UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
(Mark One)
x | Quarterly report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 |
For the quarterly period ended July 31, 2013
OR
¨ | Transition report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 |
Commission File Number: 001-32224
salesforce.com, inc.
(Exact name of registrant as specified in its charter)
Delaware | 94-3320693 | |
(State or other jurisdiction of incorporation or organization) |
(IRS Employer Identification No.) |
The Landmark @ One Market, Suite 300
San Francisco, California 94105
(Address of principal executive offices)
Telephone Number (415) 901-7000
(Registrants telephone number, including area code)
Indicate by check mark whether the Registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 (the Exchange Act) during the preceding 12 months (or for such shorter period that the Registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days: Yes x No ¨
Indicate by check mark whether the Registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the Registrant was required to submit and post such files). Yes x No ¨
Indicate by check mark whether the Registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of large accelerated filer, accelerated filer and smaller reporting company in Rule 12b-2 of the Exchange Act.
Large accelerated filer x | Accelerated filer ¨ | |
Non-accelerated filer ¨ (Do not check if a smaller reporting company) | Smaller reporting company ¨ |
Indicate by check mark whether the Registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes ¨ No x
As of July 31, 2013, there were approximately 596.0 million shares of the Registrants Common Stock outstanding.
salesforce.com, inc.
PART I. | FINANCIAL INFORMATION |
ITEM 1. | FINANCIAL STATEMENTS |
Condensed Consolidated Balance Sheets
(in thousands)
July 31, 2013 |
January 31, 2013 |
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(unaudited) | ||||||||
Assets |
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Current assets: |
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Cash and cash equivalents |
$ | 579,881 | $ | 747,245 | ||||
Short-term marketable securities |
43,610 | 120,376 | ||||||
Accounts receivable, net |
599,543 | 872,634 | ||||||
Deferred commissions |
119,503 | 142,311 | ||||||
Prepaid expenses and other current assets |
355,628 | 133,314 | ||||||
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Total current assets |
1,698,165 | 2,015,880 | ||||||
Marketable securities, noncurrent |
306,517 | 890,664 | ||||||
Property and equipment, net |
1,184,861 | 604,669 | ||||||
Deferred commissions, noncurrent |
105,864 | 112,082 | ||||||
Capitalized software, net |
537,380 | 207,323 | ||||||
Goodwill |
3,503,681 | 1,529,378 | ||||||
Other assets, net |
633,428 | 168,960 | ||||||
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Total assets |
$ | 7,969,896 | $ | 5,528,956 | ||||
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Liabilities, temporary equity and stockholders equity |
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Current liabilities: |
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Accounts payable, accrued expenses and other liabilities |
$ | 764,083 | $ | 597,706 | ||||
Deferred revenue |
1,734,841 | 1,798,640 | ||||||
Convertible 0.75% senior notes, net |
534,391 | 521,278 | ||||||
Term loan, current |
30,000 | 0 | ||||||
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Total current liabilities |
3,063,315 | 2,917,624 | ||||||
Convertible 0.25% senior notes, net |
1,035,271 | 0 | ||||||
Term loan, noncurrent |
270,000 | 0 | ||||||
Deferred revenue, noncurrent |
54,807 | 64,355 | ||||||
Other noncurrent liabilities |
687,355 | 175,732 | ||||||
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Total liabilities |
5,110,748 | 3,157,711 | ||||||
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Temporary equity |
40,499 | 53,612 | ||||||
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Stockholders equity: |
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Common stock (1) |
596 | 586 | ||||||
Additional paid-in capital (1) |
2,908,914 | 2,410,892 | ||||||
Accumulated other comprehensive income |
11,239 | 17,137 | ||||||
Accumulated deficit |
(102,100 | ) | (110,982 | ) | ||||
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Total stockholders equity |
2,818,649 | 2,317,633 | ||||||
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Total liabilities, temporary equity and stockholders equity |
$ | 7,969,896 | $ | 5,528,956 | ||||
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(1) | Prior period results have been adjusted to reflect the four-for-one stock split through a stock dividend which occurred in April 2013. |
See accompanying Notes.
1
Condensed Consolidated Statements of Operations
(in thousands, except per share data)
(unaudited)
Three Months Ended July 31, | Six Months Ended July 31, | |||||||||||||||
2013 | 2012 | 2013 | 2012 | |||||||||||||
Revenues: |
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Subscription and support |
$ | 902,844 | $ | 687,493 | $ | 1,745,065 | $ | 1,342,713 | ||||||||
Professional services and other |
54,250 | 44,156 | 104,662 | 84,403 | ||||||||||||
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Total revenues |
957,094 | 731,649 | 1,849,727 | 1,427,116 | ||||||||||||
Cost of revenues (1)(2): |
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Subscription and support |
160,908 | 118,519 | 314,458 | 227,263 | ||||||||||||
Professional services and other |
56,809 | 43,899 | 112,253 | 86,706 | ||||||||||||
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Total cost of revenues |
217,717 | 162,418 | 426,711 | 313,969 | ||||||||||||
Gross profit |
739,377 | 569,231 | 1,423,016 | 1,113,147 | ||||||||||||
Operating expenses (1)(2): |
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Research and development |
148,079 | 99,442 | 280,018 | 194,218 | ||||||||||||
Marketing and sales |
480,621 | 380,160 | 947,111 | 749,949 | ||||||||||||
General and administrative |
150,534 | 103,095 | 280,284 | 204,695 | ||||||||||||
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Total operating expenses |
779,234 | 582,697 | 1,507,413 | 1,148,862 | ||||||||||||
Loss from operations |
(39,857 | ) | (13,466 | ) | (84,397 | ) | (35,715 | ) | ||||||||
Investment income |
4,387 | 7,173 | 7,741 | 11,634 | ||||||||||||
Interest expense |
(19,656 | ) | (8,033 | ) | (31,539 | ) | (14,403 | ) | ||||||||
Other income (expense) |
(1,678 | ) | 294 | (2,552 | ) | (416 | ) | |||||||||
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Loss before benefit from income taxes |
(56,804 | ) | (14,032 | ) | (110,747 | ) | (38,900 | ) | ||||||||
Benefit from income taxes (3) |
133,407 | 4,203 | 119,629 | 9,596 | ||||||||||||
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Net income (loss) |
$ | 76,603 | $ | (9,829 | ) | $ | 8,882 | $ | (29,304 | ) | ||||||
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Basic net income (loss) per share (4) |
$ | 0.13 | $ | (0.02 | ) | $ | 0.02 | $ | (0.05 | ) | ||||||
Diluted net income (loss) per share (4) |
$ | 0.12 | $ | (0.02 | ) | $ | 0.01 | $ | (0.05 | ) | ||||||
Shares used in computing basic net income (loss) per share (4) |
593,955 | 557,700 | 591,210 | 555,156 | ||||||||||||
Shares used in computing diluted net income (loss) per share (4) |
624,656 | 557,700 | 623,865 | 555,156 | ||||||||||||
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(1) Amounts include amortization of purchased intangibles from | Three Months Ended July 31, | Six Months Ended July 31, | ||||||||||||||
business combinations, as follows: | 2013 | 2012 | 2013 | 2012 | ||||||||||||
Cost of revenues |
$ | 22,550 | $ | 17,668 | $ | 43,855 | $ | 35,116 | ||||||||
Marketing and sales |
4,476 | 2,407 | 6,936 | 5,834 | ||||||||||||
(2) Amounts include stock-based expenses, as follows: | Three Months Ended July 31, | Six Months Ended July 31, | ||||||||||||||
2013 | 2012 | 2013 | 2012 | |||||||||||||
Cost of revenues |
$ | 9,981 | $ | 7,864 | $ | 20,659 | $ | 15,117 | ||||||||
Research and development |
26,032 | 16,089 | 50,461 | 31,756 | ||||||||||||
Marketing and sales |
56,133 | 44,781 | 115,935 | 86,768 | ||||||||||||
General and administrative |
18,330 | 16,683 | 38,150 | 33,042 |
(3) | Amounts include a $128.8 million tax benefit recorded during the three months ended July 31, 2013 as a result of the partial release of the Companys tax valuation allowance. See Note 8. |
(4) | Prior period results have been adjusted to reflect the four-for-one stock split through a stock dividend which occurred in April 2013. |
See accompanying Notes.
2
Condensed Consolidated Statements of Comprehensive Income (Loss)
(in thousands)
(unaudited)
Three Months Ended July 31, |
Six Months Ended July 31, |
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2013 | 2012 | 2013 | 2012 | |||||||||||||
Net income (loss) |
$ | 76,603 | $ | (9,829 | ) | $ | 8,882 | $ | (29,304 | ) | ||||||
Other comprehensive income (loss), before tax and net of reclassification adjustments: |
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Foreign currency translation and other gains (losses) |
(1,431 | ) | 10,135 | (7,191 | ) | 6,947 | ||||||||||
Unrealized gains (losses) on investments |
117 | (961 | ) | 1,838 | 159 | |||||||||||
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Other comprehensive income (loss), before tax |
(1,314 | ) | 9,174 | (5,353 | ) | 7,106 | ||||||||||
Tax effect |
(1,173 | ) | 359 | (545 | ) | (59 | ) | |||||||||
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Other comprehensive income (loss), net of tax |
(2,487 | ) | 9,533 | (5,898 | ) | 7,047 | ||||||||||
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Comprehensive income (loss) |
$ | 74,116 | $ | (296 | ) | $ | 2,984 | $ | (22,257 | ) | ||||||
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See accompanying Notes.
3
Condensed Consolidated Statements of Cash Flows
(in thousands)
(unaudited)
Three Months
Ended July 31, |
Six Months
Ended July 31, |
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2013 | 2012 | 2013 | 2012 | |||||||||||||
Operating activities: |
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Net income (loss) |
$ | 76,603 | $ | (9,829 | ) | $ | 8,882 | $ | (29,304 | ) | ||||||
Adjustments to reconcile net income (loss) to net cash provided by operating activities: |
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Depreciation and amortization |
77,966 | 49,999 | 140,263 | 99,440 | ||||||||||||
Amortization of debt discount and transaction costs |
13,194 | 6,371 | 22,864 | 11,040 | ||||||||||||
Amortization of deferred commissions |
46,189 | 35,783 | 91,856 | 72,029 | ||||||||||||
Expenses related to employee stock plans |
110,476 | 85,417 | 225,205 | 166,683 | ||||||||||||
Excess tax benefits from employee stock plans |
1,278 | (14,702 | ) | (588 | ) | (25,745 | ) | |||||||||
Changes in assets and liabilities, net of business combinations: |
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Accounts receivable, net |
(33,297 | ) | (75,522 | ) | 336,592 | 237,138 | ||||||||||
Deferred commissions |
(45,347 | ) | (35,222 | ) | (62,830 | ) | (67,340 | ) | ||||||||
Prepaid expenses and other current assets |
(2,990 | ) | (35,747 | ) | (10,862 | ) | (56,096 | ) | ||||||||
Other assets |
60 | (891 | ) | 1,582 | 864 | |||||||||||
Accounts payable, accrued expenses and other liabilities |
(70,750 | ) | 128,071 | (166,558 | ) | (16,189 | ) | |||||||||
Deferred revenue |
9,801 | 2,469 | (120,034 | ) | (43,111 | ) | ||||||||||
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Net cash provided by operating activities |
183,183 | 136,197 | 466,372 | 349,409 | ||||||||||||
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Investing activities: |
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Business combinations, net of cash acquired |
(2,592,571 | ) | (10,078 | ) | (2,614,732 | ) | (58,991 | ) | ||||||||
Land activity and building improvements |
0 | 0 | 0 | (4,106 | ) | |||||||||||
Strategic investments |
(3,698 | ) | (1,129 | ) | (8,814 | ) | (3,794 | ) | ||||||||
Purchases of marketable securities |
(56,458 | ) | (107,101 | ) | (320,745 | ) | (594,904 | ) | ||||||||
Sales of marketable securities |
893,910 | 472,710 | 1,005,650 | 548,232 | ||||||||||||
Maturities of marketable securities |
6,046 | 47,188 | 20,604 | 84,887 | ||||||||||||
Capital expenditures |
(102,549 | ) | (29,304 | ) | (156,559 | ) | (74,025 | ) | ||||||||
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Net cash provided by (used in) investing activities |
(1,855,320 | ) | 372,286 | (2,074,596 | ) | (102,701 | ) | |||||||||
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Financing activities: |
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Proceeds from borrowings on convertible senior notes, net |
0 | 0 | 1,132,750 | 0 | ||||||||||||
Proceeds from issuance of warrants |
0 | 0 | 84,800 | 0 | ||||||||||||
Purchase of convertible note hedge |
0 | 0 | (153,800 | ) | 0 | |||||||||||
Proceeds from term loan, net |
298,500 | 0 | 298,500 | 0 | ||||||||||||
Proceeds from employee stock plans |
40,195 | 33,824 | 106,719 | 127,391 | ||||||||||||
Excess tax benefits from employee stock plans |
(1,278 | ) | 14,702 | 588 | 25,745 | |||||||||||
Principal payments on capital lease obligations |
(12,108 | ) | (7,479 | ) | (20,607 | ) | (15,053 | ) | ||||||||
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Net cash provided by financing activities |
325,309 | 41,047 | 1,448,950 | 138,083 | ||||||||||||
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Effect of exchange rate changes |
(1,281 | ) | 10,415 | (8,090 | ) | 8,655 | ||||||||||
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Net (decrease) increase in cash and cash equivalents |
(1,348,109 | ) | 559,945 | (167,364 | ) | 393,446 | ||||||||||
Cash and cash equivalents, beginning of period |
1,927,990 | 440,785 | 747,245 | 607,284 | ||||||||||||
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Cash and cash equivalents, end of period |
$ | 579,881 | $ | 1,000,730 | $ | 579,881 | $ | 1,000,730 | ||||||||
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Supplemental cash flow disclosure: |
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Cash paid during the period for: |
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Interest, net |
$ | 4,549 | $ | 2,766 | $ | 5,191 | $ | 3,390 | ||||||||
Income taxes, net of tax refunds |
$ | 2,238 | $ | 3,506 | $ | 19,521 | $ | 45,467 | ||||||||
Non-cash financing and investing activities: |
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Property and equipment acquired under capital leases |
$ | 467,117 | $ | 8,923 | $ | 473,674 | $ | 15,797 | ||||||||
Fair value of equity awards assumed in business combinations |
$ | 41,676 | $ | 0 | $ | 41,676 | $ | 2,204 |
See accompanying Notes.
4
Notes to Condensed Consolidated Financial Statements
1. Summary of Business and Significant Accounting Policies
Description of Business
Salesforce.com, inc. (the Company) is a provider of enterprise cloud computing services. The Company is dedicated to helping customers of all sizes and industries worldwide transform themselves into customer companies by empowering them to connect with their customers, partners, employees and products in entirely new ways. The Company provides customers with the solutions they need to build a next generation social front office with social and mobile cloud technologies.
Fiscal Year
The Companys fiscal year ends on January 31. References to fiscal 2014, for example, refer to the fiscal year ending January 31, 2014.
Basis of Presentation
The accompanying condensed consolidated balance sheet as of July 31, 2013 and the condensed consolidated statements of operations, the condensed consolidated statements of comprehensive income (loss) and the condensed consolidated statements of cash flows for the three and six months ended July 31, 2013 and 2012, respectively, are unaudited. The condensed consolidated balance sheet data as of January 31, 2013 was derived from the audited consolidated financial statements which are included in the Companys Form 10-K for the fiscal year ended January 31, 2013, which was filed with the Securities and Exchange Commission (the SEC) on March 8, 2013. The accompanying statements should be read in conjunction with the audited consolidated financial statements and related notes contained in the Companys fiscal 2013 Form 10-K.
The accompanying condensed consolidated financial statements have been prepared in accordance with U.S. generally accepted accounting principles (U.S. GAAP) for interim financial information. Accordingly, they do not include all of the financial information and footnotes required by U.S. GAAP for complete financial statements. In the opinion of the Companys management, the unaudited condensed consolidated financial statements have been prepared on the same basis as the audited consolidated financial statements in the Form 10-K, and include all adjustments necessary for the fair presentation of the Companys statement of financial position as of July 31, 2013, and its results of operations, including its comprehensive income (loss), and its cash flows for the three and six months ended July 31, 2013 and 2012. All adjustments are of a normal recurring nature. The results for the three and six months ended July 31, 2013 are not necessarily indicative of the results to be expected for any subsequent quarter or for the fiscal year ending January 31, 2014.
On March 20, 2013, the Companys 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.
Use of Estimates
The preparation of financial statements in conformity with U.S. GAAP requires management to make estimates and assumptions in the Companys condensed consolidated financial statements and notes thereto.
Significant estimates and assumptions made by management include the determination of:
| the best estimate of selling price of the deliverables included in multiple-deliverable revenue arrangements, |
| the assessment of recoverability of long-lived assets (property and equipment, goodwill and identified intangibles), |
| the fair value of assets acquired and liabilities assumed for business combinations, |
| the recognition, measurement and valuation of current and deferred income taxes, |
| the recognition and measurement of loss contingencies, |
5
| the fair value of stock awards issued, and |
| the valuation of strategic investments and the determination of other-than-temporary impairments. |
Actual results could differ materially from those estimates.
Principles of Consolidation
The condensed consolidated financial statements include the accounts of the Company and its wholly-owned subsidiaries. All significant intercompany balances and transactions have been eliminated in consolidation.
Segments
The Company operates as one operating segment. Operating segments are defined as components of an enterprise for which separate financial information is evaluated regularly by the chief operating decision maker, who is the chief executive officer, in deciding how to allocate resources and assessing performance. Over the past few years, the Company has completed several acquisitions. These acquisitions have allowed the Company to expand its offerings, presence and reach in various market segments of the enterprise cloud computing market. While the Company has offerings in multiple enterprise cloud computing market segments, the Companys business operates in one operating segment because the Companys chief operating decision maker evaluates the Companys financial information and resources and assesses the performance of these resources on a consolidated basis. Since the Company operates in one operating segment, all required financial segment information can be found in the condensed consolidated financial statements.
Concentrations of Credit Risk and Significant Customers
The Companys financial instruments that are exposed to concentrations of credit risk consist primarily of cash and cash equivalents, marketable securities and trade accounts receivable. Although the Company deposits its cash with multiple financial institutions, its deposits, at times, may exceed federally insured limits. Collateral is not required for accounts receivable. The Company maintains an allowance for doubtful accounts receivable balances. The allowance is based upon historical loss patterns, the number of days that billings are past due and an evaluation of the potential risk of loss associated with delinquent accounts.
No customer accounted for more than five percent of accounts receivable at July 31, 2013 and January 31, 2013, respectively. No single customer accounted for five percent or more of total revenue during the three and six months ended July 31, 2013 and 2012.
Geographic Locations
As of July 31, 2013 and January 31, 2013, assets located outside the Americas were 9 percent and 16 percent of total assets, respectively.
Revenues by geographical region are as follows (in thousands):
Three Months
Ended July 31, |
Six Months
Ended July 31, |
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2013 | 2012 | 2013 | 2012 | |||||||||||||
Americas |
$ | 678,535 | $ | 507,974 | $ | 1,309,643 | $ | 992,927 | ||||||||
Europe |
173,705 | 124,609 | 336,531 | 242,903 | ||||||||||||
Asia Pacific |
104,854 | 99,066 | 203,553 | 191,286 | ||||||||||||
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$ | 957,094 | $ | 731,649 | $ | 1,849,727 | $ | 1,427,116 | |||||||||
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Americas revenue attributed to the United States was approximately 96 percent and 94 percent for the three months ended July 31, 2013 and 2012, respectively, and approximately 95 percent and 94 percent for the six months ended July 31, 2013 and 2012, respectively.
Revenue Recognition
The Company derives its revenues from two sources: (1) subscription revenues, which are comprised of subscription fees from customers accessing the Companys 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.
6
The Company commences revenue recognition when all of the following conditions are satisfied:
| There is persuasive evidence of an arrangement; |
| The service has been or is being provided to the customer; |
| The collection of the fees is reasonably assured; and |
| The amount of fees to be paid by the customer is fixed or determinable. |
The Companys subscription service arrangements are non-cancelable and do not contain refund-type provisions.
Subscription and Support Revenues
Subscription and support revenues are recognized ratably over the contract terms beginning on the commencement date of each contract, which is the date the Companys service is made available to customers.
Amounts that have been invoiced are recorded in accounts receivable and in deferred revenue or revenue, depending on whether the revenue recognition criteria have been met.
Professional Services and Other Revenues
The majority of the Companys professional services contracts are on a time and material basis. When these services are not combined with subscription revenues as a single unit of accounting, as discussed below, these revenues are recognized as the services are rendered for time and material contracts, and when the milestones are achieved and accepted by the customer for fixed price contracts. Training revenues are recognized as the services are performed.
Multiple-Deliverable Arrangements
The Company enters into arrangements with multiple-deliverables that generally include multiple subscriptions, premium support and professional services. If the deliverables have standalone value upon delivery, the Company accounts for each deliverable separately. Subscription services have standalone value as such services are often sold separately. In determining whether professional services have standalone value, the Company considers the following factors for each professional services agreement: availability of the services from other vendors, the nature of the professional services, the timing of when the professional services contract was signed in comparison to the subscription service start date and the contractual dependence of the subscription service on the customers satisfaction with the professional services work. To date, the Company has concluded that all of the professional services included in multiple-deliverable arrangements executed have standalone value.
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. The Company determines the relative selling price for a deliverable based on its vendor-specific objective evidence of selling price (VSOE), if available, or its best estimate of selling price (BESP), if VSOE is not available. The Company has determined that third-party evidence of selling price (TPE) is not a practical alternative due to differences in its service offerings compared to other parties and the availability of relevant third-party pricing information. The amount of revenue allocated to delivered items is limited by contingent revenue, if any.
For certain professional services, the Company has established VSOE as a consistent number of standalone sales of this deliverable have been priced within a reasonably narrow range. The Company has not established VSOE for its subscription services due to lack of pricing consistency, the introduction of new services and other factors. Accordingly, the Company uses its BESP to determine the relative selling price.
The Company determined BESP by considering its overall pricing objectives and market conditions. Significant pricing practices taken into consideration include the Companys discounting practices, the size and volume of the Companys transactions, the customer demographic, the geographic area where services are sold, price lists, its go-to-market strategy, historical standalone sales and contract prices. The determination of BESP is made through consultation with and approval by the Companys management, taking into consideration the go-to-market strategy. As the Companys go-to-market strategies evolve, the Company may modify its pricing practices in the future, which could result in changes in relative selling prices, including both VSOE and BESP.
7
Deferred Revenue
The deferred revenue balance does not represent the total contract value of annual or multi-year, non-cancelable subscription agreements. Deferred revenue primarily consists of billings or payments received in advance of revenue recognition from subscription services described above and is recognized as the revenue recognition criteria are met. The Company generally invoices customers in annual or quarterly installments. Deferred revenue is influenced by several factors, including seasonality, the compounding effects of renewals, invoice duration, invoice timing and new business linearity within the quarter.
Deferred revenue that will be recognized during the succeeding twelve month period is recorded as current deferred revenue and the remaining portion is recorded as noncurrent.
Deferred Commissions
Deferred commissions are the incremental costs that are directly associated with non-cancelable subscription contracts with customers and consist of sales commissions paid to the Companys direct sales force.
The commissions are deferred and amortized over the non-cancelable terms of the related customer contracts, which are typically 12 to 36 months. The commission payments are paid in full the month after the customers service commences. The deferred commission amounts are recoverable through the future revenue streams under the non-cancelable customer contracts. The Company believes this is the preferable method of accounting as the commission charges are so closely related to the revenue from the non-cancelable customer contracts that they should be recorded as an asset and charged to expense over the same period that the subscription revenue is recognized. Amortization of deferred commissions is included in marketing and sales expense in the accompanying condensed consolidated statements of operations.
Cash and Cash Equivalents
The Company considers all highly liquid investments purchased with an original maturity of three months or less to be cash equivalents. Cash and cash equivalents are stated at fair value.
Marketable Securities
Management determines the appropriate classification of marketable securities at the time of purchase and reevaluates such determination at each balance sheet date. Securities are classified as available for sale and are carried at fair value, with the change in unrealized gains and losses, net of tax, reported as a separate component on the condensed consolidated statements of comprehensive income (loss). Fair value is determined based on quoted market rates when observable or utilizing data points that are observable, such as quoted prices, interest rates and yield curves. Declines in fair value judged to be other-than-temporary on securities available for sale are included as a component of investment income. In order to determine whether a decline in value is other-than-temporary, the Company evaluates, among other factors: the duration and extent to which the fair value has been less than the carrying value and its intent and ability to retain the investment for a period of time sufficient to allow for any anticipated recovery in fair value. The cost of securities sold is based on the specific-identification method. Interest on securities classified as available for sale is also included as a component of investment income.
Fair Value Measurement
The Company measures its cash equivalents, marketable securities and foreign currency derivative contracts at fair value.
The Company reports its financial and non-financial assets and liabilities that are re-measured and reported at fair value at each reporting period.
The additional disclosures regarding the Companys fair value measurements are included in Note 2.
Property and Equipment
Property and equipment are stated at cost. Depreciation is calculated on a straight-line basis over the estimated useful lives of those assets.
8
When assets are retired or otherwise disposed of, the cost and accumulated depreciation and amortization are removed from their respective accounts and any loss on such retirement is reflected in operating expenses.
Capitalized Internal-Use Software Costs
The Company capitalizes costs related to its enterprise cloud computing services and certain projects for internal use incurred during the application development stage. Costs related to preliminary project activities and post implementation activities are expensed as incurred. Internal-use software is amortized on a straight line basis over its estimated useful life. Management evaluates the useful lives of these assets on an annual basis and tests for impairment whenever events or changes in circumstances occur that could impact the recoverability of these assets.
Goodwill, Intangible Assets, Long-Lived Assets and Impairment Assessments
The Company evaluates and tests the recoverability of its goodwill for impairment at least annually during the fourth quarter or more often if and when circumstances indicate that goodwill may not be recoverable.
Intangible assets are amortized over their useful lives. Each period the Company evaluates the estimated remaining useful life of its intangible assets and whether events or changes in circumstances warrant a revision to the remaining period of amortization. The carrying amounts of these assets are periodically reviewed for impairment whenever events or changes in circumstances indicate that the carrying value of these assets may not be recoverable. Recoverability of these assets is measured by comparison of the carrying amount of each asset to the future undiscounted cash flows the asset is expected to generate. If the undiscounted cash flows used in the test for recoverability are less than the carrying amount of these assets then the Company will recognize an impairment charge.
The Company evaluates the recoverability of its long-lived assets for possible impairment whenever events or circumstances indicate that the carrying amount of such assets may not be recoverable. If such review indicates that the carrying amount of long-lived assets is not recoverable, the carrying amount of such assets is reduced to fair value.
Business Combinations
The Company uses its best estimates and assumptions to accurately assign fair value to the tangible and intangible assets acquired and liabilities assumed at the acquisition date. The Companys estimates are inherently uncertain and subject to refinement. During the measurement period, which may be up to one year from the acquisition date, the Company may record adjustments to the fair value of these tangible and intangible assets acquired and liabilities assumed, with the corresponding offset to goodwill. In addition, uncertain tax positions and tax related valuation allowances are initially established in connection with a business combination as of the acquisition date. The Company continues to collect information and reevaluates these estimates and assumptions quarterly and records any adjustments to the Companys preliminary estimates to goodwill provided that the Company is within the measurement period. Upon the conclusion of the measurement period or final determination of the fair value of assets acquired or liabilities assumed, whichever comes first, any subsequent adjustments are recorded to the Companys condensed consolidated statements of operations.
Leases and Asset Retirement Obligations
The Company categorizes leases at their inception as either operating or capital leases. On certain lease agreements, the Company may receive rent holidays and other incentives. The Company recognizes lease costs on a straight-line basis once control of the space is achieved, without regard to deferred payment terms, such as rent holidays that defer the commencement date of required payments. Additionally, incentives received are treated as a reduction of costs over the term of the agreement. Leasehold improvements are capitalized at cost and amortized over the lesser of the non-cancellable term of the lease or 10 years.
The Company establishes assets and liabilities for the present value of estimated future costs to retire long-lived assets at the termination or expiration of a lease. Such assets are depreciated over the lease period into operating expense, and the recorded liabilities are accreted to the future value of the estimated retirement costs.
9
Accounting for Stock-Based Compensation
The Company recognizes stock-based expenses related to stock options and restricted stock awards on a straight-line basis over the requisite service period of the awards, which is generally the vesting term of four years. The Company recognizes stock-based expenses related to shares issued pursuant to its Employee Stock Purchase Plan (ESPP) on a straight-line basis over the offering period, which is 12 months. Stock-based expenses are recognized net of estimated forfeiture activity. The estimated forfeiture rate applied is based on historical forfeiture rates.
The fair value of each stock option grant was estimated on the date of grant using the Black-Scholes option pricing model with the following assumptions and fair value per share:
Three Months Ended July 31, |
Six Months
Ended July 31, |
|||||||||||||||
Stock Options |
2013 | 2012 | 2013 | 2012 | ||||||||||||
Volatility |
39-43 | % | 47 | % | 39-43 | % | 47-51 | % | ||||||||
Estimated life |
3.1 years | 3.7 years | 3.1 years | 3.7 years | ||||||||||||
Risk-free interest rate |
0.48-0.95 | % | 0.43-0.66 | % | 0.48-0.95 | % | 0.43-0.77 | % | ||||||||
Dividend yield |
0 | 0 | 0 | 0 | ||||||||||||
Weighted-average fair value per share of grants |
$ | 10.89 | $ | 11.85 | $ | 11.10 | $ | 13.23 |
Three Months Ended July 31, |
Six Months Ended July 31, |
|||||||||||||||
ESPP |
2013 | 2012 | 2013 | 2012 | ||||||||||||
Volatility |
31-32 | % | 42-46 | % | 31-32 | % | 42-46 | % | ||||||||
Estimated life |
0.75 years | 0.75 years | 0.75 years | 0.75 years | ||||||||||||
Risk-free interest rate |
0.07-0.10 | % | 0.12-0.13 | % | 0.07-0.10 | % | 0.12-0.13 | % | ||||||||
Dividend yield |
0 | 0 | 0 | 0 | ||||||||||||
Weighted-average fair value per share of grants |
$ | 9.69 | $ | 10.09 | $ | 9.69 | $ | 10.09 |
The Company estimated its future stock price volatility considering both its observed option-implied volatilities and its historical volatility calculations. Management believes this is the best estimate of the expected volatility over the expected life of its stock options.
The estimated life for the stock options was based on an analysis of expected life. The estimated life for the ESPP was based on the two purchase periods within each offering period. The risk free interest rate is based on the rate for a U.S. government security with the same estimated life at the time of the option grant.
Income Taxes
The Company uses 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 laws is recognized in the consolidated statement of operations in the period that includes the enactment date. Valuation allowances are established when necessary to reduce deferred tax assets to the amounts more likely than not expected to be realized.
The Companys tax positions are subject to income tax audits by multiple tax jurisdictions throughout the world. The Company recognizes 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. The Company recognizes interest accrued and penalties related to unrecognized tax benefits in the income tax provision.
Foreign Currency Translation
The functional currency of the Companys major foreign subsidiaries is generally the local currency. Adjustments resulting from translating foreign functional currency financial statements into U.S. dollars are recorded as a separate component on the condensed consolidated statements of comprehensive income (loss). Foreign currency transaction gains and losses are included in net income (loss) for the period. All assets and liabilities denominated in a foreign currency are translated into U.S. dollars at the exchange rate on the balance sheet date. Revenues and expenses are translated at the average exchange rate during the period. Equity transactions are translated using historical exchange rates.
10
Warranties and Indemnification
The Companys enterprise cloud computing services are typically warranted to perform in a manner consistent with general industry standards that are reasonably applicable and materially in accordance with the Companys online help documentation under normal use and circumstances.
The Companys arrangements generally include certain provisions for indemnifying customers against liabilities if its products or services infringe a third-partys intellectual property rights. To date, the Company has not incurred any material costs as a result of such obligations and has not accrued any liabilities related to such obligations in the accompanying condensed consolidated financial statements.
The Company has also agreed to indemnify its directors and executive officers for costs associated with any fees, expenses, judgments, fines and settlement amounts incurred by any of these persons in any action or proceeding to which any of those persons is, or is threatened to be, made a party by reason of the persons service as a director or officer, including any action by the Company, arising out of that persons services as the Companys director or officer or that persons services provided to any other company or enterprise at the Companys request. The Company maintains director and officer insurance coverage that would generally enable the Company to recover a portion of any future amounts paid. The Company may also be subject to indemnification obligations by law with respect to the actions of its employees under certain circumstances and in certain jurisdictions.
New Accounting Pronouncement
In July 2012, the Financial Accounting Standards Board (the FASB) issued Accounting Standards Update No. 2012-02, IntangiblesGoodwill and Other (Topic 350)Testing Indefinite-Lived Intangible Assets for Impairment (ASU 2012-02), to allow entities to use a qualitative approach to test indefinite-lived intangible assets for impairment. ASU 2012-02 permits an entity to first perform a qualitative assessment to determine whether it is more likely than not that the fair value of an indefinite-lived intangible asset is less than its carrying value. If it is concluded that this is the case, it is necessary to perform the currently prescribed quantitative impairment test by comparing the fair value of the indefinite-lived intangible asset with its carrying value. Otherwise, the quantitative impairment test is not required. The Company adopted ASU 2012-02 in fiscal 2014 and does not believe that the adoption will have a material effect on the condensed consolidated financial statements.
In July 2013, the FASB issued Accounting Standards Update No. 2013-11, Income Taxes (Topic 740): Presentation of an Unrecognized Tax Benefit When a Net Operating Loss Carryforward, a Similar Tax Loss, or a Tax Credit Carryforward Exists (ASU 2013-11), which provides guidance on the financial statement presentation of an unrecognized tax benefit when a net operating loss (NOL) carryforward, a similar tax loss, or a tax credit carryforward exists. ASU 2013-11 supports the approach for companies to present an unrecognized tax benefit as a reduction of a deferred tax asset for a NOL or tax credit carryforward whenever the NOL or tax credit carryforward would be available to reduce the additional taxable income or tax due if the tax position is disallowed. This approach requires companies to assess whether to net the unrecognized tax benefit with a deferred tax asset as of the reporting date. The Company plans to adopt ASU 2013-11 in fiscal 2015 and is currently evaluating the impact to its consolidated financial statements.
2. Investments
Marketable Securities
At July 31, 2013, marketable securities consisted of the following (in thousands):
Investments classified as Marketable Securities |
Amortized Cost |
Unrealized Gains |
Unrealized Losses |
Fair Value | ||||||||||||
Corporate notes and obligations |
$ | 195,775 | $ | 690 | $ | (421 | ) | $ | 196,044 | |||||||
U.S. treasury securities |
5,130 | 5 | (1 | ) | 5,134 | |||||||||||
Mortgage backed obligations |
31,916 | 276 | (127 | ) | 32,065 | |||||||||||
Asset backed securities |
29,443 | 26 | (98 | ) | 29,371 | |||||||||||
Municipal securities |
1,000 | 0 | (4 | ) | 996 | |||||||||||
Foreign government obligations |
14,840 | 0 | (7 | ) | 14,833 | |||||||||||
U.S. agency obligations |
14,712 | 3 | (75 | ) | 14,640 | |||||||||||
Covered bonds |
56,904 | 144 | (4 | ) | 57,044 | |||||||||||
|
|
|
|
|
|
|
|
|||||||||
Total marketable securities |
$ | 349,720 | $ | 1,144 | $ | (737 | ) | $ | 350,127 | |||||||
|
|
|
|
|
|
|
|
11
At January 31, 2013, marketable securities consisted of the following (in thousands):
Investments classified as Marketable Securities |
Amortized Cost |
Unrealized Gains |
Unrealized Losses |
Fair Value | ||||||||||||
Corporate notes and obligations |
$ | 685,695 | $ | 5,113 | $ | (919 | ) | $ | 689,889 | |||||||
U.S. treasury securities |
38,864 | 20 | (15 | ) | 38,869 | |||||||||||
Mortgage backed obligations |
12,447 | 278 | (2 | ) | 12,723 | |||||||||||
Foreign government obligations |
9,572 | 72 | (3 | ) | 9,641 | |||||||||||
Municipal securities |
2,697 | 1 | (32 | ) | 2,666 | |||||||||||
Collateralized mortgage obligations |
150,794 | 1,775 | (693 | ) | 151,876 | |||||||||||
U.S. agency obligations |
105,224 | 157 | (5 | ) | 105,376 | |||||||||||
|
|
|
|
|
|
|
|
|||||||||
Total marketable securities |
$ | 1,005,293 | $ | 7,416 | $ | (1,669 | ) | $ | 1,011,040 | |||||||
|
|
|
|
|
|
|
|
The duration of the investments classified as marketable securities is as follows (in thousands):
As of | ||||||||
July 31, 2013 |
January 31, 2013 |
|||||||
Short-term (due in one year or less) |
$ | 43,610 | $ | 120,376 | ||||
Long-term (due between one and 3 years) |
306,517 | 890,664 | ||||||
|
|
|
|
|||||
$ | 350,127 | $ | 1,011,040 | |||||
|
|
|
|
As of July 31, 2013, the following marketable securities were in an unrealized loss position (in thousands):
Less than 12 Months | 12 Months or Greater | Total | ||||||||||||||||||||||
Fair Value | Unrealized Losses |
Fair Value | Unrealized Losses |
Fair Value | Unrealized Losses |
|||||||||||||||||||
Corporate notes and obligations |
$ | 64,569 | (377 | ) | $ | 3,013 | (44 | ) | $ | 67,582 | $ | (421 | ) | |||||||||||
U.S. treasury securities |
620 | (1 | ) | 0 | 0 | 620 | (1 | ) | ||||||||||||||||
Mortgage backed obligations |
13,781 | (94 | ) | 3,057 | (33 | ) | 16,838 | (127 | ) | |||||||||||||||
Asset backed securities |
16,724 | (98 | ) | 0 | 0 | 16,724 | (98 | ) | ||||||||||||||||
Municipal securities |
996 | (4 | ) | 0 | 0 | 996 | (4 | ) | ||||||||||||||||
Foreign government obligations |
14,833 | (7 | ) | 0 | 0 | 14,833 | (7 | ) | ||||||||||||||||
U.S. agency obligations |
10,138 | (75 | ) | 0 | 0 | 10,138 | (75 | ) | ||||||||||||||||
Covered bonds |
3,755 | (4 | ) | 0 | 0 | 3,755 | (4 | ) | ||||||||||||||||
|
|
|
|
|
|
|
|
|
|
|
|
|||||||||||||
$ | 125,416 | $ | (660 | ) | $ | 6,070 | $ | (77 | ) | $ | 131,486 | $ | (737 | ) | ||||||||||
|
|
|
|
|
|
|
|
|
|
|
|
The unrealized loss for each of these fixed rate marketable securities ranged from less than $1,000 to $49,000. The Company does not believe any of the unrealized losses represent an other-than-temporary impairment based on its evaluation of available evidence as of July 31, 2013. The Company expects to receive the full principal and interest on all of these marketable securities.
12
Fair Value Measurement
All of the Companys cash equivalents, marketable securities and foreign currency derivative contracts are classified within Level 1 or Level 2 because the Companys cash equivalents, marketable securities and foreign currency derivative contracts are valued using quoted market prices or alternative pricing sources and models utilizing market observable inputs.
As of July 31, 2013, the Company transferred certain amounts within the fair value hierarchy. U.S. treasury securities and Foreign government obligations at July 31, 2013 are now reported as Level 2 fair value instruments rather than Level 1 based on market activity.
The Company uses a three-tier fair value hierarchy, which prioritizes the inputs used in the valuation methodologies in measuring fair value:
Level 1. | Quoted prices (unadjusted) in active markets for identical assets or liabilities. | |
Level 2. | Other inputs that are directly or indirectly observable in the marketplace. | |
Level 3. | Unobservable inputs which are supported by little or no market activity. |
The following table presents information about the Companys assets and liabilities that are measured at fair value as of July 31, 2013 and indicates the fair value hierarchy of the valuation (in thousands):
Description |
Quoted Prices in Active Markets for Identical Assets (Level 1) |
Significant Other Observable Inputs (Level 2) |
Significant Unobservable Inputs (Level 3) |
Balances as of July 31, 2013 |
||||||||||||
Cash equivalents (1): |
||||||||||||||||
Time deposits |
$ | 0 | $ | 11,476 | $ | 0 | $ | 11,476 | ||||||||
Money market mutual funds |
264,860 | 0 | 0 | 264,860 | ||||||||||||
Marketable securities: |
||||||||||||||||
Corporate notes and obligations |
0 | 196,044 | 0 | 196,044 | ||||||||||||
U.S. treasury securities |
0 | 5,134 | 0 | 5,134 | ||||||||||||
Mortgage backed obligations |
0 | 32,065 | 0 | 32,065 | ||||||||||||
Asset backed securities |
0 | 29,371 | 0 | 29,371 | ||||||||||||
Municipal securities |
0 | 996 | 0 | 996 | ||||||||||||
Foreign government obligations |
0 | 14,833 | 0 | 14,833 | ||||||||||||
U.S. agency obligations |
0 | 14,640 | 0 | 14,640 | ||||||||||||
Covered bonds |
0 | 57,044 | 57,044 | |||||||||||||
Foreign currency derivative contracts (2) |
0 | 3,076 | 0 | 3,076 | ||||||||||||
|
|
|
|
|
|
|
|
|||||||||
Total Assets |
$ | 264,860 | $ | 364,679 | $ | 0 | $ | 629,539 | ||||||||
|
|
|
|
|
|
|
|
|||||||||
Liabilities |
||||||||||||||||
Foreign currency derivative contracts (3) |
$ | 0 | $ | 1,137 | $ | 0 | $ | 1,137 | ||||||||
|
|
|
|
|
|
|
|
|||||||||
Total Liabilities |
$ | 0 | $ | 1,137 | $ | 0 | $ | 1,137 | ||||||||
|
|
|
|
|
|
|
|
(1) | Included in cash and cash equivalents in the accompanying condensed consolidated balance sheet as of July 31, 2013, in addition to $303.5 million of cash. |
(2) | Included in prepaid expenses and other current assets in the accompanying condensed consolidated balance sheet as of July 31, 2013. |
(3) | Included in accounts payable, accrued expenses and other liabilities in the condensed consolidated balance sheet as of July 31, 2013. |
13
The following table presents information about the Companys assets and liabilities that are measured at fair value as of January 31, 2013 and indicates the fair value hierarchy of the valuation (in thousands):
Description |
Quoted Prices in Active Markets for Identical Assets (Level 1) |
Significant Other Observable Inputs (Level 2) |
Significant Unobservable Inputs (Level 3) |
Balances as of January 31, 2013 |
||||||||||||
Cash equivalents (1): |
||||||||||||||||
Time deposits |
$ | 0 | $ | 22,372 | $ | 0 | $ | 22,372 | ||||||||
Money market mutual funds |
385,700 | 0 | 0 | 385,700 | ||||||||||||
Marketable securities: |
||||||||||||||||
Corporate notes and obligations |
0 | 689,889 | 0 | 689,889 | ||||||||||||
U.S. treasury securities |
38,869 | 0 | 0 | 38,869 | ||||||||||||
Mortgage backed obligations |
0 | 12,723 | 0 | 12,723 | ||||||||||||
Foreign government obligations |
9,641 | 0 | 0 | 9,641 | ||||||||||||
Municipal securities |
0 | 2,666 | 0 | 2,666 | ||||||||||||
Collateralized mortgage obligations |
0 | 151,876 | 0 | 151,876 | ||||||||||||
U.S. agency obligations |
0 | 105,376 | 0 | 105,376 | ||||||||||||
Foreign currency derivative contracts (2) |
0 | 5,643 | 0 | 5,643 | ||||||||||||
|
|
|
|
|
|
|
|
|||||||||
Total Assets |
$ | 434,210 | $ | 990,545 | $ | 0 | $ | 1,424,755 | ||||||||
|
|
|
|
|
|
|
|
|||||||||
Liabilities |
||||||||||||||||
Foreign currency derivative contracts (3) |
$ | 0 | $ | 3,307 | $ | 0 | $ | 3,307 | ||||||||
|
|
|
|
|
|
|
|
|||||||||
Total Liabilities |
$ | 0 | $ | 3,307 | $ | 0 | $ | 3,307 | ||||||||
|
|
|
|
|
|
|
|
(1) | Included in cash and cash equivalents in the accompanying condensed consolidated balance sheet as of January 31, 2013, in addition to $339.2 million of cash. |
(2) | Included in prepaid expenses and other current assets in the accompanying condensed consolidated balance sheet as of January 31, 2013. |
(3) | Included in accounts payable, accrued expenses and other liabilities in the accompanying condensed consolidated balance sheet as of January 31, 2013. |
14
Derivative Financial Instruments
The Company enters into foreign currency derivative contracts with financial institutions to reduce the risk that its cash flows and earnings will be adversely affected by foreign currency exchange rate fluctuations. The Company uses forward currency derivative contracts to minimize the Companys exposure of balances primarily denominated in Euros, Japanese yen, Canadian dollars and British pounds. The Companys foreign currency derivative contracts which are not designated as hedging instruments are used to reduce the exchange rate risk associated primarily with intercompany receivables and payables. The Companys program is not designated for trading or speculative purposes. As of July 31, 2013 and January 31, 2013, the foreign currency derivative contracts that were not settled are recorded at fair value on the condensed consolidated balance sheets.
Foreign currency derivative contracts are marked-to-market at the end of each reporting period with gains and losses recognized as other expense to offset the gains or losses resulting from the settlement or remeasurement of the underlying foreign currency denominated receivables and payables. While the contract or notional amount is often used to express the volume of foreign currency derivative contracts, the amounts potentially subject to credit risk are generally limited to the amounts, if any, by which the counterparties obligations under the agreements exceed the obligations of the Company to the counterparties.
Details on outstanding foreign currency derivative contracts related primarily to intercompany receivables and payables are presented below (in thousands):
As of | ||||||||
July 31, 2013 |
January 31, 2013 |
|||||||
Notional amount of foreign currency derivative contracts |
$ | 425,037 | $ | 692,637 | ||||
Fair value of foreign currency derivative contracts, net |
$ | 1,939 | $ | 2,336 |
The fair value of the Companys outstanding derivative instruments are summarized below (in thousands):
Fair Value of Derivative Instruments | ||||||||||
As of | ||||||||||
Balance Sheet Location |
July 31, 2013 | January 31, 2013 | ||||||||
Derivative Assets |
||||||||||
Derivatives not designated as hedging instruments: |
||||||||||
Foreign currency derivative contracts |
Prepaid expenses and other current assets |
$ | 3,076 | $ | 5,643 | |||||
|
|
|
|
|||||||
Derivative Liabilities |
||||||||||
Derivatives not designated as hedging instruments: |
||||||||||
Foreign currency derivative contracts |
Accounts payable, accrued expenses and other liabilities |
$ | 1,137 | $ | 3,307 | |||||
|
|
|
|
15
The effect of the derivative instruments not designated as hedging instruments on the condensed consolidated statements of operations during the three and six months ended July 31, 2013 and 2012, respectively, are summarized below (in thousands):
Derivatives Not Designated as Hedging |
Gains (Losses) on Derivative Instruments |
|||||||||||
Three Months Ended July 31, |
||||||||||||
Location |
2013 | 2012 | ||||||||||
Foreign currency derivative contracts |
Other income (expense) |
$ | (2,411 | ) | $ | 2,054 | ||||||
|
|
|
|
Derivatives Not Designated as Hedging |
Gains (Losses) on Derivative Instruments |
|||||||||||
Six Months Ended July 31, |
||||||||||||
Location |
2013 | 2012 | ||||||||||
Foreign currency derivative contracts |
Other income (expense) |
$ | (116 | ) | $ | 1,132 | ||||||
|
|
|
|
Strategic Investments
The Company has two investments in marketable equity securities measured using quoted prices in their respective active markets and certain interests in non-marketable equity and debt securities that are collectively considered strategic investments. As of July 31, 2013, the fair value of the Companys marketable equity securities of $11.1 million includes an unrealized gain of $8.8 million. As of January 31, 2013, the Company had four investments in marketable equity securities. The fair value of the Companys marketable equity securities of $4.9 million included an unrealized gain of $1.7 million. These investments are recorded in other assets, net on the condensed consolidated balance sheets.
The Companys interest in non-marketable equity and debt securities consists of noncontrolling equity and debt investments in privately-held companies. The Companys investments in these privately-held companies are reported at cost or marked down to fair value when an event or circumstance indicates an other-than-temporary decline in value has occurred. These investments are valued using significant unobservable inputs or data in an inactive market and the valuation requires the Companys judgment due to the absence of market price and inherent lack of liquidity.
As of July 31, 2013 and January 31, 2013, the carrying value that approximates the fair value of the Companys investments in privately-held companies was $54.9 million and $46.8 million, respectively. These investments are recorded in other assets, net on the condensed consolidated balance sheets.
Investment Income
Investment income consists of interest income, realized gains, and realized losses on the Companys cash, cash equivalents and marketable securities. The components of investment income are presented below (in thousands):
Three Months Ended July 31, |
Six Months Ended July 31, |
|||||||||||||||
2013 | 2012 | 2013 | 2012 | |||||||||||||
Interest income |
$ | 3,374 | $ | 4,915 | $ | 6,771 | $ | 9,664 | ||||||||
Realized gains |
4,762 | 3,463 | 5,400 | 3,554 | ||||||||||||
Realized losses |
(3,749 | ) | (1,205 | ) | (4,430 | ) | (1,584 | ) | ||||||||
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|
|
|
|
|
|
|||||||||
Total investment income |
$ | 4,387 | $ | 7,173 | $ | 7,741 | $ | 11,634 | ||||||||
|
|
|
|
|
|
|
|
Reclassification adjustments out of accumulated other comprehensive income into net income were immaterial for the three and six months ended July 31, 2013.
16
3. Property and Equipment
Property and equipment consisted of the following (in thousands):
As of | ||||||||
July 31, 2013 |
January 31, 2013 |
|||||||
Land |
$ | 248,263 | $ | 248,263 | ||||
Building improvements |
49,572 | 49,572 | ||||||
Computers, equipment and software |
877,175 | 328,318 | ||||||
Furniture and fixtures |
51,687 | 38,275 | ||||||
Leasehold improvements |
252,828 | 193,181 | ||||||
|
|
|
|
|||||
1,479,525 | 857,609 | |||||||
Less accumulated depreciation and amortization |
(294,664 | ) | (252,940 | ) | ||||
|
|
|
|
|||||
$ | 1,184,861 | $ | 604,669 | |||||
|
|
|
|
Depreciation and amortization expense totaled $41.7 million and $23.3 million for the three months ended July 31, 2013 and 2012, respectively, and $72.5 million and $45.7 million for the six months ended July 31, 2013 and 2012, respectively.
Computers, equipment and software at July 31, 2013 and January 31, 2013 included a total of $598.3 million and $136.9 million acquired under capital lease agreements, respectively. Accumulated amortization relating to computers, equipment and software under capital leases totaled $69.9 million and $57.8 million, respectively, at July 31, 2013 and January 31, 2013. Amortization of assets under capital leases is included in depreciation and amortization expense.
In June 2013, the Company entered into a large capital lease agreement for software for a period of nine years, which consists of the contractual term of six years and a renewal option of three years. The capitalized portion will be depreciated over the estimated useful life of the software, which is nine years.
In November 2010, the Company purchased approximately 14 acres of undeveloped real estate in San Francisco, California, including entitlements and improvements associated with the land. In addition to the amounts reflected in the table above, the Company recorded $23.3 million related to the perpetual parking rights and classified such rights as a purchased intangible asset as it represents an intangible right to use the existing garage. The Company has capitalized pre-construction activities related to the development of the land, including interest costs and property taxes since the November 2010 purchase. During the first quarter of fiscal 2013, the Company suspended pre-construction activity. The total carrying value of the land, building improvements and perpetual parking rights was $321.1 million as of July 31, 2013. The Company continues to evaluate its future needs for office facilities space and its options for the undeveloped real estate, which may include selling a portion of or all the real estate holdings, or suspending pre-construction activity for several more years.
There was no impairment of long-lived assets during the three and six months ended July 31, 2013 and 2012, respectively.
4. Business Combinations
ExactTarget
On July 12, 2013, the Company acquired for cash the outstanding stock of ExactTarget, a leading global provider of cross-channel, digital marketing solutions that empower organizations of all sizes to communicate with their customers through the digital channels they use most. The Company acquired ExactTarget to, among other things, create a world-class marketing platform across the channels of email, social, mobile and the web. The Company has included the financial results of ExactTarget in the consolidated financial statements from the date of acquisition. The preliminary acquisition date fair value of the consideration transferred for ExactTarget was approximately $2.6 billion, including the proceeds from the term loan of $300.0 million (see Note 5), which consisted of the following (in thousands):
Fair Value | ||||
Cash |
$ | 2,567,098 | ||
Fair value of equity awards assumed |
40,067 | |||
|
|
|||
Total |
$ | 2,607,165 | ||
|
|
17
The preliminary estimated fair value of the stock options assumed by the Company was determined using the Black-Scholes option pricing model. The share conversion ratio of 0.84 was applied to convert ExactTargets outstanding equity awards for ExactTargets common stock into equity awards for shares of the Companys common stock.
The following table summarizes the preliminary estimated fair values of assets acquired and liabilities assumed as of the date of acquisition (in thousands):
Fair Value | ||||
Cash, cash equivalents and marketable securities |
$ | 91,549 | ||
Accounts receivable |
63,320 | |||
Other current assets |
20,965 | |||
Customer contract asset, current and noncurrent |
201,161 | |||
Property and equipment |
64,782 | |||
Other noncurrent assets |
4,379 | |||
Intangible assets |
708,260 | |||
Goodwill |
1,852,852 | |||
Accounts payable, accrued expenses and other liabilities |
(66,346 | ) | ||
Deferred revenue, current and noncurrent |
(46,525 | ) | ||
Customer liability, current and noncurrent |
(141,783 | ) | ||
Other liabilities, noncurrent |
(1,825 | ) | ||
Deferred tax liability |
(143,624 | ) | ||
|
|
|||
Net assets acquired |
$ | 2,607,165 | ||
|
|
The excess of preliminary purchase consideration over the preliminary fair value of net tangible and identifiable intangible assets acquired was recorded as goodwill. The preliminary fair values assigned to tangible and identifiable intangible assets acquired and liabilities assumed are based on managements estimates and assumptions. The deferred tax liability established was primarily a result of the difference in the book basis and tax basis related to the identifiable intangible assets. The preliminary estimated fair values of assets acquired and liabilities assumed, including current and noncurrent income taxes payable and deferred taxes, and identifiable intangible assets may be subject to change as additional information is received and certain tax returns are finalized. Thus the provisional measurements of fair value set forth above are subject to change. The Company expects to finalize the valuation as soon as practicable, but not later than one-year from the acquisition date.
The following table sets forth the components of identifiable intangible assets acquired and their preliminary estimated useful lives as of the date of acquisition (in thousands):
Fair Value | Useful Life | |||||||
Developed technology |
$ | 307,200 | 4-7 years | |||||
Customer relationships |
362,200 | 6-8 years | ||||||
Trade name and trademark |
29,400 | 10 years | ||||||
Other purchased intangible assets |
9,460 | 3-4 years | ||||||
|
|
|||||||
Total intangible assets subject to amortization |
$ | 708,260 | ||||||
|
|
18
Developed technology represents the preliminary estimated fair value of ExactTargets digital marketing technology. Customer relationships represent the preliminary estimated fair values of the underlying relationships with ExactTarget customers. The goodwill balance is primarily attributed to the assembled workforce and expanded market opportunities when integrating ExactTargets digital marketing technology with the Companys other offerings. The goodwill balance is not deductible for U.S. income tax purposes.
The Company assumed unvested options and restricted stock with a preliminary estimated fair value of $101.6 million. Of the total consideration, a portion was preliminarily allocated to the purchase consideration and the remainder of the preliminary estimated fair value was preliminarily allocated to future services and will be expensed over the remaining service periods on a straight-line basis.
The amounts of revenue and earnings of ExactTarget included in the Companys condensed consolidated statement of operations from the acquisition date of July 12, 2013 to the period ending July 31, 2013 are as follows (in thousands):
Total revenues |
$ | 15,968 | ||
Pretax loss |
$ | (10,371 | ) |
The following pro forma financial information summarizes the combined results of operations for the Company and ExactTarget, which was significant for purposes of the unaudited pro forma financial information disclosure, as though the companies were combined as of the beginning of the Companys fiscal 2013.
The unaudited pro forma financial information was as follows (in thousands):
Three Months
Ended July 31, |
Six Months
Ended July 31, |
|||||||||||||||
2013 | 2012 | 2013 | 2012 | |||||||||||||
Total revenues |
$ | 1,030,672 | $ | 782,808 | $ | 2,006,457 | $ | 1,518,335 | ||||||||
Pretax loss |
$ | (72,964 | ) | $ | (69,828 | ) | $ | (172,422 | ) | $ | (159,915 | ) |
The pro forma financial information for all periods presented has been calculated after adjusting the results of ExactTarget to reflect the business combination accounting effects resulting from this acquisition including the amortization expense from acquired intangible assets and the stock-based compensation expense for unvested stock options and restricted stock awards assumed as though the acquisition occurred as of the beginning of the Companys fiscal year 2013. The pro forma financial information is for informational purposes only and is not indicative of the results of operations that would have been achieved if the acquisition had taken place at the beginning of the Companys fiscal 2013.
The pro forma financial information for the three and six months ended July 31, 2013 and 2012 combines the historical results of the Company for the three and six months ended July 31, 2013 and 2012, the adjusted historical results of ExactTarget for the three and six months ended June 30, 2013 and 2012, due to differences in reporting periods and considering the date the Company acquired ExactTarget, and the effects of the pro forma adjustments listed above.
EdgeSpring
On June 12, 2013, the Company acquired for cash and the Companys common stock the outstanding stock of EdgeSpring, Inc. (EdgeSpring), a provider of an end-to-end business intelligence exploration platform used to build analytic applications. The Company acquired EdgeSpring to, among other things, expand its analytical capabilities and offerings. The Company has included the financial results of EdgeSpring in the consolidated financial statements from the date of acquisition, which have not been material to date. The acquisition date fair value of the consideration transferred for EdgeSpring was approximately $133.7 million, which consisted of the following (in thousands, except share data):
Fair Value | ||||
Cash |
$ | 62,580 | ||
Common stock (1,850,258 shares) |
69,533 | |||
Fair value of stock options and restricted stock awards assumed |
1,609 | |||
|
|
|||
Total |
$ | 133,722 | ||
|
|
19
The fair value of the stock options assumed by the Company was determined using the Black-Scholes option pricing model. The share conversion ratio of 0.17 was applied to convert EdgeSprings outstanding equity awards for EdgeSprings common stock into equity awards for shares of the Companys common stock.
The following table summarizes the estimated fair values of assets acquired and liabilities assumed as of the date of acquisition (in thousands):
Fair Value | ||||
Current and noncurrent tangible assets |
$ | 4,462 | ||
Intangible assets |
32,300 | |||
Goodwill |
107,165 | |||
Current and noncurrent liabilities |
(666 | ) | ||
Deferred tax liability |
(9,539 | ) | ||
|
|
|||
Net assets acquired |
$ | 133,722 | ||
|
|
The excess of purchase consideration over the fair value of net tangible and identifiable intangible assets acquired was recorded as goodwill. The fair values assigned to tangible assets acquired, liabilities assumed and identifiable intangible assets are based on managements estimates and assumptions. The estimated fair values of current and noncurrent income taxes payable and deferred taxes may be subject to change as additional information is received and certain tax returns are finalized. Thus the provisional measurements of fair value set forth above are subject to change. The Company expects to finalize the valuation as soon as practicable, but not later than one-year from the acquisition date.
The following table sets forth the components of identifiable intangible assets acquired and their estimated useful lives as of the date of acquisition (in thousands):
Fair Value | Useful Life | |||||||
Developed technology |
$ | 31,030 | 5-6 years | |||||
Customer relationships |
560 | 5 years | ||||||
Trade name and trademark |
710 | 5 years | ||||||
|
|
|||||||
Total intangible assets subject to amortization |
$ | 32,300 | ||||||
|
|
Developed technology represents the estimated fair value of EdgeSprings end-to-end business intelligence exploration technology. Customer relationships represent the fair values of the underlying relationships with EdgeSpring customers. The goodwill balance is primarily attributed to the assembled workforce and expanded market opportunities when integrating EdgeSprings business intelligence technology with the Companys other offerings. The goodwill balance is not deductible for U.S. income tax purposes.
The Company assumed unvested equity awards for shares of EdgeSprings common stock with a fair value of $4.7 million. Of the total consideration, $1.6 million was allocated to the purchase consideration and $3.1 million was allocated to future services and will be expensed over the remaining service periods on a straight-line basis.
20
Other Business Combinations
During the six months ended July 31, 2013, the Company acquired two other companies for an aggregate of $29.1 million in cash, net of cash acquired, and has included the financial results of these companies in its condensed consolidated financial statements from the date of each respective acquisition. The Company accounted for these transactions as business combinations. In allocating the purchase consideration based on estimated fair values, the Company recorded $13.3 million of acquired intangible assets with useful lives of three to five years, $19.1 million of goodwill, $2.8 million of net tangible assets, including cash acquired, and $4.0 million of deferred tax liabilities. The goodwill balance is deductible for U.S. income tax purposes. The two aforementioned business combinations and EdgeSpring were not included in the pro forma combined historical results of operations of the Company as they are not material.
Goodwill
Goodwill represents the excess of the purchase price in a business combination over the fair value of net tangible and intangible assets acquired. Goodwill amounts are not amortized, but rather tested for impairment at least annually during the fourth quarter.
Goodwill consisted of the following (in thousands):
Balance as of January 31, 2013 |
$ | 1,529,378 | ||
EdgeSpring |
107,165 | |||
ExactTarget |
1,852,852 | |||
Other acquisitions |
19,079 | |||
Finalization of acquisition date fair values and other adjustments |
(4,793 | ) | ||
|
|
|||
Balance as of July 31, 2013 |
$ | 3,503,681 | ||
|
|
5. Convertible Senior Notes and Term Loan
Convertible Senior Notes
Par Value | Equity Component |
Liability Component of Par Value as of | ||||||||||||||
(in thousands) |
July 31, 2013 | January 31, 2013 | ||||||||||||||
0.75% Convertible Senior Notes due January 15, 2015 |
$ | 574,890 | $ | 125,530 | (1) | $ | 534,391 | $ | 521,278 | |||||||
0.25% Convertible Senior Notes due April 1, 2018 |
1,150,000 | 122,421 | (2) | 1,035,271 | |
(1) | This amount represents the equity component recorded at the initial issuance of the 0.75% convertible senior notes. As of July 31, 2013, $40.5 million was reclassified as temporary equity on the condensed consolidated balance sheet as these notes were convertible. |
(2) | This amount represents the equity component recorded at the initial issuance of the 0.25% convertible senior notes. |
In January 2010, the Company issued at par value $575.0 million of 0.75% convertible senior notes (the 0.75% Senior Notes) due January 15, 2015, unless earlier purchased by the Company or converted. Interest is payable semi-annually in arrears on January 15 and July 15 of each year. In March 2013, the Company issued at par value $1.15 billion of 0.25% convertible senior notes (the 0.25% Senior Notes) due April 1, 2018, unless earlier purchased by the Company or converted. Interest is payable semi-annually, in arrears on April 1 and October 1 of each year commencing October 1, 2013, (collectively the Notes).
The Notes are governed by indentures between the Company, as issuer, and U.S. Bank National Association, as trustee. The Notes are unsecured and do not contain any financial covenants or any restrictions on the payment of dividends, the incurrence of senior debt or other indebtedness, or the issuance or repurchase of securities by the Company.
21
If converted, holders will receive cash equal to the principal amount of the Notes, and at the Companys election, cash and/or shares of the Companys common stock for any amounts in excess of the principal amounts.
Conversion Rate per $1,000 Par Value |
Initial Conversion Price per Share |
Convertible Date | ||||||||
0.75% Senior Notes |
46.8588 | $ | 21.34 | October 15, 2014 | ||||||
0.25% Senior Notes |
15.0512 | $ | 66.44 | January 1, 2018 |
Throughout the term of the Notes, the conversion rate may be adjusted upon the occurrence of certain events, including any cash dividends. Holders of the Notes will not receive any cash payment representing accrued and unpaid interest upon conversion of a Note. Accrued but unpaid interest will be deemed to be paid in full upon conversion rather than cancelled, extinguished or forfeited. Holders may convert their Notes under the following circumstances:
| during any fiscal quarter, if, for at least 20 trading days during the 30 consecutive trading day period ending on the last trading day of the immediately preceding fiscal quarter, the last reported sales price of the Companys common stock for such trading day is greater than or equal to 130% of the applicable conversion price on such trading day share of common stock on such last trading day; |
| in certain situations, when the trading price of the Notes is less than 98% of the product of the sale price of the Companys common stock and the conversion rate; |
| upon the occurrence of specified corporate transactions described under the Notes Indenture, such as a consolidation, merger or binding share exchange; or |
| at any time on or after the convertible dates noted above. |
Holders of the Notes have the right to require the Company to purchase with cash all or a portion of the Notes upon the occurrence of a fundamental change, such as a change of control, at a purchase price equal to 100% of the principal amount of the Notes plus accrued and unpaid interest. Following certain corporate transactions that constitute a change of control, the Company will increase the conversion rate for a holder who elects to convert the Notes in connection with such change of control.
In accounting for the issuance of the Notes, the Company separated the Notes into liability and equity components. The carrying amount of the liability component was calculated by measuring the fair value of a similar liability that does not have an associated convertible feature. The carrying amount of the equity component representing the conversion option was determined by deducting the fair value of the liability component from the par value of the Notes as a whole. The excess of the principal amount of the liability component over its carrying amount (debt discount) is amortized to interest expense over the term of the Notes. The equity component is not remeasured as long as it continues to meet the conditions for equity classification.
In accounting for the transaction costs related to the Note issuance, the Company allocated the total amount incurred to the liability and equity components based on their relative values. Transaction costs attributable to the liability component are being amortized to expense over the term of the Notes, and transaction costs attributable to the equity component were netted with the equity component in temporary stockholders equity and stockholders equity. Additionally, the Company recorded a deferred tax liability of $51.1 million in connection with the 0.75% Senior Notes.
The Notes consisted of the following (in thousands):
As of | ||||||||
July 31, 2013 |
January 31, 2013 |
|||||||
Liability component : |
||||||||
Principal: |
||||||||
0.75% Senior Notes (1) |
$ | 574,890 | $ | 574,890 | ||||
0.25% Senior Notes (1) |
1,150,000 | 0 | ||||||
Less: debt discount, net |
||||||||
0.75% Senior Notes (2) |
(40,499 | ) | (53,612 | ) | ||||
0.25% Senior Notes (3) |
(114,729 | ) | 0 | |||||
|
|
|
|
|||||
Net carrying amount |
$ | 1,569,662 | $ | 521,278 | ||||
|
|
|
|
22
(1) | The effective interest rates of the 0.75% Senior Notes and 0.25% Senior Notes are 5.86% and 2.53%, respectively. These interest rates were based on the interest rates of a similar liability at the time of issuance that did not have an associated convertible feature. |
(2) | Included in the condensed consolidated balance sheets within Convertible 0.75% Senior Notes (which is classified as a current liability, as these notes were convertible) and is amortized over the life of the 0.75% Senior Notes using the effective interest rate method. |
(3) | Included in the condensed consolidated balance sheets within Convertible 0.25% Senior Notes (which is classified as a noncurrent liability) and is amortized over the life of the 0.25% Senior Notes using the effective interest rate method. |
The total estimated fair values of the Companys 0.75% Senior Notes and 0.25% Senior Notes at July 31, 2013 were $1.2 billion and $1.1 billion, respectively. The fair value was determined based on the closing trading price per $100 of the 0.75% Senior Notes and 0.25% Senior Notes as of the last day of trading for the second quarter of fiscal 2014.
Based on the closing price of the Companys common stock of $43.75 on July 31, 2013, the if-converted value of the 0.75% Senior Notes exceeded their principal amount by approximately $603.7 million and the if-converted value of the 0.25% Senior Notes was less than their principal amount.
Note Hedges
To minimize the impact of potential economic dilution upon conversion of the Notes, the Company entered into convertible note hedge transactions with respect to its common stock (the Note Hedges).
(in thousands, except for shares) |
Date | Purchase | Shares | |||||||
0.75% Note Hedges |
January 2010 | $ | 126,500 | 26,943,812 | ||||||
0.25% Note Hedges |
March 2013 | $ | 153,800 | 17,308,880 |
The Note Hedges cover shares of the Companys common stock at a strike price that corresponds to the initial conversion price of the respective Notes, also subject to adjustment, and are exercisable upon conversion of the Notes. The Note Hedges will expire upon the maturity of the Notes. The Note Hedges are intended to reduce the potential economic dilution upon conversion of the Notes in the event that the market value per share of the Companys common stock, as measured under the Notes, at the time of exercise is greater than the conversion price of the Notes. The Note Hedges are separate transactions and are not part of the terms of the Notes. Holders of the Notes will not have any rights with respect to the Note Hedges. The Company initially recorded a deferred tax asset of $51.4 million in connection with the 0.75% Note Hedges. The Note Hedges do not impact earnings per share, as they were entered into to offset any dilution from the Notes.
Warrants
Date | Proceeds (in thousands) |
Shares | Strike Price |
|||||||||||
0.75% Warrants |
January 2010 | $ | 59,300 | 26,943,812 | $ | 29.88 | ||||||||
0.25% Warrants |
March 2013 | $ | 84,800 | 17,308,880 | $ | 90.40 |
Separately, in January 2010 and March 2013, the Company also entered into warrant transactions (the 0.75% Warrants and the 0.25% Warrants, respectively) (collectively, the Warrants), whereby the Company sold warrants to acquire, subject to anti-dilution adjustments, shares of the Companys common stock. As the average market value per share of the Companys common stock for the reporting period, as measured under the Warrants, exceeds the strike price of the Warrants, the Warrants would have a dilutive effect on the Companys earnings/loss per share. The 0.75% Warrants were dilutive during the three and six months ended July 31, 2013 based on the Companys net income during the three and six months ended July 31, 2013, while the 0.25% Warrants were anti-dilutive during the three and six months ended July 31, 2013. The Warrants are separate transactions, entered into by the Company and are not part of the terms of the Notes or Note Hedges. Holders of the Notes and Note Hedges will not have any rights with respect to the Warrants.
23
Term Loan
On July 11, 2013, the Company entered into a credit agreement (the Credit Agreement) with Bank of America, N.A. and certain other lenders. The Credit Agreement provides for a $300.0 million term loan (the Term Loan) maturing on July 11, 2016 (the Maturity Date) and bears interest at the Companys option at either a base rate plus a spread of 0.50% to 1.00% or an adjusted LIBOR rate as defined in the Credit Agreement plus a spread of 1.50% to 2.00%.
The Company entered into the Term Loan in conjunction with and for purposes of funding the acquisition of ExactTarget.
Interest is due and payable in arrears quarterly for the loan bearing interest at the base rate and at the end of an interest period in the case of the loan bearing interest at the adjusted LIBOR rate. The Term Loan is payable in quarterly installments equal to $7.5 million beginning on September 30, 2013, with the remaining outstanding principal amount of the term loan being due and payable on the Maturity Date. The Company may prepay the Term Loan, in whole or in part at anytime during the term of the Term Loan. Amounts repaid or prepaid may not be reborrowed under the terms of the Credit Agreement. The Term Loan is secured by a pledge of 100 percent of the equity securities of the Companys direct domestic subsidiaries and 65 percent of the equity securities of the Companys foreign subsidiaries.
The Credit Agreement contains certain customary affirmative and negative covenants, including a consolidated leverage ratio covenant, a consolidated interest coverage ratio covenant, a limit on the Companys ability to incur additional indebtedness, issue preferred stock or pay dividends, and certain other restrictions on the Companys activities each defined specifically in the Credit Agreement. The Company was in compliance with the Credit Agreements covenants as of July 31, 2013.
The weighted average interest rate on the Term Loan was 2.3% as of July 31, 2013. Accrued interest on the Term Loan was $0.4 million as of July 31, 2013. As of July 31, 2013, the current portion outstanding under the Term Loan was $30.0 million and the noncurrent outstanding portion was $270.0 million.
Interest Expense
The following table sets forth total interest expense recognized related to the Notes and the Term Loan prior to capitalization of interest (in thousands):
Three Months Ended July 31, |
Six Months Ended July 31, |
|||||||||||||||
2013 | 2012 | 2013 | 2012 | |||||||||||||
Contractual interest expense |
$ | 2,178 | $ | 1,078 | $ | 3,593 | $ | 2,156 | ||||||||
Amortization of debt issuance costs |
1,179 | 332 | 1,920 | 662 | ||||||||||||
Amortization of debt discount |
12,352 | 6,207 | 21,592 | 12,384 | ||||||||||||
|
|
|
|
|
|
|
|
|||||||||
$ | 15,709 | $ | 7,617 | $ | 27,105 | $ | 15,202 | |||||||||
|
|
|
|
|
|
|
|
Interest expense consists of interest on the Companys capital lease commitments, the Notes, and the Term Loan, net of amounts capitalized.
24
6. Other Balance Sheet Accounts
Prepaid Expenses and Other Current Assets
Prepaid expenses and other current assets consisted of the following (in thousands):
As of | ||||||||
July 31, 2013 |
January 31, 2013 |
|||||||
Deferred income taxes, net |
$ | 14,157 | $ | 7,321 | ||||
Prepaid income taxes |
25,965 | 21,180 | ||||||
Customer contract asset |
150,498 | 0 | ||||||
Prepaid expenses and other current assets |
165,008 | 104,813 | ||||||
|
|
|
|
|||||
$ | 355,628 | $ | 133,314 | |||||
|
|
|
|
Customer contract asset reflects future billings of amounts that are contractually committed by ExactTargets existing customers as of the acquisition date that will be billed in the next twelve months. As the Company bills these customers this balance will reduce and accounts receivable will increase.
Capitalized Software, net
Capitalized software consisted of the following (in thousands):
As of | ||||||||
July 31, 2013 |
January 31, 2013 |
|||||||
Capitalized internal-use software development costs, net of accumulated amortization of $86,264 and $72,448, respectively |
$ | 66,578 | $ | 59,647 | ||||
Acquired developed technology, net of accumulated amortization of $226,040 and $179,906, respectively |
470,802 | 147,676 | ||||||
|
|
|
|
|||||
$ | 537,380 | $ | 207,323 | |||||
|
|
|
|
Capitalized internal-use software amortization expense totaled $7.1 million and $5.5 million for the three months ended July 31, 2013 and 2012, respectively. Acquired developed technology amortization expense totaled $24.1 million and $18.3 million for the three months ended July 31, 2013 and 2012, respectively. Capitalized internal-use software amortization expense totaled $13.8 million and $10.1 million for the six months ended July 31, 2013 and 2012, respectively. Acquired developed technology amortization expense totaled $46.1 million and $36.5 million for the six months ended July 31, 2013 and 2012, respectively.
The Company capitalized $0.9 million and $0.7 million of stock-based expenses related to capitalized internal-use software development and deferred professional services during the three months ended July 31, 2013 and 2012, respectively. The Company capitalized $1.8 million and $1.7 million of stock-based expenses related to capitalized internal-use software development and deferred professional services during the six months ended July 31, 2013 and 2012, respectively.
25
Other Assets, net
Other assets consisted of the following (in thousands):
As of | ||||||||
July 31, 2013 |
January 31, 2013 |
|||||||
Deferred income taxes, noncurrent, net |
$ | 8,189 | $ | 19,212 | ||||
Long-term deposits |
13,917 | 13,422 | ||||||
Purchased intangible assets, net of accumulated amortization of $35,757 and $28,790, respectively |
448,976 | 49,354 | ||||||
Acquired intellectual property, net of accumulated amortization of $9,142 and $7,074, respectively |
12,820 | 13,872 | ||||||
Strategic investments |
65,984 | 51,685 | ||||||
Customer contract asset |
48,029 | 0 | ||||||
Other |
35,513 | 21,415 | ||||||
|
|
|
|
|||||
$ | 633,428 | $ | 168,960 | |||||
|
|
|
|
Customer contract asset reflects the noncurrent portion of future billings that are contractually committed by ExactTargets existing customers as of the acquisition date. As the Company bills these customers this balance will reduce and accounts receivable will increase.
Purchased intangible assets amortization expense for the three months ended July 31, 2013 and 2012 was $4.5 million and $2.4 million, respectively, and for the six months ended July 31, 2013 and 2012, was $7.0 million and $5.8 million, respectively. Acquired intellectual property amortization expense for the three months ended July 31, 2013 and 2012 was $1.1 million and $0.8 million, respectively, and for the six months ended July 31, 2013 and 2012 was $2.1 million and $2.0 million, respectively.
Accounts Payable, Accrued Expenses and Other Liabilities
Accounts payable, accrued expenses and other liabilities consisted of the following (in thousands):
As of | ||||||||
July 31, 2013 |
January 31, 2013 |
|||||||
Accounts payable |
$ | 66,859 | $ | 14,535 | ||||
Accrued compensation |
239,961 | 311,595 | ||||||
Accrued other liabilities |
227,626 | 138,165 | ||||||
Accrued income and other taxes payable |
93,767 | 120,341 | ||||||
Accrued professional costs |
16,751 | 10,064 | ||||||
Accrued rent |
13,044 | 3,006 | ||||||
Customer liability, current |
106,075 | 0 | ||||||
|
|
|
|
|||||
$ | 764,083 | $ | 597,706 | |||||
|
|
|
|
Customer liability reflects the legal obligation to provide future services that are contractually committed by ExactTargets existing customers but unbilled as of the acquisition date. As these services are invoiced this balance will reduce and deferred revenue will increase.
Other Noncurrent Liabilities
Other noncurrent liabilities consisted of the following (in thousands):
As of | ||||||||
July 31, 2013 |
January 31, 2013 |
|||||||
Income taxes payable, noncurrent |
$ | 86,658 | $ | 49,074 | ||||
Long-term lease liabilities and other |
570,114 | 126,658 | ||||||
Customer liability, noncurrent |
30,583 | 0 | ||||||
|
|
|
|
|||||
$ | 687,355 | $ | 175,732 | |||||
|
|
|
|
26
Customer liability, noncurrent reflects the noncurrent fair value of the legal obligation to provide future services that are contractually committed by ExactTargets existing customers but unbilled as of the acquisition date. As these services are invoiced this balance will reduce and deferred revenue will increase.
In June 2013, the Company entered into a large capital lease agreement for software for a period of nine years, which consists of the contractual term of six years and a renewal option of three years.
7. Stockholders Equity
The Company maintains the following stock plans: the 2006 Inducement Equity Incentive Plan (the Inducement Plan), 2004 Employee Stock Purchase Plan and the 2013 Equity Incentive Plan. These plans provide for annual automatic increases on February 1 to the shares reserved for issuance. The expiration of the 1999 Stock Option Plan (1999 Plan) in fiscal 2010 did not affect awards outstanding, which continue to be governed by the terms and conditions of the 1999 Plan.
On February 1, 2013, 14.0 million additional shares were reserved under the 2004 Equity Incentive Plan and 4.0 million additional shares were reserved under the 2004 Employee Stock Purchase Plan pursuant to the automatic increase in each respective plan.
On June 6, 2013, the Companys stockholders approved the 2013 Equity Incentive Plan (the 2013 Plan) with a reserve of 48.0 million shares of common stock for future issuance. In addition, 21.9 million shares of common stock that were previously available for grant under the 2004 Equity Incentive Plan and the 2004 Outside Directors Stock Plan (collectively, the Prior Plans) as of June 6, 2013, expired and were added to the 2013 Plan share reserve. Any shares of common stock subject to outstanding awards under the Prior Plans that expire, are forfeited, or repurchased by the Company also will be available for future grant under the 2013 Plan.
In September 2011, the Companys Board of Directors amended and restated the 2004 Employee Stock Purchase Plan (the ESPP). In conjunction with the amendment of the ESPP, the Companys Board of Directors determined that the offerings under the ESPP would commence, beginning with a twelve month offering period starting in December 2011. As of July 31, 2013, $18.8 million has been withheld on behalf of employees for future purchases under the plan and is recorded in accrued expenses and other liabilities. Employees purchased 1.4 million shares in the three months ended July 31, 2013 for $43.7 million under the ESPP.
Prior to February 1, 2006, options issued under the Companys stock option plans generally had a term of 10 years. From February 1, 2006 through July 3, 2013, options issued had a term of 5 years. After July 3, 2013, options issued have a term of 7 years.
Stock activity excluding the ESPP is as follows:
Options Outstanding | ||||||||||||||||
Shares Available for Grant |
Outstanding Stock Options |
Weighted- Average Exercise Price |
Aggregate Intrinsic Value (in thousands) |
|||||||||||||
Balance as of January 31, 2013 |
11,759,740 | 29,983,292 | $ | 26.60 | ||||||||||||
Increase in shares authorized: |
||||||||||||||||
2004 Equity Incentive Plan |
14,000,000 | 0 | 0.00 | |||||||||||||
2013 Equity Incentive Plan |
69,924,140 | 0 | 0.00 | |||||||||||||
2010 EdgeSpring Plan |
124,859 | 0 | 0.00 | |||||||||||||
2004 ExactTarget Plan |
136,986 | 0 | 0.00 | |||||||||||||
2008 ExactTarget Plan |
3,202,185 | 0 | 0.00 | |||||||||||||
Options granted under all plans |
(4,554,571 | ) | 4,554,571 | 26.14 | ||||||||||||
Restricted stock activity |
(1,352,834 | ) | 0 | 0.00 | ||||||||||||
Stock grants to board and advisory board members |
(62,400 | ) | 0 | 0.00 | ||||||||||||
Exercised |
0 | (3,584,945 | ) | 17.27 | ||||||||||||
Plan shares expired |
(22,946,483 | ) | 0 | 0.00 | ||||||||||||
Cancelled |
554,131 | (554,131 | ) | 30.29 | ||||||||||||
|
|
|
|
|
|
|||||||||||
Balance as of July 31, 2013 |
70,785,753 | 30,398,787 | $ | 27.56 | $ | 492,193 | ||||||||||
|
|
|
|
|
|
|
|
|||||||||
Vested or expected to vest |
29,192,079 | $ | 27.42 | $ | 476,849 | |||||||||||
|
|
|
|
|
|
|||||||||||
Exercisable as of July 31, 2013 |
12,232,395 | $ | 22.82 | $ | 256,054 |
27
The total intrinsic value of the options exercised during the six months ended July 31, 2013 and 2012 was $93.5 million and $166.0 million, respectively. The intrinsic value is the difference between the current market value of the stock and the exercise price of the stock option.
The weighted-average remaining contractual life of vested and expected to vest options is approximately 3.4 years.
As of July 31, 2013, options to purchase 12,232,395 shares were vested at a weighted average exercise price of $22.82 per share and had a remaining weighted-average remaining contractual life of approximately 2.2 years. The total intrinsic value of these vested options as of July 31, 2013 was $256.1 million.
The following table summarizes information about stock options outstanding as of July 31, 2013:
Options Outstanding | Options Exercisable | |||||||||||||||||||
Range of Exercise Prices |
Number Outstanding |
Weighted- Average Remaining Contractual Life (Years) |
Weighted- Average Exercise Price |
Number of Shares |
Weighted- Average Exercise Price |
|||||||||||||||
$0.26 to $13.29 |
4,426,163 | 3.3 | $ | 6.02 | 2,948,720 | $ | 5.37 | |||||||||||||
$14.14 to $22.98 |
4,411,844 | 2.6 | 17.30 | 2,757,702 | 16.84 | |||||||||||||||
$23.16 to $27.06 |
5,038,888 | 4.0 | 26.79 | 1,602,542 | 26.98 | |||||||||||||||
$27.56 to $35.07 |
2,567,970 | 4.2 | 31.70 | 750,608 | 32.05 | |||||||||||||||
$35.63 |
5,676,624 | 2.3 | 35.63 | 3,311,229 | 35.63 | |||||||||||||||
$35.87 to $38.03 |
4,593,550 | 3.9 | 37.04 | 837,354 | 36.60 | |||||||||||||||
$38.38 to $43.40 |
3,683,748 | 4.6 | 39.64 | 24,240 | 38.38 | |||||||||||||||
|
|
|
|
|||||||||||||||||
30,398,787 | 3.5 | $ | 27.56 | 12,232,395 | $ | 22.82 | ||||||||||||||
|
|
|
|
Restricted stock activity is as follows:
Restricted Stock Outstanding | ||||||||||||
Outstanding | Weighted- Average Exercise Price |
Aggregate Intrinsic Value (in thousands) |
||||||||||
Balance as of January 31, 2013 |
26,782,620 | $ | 0.001 | |||||||||
Granted |
2,844,285 | 0.001 | ||||||||||
Cancelled |
(1,450,910 | ) | 0.001 | |||||||||
Acquired plan shares expired |
(33,653 | ) | 0.001 | |||||||||
Vested and converted to shares |
(3,855,227 | ) | 0.001 | |||||||||
|
|
|
|
|||||||||
Balance as of July 31, 2013 |
24,287,115 | $ | 0.001 | $ | 1,062,561 | |||||||
|
|
|
|
|
|
|||||||
Expected to vest |
21,248,104 | $ | 929,605 | |||||||||
|
|
|
|
28
The restricted stock, which upon vesting entitles the holder to one share of common stock for each share of restricted stock, has an exercise price of $0.001 per share, which is equal to the par value of the Companys common stock, and generally vest over 4 years.
The weighted-average grant date fair value of the restricted stock issued for the six months ended July 31, 2013 and 2012 was $43.43 and $35.54, respectively.
Common Stock
The following number of shares of common stock were reserved and available for future issuance at July 31, 2013:
Options outstanding |
30,398,787 | |||
Restricted stock awards and units outstanding |
24,287,115 | |||
Stock available for future grant: |
||||
2013 Equity Incentive Plan |
69,586,359 | |||
2006 Inducement Equity Incentive Plan |
1,199,394 | |||
2004 Employee Stock Purchase Plan |
7,643,392 | |||
Convertible senior notes |
44,247,536 | |||
Warrants |
44,252,692 | |||
|
|
|||
221,615,275 | ||||
|
|
8. Income Taxes
Effective Tax Rate
The Company computes its year to date provision for income taxes by applying the estimated annual effective tax rate to year to date pretax loss and adjusts the provision for discrete tax items recorded in the period. For the six months ended July 31, 2013, the Company reported a tax benefit of $119.6 million with a pretax loss of $110.7 million, which resulted in an effective tax rate of 108 percent. Primarily in connection with the acquisition of ExactTarget, the Company recorded a discrete tax benefit of $128.8 million from a partial release of the tax valuation allowance. The valuation allowance was established in the third quarter of fiscal 2013. The net deferred tax liability from the acquisition of ExactTarget provided an additional source of income to support the realizability of the Companys pre-existing deferred tax assets and as a result, the Company released a portion of its valuation allowance.
For the six months ended July 31, 2012, the Company reported a tax benefit of $9.6 million with a pretax loss of $38.9 million, which resulted in an effective tax rate of 25 percent. The Companys effective tax rate was lower than the federal statutory tax rate of 35 percent primarily due to California tax credits and the tax impact of structuring intellectual property related to acquisitions, partially offset by foreign tax expense and non-deductible amounts.
29
Tax Benefits Related to Stock-Based Compensation
The total income tax benefit in the accompanying condensed consolidated statements of operations related to stock-based awards was $65.9 million and $51.6 million for the six months ended July 31, 2013 and 2012, respectively. The majority of the tax benefit was not recognized as a result of the valuation allowance.
Unrecognized Tax Benefits and Other Considerations
The Company records liabilities related to its uncertain tax positions. Tax positions for the Company and its subsidiaries are subject to income tax audits by multiple tax jurisdictions throughout the world. Certain prior year tax returns are currently being examined by taxing authorities including the Internal Revenue Service, California Franchise Tax Board and the National Tax Agency of Japan. The examinations by these major jurisdictions are in early stages and the Company has not been informed of any proposed adjustments.
The Company believes that it has provided adequate reserves for its income tax uncertainties in all open tax years. In the next twelve months, it is reasonably possible that the unrecognized tax benefits may decrease by approximately $4.0 million due to lapsing of the statute of limitations.
9. Earnings/Loss Per Share
Basic earnings/loss per share is computed by dividing net income (loss) by the weighted-average number of common shares outstanding for the fiscal period. Diluted earnings/loss per share is computed giving effect to all potential weighted average dilutive common stock, including options, restricted stock units, warrants and the convertible senior notes. The dilutive effect of outstanding awards and convertible securities is reflected in diluted earnings per share by application of the treasury stock method. Diluted loss per share for the three and six months ended July 31, 2012 are the same as basic loss per share as there is a net loss in these periods and inclusion of potentially issuable shares would be anti-dilutive.
A reconciliation of the denominator used in the calculation of basic and diluted earnings/loss per share is as follows (in thousands):
Three Months Ended July 31, |
Six Months Ended July 31, |
|||||||||||||||
2013 | 2012 | 2013 | 2012 | |||||||||||||
Numerator: |
||||||||||||||||
Net income (loss) |
$ | 76,603 | $ | (9,829 | ) | $ | 8,882 | $ | (29,304 | ) | ||||||
|
|
|
|
|
|
|
|
|||||||||
Denominator: |
||||||||||||||||
Weighted-average shares outstanding for basic net income (loss) per share |
593,955 | 557,700 | 591,210 | 555,156 | ||||||||||||
Effect of dilutive securities: |
||||||||||||||||
Convertible senior notes |
12,977 | 0 | 13,270 | 0 | ||||||||||||
Warrants |
7,394 | 0 | 7,804 | 0 | ||||||||||||
Employee stock awards |
10,330 | 0 | 11,581 | 0 | ||||||||||||
|
|
|
|
|
|
|
|
|||||||||
Adjusted weighted-average shares outstanding and assumed conversions for diluted net income (loss) per share |
624,656 | 557,700 | 623,865 | 555,156 | ||||||||||||
|
|
|
|
|
|
|
|
Only the 0.75% Convertible Senior Notes and 0.75% Warrants have a dilutive effect for the three and six months ended July 31, 2103, as seen above.
The weighted-average number of shares outstanding used in the computation of basic and diluted earnings/loss per share does not include the effect of the following potential outstanding common stock. The effects of these potentially outstanding shares were not included in the calculation of diluted earnings/loss per share because the effect would have been anti-dilutive (in thousands):
Three Months Ended July 31, |
Six Months Ended July 31, |
|||||||||||||||
2013 | 2012 | 2013 | 2012 | |||||||||||||
Stock awards |
9,310 | 33,924 | 8,172 | 34,456 | ||||||||||||
Warrants |
17,309 | 26,944 | 17,309 | 26,944 | ||||||||||||
Convertible senior notes |
17,309 | 26,940 | 17,309 | 26,940 |
30
10. Commitments
Letters of Credit
As of July 31, 2013, the Company had a total of $57.2 million in letters of credit outstanding substantially in favor of certain landlords for office space. These letters of credit renew annually and expire at various dates through December 2030.
Leases
The Company leases facilities space and certain fixed assets under non-cancelable operating and capital leases with various expiration dates.
As of July 31, 2013, the future minimum lease payments under non-cancelable operating and capital leases are as follows (in thousands):
Capital Leases |
Operating Leases |
|||||||
Fiscal Period: |
||||||||
Remaining six months of fiscal 2014 |
$ | 29,177 | $ | 80,712 | ||||
Fiscal 2015 |
69,951 | 166,521 | ||||||
Fiscal 2016 |
66,633 | 160,237 | ||||||
Fiscal 2017 |
68,672 | 149,678 | ||||||
Fiscal 2018 |
80,933 | 144,397 | ||||||
Thereafter |
298,440 | 996,485 | ||||||
|
|
|
|
|||||
Total minimum lease payments |
613,806 | $ | 1,698,030 | |||||
|
|
|||||||
Less: amount representing interest |
(96,750 | ) | ||||||
|
|
|||||||
Present value of capital lease obligations |
$ | 517,056 | ||||||
|
|
The Companys agreements for the facilities and certain services provide the Company with the option to renew. The Companys future contractual obligations would change if the Company exercised these options.
11. Legal Proceedings and Claims
In the ordinary course of business, the Company is involved in various legal proceedings and claims related to alleged infringement of third-party patents and other intellectual property rights, commercial, labor and employment, wage and hour, and other claims. We have been, and may in the future be, put on notice and/or sued by third parties for alleged infringement of their proprietary rights, including patent infringement. For example, we received a notice from a large non-practicing entity several quarters ago alleging that we infringed upon certain of its patents. While no litigation was ever filed, in May 2013 we entered into a multi-year license agreement with that non-practicing entity. During the first quarter of fiscal 2014, the Company recorded approximately $8.0 million of expense for the portion of the license agreement related to prior periods.
In general, the resolution of a legal matter could prevent the Company from offering its service to others, could be material to the Companys financial condition or cash flows, or both, or could otherwise adversely affect the Companys operating results.
The Company makes a provision for a liability relating to legal matters when it is both probable that a liability has been incurred and the amount of the loss can be reasonably estimated. These provisions are reviewed at least quarterly and adjusted to reflect the impacts of negotiations, estimated settlements, legal rulings, advice of legal counsel and other information and events pertaining to a particular matter. In managements opinion, resolution of all current matters is not expected to have a material adverse impact on the Companys condensed consolidated results of operations, cash flows or financial position. However, depending on the nature and timing of any such dispute, an unfavorable resolution of a matter could materially affect the Companys future results of operations or cash flows, or both, of a particular quarter.
31
12. Related-Party Transactions
In January 1999, the salesforce.com/foundation, also referred to as the Foundation, a non-profit public charity, was chartered to build philanthropic programs that are focused on youth and technology. The Companys chairman is the chairman of the Foundation. The Companys chairman, two of the Companys employees and one of the Companys board members hold four of the Foundations ten board seats. The Company does not control the Foundations activities, and accordingly, the Company does not consolidate the Foundations statement of activities with its financial results.
Since the Foundations inception, the Company has provided at no charge certain resources to Foundation employees such as office space. The value of these items was approximately $205,000 for the quarter ended July 31, 2013.
In addition to the resource sharing with the Foundation, the Company issued the Foundation warrants in August 2002 to purchase shares of the Companys common stock. All of the warrants were exercised in prior years. As of July 31, 2013, the Foundation held no shares of salesforce.com common stock. Additionally, the Company has donated subscriptions to the Companys service to other qualified non-profit organizations. The Company also allows an affiliate of the Foundation to resell the Companys service to non-profit organizations. The Company does not charge the affiliate for these subscriptions, so any revenue from subscriptions provided to non-profit organizations is retained by the Foundation to fund its charitable work. The value of the subscriptions was approximately $3.8 million for the quarter ended July 31, 2013. The Company plans to continue these programs.
32
ITEM 2. | MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS |
The following discussion in Managements 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, term loan, compliance with our related debt covenants, and capital lease obligations, 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 servicesSales Cloud, Service Cloud, Marketing Cloud and the Salesforce Platformcustomers 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. |
33
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.
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 in past quarters. This quarter, due to the deferred taxes associated with the ExactTarget acquisition, we recorded a tax benefit and therefore had net income 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.
Our typical subscription contract term is 12 to 36 months, although terms range from one to 60 months, so during any fiscal reporting period only a subset of active subscription contracts are available for renewal. We calculate our renewal rates as of the end of each reporting period. Renewal rates remained in the high 80s percentage range as of July 31, 2013, improving slightly from the renewal percentage as of January 31, 2013. We expect our renewal rates to continue to improve slowly over time, as we continue to expand our enterprise business and invest in customer success and other related programs.
We expect marketing and sales costs, which were 51 percent of our total revenues for the six months ended July 31, 2013 and 53 percent for the same period a year ago, to continue to represent a substantial portion of total revenues in the future as we seek to add and manage more paying customers, and build greater brand awareness.
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.
On July 12, 2013, we acquired for cash the outstanding stock of ExactTarget, Inc. (ExactTarget), a leading global provider of cross-channel, digital marketing solutions. We acquired ExactTarget for the assembled workforce, expected synergies and to create a world-class marketing platform across the channels of email, social, mobile and the web. The financial results of ExactTarget are included in our condensed consolidated financial statements from the date of acquisition. The total purchase price for ExactTarget was approximately $2.6 billion.
On July 12, 2013, we entered into a credit agreement which provides for a $300.0 million term loan due on July 11, 2016. All amounts borrowed under the term loan were used to pay a portion of the total purchase price for ExactTarget.
34
In June 2013, we entered into a large capital lease agreement for software for a period of nine years, which consists of the contractual term of six years and a renewal option of three years.
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 six months ended July 31, 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 six months ended July 31 2013 and 2012.
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 EstimatesRevenue 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. Approximately 70 percent of all invoices were issued with annual terms during the three months ended July 31, 2013.
35
Accordingly, the sequential quarterly changes in accounts receivable and the related deferred revenue during the first three quarters of our fiscal year are not necessarily indicative of the billing activity that occurs in the fourth quarter as displayed below (in thousands):
April 30, 2013 |
July 31, 2013 |
|
|
|||||||||||||
Fiscal 2014 |
||||||||||||||||
Accounts receivable, net |
$ | 502,609 | $ | 599,543 | ||||||||||||
Deferred revenue, current and noncurrent |
1,733,160 | 1,789,648 |
April 30, 2012 |
July 31, 2012 |
October 31, 2012 |
January 31, 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 |
April 30, 2011 |
July 31, 2011 |
October 31, 2011 |
January 31, 2012 |
|||||||||||||
Fiscal 2012 |
||||||||||||||||
Accounts receivable, net |
$ | 270,816 | $ | 342,397 | $ | 312,331 | $ | 683,745 | ||||||||
Deferred revenue, current and noncurrent |
915,133 | 935,266 | 917,821 | 1,380,295 |
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 $3.8 billion as of July 31, 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.
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We intend to continue to invest additional resources in our enterprise cloud computing services. For example, we have invested in additional database software and 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.
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 six months ended July 31, 2013, we recognized stock-based expense of $225.2 million. As of July 31, 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: $283.7 million during the remaining six months of fiscal 2014; $465.4 million during fiscal 2015; $300.0 million during fiscal 2016; $128.9 million during fiscal 2017 and $7.5 million during fiscal 2018. The expected amortization reflects only outstanding stock awards as of July 31, 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 companys research and development efforts, trade names, customer lists and customer relationships. We expect this expense to increase as we acquire more companies.
37
Critical Accounting Estimates
Our condensed consolidated financial statements are prepared in accordance with accounting principles generally accepted in the United States. The preparation of these condensed consolidated financial statements requires us to make estimates and assumptions that affect the reported amounts of assets, liabilities, revenues, costs and expenses, and related disclosures. On an ongoing basis, we evaluate our estimates and assumptions. Our actual results may differ from these estimates under different assumptions or conditions.
We believe that of our significant accounting policies, which are described in Note 1 to our condensed consolidated financial statements, the following accounting policies involve a greater degree of judgment and complexity. Accordingly, these are the policies we believe are the most critical to aid in fully understanding and evaluating our condensed consolidated financial condition and results of operations.
Revenue Recognition. We derive our revenues from two sources: (1) subscription revenues, which are comprised of subscription fees from customers accessing our enterprise cloud computing services and from customers purchasing additional support beyond the standard support that is included in the basic subscription fee; and (2) related professional services such as process mapping, project management, implementation services and other revenue. Other revenue consists primarily of training fees.
We commence revenue recognition when all of the following conditions are satisfied:
| There is persuasive evidence of an arrangement; |
| The service has been or is being provided to the customer; |
| The collection of the fees is reasonably assured; and |
| The amount of fees to be paid by the customer is fixed or determinable. |
Our subscription service arrangements are non-cancelable and do not contain refund-type provisions.
Subscription and Support Revenues
Subscription and support revenues are recognized ratably over the contract terms beginning on the commencement date of each contract, which is the date our service is made available to customers. Amounts that have been invoiced are recorded in accounts receivable and in deferred revenue or revenue, depending on whether the revenue recognition criteria have been met.
Professional Services and Other Revenues
The majority of our professional services contracts are on a time and material basis. When these services are not combined with subscription revenues as a single unit of accounting, as discussed below, these revenues are recognized as the services are rendered for time and material contracts, and when the milestones are achieved and accepted by the customer for fixed price contracts. Training revenues are recognized after the services are performed.
Multiple-Deliverable Arrangements
We enter into arrangements with multiple-deliverables that generally include 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 customers 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.
38
For certain professional services, we have established VSOE as a consistent number of standalone sales of this deliverable have been priced within a reasonably narrow range. We have not established VSOE for our subscription services due to lack of pricing consistency, the introduction of new services and other factors. Accordingly, we use our BESP to determine the relative selling price.
We determined BESP by considering our overall pricing objectives and market conditions. Significant pricing practices taken into consideration include our discounting practices, the size and volume of our transactions, the customer demographic, the geographic area where our services are sold, our price lists, our go-to-market strategy, historical standalone sales and contract prices. The determination of BESP is made through consultation with and approval by management, taking into consideration the go-to-market strategy. As our go-to-market strategies evolve, we may modify our pricing practices in the future, which could result in changes in relative selling prices, including both VSOE and BESP.
Deferred Revenue. The deferred revenue balance does not represent the total contract value of annual or multi-year, non-cancelable subscription agreements. Deferred revenue primarily consists of billings or payments received in advance of revenue recognition from subscription service described above and is recognized as the revenue recognition criteria are met. We generally invoice customers in annual or quarterly installments. Deferred revenue is influenced by several factors, including seasonality, the compounding effects of renewals, invoice duration, invoice timing and new business linearity within the quarter.
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 customers service commences, are a direct and incremental cost of the revenue arrangements. The deferred commission amounts are recoverable through the future revenue streams under the non-cancelable customer contracts. We believe this is the preferable method of accounting as the commission charges are so closely related to the revenue from the non-cancelable customer contracts that they should be recorded as an asset and charged to expense over the same period that the subscription revenue is recognized.
During the six months ended July 31, 2013, we deferred $62.8 million of commission expenditures and we amortized $91.9 million to sales expense. During the same period a year ago, we deferred $67.3 million of commission expenditures and we amortized $72.0 million to sales expense. Deferred commissions on our condensed consolidated balance sheets totaled $225.4 million at July 31, 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.
39
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; |
| the acquired companys 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. We evaluate the forfeiture rates at least annually, or when events or circumstances indicate a change may be needed. This may cause a fluctuation in our stock-based compensation in the period of change. 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.
40
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.
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.
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.
Results of Operations
The following tables set forth selected data for each of the periods indicated (in thousands):
Three Months Ended July 31, |
Six Months
Ended July 31, |
|||||||||||||||
2013 | 2012 | 2013 | 2012 | |||||||||||||
Revenues: |
||||||||||||||||
Subscription and support |
$ | 902,844 | $ | 687,493 | $ | 1,745,065 | $ | 1,342,713 | ||||||||
Professional services and other |
54,250 | 44,156 | 104,662 | 84,403 | ||||||||||||
|
|
|
|
|
|
|
|
|||||||||
Total revenues |
957,094 | 731,649 | 1,849,727 | 1,427,116 | ||||||||||||
Cost of revenues: |
||||||||||||||||
Subscription and support |
160,908 | 118,519 | 314,458 | 227,263 | ||||||||||||
Professional services and other |
56,809 | 43,899 | 112,253 | 86,706 | ||||||||||||
|
|
|
|
|
|
|
|
|||||||||
Total cost of revenues |
217,717 | 162,418 | 426,711 | 313,969 | ||||||||||||
Gross profit |
739,377 | 569,231 | 1,423,016 | 1,113,147 | ||||||||||||
Operating expenses: |
||||||||||||||||
Research and development |
148,079 | 99,442 | 280,018 | 194,218 | ||||||||||||
Marketing and sales |
480,621 | 380,160 | 947,111 | 749,949 | ||||||||||||
General and administrative |
150,534 | 103,095 | 280,284 | 204,695 | ||||||||||||
|
|
|
|
|
|
|
|
|||||||||
Total operating expenses |
779,234 | 582,697 | 1,507,413 | 1,148,862 | ||||||||||||
Loss from operations |
(39,857 | ) | (13,466 | ) | (84,397 | ) | (35,715 | ) | ||||||||
Investment income |
4,387 | 7,173 | 7,741 | 11,634 | ||||||||||||
Interest expense |
(19,656 | ) | (8,033 | ) | (31,539 | ) | (14,403 | ) | ||||||||
Other income (expense) |
(1,678 | ) | 294 | (2,552 | ) | (416 | ) | |||||||||
|
|
|
|
|
|
|
|
|||||||||
Loss before benefit from income taxes |
(56,804 | ) | (14,032 | ) | (110,747 | ) | (38,900 | ) | ||||||||
Benefit from income taxes (1) |
133,407 | 4,203 | 119,629 | 9,596 | ||||||||||||
|
|
|
|
|
|
|
|
|||||||||
Net income (loss) |
$ | 76,603 | $ | (9,829 | ) | $ | 8,882 | $ | (29,304 | ) | ||||||
|
|
|
|
|
|
|
|
(1) | During the three months ended July 31, 2013, we recorded a $128.8 million tax benefit as a result of the partial release of our tax valuation allowance. |
41
Cost of revenues and marketing and sales expenses include the following amounts related to amortization of purchased intangibles from business combinations (in thousands):
Three Months Ended July 31, |
Six Months
Ended July 31, |
|||||||||||||||
2013 | 2012 | 2013 | 2012 | |||||||||||||
Cost of revenues |
$ | 22,550 | $ | 17,668 | $ | 43,855 | $ | 35,116 | ||||||||
Marketing and sales |
4,476 | 2,407 | 6,936 | 5,834 |
Cost of revenues and operating expenses include the following amounts related to stock-based awards (in thousands):
Three Months Ended July 31, |
Six Months Ended July 31, |
|||||||||||||||
2013 | 2012 | 2013 | 2012 | |||||||||||||
Cost of revenues |
$ | 9,981 | $ | 7,864 | $ | 20,659 | $ | 15,117 | ||||||||
Research and development |
26,032 | 16,089 | 50,461 | 31,756 | ||||||||||||
Marketing and sales |
56,133 | 44,781 | 115,935 | 86,768 | ||||||||||||
General and administrative |
18,330 | 16,683 | 38,150 | 33,042 |
Revenues by geography were as follows (in thousands):
Three Months Ended July 31, |
Six Months
Ended July 31, |
|||||||||||||||
2013 | 2012 | 2013 | 2012 | |||||||||||||
Americas |
$ | 678,535 | $ | 507,974 | $ | 1,309,643 | $ | 992,927 | ||||||||
Europe |
173,705 | 124,609 | 336,531 | 242,903 | ||||||||||||
Asia Pacific |
104,854 | 99,066 | 203,553 | 191,286 | ||||||||||||
|
|
|
|
|
|
|
|
|||||||||
$ | 957,094 | $ | 731,649 | $ | 1,849,727 | $ | 1,427,116 | |||||||||
|
|
|
|
|
|
|
|
42
Americas revenue attributed to the United States was approximately 96 percent and 94 percent for the three months ended July 31, 2013 and 2012, respectively, and approximately 95 percent and 94 percent for the six months ended July 31, 2013 and 2012, respectively.
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 July 31, |
Six Months Ended July 31, |
|||||||||||||||
2013 | 2012 | 2013 | 2012 | |||||||||||||
Revenues: |
||||||||||||||||
Subscription and support |
94 | % | 94 | % | 94 | % | 94 | % | ||||||||
Professional services and other |
6 | 6 | 6 | 6 | ||||||||||||
|
|
|
|
|
|
|
|
|||||||||
Total revenues |
100 | 100 | 100 | 100 | ||||||||||||
Cost of revenues: |
||||||||||||||||
Subscription and support |
17 | 16 | 17 | 16 | ||||||||||||
Professional services and other |
6 | 6 | 6 | 6 | ||||||||||||
|
|
|
|
|
|
|
|
|||||||||
Total cost of revenues |
23 | 22 | 23 | 22 | ||||||||||||
Gross profit |
77 | 78 | 77 | 78 | ||||||||||||
Operating expenses: |
||||||||||||||||
Research and development |
15 | 14 | 15 | 14 | ||||||||||||
Marketing and sales |
50 | 52 | 51 | 53 | ||||||||||||
General and administrative |
16 | 14 | 15 | 14 | ||||||||||||
|
|
|
|
|
|
|
|
|||||||||
Total operating expenses |
81 | 80 | 81 | 81 | ||||||||||||
Loss from operations |
(4 | ) | (2 | ) | (4 | ) | (3 | ) | ||||||||
Investment income |
0 | 1 | 0 | 1 | ||||||||||||
Interest expense |
(2 | ) | (1 | ) | (2 | ) | (1 | ) | ||||||||
Other income (expense) |
0 | 0 | 0 | 0 | ||||||||||||
|
|
|
|
|
|
|
|
|||||||||
Loss before benefit from income taxes |
(6 | ) | (2 | ) | (6 | ) | (3 | ) | ||||||||
Benefit from income taxes |
14 | 1 | 6 | 1 | ||||||||||||
|
|
|
|
|
|
|
|
|||||||||
Net income (loss) |
8 | % | (1 | )% | 0 | % | (2 | )% | ||||||||
|
|
|
|
|
|
|
|
Three Months Ended July 31, |
Six Months Ended July 31, |
|||||||||||||||
2013 | 2012 | 2013 | 2012 | |||||||||||||
Amortization of purchased intangibles: |
||||||||||||||||
Cost of revenues |
2 | % | 2 | % | 2 | % | 2 | % | ||||||||
Marketing and sales |
0 | 0 | 0 | 0 |
43
Three Months Ended July 31, |
Six Months Ended July 31, |
|||||||||||||||
2013 | 2012 | 2013 | 2012 | |||||||||||||
Stock-based awards: |
||||||||||||||||
Cost of revenues |
1 | % | 1 | % | 1 | % | 1 | % | ||||||||
Research and development |
3 | 2 | 3 | 2 | ||||||||||||
Marketing and sales |
6 | 6 | 6 | 6 | ||||||||||||
General and administrative |
2 | 2 | 2 | 2 |
Three Months Ended July 31, |
Six Months Ended July 31, |
|||||||||||||||
2013 | 2012 | 2013 | 2012 | |||||||||||||
Revenues by geography: |
||||||||||||||||
Americas |
71 | % | 69 | % | 71 | % | 70 | % | ||||||||
Europe |
18 | 17 | 18 | 17 | ||||||||||||
Asia Pacific |
11 | 14 | 11 | 13 | ||||||||||||
|
|
|
|
|
|
|
|
|||||||||
100 | % | 100 | % | 100 | % | 100 | % | |||||||||
|
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|
|
|
|
|
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Three Months Ended July 31, 2013 compared to Three Months Ended July 31, 2012 |
Three Months Ended July 31, 2012 compared to Three Months Ended July 31, 2011 |
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Revenue constant currency growth rates (as compared to the comparable prior periods) |
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Americas |
34 | % | 38 | % | ||||
Europe |
34 | % | 40 | % | ||||
Asia Pacific |
19 | % | 28 | % | ||||
Total growth |
32 | % | 37 | % |
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.
As of | ||||||||
July 31, 2013 |
January 31, 2013 |
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Balance Sheet Data: |
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Cash, cash equivalents and marketable securities |
$ | 930,008 | $ | 1,758,285 | ||||
Deferred revenue, current and noncurrent |
1,789,648 | 1,862,995 | ||||||
Principal due on convertible senior notes and term loan |
2,024,890 | 574,890 |
Unbilled deferred revenue was approximately $3.8 billion as of July 31, 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.
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Three Months Ended July 31, 2013 and 2012
Revenues.
Three Months
Ended July 31, |
Variance | |||||||||||||||
(in thousands) |
2013 | 2012 | Dollars | Percent | ||||||||||||
Subscription and support |
$ | 902,844 | $ | 687,493 | $ | 215,351 | 31 | % | ||||||||
Professional services and other |
54,250 | 44,156 | 10,094 | 23 | % | |||||||||||
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Total revenues |
$ | 957,094 | $ | 731,649 | $ | 225,445 | 31 | % |
Total revenues were $957.1 million for the three months ended July 31, 2013, compared to $731.6 million during the same period a year ago, an increase of $225.4 million, or 31 percent. On a constant currency basis, total revenues grew 32 percent. Subscription and support revenues were $902.8 million, or 94 percent of total revenues, for the three months ended July 31, 2013, compared to $687.5 million, or 94 percent of total revenues, during the same period a year ago, an increase of $215.4 million, or 31 percent. 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 July 31, 2013 has generally remained consistent relative to prior periods. Professional services and other revenues were $54.3 million, or six percent of total revenues, for the three months ended July 31, 2013, compared to $44.2 million, or six percent of total revenues, for the same period a year ago, an increase of $10.1 million, or 23 percent. 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 $278.6 million, or 29 percent of total revenues, for the three months ended July 31, 2013, compared to $223.7 million, or 31 percent of total revenues, during the same period a year ago, an increase of $54.9 million, or 25 percent. The increase in revenues outside of the Americas was the result of the increasing acceptance of our service, our focus on marketing our services internationally and improved renewal rates 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 $6.6 million compared to the same period a year ago.
Cost of Revenues.
Three Months
Ended July 31, |
Variance | |||||||||||
(in thousands) |
2013 | 2012 | Dollars | |||||||||
Subscription and support |
$ | 160,908 | $ | 118,519 | $ | 42,389 | ||||||
Professional services and other |
56,809 | 43,899 | 12,910 | |||||||||
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Total cost of revenues |
$ | 217,717 | $ | 162,418 | $ | 55,299 | ||||||
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Percent of total revenues |
23 | % | 22 | % |
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Cost of revenues was $217.7 million, or 23 percent of total revenues, for the three months ended July 31, 2013, compared to $162.4 million, or 22 percent of total revenues, during the same period a year ago, an increase of $55.3 million. The increase in absolute dollars was primarily due to an increase of $20.3 million in employee-related costs, an increase of $2.1 million in stock-based expenses, an increase of $9.7 million in service delivery costs, primarily due to our efforts to increase data center capacity, an increase of $15.3 million in depreciation and amortization expenses, $4.9 million of which related to the amortization of purchased intangible assets, and an increase of $5.4 million in allocated overhead. We have increased our headcount by 69 percent since July 31, 2012 to meet the higher demand for services from our customers, of which the majority was due to the acquisition of ExactTarget on July 12, 2013.
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. In June 2013, we entered into a large capital lease agreement for software for a period of nine years, which consists of the contractual term of six years and a renewal option of three years. The capitalized portion will be depreciated over the estimated useful life of the software, which is nine years. A portion of the depreciation expense on this asset will be allocated to cost of revenues. 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 July 31, |
Variance | |||||||||||
(in thousands) |
2013 | 2012 | Dollars | |||||||||
Research and development |
$ | 148,079 | $ | 99,442 | $ | 48,637 | ||||||
Percent of total revenues |
15 | % | 14 | % |
Research and development expenses were $148.1 million, or 15 percent of total revenues, for the three months ended July 31, 2013, compared to $99.4 million, or 14 percent of total revenues, during the same period a year ago, an increase of $48.6 million. The increase in absolute dollars was primarily due to an increase of $25.6 million in employee-related costs, an increase of $9.9 million in stock-based expenses and an increase of $4.6 million in our development and test data center. We increased our research and development headcount by 48 percent since July 31, 2012 in order to improve and extend our service offerings and develop new technologies. A majority of the increase was due to the acquisition of ExactTarget on July 12, 2013. We expect that research and development expenses will increase in absolute dollars and may increase as a percentage of revenues in the remaining six months of fiscal 2014 and future periods as we continue to invest in additional employees and technology to support the development of new, and improve existing, technologies and the integration of acquired technologies. In June 2013, we entered into a large capital lease agreement for software for a period of nine years, which consists of the contractual term of six years and a renewal option of three years. The capitalized portion will be depreciated over the estimated useful life of the software, which is nine years. A portion of the depreciation expense on this asset will be allocated to research and development.
Marketing and Sales.
Three Months Ended July 31, |
Variance | |||||||||||
(in thousands) |
2013 | 2012 | Dollars | |||||||||
Marketing and sales |
$ | 480,621 | $ | 380,160 | $ | 100,461 | ||||||
Percent of total revenues |
50 | % | 52 | % |
Marketing and sales expenses were $480.6 million, or 50 percent of total revenues, for the three months ended July 31, 2013, compared to $380.2 million, or 52 percent of total revenues, during the same period a year ago, an increase of $100.5 million. The increase in absolute dollars was primarily due to increases of $63.8 million in employee-related costs, including amortization of deferred commissions, $11.4 million in stock-based expenses, $10.1 million in advertising, marketing and event costs and increases in allocated overhead. Our marketing and sales headcount increased by 37 percent since July 31, 2012, of which the majority was due to the acquisition of ExactTarget with the remainder attributable to hiring additional sales personnel to focus on adding new customers and increasing penetration within our existing customer base.
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General and Administrative.
Three Months Ended July 31, |
Variance | |||||||||||
(in thousands) |
2013 | 2012 | Dollars | |||||||||
General and administrative |
$ | 150,534 | $ | 103,095 | $ | 47,439 | ||||||
Percent of total revenues |
16 | % | 14 | % |
General and administrative expenses were $150.5 million, or 16 percent of total revenues, for the three months ended July 31, 2013, compared to $103.1 million, or 14 percent of total revenues, during the same period a year ago, an increase of $47.4 million. The increase was primarily due to increases of $17.5 million in employee-related costs, $23.3 million in professional and outside services, $1.6 million in stock-based expenses and increases in allocated overhead. Our general and administrative headcount increased by 35 percent since July 31, 2012, of which the majority was due to the acquisition of ExactTarget. Additionally, we incurred $16.0 million in acquisition costs associated with the acquisition of ExactTarget.
Loss from operations.
Three Months Ended July 31, |
Variance | |||||||||||
(in thousands) |
2013 | 2012 | Dollars | |||||||||
Loss from operations |
$ | (39,857 | ) | $ | (13,466 | ) | $ | (26,391 | ) | |||
Percent of total revenues |
(4 | )% | (2 | )% |
Loss from operations for the three months ended July 31, 2013 was $39.9 million and included $110.5 million of stock-based expenses and $27.0 million of amortization of purchased intangibles. During the same period a year ago, loss from operations was $13.5 million and included $85.4 million of stock-based expenses and $20.1 million of amortization of purchased intangibles.
Investment income.
Three Months Ended July 31, |
Variance | |||||||||||
(in thousands) |
2013 | 2012 | Dollars | |||||||||
Investment income |
$ | 4,387 | $ | 7,173 | $ | (2,786 | ) | |||||
Percent of total revenues |
0 | % | 1 | % |
Investment income consists of income on our cash and marketable securities balances. Investment income was $4.4 million for the three months ended July 31, 2013 and was $7.2 million during the same period a year ago. The decrease was primarily due to the decrease in marketable securities.
Interest expense.
Three Months Ended July 31, |
Variance | |||||||||||
(in thousands) |
2013 | 2012 | Dollars | |||||||||
Interest expense |
$ | (19,656 | ) | $ | (8,033 | ) | $ | (11,623 | ) | |||
Percent of total revenues |
(2 | )% | (1 | )% |
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Interest expense consists of interest on our convertible senior notes, capital leases and term loan. Interest expense, net of interest costs capitalized, was $19.7 million for the three months ended July 31, 2013 and was $8.0 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 of 0.25% convertible senior notes, the $300.0 million term loan that was entered into in connection with the acquisition of ExactTarget and the large capital lease agreement for software which we entered into in June 2013.
Benefit from income taxes.
Three Months Ended July 31, |
Variance | |||||||||||
(in thousands) |
2013 | 2012 | Dollars | |||||||||
Benefit from income taxes |
$ | 133,407 | $ | 4,203 | $ | 129,204 | ||||||
Effective tax rate |
235 | % | 30 | % |
We recognized a tax benefit of $133.4 million with a pretax loss of $56.8 million, which resulted in an effective tax rate of 235 percent for the three months ended July 31, 2013. Included in the tax benefit was $128.8 million of discrete tax benefit from a partial release of the valuation allowance on our deferred tax assets. Due to the acquisition of ExactTarget, we established a deferred tax liability for the book-tax basis difference related to purchased intangibles. The net deferred tax liability from the acquisition of ExactTarget provided an additional source of income to support the realizability of our pre-existing deferred tax assets and as a result, we recorded a partial release of our valuation allowance.
We recorded a tax benefit of $4.2 million which resulted in an effective tax rate of 30 percent for the three months ended July 31, 2012. Our effective tax rate was lower than the federal statutory tax rate of 35 percent primarily due to California tax credits, partially offset by foreign tax expense and non-deductible amounts.
Six Months Ended July 31, 2013 and 2012
Revenues.
Six Months
Ended July 31, |
Variance | |||||||||||||||
(in thousands) |
2013 | 2012 | Dollars | Percent | ||||||||||||
Subscription and support |
$ | 1,745,065 | $ | 1,342,713 | $ | 402,352 | 30 | % | ||||||||
Professional services and other |
104,662 | 84,403 | 20,259 | 24 | % | |||||||||||
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Total revenues |
$ | 1,849,727 | $ | 1,427,116 | $ | 422,611 | 30 | % | ||||||||
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Total revenues were $1.8 billion for the six months ended July 31, 2013, compared to $1.4 billion during the same period a year ago, an increase of $422.6 million, or 30 percent. Subscription and support revenues were $1.7 billion, or 94 percent of total revenues, for the six months ended July 31, 2013, compared to $1.3 billion, or 94 percent of total revenues, during the same period a year ago, an increase of $402.4 milli