SERVICENOW, INC. - 10-K - MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

(Edgar Glimpses Via Acquire Media NewsEdge) You should read the following discussion and analysis of our financial condition and results of operations together with our consolidated financial statements and the related notes appearing at the end of this filing. Some of the information contained in this discussion and analysis or set forth elsewhere in this filing, including information with respect to our plans and strategy for our business, includes forward-looking statements that involve risks and uncertainties. You should read the "Risk Factors" section of this filing for a discussion of important factors that could cause actual results and the timing of certain events to differ materially from future results expressed or implied by the forward-looking statements contained in the following discussion and analysis.

Overview ServiceNow is a leading provider of cloud-based services to automate enterprise IT operations. We focus on transforming enterprise IT by automating and standardizing business processes and consolidating IT across the global enterprise. Organizations deploy our service to create a single system of record for enterprise IT, lower operational costs and enhance efficiency. Additionally, our customers use our extensible platform to build custom applications for automating activities unique to their business requirements.

We offer our service under a SaaS business model. Our subscription fee includes access to our suite of on-demand applications, access to our platform to build custom applications, and our technical support and management of our cloud-based infrastructure. We provide a scaled pricing model based on the duration of the subscription term and we frequently extend discounts to our customers based on the number of users. We generally bill our customers annually in advance. We generate sales through our direct sales team and indirectly through channel partners and third-party referrals. We also generate revenues from professional services for implementation and training of customer personnel.

Many customers initially subscribe to our service to solve a specific and immediate problem. Once their problem is solved, many of our customers deploy additional applications as they become more familiar with our service and apply it to new IT processes. In addition, some customers adopt our platform to build applications that automate various processes for business uses outside of IT such as human resources, facilities and quality control management. A majority of our revenues come from large global enterprise customers. Our total customers grew 55% to 1,512 as of December 31, 2012 from 974 as of December 31, 2011.

We were founded in 2004 and entered into our first commercial contract in 2005.

To date, we have funded our business primarily with cash flows from operations.

We raised net proceeds of $173.3 million in our June 2012 initial public offering after deducting underwriting discounts and commissions and before deducting expenses in connection with the offering of $3.5 million. In November 2012, we raised an additional $51.0 million after deducting underwriting discounts and commissions and before deducting expenses in connection with the offering of $1.2 million. We continue to invest in the development of our service, infrastructure and sales and marketing to drive long-term growth. We increased our overall employee headcount to 1,077 as of December 31, 2012 from 603 as of December 31, 2011.

Fiscal Year End On February 3, 2012, our board of directors approved a change to our fiscal year-end from June 30 to December 31. Included in this filing is the transition period for the six months ended December 31, 2011. References to "fiscal 2011" and "fiscal 2010" still refer to the fiscal years ended June 30, 2011 and 2010, respectively.

Key Factors Affecting Our Performance Total customers. We believe total customers is a key indicator of our market penetration, growth and future revenues. We have aggressively invested in and intend to continue to invest in our direct sales force, as well as the pursuit of additional partnerships within our indirect sales channel. We generally define a customer as an entity with an active service contract as of the measurement date. In situations where there is a single contract that applies to entities with multiple subsidiaries or divisions, universities, or governmental organizations, each entity that has contracted for a separate production instance of our service is counted as a separate customer. Our total customers were 1,512 and 974 as of December 31, 2012 and December 31, 2011, respectively.

Investment in growth. We have aggressively invested, and intend to continue to invest, in expanding our operations, increasing our headcount and developing technology to support our growth. We expect our total operating expenses to increase in the foreseeable future, particularly as we continue to expand our sales and marketing organizations, further invest in research and development and grow our cloud-based infrastructure to support our growth. We continue to invest in our sales and marketing organization to drive additional revenues and support the growth of our customer base. Any investments we make in our sales and marketing organization and our capacity to deliver our services will occur in advance of experiencing any benefits from such investments, so it may be difficult for us to determine if we are efficiently allocating our resources in these areas.

26 -------------------------------------------------------------------------------- Renewal rate. We calculate our renewal rate by subtracting our attrition rate from 100%. Our attrition rate for a period is equal to the annual contract value from customers that are due for renewal in the period and did not renew, divided by the total annual contract value from all customers due for renewal during the period. Annual contract value is equal to the first twelve months of expected subscription revenues under a contract. We believe our renewal rate is an important metric to measure the long-term value of customer agreements and our ability to retain our customers. Our renewal rate was 97% for each of the years ended December 31, 2012 and 2011, 97% and 99% for the six months ended December 31, 2011 and 2010, respectively, and 97% and 95% for fiscal 2011 and 2010, respectively.

Upsells. In order for us to continue to grow our business, it is important to generate additional revenue from existing customers. We believe there is significant opportunity to increase the number of subscriptions sold to current customers as customers become more familiar with our platform, adopt our applications to address additional business use cases and expand the use of the platform throughout their enterprise. Our increase in subscriptions is driven by the increased number of users accessing our suite of on-demand applications, as well as our other enabling technologies, Discovery and Orchestration, that are separately priced on a per server basis. We believe our ability to upsell is a key factor affecting our ability to further penetrate our existing customer base. We monitor upsells by measuring the annual contract value of upsells signed in the period as a percentage of our total annual contract value of all contracts signed in the period. Upsells as a percentage of total annual contract value signed was 30% and 29% for the year ended December 31, 2012 and 2011, respectively, 28% and 25% for the six months ended December 31, 2011 and 2010, and 27% and 25% for fiscal 2011 and 2010, respectively.

Investment in infrastructure. We have made and will continue to make investments in new equipment to support growth and enhancements at our data centers and expand our office facilities around the world. During the fourth quarter of 2012, we completed our transition from a managed service hosting model to a co-location model and invested in enhancements to our cloud architecture in our co-location data centers. We recorded additional expense during the year ended December 31, 2012 related to the transition from our managed service data centers to our co-location infrastructure investments. During 2013, we will continue to invest in enhancements to our cloud architecture, which are designed to provide our customers with enhanced scalability, data reliability and availability, including the purchase of additional networking infrastructure. We are also evaluating the expansion of our data center locations to address additional geographic markets, which will result in additional investments to our infrastructure if pursued. In addition, we will continue to enter into new office facility leases in the future to accommodate our projected headcount growth at various locations around the world. These new leases may require investments in leasehold improvements, as well as furniture and equipment to support our employees. If we add to our headcount at a faster rate than anticipated, we may incur substantial costs in terminating leases to enter into new leases for larger space.

Professional services model. We believe our investment in professional services facilitates the adoption of our subscription service. Prior to 2012, our pricing for professional services was predominantly on a fixed-fee basis and the cost of the time and materials incurred to complete these services was often greater than the amount charged to the customer. Beginning in December 2011, we began shifting our pricing model to a time-and-materials basis and increased our focus on scoping projects and managing resource utilization. As a result of these changes, our gross profit percentage from professional services improved to (4)% for the year ended December 31, 2012 compared to (30)% for the year ended December 31, 2011, and (51)% and (43)% in the six months ended December 31, 2011 and 2010, and (21)% and (202)% in fiscal 2011 and 2010, respectively. The improvement in gross profit percentages was also due in part to the adoption of the new revenue recognition accounting guidance commencing on July 1, 2010.

Platform adoption. Our service includes access to our suite of applications, as well as access to our platform to create customer-built extensions to our suite of applications. Customers may also purchase the use of the platform to develop custom applications. Though in the near term we expect our revenue growth to be primarily driven by the pace of adoption and penetration of our suite of applications, we are investing resources to enhance the development capabilities of our platform. We believe the extensibility and simplicity of our platform is resulting in an increased use of our platform by our customers to create extensions of our applications or custom applications, and will enhance our ability to acquire new customers, increase upsells and sustain high renewal rates.

Components of Results of Operations Revenues Subscription revenues. Subscription revenues are primarily comprised of fees which give customers access to our suite of on-demand applications, as well as access to our platform to build custom applications. Pricing includes multiple instances, hosting and support services, data backup and disaster recovery services, as well as future upgrades offered during the subscription period. In addition, we offer two separately priced enabling technologies, Discovery and Orchestration. We typically invoice our customers for subscription fees in annual increments upon initiation of the initial contract or subsequent renewal.

Our average initial contract 27 --------------------------------------------------------------------------------term was approximately 32 months for 2012. Our contracts are generally non-cancelable, though customers can terminate for breach if we materially fail to perform.

We generate sales directly through our sales team and, to a lesser extent, through our channel partners. Sales to our channel partners are made at a discount and revenues are recorded at the discounted price when all revenue recognition criteria are met. In addition, in some cases, we pay referral fees to third parties typically ranging from 10% to 20% of the first year's annual contract value. These fees are included in sales and marketing expense.

Professional services and other revenues. Professional services revenues consist of fees associated with the implementation and configuration of our subscription service. Other revenues include customer training and attendance and sponsorship fees for our annual user conference, Knowledge. Prior to 2012, our pricing for professional services was predominantly on a fixed-fee basis. Beginning in December 2011, we began shifting our pricing model to a time-and-materials basis. Going forward, we anticipate the majority of our new business will be priced on a time-and-materials basis. Historically, most of our professional services engagements spanned six to eight months. During 2012, our professional services engagements spanned approximately four to six months. Historically, we billed for our fixed price professional services in two installments, with the first installment due up front and the second installment due at either a specified future date (usually approximately three months from the contract start date) or upon completion of the services. In December 2011, we changed these billing practices to bill for our fixed price professional services in installments based on milestones related to the completion of specified projects or specified dates. Our time-and-materials professional services are generally billed monthly in arrears based on actual hours and expenses incurred. Typical payment terms provide our customers pay us within 30 days of invoice.

Prior to fiscal 2011, we recorded revenues from our professional services over a period commensurate with our subscription service contracts. However, the cost associated with our professional services engagements was recorded as the services were delivered, resulting in lower gross profit percentages in fiscal 2010 and 2009. On July 1, 2010, we adopted new revenue recognition accounting guidance on a prospective basis that enabled us to separately allocate value for our multiple element arrangements between our subscription revenues and professional services revenues, based on the best estimate of selling price. As a result, professional services revenues are recognized as the services are delivered, which is substantially the same period as the associated costs are incurred. This shift resulted in an increase to professional services and other revenues of $5.5 million for fiscal 2011. Refer to "Critical Accounting Policies and Significant Judgments and Estimates" below for further discussion of our revenue recognition accounting policy.

Backlog. Backlog represents future amounts to be invoiced under our agreements and is not included in deferred revenue. As of December 31, 2012 and 2011, we had backlog of approximately $379 million and $210 million, respectively. We expect backlog will change from period to period for several reasons, including the timing and duration of customer subscription and professional services agreements, varying billing cycles of subscription agreements, and the timing of customer renewals.

Overhead Allocation Overhead associated with benefits, facilities, IT costs and noncloud-based infrastructure related depreciation is allocated to cost of revenues and operating expenses based on headcount. Depreciation related to our cloud-based infrastructure are classified as cost of subscription revenues.

Cost of Revenues Subscription cost of revenues. Cost of subscription revenues primarily consists of expenses related to hosting our service and providing support to our customers. These expenses are comprised of data center capacity costs; personnel and related costs directly associated with our cloud infrastructure and customer support, including salaries, benefits, bonuses and stock-based compensation; and allocated overhead.

Professional services and other cost of revenues. Cost of professional services and other revenues consists primarily of personnel and related costs directly associated with our professional services and training departments, including salaries, benefits, bonuses and stock-based compensation; the costs of contracted third-party vendors; and allocated overhead.

Professional services associated with the implementation and configuration of our subscription services are performed directly by our services team, as well as by contracted third-party vendors. Fees paid up-front to our third-party vendors are deferred and amortized to cost of revenues as the professional services are delivered. Fees owed to our third-party vendors are accrued over the same requisite service period. Internal payroll costs are similarly recognized as professional services are delivered. Cost of revenues associated with our professional services engagements contracted with third-party vendors as a percentage of professional services and other revenues was 26% and 55% in the year ended December 31, 2012 and 2011, respectively, 64% and 70% in the six months ended December 31, 2011 and 2010, and 54% and 135% in fiscal 2011 and 2010, respectively.

28 --------------------------------------------------------------------------------Sales and Marketing Expenses Sales and marketing expenses consist primarily of personnel and related expenses directly associated with our sales and marketing staff, including salaries, benefits, bonuses, commissions and stock-based compensation. Other costs included in this expense are third-party referral fees, marketing and promotional events, including our Knowledge conference, online marketing, product marketing and allocated overhead.

Research and Development Expenses Research and development expenses consist primarily of personnel and related expenses directly associated with our research and development staff, including salaries, benefits, bonuses and stock-based compensation, and allocated overhead.

General and Administrative Expenses General and administrative expenses primarily consist of personnel and related expenses for our executive, finance, legal, human resources and administrative personnel, including salaries, benefits, bonuses and stock-based compensation; legal, accounting and other professional services fees; other corporate expenses; and allocated overhead.

Provision for Income Taxes Provision for income taxes consists of federal, state and foreign income taxes.

Due to recent losses, we maintain a valuation allowance against our deferred tax assets as of December 31, 2012. We consider all available evidence, both positive and negative, in assessing the extent to which a valuation allowance should be applied against our deferred tax assets.

29 --------------------------------------------------------------------------------Results of Operations To enhance comparability, the following table sets forth our results of operations for the periods presented. The period-to-period comparison of financial results is not necessarily indicative of future results.

Six Months Ended Year Ended December 31, December 31, Fiscal Year Ended June 30, 2012 2011 2011 2010 2011 2010 (in thousands) Revenues(1): Subscription $ 204,526 $ 110,886 $ 64,886 $ 33,191 $ 79,191 $ 40,078 Professional services and other 39,186 17,186 8,489 4,753 13,450 3,251 Total revenues 243,712 128,072 73,375 37,944 92,641 43,329 Cost of revenues(2)(3): Subscription 63,258 24,288 15,073 6,096 15,311 6,378 Professional services and other 40,751 22,336 12,850 6,778 16,264 9,812 Total cost of revenues 104,009 46,624 27,923 12,874 31,575 16,190 Gross profit 139,703 81,448 45,452 25,070 61,066 27,139 Operating expenses(2)(3): Sales and marketing 103,837 52,896 32,501 13,728 34,123 19,334 Research and development 39,333 11,276 7,030 2,758 7,004 7,194 General and administrative 34,117 16,046 10,084 3,417 9,379 28,810 Total operating expenses 177,287 80,218 49,615 19,903 50,506 55,338Income (loss) from operations (37,584 ) 1,230 (4,163 ) 5,167 10,560 (28,199 ) Interest and other income (expense), net 1,604 (1,129 ) (1,446 ) 289 606 (1,226 ) Income (loss) before provision for income taxes (35,980 ) 101 (5,609 ) 5,456 11,166 (29,425 ) Provision for income taxes 1,368 1,758 1,075 653 1,336 280 Net income (loss) $ (37,348 ) $ (1,657 ) $ (6,684 ) $ 4,803 $ 9,830 $ (29,705 ) (1) Revenues for the year ended December 31, 2012 and 2011, the six months ended December 31, 2011 and 2010 and the fiscal year ended June 30, 2011 reflect the prospective adoption of new revenue accounting guidance commencing on July 1, 2010. As a result of this guidance, we separately allocate value for multiple element contracts between our subscription revenues and professional services revenues based on the best estimate of selling price. Additionally, we recognize professional services revenues as the services are delivered.

Please refer to Note 2 to our consolidated financial statements for further discussion of our revenue recognition policies.

(2) Stock-based compensation included in the statements of operations data above was as follows: Six Months Ended Year Ended December 31, December 31, Fiscal Year Ended June 30, 2012 2011 2011 2010 2011 2010 (in thousands) Cost of revenues: Subscription $ 3,929 $ 997 $ 674 $ 225 $ 548 $ 48 Professional services and other 1,574 273 193 37 117 28 Sales and marketing 10,189 2,583 2,010 431 1,004 277 Research and development 6,496 965 704 207 468 90 General and administrative 5,749 2,652 2,056 221 817 102 (3) Cost of revenues and operating expenses for the fiscal year ended June 30, 2010 reflect compensation expense of $0.7 million and $30.1 million, respectively, related to the repurchase of shares from eligible stockholders in connection with our sale and issuance of Series D preferred stock.

30-------------------------------------------------------------------------------- Six Months Ended Year Ended December 31, December 31, Fiscal Year Ended June 30, 2012 2011 2011 2010 2011 2010 Revenues: Subscription 84 % 87 % 88 % 87 % 85 % 92 % Professional services and other 16 13 12 13 15 8 Total revenues 100 100 100 100 100 100 Cost of revenues: Subscription 26 19 20 16 16 15 Professional services and other 17 17 18 18 18 22 Total cost of revenues 43 36 38 34 34 37 Gross profit 57 64 62 66 66 63 Operating expenses: Sales and marketing 42 41 44 36 37 45 Research and development 16 9 10 7 8 17 General and administrative 14 13 14 9 10 66 Total operating expenses 72 63 68 52 55 128 Income (loss) from operations (15 ) 1 (6 ) 14 11 (65 ) Interest and other income (expense), net 1 (1 ) (2 ) 1 1 (3 ) Income (loss) before provision for income taxes (14 ) - (8 ) 15 12 (68 ) Provision for income taxes 1 1 1 2 1 1 Net income (loss) (15 )% (1 )% (9 )% 13 % 11 % (69 )% Six Months Ended Year Ended December 31, December 31, Fiscal Year Ended June 30, 2012 2011 2011 2010 2011 2010 (in thousands) Revenues by geography North America $ 173,001 $ 93,315 $ 51,901 $ 27,919 $ 69,333 $ 31,396 Europe 60,579 30,242 18,842 8,693 20,093 10,708 Asia Pacific and other 10,132 4,515 2,632 1,332 3,215 1,225 Total revenues $ 243,712 $ 128,072 $ 73,375 $ 37,944 $ 92,641 $ 43,329 Six Months Ended Year Ended December 31, December 31, Fiscal Year Ended June 30, 2012 2011 2011 2010 2011 2012 Revenues by geography North America 71 % 73 % 71 % 74 % 75 % 72 % Europe 25 24 26 23 22 25 Asia Pacific and other 4 3 3 3 3 3 Total revenues 100 % 100 % 100 % 100 % 100 % 100 % 31--------------------------------------------------------------------------------Comparison of the years ended December 31, 2012 and 2011 Revenues Year Ended December 31, 2012 2011 % Change (dollars in thousands) Revenues: Subscription $ 204,526 $ 110,886 84 %Professional services and other 39,186 17,186 128 % Total revenues $ 243,712 $ 128,072 90 % Percentage of revenues: Subscription 84 % 87 % Professional services and other 16 13 Total 100 % 100 % Revenues increased $115.6 million, primarily due to the increase in subscription revenues of $93.6 million. Of the total increase in subscription revenues, 34% represented revenues from new customers acquired after December 31, 2011, and 66% represented revenues from existing customers at or prior to December 31, 2011. Our total customers increased 55% to 1,512 at December 31, 2012 from 974 at December 31, 2011. The average total revenues per customer, calculated based on revenue during the trailing four quarters divided by the average number of customers during the trailing four quarters, increased to approximately $190,000 from approximately $157,000 over this period primarily due to an increase in the number of subscriptions sold to existing customers and an increase in average new customer deal size.

Of the $93.6 million total increase in subscription revenues for the year ended December 31, 2012, 86% represented sales to customers by our direct sales organization and 14% represented revenues from channel partners. Subscription revenues in North America represented 68% of the $93.6 million total increase in subscription revenues and 32% represented subscription revenues outside North America. During the year ended December 31, 2012, we continued to increase our focus on international markets through the addition of new channel partners, the expansion of our direct sales organization and the opening of additional sales and marketing offices in Sweden and Israel.

The increase in professional services and other revenues of $22.0 million was primarily due to an increase in the services provided to our growing customer base in addition to a shift in our pricing model to a time-and-materials basis.

We had an increase in revenues of $3.4 million associated with acceptances received in 2012 and an increase of $0.9 million associated with our Knowledge conference, held in May 2012. Revenues in North America represented 71% of the $22.0 million total increase in professional services and other revenues.

Revenues outside North America represented the remaining 29%.

32 --------------------------------------------------------------------------------Cost of Revenues and Gross Profit Percentage Year Ended December 31, 2012 2011 % Change (dollars in thousands) Cost of revenues: Subscription $ 63,258 $ 24,288 160 % Professional services and other 40,751 22,336 82 % Total cost of revenues $ 104,009 $ 46,624 123 % Gross profit percentage: Subscription 69 % 78 % Professional services and other (4 )% (30 )% Total gross profit percentage 57 % 64 % Gross profit $ 139,703 $ 81,448 72 % Headcount (at period end) Subscription 218 119 83 % Professional services and other 183 98 87 % Total headcount 401 217 85 % Cost of subscription revenues increased $39.0 million during the year ended December 31, 2012 compared to the prior year, primarily due to increases in personnel-related and overhead expenses and expenses related to our data centers. Personnel-related expenses increased $18.6 million, consisting primarily of increased employee compensation, benefits and travel expenses of $15.5 million and additional stock-based compensation of $2.9 million. Overhead expenses increased $1.7 million. Growth in personnel-related and overhead expenses was driven by headcount growth and investments in our cloud infrastructure and support organizations. We expect personnel-related and overhead expenses to continue to increase as we continue to hire employees in our cloud infrastructure and support organizations in order to stay ahead of our growing customer demands.

Hosting expenses related to our network infrastructure increased $6.9 million as we increased data center capacity to migrate customers from our managed service data centers to our co-location data centers and to support our customer growth.

We also opened six new data centers since December 31, 2011. In the fourth quarter of 2012, we completed the transition of all our managed services data centers to our co-location data centers. Depreciation expense related to our equipment in our data centers increased $8.3 million, of which $6.6 million is due to purchases of network infrastructure to support our new data centers and growth within our existing data centers and $1.7 million is due to the accelerated depreciation of the assets located in our managed services data centers. Depreciation expense related to our managed services data centers for the year ended December 31, 2012 was $3.1 million. Additionally, outside services primarily related to enhancements to our data center security and the migration of our customers increased $2.0 million for the year ended December 31, 2012. We expect data center costs to continue to increase as we continue to grow our data center footprint and purchase new equipment to support our new customers.

In 2013, we anticipate a substantial portion of our capital expenditures on data center capacity will be on new equipment within existing data centers to accommodate growth, which generally requires less capital expenditure than provisioning the equivalent capacity in a new data center. We may also add an additional data center during 2013 to service our growth in customers.

Our subscription gross profit percentage decreased from 78% during the year ended December 31, 2011 to 69% for the year ended December 31, 2012. We anticipate cost of subscription revenues to increase as we increase capacity and invest in ongoing infrastructure improvements in our existing co-location data centers, which will partially offset the savings related to the exit of our managed service data centers during 2012. Cost of subscription revenues will also increase if we add new data centers. However, we anticipate cost of subscription revenues will grow at rates slower than our anticipated subscription revenue growth such that our gross profit percentage should improve during 2013.

Cost of professional services and other revenues increased $18.4 million during the year ended December 31, 2012 as compared to the prior year. The overall increase was primarily attributable to increased personnel-related expenses of $15.5 million, consisting primarily of increased employee compensation, benefits and travel expenses of $13.8 million and additional stock-based compensation of $1.3 million, driven by headcount growth and an increase in our stock price.

Overhead expenses increased $1.1 million also due to headcount growth. In addition, outside services expenses increased $1.8 million primarily due to an increase in implementation services as a result of our increased sales volume.

33 -------------------------------------------------------------------------------- Our professional services and other gross profit (loss) percentage improved from (30)% during the year ended December 31, 2011 to (4)% during the year ended December 31, 2012. The improved gross profit percentage was primarily attributable to a shift in our pricing model to a time-and-materials basis and an increased focus on scoping projects and managing resource utilization.

Additionally, during the year ended December 31, 2012, the amount of work we sub-contracted to our partners decreased as a percentage of total professional services and other revenues compared to the prior year. Professional services and other revenues include $2.0 million and $1.1 million for our Knowledge conference, for the years ended December 31, 2012 and 2011, respectively.

Revenues from our Knowledge conference contributed 6 percentage points and 9 percentage points to the professional services and other gross profit percentage for the years ended December 31, 2012 and 2011, respectively. Expenses associated with the conference are included in sales and marketing expense. We expect our gross profit percentage from professional services and other to improve as we continue to realize the benefits of the shift in our pricing model to primarily time and materials.

Sales and Marketing Year Ended December 31 2012 2011 % Change (dollars in thousands) Sales and marketing $ 103,837 $ 52,896 96 % Percentage of revenues 42 % 41 % Headcount (at period end) 350 242 45 % Sales and marketing expenses increased $50.9 million due to the expansion of our sales force and increases in marketing programs to address additional opportunities in new and existing markets. Total headcount in sales and marketing increased 45% from December 31, 2011 to December 31, 2012, contributing to a $34.1 million increase in personnel-related expenses, consisting primarily of increased employee compensation, benefits and travel expenses associated with our marketing team and direct sales force of $25.5 million and additional stock-based compensation of $7.6 million. The increase is also due to increased overhead expenses of $2.3 million due to increased headcount. In addition, we incurred an increase of $4.8 million in marketing and event expenses primarily attributable to our Knowledge conference, which experienced a 102% increase in attendance year-over-year. Commissions increased $9.0 million in the year ended December 31, 2012 as compared to the year ended December 31, 2011, which was directly attributable to increased revenues and changes made to our commission plans. Commissions and referral fees amounted to 8% and 7% of subscription revenues in 2012 and 2011, respectively. These fees are deferred and amortized on a straight-line basis over the non-cancelable terms of the related customer contracts.

During 2013, we expect sales and marketing expenses to increase in terms of dollars but remain relatively flat as a percent of total revenues as we continue to expand our direct sales force, increase our marketing activities, grow our international operations, build brand awareness and sponsor additional marketing events. In the second quarter of 2013, we expect to incur expenses of approximately $8.0 million to $9.0 million related to our Knowledge conference in May 2013 compared to $3.6 million incurred for the event in the second quarter of 2012, due to a significant increase in the size of the event.

Research and Development Year Ended December 31 2012 2011 % Change (dollars in thousands) Research and development $ 39,333 $ 11,276 249 % Percentage of revenues 16 % 9 % Headcount (at period end) 200 83 141 % Research and development expenses increased $28.1 million primarily due to increased personnel-related expenses of $25.3 million, consisting primarily of increased employee compensation, benefits and travel expenses associated with our research and development team of $19.3 million and additional stock-based compensation of $5.5 million. Overhead expenses also increased $1.5 million due to headcount growth. Total headcount in research and development increased 141% from December 31, 2011 to December 31, 2012 as we upgraded and extended our service offerings and developed new technologies.

34 -------------------------------------------------------------------------------- During 2013, we expect research and development expenses to increase in terms of dollar and as a percent of revenue as we continue to improve the existing functionality of our service, develop new applications to fill market needs and continue to enhance our core platform.

General and Administrative Year Ended December 31 2012 2011 % Change (dollars in thousands) General and administrative $ 34,117 $ 16,046 113 % Percentage of revenues 16 % 9 % Headcount (at period end) 126 61 107 % General and administrative expenses increased $18.1 million primarily due to increased headcount, expenses associated with being a public company and our international expansion. Personnel-related expenses increased $10.6 million, consisting primarily of increased employee compensation, benefits and travel expenses of $7.4 million and additional stock-based compensation of $3.1 million, as we added employees to support the growth of our business.

Professional and outside service expenses increased $2.7 million, comprised primarily of accounting fees related to our external audit and tax consulting fees associated with our international expansion. Expenses from third-party software and service license agreements increased $1.5 million due to the implementation of additional systems to support the growth of our business. In August 2012, we relocated our San Diego, California office to another facility in the same city. As part of this move, we incurred $2.5 million in lease abandonment costs, which included a loss on disposal of our leasehold improvements and furniture and fixtures and a cease-use loss.

During 2013, we expect general and administrative expenses to increase in terms of dollars but decrease as a percent of revenue as we continue to grow and incur expenses related to being a public company. These expenses include higher legal, corporate insurance and accounting expenses, and the additional expenses of achieving and maintaining compliance with Section 404 of the Sarbanes-Oxley Act and related regulations. We also anticipate to incur exits costs related to the relocation of our San Jose facility of less than $1.0 million and may incur other lease abandonment costs in the future if our existing leases cannot accommodate our future headcount growth.

Interest and Other Income, net Year Ended December 31 2012 2011 % Change (dollars in thousands) Interest and other income, net $ 1,604 $ (1,129 ) NM Percentage of revenues 1 % (1 )% Interest and other income, net, primarily consists of foreign currency transaction gains and losses. The increase is due to the strengthening of the U.S. dollar compared to the prior year and an increase in interest income of $0.3 million related to our investments in marketable securities.

While we have not engaged in the hedging of our foreign currency transactions to date, we are presently evaluating the costs and benefits of initiating such a program and may hedge selected significant transactions denominated in currencies other than the U.S. dollar in the future.

Provision for Income Taxes Year Ended December 31 2012 2011 % Change (dollars in thousands) Income before income taxes $ (35,980 ) $ 101 NM Provision for income taxes 1,368 1,758 (22 )% Effective tax rate (4 )% 1,741 % 35-------------------------------------------------------------------------------- The provision for income taxes decreased $0.4 million, primarily as a result of our operating loss, a lower proportion of earnings in taxable jurisdictions, and benefit from California research and development credits in the year ended December 31, 2012 compared to the prior year. See Note 15 to our consolidated financial statements for our reconciliation of income taxes at the statutory federal rate to the provision for income taxes.

We continue to maintain a full valuation allowance on our federal and state deferred tax assets, and the significant components of the tax expense recorded are current cash taxes in various jurisdictions. The cash tax expenses are impacted by each jurisdiction's individual tax rates, laws on timing of recognition of income and deductions and availability of net operating losses and tax credits. In December 2011, we reorganized our international operations and established our non-U.S. headquarters in the Netherlands, which has an effective tax rate that is lower than the U.S. federal statutory rate. Given the full valuation allowance, sensitivity of current cash taxes to local rules and our foreign restructuring, we expect our effective tax rate could fluctuate significantly on a quarterly basis and could be adversely affected to the extent earnings are lower than anticipated in countries that have lower statutory rates and higher than anticipated in countries that have higher statutory rates. The earnings of our foreign subsidiaries are considered to be permanently reinvested outside of the United States.

Comparison of the six months ended December 31, 2011 and 2010 Revenues Six Months Ended December 31, 2011 2010 % Change (dollars in thousands) Revenues: Subscription $ 64,886 $ 33,191 95 % Professional services and other 8,489 4,753 79 % Total revenues $ 73,375 $ 37,944 93 % Percentage of revenues: Subscription 88 % 87 % Professional services and other 12 13 Total 100 % 100 % Revenues increased $35.4 million, primarily due to the increase in subscription revenues of $31.7 million. Of the total increase in subscription revenues, 55% represented revenues from new customers acquired after December 31, 2010, and 45% represented revenues from existing customers at or prior to December 31, 2010. Our total customers increased 62% from December 31, 2010 to December 31, 2011. The average subscription revenues per customer increased 19% over this period primarily due to an increase in the number of subscriptions sold to existing customers.

Of the $31.7 million total increase in subscription revenues for the six months ended December 31, 2011, 81% represented sales to customers by our direct sales organization and 19% represented revenues from channel partners. Subscription revenues in North America represented 67% of the $31.7 million total increase in subscription revenues and 33% represented subscription revenues outside North America. The increase in revenues from channel partners was due primarily to increased market adoption of our subscription service through sales by our existing channel partners and to a lesser extent the addition of new channel partners. The increase in subscription revenues outside North America was due primarily to increased adoption of our subscription service through sales by our existing channel partners and direct sales organization, and to a lesser extent the addition of new channel partners and the expansion of our direct sales organization. During the six months ended December 31, 2011, we opened additional sales and marketing offices in Denmark and France, which did not account for a significant portion of increased revenues during the period.

The increase in professional services and other revenues of $3.7 million was primarily due to the growth in our customer base. Revenues in North America represented 73% of the $3.7 million total increase in professional services and other revenues. Revenues outside North America represented the remaining 27%.

36 --------------------------------------------------------------------------------Cost of Revenues and Gross Profit Percentage Six Months Ended December 31, 2011 2010 % Change (dollars in thousands) Cost of revenues: Subscription $ 15,073 $ 6,096 147 % Professional services and other 12,850 6,778 90 % Total cost of revenues $ 27,923 $ 12,874 117 % Gross profit percentage: Subscription 77 % 82 % Professional services and other (51 ) (43 ) Total gross profit percentage 62 % 66 % Gross profit $ 45,452 $ 25,070 81 % Headcount (at period end): Subscription 119 51 133 % Professional services and other 98 50 96 % Total headcount 217 101 115 % Cost of subscription revenues increased $9.0 million during the six months ended December 31, 2011 as compared to the same period in the prior year. The overall increase in cost of subscription revenues was primarily attributed to increased personnel-related expenses of $4.9 million, consisting of increased employee compensation, benefits and travel expenses of $4.5 million and additional stock-based compensation of $0.4 million. The increase in personnel-related expenses was driven by headcount growth. In addition, hosting fees for our network infrastructure increased $1.6 million as we increased data center capacity to support our growth. At December 31, 2011, we delivered our service from six data centers in North America and seven data centers internationally, compared to three data centers in North America and five data centers internationally at December 31, 2010. Depreciation expense also increased $1.1 million as we started the transition of our network infrastructure from a managed services hosting model to a co-location model.

Our subscription gross profit percentage decreased from 82% to 77% during the six months ended December 31, 2011 as compared to the same period in the prior year primarily due to these increased expenses.

Cost of professional services and other revenues increased $6.1 million during the six months ended December 31, 2011 as compared to the same period in the prior year. The overall increase was primarily attributed to increased personnel-related expenses of $3.7 million, consisting of increased employee compensation, benefits and travel expenses of $3.5 million and additional stock-based compensation of $0.2 million driven by headcount growth. In addition, outside services expenses increased $1.9 million primarily due to additional fees paid to third-parties to provide implementation services.

Our professional services and other gross profit percentage decreased from (43)% to (51)% during the six months ended December 31, 2011 as compared to the same period in the prior year primarily due to these increased expenses.

Sales and Marketing Six Months Ended December 31, 2011 2010 % Change (dollars in thousands) Sales and marketing $ 32,501 $ 13,728 137 % Percentage of revenues 44 % 36 % Headcount (at period end) 242 90 169 % Sales and marketing expenses increased $18.8 million due to the expansion of our sales force and increases in marketing programs to address additional opportunities in new and existing markets. Total headcount in sales and marketing increased, 169% from December 31, 2010 to December 31, 2011, contributing to a $13.3 million increase in personnel-related expenses, consisting primarily of increased employee compensation, benefits and travel expenses associated with our direct sales force of $11.8 million, 37 -------------------------------------------------------------------------------- and additional stock-based compensation of $1.6 million. In addition, we incurred an increase of $3.1 million in commissions, which was directly attributed to increased revenues and changes made to our commission plans in the six months ended December 31, 2011. Marketing and event expenses increased $1.3 million due to our continued efforts to generate sales leads and build brand awareness.

Research and Development Six Months Ended December 31, 2011 2010 % Change (dollars in thousands) Research and development $ 7,030 $ 2,758 155 % Percentage of revenues 10 % 7 % Headcount (at period end) 83 34 144 % Research and development expenses increased $4.3 million primarily due to increased personnel-related expenses of $4.0 million, consisting of increased employee compensation, benefits and travel expenses associated with our research and development team of $3.5 million and additional stock-based compensation of $0.5 million. Total headcount in research and development increased as we upgraded and extended our service offerings and developed new technologies.

General and Administrative Six Months Ended December 31, 2011 2010 % Change (dollars in thousands) General and administrative $ 10,084 $ 3,417 195 % Percentage of revenues 14 % 9 % Headcount (at period end) 61 25 144 % General and administrative expenses increased $6.7 million primarily due to increased headcount. Personnel-related expenses increased $4.1 million, consisting of increased employee compensation, benefits and travel expenses of $2.3 million and additional stock-based compensation of $1.8 million, as we added employees to support the growth of our business. Professional and outside service expenses increased $1.6 million, comprised primarily of legal and accounting fees associated with our international expansion.

Interest and Other Income (Expense), net Six Months Ended December 31, 2011 2010 % Change (dollars in thousands)Interest and other income (expense), net $ (1,446 ) $ 289 NM Percentage of revenues (2 )% 1 % Interest and other income (expense), net primarily consist of foreign currency transaction gains and losses. The decrease of $1.7 million is primarily due to unrealized losses on amounts invoiced to customers that are denominated in British Pounds and Euros as the U.S. Dollar strengthened over the six months ended December 31, 2011 as compared to the six months ended December 31, 2010.

38 -------------------------------------------------------------------------------- Provision for Income Taxes Six Months Ended December 31, 2011 2010 % Change (dollars in thousands) Income before income taxes $ (5,609 ) $ 5,456 NM Provision for income taxes 1,075 653 65 % Effective tax rate (19 )% 12 % The provision for income taxes increased $0.4 million, primarily as a result of the increase in pre-tax income related to international operations and California taxes for the six months ended December 31, 2011 compared to the same period in the prior year. During the six months ended December 31, 2011, we recorded a provision for income taxes principally attributable to foreign taxes, U.S. federal taxes and California taxes.

We maintain a full valuation allowance on our federal and state deferred tax assets, and the significant components of the tax expense recorded are current cash taxes in various jurisdictions. The cash tax expenses are impacted by each jurisdiction's individual tax rates, laws on timing of recognition of income and deductions and availability of net operating losses and tax credits. In December 2011, we reorganized our international operations and established our non-U.S.

headquarters in the Netherlands, which has an effective tax rate that is lower than the U.S. federal statutory rate. Given the full valuation allowance, sensitivity of current cash taxes to local rules and our foreign restructuring, our effective tax rate fluctuates significantly on a quarterly basis and could be adversely affected to the extent earnings are lower than anticipated in countries that have lower statutory rates and higher than anticipated in countries that have higher statutory rates.

Comparison of Fiscal 2011 and 2010 Revenues Fiscal Year Ended June 30, 2011 2010 % Change (dollars in thousands) Revenues: Subscription $ 79,191 $ 40,078 98 % Professional services and other 13,450 3,251 314 % Total revenues $ 92,641 $ 43,329 114 % Percentage of revenues: Subscription 85 % 92 % Professional services and other 15 8 Total 100 % 100 % Revenues increased $49.3 million, primarily due to the increase in subscription revenues of $39.1 million. Of the total increase in subscription revenues, 46% represented revenues from new customers acquired after June 30, 2010, and 54% represented revenues from existing customers at or prior to June 30, 2010. Our total customers increased 68% from June 30, 2010 to June 30, 2011. The average subscription revenues per customer increased 19% over this period primarily due to an increase in the number of subscriptions sold to existing customers.

Of the $39.1 million total increase in subscription revenues for fiscal 2011, 87% represented sales to customers by our direct sales organization and 13% represented revenues from channel partners. Subscription revenues in North America represented 75% of the $39.1 million total increase in subscription revenues and 25% represented subscription revenues outside North America.

The increase in professional services and other revenues of $10.2 million was primarily due to the prospective adoption of new revenue accounting guidance resulting in an increase to professional services and other revenues of $5.5 million in fiscal 2011. The remaining increase of $4.7 million was attributable to the growth in our customer base. Revenues in North America represented 83% of the $10.2 million total increase in professional services and other revenues.

Revenues outside North America represented 17% of the $10.2 million total increase in professional services and other revenues. The increase in subscription revenues outside North America was due primarily to increased adoption of our subscription service through sales from new 39 --------------------------------------------------------------------------------channel partners and to a lesser extent, sales by our existing channel partners and the expansion of our direct sales organization. During fiscal 2011, we opened additional sales and marketing offices in Australia and the Netherlands.

Cost of Revenues and Gross Profit Percentage Fiscal Year Ended June 30, 2011 2010 % Change (dollars in thousands) Cost of revenues: Subscription $ 15,311 $ 6,378 140 % Professional services and other 16,264 9,812 66 % Total cost of revenues $ 31,575 $ 16,190 95 % Gross profit percentage: Subscription 81 % 84 % Professional services and other (21 ) (202 ) Total gross profit percentage 66 % 63 % Gross profit $ 61,066 $ 27,139 125 % Headcount (at period end): Subscription 83 30 177 % Professional services and other 67 36 86 % Total headcount 150 66 127 % Cost of subscription revenues increased $8.9 million during fiscal 2011 as compared to the same period in the prior year. The overall increase in cost of subscription revenues was primarily attributed to increased personnel-related expenses of $5.0 million, consisting of increased employee compensation, benefits and travel expenses of $4.5 million and additional stock-based compensation of $0.5 million. These personnel-related expenses increases were driven by headcount. In addition, hosting fees for our network infrastructure increased $2.1 million as we increased data center capacity to support our growth. At June 30, 2011, we delivered our service from six data centers in North America and five data centers internationally compared to three data centers in the United States and five data centers internationally at June 30, 2010. Depreciation expense also increased $0.8 million as we started the transition of our network infrastructure from a managed service hosting model to a co-location model.

Our subscription gross profit percentage decreased from 84% to 81% from fiscal 2010 to fiscal 2011 primarily due to these increased expenses.

Cost of professional services and other revenues increased $6.5 million during fiscal 2011 as compared to the same period in the prior year. The overall increase in cost of professional services and other revenues was primarily attributed to increased employee compensation, benefits and travel expenses of $3.1 million driven by headcount growth. In addition, outside services expenses increased $3.1 million primarily due to additional fees paid to third parties to provide implementation services.

Our professional services and other gross profit percentage improved from (202)% to (21)% from fiscal 2010 to fiscal 2011, primarily due to increased revenues as a result of the prospective adoption of new revenue recognition accounting guidance. This guidance enabled us to recognize professional services revenues as the services are delivered.

Sales and Marketing Fiscal Year Ended June 30, 2011 2010 % Change (dollars in thousands) Sales and marketing $ 34,123 $ 19,334 76 % Percentage of revenues 37 % 45 % Headcount (at period end) 140 72 94 % 40-------------------------------------------------------------------------------- Sales and marketing expenses increased $14.8 million. Employee-related expenses increased $13.3 million, consisting of increased employee compensation, benefits and travel expenses in connection with our direct sales force of $11.5 million, increased commissions of $1.1 million, and an increase in stock-based compensation of $0.7 million, which was primarily driven by an increase in sales and marketing headcount. In addition, we incurred an increase of $2.7 million in marketing and event expenses primarily attributable to our annual Knowledge conference, which experienced a 107% increase in attendance year-over-year.

Offsetting these increases was a decrease of $2.0 million in compensation expenses related to the fiscal 2010 repurchase of shares from eligible stockholders in connection with our sale and issuance of Series D preferred stock. Please see Note 9 to our consolidated financial statements for further explanation of this transaction.

Research and Development Fiscal Year Ended June 30, 2011 2010 % Change (dollars in thousands) Research and development $ 7,004 $ 7,194 (3 )% Percentage of revenues 8 % 17 % Headcount (at period end) 44 28 57 % Research and development expenses decreased $0.2 million. Personnel-related costs increased $2.8 million, consisting of increased employee compensation, benefits and travel expenses of $2.4 million and increased stock-based compensation of $0.4 million, which was primarily driven by an increase in research and development headcount. In addition, outside services expenses increased $0.4 million. Offsetting these increases was a decrease of $3.6 million in compensation expenses related to the fiscal 2010 repurchase of shares from eligible stockholders in connection with our sale and issuance of Series D preferred stock.

General and Administrative Fiscal Year Ended June 30, 2011 2010 % Change (dollars in thousands) General and administrative $ 9,379 $ 28,810 (67 )% Percentage of revenues 10 % 66 % Headcount (at period end) 41 12 242 % General and administrative expenses decreased $19.4 million. Personnel-related expenses increased $3.3 million, consisting of increased employee compensation, benefits and travel costs of $2.6 million and increased stock-based compensation of 0.7 million primarily driven by an increase in general and administrative headcount. Professional and outside service costs, comprised primarily of legal and accounting and auditing fees, increased $1.1 million. Offsetting these increases was a decrease of $24.5 million in compensation expenses related to the fiscal 2010 repurchase of shares from eligible stockholders in connection with our sale and issuance of Series D preferred stock.

Interest and Other Income (Expense), net Fiscal Year Ended June 30, 2011 2010 % Change (dollars in thousands) Interest and other income (expense), net $ 606 $ (1,226 ) NM Percentage of revenues - (3 )% The increase in interest and other income (expense), net of $1.8 million is due to losses on foreign currency transactions of $0.6 million during fiscal 2011 as compared to realized and unrealized gains of $0.5 million during fiscal 2010.

Additionally, 41 --------------------------------------------------------------------------------during fiscal 2010, we marked to market our preferred stock warrants and revalued them upon settlement as part of the sale and issuance of Series D preferred stock, resulting in additional expense of $0.7 million.

Provision for Income Taxes Fiscal Year Ended June 30, 2011 2010 % Change (dollars in thousands) Income before income taxes $ 11,166 $ (29,425 ) NM Provision for income taxes 1,336 280 377 % Effective tax rate 12 % (1 )% The provision for income taxes increased $1.1 million primarily as a result of the increase in pre-tax income related to international operations and California taxes.

We maintain a full valuation allowance on our U.S. federal and state deferred tax assets, and the significant components of the tax expense recorded are current cash taxes in various jurisdictions. The cash tax expenses are impacted by each jurisdiction's individual tax rates, laws on timing of recognition of income and deductions and availability of net operating losses and tax credits.

Given the full valuation allowance and sensitivity of current cash taxes to local rules, our effective tax rate fluctuates significantly on an annual basis and could be adversely affected to the extent earnings are lower than anticipated in countries that have lower statutory rates and higher than anticipated in countries that have higher statutory rates.

Quarterly Results of Operations The following table set forth our quarterly consolidated statements of operations. We have prepared the quarterly data on a consistent basis with the audited consolidated financial statements included in this Annual Report on Form 10-K. In the opinion of management, the financial information reflects all necessary adjustments, consisting only of normal recurring adjustments, necessary for a fair presentation of this data. This information should be read in conjunction with the audited consolidated financial statements and related notes included in this Annual Report on Form 10-K. The results of historical periods are not necessarily indicative of the results of operations for a full year or any future period.

42-------------------------------------------------------------------------------- For the Three Months Ended Dec 31, Sep 30, June 30, March 31, Dec 31, Sep 30, June 30, March 31, 2012 2012 2012 2012 2011 2011 2011 2011 (in thousands, except per share data) Revenues: Subscription $ 62,886 $ 55,279 $ 46,820 $ 39,541 $ 34,555 $ 30,331 $ 24,776 $ 21,224 Professional services and other 12,276 9,066 9,954 7,890 4,623 3,866 4,709 3,988 Total revenues 75,162 64,345 56,774 47,431 39,178 34,197 29,485 25,212 Cost of revenues(1): Subscription 20,076 17,931 14,239 11,012 8,750 6,323 4,764 4,451 Professional services and other 12,232 9,643 8,652 10,224 7,241 5,609 4,723 4,763 Total cost of revenues 32,308 27,574 22,891 21,236 15,991 11,932 9,487 9,214 Gross profit 42,854 36,771 33,883 26,195 23,187 22,265 19,998 15,998 Operating expenses: Sales and marketing 29,481 28,140 26,909 19,307 18,521 13,980 12,086 8,309 Research and development 13,235 10,783 9,272 6,043 4,273 2,757 2,361 1,885 General and administrative 9,676 11,195 6,819 6,427 5,575 4,509 3,282 2,680 Total operating expenses 52,392 50,118 43,000 31,777 28,369 21,246 17,729 12,874 Income (loss) from operations (9,538 ) (13,347 ) (9,117 ) (5,582 ) (5,182 ) 1,019 2,269 3,124 Interest and other income (expense), net 456 615 41 492 (717 ) (729 ) 65 252 Income (loss) before provision for income taxes (9,082 ) (12,732 ) (9,076 ) (5,090 ) (5,899 ) 290 2,334 3,376 Provision for income taxes 849 321 (352 ) 550 906 169 298 385 Net income (loss) $ (9,931 ) $ (13,053 ) $ (8,724 ) $ (5,640 ) $ (6,805 ) $ 121 $ 2,036 $ 2,991 Net income (loss) per share attributable to common stockholder - Basic $ (9,931 ) $ (13,053 ) $ (8,878 ) $ (5,794 ) $ (6,960 ) $ (36 ) $ 358 $ 516 Net income (loss) per share attributable to common stockholder - Diluted $ (9,931 ) $ (13,053 ) $ (8,878 ) $ (5,794 ) $ (6,960 ) $ (10 ) $ 491 $ 716 Basic $ (0.08 ) $ (0.11 ) $ (0.32 ) $ (0.23 ) $ (0.32 ) $ - $ 0.02 $ 0.03 Diluted $ (0.08 ) $ (0.11 ) $ (0.32 ) $ (0.23 ) $ (0.32 ) $ - $ 0.02 $ 0.03 Seasonality, Cyclicality and Quarterly Trends We have historically experienced seasonality in terms of when we enter into customer agreements for our service. We sign a significantly higher percentage of agreements with new customers, as well as renewal agreements with existing customers, in the quarters ended June 30 and December 31. The increase in customer agreements for the quarters ended June 30 is primarily as 43 -------------------------------------------------------------------------------- a result of the historical terms of our commission plans to incentivize our direct sales force to meet their quotas by June 30, our prior fiscal year end.

The increase in customer agreements for the quarter ended December 31 can be attributed to large enterprise account buying patterns typical in the software industry. Furthermore, we usually sign a significant portion of these agreements during the last month, and often the last two weeks, of each quarter. This seasonality is reflected to a much lesser extent, and sometimes is not immediately apparent, in our revenues, due to the fact that we recognize subscription revenues over the term of the license agreement, which is generally 12 to 36 months. As a result of the change in our fiscal year end from June 30 to December 31 and changes to our commission plans to provide for earlier incentives, we may not see the same seasonality pattern for future quarters ended June 30. Although these seasonal factors are common in the technology industry, historical patterns should not be considered a reliable indicator of our future sales activity or performance.

Our revenues have increased over the periods presented due to increased sales to new customers, as well as upsells to existing customers. Our operating expenses have increased sequentially in every quarter primarily due to increases in headcount and other related expenses to support our growth. We anticipate these expenses will continue to increase in future periods as we continue to focus on investing in the long-term growth of our business.

Beginning in the quarter ended September 30, 2011, we accelerated investments in our headcount and infrastructure to drive our future growth. As a result, we generated net losses for each of the quarters in the period from the three months ended December 31, 2011 through the three months ended December 31, 2012 despite significant revenue growth in the period.

Liquidity and Capital Resources Six Months Ended Year Ended December 31, December 31, Fiscal Year Ended June 30, 2012 2011 2011 2010 2011 2010 (dollars in thousands) Net cash provided by (used in) operating activities $ 48,766 $ 39,977 $ 13,220 $ 10,711 $ 37,468 $ (7,532 ) Net cash used in investing activities (239,149 ) (14,485 ) (7,959 ) (1,857 ) (8,383 ) (1,455 ) Net cash provided by financing activities 241,839 3,159 2,154 222 1,227 30,672 Net increase in cash and cash equivalents, net of impact of exchange rates on cash 50,901 29,631 8,235 9,055 30,451 21,614 To date, we have funded our business primarily with cash flows from operating activities and the net proceeds from our two public offerings. At December 31, 2012, we had $119.0 million in cash and cash equivalents, of which $7.7 million represented cash located overseas. We also had $195.7 million in short-term investments consisting of commercial paper, corporate debt securities and U.S.

government agency securities.

Our historical cash flows from operating activities have been significantly impacted by customer billings and payment terms, as well as operating expenses related to sales and marketing, research and development, and expenses related to our cloud infrastructure and professional services.

Based on our current level of operations and anticipated growth, we believe our current cash, cash equivalents and short term investments, and cash flows from operating activities will be sufficient to fund our operating needs for at least the next 12 months, barring unforeseen circumstances.

In 2013, we expect to reinvest our cash flows from operations back into the business to support our growth. Our primary short-term needs for cash, which are subject to change, include expenditures related to the growth of our sales and marketing and cloud infrastructure organizations, including the expansion of data centers, and the acquisition of fixed assets and investments in office facilities to accommodate our growth. We made capital expenditures of $42.1 million in the year ended December 31, 2012 and anticipate increasing capital expenditures in 2013, primarily related to investments in our cloud infrastructure and facilities build-outs to accommodate our growth. In 2013, we expect our cash flows from operations less capital expenditures to be relatively flat compared to 2012.

Our short-term needs for cash also include expenditures related to: • the growth of our sales and marketing and professional services efforts; 44 -------------------------------------------------------------------------------- • support of our sales and marketing efforts related to our current and future services and applications, including expansion of our direct sales force and support resources both in the United States and abroad; • the continued advancement of research and development; and • the expansion and buildout of our facilities, including costs of leasing additional facilities.

To the extent existing cash and cash equivalents, short-term investments and cash from operations are not sufficient to fund our future activities, we may need to raise additional funds. Although we are not currently a party to any agreement or letter of intent with respect to potential investments in, or acquisitions of, complementary businesses, services or technologies, we may enter into these types of arrangements in the future, which could also require us to seek additional equity financing or use our cash resources. We have no present understandings, commitments or agreements to enter into any such acquisitions.

Depending on certain growth opportunities, we may choose to accelerate investments in sales and marketing, cloud infrastructure, professional services, and research and development, which may require the use of proceeds from our public offerings.

Operating Activities Net cash provided by operating activities in the year ended December 31, 2012 was $48.8 million, reflecting our net loss of $37.3 million, adjusted by non-cash charges including $27.9 million for stock-based compensation, $13.7 million for the amortization of deferred commissions, $13.5 million for depreciation and amortization and $2.5 million for lease abandonment costs, and non-cash benefits including $1.7 million tax benefit from exercise of stock options and changes in our operating assets and liabilities. Our overall net change in operating assets and liabilities was primarily comprised of an increase of $64.8 million in deferred revenue, a $22.9 million increase in accrued liabilities, an increase of $4.2 million in other long-term liabilities, and an increase of $4.9 million in accounts payable, partially offset by a $33.3 million increase in accounts receivable, a $29.2 million increase in deferred commissions, a $2.5 million increase in prepaid expenses and other current assets and a $2.2 million decrease in deferred rent. The increases in deferred revenue, deferred commissions and accounts receivable were primarily due to increased sales in the year ended December 31, 2012. The increase in accrued liabilities, accounts payable and prepaid expenses are due to the growth of our business and increased headcount of 79% during the year ended December 31, 2012.

The decrease in deferred rent is offset by the increase in other long-term liabilities related to the relocation of our San Diego office to another facility in San Diego in August 2012.

Net cash provided by operating activities in the year ended December 31, 2011 was $40 million, reflecting our net loss of $1.7 million, adjusted by non-cash charges including $7.5 million for stock-based compensation, $5.9 million for the amortization of deferred commissions, and $3.0 million for depreciation, and changes in our operating assets and liabilities. The fluctuations in our operating assets and liabilities were primarily attributed to an increase of $51.3 million in deferred revenue, $10.8 million increase in accrued liabilities, $3.1 million increase in deferred rent and $2.6 million increase in accounts payable partially offset by an increase of $27.5 million in accounts receivable, $11.7 million increase in deferred commissions and $3.7 million increase in prepaid expenses and other current assets. The increase in deferred revenue, accounts receivable and deferred commissions was primarily due to increased sales. The increase in deferred rent, accrued liabilities, accounts payable and prepaid expenses was primarily due to the growth of our business, increased headcount and the resulting move of our San Diego office to a new building during the period. Our total headcount increased 141% during the year ended December 31, 2011.

Net cash provided by operating activities in the six months ended December 31, 2011 reflected our net loss of $6.7 million, adjusted by non-cash charges including $5.6 million for stock-based compensation, $3.5 million for amortization of deferred commissions and $2.0 million for depreciation, and changes in our operating assets and liabilities. The fluctuations in our operating assets and liabilities were primarily attributed to a $30.0 million increase in deferred revenue and a $6.9 million increase in accrued liabilities, partially offset by a $20.4 million increase in accounts receivable and an $8.3 million increase in deferred commissions. The increase in deferred revenue, accounts receivable and deferred commissions was primarily due to increased sales. Our sales and marketing headcount increased 73% during the six months ended December 31, 2011. The increase in accrued liabilities was due to the growth in our business and increased headcount.

Net cash provided by operating activities in the six months ended December 31, 2010 reflected our net income of $4.8 million and changes in our working capital. The fluctuations in our operating assets and liabilities were primarily attributed to a $12.6 million increase in deferred revenue, partially offset by a $7.6 million increase in accounts receivable. The increase in deferred revenue and accounts receivable was primarily due to increased sales.

Net cash provided by operating activities in fiscal 2011 reflected our net income of $9.8 million, adjusted by non-cash charges including $4.0 million for the amortization of deferred commissions and $3.0 million for stock-based compensation, and changes in our working capital. The fluctuations in our operating assets and liabilities were primarily attributed to a $33.9 million 45 -------------------------------------------------------------------------------- increase in deferred revenue, a $5.4 million increase in accrued liabilities and a $3.2 million increase in deferred rent, partially offset by a $14.8 million increase in accounts receivable and a $5.6 million increase in deferred commissions. The increase in deferred revenue, accounts receivable and deferred commissions was primarily due to increased sales in fiscal 2011. The increase in accrued liabilities and deferred rent was primarily due to the growth of our business and the move of our San Diego office to a new building during the period.

Net cash used in operating activities in fiscal 2010 reflected our net loss of $29.7 million, which included non-cash compensation expense of $30.8 million related to the premium paid to eligible stockholders for the repurchase of common stock in connection with the sale of Series D preferred stock, and the changes in our operating assets and liabilities. The fluctuations in our working capital were primarily attributed to a $24.0 million increase in deferred revenue and an $8.9 million increase in accrued liabilities, partially offset by a $5.3 million increase in deferred commissions, a $5.2 million increase in accounts receivable and a $4.9 million increase in prepaid expenses and other current assets. The increase in accrued liabilities included $4.5 million in withholding taxes associated with the repurchase of our founder's shares as part of the sale and issuance Series D preferred stock, with a corresponding offset of $4.5 million for a receivable in prepaid expenses and other current assets owed to us by our founder. The remaining increase to accrued liabilities was due to the increase in headcount.

Investing Activities In the year ended December 31, 2012, cash used in investing activities was primarily attributed to the purchase of $240.6 million in short-term investments offset by maturities of $42.5 million. In addition, we paid cash for capital expenditures of $42.1 million primarily related to the purchase of servers, networking equipment and storage infrastructure to support the expansion of our data centers as well as investments in leasehold improvements and furniture and equipment to support our headcount growth. We expect these investments to continue in 2013.

In the year ended December 31, 2011, the six months ended December 31, 2011 and 2010, and fiscal 2011 and 2010, our investing activities primarily consisted of capital expenditures related to the purchase of servers, networking equipment and storage infrastructure to support the expansion of our data centers and tenant improvements associated with the growth of our office facilities.

Financing Activities Our financing activities have primarily consisted of equity issuances, including excess tax benefits from stock award activities.

In the year ended December 31, 2012, cash provided by financing activities primarily consisted of initial public offering proceeds of $169.8 million, net of paid underwriter discounts, commissions and issuance costs, follow-on offering proceeds of $50.6 million, net of paid underwriter discounts, commissions and issuance costs, $17.8 million in gross proceeds from the issuance of 1,750,980 shares of common stock at a price of $10.20 per share through a private placement with a new stockholder and $3.9 million in proceeds from the issuance of common stock through the exercise and early exercise of employee stock options. These increases in cash were slightly offset by purchases of common stock and restricted stock from stockholders of $2.0 million.

In the year ended December 31, 2011, cash provided by financing activities primarily consisted of $3.1 million in proceeds from the issuance of common stock through the exercise and early exercise of employee stock options.

In the six months ended December 31, 2011, cash provided by financing activities primarily consisted of $2.1 million in proceeds from the issuance of common stock through the exercise and early exercise of employee stock options.

In the six months ended December 31, 2010, we had no significant financing activities.

In fiscal 2011, cash provided by financing activities primarily consisted of $1.1 million in proceeds from the issuance of common stock through the exercise and early exercise of employee stock options.

In fiscal 2010, we received net proceeds of $51.2 million from the sale and issuance of Series D preferred stock, which was used to repurchase and subsequently cancel shares of common stock from eligible stockholders and warrants to purchase Series B preferred stock from a warrant holder.

Contractual Obligations and Commitments Contractual obligations represent future cash commitments and liabilities under agreements with third parties, and exclude orders for goods and services entered into in the normal course of business that are not enforceable or legally binding.

46 --------------------------------------------------------------------------------The following table represents our known contractual obligations as of December 31, 2012, aggregated by type: Payments Due by Period Less More Than 1 - 3 3 - 5 Than Contractual Obligations Total 1 Year Years Years 5 Years (in thousands) Operating leases: Data centers(1) $ 13,077 $ 7,474 $ 5,603 $ - $ -Facilities space(2) 98,213 6,251 21,759 22,776 47,427 Total operating leases $ 111,290 $ 13,725 $ 27,362 $ 22,776 $ 47,427 (1) Operating leases for data centers represent our principal commitment for co-location facilities for data center capacity.

(2) Operating leases for facilities space represents our principal commitments, which consists of obligations under leases for office space. Lease commitments of $9.9 million related to the lease for our former San Diego office are also included in the table above.

In addition to the obligations in the table above, approximately $0.9 million of unrecognized tax benefits have been recorded as liabilities as of December 31, 2012. It is uncertain as to if or when such amounts may be settled. We have also recorded a liability for potential penalties of $0.2 million and interest of $0.1 million related to these unrecognized tax benefits.

Off-Balance Sheet Arrangements During all periods presented, we did not have any relationships with unconsolidated entities or financial partnerships, such as entities often referred to as structured finance or special purpose entities, which would have been established for the purpose of facilitating off-balance sheet arrangements or other contractually narrow or limited purposes. As such, we are not exposed to any financing, liquidity, market or credit risk that could arise if we had engaged in those types of relationships.

Critical Accounting Policies and Significant Judgments and Estimates Our management's discussion and analysis of financial condition and results of operations is based on our consolidated financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States. The preparation of these consolidated financial statements requires us to make estimates and assumptions that affect the reported amounts of assets and liabilities and the disclosure of contingent assets and liabilities at the date of the consolidated financial statements, as well as the reported revenues and expenses during the reporting periods. These items are monitored and analyzed by us for changes in facts and circumstances, and material changes in these estimates could occur in the future. We base our estimates on historical experience and on various other factors that we believe are reasonable under the circumstances, the results of which form the basis for making judgments about the carrying value of assets and liabilities that are not readily apparent from other sources. Changes in estimates are reflected in reported results for the period in which they become known. Actual results may differ from these estimates under different assumptions or conditions.

While our significant accounting policies are more fully described in Note 2 to our consolidated financial statements, we believe that the following accounting policies are critical to the process of making significant judgments and estimates in the preparation of our audited consolidated financial statements.

Revenue Recognition We commence revenue recognition when all of the following conditions are met: • There is persuasive evidence of an arrangement; • The service has been provided to the customer; • The collection of related fees is reasonably assured; and • The amount of fees to be paid by the customer is fixed or determinable.

Signed agreements are used as evidence of an arrangement. If a signed contract by the customer does not exist, we have historically used either a purchase order or a signed order form as evidence of an arrangement. In cases where both a signed contract and either a purchase order or signed order form exist, we consider the signed contract to be the final persuasive evidence of an arrangement.

47 -------------------------------------------------------------------------------- Subscription revenues are recognized ratably over the contract term beginning on the commencement date of each contract, which is the date we make our service available to our customers. Once our service is available to customers, amounts that have been invoiced are recorded in accounts receivable and in deferred revenue. Our professional services are priced either on a fixed-fee basis or on a time-and-materials basis. Professional services and other revenues are recognized as the services are delivered using a proportional performance model.

Such services are delivered over a short period of time. In instances where final acceptance of the services are required before revenues are recognized, professional services revenues and the associated costs are deferred until all acceptance criteria have been met.

We assess collectibility based on a number of factors such as past collection history and creditworthiness of the customer. If we determine collectibility is not reasonably assured, we defer revenue recognition until collectibility becomes reasonably assured. We assess whether the fee is fixed or determinable based on the payment terms associated with the transaction and whether the sales price is subject to refund or adjustment. Our arrangements do not include general rights of return.

We have multiple element arrangements comprised of subscription fees and professional services. In October 2009, the Financial Accounting Standards Board, or FASB, ratified authoritative accounting guidance regarding revenue recognition for arrangements with multiple deliverables effective for fiscal periods beginning on or after June 15, 2010. The guidance affects the determination of separate units of accounting in arrangements with multiple deliverables and the allocation of transaction consideration to each of the identified units of accounting. Previously, a delivered item was considered a separate unit of accounting when (i) it had value to the customer on a stand-alone basis, (ii) there was objective and reliable evidence of the fair value of the undelivered items, and (iii) there was no general right of return relative to the delivered services or the performance of the undelivered services was probable and substantially controlled by the vendor. The new guidance eliminates the requirement for objective and reliable evidence of fair value to exist for the undelivered items in order for a delivered item to be treated as a separate unit of accounting. The guidance also requires arrangement consideration to be allocated at the inception of the arrangement to all deliverables using the relative-selling-price method and eliminates the use of the residual method of allocation. Under the relative-selling-price method, the selling price for each deliverable is determined using vendor-specific objective evidence, or VSOE, of selling price or third-party evidence, or TPE, of selling price if VSOE does not exist. If neither VSOE nor TPE of selling price exists for a deliverable, the guidance requires an entity to determine the best estimate of selling price, or BESP.

Prior to the adoption of this authoritative accounting guidance, we did not have objective and reliable evidence of fair value for the items in our multiple element arrangements. As a result, we accounted for subscription and professional services revenues as one unit of account and recognized total contracted revenues ratably over the contracted term of the subscription agreement.

We adopted the new guidance on a prospective basis for fiscal 2011. As a result, this guidance was applied to all revenue arrangements entered into or materially modified since July 1, 2010. The following table summarizes the effects of this new guidance on our consolidated balance sheets and statements of comprehensive income (loss) (in thousands): As of and for the Fiscal Year Ended June 30, 2011 Under Previous Impact of As Accounting Adoption of Reported Guidance ASU 2009-13 Total deferred revenue $ 74,646 $ 81,036 $ (6,390 ) Revenues: Subscription $ 79,191 $ 78,305 $ 886 Professional services and other 13,450 7,946 5,504 Total revenues $ 92,641 $ 86,251 $ 6,390 Upon adoption of this authoritative accounting guidance, we have accounted for subscription and professional services revenues as separate units of accounting.

To qualify as a separate unit of accounting, the delivered item must have value to the customer on a standalone basis. Our subscription service has standalone value as it is routinely sold separately by us, we provide customers access to our subscription service at the beginning of the contract term, and our on-demand application is fully functional without any additional development, modification or customization. In determining whether professional services have standalone value, we consider the following factors for each professional services agreement: availability of the services from other vendors, the nature of the professional services, the timing of when the professional services contract was signed in comparison to the subscription service start date and the contractual dependence of the subscription service on the customer's satisfaction with the professional services work. Our professional services, including implementation and configuration services, are not so unique and complex that other vendors cannot provide them. In some instances, our customers independently contract with third-party vendors 48 -------------------------------------------------------------------------------- to do the implementation and we regularly outsource implementation services to contracted third-party vendors. As a result, we concluded professional services, including implementation and configuration services, also have standalone value.

We determine the selling price of each deliverable in the arrangement using the relative-selling price method based on the selling price hierarchy. The selling price for each unit of account is based on the BESP since VSOE and TPE are not available for our subscription service or professional services and other. The BESP for each deliverable is determined primarily by considering the historical selling price of these deliverables in similar transactions as well as other factors, including, but not limited to, market competition, review of stand-alone sales and pricing practices. The total arrangement fee for these multiple element arrangements is then allocated to the separate units of account based on the relative selling price. The method used to determine the BESP for our subscription service is consistent with the method used to determine prices for our services that are sold regularly on a standalone basis. In determining the appropriate pricing structure, we consider the extent of competitive pricing of similar products, marketing analyses and other feedback from analysts. We price our subscription service based on the number of users with a defined process role, according to a tiered structure. The BESP for our subscription service is based upon the historical selling price of these deliverables. Prior to December 2011, our professional services were priced on a fixed-fee basis as a percentage of the subscription fee. We also prepared a standard build-up cost analysis to estimate the fixed fee for our professional services based on the estimated level of effort to complete the professional services. If professional services were priced below the expected range due to discounting, fees allocated to professional services were limited to the amount not contingent upon the delivery of our subscription service. In December 2011, we began shifting our pricing model for professional services to a time-and-materials basis.

In limited circumstances, we grant certain customers the right to deploy our subscription service on the customers' own servers without significant penalty.

We have analyzed all of the elements in these particular multiple element arrangements and determined we do not have sufficient VSOE of fair value to allocate revenue to our subscription service and professional services. We defer all revenue under the arrangement until the commencement of the subscription service and any associated professional services. Once the subscription service and the associated professional services have commenced, the entire fee from the arrangement is recognized ratably over the remaining period of the arrangement.

Deferred Commissions We defer expenses associated with commission payments made to our direct sales force and referral fees paid to independent third-parties. The commissions are deferred and amortized to sales expense over the non-cancelable terms of the related contracts with our customers. The commission payments 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 preferable to expensing sales commissions as incurred because the commission charges are so closely related to revenues they should be recorded as an asset and charged to expense over the same period the revenues are recognized. Additionally, we believe this policy election enhances the comparability of our consolidated financial statements to those of other companies in our industry.

Stock-Based Compensation We measure compensation expense for all stock-based payments made to employees and directors based on the fair value of the award as of the date of grant. The expense is recognized, net of estimated forfeitures, over the requisite service period, which is generally the vesting period of the respective award. We estimate forfeitures based upon our historical experience. At each period end, we review the estimated forfeiture rate and make changes as factors affecting the forfeiture rate calculations and assumptions change. We use the Black-Scholes option-pricing model to determine the fair value of our stock-based awards.

Determining the fair value under this model requires the use of inputs that are subjective and generally require significant analysis and judgment to develop.

These inputs include the fair value of our common stock, expected volatility, expected term, risk-free interest rate, and expected dividend yield, which are estimated as follows: • Fair value of our common stock: Because our stock was not publicly traded prior to our initial public offering, we estimated the fair value of our common stock, as discussed in "Common Stock Valuations" below. Following our initial public offering in June 2012, our common stock was valued by reference to its publicly traded price.

• Expected volatility: We use the historic volatility of publicly traded peer companies as an estimate for our expected volatility. In considering peer companies, we assess characteristics such as industry, stage of development, size, and financial leverage. For each period, the peer group of publicly traded companies used to determine expected volatility was the same as the peer group used to determine the fair value of our common stock. We intend to continue to consistently apply this process using the same or similar public companies until a sufficient amount of historical information regarding the volatility of our own common stock share price becomes available.

49--------------------------------------------------------------------------------• Expected term: We estimate the expected term using the simplified method due to the lack of historical exercise activity for our company. The simplified method calculates the expected term as the mid-point between the vesting date and the contractual expiration date of the award.

• Risk-free interest rate: The risk-free interest rate is based on the U.S.

Treasury yield curve in effect at the time of grant for the expected term of the stock-based award.

• Dividend yield: Our expected dividend yield is zero, as we have not and do not currently intend to declare dividends in the foreseeable future.

If any assumptions used in the Black-Scholes model change significantly, stock-based compensation for future awards may differ materially compared with the awards granted previously.

Common Stock Valuations Prior to our initial public offering, the fair value of the common stock underlying our stock options was determined by our board of directors, which intended all options granted to be exercisable at a price per share not less than the per share fair value of our common stock underlying those options on the date of grant. The valuations of our common stock were determined in accordance with the guidelines outlined in the American Institute of Certified Public Accountants Practice Aid, Valuation of Privately-Held-Company Equity Securities Issued as Compensation. The assumptions we used in the valuation model were based on future expectations combined with management judgment. In the absence of a public trading market, our board of directors with input from management exercised significant judgment and considered numerous objective and subjective factors to determine the fair value of our common stock as of the date of each option grant, including the following factors: • contemporaneous independent valuations performed at periodic intervals; • the prices, rights, preferences and privileges of our convertible preferred stock relative to the common stock; • recent sales of our common stock; • our operating and financial performance and forecast; • current business conditions; • the hiring of key personnel; • our stage of development; • the likelihood of achieving a liquidity event for the shares of common stock underlying these stock options, such as an initial public offering or sale of our company, given prevailing market conditions; • any adjustment necessary to recognize a lack of marketability for our common stock; • the market performance of comparable publicly traded technology companies; • mergers and acquisition activity in our industry; and • the U.S. and global capital market conditions.

In order to determine the fair value of our common stock underlying award grants prior to our initial public offering, we considered contemporaneous valuations of our stock. We utilized the probability weighted expected return method, or PWERM, approach to allocate value to our common shares. The PWERM approach employs various market approach and income approach calculations depending upon the likelihood of various liquidation scenarios. For each of the various scenarios, an equity value is estimated and the rights and preferences for each stockholder class are considered to allocate the equity value to common shares.

The common share value is then multiplied by a discount factor reflecting the calculated discount rate and the timing of the event. Lastly, the common share value is multiplied by an estimated probability for each scenario. The probability and timing of each scenario were based upon discussions between our board of directors and our management team. Under the PWERM, the value of our common stock was based upon four possible future events for our company: • initial public offering, or IPO; • strategic merger or sale; • remaining a private company; and • dissolution.

50-------------------------------------------------------------------------------- The market approach uses similar companies or transactions in the marketplace.

We utilized the guideline company method of the market approach for determining the fair value of our common stock under the initial public offering scenario.

We identified companies similar to our business and used these guideline companies to develop relevant market multiples and ratios. We selected the peer group of companies based on their size, business model, industry, business description and developmental stage. While we believe that our proprietary platform to automate enterprise IT operations that we provide to our customers differentiates us from other software companies, we selected this peer group from publicly traded companies that are similarly viewed as being in the information technology industry and offering their services under a SaaS business model. We then applied these market multiples and ratios to our financial forecasts to create an indication of total equity value. Under the strategic merger or sale scenario, we utilized the guideline company method and the guideline transaction method of the market approach to determine the fair value of the common stock. The guideline transaction method compares the operating results and market value of the equity or invested capital of acquired companies similar to our business. The income approach, which we utilized to assess fair value of the common stock under the assumption we remained a private company, is an estimate of the present value of the future monetary benefits generated by an investment in that asset. Specifically, debt free cash flows and the estimated terminal value are discounted at an appropriate risk-adjusted discount rate to estimate the total invested capital value of the entity. Under the dissolution scenario, we assumed no value remained to be allocated to our common stockholders. We continually reviewed and updated the selection of companies in the peer group of publicly traded companies to better reflect the size and developmental stage of our company and to account for the acquisition of certain of the peer companies.

Stock Options and RSUs Granted Subsequent to our Initial Public Offering For stock options and RSUs granted subsequent to our initial public offering, our board of directors determined the fair value based on the closing price of our common stock as reported on the New York Stock Exchange on the date of grant.

Income Taxes Our provision for income taxes, deferred tax assets and liabilities, and reserves for unrecognized tax benefits reflect our best assessment of estimated future taxes to be paid. Significant judgments and estimates based on interpretations of existing tax laws or regulations in the United States and the numerous foreign jurisdictions where we are subject to income tax are required in determining our provision for income taxes. Changes in tax laws, statutory tax rates, and estimates of our future taxable income could impact the deferred tax assets and liabilities provided for in the consolidated financial statements and would require an adjustment to the provision for income taxes.

Deferred tax assets are regularly assessed to determine the likelihood they will be recovered from future taxable income. A valuation allowance is established when we believe it is more likely than not the future realization of all or some of a deferred tax asset will not be achieved. In evaluating our ability to recover deferred tax assets within the jurisdiction in which they arise we consider all available positive and negative evidence. Factors reviewed include the cumulative pre-tax book income for the past three years, scheduled reversals of deferred tax liabilities, our history of earnings and reliable forecasting, projections of pre-tax book income over the foreseeable future, and the impact of any feasible and prudent tax planning strategies.

We recognize the impact of a tax position in our consolidated financial statements only if that position is more likely than not of being sustained upon examination by taxing authorities, based on the technical merits of the position. Tax authorities regularly examine our returns in the jurisdictions in which we do business and we regularly assess the tax risk of our return filing positions. Due to the complexity of some of the uncertainties, the ultimate resolution may result in payments that are materially different from our current estimate of the tax liability. These differences, as well as any interest and penalties, will be reflected in the provision for income taxes in the period in which they are determined.

Cease-Use Loss upon Exit of Facility In August 2012, we relocated our San Diego office to another facility in San Diego. As part of this move, we incurred lease abandonment costs of $2.5 million, which primarily consists of a loss on disposal of assets and a cease-use loss recorded upon vacating our prior San Diego office. The lease on our prior headquarters facility expires in 2019. The cease-use loss was calculated as the present value of the remaining lease obligation offset by estimated sublease rental receipts during the remaining lease period, adjusted for deferred items and lease incentives. In calculating the cease-use loss, management is required to make significant judgments to estimate the present value of future cash flows from the assumed sublease. The key assumptions used in our discounted cash flow model include the amount and timing of estimated sublease rental receipts, and a credit-adjusted, risk-free discount rate of 5.08%. These assumptions are subjective in nature and the actual future cash flows could differ from our estimates, resulting in significant adjustments to the cease-use loss recorded or to be recorded.

51 --------------------------------------------------------------------------------Recent Accounting Pronouncements In February 2013, the FASB issued new disclosure guidance related to the presentation of the Statement of Comprehensive Income. This guidance requires the disclosure of the effect of significant amounts reclassified from each component of accumulated other comprehensive income based on its source and the income statement line items affected by the reclassification. We will adopt this accounting standard upon its effective date for periods beginning on or after December 15, 2012, and this adoption will not have any impact on our financial position or results of operations.

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