SALESFORCE COM INC – 10-Q – MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

Edgar Online, Inc.

 The following discussion in "Management's Discussion and Analysis of Financial Condition and Results of Operations" ("MD&A") contains forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended (the "Securities Act") and Section 21E of the Securities Exchange Act of 1934, as amended (the "Exchange Act"). Forward-looking statements consist of, among other things, trend analyses, statements regarding future events, future financial performance, our business strategy and our plans to build our business, including our strategy to be the leading provider of enterprise cloud computing applications and to lead the industry shift to the social enterprise, our service performance and security, the expenses associated with new data centers and expanding our data center capacity, our operating results, our anticipated growth, trends in our business, new application service features, our strategy of acquiring or making investments in complementary companies, services and technologies, and intellectual property rights, our ability to successfully integrate acquired businesses and technologies, the effect of general economic and market conditions including sudden declines in the fair value of our investments in cash equivalents and marketable securities, our ability to protect our intellectual property rights, our ability to develop our brands, the effect of evolving government regulations, the effect of foreign currency exchange rate and interest rate fluctuations on our financial results, the potential availability of additional tax assets in the future and related matters, the impact of expensing stock options, the sufficiency of our capital resources, potential litigation involving us and our plan to build our new global headquarters in San Francisco, all of which are based on current expectations, estimates, and forecasts, and the beliefs and assumptions of our management. Words such as "expects," "anticipates," "aims," "projects," "intends," "plans," "believes," "estimates," "seeks," variations of such words, and similar expressions are also intended to identify such forward-looking statements. These forward-looking statements are subject to risks, uncertainties and assumptions that are difficult to predict. Therefore, actual results may differ materially and adversely from those expressed in any forward-looking statements. Readers are directed to risks and uncertainties identified below, under "Risk Factors" and elsewhere in this report, for factors that may cause actual results to be different than those expressed in these forward-looking statements. Except as required by law, we undertake no obligation to revise or update publicly any forward-looking statements for any reason.  

Overview

  We are a leading provider of enterprise cloud computing applications. We provide a comprehensive customer and collaboration relationship management, or CRM, service to businesses of all sizes and industries worldwide and we provide a technology platform for customers and developers to build and run business applications.  We were founded in February 1999 and began offering our enterprise CRM application service in February 2000. Since then, we have augmented our CRM service with new editions and enhanced features. We introduced our Force.com platform to customers and developers so they can build complementary applications to extend beyond CRM. In 2010, we introduced our AppExchange directory of enterprise cloud computing applications that are integrated with our CRM service and, in most cases, have been developed on our platform by third parties. We also introduced Chatter, a collaboration application for the enterprise to connect and share information securely and in real-time. In fiscal 2012, we introduced our vision of a social enterprise, which is a company that leverages social, mobile and open technologies to place its customers at the center of its business.  

Our objective is to be the leading provider of enterprise cloud computing applications and to lead the industry shift to the social enterprise. Key elements of our strategy include:

         •   Strengthening our existing CRM applications and extending into new          functional areas within CRM;       •   Pursuing new customers and new territories aggressively;       •   Deepening relationships with our existing customer base;                                            33 

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• Continuing to lead the industry transformation to the next phase of cloud

          computing; and          •   Encouraging the development of third-party applications on our cloud

computing platform.

   We believe the factors that will influence our ability to achieve our objectives include our prospective customers' willingness to migrate to an enterprise cloud computing application service; the performance and security of our service; our ability to continue to release, and gain customer acceptance of, new and improved features; our ability to successfully integrate acquired businesses and technologies; successful customer adoption and utilization of our service; acceptance of our service in markets where we have few customers; the emergence of additional competitors in our market and improved product offerings by existing and new competitors; the location of new data centers; third-party developers' willingness to develop applications on our platform; and general economic conditions which could affect our customers' ability and willingness to purchase our application service, delay the customers' purchasing decision or affect renewal rates.  To address these factors, we will need to, among other things, continue to add substantial numbers of paying subscriptions, upgrade our customers to fully featured versions such as our Unlimited Edition or arrangements such as a social enterprise license agreement, provide high quality technical support to our customers and encourage the development of third-party applications on our platform. Our plans to invest for future growth include the continuation of the expansion of our data center capacity. We also plan to continue to hire additional personnel, particularly in direct sales, other customer-related areas and research and development. As part of our growth plans, we intend to continue to focus on retaining customers at the time of renewal. Additionally, we plan to: expand our domestic and international selling and marketing activities; continue to develop our brands; add additional distribution channels; increase our research and development activities to upgrade and extend our service offerings; develop new services and technologies and integrate acquired technologies; and add to our global infrastructure to support our growth. We also regularly evaluate acquisitions or investment opportunities in complementary businesses, joint ventures, services and technologies, and intellectual property rights in an effort to expand our service offerings. We expect to continue to make such investments and acquisitions in the future. As such, we plan to reinvest a significant portion of our incremental revenue to grow our business and continue our leadership role in the cloud computing industry. As a result of these investments, we expect diluted earnings per share in fiscal 2012 to be significantly lower than diluted earnings per share in fiscal 2011.  Over the past two years, we acquired several businesses and technologies such as Jigsaw and Heroku. In May 2011, we acquired Radian6 for a total purchase price consideration of approximately $336.6 million, net of cash acquired. Radian6 is a cloud application vendor that provides customers with social media monitoring, measurement and engagement solutions. We acquired Radian6 for its developed technology, assembled workforce, expected synergies and expanded market opportunities when integrating Radian6's social solution technology with our current product offerings. In September 2011, we acquired Assistly for a total purchase price consideration of approximately $58.7 million. Assistly is a cloud-based provider of customer service solutions. We acquired Assistly for its developed help desk application technology in order to expand our customer service market opportunities in the small and emerging business market. We also entered into a definitive agreement to acquire Model Metrics to expand our mobile and social consulting services.  In fiscal 2010, we issued at par value $575.0 million of 0.75% convertible senior notes due on January 15, 2015 (the "Notes"). For 20 trading days during the 30 consecutive trading days ended January 31, 2011, April 30, 2011, July 31, 2011 and October 31, 2011, our common stock traded at a price exceeding 130 percent of the conversion price of $85.36 per share applicable to the Notes. Accordingly, based on the terms of the Notes, since February 1, 2011, the Notes were convertible at the option of the holder and continue to be convertible at the holders' option for the quarter ending January 31, 2012. Upon conversion of any Notes, we will deliver cash up to the principal amount of the Notes and, with respect to any excess conversion value greater than the principal amount of the Notes, shares of our common stock, cash, or a combination of both. Therefore, for the quarter ending January 31, 2012, the Notes will remain classified as a current liability on our condensed consolidated balance sheet.                                           34 

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  We expect marketing and sales costs, which were 52 percent of our total revenues for the nine months ended October 31, 2011 and 47 percent for the same period a year ago, to continue to represent a substantial portion of total revenues in the future as we seek to add more paying subscribers, build greater brand awareness and attract new customers.  

Fiscal Year

Our fiscal year ends on January 31. References to fiscal 2012, for example, refer to the fiscal year ended January 31, 2012.

Segments

  We have made several acquisitions to expand our business and offerings. For example in fiscal 2012, we acquired Radian6 to provide cloud based social media monitoring, measurement and engagement solutions. This and other acquisitions made over the past two years have allowed us to expand our offerings, presence and reach in various segments of the enterprise cloud computing market. While we have offerings in multiple enterprise cloud computing market segments, our business operates in one reportable segment because our decision making group evaluates our financial information and resources and assesses the performance of these resources on a consolidated basis only. Since we operate in one operating segment, all required financial segment information can be found in the consolidated financial statements.  

Sources of Revenues

  We derive our revenues from: (1) subscriptions fees from customers accessing our enterprise cloud computing application service; (2) support revenues from customers purchasing additional support beyond the standard support that is included in the basic subscription fee; (3) professional services, which include consulting services such as process mapping and project management, and implementation services including systems integration, technical architecture and development, and data conversion; and (4) other revenue, which consists primarily of training fees. Subscription and support revenues accounted for approximately 94 percent of our total revenues during the nine months ended October 31, 2011. Subscription revenues are driven primarily by the number of paying subscribers, varying service types, the price of our service and service renewal rates. We define a "customer" as a separate and distinct buying entity (e.g., a company, a distinct business unit of a large corporation, a partnership, etc.) that has entered into a contract to access our enterprise cloud computing service. We define a "subscription" as a unique user account purchased by a customer for use by its employees or other customer-authorized users, and we refer to each such user as a "subscriber." The number of paying subscriptions at each of our customers ranges from one to tens of thousands. None of our customers accounted for more than five percent of our revenues during the three and nine months ended October 31, 2011 and 2010, respectively.  Subscription and support revenues are recognized ratably over the contract terms beginning on the commencement dates of each contract. The typical subscription and support term is 12 to 24 months, although terms range from one to 60 months. Our subscription and support contracts are non-cancelable, though customers typically have the right to terminate their contracts for cause if we materially fail to perform. We generally invoice our customers in advance, in annual or quarterly installments, and typical payment terms provide that our customers pay us within 30 days of invoice. Amounts that have been invoiced are recorded in accounts receivable and in deferred revenue, or in revenue depending on whether the revenue recognition criteria have been met. In general, we collect our billings in advance of the subscription service period.  Professional services and other revenues consist of fees associated with consulting and implementation services and training. Our consulting and implementation engagements are typically billed on a time and materials basis. We also offer a number of training classes on implementing, using and administering our service that are billed on a per person, per class basis. Our typical professional services payment terms provide that our customers pay us within 30 days of invoice.                                           35 

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  In determining whether professional services can be accounted for separately from subscription and support revenues, we consider a number of factors, which are described in "Critical Accounting Policies and Estimates-Revenue Recognition" below. Prior to February 1, 2011, the deliverables in multiple-deliverable arrangements were accounted for separately if the delivered items had standalone value and there was objective and reliable evidence of fair value for the undelivered items. If the deliverables in a multiple-deliverable arrangement could not be accounted for separately, the total arrangement fee was recognized ratably as a single unit of accounting over the contracted term of the subscription agreement. A significant portion of our multiple-deliverable arrangements were accounted for as a single unit of accounting because we did not have objective and reliable evidence of fair value for certain of our deliverables. Additionally, in these situations, we deferred the direct costs of a related professional service arrangement and amortized those costs over the same period as the professional services revenue was recognized.  In October 2009, the Financial Accounting Standards Board ("FASB") issued Accounting Standards Update No. 2009-13, "Revenue Recognition (Topic 605), Multiple-Deliverable Revenue Arrangements-a consensus of the FASB Emerging Issues Task Force" ("ASU 2009-13") which amended the previous multiple-deliverable arrangements accounting guidance. Pursuant to the new guidance, objective and reliable evidence of fair value of the deliverables to be delivered is no longer required in order to account for deliverables in a multiple-deliverable arrangement separately. Instead, arrangement consideration is allocated to deliverables based on their relative selling price. In the first quarter of fiscal 2012, we adopted this new accounting guidance on a prospective basis. We applied the new accounting guidance to those multiple-deliverable arrangements entered into or materially modified on or after February 1, 2011 which is the beginning of our fiscal year.  

Seasonal Nature of Deferred Revenue and Accounts Receivable

  Deferred revenue primarily consists of billings to customers for our subscription service. Over 90 percent of the value of our billings to customers is for our subscription and support service. We generally invoice our customers in either quarterly or annual cycles, with a disproportionate weighting towards annual billings in the fourth quarter, primarily as a result of large enterprise account buying patterns. Additionally, our fourth quarter has historically been our strongest quarter for new business and renewals. The year on year compounding effect of this seasonality in both billing patterns and overall new and renewal business causes the value of invoices that we generate in the fourth quarter for both new and existing customers to increase as a proportion of our total annual billings.  Accordingly, the sequential quarterly changes in accounts receivable and the related deferred revenue during the first three quarters of our fiscal year are not necessarily indicative of the billing activity that occurs in the fourth quarter as displayed below:                                                 $1,426,943       $1,426,943       $1,426,943     $1,426,943                                             April 30,         July 31,       October 31, (in thousands)                                 2011             2011             2011 Fiscal 2012 Accounts receivable, net                   $    270,816     $    342,397     $    312,331 Deferred revenue, current and noncurrent        915,133          935,266          917,821                                                  $1,426,943       $1,426,943       $1,426,943       $1,426,943                                             April 30,         July 31,       October 31,      January 31,                                                2010             2010             2010             2011 Fiscal 2011 Accounts receivable, net                   $    183,612     $    228,550     $    258,764     $    426,943 Deferred revenue, current and noncurrent        664,529          683,019          694,557          934,941                                                  $1,426,943       $1,426,943       $1,426,943       $1,426,943                                             April 30,         July 31,       October 31,      January 31,                                                2009             2009             2009             2010 Fiscal 2010 Accounts receivable, net                   $    145,869     $    168,842     $    191,297     $    320,956 Deferred revenue, current and noncurrent        549,373          549,010          545,435          704,348                                            36 

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Cost of Revenues and Operating Expenses

  Cost of Revenues. Cost of subscription and support revenues primarily consists of expenses related to hosting our service and providing support, the costs of data center capacity, depreciation or operating lease expense associated with computer equipment and software, allocated overhead and amortization expense associated with capitalized software related to our application service and acquired developed technologies. We allocate overhead such as rent and occupancy charges based on headcount. Employee benefit costs and taxes are allocated based upon a percentage of total compensation expense. As such, general overhead expenses are reflected in each cost of revenue and operating expense category. Cost of professional services and other revenues consists primarily of employee-related costs associated with these services, including stock-based expenses, the cost of subcontractors and allocated overhead. The cost of providing professional services is significantly higher as a percentage of the related revenue than for our enterprise cloud computing subscription service due to the direct labor costs and costs of subcontractors.  We intend to continue to invest additional resources in our enterprise cloud computing application service. For example, we plan to open additional data centers in the future. Additionally, as we acquire new businesses and technologies, the amortization expense associated with this activity will be included in cost of revenues. The timing of these additional expenses will affect our cost of revenues, both in terms of absolute dollars and as a percentage of revenues, in the affected periods.  Research and Development. Research and development expenses consist primarily of salaries and related expenses, including stock-based expenses, the costs of our development and test data center and allocated overhead. We continue to focus our research and development efforts on adding new features and services, integrating acquired technologies, increasing the functionality and enhancing the ease of use of our enterprise cloud computing application service. Our proprietary, scalable and secure multi-tenant architecture enables us to provide all of our customers with a service based on a single version of our application. As a result, we do not have to maintain multiple versions, which enables us to have relatively lower research and development expenses as compared to traditional enterprise software companies. We expect that in the future, research and development expenses will increase in absolute dollars as we improve and extend our service offerings, develop new technologies and integrate acquired businesses and technologies.  Marketing and Sales. Marketing and sales expenses are our largest cost and consist primarily of salaries and related expenses, including stock-based expenses, for our sales and marketing staff, including commissions, payments to partners, marketing programs and allocated overhead. Marketing programs consist of advertising, events, corporate communications, brand building and product marketing activities.  We plan to continue to invest in marketing and sales by expanding our domestic and international selling and marketing activities, building brand awareness, attracting new customers and sponsoring additional marketing events. The timing of these marketing events, such as our annual and largest event, Dreamforce, will affect our marketing costs in a particular quarter. We expect that in the future, marketing and sales expenses will increase in absolute dollars and continue to be our largest cost.  General and Administrative. General and administrative expenses consist of salaries and related expenses, including stock-based expenses, for finance and accounting, legal, internal audit, human resources and management information systems personnel, legal costs, professional fees, other corporate expenses and allocated overhead. We expect that in the future, general and administrative expenses will increase in absolute dollars as we invest in our infrastructure and we incur additional employee related costs, professional fees and insurance costs related to the growth of our business and international expansion. We expect general and administrative costs as a percentage of total revenues to remain flat for the next several quarters.  Stock-Based Expenses. Our cost of revenues and operating expenses include stock-based expenses related to option and stock awards to employees and non-employee directors. We recognize our stock-based payments as an expense in the statement of operations based on their fair values and vesting periods. If our grant activity                                           37 

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remains consistent and our stock price increases in the future, stock-based expenses will rise. These charges have been significant in the past and we expect that they will increase as we hire more employees and seek to retain existing employees.

Critical Accounting Policies and Estimates

  Our consolidated financial statements 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, revenues, costs and expenses, and related disclosures. On an ongoing basis, we evaluate our estimates and assumptions. Our actual results may differ from these estimates under different assumptions or conditions.  We believe that of our significant accounting policies, which are described in Note 1 to our condensed consolidated financial statements, the following accounting policies involve a greater degree of judgment and complexity. Accordingly, these are the policies we believe are the most critical to aid in fully understanding and evaluating our condensed consolidated financial condition and results of operations.  Revenue Recognition. We derive our revenues from two sources: (1) subscription revenues, which are comprised of subscription fees from customers accessing our enterprise cloud computing application service and from customers purchasing additional support beyond the standard support that is included in the basic subscription fee; and (2) related professional services such as process mapping, project management, implementation services and other revenue. "Other revenue" consists primarily of training fees.  

We commence revenue recognition when all of the following conditions are satisfied:

     •   There is persuasive evidence of an arrangement;       •   The service has been or is being provided to the customer;       •   The collection of the fees is reasonably assured; and    

• The amount of fees to be paid by the customer is fixed or determinable.

Our subscription service arrangements are non-cancelable and do not contain refund-type provisions.

Subscription and Support Revenues

  Subscription and support revenues are recognized ratably over the contract terms beginning on the commencement date of each contract, which is the date our service is made available to customers. Amounts that have been invoiced are recorded in accounts receivable and in deferred revenue or revenue, depending on whether the revenue recognition criteria have been met.  

Professional Services and Other Revenues

  The majority of our professional services contracts are on a time and material basis. When these services are not combined with subscription revenues as a single unit of accounting, as discussed below, these revenues are recognized as the services are rendered for time and material contracts, and when the milestones are achieved and accepted by the customer for fixed price contracts. Training revenues are recognized after the services are performed.  

Multiple-Deliverable Arrangements

We enter into arrangements with multiple-deliverables that generally include subscription, premium support, and professional services.

  Prior to February 1, 2011, the deliverables in multiple-deliverable arrangements were accounted for separately if the delivered items had standalone value and there was objective and reliable evidence of fair value                                           38

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  for the undelivered items. If the deliverables in a multiple-deliverable arrangement could not be accounted for separately, the total arrangement fee was recognized ratably as a single unit of accounting over the contracted term of the subscription agreement. A significant portion of our multiple-deliverable arrangements were accounted for as a single unit of accounting because we did not have objective and reliable evidence of fair value for certain of our deliverables. Additionally, in these situations, we deferred the direct costs of a professional services arrangement and amortized those costs over the same period as the professional services revenue is recognized.  In October 2009, the FASB issued Accounting Standards Update No. 2009-13, "Revenue Recognition (Topic 605), Multiple-Deliverable Revenue Arrangements-a consensus of the FASB Emerging Issues Task Force" ("ASU 2009-13") which amended the previous multiple-deliverable arrangements accounting guidance. Pursuant to the updated guidance, objective and reliable evidence of fair value of the deliverables to be delivered is no longer required in order to account for deliverables in a multiple-deliverable arrangement separately. Instead, arrangement consideration is allocated to deliverables based on their relative selling price.  In the first quarter of fiscal 2012, we adopted this updated accounting guidance on a prospective basis. We have applied the new accounting guidance to those multiple-deliverable arrangements entered into or materially modified on or after February 1, 2011 which is the beginning of our fiscal year.  The adoption of this updated accounting guidance did not have a material impact on our financial condition, results of operations or cash flows. As of October 31, 2011, the deferred professional services revenue and deferred costs under the previous accounting guidance are $41.0 million and $19.3 million, respectively, which will continue to be recognized over the related remaining subscription period.  Under the updated accounting guidance, in order to treat deliverables in a multiple-deliverable arrangement as separate units of accounting, the deliverables must have standalone value upon delivery. If the deliverables have standalone value upon delivery, we account for each deliverable separately. Subscription services have standalone value as such services are often sold separately. In determining whether professional services have standalone value, we consider the following factors for each professional services agreement: availability of the services from other vendors, the nature of the professional services, the timing of when the professional services contract was signed in comparison to the subscription service start date, and the contractual dependence of the subscription service on the customer's satisfaction with the professional services work. To date, we have concluded that all of the professional services included in multiple-deliverable arrangements executed have standalone value.  Under the updated accounting guidance, when multiple-deliverables included in an arrangement are separated into different units of accounting, the arrangement consideration is allocated to the identified separate units based on a relative selling price hierarchy. We determine the relative selling price for a deliverable based on its vendor-specific objective evidence of selling price ("VSOE"), if available, or our best estimate of selling price ("BESP"), if VSOE is not available. We have determined that third-party evidence ("TPE") is not a practical alternative due to differences in our service offerings compared to other parties and the availability of relevant third-party pricing information. The amount of revenue allocated to delivered items is limited by contingent revenue, if any.  

For certain professional services, we have established VSOE as a consistent number of standalone sales of this deliverable have been priced within a reasonably narrow range. We have not established VSOE for our subscription services due to lack of pricing consistency, the introduction of new services and other factors. Accordingly, we use our BESP to determine the relative selling price.

  We determined BESP by considering our overall pricing objectives and market conditions. Significant pricing practices taken into consideration include our discounting practices, the size and volume of our transactions, the customer demographic, the geographic area where our services are sold, our price lists, our go-to-market strategy, historical standalone sales and contract prices. The determination of BESP is made through consultation with and approval by management, taking into consideration the go-to-market strategy. As our go-to-market strategies evolve, we may modify our pricing practices in the future, which could result in changes in relative selling prices, including both VSOE and BESP.                                           39 

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  Deferred Revenue. The deferred revenue balance does not represent the total contract value of annual or multi-year, non-cancelable subscription agreements. Deferred revenue primarily consists of billings or payments received in advance of revenue recognition from subscription service described above and is recognized as the revenue recognition criteria are met. We generally invoice customers in annual or quarterly installments. Deferred revenue is influenced by several factors, including seasonality, the compounding effects of renewals, invoice duration, invoice timing and new business linearity within the quarter.  

Billings against professional services arrangements entered into prior to February 1, 2011 will generally be added to deferred revenue and recognized over the remaining related subscription contract term.

Deferred revenue that will be recognized during the succeeding twelve month period is recorded as current deferred revenue and the remaining portion is recorded as noncurrent.

  Deferred Commissions. We defer commission payments to our direct sales force. The commissions are deferred and amortized to sales expense over the non-cancelable terms of the related subscription contracts with our customers, which are typically 12 to 24 months. The commission payments, which are paid in full the month after the customer's service commences, are a direct and incremental cost of the revenue arrangements. The deferred commission amounts are recoverable through the future revenue streams under the non-cancelable customer contracts. We believe this is the preferable method of accounting as the commission charges are so closely related to the revenue from the non-cancelable customer contracts that they should be recorded as an asset and charged to expense over the same period that the subscription revenue is recognized.  During the nine months ended October 31, 2011, we deferred $80.3 million of commission expenditures and we amortized $76.5 million to sales expense. During the same period a year ago, we deferred $65.2 million of commission expenditures and we amortized $57.6 million to sales expense. Deferred commissions on our condensed consolidated balance sheets totaled $120.4 million at October 31, 2011 and $116.6 million at January 31, 2011.  Business Combinations. We recognize separately from goodwill the fair value of assets acquired and liabilities assumed. Goodwill as of the acquisition date represents the excess of the purchase consideration of an acquired business over the fair value of the underlying net tangible and intangible assets acquired and liabilities assumed. We use our best estimates and assumptions to accurately assign fair value to the tangible and intangible assets acquired and liabilities assumed at the acquisition date. Our estimates are inherently uncertain and subject to refinement. As a result, during the measurement period, which may be up to one year from the acquisition date, we may record adjustments to the fair value of assets acquired and liabilities assumed, with the corresponding offset to goodwill. Upon the conclusion of the measurement period or final determination of the fair value of assets acquired or liabilities assumed, whichever comes first, any subsequent adjustments are recorded to our condensed consolidated statements of operations.  In addition, uncertain tax positions and tax related valuation allowances assumed in connection with a business combination are initially estimated as of the acquisition date. We reevaluate these items quarterly and record any adjustments to the preliminary estimates to goodwill provided that we are within the measurement period and we continue to collect information in order to determine their estimated fair values as of the date of acquisition. Subsequent to the measurement period or our final determination of the estimated value of the tax allowance or contingency, changes to these uncertain tax positions and tax related valuation allowances will affect our provision for income taxes in the condensed consolidated statements of operations.  

Stock-Based Awards. We recognize the fair value of our stock awards on a straight-line basis over the requisite service period of the award which is the vesting term of generally four years.

  We recognized stock-based expense of $159.2 million during the nine months ended October 31, 2011. The requirement to expense stock-based awards will continue to materially reduce our reported results of operations.                                           40

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  As of October 31, 2011, we had an aggregate of $582.3 million of stock compensation remaining to be amortized to expense over the remaining requisite service period of the underlying awards. We currently expect this stock compensation balance to be amortized as follows: $58.4 million during the remaining three months of fiscal 2012; $208.9 million during fiscal 2013; $179.0 million during fiscal 2014; $121.2 million during fiscal 2015 and $14.8 million during fiscal 2016. These amounts reflect only outstanding stock awards as of October 31, 2011 and assume no forfeiture activity. We expect to continue to issue stock-based awards to our employees in future periods, which will increase the stock compensation amortization in such future periods.  We recognize as an operating expense the payroll and social tax costs, as applicable by jurisdiction, when stock options are exercised. The impact of stock-based expense in the future is dependent upon, among other things, the timing of when we hire additional employees, the effect of long-term incentive strategies involving stock awards in order to continue to attract and retain employees, the total number of stock awards granted, the fair value of the stock awards at the time of grant, changes in estimated forfeiture assumption rates and the tax benefit that we may or may not receive from stock-based expenses. Additionally, we are required to use an option-pricing model to determine the fair value of stock option awards. This determination of fair value is affected by our stock price as well as assumptions regarding a number of highly complex and subjective variables. These variables include, but are not limited to, our expected stock price volatility over the term of the awards.  As of October 31, 2011, there were 3.3 million restricted stock awards and units outstanding. We plan to continue awarding restricted stock to our employees in the future. The restricted stock, which upon vesting entitles the holder to one share of common stock for each restricted stock, has an exercise price of $0.001 per share, which is equal to the par value of our common stock, and vests over four years. The fair value of the restricted stock is based on our closing stock price on the date of grant, and compensation expense, net of estimated forfeitures, is recognized on a straight-line basis over the vesting period.  

Income Taxes. We account for income taxes using the liability method, which requires the recognition of deferred tax assets or liabilities for the tax-effected temporary differences between the financial reporting and tax basis of our assets and liabilities and for net operating loss and tax credit carryforwards. The tax expense or benefit for unusual items, or certain adjustments to the valuation allowance are treated as discrete items in the interim period in which the events occur.

  Our effective tax rate could be adversely affected by changes in the mix of earnings and losses in countries with differing statutory tax rates, certain non-deductible expenses as a result of acquisitions, the calculation of deferred tax assets and liabilities, and changes in tax laws and accounting principles.  Strategic Investments. We report our investments in marketable equity securities at fair market value using the quoted prices in their respective active markets. We report our investments in non-marketable equity and debt securities, which consist of minority equity and debt investments in privately-held companies, at cost or fair value when an event or circumstance indicates an other-than-temporary decline in value has occurred. Management evaluates financial results, earnings trends, technology milestones and subsequent financing of these companies, as well as the general market conditions to identify indicators of other-than temporary impairment.                                           41

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Results of Operations

  The following tables set forth selected data for each of the periods indicated (in thousands, unaudited).                                                 Three Months Ended                 Nine Months Ended                                                  October 31,                       October 31,                                             2011            2010             2011              2010 Revenues: Subscription and support                  $ 549,182       $ 402,948       $ 1,531,965       $ 1,122,611 Professional services and other              35,078          26,139           102,661            77,661  Total revenues                              584,260         429,087         1,634,626         1,200,272 Cost of revenues: Subscription and support                     96,306          54,089           260,693           147,127 Professional services and other              32,259          28,042            91,848            84,375  Total cost of revenues                      128,565          82,131           352,541           231,502  Gross profit                                455,695         346,956         1,282,085           968,770 Operating expenses: Research and development                     76,049          47,305           214,734           130,357 Marketing and sales                         304,571         200,544           842,043           558,812 General and administrative                   85,232          63,951           254,016           181,713  Total operating expenses                    465,852         311,800         1,310,793           870,882 Income (loss) from operations               (10,157 )        35,156           (28,708 )          97,888 Investment income                             5,136          11,699            18,303            28,309 Interest expense                             (3,859 )        (7,374 )         (11,376 )         (21,619 ) Other income (expense)                           30            (921 )          (4,001 )          (4,659 )  Income (loss) before benefit (provision) for income taxes and noncontrolling interest                      (8,850 )        38,560           (25,782 )          99,919 Benefit (provision) for income taxes          5,094         (16,192 )          18,288           (41,092 )  Consolidated net income (loss)               (3,756 )        22,368            (7,494 )          58,827 Less: Net income attributable to noncontrolling interest                           0          (1,296 )               0            (5,266 )  Net income (loss) attributable to salesforce.com                            $  (3,756 )     $  21,072       $    (7,494 )     $    53,561                                                                          As of                                               October 31,        January 31,        October 31,                                                   2011               2011               2010 Balance Sheet Data: Cash, cash equivalents and marketable securities                                    $  1,296,693       $  1,407,557       $  1,802,440 Deferred revenue, current and noncurrent           917,821            934,941            694,557                                       Three Months Ended             Nine Months Ended                                       October 31,                   October 31,                                   2011          2010           2011            2010

Revenues by geography:

       Americas                 $ 397,118     $ 292,540     $ 1,104,052     $   826,493        Europe                     103,864        76,464         300,315         208,851        Asia Pacific                83,278        60,083         230,259         164,928                                  $ 584,260     $ 429,087     $ 1,634,626     $ 1,200,272                                             42 

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Cost of revenues and operating expenses include the following amounts related to stock-based awards (in thousands).

                                          Three Months Ended          Nine Months Ended                                           October 31,                October 31,                                        2011          2010         2011          2010        Cost of revenues             $    4,138     $  2,357     $  12,168     $  8,617        Research and development         12,197        3,976        31,224       12,119        Marketing and sales              29,123       11,969        80,024       36,496        General and administrative       11,548        7,330        35,742       21,483  

Cost of revenues and marketing and sales expenses include the following amounts related to amortization of purchased intangibles (in thousands).

                                               Three Months  Ended          Nine Months Ended                                                 October 31,                 October 31,                                              2011           2010          2011         2010

Amortization of purchased intangibles:

 Cost of revenues                         $    17,469      $ 4,168     $   42,937     $ 9,738  Marketing and sales                              953        1,013          4,499       3,063  

The following tables set forth selected consolidated statements of operations data for each of the periods indicated as a percentage of total revenues.

                                                   Three Months Ended                 Nine Months Ended                                                     October 31,                       October 31,                                                2011              2010            2011              2010

Revenues:

 Subscription and support                           94 %             94 %             94 %             94 % Professional services and other                     6                6                6                6  Total revenues                                    100              100              100              100  Cost of revenues: Subscription and support                           16               13               16               12 Professional services and other                     6                6                6                7  Total cost of revenues                             22               19               22               19  Gross profit                                       78               81               78               81 Operating expenses: Research and development                           13               11               13               11 Marketing and sales                                52               47               52               47 General and administrative                         15               15               15               15  Total operating expenses                           80               73               80               73 Income (loss) from operations                      (2 )              8               (2 )              8 Investment income                                   1                3                1                2 Interest expense                                   (1 )             (2 )             (1 )             (2 ) Other income (expense)                              0                0                0                0  Income (loss) before benefit (provision) for income taxes and noncontrolling interest                            (2 )              9               (2 )              8 Benefit (provision) for income taxes                1               (4 )              1               (3 )  Consolidated net income (loss)                     (1 )              5               (1 )              5 Less: Net income attributable to noncontrolling interest                             0                0                0               (1 )  Net income (loss) attributable to salesforce.com                                     (1 )%             5 %             (1 )%             4 %                                             43 

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   Table of Contents                                    Three Months  Ended           Nine Months Ended                                        October 31,                  October  31,                                    2011             2010         2011           2010         Revenues by geography:         Americas                        68 %           68 %          68 %          69 %         Europe                          18             18            18            17         Asia Pacific                    14             14            14            14                                         100 %          100 %         100 %         100 %                                          Three Months  Ended            Nine Months Ended                                         October 31,                   October 31,                                    2011              2010        2011             2010      Stock-based awards:      Cost of revenues                   1 %              0 %          1 %             1 %

     Research and development           2                1            2               1      Marketing and sales                5                3            5               3      General and administrative         2                2            2               2   

Three Months Ended October 31, 2011 and 2010

  Revenues.                                            Three Months Ended                                             October 31,                  Variance     (In thousands)                      2011          2010         Dollars       Percent     Subscription and support          $ 549,182     $ 402,948     $ 146,234            36 %     Professional services and other      35,078        26,139         8,939            34 %      Total revenues                    $ 584,260     $ 429,087     $ 155,173            36 %    Total revenues were $584.3 million for the three months ended October 31, 2011, compared to $429.1 million during the same period a year ago, an increase of $155.2 million, or 36 percent. Subscription and support revenues were $549.2 million, or 94 percent of total revenues, for the three months ended October 31, 2011, compared to $402.9 million, or 94 percent of total revenues, during the same period a year ago. The increase in subscription and support revenues was due primarily to new customers, upgrades and additional subscriptions from existing customers and improved renewal rates as compared to a year ago. The price per user per month for our three primary offerings, Professional Edition, Enterprise Edition and Unlimited Edition, in the quarter ended October 31, 2011 has remained substantially consistent relative to prior periods. Professional services and other revenues were $35.1 million, or six percent of total revenues, for the three months ended October 31, 2011, compared to $26.1 million, or six percent of total revenues, for the same period a year ago. The increase in professional services and other revenues was due primarily to the improved utilization of existing headcount and a small benefit from the prospective adoption of the new revenue accounting guidance for multiple-deliverable arrangements.  Revenues in Europe and Asia Pacific accounted for $187.1 million, or 32 percent of total revenues, for the three months ended October 31, 2011, compared to $136.5 million, or 32 percent of total revenues, during the same period a year ago, an increase of $50.6 million, or 37 percent. The increase in revenues outside of the Americas was the result of the increasing acceptance of our service, our focus on marketing our service internationally and improved renewal rates. Additionally, the value of the U.S. dollar relative to foreign currencies contributed to an increase in U.S. dollar revenues outside of the  for the three months ended October 31, 2011 as compared to the same period a year ago. The foreign currency impact had the effect of increasing our aggregate revenues by $9.3 million compared to the same period a year ago. As part of our overall growth, we expect the percentage of our revenue generated outside of the Americas to increase as a percentage of our total revenues worldwide.                                           44

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  Table of Contents  Cost of Revenues.                                                 Three Months Ended                                                  October 31,           Variance          (In thousands)                       2011          2010        Dollars

Subscription and support $ 96,306$ 54,089$ 42,217

Professional services and other 32,259 28,042 4,217

           Total cost of revenues            $  128,565     $ 82,131     $  

46,434

           Percent of total revenues                 22 %         19 %   Cost of revenues was $128.6 million, or 22 percent of total revenues, for the three months ended October 31, 2011, compared to $82.1 million, or 19 percent of total revenues, during the same period a year ago, an increase of $46.4 million. The increase in absolute dollars was primarily due to an increase of $6.3 million in employee-related costs, an increase of $11.2 million in service delivery costs, primarily due to our efforts to increase data center capacity, an increase of $19.2 million in depreciation and amortization expenses, $13.3 million of which related to the amortization of acquired developed technology, an increase of $6.2 million in outside subcontractor and other service costs, an increase of $1.1 million in allocated overhead and an increase of $1.8 million in stock-based expenses. Gross profit margins for professional services and other improved over the same period a year ago primarily due to the improved utilization of existing headcount, a reduction in non-billable headcount since October 31, 2010 and a small benefit from the prospective adoption of the new revenue accounting guidance for multiple-deliverable arrangements.  We intend to continue to invest additional resources in our enterprise cloud computing application service and data center capacity. Additionally, the amortization of acquired developed technology will increase as we acquire additional businesses and technologies. The timing of these expenses will affect our cost of revenues, both in terms of absolute dollars and as a percentage of revenues in future periods.  Research and Development.                                              Three Months Ended                                               October 31,           Variance             (In thousands)                 2011          2010        Dollars             Research and development    $   76,049     $ 47,305     $  28,744             Percent of total revenues           13 %         11 %   Research and development expenses were $76.0 million, or 13 percent of total revenues, for the three months ended October 31, 2011, compared to $47.3 million, or 11 percent of total revenues, during the same period a year ago, an increase of $28.7 million. The increase in absolute dollars was primarily due to an increase of $16.6 million in employee-related costs, an increase of $8.2 million in stock-based expenses and an increase of $2.2 million in allocated overhead. We increased our research and development headcount by 65 percent since October 31, 2010 in order to improve and extend our service offerings and develop new technologies. Some of the increase in headcount was due to acquired businesses.  Marketing and Sales.                                              Three Months Ended                                               October 31,           Variance             (In thousands)                2011          2010         Dollars             Marketing and sales         $ 304,571     $ 200,544     $ 104,027             Percent of total revenues          52 %          47 %                                            45 

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  Marketing and sales expenses were $304.6 million, or 52 percent of total revenues, for the three months ended October 31, 2011, compared to $200.5 million, or 47 percent of total revenues, during the same period a year ago, an increase of $104.0 million. The increase in absolute dollars was primarily due to increases of $67.0 million in employee-related costs, $17.2 million in stock-based expenses, $13.3 million in advertising, marketing and event costs and $4.0 million in allocated overhead. Our largest annual marketing event, Dreamforce, occurred during the third quarter of fiscal 2012 and was held in the fourth quarter of the prior fiscal year. The costs associated with this event are reflected in the three months ended October 31, 2011 results. Our marketing and sales headcount increased by 43 percent since October 31, 2010 as we hired additional sales personnel to focus on adding new customers and increasing penetration within our existing customer base. Some of the increase in headcount was due to acquired businesses.  General and Administrative.                                               Three Months Ended                                                October 31,           Variance             (In thousands)                  2011          2010        Dollars             General and administrative   $   85,232     $ 63,951     $  21,281             Percent of total revenues            15 %         15 %   General and administrative expenses were $85.2 million, or 15 percent of total revenues, for the three months ended October 31, 2011, compared to $64.0 million, or 15 percent of total revenues, during the same period a year ago, an increase of $21.3 million. The increase was due to an increase of $14.4 million in employee-related costs, an increase of $4.2 million in stock-based expenses and an increase of $2.7 million in professional and outside service costs. Our general and administrative headcount increased by 46 percent since October 31, 2010 as we added personnel to support our growth.  

Income (loss) from operations.

                                               Three Months Ended                                                 October 31,           Variance           (In thousands)                    2011           2010        Dollars

Income (loss) from operations $ (10,157 ) $ 35,156 $ (45,313 )

           Percent of total revenues              (2 )%          8 %   Loss from operations for the three months ended October 31, 2011 was $10.2 million and included $57.0 million of stock-based expenses and $18.4 million of amortization of purchased intangibles. During the same period a year ago, operating income was $35.2 million and included $25.6 million of stock-based expenses and $5.2 million of amortization of purchased intangibles.  Investment income.                                              Three Months Ended                                               October 31,           Variance             (In thousands)                2011           2010        Dollars             Investment income           $   5,136      $ 11,699     $  (6,563 )             Percent of total revenues           1 %           3 %   Investment income consists of income on cash and marketable securities balances. Investment income was $5.1 million for the three months ended October 31, 2011 and was $11.7 million during the same period a year ago. The decrease was primarily due to a reduction in realized gains from sales of marketable securities, the decrease in marketable securities balances and lower interest rates.                                           46 

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   Table of Contents  Interest expense.                                             Three Months Ended                                              October 31,             Variance            (In thousands)                2011           2010         Dollars            Interest expense            $  (3,859 )    $ (7,374 )    $    3,515            Percent of total revenues          (1 )%         (2 )%   Interest expense consists primarily of interest on our Notes and capital leases. Interest expense was $3.9 million, net of interest costs capitalized, for the three months ended October 31, 2011 and was $7.4 million during the same period a year ago. During the three months ended October 31, 2011, we capitalized $4.2 million of interest costs related to major construction projects, specifically our campus project, which began during the fourth quarter of fiscal 2011, and our capitalized internal-use software development costs. Capitalized interest during the same period a year ago was immaterial. We will continue to capitalize interest on these projects until these assets are ready for service.  Other income (expense).                                             Three Months Ended                                             October 31,               Variance            (In thousands)              2011             2010           Dollars            Other income (expense)   $       30       $      (921 )    $     951   Other income (expense) primarily consists of realized gains and losses resulting from strategic investment activity and foreign currency transaction gains and losses. Other income (expense) increased primarily due to the net gain of $1.2 million from activity within our portfolio of noncontrolling equity and debt investments in privately-held companies offset by realized and unrealized losses on foreign currency transactions for the three months ended October 31, 2011 compared to the same period a year ago.  

Benefit (provision) for Income Taxes.

                                                  Three Months Ended                                                    October 31,            Variance       (In thousands)                           2011          2010          Dollars

Benefit (provision) for income taxes $ 5,094 $ (16,192 ) $

21,286

       Effective tax rate                            58 %          42 %   

The benefit for income taxes was $5.1 million for the three months ended October 31, 2011, compared to an income tax provision of $16.2 million during the same period a year ago.

  Our effective tax rate for the three months ended October 31, 2011 was 58 percent, which was higher than the federal statutory rate of 35 percent. The higher tax rate was attributable to a detrimental foreign tax differential and non-deductible acquisition expenses, offset by state income taxes and Federal and California tax credits and the tax benefit from the May 2011 acquisition of Radian6. The combined effect of these tax items on a small net loss before income taxes was significant resulting in a high effective tax rate.  Our effective tax rate of 42 percent for the three months ended October 31, 2010 was higher than the federal statutory rate of 35 percent primarily due to state income taxes, a detrimental foreign tax rate differential, non-deductible acquisition expenses and the unfavorable impact of a change in California tax law, which was partially offset by California tax credits.                                           47

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Nine Months Ended October 31, 2011 and 2010

 Revenues.                                             Nine Months Ended                                             October 31,                    Variance   (In thousands)                       2011            2010          Dollars       Percent

Subscription and support $ 1,531,965$ 409,354

            36 %   Professional services and other       102,661          77,661        25,000            32 %    Total revenues                    $ 1,634,626     $ 1,200,272     $ 434,354            36 %    Total revenues were $1.6 billion for the nine months ended October 31, 2011, compared to $1.2 billion during the same period a year ago, an increase of $434.4 million, or 36 percent. Subscription and support revenues were $1.5 billion, or 94 percent of total revenues, for the nine months ended October 31, 2011, compared to $1.1 billion, or 94 percent of total revenues, during the same period a year ago. The increase in subscription and support revenues was due primarily to new customers, upgrades and additional subscriptions from existing customers and improved renewal rates as compared to a year ago. The price per user per month for our three primary offerings, Professional Edition, Enterprise Edition and Unlimited Edition, in the nine months ended October 31, 2011 has remained substantially consistent relative to prior periods. Professional services and other revenues were $102.7 million, or six percent of total revenues, for the nine months ended October 31, 2011, compared to $77.7 million, or six percent of total revenues, for the same period a year ago. The increase in professional services and other revenues was due primarily to the improved utilization of existing headcount, and a small benefit from the prospective adoption of the new revenue accounting guidance for multiple-deliverable arrangements.  Revenues in Europe and Asia Pacific accounted for $530.6 million, or 32 percent of total revenues, for the nine months ended October 31, 2011, compared to $373.8 million, or 31 percent of total revenues, during the same period a year ago, an increase of $156.8 million, or 42 percent. The increase in revenues outside of the Americas was the result of the increasing acceptance of our service, our focus on marketing our service internationally and improved renewal rates. Additionally, the value of the U.S. dollar relative to foreign currencies contributed to an increase in U.S. dollar revenues outside of the Americas for the nine months ended October 31, 2011 as compared to the same period a year ago. The foreign currency impact had the effect of increasing our aggregate revenues by $35.0 million compared to the same period a year ago. As part of our overall growth, we expect the percentage of our revenue generated outside of the Americas to increase as a percentage of our total revenues worldwide.  Cost of Revenues.                                                  Nine Months Ended                                                  October 31,           Variance          (In thousands)                      2011          2010         Dollars

Subscription and support $ 260,693$ 147,127$ 113,566

Professional services and other 91,848 84,375 7,473

         Total cost of revenues            $ 352,541     $ 231,502     $

121,039

           Percent of total revenues                22 %          19 %   Cost of revenues was $352.5 million, or 22 percent of total revenues, for the nine months ended October 31, 2011, compared to $231.5 million, or 19 percent of total revenues, during the same period a year ago, an increase of $121.0 million. The increase in absolute dollars was primarily due to an increase of $11.4 million in employee-related costs, an increase of $29.8 million in service delivery costs, primarily due to our efforts in increasing data center capacity, an increase of $50.8 million in depreciation and amortization expenses, $33.2 million of which related to the amortization of acquired developed technology, an increase of $20.0 million in                                           48

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  outside subcontractor and other service costs, an increase of $4.2 million in allocated overhead and an increase of $3.6 million in stock-based expenses. Gross profit margins for professional services and other improved over the same period a year ago primarily due to the improved utilization of existing headcount, a reduction in non-billable headcount since October 31, 2010 and a small benefit from the prospective adoption of the new revenue accounting guidance for multiple-deliverable arrangements.  We intend to continue to invest additional resources in our enterprise cloud computing application service and data center capacity. Additionally, the amortization of acquired developed technology will increase as we acquire additional businesses and technologies. The timing of these expenses will affect our cost of revenues, both in terms of absolute dollars and as a percentage of revenues in future periods.  Research and Development.                                               Nine Months Ended                                               October 31,           Variance             (In thousands)                2011          2010         Dollars             Research and development    $ 214,734     $ 130,357     $  84,377             Percent of total revenues          13 %          11 %   Research and development expenses were $214.7 million, or 13 percent of total revenues, for the nine months ended October 31, 2011, compared to $130.4 million, or 11 percent of total revenues, during the same period a year ago, an increase of $84.4 million. The increase in absolute dollars was primarily due to an increase of $52.5 million in employee-related costs, an increase of $19.1 million in stock-based expenses, an increase of $7.8 million in allocated overhead, an increase of $2.4 million in test data lab costs and an increase of $1.2 million in outside subcontractor and other service costs. We increased our research and development headcount by 65 percent since October 31, 2010 in order to improve and extend our service offerings and develop new technologies. Some of the increase in headcount was due to acquired businesses.  Marketing and Sales.                                               Nine Months Ended                                               October 31,           Variance             (In thousands)                2011          2010         Dollars             Marketing and sales         $ 842,043     $ 558,812     $ 283,231             Percent of total revenues          52 %          47 %   Marketing and sales expenses were $842.0 million, or 52 percent of total revenues, for the nine months ended October 31, 2011, compared to $558.8 million, or 47 percent of total revenues, during the same period a year ago, an increase of $283.2 million. The increase in absolute dollars was primarily due to increases of $183.2 million in employee-related costs, $43.5 million in stock-based expenses, $26.1 million in advertising, marketing and event costs, $17.1 million in allocated overhead and the preliminary settlement of the California wage and hour case discussed in Note 6. Our largest annual marketing event, Dreamforce, occurred during the third quarter of fiscal 2012 and was held in the fourth quarter of the prior fiscal year. The costs associated with this event are reflected in the nine months ended October 31, 2011 results. Our marketing and sales headcount increased by 43 percent since October 31, 2010 as we hired additional sales personnel to focus on adding new customers and increasing penetration within our existing customer base. Some of the increase in headcount was due to acquired businesses.  General and Administrative.                                                Nine Months Ended                                                October 31,           Variance             (In thousands)                 2011          2010         Dollars             General and administrative   $ 254,016     $ 181,713     $  72,303             Percent of total revenues           15 %          15 %                                            49 

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  General and administrative expenses were $254.0 million, or 15 percent of total revenues, for the nine months ended October 31, 2011, compared to $181.7 million, or 15 percent of total revenues, during the same period a year ago, an increase of $72.3 million. The increase was primarily due to an increase of $40.0 million in employee-related costs, an increase of $14.3 million in stock-based expenses, an increase of $1.5 million in depreciation and amortization and an increase of $15.4 million of professional and outside service costs. Our general and administrative headcount increased by 46 percent since October 31, 2010 as we added personnel to support our growth.  

Income (loss) from operations.

                                               Nine Months Ended                                                October 31,            Variance          (In thousands)                    2011           2010        Dollars

Income (loss) from operations $ (28,708 ) $ 97,888 $ (126,596 )

          Percent of total revenues              (2 )%          8 %   Loss from operations for the nine months ended October 31, 2011 was $28.7 million and included $159.2 million of stock-based expenses and $47.4 million of amortization of purchased intangibles. During the same period a year ago, operating income was $97.9 million and included $78.7 million of stock-based expenses and $12.8 million of amortization of purchased intangibles.  Investment income.                                              Nine Months Ended                                              October 31,           Variance             (In thousands)                2011          2010        Dollars             Investment income           $  18,303     $ 28,309     $

(10,006 )

             Percent of total revenues           1 %          2 %   Investment income consists of income on cash and marketable securities balances. Investment income was $18.3 million for the nine months ended October 31, 2011 and was $28.3 million during the same period a year ago. The decrease was primarily due to a reduction in realized gains from sales of marketable securities, the decrease in marketable securities balances and lower interest rates.  Interest expense.                                              Nine Months Ended                                              October 31,             Variance            (In thousands)                2011           2010          Dollars            Interest expense            $ (11,376 )    $ (21,619 )    $  10,243            Percent of total revenues          (1 )%          (2 )%   Interest expense consists primarily of interest on our Notes and capital leases. Interest expense was $11.4 million, net of interest costs capitalized, for the nine months ended October 31, 2011 and was $21.6 million during the same period a year ago. During the nine months ended October 31, 2011, we capitalized $12.1 million of interest costs related to major construction projects, specifically our campus project, which began during the fourth quarter of fiscal 2011, and our capitalized internal-use software development costs. Capitalized interest during the same period a year ago was immaterial. We will continue to capitalize interest on these projects until these assets are ready for service.                                           50

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   Table of Contents  Other income (expense).                                             Nine Months Ended                                             October 31,            Variance               (In thousands)             2011          2010         Dollars               Other income (expense)   $ (4,001 )    $ (4,659 )    $     658   Other income (expense) primarily consists of realized gains and losses resulting from strategic investment activity and foreign currency transaction gains and losses. The decrease is primarily due to the net gain of $1.2 million from activity within our portfolio of noncontrolling equity and debt investments in privately-held companies offset by realized and unrealized losses on foreign currency transactions for the nine months ended October 31, 2011 compared to the same period a year ago.  

Benefit (provision) for Income Taxes.

                                                   Nine Months Ended                                                    October 31,            Variance        (In thousands)                           2011         2010          Dollars

Benefit (provision) for income taxes $ 18,288 $ (41,092 ) $

59,380

        Effective tax rate                           71 %          41 %   

The benefit for income taxes was $18.3 million for the nine months ended October 31, 2011, compared to an income tax provision of $41.1 million during the same period a year ago.

  Our effective tax rate for the nine months ended October 31, 2011 was 71 percent, which was higher than the federal statutory tax rate of 35 percent. The higher tax rate was attributable to a detrimental foreign tax differential and non-deductible acquisition expenses, offset by state income taxes, Federal and California tax credits and the tax benefit from the May 2011 acquisition of Radian6. The combined effect of these tax items on a small net loss before income taxes was significant resulting in a high effective tax rate.  Our effective tax rate of 41 percent for the nine months ended October 31, 2010 was higher than the federal statutory rate of 35 percent primarily due to state income taxes, a detrimental foreign tax rate differential, non-deductible acquisition expenses and the unfavorable impact of a change in California tax law, which was partially offset by California tax credits.  

New Accounting Pronouncements

  In December 2010, the FASB issued Accounting Standards Update No. 2010-29, Disclosure of Supplementary Pro Forma Information for Business Combinations (Topic 805)-Business Combinations ("ASU 2010-29"), to improve consistency in how the pro forma disclosures are calculated. Additionally, ASU 2010-29 enhances the disclosure requirements and requires description of the nature and amount of any material, nonrecurring pro forma adjustments directly attributable to a business combination. ASU 2010-29 is effective for us in fiscal 2013 and should be applied prospectively to business combinations for which the acquisition date is after the effective date. We do not believe the impact of the pending adoption of ASU 2010-29 will have a significant effect on our consolidated financial statements.  In June 2011, the FASB issued Accounting Standards Update No. 2011-05, Comprehensive Income (Topic 220)-Presentation of Comprehensive Income ("ASU 2011-05"), to require an entity to present the total of comprehensive income, the components of net income, and the components of other comprehensive income either in a single continuous statement of comprehensive income or in two separate but consecutive statements.                                           51

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  ASU 2011-05 eliminates the option to present the components of other comprehensive income as part of the statement of equity. ASU 2011-05 is effective for us in fiscal 2013 and should be applied retrospectively. We are currently evaluating the impact of our pending adoption of ASU 2011-05 on our consolidated financial statements.  

Liquidity and Capital Resources

At October 31, 2011, our principal sources of liquidity were cash, cash equivalents and marketable securities totaling $1.3 billion and accounts receivable of $312.3 million.

  Net cash provided by operating activities was $351.2 million during the nine months ended October 31, 2011 and $293.3 million during the same period a year ago. Cash provided by operating activities has historically been affected by: the amount of net income (loss); sales of subscriptions, support and professional services; changes in working capital accounts, particularly increases and seasonality in accounts receivable and deferred revenue as described above, the timing of commission and bonus payments, and the timing of collections from large enterprise customers; and add-backs of non-cash expense items such as depreciation and amortization, amortization of debt discount and the expense associated with stock-based awards.  Net cash used in investing activities was $332.4 million during the nine months ended October 31, 2011 and $679.8 million during the same period a year ago. The net cash used in investing activities during the nine months ended October 31, 2011 primarily related to the purchase of Assistly in September 2011, the purchase of Radian6 in May 2011, the purchase of Manymoon in February 2011, investment of cash balances, capital expenditures and strategic investments offset by proceeds from sales and maturities of marketable securities.  Net cash provided by financing activities was $63.4 million during the nine months ended October 31, 2011 and $3.4 million during the same period a year ago. Net cash provided by financing activities during the nine months ended October 31, 2011 consisted primarily of $90.4 million of proceeds from the exercise of employee stock options and $11.0 million of excess tax benefits from employee stock plans, offset by $21.8 million of principal payments on capital leases and $16.2 million of contingent consideration payments.  

In January 2010, we issued the Notes and concurrently entered into convertible notes hedges (the "Note Hedges") and separate warrant transactions (the "Warrants"). The Notes will mature on January 15, 2015, unless converted earlier.

  For 20 trading days during the 30 consecutive trading days ended July 31, 2011 and October 31, 2011, our common stock traded at a price exceeding 130 percent of the conversion price of $85.36 per share applicable to the Notes. Accordingly, based on the terms of the Notes, the Notes were convertible at the option of the holder as of October 31, 2011 and continue to be convertible at the holders' option for the quarter ending January 31, 2012. Upon conversion of any Notes, we will deliver cash up to the principal amount of the Notes and, with respect to any excess conversion value greater than the principal amount of the Notes, shares of our common stock, cash or a combination of both. Therefore, for the quarter ending January 31, 2012, the Notes will remain classified as a current liability on our condensed consolidated balance sheet.  Our cash, cash equivalents and marketable securities are comprised primarily of corporate notes and obligations, U.S. agency obligations, U.S. treasury securities, mortgage backed securities, collateralized mortgage obligations, time deposits, money market mutual funds, government obligations and municipal securities.  As of October 31, 2011, we have a total of $11.2 million in letters of credit outstanding in favor of certain landlords for office space. To date, no amounts have been drawn against the letters of credit, which renew annually and mature at various dates through September 2021.                                           52

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We do not have any special purpose entities, and other than operating leases we do not engage in off-balance sheet financing arrangements. Additionally, we currently do not have a bank line of credit. We may in the future raise additional funds for general corporate purposes.

  Our principal commitments consist of obligations under leases for office space and co-location facilities for data center capacity and our development and test data center, and computer equipment and certain fixed assets. At October 31, 2011, the future non-cancelable minimum payments under these commitments were as follows (in thousands):                                                         Capital       Operating                                                       Leases         Leases         Fiscal Period:         Remaining three months of fiscal 2012        $  7,564      $   30,484         Fiscal 2013                                    28,922         119,782         Fiscal 2014                                    24,505          95,830         Fiscal 2015                                     4,496          56,846         Fiscal 2016                                     1,925          49,727         Thereafter                                      1,123         125,190          Total minimum lease payments                   68,535      $  

477,859

         Less: amount representing interest             (3,554 )          Present value of capital lease obligations   $ 64,981    Our lease agreements provide us with the option to renew. Our future operating lease obligations would change if we exercised these options and if we entered into additional operating lease agreements as we expand our operations.  We entered into a definitive agreement to acquire Model Metrics to expand our mobile and social consulting services for an estimated purchase consideration of approximately $57.6 million in cash, net of cash acquired. This transaction is expected to close in this fiscal fourth quarter, subject to customary closing conditions.  

We anticipate making a tax payment of approximately $40.0 million during the first quarter of fiscal 2013 as a result of the Radian6 transaction.

We believe our existing cash, cash equivalents and short-term marketable securities and cash provided by operating activities will be sufficient to meet our working capital and capital expenditure needs over the next 12 months.

We may in the future enter into arrangements to acquire or invest in complementary businesses, joint ventures, services and technologies, and intellectual property rights. While we believe we have sufficient financial resources to do so, we may be required to seek additional equity or debt financing. Additional funds may not be available on terms favorable to us or at all.

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