[May 24, 2013] SALESFORCE COM INC - 10-Q - MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS Tweet (Edgar Glimpses Via Acquire Media NewsEdge) 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 "customer company", 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 businesses, joint ventures, services and technologies, and intellectual property rights, our ability to successfully integrate acquired businesses and technologies, our ability to continue the growth and 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 valuation of deferred tax assets, 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 factors related to our outstanding convertible notes, and current 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 provider of enterprise cloud computing solutions. We were founded on the simple concept of delivering customer relationship management, or CRM, applications via the Internet, or "cloud." We introduced our first CRM solution in February 2000 and we have expanded our offerings with new editions, solutions and enhanced features, through internal development and acquisitions. We sell to businesses of all sizes and in almost every industry worldwide on a subscription basis. Our mission is to help our customers transform themselves into "customer companies" by empowering them to connect with their customers, partners, employees and products in entirely new ways. Our objective is to deliver solutions to help companies transform the way they sell, service, market and innovate. With our four core services-Sales Cloud, Service Cloud, Marketing Cloud and the Salesforce Platform-customers have the tools they need to build a next generation social front office with our social and mobile cloud technologies. Key elements of our strategy include: • Strengthening our market-leading core solutions; • Innovating in high-growth markets; • Improving our renewal rates; • Deepening relationships with our existing customer base; • Pursuing new customers aggressively; • Building our business in top markets globally; 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 availability, performance and security of our service; our ability to continue to release, and gain customer acceptance of, new and improved features; our ability to successfully integrate acquired businesses and technologies; successful customer adoption and utilization of our service; acceptance of our service in markets where we have few customers; the emergence of additional competitors in our market and improved product offerings by existing and new competitors; the location of new data centers; third-party developers' willingness to develop applications on our 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. 28 -------------------------------------------------------------------------------- Table of Contents 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, encourage the development of third-party applications on our platforms and continue to focus on retaining customers at the time of renewal. Our plans to invest for future growth include the continuation of the expansion of our data center capacity, the hiring of additional personnel, particularly in direct sales, other customer-related areas and research and development, the expansion of domestic and international selling and marketing activities, continuing to develop our brands, the addition of distribution channels, the upgrade of our service offerings, the development of new services, the integration of acquired technologies, the expansion of our Marketing Cloud and Salesforce Platform service offerings and the additions 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 and we plan to reinvest a significant portion of our incremental revenue in fiscal 2014 to grow our business and continue our leadership role in the cloud computing industry. As a result of our aggressive growth plans, specifically our hiring plan and acquisition activities, we have incurred significant expenses from equity awards and amortization of purchased intangibles which have resulted in net losses on a GAAP basis. As we continue with our growth plan, we anticipate we will have net losses on a GAAP basis for the next several quarters. On March 18, 2013, we issued at par value $1.15 billion of 0.25% convertible senior notes due April 1, 2018. In connection with the issuance of the debt, we entered into convertible note hedge transactions that cover the number of shares of our common stock that are underlying the notes. The note hedge transactions are designed, but not guaranteed, to reduce or eliminate the potential economic dilution arising upon conversion. On March 20, 2013, our certificate of incorporation was amended to increase the number of authorized shares of common stock from 400.0 million to 1.6 billion in order to provide for a four-for-one stock split of the common stock effected in the form of a stock dividend. The record date for the stock split was April 3, 2013, and the additional shares were distributed on April 17, 2013. Each stockholder of record on the close of business on the record date received three additional shares of common stock for each share held. All share and per share data presented herein reflect the impact of the increase in authorized shares and the stock split, as appropriate. We expect marketing and sales costs, which were 52 percent of our total revenues for the three months ended April 30, 2013 and 53 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 customers, and build greater brand awareness. Fiscal Year Our fiscal year ends on January 31. References to fiscal 2014, for example, refer to the fiscal year ending January 31, 2014. 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 revenue. "Other revenue" consists primarily of training fees. Subscription and support revenues accounted for approximately 94 percent of our total revenues for the three months ended April 30, 2013. 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 three months ended April 2013 and 2012. 29 -------------------------------------------------------------------------------- Table of Contents 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 36 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 Estimates-Revenue Recognition" below. 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 annual or quarterly cycles. Occasionally, we bill customers for their multi-year contract on a single invoice which results in an increase in noncurrent deferred revenue. We typically issue renewal invoices 30 days in advance of the renewal service period, and depending on timing, the initial invoice for the subscription and services contract and the subsequent renewal invoice may occur in different quarters. This may result in an increase in deferred revenue and accounts receivable. 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. 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: April 30, (in thousands) 2013 Fiscal 2014 Accounts receivable, net $ 502,609Deferred revenue, current and noncurrent 1,733,160 April 30, July 31, October 31, January 31, (in thousands) 2012 2012 2012 2013 Fiscal 2013 Accounts receivable, net $ 371,395 $ 446,917 $ 418,590 $ 872,634 Deferred revenue, current and noncurrent 1,334,716 1,337,184 1,291,703 1,862,995 30 -------------------------------------------------------------------------------- Table of Contents April 30, July 31, October 31, January 31, (in thousands) 2011 2011 2011 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 Unbilled Deferred Revenue The deferred revenue balance on our consolidated balance sheet does not represent the total contract value of annual or multi-year, non-cancelable subscription agreements. Unbilled deferred revenue represents future billings under our subscription agreements that have not been invoiced and, accordingly, are not recorded in deferred revenue. Unbilled deferred revenue was approximately $3.6 billion as of April 30, 2013 and approximately $3.5 billion as of January 31, 2013. Due to our sales to large enterprise accounts, we are experiencing longer contractual commitments by our customers which is reflected in our growing unbilled deferred revenue. Also as a result, our typical contract length has grown and is now between 12 and 36 months. This has a positive impact on our renewal rate. 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 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 security 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. 31-------------------------------------------------------------------------------- Table of Contents We expect that in the future, research and development expenses will increase in absolute dollars and may increase as a percentage of total revenues as we invest in building the necessary employee and system infrastructure required to support the development of new, and improve existing, technologies and the integration of 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 either remain flat or decrease 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 acquire more companies, as we hire more employees and seek to retain existing employees. During the three months ended April 30, 2013, we recognized stock-based expense of $114.7 million. As of April 30, 2013, the aggregate stock compensation remaining to be amortized to costs and expenses was $1.2 billion. We expect this stock compensation balance to be amortized as follows: $378.1 million during the remaining nine months of fiscal 2014; $412.1 million during fiscal 2015; $264.2 million during fiscal 2016; $103.9 million during fiscal 2017 and $0.8 million during fiscal 2018. The expected amortization reflects only outstanding stock awards as of April 30, 2013 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. 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. 32-------------------------------------------------------------------------------- Table of Contents 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 multiple subscriptions, premium support, and professional services. 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. Multiple-deliverables included in an arrangement are separated into different units of accounting and 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. 33 -------------------------------------------------------------------------------- Table of Contents 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. 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 36 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 three months ended April 30, 2013, we deferred $17.5 million of commission expenditures and we amortized $45.7 million to sales expense. During the same period a year ago, we deferred $32.1 million of commission expenditures and we amortized $36.2 million to sales expense. Deferred commissions on our condensed consolidated balance sheets totaled $226.2 million at April 30, 2013 and $254.4 million at January 31, 2013. Goodwill and Long-Lived Assets. We make estimates, assumptions, and judgments when valuing goodwill and other intangible assets in connection with the initial purchase price allocation of an acquired entity, as well as when evaluating the recoverability of our goodwill and other intangible assets on an ongoing basis. These estimates are based upon a number of factors, including historical experience, market conditions, and information obtained from the management of acquired companies. Critical estimates in valuing certain intangible assets include, but are not limited to, historical and projected customer retention rates, anticipated growth in revenue from the acquired customers and acquired technology, and the expected use of the acquired assets. These factors are also considered in determining the useful life of acquired intangible assets. The amounts and useful lives assigned to identified intangible assets impacts the amount and timing of future amortization expense. The value of our goodwill and intangible assets could be impacted by future adverse changes such as, but not limited to: a substantial decline in our market capitalization; an adverse action or assessment by a regulator; and unanticipated competition. We evaluate and test the recoverability of our goodwill for impairment at least annually during the fourth quarter or more often if and when circumstances indicate that goodwill may not be recoverable. Each period we evaluate the estimated remaining useful life of our intangible assets and whether events or changes in circumstances warrant a revision to the remaining period of amortization. We evaluate long-lived assets, such as property and equipment, and purchased intangible assets for impairment whenever events or changes in circumstances indicate that the carrying amount of the assets may not be recoverable. Such events or changes in circumstances include, but are not limited to, a significant decrease in the fair value of the underlying asset, a significant decrease in the benefits realized from the acquired assets, difficulty and delays in integrating the business or a significant change in the operations of the acquired assets or use of an asset. A long-lived asset is considered impaired if its carrying amount exceeds the estimated future undiscounted cash flows the asset is expected to generate. If a long-lived asset is considered to be impaired, the impairment to be recognized is the amount by which the carrying amount of the asset exceeds the fair value of the asset or asset group. 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. 34-------------------------------------------------------------------------------- Table of Contents Business Combinations. Accounting for business combinations requires us to make significant estimates and assumptions, especially at the acquisition date with respect to tangible and intangible 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 Options and Awards. We recognize the fair value of our stock options and awards on a straight-line basis over the requisite service period of the option or 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 option or ESPP share or stock purchase right 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; • 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; • 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; and • The probability of performance conditions that effect the vesting of certain awards being achieved. Expense is only recognized for those shares expected to vest. Income Taxes. We use the asset and 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 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 the condensed consolidated statements of operations in the period that includes the enactment date. At each of the interim financial reporting periods, we compute our tax provision by applying an estimated annual effective tax rate to year to date ordinary income and adjust the provision for discrete tax items recorded in the same period. The estimated annual effective tax rate at each interim period represents the best estimate based on evaluations of possible future transactions and may be subject to subsequent refinement or revision. Our tax positions are subject to income tax audits by multiple tax jurisdictions throughout the world. We recognize the tax benefit of an uncertain tax position only if it is more likely than not that the position is sustainable upon examination by the taxing authority, based on the technical merits. The tax benefit recognized is measured as the largest amount of benefit which is greater than 50 percent likely to be realized upon settlement with the taxing authority. We recognize interest accrued and penalties related to unrecognized tax benefits in our income tax provision. 35-------------------------------------------------------------------------------- Table of Contents We regularly assess the need for a valuation allowance against our deferred tax assets. In making that assessment, we consider both positive and negative evidence related to the likelihood of realization of the deferred tax assets on a jurisdictional basis to determine, based on the weight of available evidence, whether it is more likely than not that some or all of the deferred tax assets will not be realized. Examples of positive and negative evidence include historical taxable income or losses, forecasted income or losses, the estimated timing of the reversals of existing temporary differences as well as prudent and feasible tax planning strategies. A valuation allowance is established when necessary to reduce deferred tax assets to the amounts more likely than not expected to be realized. Our income tax provision would increase or decrease in the period in which the assessment is changed. Our tax provision could be adversely affected by changes in the mix of earnings and losses in countries with differing statutory tax rates, certain non-deductible expenses, changes in the valuation of deferred tax assets and liabilities, changes in tax laws and accounting principles as well as changes in excess tax benefits related to exercises and vesting of stock-based compensation that are allocated directly to stockholders' equity. Results of Operations The following tables set forth selected data for each of the periods indicated (in thousands): Three Months Ended April 30, 2013 2012 Revenues: Subscription and support $ 842,221 $ 655,220 Professional services and other 50,412 40,247 Total revenues 892,633 695,467 Cost of revenues: Subscription and support 153,550 108,744 Professional services and other 55,444 42,807 Total cost of revenues 208,994 151,551 Gross profit 683,639 543,916 Operating expenses: Research and development 131,939 94,776 Marketing and sales 466,490 369,789 General and administrative 129,750 101,600 Total operating expenses 728,179 566,165 Loss from operations (44,540 ) (22,249 ) Investment income 3,354 4,461 Interest expense (11,883 ) (6,370 ) Other expense (874 ) (710 ) Loss before benefit from (provision for) income taxes (53,943 ) (24,868 ) Benefit from (provision for) income taxes (13,778 ) 5,393 Net loss $ (67,721 ) $ (19,475 ) 36 -------------------------------------------------------------------------------- Table of Contents As of April 30, January 31, 2013 2013 Balance Sheet Data: Cash, cash equivalents and marketable securities (1) $ 3,079,457 $ 1,758,285 Deferred revenue, current and noncurrent 1,733,160 1,862,995 (1) Cash, cash equivalents and marketable securities at April 30, 2013 includes $1.1 billion of net proceeds from the convertible 0.25% senior note offering and hedge transactions in March 2013 Unbilled deferred revenue was approximately $3.6 billion as of April 30, 2013 and $3.5 billion as of January 31, 2013. 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 April 30, 2013 2012 Cost of revenues $ 21,305 $ 17,448 Marketing and sales 2,460 3,427 Cost of revenues and operating expenses include the following amounts related to stock-based awards: Three Months Ended April 30, 2013 2012 Cost of revenues $ 10,678 $ 7,253 Research and development 24,429 15,667 Marketing and sales 59,802 41,987 General and administrative 19,820 16,359 Revenues by geography were as follows: Three Months Ended April 30, 2013 2012 Americas $ 631,108 $ 484,953 Europe 162,826 118,294 Asia Pacific 98,699 92,220 $ 892,633 $ 695,467 Approximately 95 percent and 94 percent of the Americas revenue for the three months ended April 30, 2013 and 2012, respectively, was attributed to the United States. 37 -------------------------------------------------------------------------------- Table of Contents The following tables set forth selected condensed consolidated statements of operations data for each of the periods indicated as a percentage of total revenues: Three Months Ended April 30, 2013 2012 Revenues: Subscription and support 94 % 94 % Professional services and other 6 6 Total revenues 100 100 Cost of revenues: Subscription and support 17 16 Professional services and other 6 6 Total cost of revenues 23 22 Gross profit 77 78 Operating expenses: Research and development 15 14 Marketing and sales 52 53 General and administrative 15 14 Total operating expenses 82 81 Loss from operations (5 ) (3 ) Investment income 0 0 Interest expense (1 ) (1 ) Other expense 0 0 Loss before benefit from (provision for) income taxes (6 ) (4 ) Benefit from (provision for) income taxes (2 ) 1 Net loss (8 )% (3 )% Three Months Ended April 30, 2013 2012 Amortization of purchased intangibles from business combinations: Cost of revenues 2 % 3 % Marketing and sales 0 0 Three Months Ended April 30, 2013 2012 Stock-based awards: Cost of revenues 1 % 1 % Research and development 3 2 Marketing and sales 7 6 General and administrative 2 2 38 -------------------------------------------------------------------------------- Table of Contents Three Months Ended April 30, 2013 2012 Revenues by geography: Americas 71 % 70 % Europe 18 17 Asia Pacific 11 13 100 % 100 % Three Months Three Months Ended Ended April 30, 2013 April 30, 2012 compared to compared to Three Months Three Months Ended Ended April 30, 2012 April 30, 2011 Revenue constant currency growth rates (as compared to the comparable prior periods): Americas 30 % 43 % Europe 38 % 33 % Asia Pacific 17 % 30 % Total growth 30 % 39 % We present constant currency information to provide a framework for assessing how our underlying business performed excluding the effect of foreign currency rate fluctuations. To present this information, current and comparative prior period results for entities reporting in currencies other than United States dollars are converted into United States dollars at the weighted average exchange rate for the quarter being compared to for growth rate calculations presented, rather than the actual exchange rates in effect during that period. Three Months Ended April 30, 2013 and 2012 Revenues. Three Months Ended April 30, Variance (In thousands) 2013 2012 Dollars Percent Subscription and support $ 842,221 $ 655,220 $ 187,001 29 % Professional services and other 50,412 40,247 10,165 25 % Total revenues $ 892,633 $ 695,467 $ 197,166 28 % Total revenues were $892.6 million for the three months ended April 30, 2013, compared to $695.5 million during the same period a year ago, an increase of $197.2 million, or 28 percent. Subscription and support revenues were $842.2 million, or 94 percent of total revenues, for the three months ended April 30, 2013, compared to $655.2 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. We have continued to invest in a variety of customer programs and initiatives which, along with longer contract durations and increasing enterprise adoption, have helped improve our renewal rates. The price per user per month for our three primary offerings, Professional Edition, Enterprise Edition and Unlimited Edition, in the three months ended April 30, 2013 has generally remained consistent relative to prior periods. Professional services and other revenues were $50.4 million, or six percent of total revenues, for the three months ended April 30, 2013, compared to $40.2 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 higher demand for services from an increased number of customers. Revenues in Europe and Asia Pacific accounted for $261.5 million, or 29 percent of total revenues, for the three months ended April 30, 2013, compared to $210.5 million, or 30 percent of total revenues, during the same period a year ago, an increase of $51.0 million, or 24 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 as a result of the reasons stated above. Revenues outside of the Americas increased despite an overall strengthening of the U.S. dollar relative to major international currencies, which reduced aggregate international revenues by $9.9 million compared to the same period a year ago. 39-------------------------------------------------------------------------------- Table of Contents Cost of Revenues. Three Months Ended April 30, Variance (In thousands) 2013 2012 Dollars Subscription and support $ 153,550 $ 108,744 $ 44,806 Professional services and other 55,444 42,807 12,637 Total cost of revenues $ 208,994 $ 151,551 $ 57,443 Percent of total revenues 23 % 22 % Cost of revenues was $209.0 million, or 23 percent of total revenues, for the three months ended April 30, 2013, compared to $151.6 million, or 22 percent of total revenues, during the same period a year ago, an increase of $57.4 million. The increase in absolute dollars was primarily due to an increase of $18.2 million in employee-related costs, an increase of $3.4 million in stock-based expenses, an increase of $9.3 million in service delivery costs, primarily due to our efforts to increase data center capacity, an increase of $8.7 million in depreciation and amortization expenses, $3.9 million of which related to the amortization of purchased intangible assets, an increase of $4.7 million in allocated overhead and an increase of approximately $8.0 million related to an intellectual property license agreement. We have increased our headcount by 30 percent since April 30, 2012 to meet the higher demand for services from our customers. 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. Research and Development. Three Months Ended April 30, Variance (In thousands) 2013 2012 Dollars Research and development $ 131,939 $ 94,776 $ 37,163 Percent of total revenues 15 % 14 % Research and development expenses were $131.9 million, or 15 percent of total revenues, for the three months ended April 30, 2013, compared to $94.8 million, or 14 percent of total revenues, during the same period a year ago, an increase of $37.2 million. The increase in absolute dollars was primarily due to an increase of $23.1 million in employee-related costs, an increase of $8.8 million in stock-based expenses and an increase of $2.6 million in our development and test data center. We increased our research and development headcount by 30 percent since April 30, 2012 in order to improve and extend our service offerings and develop new technologies. We expect that research and development expenses will increase in absolute dollars and may increase as a percentage of revenues in the remaining nine months of fiscal 2014 and future periods because we expect to continue to invest in building the necessary employee and system infrastructure required to support the development of new, and improve existing, technologies and the integration of acquired technologies. Marketing and Sales. Three Months Ended April 30, Variance (In thousands) 2013 2012 Dollars Marketing and sales $ 466,490 $ 369,789 $ 96,701 Percent of total revenues 52 % 53 % 40 -------------------------------------------------------------------------------- Table of Contents Marketing and sales expenses were $466.5 million, or 52 percent of total revenues, for the three months ended April 30, 2013, compared to $369.8 million, or 53 percent of total revenues, during the same period a year ago, an increase of $96.7 million. The increase in absolute dollars was primarily due to increases of $56.8 million in employee-related costs, including amortization of deferred commissions, $17.8 million in stock-based expenses, $14.5 million in advertising, marketing and event costs and increases in allocated overhead. Our marketing and sales headcount increased by 22 percent since April 30, 2012 as we hired additional sales personnel to focus on adding new customers and increasing penetration within our existing customer base. General and Administrative. Three Months Ended April 30, Variance (In thousands) 2013 2012 Dollars General and administrative $ 129,750 $ 101,600 $ 28,150 Percent of total revenues 15 % 14 % General and administrative expenses were $129.8 million, or 15 percent of total revenues, for the three months ended April 30, 2013, compared to $101.6 million, or 14 percent of total revenues, during the same period a year ago, an increase of $28.2 million. The increase was primarily due to an increases of $10.9 million in employee-related costs, $5.1 million in professional and outside services, $3.5 million in stock-based expenses and increases in allocated overhead. Our general and administrative headcount increased by 14 percent since April 30, 2012 as we added personnel to support our growth. Loss from operations. Three Months Ended April 30, Variance (In thousands) 2013 2012 Dollars Loss from operations $ (44,540 ) $ (22,249 ) $ (22,291 ) Percent of total revenues (5 )% (3 )% Loss from operations for the three months ended April 30, 2013 was $44.5 million and included $114.7 million of stock-based expenses and $23.8 million of amortization of purchased intangibles. During the same period a year ago, loss from operations was $22.2 million and included $81.3 million of stock-based expenses and $20.9 million of amortization of purchased intangibles. Investment income. Three Months Ended April 30, Variance (In thousands) 2013 2012 Dollars Investment income $ 3,354 $ 4,461 $ (1,107 ) Investment income consists of income on our cash and marketable securities balances. Investment income was $3.4 million for the three months ended April 30, 2013 and was $4.5 million during the same period a year ago. The decrease was primarily due to lower investment yields from our portfolio compared to the same period a year ago. 41-------------------------------------------------------------------------------- Table of Contents Interest expense. Three Months Ended April 30, Variance (In thousands) 2013 2012 Dollars Interest expense $ (11,883 ) $ (6,370 ) $ (5,513 ) Interest expense consists of interest on our convertible senior notes and capital leases. Interest expense, net of interest costs capitalized, was $11.9 million for the three months ended April 30, 2013 and was $6.4 million during the same period a year ago. The increase was primarily due to interest expense associated with the March 2013 issuance of $1.15 billion convertible senior notes. During the three months ended April 30, 2013, we capitalized $0.2 million of interest costs related to capital projects. Capitalized interest during the same period a year ago was $1.8 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 from (provision for) income taxes. Three Months Ended April 30, Variance (In thousands) 2013 2012 Dollars Benefit from (provision for) income taxes $ (13,778 ) $ 5,393 $ (19,171 ) Effective tax rate (26 )% 22 % For the three months ended April 30, 2013, we reported a tax expense of $13.8 million with a pretax loss of $53.9 million, which resulted in a negative effective tax rate of 26 percent. We recorded a tax provision on a pretax loss primarily due to income taxes accrued in profitable jurisdictions outside of the U.S. and the loss in the U.S. was not benefited due to the valuation allowance. For the three months ended April 30, 2012, we recorded a tax benefit of $5.4 million on a pretax loss of $24.9 million, which resulted in an effective tax rate of 22 percent. The tax rate was lower than the federal statutory tax rate of 35 percent primarily attributable to California tax credits and tax benefits recorded in connection with acquisition related structuring of intellectual property, partially offset by a detrimental foreign tax differential and non-deductible expenses arising from stock-based compensation and state income taxes. Liquidity and Capital Resources At April 30, 2013, our principal sources of liquidity were cash, cash equivalents and marketable securities totaling $3.1 billion and accounts receivable of $502.6 million. Net cash provided by operating activities was $283.2 million during the three months ended April 30, 2013 and $213.2 million during the same period a year ago. Cash provided by operating activities has historically been affected by: the amount of net loss adjusted for non-cash expense items such as depreciation and amortization, amortization of purchased intangibles from business combinations, amortization of debt discount, and the expense associated with stock-based awards; the reclassification of excess tax benefits from employee stock plans to cash flows from financing activities; the timing of employee related costs including commissions and bonus payments; the timing of collections from our customers, which is our largest source of operating cash flows; and changes in working capital accounts. 42-------------------------------------------------------------------------------- Table of Contents Our working capital accounts consist of accounts receivables and prepaid assets and other current assets. Claims against working capital include accounts payable, accrued expenses and other current liabilities and our convertible notes. Our working capital may be impacted by factors in future periods, certain amounts and timing of which are seasonal, such as billings to customers for subscriptions and support services and the subsequent collection of those billings. As described above in "Seasonal Nature of Deferred Revenue and Accounts Receivable," 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 business causes the value of invoices that we generate in the fourth quarter to increase as a proportion of our total annual billings. We generally invoice our customers for our subscription and services contracts in advance in annual or quarterly installments. We typically issue renewal invoices 30 days in advance of the renewal service period, and depending on timing, the initial invoice for the subscription and services contract and the subsequent renewal invoice may occur in different quarters. Such invoice amounts are initially reflected in accounts receivable and deferred revenue, which is reflected on the balance sheet. The operating cash flow benefit of increased billing activity generally occurs in the subsequent quarter when we collect from our customers. Net cash provided by operating activities increased $70.0 million over the same period a year ago primarily due to higher net income after adjusting for depreciation and amortization, stock-based compensation and a $9.2 million decrease in the excess tax benefits from employee stock plans which improved operating cash results. Net cash used in investing activities was $219.3 million during the three months ended April 30, 2013 and $475.0 million during the same period a year ago. The net cash used in investing activities during the three months ended April 30, 2013 primarily related to business combinations, capital expenditures, investment of cash balances and strategic investments offset by proceeds from sales and maturities of marketable securities. Net cash provided by financing activities was $1.1 billion during the three months ended April 30, 2013 and $97.0 million during the same period a year ago. Net cash provided by financing activities during the three months ended April 30, 2013 consisted primarily of $1.1 billion of proceeds from the issuance of convertible senior notes, $84.8 million from proceeds from the issuance of warrants and $66.5 million of proceeds from equity plans offset by $153.8 million for the purchase of hedges on the convertible note and $8.5 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 "0.75% Senior Notes") and concurrently entered into convertible notes hedges (the "0.75% Note Hedges") and separate warrant transactions (the "0.75% Warrants"). The 0.75% Senior Notes will mature on January 15, 2015, unless earlier converted. Upon conversion of any 0.75% Senior Notes, we will deliver cash up to the principal amount of the 0.75% Senior Notes and, with respect to any excess conversion value greater than the principal amount of the 0.75% Senior Notes, shares of our common stock, cash, or a combination of both. To date, there has been a nominal amount of conversions of the 0.75% Senior Notes. For the 20 trading days during the 30 consecutive trading days ended January 31, 2013, our common stock traded at a price exceeding 130% of the conversion price of $21.34 per share applicable to the 0.75% Senior Notes. Accordingly, the 0.75% Senior Notes were convertible at the holders' option for the quarter ending April 30, 2013. The 0.75% Senior Notes are classified as a current liability on our condensed consolidated balance sheet as of April 30, 2013. For 20 trading days during the 30 consecutive trading days ended April 30, 2013, our common stock traded at a price exceeding 130% of the conversion price of $21.34 per share applicable to the 0.75% Senior Notes. Accordingly, the 0.75% Senior Notes will be convertible at the holders' option for the quarter ending July 31, 2013, and will remain classified as a current liability on our condensed consolidated balance sheet. In March 2013, we issued $1.15 billion of 0.25% convertible senior notes due April 1, 2018 (the "0.25% Senior Notes") and concurrently entered into convertible notes hedges (the "0.25% Note Hedges") and separate warrant transactions (the "0.25% Warrants"). The 0.25% Senior Notes will mature on April 1, 2018, unless earlier converted. Upon conversion of any 0.25% Senior Notes, we will deliver cash up to the principal amount of the 0.25% Senior Notes and, with respect to any excess conversion value greater than the principal amount of the 0.25% Senior Notes, shares of our common stock, cash, or a combination of both. 43 -------------------------------------------------------------------------------- Table of Contents The 0.25% Senior Notes will be convertible if during any 20 trading days during the 30 consecutive trading days of any fiscal quarter commencing after April 30, 2013, our common stock trades at a price exceeding 130% of the conversion price of $66.44 per share applicable to the 0.25% Senior Notes. The 0.25% Senior Notes have not yet been convertible at the holders' option. The 0.25% Senior Notes are classified as a noncurrent liability on our condensed consolidated balance sheet as of April 30, 2013. Our cash, cash equivalents and marketable securities are comprised primarily of corporate notes and other obligations, U.S. treasury securities, U.S. agency obligations, government obligations, collateralized mortgage obligations, mortgage backed securities, time deposits, money market mutual funds and municipal securities. As of April 30, 2013, we have a total of $60.2 million in letters of credit outstanding in favor of certain landlords for office space. To date, no amounts have been drawn against the letters of credit, which renew annually and expire at various dates through December 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 April 30, 2013, the future non-cancelable minimum payments under these commitments were as follows (in thousands): Capital Operating Leases Leases Fiscal Period: Remaining nine months of fiscal 2014 $ 23,658 $ 114,569 Fiscal 2015 14,266 158,097 Fiscal 2016 11,008 151,534 Fiscal 2017 10,206 142,966 Fiscal 2018 5,437 140,331 Thereafter 286 987,951 Total minimum lease payments 64,861 $ 1,695,448 Less: amount representing interest (4,044 ) Present value of capital lease obligations $ 60,817 The majority of our operating 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. 44 -------------------------------------------------------------------------------- Table of Contents During the remaining nine months of fiscal 2014 and in future fiscal years, we expect to make additional investments in our infrastructure to scale our operations and increase productivity. We plan to upgrade and/or replace various internal systems to scale with the overall growth of the Company. Additionally, we expect capital expenditures to be higher in absolute dollars in the remaining nine months of fiscal 2014 as a result of continued office build-outs, other leasehold improvements and data center investments. In the future, 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. 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. 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 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 senior notes that were issued in a private placement in January 2010 and the Company's $1.15 billion of convertible senior notes that were issued in a private placement in March 2013. The imputed interest rates were approximately 5.9% for the notes issued in January 2010 and approximately 2.5% for the notes issued in March 2013, while the coupon interest rates were 0.75% and 0.25%, respectively. 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. 45 -------------------------------------------------------------------------------- Table of Contents • Income Tax Effects and Adjustments. The Company's non-GAAP tax provision excludes the tax effects of expense items described above and certain tax items not directly related to the current fiscal year's ordinary operating results. Examples of such tax items include, but are not limited to, changes in the valuation allowance related to deferred tax assets, certain acquisition-related costs and unusual or infrequently occurring items. Management believes the exclusion of these income tax adjustments provides investors with useful supplemental information about the Company's operational performance We define non-GAAP gross profit as our total revenues less cost of revenues, as reported on our 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 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. 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 measures of gross profit, operating profit, net income and earnings per share to the most comparable GAAP measure, "gross profit," "loss from operations," "net loss" and "Net loss per share" for the three months ended April 30, 2013 and 2012 are as follows (in thousands): 46 -------------------------------------------------------------------------------- Table of Contents Three Months Ended April 30, 2013 2012 Non-GAAP gross profit GAAP gross profit $ 683,639 $ 543,916 Plus: Amortization of purchased intangibles 21,305 17,448 Stock-based expenses 10,678 7,253 Non-GAAP gross profit $ 715,622 $ 568,617 Three Months Ended April 30, 2013 2012 Non-GAAP operating profit GAAP loss from operations $ (44,540 ) $ (22,249 ) Plus: Amortization of purchased intangibles 23,765 20,875 Stock-based expenses 114,729 81,266 Non-GAAP operating profit $ 93,954 $ 79,892 Three Months Ended April 30, 2013 2012 Non-GAAP net income GAAP net loss $ (67,721 ) $ (19,475 ) Plus: Amortization of purchased intangibles 23,765 20,875 Stock-based expenses 114,729 81,266 Amortization of debt discount, net 9,240 4,883 Less: Income tax effect and adjustments (19,049 ) (33,095 ) Non-GAAP net income $ 60,964 $ 54,454 Three Months Ended April 30, 2013 2012 Non-GAAP diluted earnings per share (a) GAAP diluted loss per share $ (0.12 ) $ (0.04 ) Plus: Amortization of purchased intangibles 0.04 0.04 Stock-based expenses 0.19 0.14 Amortization of debt discount, net 0.01 0.01 Less: Income tax effect of Non-GAAP items (0.02 ) (0.06 ) Non-GAAP diluted earnings per share $ 0.10 $ 0.09 Shares used in computing diluted net income per share 622,677 584,204 (a) Reported GAAP loss per share was calculated using the basic share count. Non-GAAP diluted earnings per share was calculated using the diluted share count. Following the stockholders' approval, the Company amended its certificate of incorporation on March 20, 2013, to increase the number of authorized shares of common stock from 400.0 million to 1.6 billion and effect a four-for-one stock split of the common stock. Accordingly, all share and per share data presented herein reflect the impact of the increase in authorized shares and the stock split. 47 -------------------------------------------------------------------------------- Table of Contents The effects of dilutive securities were not included in the GAAP calculation of diluted earnings/loss per share for the three months ended April 30, 2013 and 2012 because we had a net loss for the periods and the effect would have been anti-dilutive. The following table reflects the effect of the dilutive securities on the basic share count used in the GAAP earnings/loss per share calculation to derive the share count used for the non-GAAP diluted earnings per share: Three Months Ended April 30, Supplemental Diluted Sharecount Information (in thousands): 2013 2012 Weighted-average shares outstanding for GAAP basic earnings per share 588,385 552,600 Effect of dilutive securities: Convertible senior notes 13,563 11,148 Warrants associated with the convertible senior note hedges 8,214 4,832 Employee stock awards 12,515 15,624 Adjusted weighted-average shares outstanding and assumed conversions for Non-GAAP diluted earnings per share 622,677 584,204 48 -------------------------------------------------------------------------------- Table of Contents [ Back To TMCnet.com's Homepage ]