professional services costs

   $ 7,825       $ 10,399   

Prepaid income taxes

     24,007         12,785   

Prepaid expenses and other current assets

     115,069         57,135   
  

 

 

    

 

 

 
   $ 146,901       $ 80,319   
  

 

 

    

 

 

 

Capitalized Software, net

Capitalized software consisted of the following (in thousands):

 

     July 31,
2012
     January 31,
2012
 

Capitalized internal-use software development costs, net of accumulated amortization of $60,368 and $50,300, respectively

   $ 53,999       $ 41,442   

Acquired developed technology, net of accumulated amortization of $136,355 and $99,886, respectively

     119,457         146,970   
  

 

 

    

 

 

 
   $ 173,456       $ 188,412   
  

 

 

    

 

 

 

Capitalized internal-use software amortization expense totaled $5.5 million and $3.8 million for the three months ended July 31, 2012 and 2011, respectively. Acquired developed technology amortization expense totaled $18.3 million and $17.1 million for the three months ended July 31, 2012 and 2011, respectively. Capitalized internal-use software amortization expense totaled $10.1 million and $7.5 million for the six months ended July 31, 2012 and 2011, respectively. Acquired developed technology amortization expense totaled $36.5 million and $26.9 million for the six months ended July 31, 2012 and 2011, respectively.

During the three months ended July 31, 2012 and 2011, the Company capitalized $0.7 million and $0.5 million, respectively, of stock based expenses related to capitalized internal-use software development and deferred professional services costs and capitalized $1.7 million and $1.1 million for the six months ended July 31, 2012 and 2011, respectively.

Other Assets, net

Other assets consisted of the following (in thousands):

 

     July 31,
2012
     January 31,
2012
 

Deferred professional services costs, noncurrent portion

   $ 2,101       $ 3,935   

Long-term deposits

     13,293         13,941   

Purchased intangible assets, net of accumulated amortization of $23,702 and $17,868, respectively

     41,311         46,110   

Acquired intellectual property, net of accumulated amortization of $5,102 and $3,139, respectively

     15,841         15,020   

Strategic investments

     51,276         53,949   

Other

     24,217         22,194   
  

 

 

    

 

 

 
   $ 148,039       $ 155,149   
  

 

 

    

 

 

 

Purchased intangible assets amortization expense for the three months ended July 31, 2012 and 2011, was $2.4 million and $2.3 million, respectively, and for the six months ended July 31, 2012 and 2011, was $5.8 million and $3.5 million, respectively. Acquired intellectual property amortization expense for the three months ended July 31, 2012 and 2011, was $0.8 million and $0.5 million, respectively, and for the six months ended July 31, 2012 and 2011, was $2.0 million and $0.8 million, respectively.

 

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Table of Contents

Accrued Expenses and Other Liabilities

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

 

     July 31,
2012
     January 31,
2012
 

Accrued compensation

   $ 192,776       $ 228,466   

Accrued other liabilities

     150,149         121,957   

Accrued income and other taxes payable

     68,519         100,471   

Accrued professional costs

     24,026         21,993   

Accrued rent

     47,418         29,555   
  

 

 

    

 

 

 
   $ 482,888       $ 502,442   
  

 

 

    

 

 

 

7. Stockholders’ Equity

The Company maintains the following stock plans: the 2006 Inducement Equity Incentive Plan (the “Inducement Plan”), 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 and the Inducement Plan, provide for annual automatic increases on February 1 to the shares reserved for issuance. The expiration of the 1999 Stock Option Plan (“1999 Plan”) in fiscal 2010 did not affect awards outstanding, which continue to be governed by the terms and conditions of the 1999 Plan.

On February 1, 2012, 3.5 million additional shares were reserved under the 2004 Equity Incentive Plan and 1.0 million additional shares were reserved under the 2004 Employee Stock Purchase Plan pursuant to the automatic increase in each respective plan.

On June 7, 2012, 400,000 additional shares were reserved under the Inducement Plan.

In September 2011, the Company’s Board of Directors amended and restated the 2004 Employee Stock Purchase Plan (the “ESPP”). 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 July 31, 2012, $13.6 million has been held on behalf of employees for future purchases under the plan and is recorded in accrued expenses and other liabilities. This amount is also included in proceeds from equity plans in the financing activities section of the condensed consolidated statements of cash flows. Employees purchased 338,306 shares in the three months ended July 31, 2012 for $30.7 million under the ESPP.

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 5 years.

Stock activity is as follows:

 

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

Balance as of January 31, 2012

     3,440,993        11,184,907      $ 79.78      

Increase in shares authorized:

         

2004 Equity Incentive Plan

     3,500,000        0        0.00      

2Catalyze, Inc. Amended 2008 Stock Option Plan

     30,177        0        0.00      

2006 Inducement Equity Incentive Plan

     400,000        0        0.00      

Options granted under all plans

     (733,592     733,592        137.88      

Restricted stock activity

     (935,968     0        0.00      

Stock grants to board and advisory board members

     (13,900     0        0.00      

Exercised

     0        (1,778,072     52.39      

1999 Plan shares expired

     (30,610     0        0.00      

Cancelled

     288,334        (288,334     99.69      
  

 

 

   

 

 

   

 

 

    

Balance as of July 31, 2012

     5,945,434        9,852,093      $ 88.46       $ 413,350   
  

 

 

   

 

 

   

 

 

    

 

 

 

Vested or expected to vest

       9,650,899      $ 87.71       $ 411,390   
    

 

 

   

 

 

    

 

 

 

Exercisable as of July 31, 2012

       4,478,241      $ 61.87       $ 297,287   
    

 

 

   

 

 

    

 

 

 

The total intrinsic value of the options exercised during the six months ended July 31, 2012 and 2011 was $166.0 million and $169.6 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 2.9 years.

As of July 31, 2012, options to purchase 4,478,241 shares were vested at a weighted average exercise price of $61.87 per share and had a remaining weighted-average remaining contractual life of approximately 2.0 years. The total intrinsic value of these vested options as of July 31, 2012 was $297.3 million.

The following table summarizes information about stock options outstanding as of July 31, 2012:

 

     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 $25.97

     2,117,378         1.7       $ 20.33         1,805,441       $ 20.16   

$27.40 to $65.41

     929,439         1.3         50.36         779,551         50.45   

$65.44

     1,439,173         2.3         65.44         724,931         65.44   

$65.68 to $108.25

     1,657,622         3.9         101.58         173,173         75.42   

$111.86 to $140.28

     978,894         4.2         129.43         154,413         131.83   

$142.50

     1,868,348         3.3         142.50         742,255         142.50   

$143.46 to $153.50

     861,239         4.3         146.51         98,477         149.53   
  

 

 

          

 

 

    
     9,852,093         2.9       $ 88.46         4,478,241       $ 61.87   
  

 

 

          

 

 

    

Restricted stock activity is as follows:

 

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

Balance as of January 31, 2012

     4,962,263      $ 0.001      

Granted

     1,187,736        0.001      

Cancelled

     (237,868     0.001      

Vested and converted to shares

     (576,525     0.001      
  

 

 

   

 

 

    

Balance as of July 31, 2012

     5,335,606      $ 0.001       $ 663,536   
  

 

 

   

 

 

    

 

 

 

Expected to vest

     5,166,030         $ 642,447   
  

 

 

      

 

 

 

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 vest over 4 years.

The weighted-average fair value of the restricted stock issued for the six months ended July 31, 2012 and 2011 was $142.16 and $143.59, respectively.

Common Stock

The following number of shares of common stock were reserved and available for future issuance at July 31, 2012:

 

Options outstanding

     9,852,093   

Restricted stock awards and units outstanding

     5,335,606   

Stock available for future grant:

  

2004 Equity Incentive Plan

     4,800,719   

2006 Inducement Equity Incentive Plan

     583,315   

2004 Employee Stock Purchase Plan

     1,661,694   

2004 Outside Directors Stock Plan

     561,400   

0.75% Convertible senior notes

     6,734,664   

Warrants

     6,735,953   
  

 

 

 
     36,265,444   
  

 

 

 

8. Income Taxes

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. As a result of the Company’s pretax loss for the six months ended July 31, 2012, the Company reported a tax benefit of $9.6 million, which resulted in an effective tax rate of 25 percent. The Company’s effective tax rate was lower than the federal statutory tax rate of 35 percent primarily due to foreign tax expense and non-deductible amounts. The tax benefit of $9.6 million included California tax credits and the impact of structuring intellectual property related to acquisitions.

As a result of the Company’s pretax loss for the six months ended July 31, 2011, the Company reported a tax benefit of $13.2 million, which resulted in an effective tax rate of 78 percent. The Company’s effective tax rate was higher than the federal statutory tax rate of 35 percent primarily due to federal and California tax credits and the impact of the Radian6 acquisition. The tax benefit was partially offset by foreign tax expense and non-deductible amounts. The effect on the tax rate was magnified because of the relatively small pretax loss.

The realization of deferred tax assets depends on sufficient taxable income. As a result, any factors that affect operating results such as changes in the general economic conditions of the market that impact customers’ purchase decisions, changes in foreign currency exchange rates and costs associated with acquisitions and subsequent integration could impact the realizability of the Company’s deferred tax assets. The Company will continue to re-assess the realizability of its deferred tax assets on a regular basis. Any significant adjustment to the deferred tax assets could result in a material impact to the Company’s effective tax rate.

Tax Benefits Related to Stock-Based Compensation

 

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The total income tax benefit recognized in the accompanying condensed consolidated statements of operations related to stock-based awards was $51.6 million and $34.6 million for the six months ended July 31, 2012 and 2011, respectively.

Unrecognized Tax Benefits and Other Considerations

The Company records liabilities related to its uncertain tax positions. Tax positions for the Company and its subsidiaries are subject to income tax audits by multiple tax jurisdictions throughout the world. The Company believes that it has provided adequate reserves for its income tax uncertainties in all open tax years. In the next 12 months, it is reasonably possible that the unrecognized tax benefits may decrease by approximately $4.0 million due to lapsing of the statute of limitations.

9. Earnings/Loss Per Share

Basic earnings/loss per share is computed by dividing net income (loss) by the weighted-average number of common shares outstanding for the fiscal period. Diluted earnings/loss per share 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 loss per share for the three and six months ended July 31, 2012 and 2011 is the same as basic loss per share as there is a net loss in these 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 is as follows (in thousands):

 

     Three Months Ended
July 31,
    Six Months Ended
July 31,
 
     2012     2011     2012     2011  

Numerator:

        

Net loss

   $ (9,829   $ (4,268   $ (29,304   $ (3,738

Denominator:

        

Weighted-average shares outstanding for basic loss per share

     139,425        135,093        138,789        134,273   

Effect of dilutive securities:

        

Convertible senior notes

     0        0        0        0   

Employee stock awards

     0        0        0        0   

Warrants

     0        0        0        0   
  

 

 

   

 

 

   

 

 

   

 

 

 

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

     139,425        135,093        138,789        134,273   
  

 

 

   

 

 

   

 

 

   

 

 

 

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
July 31,
     Six Months Ended
July 31,
 
         2012              2011              2012              2011      

Stock awards

     8,481         7,482         8,614         7,402   

Warrants

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

Convertible senior notes

     6,735         6,735         6,735         6,735   

10. Commitments

Letters of Credit

 

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As of July 31, 2012, the Company had a total of $22.0 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 April 2030.

Leases

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

As of July 31, 2012, the future minimum lease payments under non-cancelable operating and capital leases are as follows (in thousands):

 

     Capital
Leases
    Operating
Leases
 

Fiscal Period:

    

Remaining six months of fiscal 2013

   $ 15,451      $ 69,328   

Fiscal 2014

     29,448        123,269   

Fiscal 2015

     8,908        93,697   

Fiscal 2016

     5,615        75,727   

Fiscal 2017

     4,813        62,588   

Thereafter

     1,030        297,893   
  

 

 

   

 

 

 

Total minimum lease payments

     65,265      $ 722,502   
    

 

 

 

Less: amount representing interest

     (3,627  
  

 

 

   

Present value of capital lease obligations

   $ 61,638     
  

 

 

   

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.

11. 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.

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, estimated settlements, legal rulings, advice of legal counsel and other information and events pertaining to a particular matter. In management’s opinion, resolution of all current matters is not expected to have a material adverse impact on the Company’s condensed 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.

12. 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.

 

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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 $150,000 for the quarter ended July 31, 2012.

In addition to the resource sharing with the Foundation, the Company issued 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 July 31, 2012, the Foundation held 88,500 shares of salesforce.com common stock. Additionally, the Company has donated subscriptions to the Company’s service to other qualified non-profit organizations. The Company also allows an affiliate of the Foundation to resell the Company’s service to large non-profit organizations. The Company does not charge the affiliate for the subscriptions. The fair value of the subscriptions was in excess of $3.1 million for the quarter ended July 31, 2012. The Company plans to continue these programs.

13. Subsequent Events

Buddy Media, Inc.

On August 13, 2012, the Company acquired the outstanding stock of Buddy Media, Inc. (“Buddy”), a social media marketing platform. The Company acquired Buddy for the assembled workforce, expected synergies and expanded market opportunities when integrating Buddy’s social media marketing platform with the Company’s current offerings. Beginning with the fiscal quarter ended October 31, 2012, the Company will include the financial results of Buddy in its condensed consolidated financial statements from the date of acquisition. The total purchase price for Buddy included $467.1 million in cash, net of cash acquired, 1,393,859 shares of salesforce.com common stock and $33.1 million which represents the fair market value of the employee stock awards assumed.

California state wage and hour lawsuit settlement

On August 16, 2012, the Company made a payment of approximately $9.7 million as a result of court approval of the 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 Company entered into a preliminary settlement agreement in the second quarter of fiscal 2012 and recorded the estimated settlement expense in its financial results in fiscal 2012.

 

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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 anticipated growth, the effect of general economic and market conditions, our business strategy and our plan to build our business, including our strategy to be the leading provider of enterprise cloud computing applications and platforms and to lead the industry shift to the social enterprise, our service performance and security, the expenses associated with new data centers, additional data center capacity, real estate and office facilities space, our operating results, new features and services, 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, and the continued growth and ability to maintain deferred revenue and unbilled deferred revenue, 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, and potential litigation involving us, 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,” “assumes,” “may,” “should,” 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 services and are dedicated to helping customers transform themselves into social enterprises. Social enterprises leverage social, mobile and open technologies to place their customers and employees at the center of their business and to engage and collaborate with them in new and powerful ways. Our technologies are targeted at businesses of all sizes and industries worldwide.

We were founded in February 1999 and began offering our enterprise customer relationship management (“CRM”) application service in February 2000. Since then, we have augmented our CRM service with new editions, services and enhanced features. Over the last few years, we have both developed and acquired several mobile, social and open technologies. In fiscal 2012, we introduced the concept of the social enterprise. We believe that employees, customers and partners are interacting in entirely new ways via social networks, and companies need a new set of enterprise capabilities to be successful in the social world.

Our objective is to help companies put customers at the center of their businesses and transform themselves into social enterprises by leveraging our applications and platforms. Key elements of our strategy include:

 

   

Strengthening our existing Sales Cloud and Service Cloud applications and extending into new functional areas within the social enterprise;

 

   

Leading the industry transformation to the social enterprise;

 

   

Pursuing new customers and new territories aggressively;

 

   

Deepening relationships with our existing customer base; and

 

   

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

We believe the factors that will influence our ability to achieve our objectives include: our prospective customers’ willingness to migrate to enterprise cloud computing services; the performance and security of our service; our ability to continue to release, and

 

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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 platforms; our ability to attract new personnel and retain and motivate current personnel; and general economic conditions which could affect our customers’ ability and willingness to purchase our services, 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 platforms. 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 in fiscal 2013 to grow our business and continue our leadership role in the cloud computing industry.

In November 2010, we purchased approximately 14 acres of undeveloped real estate in San Francisco, California, including entitlements and improvements associated with the land. We have capitalized all pre-construction activities related to the development of the land, including interest costs and property taxes since the November 2010 purchase. The pre-construction costs capitalized for the six months ended July 31, 2012 were $5.7 million. During the first quarter of fiscal 2013, we suspended pre-construction activity. The total carrying value of the land, building improvements and perpetual parking rights was $321.1 million as of July 31, 2012. We are currently evaluating our future needs for office facilities space and our options for the undeveloped real estate.

We expect marketing and sales costs, which were 53 percent of our total revenues for the six months ended July 31, 2012 and 52 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 and manage more paying subscribers, and build greater brand awareness.

On August 13, 2012, we acquired the outstanding stock of Buddy Media, Inc., (“Buddy”), a social media marketing platform. We acquired Buddy for the assembled workforce, expected synergies and expanded market opportunities when integrating Buddy’s social media marketing platform with our current offerings. Beginning with the fiscal quarter ended October 31, 2012, we will include the financial results of Buddy in our condensed consolidated financial statements from the date of acquisition. The total purchase price for Buddy included $467.1 million, net of cash acquired, 1,393,859 shares of our common stock and $33.1 million which represents the fair market value of the employee stock awards assumed.

Fiscal Year

Our fiscal year ends on January 31. References to fiscal 2013, for example, refer to the fiscal year ending January 31, 2013.

Sources of Revenues

We derive our revenues from two sources: (1) subscription revenues, which are comprised of subscription fees from customers accessing our enterprise cloud computing services and from customers purchasing additional support beyond the standard support that is included in the basic subscription fees; and (2) related professional services such as process mapping, project management, implementation services and other

 

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revenue. “Other revenue” consists primarily of training fees. Subscription and support revenues accounted for approximately 94 percent of our total revenues during the six months ended July 31, 2012. 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 services. 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 hundreds of thousands. None of our customers accounted for more than five percent of our revenues during the six months ended July 31, 2012 and 2011.

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.

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 was the beginning of our fiscal 2012.

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. In the fourth quarter of fiscal 2012, we introduced greater operational discipline around annual invoicing, for both new business and renewals which resulted in an increase in deferred revenue. Occasionally, we bill customers for their multi-year contract on a single invoice which results in an increase in noncurrent deferred revenue. There is a disproportionate weighting towards annual billings in the fourth quarter, primarily as a result of large enterprise account buying patterns. 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 business and renewals to increase as a proportion of our total annual billings.

 

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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:

 

(in thousands)

   April 30,
2012
     July 31,
2012
               

Fiscal 2013

           

Accounts receivable, net

   $ 371,395       $ 446,917         

Deferred revenue, current and noncurrent

     1,334,716         1,337,184         

(in thousands)

   April 30,
2011
     July 31,
2011
     October 31,
2011
     January 31,
2012
 

Fiscal 2012

           

Accounts receivable, net

   $ 270,816       $ 342,397       $ 312,331       $ 683,745   

Deferred revenue, current and noncurrent

     915,133         935,266         917,821         1,380,295   

(in thousands)

   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   

Unbilled Deferred Revenue

The deferred revenue balance on our condensed consolidated balance sheet does not represent the total contract value of annual or multi-year, non-cancelable subscription agreements. Unbilled deferred revenue was approximately $2.8 billion as of July 31, 2012 and approximately $2.2 billion as of January 31, 2012. Unbilled deferred revenue represents future billings under our subscription agreements that have not been invoiced and, accordingly, are not recorded in deferred revenue. We expect that the amount of unbilled deferred revenue will change from quarter to quarter for several reasons, including the specific timing and duration of large customer subscription agreements, varying billing cycles of subscription agreements, the specific timing of customer renewals, foreign currency fluctuations, the timing of when unbilled deferred revenue is to be recognized as revenue, and changes in customer financial circumstances. For multi-year subscription agreements billed annually, the associated unbilled deferred revenue is typically high at the beginning of the contract period, zero just prior to renewal, and increases if the agreement is renewed. Low unbilled deferred revenue attributable to a particular subscription agreement is often associated with an impending renewal and may not be an indicator of the likelihood of renewal or future revenue from such customer. Accordingly, we expect that the amount of aggregate unbilled deferred revenue will change from year-to-year depending in part upon the number and dollar amount of subscription agreements at particular stages in their renewal cycle. Such fluctuations are not a reliable indicator of future revenues.

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 services and acquired developed technologies. We allocate overhead such as information technology infrastructure, 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

 

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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 services. For example, we plan to open additional data centers and expand our current 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 services. 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 equity plans for employees and non-employee directors. We recognize our stock-based compensation as an expense in the statement of operations based on their fair values and vesting periods. These charges have been significant in the past and we expect that they will increase as our stock price increases, as we hire more employees and seek to retain existing employees.

During the six months ended July 31, 2012, we recognized stock-based expense of $166.7 million. As of July 31, 2012, the aggregate stock compensation remaining to be amortized to costs and expenses was $869.9 million. We expect this stock compensation balance to be amortized as follows: $178.1 million during the remaining six months of fiscal 2013; $312.0 million during fiscal 2014; $249.6 million during fiscal 2015; $122.2 million during fiscal 2016; and $8.0 million during fiscal 2017. The expected amortization reflects only outstanding stock awards as of July 31, 2012 and assumes no forfeiture activity. We expect to continue to issue stock-based awards to our employees in future periods.

Amortization of Purchased Intangibles from Business Combinations. Our cost of revenues and operating expenses include amortization of acquisition-related intangible assets, such as the amortization of the cost associated with an acquired company’s research and development efforts, trade names, customer lists and customer relationships. We expect this expense to increase as we acquire more companies.

 

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Critical Accounting Estimates

Our condensed consolidated financial statements are prepared in accordance with accounting principles generally accepted in the United States. The preparation of these condensed 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 services 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 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.

 

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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 updated 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 for the fiscal year ended January 31, 2012 As of July 31, 2012, the deferred professional services revenue and deferred costs under the previous accounting guidance are $17.4 million and $9.9 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.

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.

 

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As a result of the updated accounting guidance previously described, billings against professional services arrangements entered into prior to February 1, 2011 were generally 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 six months ended July 31, 2012, we deferred $67.3 million of commission expenditures and we amortized $72.0 million to sales expense. During the same period a year ago, we deferred $46.6 million of commission expenditures and we amortized $49.6 million to sales expense. Deferred commissions on our condensed consolidated balance sheets totaled $171.9 million at July 31, 2012 and $176.6 million at January 31, 2012.

Strategic Investments. 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.

Business Combinations. Accounting for business combinations requires us to make significant estimates and assumptions, especially at the acquisition date with respect to intangible assets and assets acquired and liabilities assumed and pre-acquisition contingencies. 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.

Examples of critical estimates in valuing certain of the intangible assets and goodwill we have acquired include but are not limited to:

 

   

future expected cash flows from subscription and support contracts, professional services contracts, other customer contracts and acquired developed technologies and patents;

 

   

expected costs to develop the in-process research and development into commercially viable products and estimated cash flows from the projects when completed;

 

   

the acquired company’s trade name, trademark and existing customer relationship, as well as assumptions about the period of time the acquired trade name and trademark will continue to be used in our offerings;

 

   

uncertain tax positions and tax related valuation allowances assumed; and

 

   

discount rates.

Unanticipated events and circumstances may occur that may affect the accuracy or validity of such assumptions, estimates or actual results.

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 for stock options and restricted stock awards and one year for shares issued pursuant to our Employee Stock Purchase Plan (“ESPP”). The fair value of each award is estimated on the date of grant using the Black-Scholes option pricing model. The estimated forfeiture rate applied is based on historical forfeiture rates. Inputs into the Black-Scholes option pricing model include:

 

   

The estimated life for the stock options which is estimated based on an actual analysis of expected life. The estimated life for shares issued pursuant to our ESPP is based on the two purchase periods within the 12 month offering period;

 

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The risk free interest rate which is based on the rate for a U.S. government security with the same estimated life at the time of the option grant and the stock purchase rights; and

 

   

The future stock price volatility which is estimated considering both our observed option-implied volatilities and our historical volatility calculations. We believe this is the best estimate of the expected volatility over the expected life of our stock options and stock purchase rights.

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 bases 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, compensation, the valuation of deferred tax assets and liabilities and changes in tax laws and accounting principles.

Results of Operations

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

 

     Three Months Ended
July 31,
    Six Months Ended
July 31,
 
     2012     2011     2012     2011  

Revenues:

        

Subscription and support

   $ 687,493      $ 509,279      $ 1,342,713      $ 982,783   

Professional services and other

     44,156        36,723        84,403        67,583   
  

 

 

   

 

 

   

 

 

   

 

 

 

Total revenues

     731,649        546,002        1,427,116        1,050,366   

Cost of revenues:

        

Subscription and support

     118,519        89,144        227,263        164,387   

Professional services and other

     43,899        31,766        86,706        59,589   
  

 

 

   

 

 

   

 

 

   

 

 

 

Total cost of revenues

     162,418        120,910        313,969        223,976   

Gross profit

     569,231        425,092        1,113,147        826,390   

Operating expenses:

        

Research and development

     99,442        73,393        194,218        138,685   

Marketing and sales

     380,160        283,001        749,949        537,472   

General and administrative

     103,095        84,446        204,695        168,784   
  

 

 

   

 

 

   

 

 

   

 

 

 

Total operating expenses

     582,697        440,840        1,148,862        844,941   

Loss from operations

     (13,466     (15,748     (35,715     (18,551

Investment income

     7,173        5,112        11,634        13,167   

Interest expense

     (8,033     (3,846     (14,403     (7,517

Other income (expense)

     294        (3,231     (416     (4,031
  

 

 

   

 

 

   

 

 

   

 

 

 

Loss before benefit from income taxes

     (14,032     (17,713     (38,900     (16,932

Benefit from income taxes

     4,203        13,445        9,596        13,194   
  

 

 

   

 

 

   

 

 

   

 

 

 

Net loss

   $ (9,829   $ (4,268   $ (29,304   $ (3,738
  

 

 

   

 

 

   

 

 

   

 

 

 

 

     As of  
     July 31,
2012
     January 31,
2012
 

Balance Sheet Data:

     

Cash, cash equivalents and marketable securities

   $ 1,804,265       $ 1,447,174   

Deferred revenue, current and noncurrent

     1,337,184         1,380,295   

 

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Unbilled deferred revenue was approximately $2.8 billion as of July 31, 2012 and $2.2 billion as of January 31, 2012. Unbilled deferred revenue represents future billings under our non-cancelable subscription agreements that have not been invoiced and, accordingly, are not recorded in deferred revenue.

Cost of revenues and marketing and sales expenses include the following amounts related to amortization of purchased intangibles from business combinations:

 

     Three Months Ended
July 31,
     Six Months Ended
July 31,
 
     2012      2011      2012      2011  

Cost of revenues

   $ 17,668       $ 16,373       $ 35,116       $ 25,468   

Marketing and sales

     2,407         2,306         5,834         3,546   

Cost of revenues and operating expenses include the following amounts related to stock-based awards:

 

     Three Months Ended
July 31,
     Six Months Ended
July 31,
 
     2012      2011      2012      2011  

Cost of revenues

   $ 7,864       $ 4,379       $ 15,117       $ 8,030   

Research and development

     16,089         11,188         31,756         19,027   

Marketing and sales

     44,781         27,114         86,768         50,901   

General and administrative

     16,683         11,913         33,042         24,194   

Revenues by geography were as follows:

 

     Three Months Ended
July 31,
     Six Months Ended
July 31,
 
     2012      2011      2012      2011  

Americas

   $ 507,974       $ 366,916       $ 992,927       $ 706,934   

Europe

     124,609         102,056         242,903         196,451   

Asia Pacific

     99,066         77,030         191,286         146,981   
  

 

 

    

 

 

    

 

 

    

 

 

 
   $ 731,649       $ 546,002       $ 1,427,116       $ 1,050,366   
  

 

 

    

 

 

    

 

 

    

 

 

 

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

 

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Table of Contents
     Three Months Ended
July 31,
    Six Months Ended
July 31,
 
     2012     2011     2012     2011  

Revenues:

        

Subscription and support

     94     93     94     94

Professional services and other

     6        7        6        6   
  

 

 

   

 

 

   

 

 

   

 

 

 

Total revenues

     100        100        100        100   

Cost of revenues:

        

Subscription and support

     16        16        16        15   

Professional services and other

     6        6        6        6   
  

 

 

   

 

 

   

 

 

   

 

 

 

Total cost of revenues

     22        22        22        21   

Gross profit

     78        78        78        79   

Operating expenses:

        

Research and development

     14        13        14        13   

Marketing and sales

     52        52        53        52   

General and administrative

     14        16        14        16   
  

 

 

   

 

 

   

 

 

   

 

 

 

Total operating expenses

     80        81        81        81   

Loss from operations

     (2     (3     (3     (2

Investment income

     1        1        1        1   

Interest expense

     (1     (1     (1     0   

Other income (expense)

     0        0        0        0   
  

 

 

   

 

 

   

 

 

   

 

 

 

Loss before benefit from income taxes

     (2     (3     (3     (1

Benefit from income taxes

     1        2        1        1   
  

 

 

   

 

 

   

 

 

   

 

 

 

Net loss

     (1 )%      (1 )%      (2 )%      0
  

 

 

   

 

 

   

 

 

   

 

 

 

 

     Three Months Ended
July 31,
    Six Months Ended
July 31,
 
     2012     2011     2012     2011  

Amortization of purchased intangibles:

        

Cost of revenues

     2     3     2     2

Marketing and sales

     0        0        0        0   
     Three Months Ended
July 31,
    Six Months Ended
July 31,
 
     2012     2011     2012     2011  

Stock-based awards:

        

Cost of revenues

     1     1     1     1

Research and development

     2        2        2        2   

Marketing and sales

     6        5        6        5   

General and administrative

     2        2        2        2   
     Three Months Ended
July 31,
    Six Months Ended
July 31,
 
     2012     2011     2012     2011  

Revenues by geography:

        

Americas

     69     67     70     67

Europe

     17        19        17        19   

Asia Pacific

     14        14        13        14   
  

 

 

   

 

 

   

 

 

   

 

 

 
     100     100     100     100
  

 

 

   

 

 

   

 

 

   

 

 

 

Three Months Ended July 31, 2012 and 2011

Revenues.

 

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     Three Months Ended
July 31,
     Variance  

(In thousands)

   2012      2011      Dollars      Percent  

Subscription and support

   $ 687,493       $ 509,279       $ 178,214         35 %

Professional services and other

     44,156         36,723         7,433         20 %
  

 

 

    

 

 

    

 

 

    

 

 

 

Total revenues

   $ 731,649       $ 546,002       $ 185,647         34 %
  

 

 

    

 

 

    

 

 

    

 

 

 

Total revenues were $731.6 million for the three months ended July 31, 2012, compared to $546.0 million during the same period a year ago, an increase of $185.6 million, or 34 percent. Subscription and support revenues were $687.5 million, or 94 percent of total revenues, for the three months ended July 31, 2012, compared to $509.3 million, or 93 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 July 31, 2012 has generally remained consistent relative to prior periods. Professional services and other revenues were $44.2 million, or six percent of total revenues, for the three months ended July 31, 2012, compared to $36.7 million, or seven percent of total revenues, for the same period a year ago. The increase in professional services and other revenues was due primarily to the higher demand for services from an increased number of customers.

Revenues in Europe and Asia Pacific accounted for $223.7 million, or 31 percent of total revenues, for the three months ended July 31, 2012, compared to $179.1 million, or 33 percent of total revenues, during the same period a year ago, an increase of $44.6 million, or 25 percent. The increase in revenues outside of the Americas was the result of the increasing acceptance of our service, our focus on marketing our services internationally and improved renewal rates. However, the value of the U.S. dollar relative to foreign currencies caused a decrease in U.S. dollar revenues outside of the Americas for the three months ended July 31, 2012 as compared to the same period a year ago. The foreign currency impact had the effect of decreasing our aggregate revenues by $17.1 million compared to the same period a year ago.

Cost of Revenues.

 

     Three Months Ended
July 31,
    Variance  

(In thousands)

   2012     2011     Dollars  

Subscription and support

   $ 118,519      $ 89,144      $ 29,375   

Professional services and other

     43,899        31,766        12,133   
  

 

 

   

 

 

   

 

 

 

Total cost of revenues

   $ 162,418      $ 120,910      $ 41,508   
  

 

 

   

 

 

   

 

 

 

Percent of total revenues

     22 %     22  

Cost of revenues was $162.4 million, or 22 percent of total revenues, for the three months ended July 31, 2012, compared to $120.9 million, or 22 percent of total revenues, during the same period a year ago, an increase of $41.5 million. The increase in absolute dollars was primarily due to an increase of $18.4 million in employee-related costs, an increase of $3.5 million in stock based expenses, an increase of $7.9 million in service delivery costs, primarily due to our efforts to increase data center capacity, an increase of $6.2 million in depreciation and amortization expenses, $1.3 million of which related to the amortization of purchased intangible assets and an increase of $3.6 million in allocated overhead. We have increased our professional services headcount since July 31, 2011 to meet the higher demand for services from our customers. A majority of the increase in headcount was due to the acquisition of Model Metrics in the fourth quarter of fiscal 2012.

We intend to continue to invest additional resources in our enterprise cloud computing services and data center capacity. Additionally, the amortization of purchased intangible assets will increase as we acquire additional businesses and technologies. We also plan to add additional employees in our professional services group to facilitate the adoption of our services. 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.

 

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Research and Development.

 

     Three Months Ended
July 31,
    Variance  

(In thousands)

   2012     2011     Dollars  

Research and development

   $ 99,442      $ 73,393      $ 26,049   

Percent of total revenues

     14 %     13 %  

Research and development expenses were $99.4 million, or 14 percent of total revenues, for the three months ended July 31, 2012, compared to $73.4 million, or 13 percent of total revenues, during the same period a year ago, an increase of $26.0 million. The increase in absolute dollars was primarily due to an increase of $19.4 million in employee-related costs, an increase of $4.9 million in stock-based expenses and an increase of $1.5 million in our development and test data center. We increased our research and development headcount by 46 percent since July 31, 2011 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
July 31,
    Variance  

(In thousands)

   2012     2011     Dollars  

Marketing and sales

   $ 380,160      $ 283,001      $ 97,159   

Percent of total revenues

     52 %     52 %  

Marketing and sales expenses were $380.2 million, or 52 percent of total revenues, for the three months ended July 31, 2012, compared to $283.0 million, or 52 percent of total revenues, during the same period a year ago, an increase of $97.2 million. The increase in absolute dollars was primarily due to increases of $75.0 million in employee-related costs, including amortization of deferred commissions, $17.7 million in stock-based expenses and an increase in advertising, marketing and event costs. Our marketing and sales headcount increased by 35 percent since July 31, 2011 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
July 31,
    Variance  

(In thousands)

   2012     2011     Dollars  

General and administrative

   $ 103,095      $ 84,446      $ 18,649   

Percent of total revenues

     14 %     16 %  

General and administrative expenses were $103.1 million, or 14 percent of total revenues, for the three months ended July 31, 2012, compared to $84.4 million, or 16 percent of total revenues, during the same period a year ago, an increase of $18.6 million. The increase was primarily due to increases of $4.8 million in stock-based expenses, $5.6 million in depreciation and amortization and increases in employee-related costs. Our general and administrative headcount increased by 30 percent since July 31, 2011 as we added personnel to support our growth.

Loss from operations.

 

     Three Months Ended
July 31,
    Variance  

(In thousands)

   2012     2011     Dollars  

Loss from operations

   $ (13,466   $ (15,748   $ 2,282   

Percent of total revenues

     (2 )%     (3 )%  

Loss from operations for the three months ended July 31, 2012 was $13.5 million and included $85.4 million of stock-based expenses and $20.1 million of amortization of purchased intangibles. During the same period a year ago, loss from operations was $15.7 million and included $54.6 million of stock-based expenses and $18.7 million of amortization of purchased intangibles.

 

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Table of Contents

Investment income.

 

     Three Months Ended
July 31,
    Variance  

(In thousands)

   2012     2011     Dollars  

Investment income

   $ 7,173      $ 5,112      $ 2,061   

Percent of total revenues

     1 %     1 %  

Investment income consists of income on cash and marketable securities balances. Investment income was $7.2 million for the three months ended July 31, 2012 and was $5.1 million during the same period a year ago. The increase was primarily due to an increase in realized gains from sales of marketable securities.

Interest expense.

 

     Three Months Ended
July 31,
    Variance  

(In thousands)

   2012     2011     Dollars  

Interest expense

   $ (8,033   $ (3,846   $ (4,187

Percent of total revenues

     (1 )%     (1 )%  

Interest expense consists of interest on our convertible senior notes and capital leases. Interest expense, net of interest costs capitalized, was $8.0 million for the three months ended July 31, 2012 and was $3.8 million during the same period a year ago. During the three months ended July 31, 2012, we capitalized $0.2 million of interest costs related to capital projects. Capitalized interest during the same period a year ago was $4.0 million. During the first quarter of fiscal 2013, we suspended pre-construction activity, which includes capitalized interest costs, on the undeveloped real estate in San Francisco, California.

Benefit for income taxes.

 

     Three Months Ended
July 31,
    Variance  

(In thousands)

   2012     2011     Dollars  

Benefit for income taxes

   $ 4,203      $ 13,445      $ (9,242

Effective tax rate

     30 %     76 %  

We recorded a tax benefit of $4.2 million for the three months ended July 31, 2012, which resulted in an effective tax rate of 30 percent. The effective tax rate was lower than the federal statutory tax rate of 35 percent primarily due to foreign tax expense and non-deductible amounts. The tax benefit of $4.2 million included California tax credits.

We recorded a tax benefit of $13.4 million for the three months ended July 31, 2011, which resulted in an effective tax rate of 76 percent. The effective tax rate was higher than the federal statutory tax rate of 35 percent primarily due to federal and California tax credits and the impact of the Radian6 acquisition. The tax benefit was partially offset by foreign tax expense and non-deductible amounts. The effect on the tax rate was magnified because of the relatively small pre-tax loss.

Six Months Ended July 31, 2012 and 2011

Revenues.

 

     Six Months Ended
July 31,
     Variance  

(In thousands)

   2012      2011      Dollars      Percent  

Subscription and support

   $ 1,342,713       $ 982,783       $ 359,930        37

Professional services and other

     84,403         67,583         16,820        25
  

 

 

    

 

 

    

 

 

    

 

 

 

Total revenues

   $ 1,427,116       $ 1,050,366       $ 376,750        36
  

 

 

    

 

 

    

 

 

    

 

 

 

 

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Total revenues were $1.43 billion for the six months ended July 31, 2012, compared to $1.05 billion during the same period a year ago, an increase of $376.8 million, or 36 percent. Subscription and support revenues were $1.3 billion, or 94 percent of total revenues, for the six months ended July 31, 2012, compared to $982.8 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 six months ended July 31, 2012 has remained substantially consistent relative to prior periods. Professional services and other revenues were $84.4 million, or six percent of total revenues, for the six months ended July 31, 2012, compared to $67.6 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 $434.2 million, or 30 percent of total revenues, for the six months ended July 31, 2012, compared to $343.4 million, or 33 percent of total revenues, during the same period a year ago, an increase of $90.8 million, or 26 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. However, the value of the U.S. dollar relative to foreign currencies caused a decrease in U.S. dollar revenues outside of the Americas for the six months ended July 31, 2012 as compared to the same period a year ago. The foreign currency impact had the effect of decreasing our aggregate revenues by $23.3 million compared to the same period a year ago.

Cost of Revenues.

 

     Six Months Ended
July 31,
    Variance  

(In thousands)

   2012     2011     Dollars  

Subscription and support

   $ 227,263      $ 164,387      $ 62,876   

Professional services and other

     86,706        59,589        27,117   
  

 

 

   

 

 

   

 

 

 

Total cost of revenues

   $ 313,969      $ 223,976      $ 89,993   
  

 

 

   

 

 

   

 

 

 

Percent of total revenues

     22 %     21 %  

Cost of revenues was $314.0 million, or 22 percent of total revenues, for the six months ended July 31, 2012, compared to $224.0 million, or 21 percent of total revenues, during the same period a year ago, an increase of $90.0 million. The increase in absolute dollars was primarily due to an increase of $37.8 million in employee-related costs, an increase of $15.3 million in service delivery costs, primarily due to our efforts in increasing data center capacity, an increase of $20.0 million in depreciation and amortization expenses, $9.6 million of which related to the amortization of acquired developed technology, an increase of $6.0 million in allocated overhead and an increase of $7.1 million in stock-based expenses. We have increased our professional services headcount since July 31, 2011 to meet the higher demand for services from our customers. A majority of the increase in headcount was due to the acquisition of Model Metrics in the fourth quarter of fiscal 2012. The increase in expense for the additional professional services headcount mentioned above resulted in the cost of professional services and other revenues to be in excess of the related revenue for the six months ended July 31, 2012 by $2.3 million.

We intend to continue to invest additional resources in our enterprise cloud computing services and data center capacity. 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 future periods.

Research and Development.

 

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Table of Contents
     Six Months Ended
July 31,
    Variance  

(In thousands)

   2012     2011     Dollars  

Research and development

   $ 194,218      $ 138,685      $ 55,533   

Percent of total revenues

     14 %     13 %  

Research and development expenses were $194.2 million, or 14 percent of total revenues, for the six months ended July 31, 2012, compared to $138.7 million, or 13 percent of total revenues, during the same period a year ago, an increase of $55.5 million. The increase in absolute dollars was due to an increase of $39.9 million in employee-related costs, an increase of $12.7 million in stock-based expenses and an increase of $2.5 million in test data lab costs. We increased our research and development headcount by 46 percent since July 31, 2011 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.

 

     Six Months Ended
July 31,
    Variance  

(In thousands)

   2012     2011     Dollars  

Marketing and sales

   $ 749,949      $ 537,472      $ 212,477   

Percent of total revenues

     53 %     52 %  

Marketing and sales expenses were $749.9 million, or 53 percent of total revenues, for the six months ended July 31, 2012, compared to $537.5 million, or 52 percent of total revenues, during the same period a year ago, an increase of $212.5 million. The increase in absolute dollars was primarily due to increases of $155.7 million in employee-related costs, $35.9 million in stock-based expenses, $13.0 million in advertising, marketing and event costs and an increase in allocated overhead. Our marketing and sales headcount increased by 35 percent since July 31, 2011 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.

 

     Six Months Ended
July 31,
    Variance  

(In thousands)

   2012     2011     Dollars  

General and administrative

   $ 204,695      $ 168,784      $ 35,911   

Percent of total revenues

     14 %     16 %  

General and administrative expenses were $204.7 million, or 14 percent of total revenues, for the six months ended July 31, 2012, compared to $168.8 million, or 16 percent of total revenues, during the same period a year ago, an increase of $35.9 million. The increase was primarily due to an increases of $8.8 million in stock-based expenses, $11.1 million in depreciation and amortization, $4.4 million in infrastructure costs and professional and outside service costs and an increase in employee-related costs. Our general and administrative headcount increased by 30 percent since July 31, 2011 as we added personnel to support our growth.

Loss from operations.

 

     Six Months Ended
July 31,
    Variance  

(In thousands)

   2012     2011     Dollars  

Loss from operations

   $ (35,715   $ (18,551   $ (17,164

Percent of total revenues

     (3 )%     (2 )%  

Loss from operations for the six months ended July 31, 2012, was $35.7 million and included $166.7 million of stock-based expenses and $41.0 million of amortization of purchased intangibles. During the same period a year ago, operating loss was $18.6 million and included $102.2 million of stock-based expenses and $29.0 million of amortization of purchased intangibles.

Investment income.

 

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     Six Months Ended
July 31,
    Variance  

(In thousands)

   2012     2011     Dollars  

Investment income

   $ 11,634      $ 13,167      $ (1,533

Percent of total revenues

     1 %     1 %  

Investment income consists of income on cash and marketable securities balances. Investment income was $11.6 million for the six months ended July 31, 2012, and was $13.2 million during the same period a year ago. The decrease was primarily due to increased realized losses from sales of marketable securities, the decrease in marketable securities balances and lower interest rates.

Interest expense.

 

     Six Months Ended
July 31,
    Variance  

(In thousands)

   2012     2011     Dollars  

Interest expense

   $ (14,403   $ (7,517   $ (6,886

Percent of total revenues

     (1 )%     0 %  

Interest expense consists of interest on our convertible senior notes and capital leases. Interest expense, net of interest costs capitalized, was $14.4 million for the six months ended July 31, 2012 and was $7.5 million during the same period a year ago. During the six months ended July 31, 2012, we capitalized $2.0 million of interest costs related to capital projects. Capitalized interest during the same period a year ago was $7.9 million. During the first quarter of fiscal 2013, we suspended pre-construction activity, which includes capitalized interest costs, on the undeveloped real estate in San Francisco, California.

Benefit for Income Taxes.

 

     Six Months Ended
July 31,
    Variance  

(In thousands)

   2012     2011     Dollars  

Benefit for income taxes

   $ 9,596      $ 13,194      $ (3,598

Effective tax rate

     25 %     78 %  

We recorded a tax benefit of $9.6 million for the six months ended July 31, 2012, which resulted in an effective tax rate of 25%. The effective tax rate was lower than the federal statutory tax rate of 35 percent primarily due to foreign tax expense and non-deductible amounts. The tax benefit of $9.6 million included California tax credits and the impact of structuring intellectual property related to acquisitions.

We recorded a tax benefit of $13.2 million for the six months ended July 31, 2011, which resulted in an effective tax rate of 78%. The effective tax rate was higher than the federal statutory tax rate of 35 percent primarily due to federal and California tax credits and tax benefit related to the Radian6 acquisition. The tax benefit was partially offset by foreign tax expense and non-deductible amounts. The effect on the tax rate was magnified because of the relatively small pre-tax loss.

The realization of deferred tax assets depends on sufficient taxable income. As a result, any factors that affect operating results such as changes in the general economic conditions of the market that impact customers’ purchase decisions, changes in foreign currency exchange rates and costs associated with acquisitions and subsequent integration could impact the realizability of the deferred tax assets. Any significant adjustment to the deferred tax assets could result in a material impact to our provision for income taxes.

New Accounting Pronouncement

In September 2011, the FASB issued Accounting Standards Update No. 2011-08, Intangibles—Goodwill and Other (Topic 350)—Testing Goodwill for Impairment (ASU 2011-08), to allow entities to use a qualitative approach to test goodwill for impairment. ASU 2011-08 permits an entity to first perform a qualitative assessment to determine whether it is more likely than not that the fair value of a reporting unit is less than its carrying value. If it is concluded that this is the case, it is necessary to perform the currently prescribed two-step goodwill impairment test. Otherwise, the two-step goodwill impairment test is not required. We plan to adopt ASU 2011-08 by the fourth quarter of fiscal 2013 and do not believe that the adoption will have a material effect on the condensed consolidated financial statements.

Liquidity and Capital Resources

At July 31, 2012, our principal sources of liquidity were cash, cash equivalents and marketable securities totaling $1.8 billion and accounts receivable of $446.9 million.

 

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Net cash provided by operating activities was $349.4 million during the six months ended July 31, 2012 and $222.5 million during the same period a year ago. Cash provided by operating activities has historically been affected by: the amount of net 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, increases in the amount of billings to customers because of increased invoice durations, the timing of commission and bonus payments, and the timing of collections from large enterprise customers; add-backs of non-cash expense items such as depreciation and amortization, amortization of debt discount and the expense associated with stock-based awards. We made a tax payment of approximately $40.0 million during the six months ended July 31, 2012 as a result of the Radian6 transaction.

Net cash used in investing activities was $102.7 million during the six months ended July 31, 2012 and $242.6 million during the same period a year ago. The net cash used in investing activities during the six months ended July 31, 2012 primarily related to the purchase of Rypple in February 2012, capital expenditures, investment of cash balances and strategic investments offset by proceeds from sales and maturities of marketable securities. We expect capital expenditures to be significantly higher in the remaining six months of fiscal 2013 primarily due to leasehold improvement costs associated with the office lease agreement we signed in January 2012 at 50 Fremont Street, San Francisco, California.

Net cash provided by financing activities was $138.1 million during the six months ended July 31, 2012 and $48.4 million during the same period a year ago. Net cash provided by financing activities during the six months ended July 31, 2012 consisted primarily of $127.4 million of proceeds from equity plans and $25.7 million of excess tax benefits from employee stock plans offset by $15.1 million of principal payments on capital leases.

In January 2010, we issued $575.0 million of 0.75% convertible senior notes due January 15, 2015 (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 earlier converted. 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.

For 20 trading days during the 30 consecutive trading days ended April 30, 2012, our common stock traded at a price exceeding 130% of the conversion price of $85.36 per share applicable to the Notes. Accordingly, the Notes were convertible at the holders’ option for the quarter ending July 31, 2012. The Notes are classified as a current liability on our condensed consolidated balance sheet as of July 31, 2012. For 20 trading days during the 30 consecutive trading days ended July 31, 2012, our common stock traded at a price exceeding 130% of the conversion price of $85.36 per share applicable to the Notes. Accordingly, the Notes will be convertible at the holders’ option for the quarter ending October 31, 2012, and 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 other obligations, U.S. treasury, U.S. government and U.S. agency obligations, U.S agency mortgage backed securities, time deposits, money market mutual funds and municipal securities.

As of July 31, 2012, we have a total of $22.0 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 April 2030.

We do not have any special purpose entities, and other than operating leases for office space and computer equipment, we do not engage in off-balance sheet financing arrangements. Additionally, we currently do not have a bank line of credit.

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 furniture and fixtures. At July 31, 2012, the future non-cancelable minimum payments under these commitments were as follows (in thousands):

 

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     Capital
Leases
    Operating
Leases
 

Fiscal Period:

    

Remaining six months of fiscal 2013

   $ 15,451      $ 69,328   

Fiscal 2014

     29,448        123,269   

Fiscal 2015

     8,908        93,697   

Fiscal 2016

     5,615        75,727   

Fiscal 2017

     4,813        62,588   

Thereafter

     1,030        297,893   
  

 

 

   

 

 

 

Total minimum lease payments

     65,265      $ 722,502   
    

 

 

 

Less: amount representing interest

     (3,627  
  

 

 

   

Present value of capital lease obligations

   $ 61,638     
  

 

 

   

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 expect cash flow from operations in subsequent periods to be lower because of the acquisition of Buddy and the wage and hour settlement agreement payment.

On August 13, 2012, we acquired the outstanding stock of Buddy, a social media marketing platform. The total purchase price for Buddy included $467.1 million in cash, net of cash acquired, 1,393,859 shares of our common stock and $33.1 million which represents the fair market value of the employee stock awards assumed.

On August 16, 2012, we made a payment of approximately $9.7 million as a result of court approval of the settlement agreement with respect to a California state wage and hour lawsuit that had been filed against us early in 2011 in the Superior Court of California, County of San Francisco. We entered into a preliminary settlement agreement in the second quarter of fiscal 2012 and recorded the estimated settlement expense in our financial results for fiscal 2012.

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.

During fiscal 2013, we may enter into arrangements to acquire or invest in complementary businesses or joint ventures, services and technologies, and intellectual property rights. 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.

Non-GAAP Financial Measures

Regulation S-K Item 10(e), “Use of Non-GAAP Financial Measures in Commission Filings,” defines and prescribes the conditions for use of non-GAAP financial information. Our measures of non-GAAP gross profit, non-GAAP operating profit, non-GAAP net income and non-GAAP earnings per share each meet the definition of a non-GAAP financial measure.

Non-GAAP gross profit, Non-GAAP operating profit and Non-GAAP net income

We use the non-GAAP measures of non-GAAP gross profit, non-GAAP operating profit and non-GAAP net income to provide an additional view of operational performance by excluding non-cash expenses that are not directly related to performance in any particular period. In addition to our GAAP measures we use these non-GAAP measures when planning, monitoring, and evaluating our performance. We believe that these non-GAAP measures reflect our ongoing business in a manner that allows for meaningful period-to-period comparisons and analysis of trends in our business, as they exclude certain expenses. These certain expenses are excluded because the decisions which gave rise to these expenses are not made to increase revenue in a particular period, but are made for our long-term benefit over multiple periods and we are not able to change or affect these items in any particular period.

We define non-GAAP net income as our total net income excluding the following components, which we believe are not reflective of our ongoing operational expenses. In each case, for the reasons set forth below, we believe that excluding the component provides useful information to investors and others in understanding and evaluating the impact of certain non-cash items to our

 

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operating results and future prospects in the same manner as us, in comparing financial results across accounting periods and to those of peer companies and to better understand the impact of these non-cash items on our gross margin and operating performance. Additionally, as significant, unusual or discrete events occur, the results may be excluded in the period in which the events occur.

 

   

Stock-Based Expenses. The Company’s compensation strategy includes the use of stock-based compensation to attract and retain employees and executives. It is principally aimed at aligning their interests with those of our stockholders and at long-term employee retention, rather than to motivate or reward operational performance for any particular period. Thus, stock-based compensation expense varies for reasons that are generally unrelated to operational decisions and performance in any particular period.

 

   

Amortization of Purchased Intangibles. The Company views amortization of acquisition-related intangible assets, such as the amortization of the cost associated with an acquired company’s research and development efforts, trade names, customer lists and customer relationships, as items arising from pre-acquisition activities determined at the time of an acquisition. While it is continually viewed for impairment, amortization of the cost of purchased intangibles is a static expense, one that is not typically affected by operations during any particular period.

 

   

Amortization of Debt Discount. Under GAAP, certain convertible debt instruments that may be settled in cash (or other assets) on conversion are required to be separately accounted for as liability (debt) and equity (conversion option) components of the instrument in a manner that reflects the issuer’s non-convertible debt borrowing rate. Accordingly, for GAAP purposes we are required to recognize imputed interest expense on the Company’s $575 million of convertible subordinated notes that were issued in a private placement in January 2010. The imputed interest rate is approximately 5.9%, while the coupon interest rate is 0.75%. The difference between the imputed interest expense and the coupon interest expense, net of the interest amount capitalized, is excluded from management’s assessment of the Company’s operating performance because management believes that this non-cash expense is not indicative of ongoing operating performance. Management believes that the exclusion of the non-cash interest expense provides investors an enhanced view of the Company’s operational performance.

 

   

Income Tax Effects. The company’s non-GAAP effective tax rate excludes the tax effect of the expense items described above.

We define non-GAAP gross profit as our total revenues less cost of revenues, as reported on our condensed consolidated statement of operations, excluding the portions of stock-based expenses and amortization of purchased intangibles that are included in cost of revenues.

We define non-GAAP operating profit as our non-GAAP gross profit less operating expenses, as reported on our condensed consolidated statement of operations, excluding the portions of stock-based expenses and amortization of purchased intangibles that are included in operating expenses.

Non-GAAP earnings per share

Management uses the non-GAAP earnings per share to provide an additional view of performance by excluding expenses that are not directly related to performance in any particular period in the earnings per share calculation.

We define non-GAAP earnings per share as our non-GAAP net income, which excludes the above components, which we believe are not reflective of our ongoing operational expenses, divided by basic or diluted shares outstanding.

Limitations on the use of Non-GAAP financial measures

A limitation of our non-GAAP financial measures of non-GAAP gross profit, non-GAAP operating profit, non-GAAP net income and non-GAAP earnings per share is that they do not have uniform definitions. Our definitions will likely differ from the definitions used by other companies, including peer companies, and therefore comparability may be limited. Thus, our non-GAAP measures of non-GAAP gross profit, non-GAAP operating profit, non-GAAP net income and non-GAAP earnings per share should be considered in addition to, not as a substitute for, or in isolation from, measures prepared in accordance with GAAP. Additionally, in the case of stock-based expense, if we did not pay a portion of compensation in the form of stock-based expense, the cash salary expense included in costs of revenues and operating expenses would be higher which would affect our cash position.

 

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We compensate for these limitations by reconciling non-GAAP gross profit, non-GAAP operating profit, non-GAAP net income and non-GAAP earnings per share to the most comparable GAAP financial measure. We encourage investors and others to review our financial information in its entirety, not to rely on any single financial measure and to view our non-GAAP financial measures in conjunction with the most comparable GAAP financial measures.

Our reconciliation of the non-GAAP financial measure of gross profit, operating profit, net income and earnings per share to the most comparable GAAP measure, “gross profit,” “income (loss) from operations,” “net income (loss)” and “Diluted earnings (loss) per share” for the three and six months ended July 31, 2012 and 2011 are as follows (in thousands):

 

     Three Months Ended
July 31,
    Six Months Ended
July 31,
 
     2012     2011     2012     2011  

Non-GAAP gross profit

        

GAAP gross profit

   $ 569,231      $ 425,092      $ 1,113,147      $ 826,390   

Plus:

        

Amortization of purchased intangibles

     17,668        16,373        35,116        25,468   

Stock-based expenses

     7,864        4,379        15,117        8,030   
  

 

 

   

 

 

   

 

 

   

 

 

 

Non-GAAP gross profit

   $ 594,763      $ 445,844      $ 1,163,380      $ 859,888   
  

 

 

   

 

 

   

 

 

   

 

 

 
     Three Months Ended
July 31,
    Six Months Ended
July 31,
 
     2012     2011     2012     2011  

Non-GAAP operating profit

        

GAAP loss from operations

   $ (13,466   $ (15,748   $ (35,715   $ (18,551

Plus:

        

Amortization of purchased intangibles

     20,075        18,679        40,950        29,014   

Stock-based expenses

     85,417        54,594        166,683        102,152   
  

 

 

   

 

 

   

 

 

   

 

 

 

Non-GAAP operating profit

   $ 92,026      $ 57,525      $ 171,918      $ 112,615   
  

 

 

   

 

 

   

 

 

   

 

 

 
     Three Months Ended
July 31,
    Six Months Ended
July 31,
 
     2012     2011     2012     2011  

Non-GAAP net income

        

GAAP net loss

   $ (9,829   $ (4,268   $ (29,304   $