News Column

CORNERSTONE ONDEMAND INC - 10-K - Management's Discussion and Analysis of Financial Condition and Results of Operations

February 26, 2014

The following discussion of our financial condition and results of operations should be read together with the financial statements and the related notes set forth in Item 8. "Financial Statements and Supplementary Data." The following discussion also contains forward-looking statements that involve a number of risks and uncertainties. See Part I, "Special Note Regarding Forward-Looking Statements" for a discussion of the forward-looking statements contained below and Part I, Item 1A. "Risk Factors" for a discussion of certain risks that could cause our actual results to differ materially from the results anticipated in such forward-looking statements. Overview We are a leading global provider of comprehensive talent management solutions delivered as software-as-a-service, or SaaS. We enable organizations to meet the challenges they face in empowering their people and maximizing the productivity of their human capital. These challenges include hiring and developing employees throughout their careers, engaging all employees effectively, improving business execution, cultivating future leaders and enabling an organization's extended enterprise of clients, vendors and distributors by delivering training, certification programs and other content. Our core solution is a comprehensive and integrated cloud-based suite consisting of four integrated clouds for recruiting, learning, performance, and extended enterprise. Clients can purchase these clouds individually and easily add and integrate additional clouds at any time. We offer a number of cross-cloud tools for analytics and reporting, employee profile management, employee on-boarding and e-learning content aggregation. We also provide consulting services for configuration and training for our core solution as well as third-party e-learning content for use with the solution. We target our sales and marketing efforts for these four integrated clouds to large and mid-sized clients with 400 or more employees, and our core solution can be used in multiple industry vertical segments. After the initial purchase of our core solution, we continue to market and sell to our existing clients, who may renew their subscriptions, add additional clouds, broaden the deployment of the solution across their organizations and increase usage of the solution over time. We currently have over 1,600 clients who use our core solution to empower more than 14 million users across 191 countries and 41 languages. For 2013 and 2012, no single client or distributor accounted for more than 10% of our revenue. The number of clients using our core solution has grown from 105 at December 31, 2007 to 805 at December 31, 2011 to 1,237 at December 31, 2012 and to 1,631 at December 31, 2013. In addition to our core solution, we also offer Cornerstone Small Business, or CSB, a cloud-based talent management solution that is targeted to clients with less than 400 employees. We also offer Cornerstone for Salesforce, a 39 -------------------------------------------------------------------------------- cloud-based talent management solution developed natively on the Salesforce.com platform, which allows organizations to provide seamless access to sales enablement and just-in-time training from within the Salesforce.com platform. We currently do not include the number of clients and users of our CSB and Cornerstone for Salesforce solutions in our client and user key metrics as we believe the client and user count metrics for our core solution gives a better indication of our overall performance. We generate most of our revenue from the sale of our solutions pursuant to multi-year client agreements. Our sales processes are typically competitive, and sales cycles generally vary in duration from two to nine months depending on the size of the potential client. We price our core solution based on the number of clouds purchased and the permitted number of users with access to each cloud. Client agreements for our core solution typically have terms of three years. We also generate revenue from consulting services for configuration, training, and consulting, as well as from the resale or hosting of third-party e-learning content. We sell our solutions through our direct sales teams and, to a lesser extent, indirectly through our distributors. We intend to continue to invest in our direct sales and distribution activities to address our market opportunity. We generally recognize revenue from subscriptions ratably over the term of the client agreement and revenue from consulting services as the services are performed. In certain instances, our clients request enhancements to the underlying features and functionality of our core solution, and in these instances, revenue from subscriptions is recognized over the remaining term of the agreement once the additional features are delivered to the client. We generally invoice our clients a portion of the annual subscription fees upfront for multi-year subscriptions and upfront for consulting services. For amounts not invoiced in advance for multi-year subscriptions or consulting services, we invoice under various terms over the subscription and service periods. We record amounts invoiced for annual subscription periods that have not occurred or services that have not been performed as deferred revenue on our balance sheet. With the growth in the number of clients, our revenue has grown to $185.1 million for the year ended December 31, 2013 from $117.9 million for the same period in 2012. We have historically experienced seasonality in terms of when we enter into client agreements. We sign a significantly higher percentage of agreements with new clients, as well as renewal agreements with existing clients, in the fourth quarter of each year. In addition, within a given quarter, we sign a large portion of these agreements during the last month, and often the last two weeks, of that quarter. We believe this seasonality is driven by several factors, most notably the tendency of procurement departments at our enterprise clients to purchase technology at the end of a quarter or calendar year, possibly in order to use up their available quarterly or annual funding allocations, or to be able to deploy new talent management capabilities prior to the beginning of a new financial or performance period. As the terms of most of our client agreements are measured in full year increments, agreements initially entered into the fourth quarter or last month of any quarter will generally come up for renewal at that same time in subsequent years. This seasonality is reflected to a much lesser extent, and sometimes is not immediately apparent, in our revenue, due to the fact that we recognize subscription revenue over the term of the client agreement, which is generally three years. In addition, this seasonality is reflected in changes in our deferred revenue balance, which generally is impacted by the timing of when we enter into agreements with new clients, the timing of when we invoice new clients, the timing of when we invoice existing clients for annual subscription periods, and the timing of when we recognize revenue. We expect this seasonality to continue in the future, which may cause fluctuations in certain of our operating results and financial metrics, and thus limit our ability to predict future results. We believe the market for talent management remains large and underpenetrated, providing us with significant growth opportunities. We expect businesses and other organizations to continue to increase their spending on talent management solutions in order to maximize the productivity of their employees, manage changing workforce demographics and ensure compliance with global regulatory requirements. Historically, many of these software solutions have been human resource applications running on hardware located on organizations' premises. However, we believe that just as organizations have increasingly chosen SaaS solutions for business applications such as sales force management, they are also increasingly adopting SaaS talent management solutions. We have focused on growing our business to pursue what we believe is a significant market opportunity, and we plan to continue to invest in building for growth. As a result, we expect our cost of revenue and operating expenses to increase in future periods. Sales and marketing expenses are expected to increase, as we continue to expand our direct sales teams, increase our marketing activities, and grow our international operations. Research and development expenses are expected to increase as we continue to improve the existing functionality for our solutions. We also believe that we must invest in maintaining a high degree of client service and support that is critical for our continued success. We plan to continue our policy of implementing best practices across our organization, expanding our technical operations and investing in our network infrastructure and services capabilities in order to support continued future growth. We also 40 -------------------------------------------------------------------------------- expect to incur additional general and administrative expenses as a result of our growth. In addition, to the extent that we make additional strategic acquisitions in the future, like our acquisition of Sonar, our investments in operations may increase. Our operating results have fluctuated in the past and may continue to fluctuate in the future based on a number of factors, many of which are beyond our control. In addition to those in the "Risk Factors" section of this Annual Report on Form 10-K, such factors include: our ability to attract new clients;



the timing and rate at which we enter into agreements for our solutions

with new clients;

the timing and duration of our client implementations, which is often

outside of our direct control, and our ability to provide resources for

client implementations and consulting projects;

the extent to which our existing clients renew their subscriptions for our

solutions and the timing of those renewals;

the extent to which our existing clients purchase additional clouds or add

incremental users;

the extent to which our clients request enhancements to underlying features

and functionality of our solutions and the timing for us to deliver the enhancements to our clients;



changes in the mix of our sales between new and existing clients;

changes to the proportion of our client base that is comprised of enterprise or mid-sized organizations;



seasonal factors affecting the demand for our solutions;

the timing of our client implementations;

our ability to manage growth, including in terms of new clients, additional

users and new geographies;

the timing and success of competitive solutions offered by our competitors;

changes in our pricing policies and those of our competitors; and

general economic and market conditions.

One or more of these factors may cause our operating results to vary widely. As such, we believe that our results of operations may vary significantly in the future and that period-to-period comparisons of our operating results may not be meaningful and should not be relied upon as an indication of future performance. Metrics We regularly review a number of metrics, including the following key metrics, to evaluate our business, measure our performance, identify trends affecting our business, formulate financial projections and make strategic decisions. Revenue. We generally recognize subscription revenue over the contract



period, and as a result of our revenue recognition policy and the

seasonality of when we enter into new client agreements, revenue from

client agreements signed in the current period may not be fully reflected

in the current period. As a result, revenue increases period over period

are primarily from contracts that existed prior to the beginning of that period. Gross revenue in the year ended December 31, 2011, excludes the



impact of a non-cash reduction of revenue related to a common stock warrant

issued to ADP of $2.5 million. Net revenue for the year ended December 31,

2011 was impacted by this non-cash reduction of revenue. There were no such

reductions of revenue in the years ended December 31, 2013 and 2012, and as

such, net revenue was equal to gross revenue for those periods.

Bookings. Under our revenue recognition policy, we generally recognize

subscription revenue from our client agreements ratably over the terms of

those agreements. For this reason, the major portion of our revenue for a

period will be from client agreements signed in prior periods rather than

from new business activity during the current period. In order to assess

our business performance with a metric that more fully reflects current

period business activity, we track bookings, which is a non-GAAP financial

measure we define as the sum of revenue and the change in the deferred

revenue balance for the period. We include changes in the deferred revenue

balance to calculate bookings so it better reflects new business activity

in the period as evidenced by prepayments or billings under our billing

policies arising from acquisition of new clients, sales of additional

clouds to existing clients, the addition of incremental users by existing

clients and client renewals. We excluded the non-cash reduction of revenue

related to the issuance of common stock warrants in the second quarter of

2011 because these charges did not relate to sales activity in that period,

and we did not consider the issuance of such warrants to have been

indicative of our core operating performance. Bookings are affected by our

billing terms, and any changes in those billing terms may shift bookings

between periods. Due to the seasonality of our sales, bookings growth is inconsistent from quarter to quarter throughout a calendar year. For a reconciliation of bookings to revenue, please see "Results of Operations - Revenue and Metrics." 41

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Annual dollar retention rate. We define annual dollar retention rate as the

implied monthly recurring revenue under client agreements at the end of a

fiscal year, divided by the implied monthly recurring revenue, for that

same client base, at the end of the prior fiscal year and excluding implied

monthly recurring revenue from clients of our CSB and Cornerstone for

Salesforce solutions. This ratio does not reflect implied monthly recurring

revenue for new clients added between the end of the prior fiscal year and

the end of the current fiscal year. Beginning in 2013, incremental sales up

to and not exceeding the original renewal amount to the existing client

base are included in this ratio. We define implied monthly recurring

revenue as the total amount of minimum recurring revenue to which we have a

contractual right under each of our client agreements over the entire term

of the agreement, but excluding non-recurring support, consulting and

maintenance fees, divided by the number of months in the term of the

agreement. Implied monthly recurring revenue is substantially comprised of

subscriptions to our core solution. We believe that our annual dollar

retention rate is an important metric to measure the long-term value of

client agreements and our ability to retain our clients.

Number of clients. We believe that our ability to expand our client base is

an indicator of our market penetration and the growth of our business as we

continue to invest in our direct sales teams and distributors. Our client

count includes contracted clients for any combination of the four integrated clouds for our core solution as of the end of the period and excludes clients of our CSB and Cornerstone for Salesforce solutions.



Number of users. Since our clients generally pay fees based on the number

of users of our solutions within their organizations, we believe the total

number of users is an indicator of the growth of our business. Our user

count includes active users for our core solution and excludes users of our

CSB and Cornerstone for Salesforce solutions.

Key Components of Our Results of Operations Sources of Revenue and Revenue Recognition Our solutions are designed to enable organizations to meet the challenges they face in maximizing the productivity of their human capital. We generate revenue from the following sources: Subscriptions to Our Solutions. Clients pay subscription fees for access to



our solutions for a specified period of time, typically three years for our

core solution or monthly, annual, or three-year periods for our CSB and Cornerstone for Salesforce solutions. Fees are based on a number of factors, including the number of users having access to a solution. We



generally recognize revenue from subscriptions ratably over the term of the

agreements.

Consulting Services. We offer our clients assistance in implementing our

solutions and optimizing their use. Consulting services include application

configuration, system integration, business process re-engineering, change

management and training services. Services are billed either on a

time-and-material or a fixed-fee basis. These services are generally

purchased as part of a subscription arrangement and are typically performed

within the first several months of the arrangement. Clients may also

purchase consulting services at any other time. Our consulting services are

performed by us directly or by third-party service providers we engage.

Clients may also choose to perform these services themselves or engage

their own third-party service providers. We generally recognize revenue

from fixed fee consulting services using the proportional performance

method over the period the services are performed and as time is incurred

for time-and-material arrangements.

E-learning Content. We resell third-party on-line training content, which

we refer to as e-learning content, to our clients. We also host other

e-learning content provided by our clients. We generally recognize revenue

from the resale of e-learning content as it is delivered and recognize

revenue from hosting as the hosting services are provided.

Our client agreements generally include both a subscription to access our solutions and related consulting services, and may also include e-learning content. Our agreements generally do not contain any cancellation or refund provisions other than in the event of our default. Cost of Revenue Cost of revenue consists primarily of costs related to hosting our solutions; personnel and related expenses, including stock-based compensation, for network infrastructure, IT support, consulting services and on-going client support; payments to external service providers; amortization of capitalized software costs, amortization of developed technology and software license rights; licensing fees; and referral fees. In addition, we allocate a portion of overhead, such as rent, IT costs, depreciation and amortization and employee benefits costs, to cost of revenue based on headcount. The costs associated with providing consulting services are significantly higher as a percentage of revenue than the costs associated with providing access to our solutions due to the labor costs to provide the consulting services. 42 -------------------------------------------------------------------------------- Operating Expenses Our operating expenses are as follows: Sales and Marketing. Sales and marketing expenses consist primarily of



personnel and related expenses for our sales and marketing staff, including

salaries, benefits, bonuses, stock-based compensation and commissions;

costs of marketing and promotional events, corporate communications, online

marketing, product marketing and other brand-building activities; and

allocated overhead.

We intend to continue to invest in sales and marketing and expect spending in these areas to increase as we continue to expand our business both domestically and internationally. We expect sales and marketing expenses to continue to be among the most significant components of our operating expenses. Research and Development. Research and development expenses consist



primarily of personnel and related expenses for our research and

development staff, including salaries, benefits, bonuses and stock-based

compensation; the cost of certain third-party service providers; and

allocated overhead. Research and development costs, other than software

development costs qualifying for capitalization, are expensed as incurred.

We have focused our research and development efforts on continuously improving our solutions. We believe that our research and development activities are efficient because we benefit from maintaining a single software code base for each of our solutions. We expect research and development expenses to increase in absolute dollars in the future, as we scale our research and development department and expand our network infrastructure. General and Administrative. General and administrative expenses consist



primarily of personnel and related expenses for administrative, legal,

finance and human resource staffs, including salaries, benefits, bonuses

and stock-based compensation; professional fees; insurance premiums; other

corporate expenses; and allocated overhead. We expect our general and administrative expenses to increase as we continue to expand our operations. Amortization of Certain Acquired Intangible Assets. Amortization of certain acquired intangibles consists of amortization of Sonar acquisition-related intangibles, including customer relationships, non-compete agreements, patents, trade names and trademarks. We also



record amortization of developed technology and software license rights in

cost of revenue.



Other Income (Expense) Interest Income. Interest income consists primarily of interest income from

investment securities partially offset by amortization of investment

premiums. We expect interest income to increase as a result of our

investments in marketable securities, which include corporate and agency

bonds, in the year ended December 31, 2013.

Interest Expense. Interest expense consists primarily of interest expense

from our promissory notes, convertible debt, capital lease payments, accretion of debt discount, and amortization of debt issuance costs.



Change in Fair Value of Preferred Stock Warrant Liabilities. Preferred

stock warrant liabilities are the result of warrants issued prior to our

initial public offering in connection with long-term debt and preferred

stock financings. Changes in the fair value of our preferred stock occurred

in connection with changes in the overall value of our company. Immediately

prior to the completion of our initial public offering, all of our warrants

to purchase preferred stock were exercised, and as a result, we no longer

record any changes in the fair value of these liabilities in our statements

of operations. Withdrawn Secondary Offering Expense. On July 20, 2011, we filed a



Registration Statement on Form S-1 in connection with a proposed secondary

offering of shares of our common stock. On August 8, 2011, pursuant to Rule

477 under the Securities Act of 1933, as amended, we requested that the Securities and Exchange Commission consent to the withdrawal of the Registration Statement. During the year ended December 31, 2011, we incurred expenses of approximately $0.6 million in connection with the proposed secondary offering. Other, Net. Other, net consists of income and expense associated with



fluctuations in foreign currency exchange rates and other non-operating

expenses. We expect interest income (expense) and other income (expense) to

vary depending on the movement in foreign currency exchange rates and the related impact on our foreign exchange gain (loss). Income Tax Benefit (Provision) The income tax benefit is related to amortization of deferred tax liabilities assumed as part of the Sonar acquisition, partially offset by minimum and franchise state taxes and foreign taxes. As we have historically recorded a full valuation allowance against our United States and United Kingdom net deferred tax assets, we have not historically recorded a provision for United States and United Kingdom income taxes. Certain foreign subsidiaries and branches of ours provide 43 -------------------------------------------------------------------------------- intercompany services and are compensated on a cost-plus basis, and therefore, have incurred liabilities for foreign income taxes in their respective jurisdictions. Critical Accounting Policies and Estimates Our consolidated financial statements and the related notes included elsewhere in this Annual Report on Form 10-K are 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, liabilities, revenue, costs and expenses, provision for income taxes and related disclosures. We base our estimates on historical experience and on various other assumptions that we believe to be reasonable under the circumstances. Changes in accounting estimates are reasonably likely to occur from period to period. Accordingly, actual results could differ significantly from the estimates made by our management. We evaluate our estimates and assumptions on an ongoing basis. To the extent that there are material differences between these estimates and actual results, our future financial statement presentation, financial condition, results of operations and cash flows will be affected. We believe that the following critical accounting policies involve a greater degree of judgment or complexity than our other accounting policies. Accordingly, these are the policies we believe are the most critical to aid in fully understanding and evaluating our consolidated financial condition and results of operations. Revenue Recognition and Deferred Revenue We recognize revenue when: (i) persuasive evidence of an arrangement for the sale of our solutions or consulting services exists, (ii) our solutions have been made available or delivered, or our services have been performed, (iii) the sales price is fixed or determinable, and (iv) collectability is reasonably assured. The timing and amount we recognize as revenue is determined based on the facts and circumstances of each client arrangement. Evidence of an arrangement consists of a signed client agreement. We consider that delivery of our software has commenced once we provide the client with log-in information to access and use our solutions. If non-standard acceptance periods or non-standard performance criteria exist, revenue recognition commences upon the satisfaction of the acceptance or performance criteria, as applicable. Our fees are fixed based on stated rates specified in each client agreement. We assess collectability based in part on an analysis of the creditworthiness of each client, as well as other relevant economic or financial factors. If we do not consider collection reasonably assured, we defer the revenue until the fees are actually collected. We record amounts that have been invoiced to our clients in accounts receivable and as either deferred revenue on our balance sheet or revenue on our statement of operations, depending on whether the revenue recognition criteria have been met. The majority of our client arrangements include multiple deliverables, such as subscriptions to our software solutions accompanied by consulting services. Therefore, we recognize revenue in accordance with the guidance for arrangements with multiple deliverables under Accounting Standards Update 2009-13 "Revenue Recognition (Topic 605)-Multiple-Deliverable Revenue Arrangements-a Consensus of the Emerging Issues Task Force," or ASU 2009-13 (formerly known as EITF 08-1, "Revenue Arrangements with Multiple Deliverables"). As our clients do not have the right to the underlying software code of our solutions, our revenue arrangements are outside the scope of software client recognition guidance. For such arrangements, we first assess whether each deliverable has value to the client on a standalone basis. Our solutions have standalone value because once we give a client access, they are fully functional and do not require any additional development, modification or customization. Our consulting services have standalone value because third-party service providers, distributors or our clients themselves can perform these services without our involvement. The consulting services we provide are to assist clients with the configuration and integration of our solutions. The performance of these services does not require highly specialized individuals. Based on the standalone value of our deliverables, and, since clients generally do not have a right of return with respect to the included consulting services, we allocate revenue among the separate deliverables under the relative selling price method using the selling price hierarchy established in ASU 2009-13. This hierarchy requires the selling price of each deliverable in a multiple deliverables arrangement to be based on, in descending order of preference, (i) vendor-specific objective evidence of fair value, or VSOE, (ii) third-party evidence of fair value, or TPE, or (iii) management's best estimate of the selling price, or BESP. We are not generally able to determine VSOE or TPE for our deliverables because we sell them separately and within a sufficiently narrow price range only infrequently, and because we have determined that there are no third-party offerings reasonably comparable to our solutions. Accordingly, we determine the selling prices of subscriptions to our solutions, consulting services and e-learning content based on BESP. In determining BESP for subscriptions to our solutions, we consider the size of client arrangements, as measured by number of users; whether the sales were made by 44 -------------------------------------------------------------------------------- our direct sales team or distributors; and whether the sales are to a domestic or an international client. We group sales of our solutions into multiple categories based on these criteria. We then compute an average selling price for each group. This average selling price represents our BESP for that type of client arrangement. For consulting services, we analyze both bundled arrangements that include subscriptions to our solutions and consulting services, as well as standalone purchases of different types of consulting services made subsequent to the original subscription. For these consulting services arrangements, we then examine the actual rate per hour we charge or, for fixed fee arrangements, the implied average rate per hour based on the fixed fee divided by the estimated hours to complete the service. The BESP is then the product of this average rate per hour and our estimate of the hours needed to complete the services. In evaluating and arriving at BESP for consulting services, we also consider the reasonableness of the implied gross margins, as indicated by our internal costs to deliver such services, as well as comparisons to rates per hour for information technology consulting services in our industry generally. For e-learning content, we estimate BESP by reviewing fees for content in order to establish an average annual fee per user that reflects the cost we incur to acquire the related content from third-party providers. Additionally, we estimate BESP by reviewing fees for content-hosting by reviewing the selling price of gigabytes sold in order to establish a fee on a per user or bandwidth basis. The determination of BESP for our deliverables as described above requires us to make significant estimates and judgments, including the comparability of different subscription arrangements and consulting services and estimates of the hours required to complete various types of services. In addition, we consider other factors including: Nature of the deliverables. For example, in categorizing our subscriptions



into meaningful groupings for determining BESP, we consider the number and

type of clouds the client purchased. For consulting services, we consider

the type of consulting service and the estimated hours required to complete

the service based on our historical experience. Location of our clients. Our pricing is different for domestic and



international clients, and therefore in determining BESP of subscriptions

to our solutions, we evaluate domestic arrangements separately from international arrangements.



Market conditions and competitive landscape for the sale. Our pricing and

discounting varies based on the economic environment and competition. We

consider these factors in determining the grouping of comparable services

and the periods over which we compare arrangements to compute the BESP.

Internal costs. Our pricing for consulting services and e-learning content

considers our internal costs to provide the consulting services and the third-party purchase costs of e-learning content.



Size of the arrangement. Discounting generally increases as the relative

size of an arrangement increases, and we take this into consideration in the grouping of our clients to determine BESP. Our discounting for multiple-deliverable arrangements varies based on the extent and type of



the consulting services and content included with the subscriptions in the

arrangement.

The determination of BESP is made through consultation with, and formal approval by, our senior management. We update our estimates of BESP on an ongoing basis as events and circumstances require, and we update our determination to use BESP on a semi-annual basis, including assessing whether we can determine VSOE or TPE. After we determine the fair value of revenue allocable to each deliverable based on the relative selling price method, we recognize the revenue for each based on the type of deliverable. For subscriptions to our solutions, we recognize the revenue on a straight-line basis over the term of the client agreement, which is typically three years. For consulting services, we generally recognize revenue using the proportional performance method over the period the services are performed. In a limited number of cases, multiple deliverable arrangements may include consulting services that do not have value on a standalone basis separate from a solution, such as when the client's intended use of a solution requires enhancements to its underlying features and functionality. In these cases, revenue is recognized as one unit of accounting on a straight-line basis from the point at which the consulting services that do not have value on a standalone basis have been completed and accepted by the client, through the remaining term of the agreement. For arrangements in which we resell third-party e-learning content to our clients or host client or third-party e-learning content provided by the client, we recognize revenue in accordance with accounting guidance as to when to report gross revenue as a principal and when to report net revenue as an agent. We recognize e-learning content revenue in the gross amount that we invoice our client when: (i) we are the primary obligor, (ii) we have latitude to establish the price charged and (iii) we bear the credit risk in the transaction. For arrangements involving our sale of e-learning content, we charge our clients for the content based on pay-per-use or a fixed rate for a specified number of users and recognize the gross amount invoiced as revenue as the content is delivered. For arrangements where clients purchase e-learning content directly from a third-party, or provide it themselves, and we integrate the content into our solutions, we 45 -------------------------------------------------------------------------------- charge a hosting fee. In such cases, we recognize the amount invoiced for hosting as the content is delivered, excluding any portion we invoice that is attributable to fees the third-party charges for the content. Offsets to Revenue On May 6, 2009, we entered into a five-year global distributor agreement with ADP that provides ADP the right to distribute our core solution to its customers under ADP's name. In connection with the distributor agreement, we also entered into a warrant agreement to provide additional incentives to ADP. The warrant agreement provided that ADP was eligible to earn fully vested and immediately exercisable ten-year warrants to purchase between zero and 886,096 shares of our common stock at an exercise price of $0.53 per share if ADP met specified sales targets for each contract year until the earlier of the completion of the five-year term of the distributor agreement or the completion of an initial public offering of our common stock. When ADP achieved the defined sales targets and earned a warrant for a contract year, we recorded the fair value of such warrant as a reduction of revenue. We determined the fair value of these warrants using a Black-Scholes option-pricing model, which incorporates several estimates and assumptions that are subject to significant judgment. The warrants could only be exercised immediately prior to an acquisition of our company through a reorganization, merger or consolidation; immediately prior to a sale, lease or other disposition of all of our assets; or within three years after an initial public offering. On November 24, 2010, we amended our warrant agreement with ADP to modify certain definitions related to future sales targets, to acknowledge that no warrants would be issued for the contract year ended June 30, 2010 and to remove the anti-dilution provisions in the warrant agreement. In connection with the amendment, we issued ADP a fully vested and non-forfeitable warrant to purchase 360,000 shares of our common stock at an exercise price of $0.01 per share, which was valued at approximately $2.9 million as of the amendment date, using the Black-Scholes option pricing model. We recorded this amount as a reduction of revenue in the fourth quarter of 2010, as the distributor agreement provides ADP with the right to distribute our services, and we estimated that ADP would purchase additional services from us. In issuing this warrant, we considered the strategic importance of our ongoing relationship with ADP and the expected timing of the completion of our initial public offering, after which ADP would no longer be eligible to earn any warrants. At December 31, 2010, we did not record any reduction in revenue for the contract year ending June 30, 2011, as the minimum specified sales target had not been achieved to earn the applicable warrant as of December 31, 2010. Upon the completion of our initial public offering, ADP was no longer eligible to earn warrants under the warrant agreement. However, ADP remained eligible to earn a warrant for the partial contract year that began on July 1, 2010 and ended on March 22, 2011, the closing date of our initial public offering, if it met pro-rated specified sales targets for that period. Through the three months ended March 31, 2011, no reductions of revenue were recorded because we concluded that ADP had not met the pro-rated specified sales targets for such partial contract year based on our assessment of the contractual terms of the arrangement, and as of March 31, 2011, it was not considered probable that we would be required to issue a warrant for such partial contract year. Pursuant to the terms of the arrangement, we notified ADP that it had not earned the warrant for such partial year. ADP contended that it met the pro-rated specified sales target for the partial contract year that would entitle ADP to a warrant to purchase 443,048 shares of our common stock at an exercise price of $0.53 per share. During June 2011, in order to resolve a dispute with respect to this matter, we issued ADP a fully vested and non-forfeitable warrant to purchase 133,000 shares of our common stock at an exercise price of $0.53 per share. The warrant was valued at approximately $2.5 million using a Black-Scholes option-pricing model as of the issuance date and was recorded as a non-cash reduction of revenue in the second quarter of 2011. In connection with the issuance of the warrant described above, ADP agreed and acknowledged that it is no longer eligible to earn or receive any additional warrants exercisable for shares of our common stock pursuant to the distributor agreement. In April 2012, we amended certain provisions in our agreement with ADP and extended the term to 2017. 46 -------------------------------------------------------------------------------- Commission Expense We defer commissions paid to our sales force because these amounts are recoverable from future revenue from the non-cancelable client agreements that give rise to the commissions. We defer expense recognition upon payment and amortize expense to sales and marketing expenses over the term of the client agreement in proportion to the revenue that is recognized. Commissions are direct and incremental costs of our client agreements and generally have been paid in the periods we received payment from the client under the associated client agreement. Commencing in the fourth quarter of 2012, we pay commissions between 45 and 75 days after execution of the client agreement. Stock-based Compensation We account for stock-based awards granted to employees and directors by recording compensation expense based on the awards' estimated fair values. We grant stock options and restricted stock units that vest over time based on the continuing employment of the employee, as well as options and restricted stock units that vest based on meeting certain performance targets. We expect that our expense related to stock-based compensation will increase over time. We estimate the fair value of our stock-based awards as of the date of grant using the Black-Scholes option-pricing model. Determining the fair value of stock-based awards under this model requires judgment, including estimating (i) the value per share of our common stock, (ii) volatility, (iii) the term of the awards, (iv) the dividend yield and (v) the risk-free interest rate. The assumptions used in calculating the fair value of stock-based awards represent our best estimates, based on management's judgment and subjective future expectations. These estimates involve inherent uncertainties. If any of the assumptions used in the model change significantly, stock-based compensation recorded for future awards may differ materially from that recorded for awards granted previously. Prior to our initial public offering, given the absence of an active market for our common stock, our board of directors was required to estimate the fair value of our common stock at the time of each grant of stock-based awards. From 2007 through our initial public offering our management regularly commissioned an independent third-party valuation firm to prepare contemporaneous valuation analyses near the time of each grant to assist our board of directors in this determination. We use the average volatility of similar publicly traded companies as an estimate for our volatility. For purposes of determining the expected term of the awards in the absence of sufficient historical data relating to stock-option exercises for our company, we apply a simplified approach in which the expected term of an award is presumed to be the mid-point between the vesting date and the expiration date of the award. The risk-free interest rate for periods within the expected life of an award, as applicable, is based on the United States Treasury yield curve in effect during the period the award was granted. Our estimated dividend yield is zero, as we have not and do not currently intend to declare dividends in the foreseeable future. Once we have determined the estimated fair value of our stock-based awards, we recognize the portion of that value that corresponds to the portion of the award that is ultimately expected to vest, taking estimated forfeitures into account. This amount is recognized as an expense over the vesting period of the award using the straight-line method. We estimate forfeitures based upon our historical experience and, for each period, review the estimated forfeiture rate and make changes as factors affecting the forfeiture rate calculations and assumptions change. In addition, we issued performance shares that are dependent on performance goals, established by the Board of Directors, for a predetermined period. The fair value of each performance unit and performance share awarded is equal to the fair market value of the Company's common stock at the close of the applicable performance period. 47 --------------------------------------------------------------------------------



Information related to our stock-based compensation activity, including weighted-average grant date fair values and associated Black-Scholes option-pricing model assumptions associated with time-based options, is as follows:

Year Ended December 31, 2013 2012



2011

Stock options granted (in thousands) 2,394 2,553



1,674

Weighted-average exercise price $ 43.32$ 22.09$ 13.21 Weighted-average grant date fair value per share of stock options granted $ 21.52$ 11.12$ 7.12 Weighted-average Black-Scholes model assumptions: Estimated fair value of common stock $ 43.32$ 22.09$ 13.21 Estimated volatility 51.5 % 53.9 % 56.9 % Estimated dividend yield - - - Expected term (years) 6.0 5.8 6.0 Risk-free rate 1.5 % 1.0 % 1.7 % As of December 31, 2013, we had approximately $59.6 million of unrecognized employee related stock-based compensation, net of estimated forfeitures, relating to stock options that we expect to recognize over a weighted-average period of approximately 2.7 years. Unrecognized compensation expense related to nonvested restricted stock units was $8.7 million at December 31, 2013, which is expected to be recognized as expense over the weighted-average period of 2.3 years. Additionally, during 2012, we granted certain employees performance based options and performance based restricted stock units. As of December 31, 2013, we estimate that stock options to purchase 53,714 shares of common stock and 12,892 restricted stock units are probable of vesting. Unrecognized compensation expense related to performance based options and units was $0.4 million at December 31, 2013, which is expected to be recognized as expense over the weighted-average period of 2.0 years. The amount of compensation cost relating to performance awards may change in future periods to the extent that another target level becomes probable of achievement. Stock-based compensation expense is expected to increase in 2014 compared to 2013 as a result of our existing unrecognized stock-based compensation and as we issue additional stock-based awards to continue to attract and retain employees. Allowance for Doubtful Accounts On a quarterly basis we evaluate the need to establish an allowance for doubtful accounts, by analyzing our clients' creditworthiness. Our evaluation and analysis includes specific identification and review of all outstanding accounts receivable balances, review of our historical collection experience with each client, and consideration of overall economic conditions, as well as of any specific facts and circumstances that may indicate that a specific client receivable is not collectible. We make judgments as to our ability to collect outstanding receivables and establish an allowance when collection becomes doubtful. At December 31, 2013 and 2012, our allowance for doubtful accounts was $1.0 million and $0.5 million, respectively, based on our evaluation and analysis. If our future actual collections are lower than expected, our cash flows and future results of operations could be negatively impacted. Capitalized Software Costs We capitalize the costs associated with software developed or obtained for internal use, including costs incurred in connection with the development of our solutions, when the preliminary project stage is completed, management has decided to make the project a part of a future offering, and the software will be used to perform the function intended. These capitalized costs include external direct costs of materials and services consumed in developing or obtaining internal-use software, personnel and related expenses for employees who are directly associated with, and who devote time to, internal-use software projects and, when material, interest costs incurred during the development. Capitalization of these costs ceases once the project is substantially complete and the software is ready for its intended purpose. Costs incurred for upgrades and enhancements to our solutions are also capitalized. Post-configuration training and maintenance costs are expensed as incurred. Capitalized software costs are amortized to cost of revenue using the straight-line method over an estimated useful life of the software of typically three years, commencing when the software is ready for its intended use. 48 --------------------------------------------------------------------------------



Goodwill

Goodwill is not amortized, but instead is required to be tested for impairment annually and under certain circumstances. We perform such testing of goodwill in the fourth quarter of each year, or as events occur or circumstances change that would more likely than not reduce the fair value of a reporting unit below its carrying amount. Events or changes in circumstances which could trigger an impairment review include a significant adverse change in legal factors or in the business climate, an adverse action or assessment by a regulator, unanticipated competition, a loss of key personnel, significant changes in the manner we use the acquired assets or the strategy we have for our overall business, significant negative industry or economic trends, or significant underperformance relative to expected historical or projected future results of operations. As part of the annual impairment test, we conduct an assessment of qualitative factors to determine whether it is more likely than not that the fair value of a reporting unit is less than its carrying amount. If we determine that it is more likely than not that the fair value of a reporting unit is less than its carrying amount, we then conduct the first step of a two-step impairment test. The first step of the test for goodwill impairment compares the fair value of the applicable reporting unit with its carrying value. Fair value is determined using a discounted cash flow method and/or prevailing earnings multiples for the reporting unit. The use of discounted cash flows requires the use of various economic, market and business assumptions in developing our internal forecasts, the useful life over which cash flows will occur, and determination of our weighted average cost of capital that reflect our best estimates when performing the annual impairment test. Judgment is required in selecting relevant earnings multiples. If the fair value of a reporting unit is less than the reporting unit's carrying value, we perform the second step of the test for impairment of goodwill. During the second step, we compare the implied fair value of the reporting unit's goodwill with the carrying value of that goodwill. The estimate of implied fair value of goodwill may require valuations of certain internally generated and unrecognized intangible assets and other assets and liabilities. If the carrying value of the goodwill exceeds the calculated implied fair value, the excess amount will be recognized as an impairment loss. All our goodwill is allocated to the CSB reporting unit. Based on the results of the annual impairment test, the fair value of the reporting unit exceeded its carrying value by a significant amount and therefore no impairment of goodwill existed at December 31, 2013. However, if we are unable to achieve our internal forecasts, future impairment could occur. Intangible Assets Identifiable intangible assets primarily consist of trade names and intellectual property and acquisition-related intangibles, including developed technology, customer relationships, non-compete agreements, patents, trade names and trademarks. We determine the appropriate useful life of our intangible assets by performing an analysis of expected cash flows of the acquired assets. Intangible assets are amortized over their estimated useful lives ranging from two to ten years, generally using the straight-line method, which approximates the pattern in which the economic benefits are consumed. We evaluate the recoverability of our long-lived assets with finite useful lives, including intangible assets for impairment, whenever events or changes in circumstances indicate that the carrying amounts may not be recoverable. Such triggering events or changes in circumstances may include: a significant decrease in the market price of a long-lived asset, a significant adverse change in the extent or manner in which a long-lived asset is being used, a significant adverse change in legal factors or in the business climate, the impact of competition or other factors that could affect the value of a long-lived asset, a significant adverse deterioration in the amount of revenue or cash flows expected to be generated from an asset group, an accumulation of costs significantly in excess of the amount originally expected for the acquisition or development of a long-lived asset, current or future operating or cash flow losses that demonstrate continuing losses associated with the use of a long-lived asset, or a current expectation that, more likely than not, a long-lived asset will be sold or otherwise disposed of significantly before the end of its previously estimated useful life. We perform impairment testing at the asset group level that represents the lowest level for which identifiable cash flows are largely independent of the cash flows of other assets and liabilities. If events or changes in circumstances indicate that the carrying amount of an asset group may not be recoverable and the expected undiscounted future cash flows attributable to the asset group are less than the carrying amount of the asset group, an impairment loss equal to the excess of the asset's carrying value over its fair value is recorded. Fair value is determined based upon estimated discounted future cash flows. There were no impairment charges related to the identified intangible assets in the years ended December 31, 2013 and 2012. 49 -------------------------------------------------------------------------------- Investments in Marketable Securities Our available-for-sale investments in marketable securities are recorded at fair value, with any unrealized gains and losses, net of taxes, reported as a component of stockholders' equity until realized or until a determination is made that an other-than-temporary decline in market value has occurred. If we determine that an other-than-temporary decline has occurred for debt securities that we do not then currently intend to sell, we recognize the credit loss component of an other-than-temporary impairment in other income (expense) and the remaining portion in other comprehensive income (loss). The credit loss component is identified as the amount of the present value of cash flows not expected to be received over the remaining term of the security, based on cash flow projections. In determining whether an other-than-temporary impairment exists, we consider: (i) the length of time and the extent to which the fair value has been less than cost; (ii) the financial condition and near-term prospects of the issuer of the securities; and (iii) our intent and ability to retain the security for a period of time sufficient to allow for any anticipated recovery in fair value. The cost of marketable securities sold is determined based on the specific identification method and any realized gains or losses on the sale of investments are reflected as a component of interest income or expense. In addition, we classify marketable securities as current or non-current based upon the maturity dates of the securities. At December 31, 2013, we had $199.9 million of short-term investments in marketable securities. Senior Convertible Notes In accounting for senior convertible notes (the "Notes") at issuance, we separated the Notes into debt and equity components pursuant to the accounting standards for convertible debt instruments that may be fully or partially settled in cash upon conversion. The fair value of the debt component was estimated using an interest rate for nonconvertible debt, with terms similar to the Notes, excluding the conversion feature. The carrying amount of the liability component was calculated by measuring the fair value of a similar liability that does not have an associated convertible feature. The excess of the principal amount of the Notes over the fair value of the debt component was recorded as a debt discount and a corresponding increase in additional paid-in capital. The debt discount is accreted to interest expense over the term of the Notes using the interest method. The amount recorded to additional paid-in capital is not to be remeasured as long as it continues to meet the conditions for equity classification. Income Taxes We use the liability method of accounting for income taxes. Under the liability method, deferred taxes are determined based on the temporary differences between the financial statement and tax bases of assets and liabilities, using tax rates expected to be in effect during the years in which the bases differences are expected to reverse. We record a valuation allowance when it is more likely than not that some of our net deferred tax assets will not be realized. In determining the need for valuation allowances, we consider our projected future taxable income and the availability of tax planning strategies. We have recorded a full valuation allowance to reduce our United States and United Kingdom net deferred tax assets to zero, because we have determined that it is not more likely than not that any of our United States and United Kingdom net deferred tax assets will be realized. If in the future we determine that we will be able to realize any of our United States and United Kingdom net deferred tax assets, we will make an adjustment to the allowance, which would increase our income in the period that the determination is made. We have assessed our income tax positions and recorded tax benefits for all years subject to examination, based upon our evaluation of the facts, circumstances and information available at each period end. For those tax positions where we have determined there is a greater than 50% likelihood that a tax benefit will be sustained, we have recorded the largest amount of tax benefit that may potentially be realized upon ultimate settlement with a taxing authority that has full knowledge of all relevant information. For those income tax positions where we have determined there is a less than 50% likelihood that a tax benefit will be sustained, no tax benefit has been recognized in our financial statements. Recent Accounting Pronouncements For information regarding recent accounting pronouncements, refer to Note 2 of notes to consolidated financial statements included in this Annual Report on Form 10-K. 50 -------------------------------------------------------------------------------- Results of Operations The following table sets forth our results of operations for each of the periods indicated (in thousands). The period-to-period comparison of financial results is not necessarily indicative of future results. Year Ended December 31, 2013 2012 2011 Gross revenue(1) $ 185,129$ 117,914$ 75,522 Common stock warrant charge(1) - - (2,500 ) Net revenue 185,129 117,914 73,022 Cost of revenue 53,548 34,591 21,285 Gross profit 131,581 83,323 51,737 Operating expenses: Sales and marketing 109,737 73,563 45,773 Research and development 21,260 14,886 10,149 General and administrative 33,572 25,912 15,122 Amortization of certain acquired intangibles 1,004 739 - Total operating expenses 165,573 115,100 71,044 Loss from operations(1) (33,992 ) (31,777 ) (19,307 ) Other income (expense): Interest expense, net (6,206 ) (442 ) (882 ) Change in fair value of preferred stock warrant liabilities - - (42,559 ) Withdrawn secondary offering expense - - (555 ) Other, net (356 ) 40 (416 ) Other income (expense), net (6,562 ) (402 ) (44,412 ) Loss before income tax benefit (provision) (40,554 ) (32,179 ) (63,719 ) Income tax benefit (provision) 128 789 (181 ) Net loss $ (40,426 )$ (31,390 )$ (63,900 )



(1) During the second quarter of 2011, we recorded a $2.5 million reduction of

revenue associated with common stock warrants. There were no such

reductions of revenue in any other periods presented. We have presented

gross revenue excluding non-cash common stock warrant charges, because

these charges do not relate to sales activity in the period, and we do not

consider the issuance of warrants to be indicative of our core operating

performance. See "Management's Discussion and Analysis of Financial

Condition and Results of Operations-Critical Accounting Policies and

Estimates-Offsets to Revenue" for additional information about common stock

warrants that are accounted for as reductions of revenue.

The following table sets forth our revenue and key metrics that we use to evaluate our business, measure our performance, identify trends affecting our business, formulate financial projections and make strategic decisions: Metrics

At or For Year Ended December 31, 2013 2012 2011



Net revenue (in thousands) $ 185,129$ 117,914$ 73,022 Gross revenue (in thousands) $ 185,129$ 117,914$ 75,522 Bookings (in thousands) $ 231,699$ 154,286$ 97,584 Annual dollar retention rate 94.6 % 94.3 % 94.9 % Number of clients

1,631 1,237 805 Number of users (in millions) 14.1 10.6 7.5 51 -------------------------------------------------------------------------------- Net and gross revenue increased $67.2 million, or 57%, for the year ended December 31, 2013 as compared to the same period in 2012. The increase was primarily the result of a $45.0 million increase in revenue from existing clients, specifically, revenue from client agreements that were entered into prior to January 1, 2013. In addition, net and gross revenue increased by $22.2 million from the acquisition of new clients during the year ended December 31, 2013. Net revenue increased by $44.9 million, or 61%, for the year ended December 31, 2012 as compared to the same period in 2011. Gross revenue increased $42.4 million, or 56%, for the year ended December 31, 2012 as compared to the same period in 2011. The increase in net and gross revenue was primarily the result of a $27.9 million increase in revenue from existing clients, specifically, revenue from client agreements that were entered into prior to January 1, 2012. In addition, net and gross revenue increased by $14.5 million from the acquisition of new clients during the year ended December 31, 2012 and net revenue also increased by $2.5 million from the reduction of revenue related to a non-cash charge for a common stock warrant issued during the second quarter of 2011. See "-Critical Accounting Policies and Estimates-Fair Value of Warrants" for further discussion of common stock warrants accounted for as reductions of revenue. Net and gross revenue generated in the United States was $129.0 million, or 70%, of total revenue for the year ended December 31, 2013 as compared to $81.8 million, or 69%, for the same period in 2012, resulting in a 58% increase. Net and gross revenue generated outside of the United States was $56.1 million, or 30%, of total revenue for the year ended December 31, 2013 as compared to $36.1 million, or 31%, for the same period in 2012, resulting in a 56% increase. Revenue generated outside of the United States increased primarily due to an increase in our sales efforts internationally. Net and gross revenue generated in the United States increased $47.1 million and revenue generated outside of the United States increased $20.1 million for the year ended December 31, 2013 as compared to the same period in 2012. Net revenue in the United States for 2011 was impacted by the $2.5 million in reduction of revenue related to the common stock warrants described above. Net revenue in the United States increased by $31.0 million, or 61%, in 2012 as compared to 2011, while international net and gross revenue, increased by $13.9 million, or 63%. Gross revenue in the United States increased by $28.5 million, or 53%, in 2012 as compared to 2011. As a percentage of total net revenue, international net revenue accounted for 31% in 2012 as compared to 30% in 2011. As a percentage of total gross revenue, international gross revenue accounted for 31% in 2012 as compared 29% in 2011. Bookings increased $77.4 million, or 50% for the year ended December 31, 2013 as compared to the same period in 2012, reflecting the increase in revenue for the period, and an increase in deferred revenue at December 31, 2013 from December 31, 2012 compared to the increase at December 31, 2012 from December 31, 2011. The growth rates for revenue and bookings are not correlated with each other in a given period due to the seasonality of when we enter into client agreements, the varied timing of billings, the recognition generally of subscription revenue on a straight-line basis over the term of each client agreement, and the recognition of consulting revenue generally on a proportional performance basis over the period the services are performed. As discussed above under the heading "Metrics," bookings is a non-GAAP financial measure defined as the sum of gross revenue and the change in the deferred revenue balance for the period. Management uses bookings in analyzing its financial results and believes it is useful to investors, as a supplement to the corresponding GAAP measure, in evaluating our ongoing operational performance and trends and in comparing our financial measures with other companies in the same industry. However, it is important to note that other companies, including companies in our industry, may calculate bookings differently or not at all, which may reduce its usefulness as a comparative measure. 52 --------------------------------------------------------------------------------



The following table presents a reconciliation of revenue to bookings for each of the periods presented (in thousands):

Deferred Revenue Year Ended Balance December 31, 2013 Gross revenue $ 185,129 Deferred revenue at December 31, 2012 $ 92,252 Deferred revenue at December 31, 2013 138,822 Change in deferred revenue 46,570 Bookings $ 231,699 Deferred Revenue Balance Year Ended December 31, 2012 Gross revenue $ 117,914 Deferred revenue at December 31, 2011 $ 55,880 Deferred revenue at December 31, 2012 92,252 Change in deferred revenue 36,372 Bookings $ 154,286 Deferred Revenue Balance Year Ended December 31, 2011 Gross revenue $ 75,522 Deferred revenue at December 31, 2010 $ 33,818 Deferred revenue at December 31, 2011 55,880 Change in deferred revenue 22,062 Bookings $ 97,584 We believe our revenue and bookings growth is a result of our continued investment in and development of our direct sales and sales support teams. We believe this investment has enabled us to achieve greater sales coverage and better sales execution, as well as increase our marketing activities, which we believe have improved brand awareness and created higher demand for our solutions. We have also continued to enhance our core solution, which we believe has encouraged existing clients to add additional clouds and users. Our number of clients increased by 32% at December 31, 2013 compared to December 31, 2012. Our number of users increased by 33% at December 31, 2013 compared to December 31, 2012. The increase in the number of clients and users is representative of continued growth of the business during the current year. Cost of Revenue and Gross Margin Year Ended December 31, 2013 2012 2011 (dollars in thousands) Cost of revenue $ 53,548$ 34,591$ 21,285 Gross profit $ 131,581$ 83,323$ 51,737 Gross margin 71 % 71 % 71 % Cost of revenue increased $19.0 million, or 55%, in 2013 as compared to 2012, attributable to $8.2 million in increased costs related to outsourced consulting services, $6.0 million in increased employee-related costs due to higher headcount, $1.4 million in increased amortization of capitalized software, and $1.2 million in increased reseller and referral fees, in each case to service our existing clients and support our continued growth. We also incurred $0.8 million in increased third-party content costs and $0.7 million in increased allocated overhead such as rent, IT costs, depreciation and amortization and employee benefits costs. The remaining increase relates to various other costs associated with generating revenue from our clients. 53 -------------------------------------------------------------------------------- Cost of revenue increased $13.3 million, or 63%, in 2012 as compared to 2011, attributable to $6.5 million in increased employee-related costs due to higher headcount, $2.0 million in increased costs related to outsourced consulting services, and $1.2 million in increased allocated overhead such as rent, IT costs, depreciation and amortization and employee benefits costs, in each case to service our existing clients and support our continued growth. We also incurred $1.0 million in increased amortization of capitalized software, $0.8 million in increased reseller and referral fees and $0.6 million in increased amortization of developed technology related to intangible assets acquired in connection with our acquisition of Sonar Limited. The remaining increase relates to various other costs associated with generating revenue from our clients. Sales and Marketing Year Ended December 31, 2013 2012 2011 (dollars in thousands)



Sales and marketing $ 109,737$ 73,563$ 45,773 Percent of net revenue 59 % 62 % 63 %

Sales and marketing expenses increased $36.2 million, or 49%, in 2013 as compared to 2012. The increase was attributable 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 at December 31, 2013 increased compared to December 31, 2012, contributing to an increase in employee-related costs of $24.0 million. In addition, we incurred increased costs associated with outsourced marketing programs and events of $4.3 million, increased travel costs associated with our direct sales teams of $3.5 million, overhead costs, such as rent, IT costs, and depreciation and amortization, of $2.2 million, and increased costs associated with the use of sales contractors in Asia and Latin America of $1.2 million. Sales and marketing expenses are expected to increase with the growth of our company and decrease as a percentage of revenue due to the increased leverage of our sales teams. Sales and marketing expenses increased $27.8 million, or 61%, in 2012 as compared to 2011. The increase was attributable 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 at December 31, 2012 increased compared to December 31, 2011, contributing to an increase in employee-related costs of $19.6 million. In addition, we incurred increased overhead costs, such as rent, IT costs, and depreciation and amortization, of $2.5 million, increased costs associated with outsourced marketing programs and events of $2.5 million, and increased travel costs associated with our direct sales teams of $1.9 million. Research and Development Year Ended December 31, 2013 2012 2011 (dollars in thousands)



Research and development $ 21,260$ 14,886$ 10,149 Percent of net revenue 11 % 13 % 14 %

Research and development expenses increased $6.4 million, or 43%, in 2013 as compared to 2012. The increase was principally due to an increase in research and development headcount at December 31, 2013 compared to December 31, 2012 to maintain and improve the functionality of our solutions. As a result, we incurred increased employee-related costs of $5.9 million. The remaining increases relate to allocated overhead costs. Research and development expenses increased $4.7 million, or 47%, in 2012 as compared to 2011. The increase was principally due to an increase in research and development headcount at December 31, 2012 compared to December 31, 2011 to maintain and improve the functionality of our solutions. As a result, we incurred increased employee-related costs of $3.0 million. The remaining increases relate to allocated overhead costs. We capitalize a portion of our software development costs related to the development and enhancements of our solutions, which are then amortized to cost of revenue. The timing of our capitalizable development and enhancement projects may affect the amount of development costs expensed in any given period. We capitalized $7.9 million, $5.7 54 --------------------------------------------------------------------------------



million and $3.3 million of software development costs and amortized $4.3 million, $2.8 million and $1.9 million in 2013, 2012 and 2011, respectively. General and Administrative

Year Ended December 31, 2013 2012 2011 (dollars in thousands)



General and administrative $ 33,572$ 25,912$ 15,122 Percent of net revenue

18 % 22 % 21 % General and administrative expenses increased $7.7 million, or 30%, in 2013 as compared to 2012. The increase was driven by higher costs to support our growing business. We incurred increased employee-related costs of $4.6 million as a result of increased headcount and stock-based compensation awards at December 31, 2013 compared to December 31, 2012. In addition, we incurred increased software license subscription fees of $1.6 million. General and administrative expenses are expected to increase with the growth of our company. General and administrative expenses increased $10.8 million, or 71%, in 2012 as compared to 2011. The increase was driven by higher employee-related costs to support our growing business. We incurred increased employee-related costs of $5.8 million as a result of increased headcount and stock-based compensation awards at December 31, 2012 compared to December 31, 2011. In addition, we incurred increased professional fees of $2.3 million for accounting, audit, legal and tax services, increased subscription fees of $0.6 million, and increased expenses related to travel and entertainment of $0.6 million. Amortization of certain acquired intangible assets Year Ended December 31, 2013 2012 2011 (dollars in thousands) Amortization of certain acquired intangible assets $ 1,004$ 739



$ -

Amortization of acquired intangibles increased $0.3 million for the year ended December 31, 2013 as compared to the same period in 2012 due to the amortization of intangible assets acquired through the April 2012 acquisition of Sonar. The following table presents our estimate of remaining amortization expense for each of the five succeeding fiscal years for finite-lived intangible assets that existed at December 31, 2013 (in thousands): 2014 $ 2,078 2015 1,840 2016 555 2017 146 2018 13 Total $ 4,632 Estimated remaining amortization expense of $1.2 million, $1.2 million, $0.4 million, $0.1 million, and $13,000 will be recorded in cost of revenue for 2014, 2015, 2016, 2017, and 2018, respectively. The remaining estimated amortization expense will be recorded in amortization of certain acquired intangible assets within operating expenses. 55 --------------------------------------------------------------------------------

Other Income (Expense) Year Ended December 31, 2013 2012 2011 (in thousands) Interest income $ 357 $ - $ 20 Interest expense (6,563 ) (442 ) (902 ) Change in fair value of preferred stock warrant liabilities - - (42,559 ) Withdrawn secondary offering expense - - (555 ) Other, net (356 ) 40 (416 ) Other income (expense), net $ (6,562 )$ (402 )$ (44,412 ) Interest income for the year ended December 31, 2013 increased by $0.4 million as compared to the same period in 2012 due to the interest income earned on purchase of investment securities net of purchased premium amortization in the year ended December 31, 2013. Interest expense for the year ended December 31, 2013 increased $6.1 million as compared to the same period in 2012 due to accretion of debt discount and the amortization of debt issuance costs of $4.3 million and interest expense of $2.0 million for the convertible notes issued in June 2013. Refer to the section titled "Liquidity and Capital Resources" below for additional information on the convertible notes. During the year ended December 31, 2011, we recorded a non-cash charge of $42.6 million related to the change in fair value of our preferred stock warrant liabilities from December 31, 2010 to the respective exercise dates of the warrants in March 2011. We valued our preferred stock warrants at the end of each fiscal period using the Black-Scholes option pricing model. During March 2011, all of our warrants to purchase preferred stock were exercised, and all outstanding shares of preferred stock, including all shares of preferred stock issued upon the exercise of the preferred stock warrants, were converted into common stock on a one-for-one basis. As a result, subsequent to the three months ended March 31, 2011, we no longer record any changes in the fair value of such liabilities in our statement of operations. During the year ended December 31, 2011, we incurred legal, accounting and printing related costs of approximately $0.6 million associated with our intended secondary offering. As a result of our withdrawal from the offering, we expensed such costs. Other, net is comprised of foreign exchange gains and losses related to transactions denominated in foreign currencies and unrealized gains and losses related to our intercompany loans. Foreign exchange gains and losses for the years ended December 31, 2013, 2012 and 2011, respectively, were primarily driven by fluctuations in the British Pound and Euro in relation to the U.S. Dollar. Income Tax Benefit (Provision) Year Ended December 31, 2013 2012 2011 (in thousands) Income tax benefit (provision) $ 128$ 789$ (181 ) We have recorded a full valuation allowance against our United States and United Kingdom net deferred tax assets and therefore have not recorded a benefit (provision) for income taxes for any of the periods presented, other than provisions for certain foreign income taxes. During the years ended December 31, 2013 and 2012, we recorded an income tax benefit primarily due to the amortization of deferred tax liabilities assumed as part of the Sonar acquisition. Liquidity and Capital Resources In June 2013, we issued $253 million of 1.5% convertible notes due July 1, 2018 (the "Notes") and concurrently entered into convertible notes hedges and separate warrant transactions. The Notes mature on July 1, 2018, unless earlier converted. Upon conversion of any Notes, we will deliver cash up to the principal amount, and we have the right to settle any amounts in excess of the principal in cash or shares. We received proceeds of $246.0 million from the issuance of the Notes, net of associated fees, received $23.2 million from the issuance of the warrants and paid $49.5 million for the note hedges. The Notes are classified as a non-current liability on our consolidated balance sheet as of December 31, 2013. 56 -------------------------------------------------------------------------------- At December 31, 2013, our principal sources of liquidity were $109.6 million of cash and cash equivalents, short-term investments of $199.9 million, and $67.2 million of accounts receivable. We intend to use our cash for general corporate purposes, including potential future acquisitions or other transactions. Depending on certain growth opportunities, we may choose to accelerate investments in sales and marketing, research and development, technology and services, which may require the use of proceeds for such additional expansion and expenditures. Based on our current level of operations and anticipated growth, we believe our future cash flows from operating activities and existing cash and cash equivalents will provide adequate funds for our ongoing operations and general corporate purposes for at least the next twelve months. Our future capital requirements will depend on many factors, including our rate of revenue, billings growth and collections, the level of our sales and marketing efforts, the timing and extent of spending to support product development efforts and expansion into new territories, the timing of introductions of new services and enhancements to existing services, the timing of general and administrative expenses as we grow our administrative infrastructure, and the continuing market acceptance of our solution. To the extent that existing cash and cash from operations are not sufficient to fund our future activities, we may need to raise additional funds or utilize our cash resources. 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 financing or utilize our cash resources. The following table sets forth a summary of our cash flows for the periods indicated (in thousands): Year Ended December 31, 2013 2012 2011 Net cash provided by operating activities $ 17,431$ 10,294$ 1,832 Net cash used in investing activities (213,445 ) (19,581 ) (3,885 ) Net cash provided by financing activities 228,928 312 80,639 Net Cash Provided by Operating Activities Our cash flows from operating activities are significantly influenced by our growth, ability to maintain our contractual billing and collection terms, and our investments in headcount and infrastructure to support anticipated growth. Given the seasonality and continued growth of our business, our cash flows from operations will vary from period to period. Cash provided by operating activities of $17.4 million during 2013 was a result of the continued growth of our business and our continued investments for further growth. In the year ended December 31, 2013, $32.2 million, or 80%, of our net loss of $40.4 million consisted of non-cash items, including $20.8 million of stock-based compensation, $9.7 million of depreciation and amortization, and $4.3 million of accretion of debt discount and amortization of debt issuance costs. These non-cash expenses were partially offset by a purchased premium of $2.0 million related to investment securities, net of amortization. Cash provided by operating activities includes a $45.2 million increase in deferred revenue due to increased billings during the year ended December 31, 2013, a $6.8 million increase in accrued liabilities primarily due to the timing of payments, an increase in accounts payable of $5.1 million attributable to increased expenses associated with our growth, and an increase in other liabilities of $0.7 million. Cash provided by operating activities is partially offset by a $19.0 million increase in accounts receivable attributable to higher billings in the fiscal year 2013 due to an increased number of clients, a $7.1 million increase in deferred commissions due to increased sales, and a $6.1 million increase in prepaid and other assets due to an increase in business activity associated with the growth of our business and the timing of payments to vendors. Cash provided by operating activities during 2012 of $10.3 million was a result of the continued growth of our business and our ability to bill and collect from our customers, partially offset by our continued investments for further growth. In the year ended December 31, 2012, $18.2 million, or 58%, of our net loss of $31.4 million consisted of non-cash items, including $12.2 million of stock-based compensation and $7.0 million of depreciation and amortization. These non-cash expenses were partially offset by a non-cash deferred tax benefit of $1.0 million. Cash provided by operating activities includes a $35.3 million increase in deferred revenue due to increased billings during the year ended December 31, 2012, a $6.3 million increase in accrued liabilities primarily due to the timing of payments, and an increase in other liabilities of $3.7 million. Cash provided by operating activities is partially offset by a $12.3 million increase in 57 -------------------------------------------------------------------------------- accounts receivable attributable to higher billings in the fiscal year 2012 due to an increased number of clients, a $5.7 million increase in deferred commissions due to increased sales and a change in our commission plan payment schedule during the period, and a $4.2 million increase in prepaid and other assets due to an increase in business activity associated with the growth of our business and the timing of payments to vendors. Cash provided by operating activities during 2011 of $1.8 million was a result of a significant increase in sales due to the growth in our business. In 2011, $54.5 million, or 85%, of our net loss of $63.9 million consisted of non-cash items, including a $42.6 million increase in preferred stock warrant liabilities, $4.5 million of stock-based compensation, $3.7 million of depreciation and amortization, a $2.5 million reduction of revenue for the issuance of a common stock warrant in connection with our distributor agreement with ADP, $0.6 million of non-cash interest expense, and approximately $0.5 million in foreign exchange losses. In addition to these non-cash items, we incurred $0.6 million in expenses associated with our secondary offering that we withdrew from in August 2011, which expenses we presented as part of cash flows from financing activities. The other elements of our cash flows from operating activities during 2011 generally reflected significantly increased sales compared to the prior-year and our continued significant investments in headcount and other expenses to grow our business. We used working capital in a $13.3 million increase in accounts receivable due to significantly increased sales compared to the prior-year. Other uses of working capital included a $1.8 million increase in prepaid expenses and other assets, including increased third-party content fees commensurate with the increased sales, and a $1.3 million increase in deferred commissions due to the increased sales. These uses of cash were partially offset by a $22.2 million increase in deferred revenue also due to the increased sales, a $3.3 million increase in accrued expenses reflecting the overall growth of our business, including additional vacation and bonus accruals consistent with our growth in headcount, a $0.9 million increase in accounts payable due to a higher level of expenses consistent with the overall growth of our business, and a $0.7 million increase in other liabilities. Net Cash Used in Investing Activities Our primary investing activities have consisted of capital expenditures to develop our capitalized software as well as to purchase computer equipment, leasehold improvements, and furniture and fixtures in support of expanding our infrastructure and workforce. In addition, in July 2013 we began to invest the proceeds of our convertible notes in investment securities. As our business grows, we expect our capital expenditures and our investment activity to continue to increase. We used $213.4 million of cash in investing activities in the year ended December 31, 2013, primarily due to $204.0 million in purchases of investment securities, $8.8 million in purchases of additional equipment, and $6.9 million of investments in our capitalized software during the period. Cash used in investing activities was partially offset by a $6.2 million increase related to cash received from the maturities and sales of investment securities. Our investments in fixed assets consisted of $10.1 million in corporate office renovations, purchases of additional furniture and equipment for our expanding infrastructure and work force, which were primarily financed through $0.1 million in capital leases and other financing arrangements, $8.8 million in cash, and $1.2 million through our accounts payable and accrued expenses. We used $19.6 million of cash in investing activities in the year ended December 31, 2012, due to cash used in our acquisition of Sonar Limited of $12.4 million, $5.0 million of investments in our capitalized software, and $2.1 million in cash purchases of net investments in fixed assets. Our investments in fixed assets consisted of $7.2 million in corporate office renovations, purchases of additional furniture and equipment for our expanding infrastructure and work force, which were primarily financed through $2.9 million in capital leases and other financing arrangements, $2.1 million in cash, $1.5 million via a lease arrangement with Water Garden Realty Holding LLC, and $0.7 million through our accounts payable. We used $3.9 million of cash in investing activities for the year ending December 31, 2011, primarily due to $3.0 million of investments in our capitalized software and approximately $0.8 million of net investments in other fixed assets. The investments in other fixed assets consisted of $1.5 million in purchases of additional equipment during the period for our expanding infrastructure and workforce that were primarily financed through $1.1 million in capital leases and other financing arrangements and through $0.7 million under our SVB Credit Facility. In addition, we financed through capital leases approximately $0.4 million of previous investments in fixed assets during 2011 which were previously reflected in accounts payable at December 31, 2010. 58 -------------------------------------------------------------------------------- Net Cash Provided by Financing Activities Cash provided by financing activities of $228.9 million in the year ended December 31, 2013 was primarily due to proceeds from the Notes of $245.7 million and proceeds from the issuance of warrants of $23.2 million, and proceeds from stock option exercises of $13.4 million. These proceeds were partially offset by our payment for the convertible note hedges of $49.5 million and repayment of our credit facility of $4.0 million. The cash provided by financing activities of $0.3 million in the year ended December 31, 2012 was primarily due to proceeds of $2.7 million from stock option exercises and common stock warrant exercises, borrowings of $1.0 million on our line of credit with Silicon Valley Bank, partially offset by payments of $1.9 million on our capital lease and financing obligations, and debt repayment of $1.5 million. The cash provided by financing activities of $80.6 million in the year ended December 31, 2011 was primarily due to $90.5 million of proceeds from our initial public offering, net of underwriting discounts and commissions but before offering expenses. In addition, cash provided by financing activities was also due to the receipt of $4.7 million in proceeds from the exercise of warrants to purchase preferred stock and common stock and stock options and borrowings of $0.7 million under our SVB Credit Facility to finance the purchase of additional equipment and software. These proceeds were partially offset by payments of $9.2 million to repay outstanding debt, payments of costs of $3.4 million related to our initial public offering, payments of $2.0 million on our capital lease obligations and other financing arrangements, and payments of costs of $0.6 million related to our withdrawn secondary offering. Contractual Obligations Our principal commitments consist of obligations for outstanding debt, leases for our office space, computer equipment, furniture and fixtures, contractual commitments for professional service projects and third party consulting firms. The following table summarizes our contractual obligations at December 31, 2013 (in thousands): Year Ending December 31, Total 2014 2015 2016 2017 2018 Thereafter Long-term debt obligations including interest $ 271,052$ 2,466$ 4,191$ 3,805$ 3,795$ 256,795 $ - Capital lease obligations 1,164 943 217 4 - - - Operating lease obligations 26,778 4,938 5,042 5,365 5,511 5,512 410 Other contractual obligations(1) 47,199 16,034 16,242 3,810 3,810 3,810 3,493 $ 346,193$ 24,381$ 25,692$ 12,984$ 13,116$ 266,117$ 3,903 (1) Other contractual obligations include agreements with various third party service providers whereby we have committed to assign certain dollar amounts or hours of professional service projects related to implementation and other services for our clients. At December 31, 2013, liabilities for unrecognized tax benefits of $0.3 million which are attributable to foreign income taxes and interest and penalties, are not included in the table above because, due to their nature, there is a high degree of uncertainty regarding the time of future cash outflows and other events that extinguish these liabilities. Off-Balance Sheet Arrangements As part of our ongoing business, we do not have any relationships with other entities or financial partnerships, such as entities often referred to as structured finance or special purpose entities, that have been established for the purpose of facilitating off-balance sheet arrangements or other contractually narrow or limited purposes. We are therefore not exposed to any financing, liquidity, market or credit risk that could arise if we had engaged in those types of relationships. During 2013, we amended a standby letter of credit in association with a building lease and signed a standby letter of credit for a contractual arrangement in Israel. In addition, we maintain standby letters of credit in association with other contractual arrangements. The total amount outstanding is $1.5 million at December 31, 2013. 59



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Source: Edgar Glimpses


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