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BROADSOFT, INC. - 10-Q - Management's Discussion and Analysis of Financial Condition and Results of Operations(Edgar Glimpses Via Acquire Media NewsEdge) The following discussion and analysis of our financial condition and results of operations should be read in conjunction with our condensed consolidated financial statements and related notes appearing elsewhere in this Quarterly Report on Form 10-Q and our Annual Report on Form 10-K for the year ended December 31, 2013 filed with the Securities and Exchange Commission, or SEC, on February 28, 2014. This Quarterly Report on Form 10-Q contains forward-looking statements, within the meaning of the Private Securities Litigation Reform Act of 1995, that involve substantial risks and uncertainties. All statements other than statements of historical facts contained in this Quarterly Report on Form 10-Q are forward-looking statements. In some cases, you can identify forward-looking statements by terminology such as "believe," "will," "may," "estimate," "continue," "anticipate," "intend," "should," "plan," "expect," "predict," "could," "potentially" or the negative of these terms or other similar expressions. Forward-looking statements in this Quarterly Report on Form 10-Q may include statements about: • our dependence on the success of BroadWorks; • any potential loss of or reductions in orders from certain significant customers; • our dependence on our service provider customers to sell services using our applications; • claims that we infringe intellectual property rights of others; • our ability to protect our intellectual property; • competitive factors, including, but not limited to, industry consolidation, entry of new competitors into our market, and new product and marketing initiatives by our competitors; • our ability to predict our revenue, operating results and gross margin accurately; • the length and unpredictability of our sales cycles; • our ability to expand our product offerings; • our international operations; • our significant reliance on distribution partners in international markets; • our ability to sell our products in certain markets; • our ability to manage our growth, including our increased headcount; • the attraction and retention of qualified employees and key personnel; • the interoperability of our products with service provider networks; • our ability to realize the benefits of our recent acquisitions and the successful integration of the personnel, technologies, and customers from such acquisitions; • the quality of our products and services, including any undetected errors or bugs in our software; and • our ability to maintain proper and effective internal controls. The outcome of the events described in these forward-looking statements is subject to known and unknown risks, uncertainties and other factors that could cause actual results to differ materially from the results anticipated by these forward-looking statements, including those factors we discuss in the "Risk Factors" sections of our Annual Report on Form 10-K for the fiscal year ended December 31, 2013 and in our other filings with the SEC. You should read these factors and the other cautionary statements made in this Quarterly Report on Form 10-Q as being applicable to all related forward-looking statements wherever they appear in this Quarterly Report on Form 10-Q. These risks are not exhaustive. Although we believe the expectations reflected in the forward-looking statements are based on reasonable assumptions, we can give no assurance we will attain these expectations or that any deviations will not be material. Except as required by law, we undertake no obligation to update publicly any forward-looking statements for any reason after the date of this Quarterly Report on Form 10-Q to conform these statements to actual results or to changes in our expectations. Overview We are the leading global provider of software and services that enable mobile, fixed-line and cable service providers to deliver hosted, or cloud-based, Unified Communications, or UC, and other voice and multimedia services over their Internet protocol, or IP, based networks. We enable carriers to offer these UC services across their broadband and wireless networks to a broad range of smartphones, tablets, laptops and other end-user devices. We believe we are well positioned to enable service providers to capitalize on their IP-based network investments by efficiently and cost-effectively offering a broad suite of services to their end-users. Our service provider customers include 19 of the top 25 telecommunications service providers globally, as measured by revenue in the year ended December 31, 2012. Our core communications platform consists of three offerings: 19-------------------------------------------------------------------------------- Table of Contents BroadWorks Our BroadWorks software enables our service provider customers to provide enterprises and consumers with a range of hosted communications offerings, such as hosted UC (also referred to as hosted IP Centrex or hosted PBX), including voice and video calling, voice and video mail, call center and audio conferencing, collaboration and messaging, as well as 4G or LTE and SIP Trunking offerings. BroadWorks performs a critical network function by serving as the software element that delivers and coordinates call control, voice, video and messaging communications through a service provider's IP-based network. BroadSoft recently introduced its BroadSoft Collaborate offerings that enable the delivery of UC services such as instant messaging and presence, or IM&P, and desktop sharing as additional BroadWorks software elements. We have significantly expanded the video calling and video conferencing capabilities of our offerings. BroadWorks, which we generally license on a perpetual license basis to service providers, is installed on industry-standard servers, typically located in service providers' data centers. BroadWorks interoperates with service providers' core networks, accesses other networks for interworking with end-users' communications devices and connects to service providers' support and billing systems. Since our inception, most of our revenue has come from license and maintenance and support fees for BroadWorks software. BroadCloud BroadCloud services are offerings hosted and managed by us, and resold by service providers under their brand. The key objectives of providing these services from our own BroadCloud service delivery network include expediting our service provider customers' time to market and enabling our service provider customers to access our BroadWorks and UC capabilities on a software as a service, or SaaS, basis. Our BroadCloud PBX service enables our service provider customers to provide BroadWorks-based hosted PBX offerings, accessed through our BroadCloud service delivery network, to their enterprise customers. We also provide certain UC offerings such as web collaboration and IM&P on a cloud basis. Additionally, we offer our BroadCloud PBX and web collaboration services directly to enterprises. Typically, we are paid a monthly recurring fee for providing BroadCloud services. We believe there is a growing acceptance by service providers of cloud-type service offerings and that our BroadCloud offerings enable us to expand our revenue opportunities with our customers. BroadTouch BroadTouch client communications applications allow service providers to put the power of voice, video and our other UC services in the hands of the end-user across a broad array of smartphone, tablet, laptop and other end-user devices. With our UC-One offering, a set of bundled UC services that combines the power of BroadWorks, BroadTouch and BroadCloud enabled Unified Communications into a seamless and consistent end-user experience, service providers can offer their customers the ability to communicate using one familiar user interface from any of the user's devices, simplifying access to a fully integrated UC experience including voice, video, messaging, conferencing and collaboration. Our UC-One offerings are optimized for a range of broadband, WiFi and 3G, 4G and mobile networks. Company We were incorporated in Delaware in 1998 and we began selling BroadWorks in 2001. We sell our products to service providers both directly and indirectly through distribution partners, such as telecommunications equipment vendors, value-added resellers, or VARs, and other distributors. Industry We believe telecommunications service providers are replacing their legacy circuit switched networks as they migrate to IP-based networks and are making these transitions for several reasons, including a desire to offer enhanced UC services in addition to traditional voice services. These service providers are facing significant challenges to their traditional business models, including declining revenues in their legacy businesses, rapidly evolving customer communications demands and the need to generate returns on their increasing investments in IP-based networks. Historically, service providers derived much of their revenue from providing reliable voice and high-speed data access. However, these legacy services have been increasingly commoditized as technological and regulatory changes have brought increased competition and lower prices. At the same time, enterprises and consumers have started to seek new and enhanced cloud-based communications services, which can provide service providers with opportunities to counter falling legacy revenues and increase subscriber growth. Service providers are using both their existing IP-based networks and third-party cloud-based platforms to deliver these services to their customers. 20-------------------------------------------------------------------------------- Table of Contents We believe that, as service providers look to rapidly introduce new UC services through their own networks, they need products like those provided by us that are capable of coordinating delivery of a large and rapidly increasing number of applications, operating across heterogeneous network elements and devices, ensuring high levels of reliability and quality and efficiently scaling as more subscribers are added. Our Strategy Our goal is to strengthen our position as the leading global provider of IP communications application servers by enabling service providers to increase revenue opportunities by delivering feature-rich services to their enterprise and consumer subscribers. Key elements of our strategy include: • Extend our technology leadership and product depth and breadth. We intend to continue to provide an industry-leading solution through our focus on product innovation and substantial investment in research and development for new features, applications and services. • Expand our BroadCloud PBX and UC offerings. We intend toaccelerate UC adoption and our service provider customers' time to market by promoting and expanding our BroadCloud PBX and UC offerings. BroadCloud enables our service providers to offer BroadWorks features and functions through a service offering hosted and/or managed by us. • Provide UC-One bundled offerings. We intend to continue to provide prepackaged integrated elements of BroadWorks, BroadCloud and BroadTouch with the goal of better enabling new and existing customers to drive adoption of their hosted UC offerings. • Drive revenue growth by: ? Assisting our current service provider customers to sell more of their currently-deployed BroadWorks, BroadCloud and BroadTouch offerings. We support our service provider customers by regularly offering enhanced and new features to their current applications, as well as providing tools and training to help them market their services to subscribers. ? Selling new applications and features to our current service provider customers. Although our initial engagement with a service provider may be for a single initiative or business unit, once a service provider deploys services using our core applications communications platform, we believe we are well-positioned to sell additional applications and features to that service provider, as software (BroadWorks and BroadTouch) and/or through our BroadCloud services delivery platform. These BroadSoft service offerings can be tied together with service provider-branded BroadTouch mobile smartphone, tablet, and personal computer clients. ? Continuing to acquire new customers. Our customers are located around the world and include 19 of the top 25 telecommunications service providers globally. We believe we are well positioned to grow by adding customers in regions where we already have a strong presence, by expanding our geographic footprint and by penetrating more deeply into some types of service provider customers, such as additional cable and mobile service providers. ? Pursuing selected acquisitions and collaborations that complement our strategy. We intend to continue to pursue acquisitions and collaborations where we believe they are strategic to strengthen our industry leadership position, expand our geographic presence or allow us to offer new or complementary products or services. Executive Summary Our management team monitors and analyzes a number of key industry trends and performance indicators to manage our business and evaluate our financial and operating performance. During 2014, we believe the trend towards cloud-based and hosted communications by service providers and others will continue as service providers further seek speed and flexibility for the delivery of communications services. Our goal is to provide our service provider customers with the service and software offerings they need to effectively address this market opportunity and their end-user customer needs. As a result, during the remainder of 2014, we will continue our strategic investments in research and development of existing and new products, including client software, mobility and cloud-based services, as well as in headcount to support our product offerings and increase our go-to-market efforts. BroadCloud PBX, our cloud-based PBX offering, is a particularly key area of investment focus for us. We believe that many of our service provider customers are interested in accessing the capabilities of our BroadWorks features and functions through a 21-------------------------------------------------------------------------------- Table of Contents service offering hosted and managed by us, reducing cost and increasing speed and ease of use for end-users. During the remainder of 2014, we expect that we will continue to invest in, and expand the availability of, BroadCloud PBX in the United States, United Kingdom and Germany. We believe that delivering innovative solutions to our existing customer base to meet their growing cloud-based needs will help service providers get to market more quickly and drive our revenue growth. We believe converged and mobile operators desire UC solutions to deliver to their enterprise customer base to grow enterprise revenue, reduce churn and raise average revenue per user. Our UC-One functionality, which is either delivered via a cloud-based platform managed by us or via server software that resides within the service provider's network, seeks to address this evolution and allows service providers and operators to rapidly and efficiently deliver a UC experience regardless of end-user device and whether or not the end-user has fixed line or wireless access. Recognizing the importance of mobile applications and the growing desire by end-users for seamless communications wherever they are, across a wide range of devices, we have architected mobility into our solutions and products and have made integrating with existing mobile networks simple and a core competency of our platform. We have optimized our client, cloud and software solutions to enable mobility in all of our services, across a wide range of personal and/or business devices. During the remainder of 2014, we expect our UC and SIP Trunking solutions to continue to experience strong growth, while our consumer fixed line broadband applications are expected to see a decline in sales. We believe our UC solutions growth is largely driven by increased market acceptance of hosted Unified Communications offerings and our SIP Trunking offerings growth from the move by service provider customers to IP-based trunks. We also believe that the migration of wireless networks to voice over LTE, or VoLTE, could drive significant growth for us over the next several years and that we are well-positioned to meet carrier demand for VoLTE-based UC and consumer solutions, especially with regard to our UC offerings for VoLTE. While we announced several VoLTE customer wins in late 2013 and early 2014 and expect to execute additional agreements during 2014 to support VoLTE offerings by our service provider customers, we think the revenue impact for these opportunities in 2014 will be modest. Key Financial Highlights Some of our key GAAP financial highlights for the quarter ended June 30, 2014 include: • Total revenue increased by $8.5 million or 19%, to $52.5 million, compared to $44.0 million for the quarter ended June 30, 2013; • Gross profit was $37.6 million, or 72% of revenue, compared to $34.2 million, or 78% of revenue, for the quarter ended June 30, 2013; • Income from operations was $0.5 million, compared to loss from operations of $2.3 million for the quarter ended June 30, 2013; • Net income was $1.7 million, compared to net loss of $3.0 million for the quarter ended June 30, 2013; • Net income per diluted share was $0.06 per common sharecompared to net loss per diluted share of $0.11 per common share for the quarter ended June 30, 2013; • Revenue plus net change in deferred revenue increased by 30% to $59.2 million, compared to $45.4 million for the quarter ended June 30, 2013; • Deferred revenue increased by $6.7 million, compared to $1.4 million for the quarter ended June 30, 2013; and • Cash provided by operating activities was $5.7 million,compared to $3.5 million for the quarter ended June 30, 2013. Some of our key non-GAAP financial highlights for the quarter ended June 30, 2014 include: • Non-GAAP gross profit increased to $39.9 million, or 76% of revenue, compared to $36.3 million, or 82% of revenue, for the quarter ended June 30, 2013; • Non-GAAP operating income decreased to $9.2 million, or 18% of revenue, compared to $9.7 million, or 22% of revenue, for the quarter ended June 30, 2013; • Non-GAAP net income decreased to $8.9 million, or 17% of revenue, compared to $9.2 million, or 21% of revenue, for the quarter ended June 30, 2013; and • Non-GAAP net income per diluted share decreased to $0.31 per common share, compared to $0.32 per common share for the quarter ended June 30, 2013. For a discussion of these non-GAAP financial measures and a reconciliation of GAAP and non-GAAP financial results, please refer to "Non-GAAP Financial Measures" included elsewhere in this Management's Discussion and Analysis of Financial Condition and Results of Operations. 22-------------------------------------------------------------------------------- Table of Contents Components of Operating Results Revenue We derive our revenue primarily from the sale of license software, subscription and maintenance support and professional services and other. We recognize revenue when all revenue recognition criteria have been met in accordance with revenue recognition guidance. This guidance provides that revenue should be recognized when persuasive evidence of an arrangement exists, delivery has occurred, the price is fixed or determinable and collection is probable. Our total revenue consists of the following: License software. We derive license software revenue from the sale of perpetual software licenses. We generally price our software based on the types of features and applications provided and on the number of subscriber licenses sold. These factors impact the average selling price of our licenses and the comparability of average selling prices. Our license software revenue may vary significantly from quarter to quarter or from year to year as a result of long sales and deployment cycles, variations in customer ordering practices and the application of management's judgment in applying complex revenue recognition rules. Our deferred license software revenue balance consists of software orders that do not meet all the criteria for revenue recognition. We are unable to predict the proportion of orders that will meet all the criteria for revenue recognition relative to those orders that will not meet all such criteria and, as a result, we cannot forecast whether recognized license software revenue and deferred license software revenue will continue to increase or decrease in a given period. As of June 30, 2014, our deferred license software revenue balance was $22.4 million, the current portion of which was $16.8 million. Subscription and maintenance support. Subscription and maintenance support revenue includes recurring revenue from annual maintenance support contracts for our software licenses and from subscriptions related to our delivery of BroadCloud services. Our annual maintenance support contracts provide for software updates, upgrades and technical support. Our typical warranty on licensed software is 90 days and, during this period, our customers are entitled to receive maintenance and support without the purchase of a maintenance contract. After the expiration of the warranty period, our customers must purchase an annual maintenance contract to continue receiving ongoing software maintenance and customer support. Under our BroadCloud subscriptions, we are paid a recurring fee typically calculated based on the number of seats and type of services purchased or a usage fee based on the actual number of transactions. The recurring fee is typically billed monthly or annually in advance based on the terms of the arrangement and the usage fee is billed one month in arrears. Our deferred subscription and maintenance support revenue balance consists of maintenance support and subscription orders that do not meet all the criteria for revenue recognition. As of June 30, 2014, our deferred subscription and maintenance support revenue balance was $45.9 million, the current portion of which was $39.2 million. Professional services and other. Professional services and other revenue primarily includes revenue from professional service engagements consisting of implementation, training and consulting services. Our professional services and other deferred revenue balance consists of orders that do not meet all the criteria for revenue recognition. As of June 30, 2014, our deferred professional services and other revenue balance was $12.6 million, the current portion of which was $10.9 million. Cost of Revenue Our total cost of revenue consists of the following: • Cost of license software revenue. A majority of the cost of license software revenue consists of amortization of acquiredtechnology, personnel-related expenses and royalties paid to third parties whose technology or products are sold as part of BroadWorks. A significant amount of the royalty fees are for the underlying embedded data base technology within BroadWorks for which we currently incur a fixed expense per quarter. Personnel-related expenses includesalaries, benefits, bonuses, reimbursement of expenses and stock-based compensation. Such costs are expensed in the period in which they are incurred. • Cost of subscription and maintenance support revenue. Cost of subscription and maintenance support revenue consistsprimarily of personnel-related expenses and other direct costs associated with the support and maintenance of our software licenses and BroadCloud services, including maintenance and support expenses due to our use of third party software, amortization of acquired technology and operating and depreciation expenses associated with thedelivery of BroadCloud services. 23-------------------------------------------------------------------------------- Table of Contents • Cost of professional services and other revenue. Cost of professional services and other revenue consists primarily of personnel-related expenses and other direct costs associated with the delivery of our professional services. Gross Profit Gross profit is the calculation of total revenue minus cost of revenue. Our gross profit as a percentage of revenue, or gross margin, has been and will continue to be affected by a variety of factors, including: • Mix of license software, subscription and maintenance support and professional services and other revenue. We generate higher gross margins on license software revenue compared to subscription and maintenance support or professional services and other revenue. • Growth or decline of license software revenue. A significant portion of cost of license software revenue is fixed and is expensed in the period in which it is incurred. This cost consists primarily of royalty fees to our embedded database provider andamortization of acquired technology. If license software revenue increases, these fixed fees will decline as a percentage of revenue. If license software revenue declines, these fixed fees will increase as a percentage of revenue. • Impact of deferred revenue. If any revenue recognitioncriteria have not been met, the applicable revenue derived from thearrangement is deferred, including license software, subscription andmaintenance support, and professional services and other revenue, until all elements of revenue recognition criteria have been met.However, the cost of revenue, including the costs of license software, subscription and maintenance support and professional services and other, is typically expensed in the period in which it is incurred. Therefore, if relatively more revenue is deferred in aparticular period, gross margin would decline in that period. Because the ability to recognize revenue on orders depends largely on the terms of the sale arrangement, and because we are not able topredict the proportion of orders that will not meet all the criteria for revenue recognition, we cannot forecast whether any historical trends in gross margin will continue. • Intangible amortization related to mergers and acquisitions. Over the last several years, we acquired a number of businesses which resulted in the recognition of intangible assets. Theseintangible assets are amortized over their useful lives, resulting in additional expense impacting gross profit over the applicable period. We may undertake additional strategic transactions in the future that would result in additional intangible amortization expense. Revenue Plus Net Change in Deferred Revenue We believe revenue we recognize in a particular period plus the net change in our deferred revenue balance is a key measure of our sales activity for that period. Revenue plus the net change in deferred revenue is as follows (in thousands): Three Months Ended Six Months Ended June 30, June 30, 2014 2013 2014 2013 Beginning of period deferred revenue balance $ 74,078 $ 59,580 $ 77,662 $ 61,149 End of period deferred revenue balance 80,792 60,966 80,792 60,966 Increase (decrease) in deferred revenue 6,714 1,386 3,130 (183 ) Revenue 52,484 44,009 96,402 83,634 Revenue plus net change in deferred revenue $ 59,198 $ 45,395 $ 99,532 $ 83,451 Operating Expenses Operating expenses consist of sales and marketing, research and development and general and administrative expenses. Salaries and other personnel costs are the most significant component of each of these expense categories. We grew our total headcount to 786 employees at June 30, 2014 from 725 employees at December 31, 2013, and we expect to continue hiring new employees to support our anticipated growth. Sales and marketing expenses. Sales and marketing expenses consist primarily of salaries and personnel costs for our sales and marketing employees, including stock-based compensation, commissions and bonuses. Additional expenses include marketing programs, consulting, travel and other related overhead. We expect our sales and marketing expenses to increase in the 24-------------------------------------------------------------------------------- Table of Contents foreseeable future as we further increase the number of our sales and marketing professionals and expand our marketing activities. In the first six months of 2014, sales and marketing expenses increased as a percentage of revenue compared with the same period in 2013, but we expect that for the remainder of 2014, sales and marketing expenses, as a percentage of total revenue, will be below such percentage in the corresponding period of 2013. Research and development expenses. Research and development expenses consist primarily of salaries and personnel costs for development employees, including stock-based compensation and bonuses. Additional expenses include costs related to development, quality assurance and testing of new software and enhancement of existing software, consulting, travel and other related overhead. We engage third-party international and domestic consulting firms for various research and development efforts, such as software development, documentation, quality assurance and software support. We intend to continue to invest in our research and development efforts, including by hiring additional development personnel and by using outside consulting firms for various research and development efforts. We believe continuing to invest in research and development efforts is essential to maintaining our competitive position. We expect research and development expenses to increase in the foreseeable future. In the first six months of 2014, research and development expenses decreased as a percentage of revenue compared with the same period in 2013, and we expect that for the remainder of 2014, research and development expenses, as a percentage of total revenue, will continue to be below such percentage in the corresponding period of 2013. General and administrative expenses. General and administrative expenses consist primarily of salary and personnel costs for administration, finance and accounting, legal, information systems and human resources employees, including stock-based compensation and bonuses. Additional expenses include consulting and professional fees, travel, insurance and other corporate expenses. We expect general and administrative expenses to increase in the foreseeable future. In the first six months of 2014, general and administrative expenses decreased as a percentage of revenue compared with the same period in 2013, and we expect that for the remainder of 2014, general and administrative expenses, as a percentage of total revenue, will be below such percentage in the corresponding period of 2013. Stock-Based Compensation We include stock-based compensation as part of cost of revenue and operating expenses in connection with the grant of stock options and other equity awards to our directors, employees and consultants. We apply the fair value method in accordance with authoritative guidance for determining the cost of stock-based compensation. The total cost of the grant is measured based on the estimated fair value of the award at the date of grant. The fair value is then recognized as stock-based compensation expense on a graded basis over the requisite service period, which is the vesting period, of the award. For the three months ended June 30, 2014 and 2013, we recorded stock-based compensation expense of $7.4 million and $11.2 million, respectively. Historically, stock-based compensation has been the fastest growing component of our employee-related expenses. For the three and six months ended June 30, 2014, stock-based compensation expense decreased compared to the same period in 2013, due to the vesting of a tranche of the RSU's granted during the first quarter of 2013. We expect the stock-based compensation to decrease in relation to the comparable period in prior year for the remainder of 2014. Based on stock options and other equity awards outstanding as of June 30, 2014, we expect to recognize future expense related to the non-vested portions of such options and other equity awards in the amount of $24.0 million over a weighted average period of approximately 1.28 years. Other Expense (Income), Net Other expense (income), net consists primarily of interest income and interest expense. Interest income represents interest received on our cash and cash equivalents and restricted cash. Interest expense consists primarily of the interest related to our 1.50% convertible senior notes due in 2018, or the Notes, and interest related to five installment loans with Tekes that were paid in full in September 2013. Income Tax Expense Income tax expense consists of U.S. federal, state and foreign income taxes. We are required to pay income taxes in certain states and foreign jurisdictions. Historically, we have not been required to pay U.S. federal income taxes due to our accumulated net operating losses. For the quarter ended June 30, 2014, we have net operating loss carryforwards to utilize in the U.S. Recent Accounting Pronouncements 25-------------------------------------------------------------------------------- Table of Contents In May 2014, the FASB issued a new accounting standard related to revenue recognition. This new standard will replace all current U.S. GAAP guidance on this topic and eliminate all industry-specific guidance. The new revenue recognition standard provides a unified model to determine when and how revenue is recognized. The core principle is that a company should recognize revenue to depict the transfer of promised goods or services to customers in an amount that reflects the consideration for which the entity expects to be entitled in exchange for those goods or services. The Company will adopt this standard effective January 1, 2017, as required. The standard can be applied either retrospectively to each period presented or as a cumulative-effect adjustment as of the date of adoption. The Company is evaluating the impact of adopting this new standard on our financial statements. Results of Operations Comparison of the Three Months Ended June 30, 2014 and 2013 Revenue Three Months Ended June 30, 2014 2013 Period-to-Period Change Percent of Percent of Amount Total Revenue Amount Total Revenue Amount Percentage (dollars in thousands) Revenue by Type: License software $ 25,649 49 % $ 24,699 56 % $ 950 4 % Subscription and maintenance support 21,958 42 16,306 37 5,652 35 Professional services and other 4,877 9 3,004 7 1,873 62 Total revenue $ 52,484 100 % $ 44,009 100 % $ 8,475 19 % Revenue by Geography: Americas $ 28,807 55 % $ 29,924 68 % $ (1,117 ) (4 )% EMEA 12,159 23 8,552 19 3,607 42 APAC 11,518 22 5,533 13 5,985 108 Total revenue $ 52,484 100 % $ 44,009 100 % $ 8,475 19 % Total revenue for the three months ended June 30, 2014 increased by 19%, or $8.5 million, to $52.5 million as compared to the same period in 2013. This growth was driven by a 35% increase in subscription and maintenance support revenue, a 62% increase in professional services and other revenue and a 4% increase in license software revenue. Deferred revenue increased by $6.7 million for the three months ended June 30, 2014, compared to an increase of $1.4 million for the same period in 2013. Americas revenue for the three months ended June 30, 2014 decreased by 4%, or $1.1 million, to $28.8 million as compared to the same period in 2013. The decrease in Americas revenue for the three months ended June 30, 2014 was primarily due to a decrease in consumer applications software license revenue, partially offset by growth in hosted UC software license sales, subscription and maintenance support and professional services and other revenues. Europe, Middle East and Africa, or EMEA, revenue for the three months ended June 30, 2014 increased 42%, or $3.6 million, to $12.2 million as compared to the same period in 2013. The increase in EMEA revenue for the three months ended June 30, 2014 was primarily due to an increase in license software, subscription and maintenance support related to our BroadCloud offering and professional services and other revenues. We had strong license software sales for the three months ended June 30, 2014, including a large order that did not meet the criteria for revenue recognition and as a result, the associated revenue was deferred, with revenue recognition anticipated in 2016. Asia Pacific, or APAC, revenue for the three months ended June 30, 2014 increased by 108%, or $6.0 million, to $11.5 million compared to the same period in 2013. The increase in APAC revenue for the three months ended June 30, 2014 was primarily due to the recognition of $4.3 million of revenue related to a multi-year project for an APAC service provider customer, including revenue from license software, subscription and maintenance support and professional services and other. 26-------------------------------------------------------------------------------- Table of Contents License Software License software revenue for the three months ended June 30, 2014 increased by 4%, or $1.0 million, to $25.6 million, compared to the same period in 2013. The increase in license software revenue for the three months ended June 30, 2014 reflects an increase in software license revenue in APAC and EMEA, partially offset by a decrease in license software revenue in the Americas. Deferred license software revenue increased by $3.6 million for the three months ended June 30, 2014, compared to an increase of $1.7 million for the same period in 2013. Subscription and Maintenance Support Subscription and maintenance support revenue for the three months ended June 30, 2014 increased by 35%, or $5.7 million, to $22.0 million, compared to the same period in 2013. The increase in subscription and maintenance support revenue for the three months ended June 30, 2014 was the result of growth in our subscription revenue associated with our BroadCloud platforms, which included contributions from recent acquisitions and growth in our installed base of customers who purchased maintenance support. Deferred subscription and maintenance support revenue decreased by $1.1 million for the three months ended June 30, 2014, compared to a decrease of $0.9 million for the same period in 2013. Professional Services and Other Professional services and other revenue for the three months ended June 30, 2014 increased by 62%, or $1.9 million, to $4.9 million, compared to the same period in 2013. The increase in professional services and other revenue for the three months ended June 30, 2014 was due to the timing of revenue recognition, including revenue related to a multi-year project for an APAC service provider customer that had been deferred in prior quarters. Deferred professional services and other revenue increased by $4.2 million for the three months ended June 30, 2014, compared to an increase of $0.7 million for the same period in 2013. Cost of Revenue and Gross Profit Three Months Ended June 30, 2014 2013 Period-to-Period Change Percent Percent of of Related Related Amount Revenue Amount Revenue Amount Percentage (dollars in thousands) Cost of Revenue: License software $ 2,529 10 % $ 2,119 9 % $ 410 19 % Subscription and maintenance support 8,606 39 4,780 29 3,826 80 Professional services and other 3,726 76 2,872 96 854 30 Total cost of revenue $ 14,861 28 % $ 9,771 22 % $ 5,090 52 % Gross Profit: License software $ 23,120 90 % $ 22,580 91 % $ 540 2 % Subscription and maintenance support 13,352 61 11,526 71 1,826 16 Professional services and other 1,151 24 132 4 1,019 772 Total gross profit $ 37,623 72 % $ 34,238 78 % $ 3,385 10 % For the three months ended June 30, 2014, our gross margin decreased to 72% of revenue as compared to 78% for the same period in 2013, and our gross profit increased by 10%, or $3.4 million, to $37.6 million. The total gross profit increase was primarily due to growth in revenue relative to cost of revenue. For the three months ended June 30, 2014, license software gross margin decreased to 90% as compared to 91% for the same period in 2013 and license software gross profit increased by 2% to $23.1 million. License software cost of revenue increased by 19%, or $0.4 million, to $2.5 million for the three months ended June 30, 2014, compared to the same period in 2013. The increase was primarily due to a $0.4 million increase in software expense. The increase in license software gross profit was driven by higher revenue growth relative to growth in license software cost of revenue. For the three months ended June 30, 2014, subscription and maintenance support gross margin decreased to 61% as compared to 71% for the same period in 2013 and subscription and maintenance support gross profit increased by 16% to $13.4 million. 27-------------------------------------------------------------------------------- Table of Contents Subscription and maintenance support cost of revenue increased by 80%, or $3.8 million, to $8.6 million for the three months ended June 30, 2014, compared to the same period in 2013. The increase in subscription and maintenance services cost of revenue was related to our continued investment in our product offerings, primarily our BroadCloud offerings in EMEA. The increase was due to a $1.4 million increase in personnel-related costs, a $1.3 million increase in operational costs associated with hosting the BroadCloud services and a $0.6 million increase in amortization of acquired intangibles. The increase in subscription and maintenance support gross profit was driven by revenue growth relative to lower growth in subscription and maintenance services cost of revenue. For the three months ended June 30, 2014, professional services and other gross margin increased to 24% as compared to 4% for the same period in 2013 and professional services and other gross profit increased by 772% to $1.2 million. Professional services and other cost of revenue increased by 30%, or $0.9 million to $3.7 million for the three months ended June 30, 2014, compared to the same period in 2013. The increase in professional services and other cost of revenue was primarily due to a $0.4 million increase in hardware cost and a $0.3 million increase in consulting expense. The increase in professional services and other gross profit was driven by revenue growth relative to lower growth in professional services and other cost of revenue. Operating Expenses Three Months Ended June 30, 2014 2013 Period-to-Period Change Percent of Percent of Amount Total Revenue Amount Total Revenue Amount Percentage (dollars in thousands) Sales and marketing $ 17,146 33 % $ 15,536 35 % $ 1,610 10 % Research and development 12,227 23 12,935 29 (708 ) (5 ) General and administrative 7,777 15 8,104 19 (327 ) (4 ) Total operating expenses $ 37,150 71 % $ 36,575 83 % $ 575 2 % Sales and Marketing. Sales and marketing expense increased by 10%, or $1.6 million, to $17.1 million for the three months ended June 30, 2014, compared to the same period in 2013. The increase was due to a $0.4 million increase in personnel-related costs, a $0.5 million increase in travel expenses and a $0.4 million increase in consulting expenses. Research and Development. Research and development expense decreased by 5%, or $0.7 million, to $12.2 million for the three months ended June 30, 2014, compared to the same period in 2013. This decrease was primarily due to a $1.1 million decrease in personnel-related costs. General and Administrative. General and administrative expense decreased by 4%, or $0.3 million, to $7.8 million for the three months ended June 30, 2014, compared to the same period in 2013. This decrease was primarily due to a $0.5 million decrease in personnel-related costs. Income (Loss) from Operations We had income from operations of $0.5 million for the three months ended June 30, 2014, as compared to a loss from operations of $2.3 million for the same period in 2013. Other Expense Three Months Ended June 30, 2014 2013 Period-to-Period Change Percent Percent of of Total Amount Total Revenue Amount Revenue Amount Percentage (dollars in thousands) Interest expense, net $ 1,796 3 % $ 1,700 4 % $ 96 6 % Other, net (206 ) * (26 ) * (180 ) 692 % Total other expense, net $ 1,590 3 % $ 1,674 4 % $ (84 ) (5 )% * Less than 1% 28-------------------------------------------------------------------------------- Table of Contents Other expense, net for the three months ended June 30, 2014 decreased by $0.1 million compared to the same period in 2013. Benefit From Income Taxes Benefit from income tax was $2.8 million for the three months ended June 30, 2014, compared to $1.0 million for the same period in 2013. Changes in our taxes are due primarily to the release of a valuation allowance, change in the mix of earnings by jurisdiction and the true-up of certain tax returns and of certain research and development credits. Comparison of the Six Months Ended June 30, 2014 and 2013 Revenue Six Months Ended June 30, 2014 2013 Period-to-Period Change Percent of Percent of Amount Total Revenue Amount Total Revenue Amount Percentage (dollars in thousands) Revenue by Type: License software $ 42,791 44 % $ 45,541 54 % $ (2,750 ) (6 )% Subscription and maintenance support 43,084 45 31,491 38 11,593 37 Professional services and other 10,527 11 6,602 8 3,925 59 Total revenue $ 96,402 100 % $ 83,634 100 % $ 12,768 15 % Revenue by Geography: Americas $ 50,468 52 % $ 54,659 65 % $ (4,191 ) (8 )% EMEA 25,426 26 18,656 22 6,770 36 APAC 20,508 21 10,319 13 10,189 99 Total revenue $ 96,402 100 % $ 83,634 100 % $ 12,768 15 % Total revenue for the six months ended June 30, 2014 increased by 15% or $12.8 million to $96.4 million as compared to the same period in 2013. This growth was driven by a 37% increase in subscription and maintenance support revenue and a 59% increase in professional services and other revenue, partially offset by a 6% decrease in license software revenue. Deferred revenue increased by $3.1 million for the six months ended June 30, 2014, compared to a decrease of $0.2 million for the same period in 2013. Americas revenue for the six months ended June 30, 2014 decreased by 8%, or $4.2 million, to $50.5 million as compared to the same period in 2013. The decrease in Americas revenue for the six months ended June 30, 2014 was primarily due to a decrease in license software revenue due to a decrease in consumer applications software license sales. The decrease in license software revenue was partially offset by growth in subscription and maintenance support revenues. EMEA revenue for the six months ended June 30, 2014 increased 36%, or $6.8 million, to $25.4 million as compared to the same period in 2013. The increase in EMEA revenue for the six months ended June 30, 2014 was primarily due to an increase in subscription and maintenance support revenues and professional services and other revenues. The increase was partially offset by a decrease in license software revenue due to the deferral of a large order that did not meet the criteria for revenue recognition, with revenue recognition anticipated in 2016. APAC revenue for the six months ended June 30, 2014 increased by 99%, or $10.2 million, to $20.5 million compared to the same period in 2013. The increase in APAC revenue for the six months ended June 30, 2014 was primarily due to the recognition of $9.4 million of revenue related to a multi-year project for an APAC service provider customer, including revenue from license software, subscription and maintenance support and professional services and other. 29-------------------------------------------------------------------------------- Table of Contents License Software License software revenue for the six months ended June 30, 2014 decreased by 6%, or $2.8 million, to $42.8 million, compared to the same period in 2013. The decrease in license software revenue for the six months ended June 30, 2014 reflects a decrease in software license revenue in the Americas and EMEA, partially offset by an increase in license software revenue in APAC. Deferred license software revenue increased by $2.2 million for the six months ended June 30, 2014, compared to a decrease of $1.1 million for the same period in 2013. Subscription and Maintenance Support Subscription and maintenance support revenue for the six months ended June 30, 2014 increased by 37%, or $11.6 million, to $43.1 million, compared to the same period in 2013. The increase in subscription and maintenance support revenue for the six months ended June 30, 2014 was the result of growth in our subscription revenue associated with our BroadCloud platforms, which included contributions from recent acquisitions and growth in our installed base of customers who purchased maintenance support. Deferred subscription and maintenance support revenue decreased by $1.1 million for the six months ended June 30, 2014, compared to an increase of $0.5 million for the same period in 2013. Professional Services and Other Professional services and other revenue for the six months ended June 30, 2014 increased by 59%, or $3.9 million, to $10.5 million, compared to the same period in 2013. The increase in professional services and other revenue for the six months ended June 30, 2014 was due to the timing of revenue recognition, including revenue related to a multi-year project for an APAC service provider customer that had been deferred in prior periods. Deferred professional services and other revenue increased by $2.0 million for the six months ended June 30, 2014, compared to an increase of $0.4 million for the same period in 2013. Cost of Revenue and Gross Profit Six Months Ended June 30, 2014 2013 Period-to-Period Change Percent Percent of of Related Related Amount Revenue Amount Revenue Amount Percentage (dollars in thousands) Cost of Revenue: License software $ 4,651 11 % $ 4,579 10 % $ 72 2 % Subscription and maintenance support 16,052 37 9,393 30 6,659 71 Professional services and other 7,215 69 5,565 84 1,650 30 Total cost of revenue $ 27,918 29 % $ 19,537 23 % $ 8,381 43 % Gross Profit: License software $ 38,140 89 % $ 40,962 90 % $ (2,822 ) (7 )%Subscription and maintenance support 27,032 63 22,098 70 4,934 22 Professional services and other 3,312 31 1,037 16 2,275 219 Total gross profit $ 68,484 71 % $ 64,097 77 % $ 4,387 7 % For the six months ended June 30, 2014, our gross margin decreased to 71% of revenue as compared to 77% for the same period in 2013, and our gross profit increased by 7%, or $4.4 million, to $68.5 million. The total gross profit increase was primarily due to growth in revenue relative to cost of revenue. For the six months ended June 30, 2014, license software gross margin decreased to 89% as compared to 90% for the same period in 2013 and license software gross profit decreased by 7% to $38.1 million. License software cost of revenue remained approximately unchanged for the six months ended June 30, 2014, compared to the same period in 2013. The decrease in license software gross profit was driven by the decline in license software revenue. For the six months ended June 30, 2014, subscription and maintenance support gross margin decreased to 63% as compared to 70% for the same period in 2013 and subscription and maintenance support gross profit increased by 22% to $27.0 million. Subscription and maintenance support cost of revenue increased by 71%, or $6.7 million, to $16.1 million for the six months ended June 30, 2014, compared to the same period in 2013. The increase in subscription and maintenance services cost of 30-------------------------------------------------------------------------------- Table of Contents revenue was related to our continued investment in our product offerings, primarily our BroadCloud offerings in EMEA. The increase was due to a $2.7 million increase in personnel-related costs, a $2.1 million increase in operational costs associated with hosting the BroadCloud services and a $1.2 million increase in amortization of acquired intangibles. The increase in subscription and maintenance support gross profit was driven by revenue growth relative to lower growth in subscription and maintenance services cost of revenue. For the six months ended June 30, 2014, professional services and other gross margin increased to 31% as compared to 16% for the same period in 2013 and professional services and other gross profit increased by 219% to $3.3 million. Professional services and other cost of revenue increased by 30%, or $1.7 million to $7.2 million for the six months ended June 30, 2014, compared to the same period in 2013. The increase in professional services and other cost of revenue was primarily due to a $1.0 million increase in hardware cost delivered under an order related to a multi-year project for an APAC service provider customer and a $0.3 million increase in outside consulting costs. The increase in professional services and other gross profit was driven by revenue growth relative to lower growth in professional services and other cost of revenue. Operating Expenses Six Months Ended June 30, 2014 2013 Period-to-Period Change Percent of Percent of Amount Total Revenue Amount Total Revenue Amount Percentage (dollars in thousands) Sales and marketing $ 35,002 36 % $ 29,265 35 % $ 5,737 20 % Research and development 25,552 27 25,303 30 249 1 General and administrative 16,682 17 15,541 19 1,141 7 Total operating expenses $ 77,236 80 % $ 70,109 84 % $ 7,127 10 % Sales and Marketing. Sales and marketing expense increased by 20%, or $5.7 million to $35.0 million for the six months ended June 30, 2014, compared to the same period in 2013. The increase was due to a $3.2 million increase in personnel-related costs, a $1.0 million increase in travel expenses and a $0.7 million increase in consulting expenses. Research and Development. Research and development expense increased by 1%, or $0.2 million, to $25.6 million for the six months ended June 30, 2014, compared to the same period in 2013. This increase was primarily due to a $0.3 million increase in equipment and software expenses. General and Administrative. General and administrative expense increased by 7%, or $1.1 million, to $16.7 million for the six months ended June 30, 2014, compared to the same period in 2013. This increase was primarily due to a $0.7 million increase in personnel-related costs. Loss from Operations We had a loss from operations of $8.8 million for the six months ended June 30, 2014, as compared to $6.0 million for the same period in 2013. Other Expense Six Months Ended June 30, 2014 2013 Period-to-Period Change Percent Percent of Total of Total Amount Revenue Amount Revenue Amount Percentage (dollars in thousands) Interest expense, net $ 3,568 4 % $ 3,375 4 % $ 193 6 % Other, net (169 ) * 56 * (225 ) (402 )% Total other expense, net $ 3,399 4 % $ 3,431 4 % $ (32 ) (1 )% * Less than 1% 31-------------------------------------------------------------------------------- Table of Contents Other expense, net for the six months ended June 30, 2014 remained approximately unchanged compared to the same period in 2013. Benefit From Income Taxes Benefit from income tax was $6.4 million for the six months ended June 30, 2014, compared to $4.1 million for the same period in 2013. Changes in our taxes are due primarily to the release of a valuation allowance, change in the mix of earnings by jurisdiction and the true-up of certain tax returns and of certain research and development credits. Liquidity and Capital Resources Resources Since the beginning of 2009, we have funded our operations principally with cash provided by operating activities, which has resulted primarily from growth in net income and deferred revenue. Cash and Cash Equivalents, Accounts Receivable and Working Capital The following tables present a summary of our cash and cash equivalents, accounts receivable, working capital and cash flows for the periods indicated (in thousands). June 30, December 31, 2014 2013Cash and cash equivalents $ 70,607 $ 69,866 Accounts receivable, net 59,461 66,595 Working capital 175,065 161,066 Six Months Ended June 30, 2014 2013 Cash provided by (used in): Operating activities $ 12,539 $ 8,395 Investing activities (16,553 ) (25,238 ) Financing activities 4,542 6,834 Our cash and cash equivalents at June 30, 2014 were held for working capital and other general corporate purposes and were invested primarily in demand deposit accounts or money market funds. We do not enter into investments for trading or speculative purposes. Restricted cash, which was immaterial at June 30, 2014, is not included in cash and cash equivalents. Operating Activities For the six months ended June 30, 2014, net cash provided by operating activities was $12.5 million, compared to $8.4 million for the same period in 2013. The increase was primarily due to a $28.2 million increase from the aggregate changes in non-cash items, offset by a $23.6 million decrease from the net change in other current and long-term assets and liabilities and by an increase in net loss of $0.5 million. Non-cash items primarily consist of stock-based compensation expense, depreciation and amortization, provision for deferred income taxes, tax windfall benefits from stock option exercises, non-cash interest on convertible debt and amortization of software licenses. Investing Activities Our investing activities have consisted primarily of net investment in marketable securities, business acquisitions and capital expenditures for property and equipment. For the six months ended June 30, 2014, net cash used in investing activities was $16.6 million, compared to $25.2 million for the same period in 2013. This decrease was attributable to a $12.3 million decrease in net purchases of marketable securities, partially offset by a $4.2 million increase in capital expenditures for property and equipment, compared to the same period in 2013. 32-------------------------------------------------------------------------------- Table of Contents Financing Activities For the six months ended June 30, 2014, net cash provided by financing activities was $4.5 million, compared to $6.8 million for the same period in 2013. Net cash provided by financing activities primarily consisted of the tax windfall benefits from stock options exercised of $9.6 million, partially offset by taxes paid on the vesting of restricted stock units of $5.3 million. Borrowings and Credit Facilities Convertible Senior Notes In June 2011, we issued $120.0 million aggregate principal amount of the Notes, with net proceeds of approximately $116 million. The Notes are our senior unsecured obligations, with interest payable semi-annually in cash at a rate of 1.50% per annum, and will mature on July 1, 2018, unless earlier repurchased, redeemed or converted. The initial conversion rate for the Notes is approximately $41.99 per share. The conversion price is subject to adjustment in some events, but will not be adjusted for accrued interest. Upon conversion, we will pay cash up to the aggregate principal amount of the Notes to be converted and deliver shares of our common stock in respect of the remainder, if any, of the conversion obligation in excess of the aggregate principal amount of the Notes being converted. See Note 6, Borrowings, contained elsewhere in this Quarterly Report on Form 10-Q for additional details about the Notes. Tekes In connection with our acquisition of Movial Applications Oy in October 2011, we assumed five installment loans with Tekes, the Finnish Funding Agency for Technology and Innovation, which we repaid in September 2013. Operating and Capital Expenditure Requirements We believe that the cash generated from operations, our current cash, cash equivalents and short-term and long-term investment balances and interest income we earn on these balances will be sufficient to meet our anticipated cash requirements through at least the next 12 months. In the future, we expect our operating and capital expenditures to grow as we increase headcount, expand our business activities, grow our customer base and implement and enhance our information technology and enterprise resource planning system. As sales grow, we expect our accounts receivable balance to increase. Any such increase in accounts receivable may not be completely offset by increases in accounts payable and accrued expenses, which would likely result in greater working capital requirements. If our available cash resources are insufficient to satisfy our liquidity requirements, we may seek to sell additional equity or convertible debt securities or enter into a credit facility. The sale of equity and convertible debt securities may result in dilution to our stockholders and those securities may have rights senior to those of our common shares. If we raise additional funds through the issuance of convertible debt securities, these securities could contain covenants that would restrict our operations. We may require additional capital beyond our currently anticipated amounts. Additional capital may not be available on reasonable terms, or at all. Contractual Obligations We have contractual obligations for non-cancelable office space, notes payable and other short-term and long-term liabilities. The following table discloses aggregate information about our contractual obligations as of June 30, 2014 and periods in which payments are due (in thousands): Payments Due by Year Remainder of Total 2014 2015 - 2016 2017 - 2018 After 2018 Convertible Senior Notes, including interest * $ 127,200 $ 900 $ 3,600 $ 122,700 $ - Operating lease obligations 17,616 1,682 6,071 5,262 4,601 Total $ 144,816 $ 2,582 $ 9,671 $ 127,962 $ 4,601 * Contractual interest obligations related to the Notes totaled $7.2 million at June 30, 2014, including $0.9 million, $3.6 million and $2.7 million due in the remainder of 2014 and years 2015-2016 and 2017-2018, respectively. 33 -------------------------------------------------------------------------------- Table of Contents As of June 30, 2014, we had unrecognized tax benefits of $4.7 million. We do not expect to recognize any of these benefits in 2014. Furthermore, we are not able to provide a reliable estimate of the timing of future payments relating to these unrecognized benefits. Non-GAAP Financial Measures In addition to our GAAP operating results, we use certain non-GAAP financial measures when planning, monitoring, and evaluating our performance. We consider these non-GAAP financial measures to be useful metrics for management and investors because they exclude the effect of certain non-cash expenses, such as stock-based compensation expense, amortization of acquired intangibles expense, non-cash interest expense on our convertible notes and non-cash tax benefit or expense included in our tax provision, so management and investors can compare our core business operating results over multiple periods. While we believe that these non-GAAP financial measures are useful in evaluating our business, this information should be considered as supplemental in nature and is not meant as a substitute for revenue recognized in accordance with U.S. GAAP. In addition, other companies, including companies in our industry, may calculate such measures differently, which reduces its usefulness as a comparative measure. 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. The presentation of non-GAAP net income, non-GAAP net income per share, non-GAAP gross profit, non-GAAP operating income and other non-GAAP financial measures in this Quarterly Report on Form 10-Q is not meant to be a substitute for "net income," "net income per share," "gross profit," "income from operations" or other financial measures presented in accordance with GAAP, but rather should be evaluated in conjunction with such data. Our definition of "non-GAAP net income," "non-GAAP net income per share," "non-GAAP gross profit," "non-GAAP operating income" and other non-GAAP financial measures may differ from similarly titled non-GAAP measures used by other companies and may differ from period to period. In reporting non-GAAP measures in the future, we may make other adjustments for expenses and gains we do not consider reflective of core operating performance in a particular period and may modify "non-GAAP net income," "non-GAAP net income per share," "non-GAAP gross profit," "non-GAAP operating income" and such other non-GAAP measures by excluding these expenses and gains. Non-GAAP gross profit, license software gross profit, subscription and maintenance support gross profit and professional services and other gross profit. We define non-GAAP gross profit as gross profit plus stock-based compensation expense and amortization expense for acquired intangible assets. We consider non-GAAP gross profit to be a useful metric for management and our investors because it excludes the effect of certain non-cash expenses so management and investors can compare our sales margins over multiple periods. Non-GAAP operating income. We define non-GAAP operating income as income from operations plus stock-based compensation expense and amortization expense for acquired intangible assets. We consider non-GAAP operating income to be a useful metric for management and investors because it excludes the effect of certain non-cash expenses so management and investors can compare our core business operating results over multiple periods. Non-GAAP operating expenses, sales and marketing expense, research and development expense and general and administrative expense. We define non-GAAP operating expenses as operating expense plus stock-based compensation expense allocated to sales and marketing, research and development and general and administrative expenses. Similarly, we define non-GAAP sales and marketing, research and development and general and administrative expenses as the relevant GAAP measure plus stock-based compensation expense allocated to the particular expense item. Non-GAAP net income and net income per share. We define non-GAAP net income as net income plus stock-based compensation expense, amortization expense for acquired intangible assets, non-cash interest expense on our Notes, and non-cash tax expense included in the GAAP tax provision. We define non-GAAP income per share as non-GAAP net income divided by the weighted average shares outstanding. 34-------------------------------------------------------------------------------- Table of Contents Three Months Ended Six Months Ended June 30, June 30, 2014 2013 2014 2013 (in thousands) Non-GAAP cost of revenue: GAAP license cost of revenue $ 2,529 $ 2,119 $ 4,651 $ 4,579 (percent of related revenue) 10 % 9 % 11 % 10 % Less: Stock-based compensation expense 157 321 414 554 Amortization of acquired intangible assets 226 210 452 422 Non-GAAP license cost of revenue $ 2,146 $ 1,588 $ 3,785 $ 3,603 (percent of related revenue) 8 % 6 % 9 % 8 % GAAP subscription and maintenance support cost of revenue $ 8,606 $ 4,780 $ 16,052 $ 9,393 (percent of related revenue) 39 % 29 % 37 % 30 % Less: Stock-based compensation expense 521 653 1,210 1,197 Amortization of acquired intangible assets 1,164 587 2,348 1,175 Non-GAAP subscription and maintenance support cost of revenue $ 6,921 $ 3,540 $ 12,494 $ 7,021 (percent of related revenue) 32 % 22 % 29 % 22 % GAAP professional services and other cost of revenue $ 3,726 $ 2,872 $ 7,215 $ 5,565 (percent of related revenue) 76 % 96 % 69 % 84 % Less: Stock-based compensation expense 173 295 418 515 Non-GAAP professional services and other cost of revenue $ 3,553 $ 2,577 $ 6,797 $ 5,050 (percent of related revenue) 73 % 86 % 65 % 76 % 35-------------------------------------------------------------------------------- Table of Contents Three Months Ended Six Months Ended June 30, June 30, 2014 2013 2014 2013 (in thousands) Non-GAAP gross profit: GAAP gross profit $ 37,623 $ 34,238 $ 68,484 $ 64,097 (percent of total revenue) 72 % 78 % 71 % 77 % Plus: Stock-based compensation expense 851 1,269 2,042 2,266 Amortization of acquired intangible assets 1,390 798 2,800 1,596 Non-GAAP gross profit $ 39,864 $ 36,305 $ 73,326 $ 67,959 (percent of total revenue) 76 % 82 % 76 % 81 % GAAP license gross profit $ 23,120 $ 22,580 $ 38,140 $ 40,962 (percent of related revenue) 90 % 91 % 89 % 90 % Plus: Stock-based compensation expense 157 321 414 554 Amortization of acquired intangible assets 226 210 452 422 Non-GAAP license gross profit $ 23,503 $ 23,111 $ 39,006 $ 41,938 (percent of related revenue) 92 % 94 % 91 % 92 % GAAP subscription and maintenance support gross profit $ 13,352 $ 11,526 $ 27,032 $ 22,098 (percent of related revenue) 61 % 71 % 63 % 70 % Plus: Stock-based compensation expense 521 653 1,210 1,197 Amortization of acquired intangible assets 1,164 588 2,348 1,175 Non-GAAP subscription and maintenance support gross profit $ 15,037 $ 12,767 $ 30,590 $ 24,470 (percent of related revenue) 68 % 78 % 71 % 78 % GAAP professional services and other gross profit $ 1,151 $ 132 $ 3,312 $ 1,037 (percent of related revenue) 24 % 4 % 31 % 16 % Plus: Stock-based compensation expense 173 295 418 515 Non-GAAP professional services and other gross profit $ 1,324 $ 427 $ 3,730 $ 1,552 (percent of related revenue) 27 % 14 % 35 % 24 % 36-------------------------------------------------------------------------------- Table of Contents Three Months Ended Six Months Ended June 30, June 30, 2014 2013 2014 2013 (in thousands) Non-GAAP income from operations: GAAP income (loss) from operations $ 473 $ (2,337 ) $ (8,752 ) $ (6,012 ) (percent of total revenue) 1 % (5 )% (9 )% (7 )% Plus: Stock-based compensation expense 7,382 11,213 17,764 19,757 Amortization of acquired intangible assets 1,390 798 2,800 1,596 Non-GAAP income from operations $ 9,245 $ 9,674 $ 11,812 $ 15,341 (percent of total revenue) 18 % 22 % 12 % 18 % GAAP operating expense $ 37,150 $ 36,575 $ 77,236 $ 70,109 (percent of total revenue) 71 % 83 % 80 % 84 % Less: Stock-based compensation expense 6,531 9,944 15,722 17,491 Non-GAAP operating expense $ 30,619 $ 26,631 $ 61,514 $ 52,618 (percent of total revenue) 58 % 61 % 64 % 63 % GAAP sales and marketing expense $ 17,146 $ 15,536 $ 35,002 $ 29,265 (percent of total revenue) 33 % 35 % 36 % 35 % Less: Stock-based compensation expense 2,565 3,799 5,979 6,557 Non-GAAP sales and marketing expense $ 14,581 $ 11,737 $ 29,023 $ 22,708 (percent of total revenue) 28 % 27 % 30 % 27 % GAAP research and development expense $ 12,227 $ 12,935 $ 25,552 $ 25,303 (percent of total revenue) 23 % 29 % 27 % 30 % Less: Stock-based compensation expense 2,304 3,609 5,510 6,487 Non-GAAP research and development expense $ 9,923 $ 9,326 $ 20,042 $ 18,816 (percent of total revenue) 19 % 21 % 21 % 22 % GAAP general and administrative expense $ 7,777 $ 8,104 $ 16,682 $ 15,541 (percent of total revenue) 15 % 18 % 17 % 19 % Less: Stock-based compensation expense 1,662 2,536 4,233 4,447 Non-GAAP general and administrative expense $ 6,115 $ 5,568 $ 12,449 $ 11,094 (percent of total revenue) 12 % 13 % 13 % 13 % 37-------------------------------------------------------------------------------- Table of Contents Three Months Ended Six Months Ended June 30, June 30, 2014 2013 2014 2013 (in thousands, except per share data) Non-GAAP net income and income per share: GAAP net income (loss) $ 1,665 $ (3,015 ) $ (5,787 ) $ (5,332 ) (percent of total revenue) 3 % (7 )% (6 )% (6 )% Adjusted for: Stock-based compensation expense 7,382 11,213 17,764 19,757 Amortization of acquired intangible assets 1,390 798 2,800 1,596 Non-cash interest expense on our notes 1,467 1,367 2,900 2,706 Non-cash tax benefit (2,964 ) (1,183 ) (6,590 ) (4,403 ) Non-GAAP net income $ 8,940 $ 9,180 $ 11,087 $ 14,324 (percent of total revenue) 17 % 21 % 12 % 17 % GAAP net income (loss) per basic common share $ 0.06 $ (0.11 ) $ (0.20 ) $ (0.19 ) Adjusted for: Stock-based compensation expense 0.26 0.40 0.62 0.70 Amortization of acquired intangible assets 0.05 0.03 0.10 0.06 Non-cash interest expense on our notes 0.05 0.05 0.10 0.10 Non-cash tax benefit (0.10 ) (0.04 ) (0.23 ) (0.16 ) Non-GAAP net income per basic common share $ 0.32 $ 0.33 $ 0.39 $ 0.51 GAAP net income (loss) per diluted common share $ 0.06 $ (0.11 ) $ (0.20 ) $ (0.19 ) Adjusted for: Stock-based compensation expense 0.25 0.39 0.60 0.69 Amortization of acquired intangible assets 0.05 0.03 0.09 0.06 Non-cash interest expense on our notes 0.05 0.05 0.10 0.09 Non-cash tax benefit (0.10 ) (0.04 ) (0.22 ) (0.15 ) Non-GAAP net income per diluted common share $ 0.31 $ 0.32 $ 0.37 $ 0.50 Off-Balance Sheet Arrangements As of June 30, 2014, we did not have any significant off-balance sheet arrangements, as defined in Item 303(a)(4)(ii) of SEC Regulation S-K. 38-------------------------------------------------------------------------------- Table of Contents |