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UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

For the quarterly period ended May 31, 2011

OR

For the transition period from                      to                    

Commission file number: 001-33634

DemandTec, Inc.

(Exact name of registrant as specified in its charter)

One Franklin Parkway, Building 910

San Mateo, California 94403

(Address of Principal Executive Offices including Zip Code)

(650) 645-7100

(Registrant’s Telephone Number, Including Area Code)

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes x No £

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate website, if any, every interactive data file required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes £ No £

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes £ No x

The number of shares of the registrant’s common stock, par value $0.001, outstanding as of June 23, 2011 was: 32,548,888.

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DEMANDTEC, INC.

FORM 10-Q

TABLE OF CONTENTS

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PART I. FINANCIAL INFORMATION

Item 1. Financial Statements

DemandTec, Inc.

Condensed Consolidated Balance Sheets

(In thousands, except par value data)

See Notes to Condensed Consolidated Financial Statements.

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DemandTec, Inc.

Condensed Consolidated Statements of Operations

(In thousands, except per share data)

(Unaudited)

See Notes to Condensed Consolidated Financial Statements.

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DemandTec, Inc

Condensed Consolidated Statements of Cash Flows

(In thousands)

(Unaudited)

See Notes to Condensed Consolidated Financial Statements.

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DemandTec, Inc.

Notes to Condensed Consolidated Financial Statements

1. Business Summary and Significant Accounting Policies

Description of Business

DemandTec, Inc. (the “Company” or “We”) was incorporated in Delaware on November 1, 1999.  We provide a collaborative optimization network of software services connecting retail and CP companies, enabling them to define category, brand, and shopper marketing strategies based on a scientific understanding of consumer behavior and make actionable pricing, promotion, assortment, space, and other merchandising and marketing decisions to achieve their revenue, profitability, sales volume, and customer loyalty objectives.  We provide our applications by means of a software-as-a-service, or SaaS, model, which allows us to capture and analyze the most recent retailer and market-level data, enhance our software services rapidly to address our customers’ ever-changing merchandising and marketing needs, and connect retailers and CP companies online to enable improved, more collaborative business processes between trading partners.  We are headquartered in San Mateo, California, with additional sales presence in North America, Europe, and South America, and research and development personnel in India, China, and Russia.

Basis of Presentation

Our condensed consolidated financial statements include our accounts and those of our wholly-owned subsidiaries. All significant intercompany balances and transactions have been eliminated in consolidation.  Our fiscal year ends on the last day in February. References to fiscal 2012, for example, refer to our fiscal year ending February 29, 2012.  The accompanying condensed consolidated balance sheet as of May 31, 2011, the condensed consolidated statements of operations for the three months ended May 31, 2011 and 2010, and the condensed consolidated statements of cash flows for the three months ended May 31, 2011 and 2010 are unaudited.  The consolidated balance sheet data as of February 28, 2011 was derived from the audited consolidated financial statements included in our Annual Report on Form 10-K for the fiscal year ended February 28, 2011 (the “Form 10-K”) filed with the Securities and Exchange Commission, or SEC, on April 21, 2011.  The accompanying statements should be read in conjunction with the audited consolidated financial statements and related notes contained in the Form 10-K, as well as subsequent filings with the SEC.

The accompanying unaudited condensed consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States, or GAAP, for interim financial information and with the instructions to Form 10-Q and Article 10 of Regulation S-X.  Accordingly, certain information and footnote disclosures normally included in consolidated financial statements prepared in accordance with GAAP have been condensed or omitted pursuant to such rules and regulations.  The unaudited condensed consolidated financial statements have been prepared on the same basis as the audited consolidated financial statements and, in the opinion of our management, include all adjustments necessary, all of which are of a normal recurring nature, for the fair presentation of our statements of financial position and our results of operations for the periods included in this Quarterly Report on Form 10-Q.  The results for the three months ended May 31, 2011 are not necessarily indicative of the results to be expected for any subsequent quarter or for the fiscal year ending February 29, 2012.

Use of Estimates

The preparation of financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities as of the date of the condensed consolidated financial statements, as well as the reported amounts of revenue and expenses during the periods presented. Significant estimates and assumptions made by management include the determination of the fair value of share-based payments, the fair value and estimated useful lives of purchased intangible assets, the recoverability of long-lived assets, the allowance for doubtful accounts, and the provision for income taxes.  We believe that the estimates and judgments upon which we rely are reasonable, based upon information available to us at the time that these estimates and judgments are made.  To the extent there are material differences between these estimates and actual results, our condensed consolidated financial statements will be affected.

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Revenue Recognition

We generate revenue from fees under agreements with initial terms that generally are one to three years in length. Our agreements contain multiple elements, which include the use of our software, SaaS delivery services, professional services, maintenance, and customer support. Professional services consist of implementation, training, data modeling, and analytical services related to our customers’ use of our software. We have determined that the elements within our agreements generally do not qualify for treatment as separate units of accounting because our elements do not have stand-alone value.  Software licenses, SaaS delivery services, maintenance, and customer support do not have stand-alone value because we do not sell these elements separately or without professional services due to their nature and complexity.  Our professional services do not have stand-alone value because we do not sell these services separately and no third party vendors provide these professional services. Therefore, we account for all fees received under our agreements as a single unit of accounting and recognize them ratably over the term of the related agreement, commencing upon the later of the agreement start date or the date access to the application is provided to the customers, and when all of the following conditions are also met:

·       there is persuasive evidence of an arrangement;

·       the service has been provided to the customer;

·       the collection of the fees is probable; and

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

Deferred Revenue

Deferred revenue consists of amounts billed or payments received in advance of revenue recognition. Contracts under which we advance bill customers have generally been non-cancellable. For agreements with terms over one year, we generally invoice our customers in annual installments. Accordingly, the deferred revenue balance associated with such multi-year, non-cancellable agreements does not represent the total contract value. Deferred revenue to be recognized in the succeeding twelve month period is included in current deferred revenue on our consolidated balance sheets, with the remaining amounts included in non-current deferred revenue.

Concentrations of Credit Risk, Significant Customers and Suppliers and Geographic Information

Our financial instruments that are exposed to concentrations of credit risk consist primarily of cash and cash equivalents, marketable securities, accounts receivable, and a line of credit. Although we deposit our cash with multiple financial institutions, our deposits, at times, may exceed federally insured limits.  Collateral is not required for accounts receivable.

As of May 31, 2011 and February 28, 2011, long-lived assets located outside the United States were not significant. As of May 31, 2011, two customers accounted for 23% and 12%, respectively, of our accounts receivable balance.  As of February 28, 2011, two customers accounted for 22% and 13%, respectively, of our accounts receivable balance.

In the three months ended May 31, 2011, one customer accounted for 22% of total revenue.  In the three months ended May 31, 2010, two customers accounted for 13% and 11%, respectively, of total revenue.  Revenue by geographic region, based on the billing address of the customer, was as follows (in thousands):

The equipment hosting our software is in three third-party data center facilities located in San Jose and Sacramento, California, and Mesa, Arizona. We do not control the operation of these facilities, and our operations are vulnerable to damage or interruption in the event either of these third-party data center facilities fails.

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Marketable Securities

Our primary objectives when investing excess cash, in order of priority, are capital preservation, short-term liquidity, and achieving a reasonable rate of return.  A significant portion of our marketable securities mature within one year and we limit the amount of credit exposure to any one issuer.  We invest excess cash primarily in the securities of high credit quality issuers, such as highly liquid debt instruments of government-sponsored enterprises, commercial paper, corporate bonds, certificate of deposit, and money market instruments.

We classify our investments as held-to-maturity at the time of purchase and reevaluate the classification at each balance sheet date. We further classify them as current or non-current based on the maturity dates of the individual debt securities at each reporting date.

We monitor our investments in marketable securities for impairment on a periodic basis. For the purposes of the impairment evaluation, we determine fair value based on the quoted market rate for the instrument or similar instruments.  In the event that the carrying value of an investment exceeds its fair value and the decline in value is determined to be other-than-temporary, we record an impairment charge and establish a new cost basis for the investment.  In order to determine whether a decline in value is other-than-temporary, we evaluate, among other things, the duration and extent to which the fair value has been less than the carrying value, current market conditions, and our intent and ability to retain the investment for a period of time sufficient to allow for any anticipated recovery in fair market value.  We did not record any impairment adjustments in the current and prior year periods.

Impairment of Long-Lived Assets

Long-lived assets are reviewed for possible impairment whenever events or circumstances indicate that the carrying amount of these assets may not be recoverable. We evaluate the recoverability of each of our long-lived assets, including purchased intangible assets and property, equipment, and leasehold improvements, by comparison of its carrying amount to the future undiscounted cash flows we expect the asset to generate. If we consider the asset to be impaired, we measure the amount of any impairment as the difference between the carrying amount and the fair value of the impaired asset. We observed no impairment indicators through the filing of this Quarterly Report on Form 10-Q.

Stock-Based Compensation

We account for and recognize all share-based payments as an expense in our statements of operations.  Grants of stock options to employees generally vest over four years.  We measure the value of stock options based on the grant date fair value using the Black-Scholes pricing model.  Performance-based stock units, or PSUs, vest pursuant to certain performance and time-based vesting criteria set by our Compensation Committee.  We evaluate the probability of meeting the performance criteria at the end of each reporting period to determine how much compensation expense to record.  Because the actual number of shares to be issued is not known until the end of the performance period, the actual compensation expense related to these awards could differ from our current expectations.  We also have time-based restricted stock units, or RSUs, outstanding that entitle the recipient to receive shares of our common stock upon vesting and settlement of the awards pursuant to time-based vesting criteria set by our Compensation Committee.  Stock-based compensation expense for PSUs and RSUs is based on the closing price of our common stock on the grant date.  We amortize the fair value of those awards, net of estimated forfeitures, as stock-based compensation expense over the vesting period of the awards.

Net Loss per Common Share

Basic net loss per share is computed using the weighted average number of common shares outstanding during the period.  Potential common shares consist of the incremental common shares issuable upon the exercise of stock options or upon the settlement of PSUs and RSUs, and shares subject to issuance under our 2007 Employee Stock Purchase Program, or ESPP.  The dilutive effect of such potential common shares is reflected in diluted loss per share by application of the treasury stock method and on an if-converted basis from the date of issuance.  In the three months ended May 31, 2011 and 2010, weighted average outstanding shares subject to options to purchase common stock, PSUs and RSUs, and shares subject to issuance under our ESPP were approximately 3,896,000 shares and 2,846,000 shares, respectively.  Because the Company has been in a loss position in all periods shown, shares used in computing basic and diluted net loss per common share were the same for all periods presented, as the impact of all potentially dilutive securities outstanding was anti-dilutive.

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Recent Accounting Pronouncements

In December 2010, the Financial Accounting Standards Board (the “FASB”) issued guidance to amend the disclosure requirements for supplementary pro forma information for business combinations. The guidance addresses the diversity in practice about the interpretation of the pro forma revenue and earnings disclosure requirements for business combinations. The amendments specify that if a public entity presents comparative financial statements, the entity should disclose revenue and earnings of the combined entity as though the business combination(s) that occurred during the current year had occurred as of the beginning of the comparable prior annual reporting period only. The amendments also expand the supplemental pro forma disclosures to include a description of the nature and amount of material, nonrecurring pro forma adjustments directly attributable to the business combination included in the reported pro forma revenue and earnings. The amendments are effective prospectively for business combinations for which the acquisition date is on or after the beginning of the first annual reporting period beginning on or after December 15, 2010. We adopted this new standard in the quarter ended May 31, 2011 and disclosed the required supplementary pro forma information in our condensed consolidated financial statements associated with the M-Factor acquisition. See Note 2 of Notes to Condensed Consolidated Financial Statements.

In April 2010, the FASB issued guidance on defining a milestone and determining when it may be appropriate to apply the milestone method of revenue recognition for research or development transactions. The guidance is effective on a prospective basis for milestones achieved in fiscal years beginning on or after June 15, 2010 and interim periods within those years, with early adoption permitted. We adopted this new standard in the quarter ended May 31, 2011 and there was no impact on our condensed consolidated financial statements upon the adoption of the new accounting standard.

In October 2009, the FASB issued a new accounting standard for revenue recognition for arrangements with multiple deliverables. The new standard impacts the determination of when the individual deliverables included in a multiple-element arrangement may be treated as separate units of accounting. Additionally, the new standard modifies the manner in which the transaction consideration is allocated across the separately identified deliverables by no longer permitting the residual method of allocating arrangement consideration. The new standard is effective for fiscal years beginning on or after June 15, 2010; however, early adoption of this standard is permitted.  We adopted this new standard in the quarter ended May 31, 2011 and there was no impact on our condensed consolidated financial statements upon the adoption of the new accounting standard.

In October 2009, the FASB issued a new accounting standard for the accounting for certain revenue arrangements that include software elements. The new standard amends the scope of pre-existing software revenue guidance by removing from the guidance non-software components of tangible products and certain software components of tangible products. The new standard is effective for fiscal years beginning on or after June 15, 2010; however, early adoption of this standard is permitted.  We adopted this new standard in the quarter ended May 31, 2011 and there was no impact on our condensed consolidated financial statements upon the adoption of the new accounting standard.

2. Acquisitions

M-Factor, Inc.

On March 11, 2011, we acquired all of the outstanding equity interests of privately-held M-Factor, Inc. (“M-Factor”) for $9.5 million in cash.  M-Factor is a software-as-service company that enables consumer products companies to continuously analyze, forecast, and optimize marketing investments and trade spending.  We paid $9.0 million in the quarter ended May 31, 2011.  The remaining $500,000, less any amounts used to satisfy any claims for indemnification obligations, will be distributed to the former M-Factor investors within sixteen months of the consummation of the acquisition.

Purchase Price Allocation

We accounted for the M-Factor acquisition as a business combination.  We allocated the purchase price to the tangible and identifiable intangible assets acquired and liabilities assumed based on their estimated fair values as of the date of acquisition.  We engaged an independent third-party valuation firm to assist us in the determination of the value of the purchased intangible assets.  The excess of the purchase price over the fair value of net tangible and identifiable intangible assets acquired was recorded as goodwill. Although we believe the purchase price allocation is substantially complete, the finalization of certain liabilities, or the settlement of tax-related issues, among other things, could result in a future adjustment to the purchase price allocation.

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The following table summarizes the estimated fair values of the assets acquired and liabilities assumed at the acquisition date (in thousands):

Goodwill will not be amortized and is not deductible for tax purposes.  As part of our acquisition accounting, we recorded $1.6 million of non-current deferred income tax liabilities to reflect the tax effect of the temporary difference between the $4.0 million in fair value assigned to intangible assets acquired and their tax bases.  As a result of the business combination, we also recorded $1.6 million of deferred tax assets to reflect the tax effect of the temporary differences in certain liabilities assumed and future tax deductible expenses, as well as a portion of M-Factor’s pre-acquisition cumulative net operating loss.  Since the filing of our Form 8-K/A regarding this business combination, we have increased the deferred income tax assets primarily due to our assessment that we have additional realizable pre-acquisition cumulative net operating losses, and have adjusted the preliminary purchase price allocation accordingly.  Approximately $1.2 million of the total $1.6 million deferred tax liabilities were offset by the non-current portion of the $1.6 million deferred tax assets.

Purchased Intangible Assets

The following table sets forth the estimated fair value of the purchased intangible assets and their estimated useful lives:

Intangible assets are being amortized on a straight-line basis over a weighted average period of 4.0 years.  Amortization expense related to the purchased intangible assets was approximately $307,000 in the quarter ended May 31, 2011, of which $210,000 was included in cost of revenue and $97,000 was included as a separate component of operating expenses in our condensed consolidated statements of operations.

Acquisition-Related Costs and M-Factor’s Post-Acquisition Operating Results

Acquisition-related costs associated with our acquisition of M-Factor were approximately $324,000, of which $194,000 was recorded in our condensed consolidated statements of operations for the three months ended May 31, 2011.  Acquisition-related costs, including legal fees and personnel costs for transitional and certain other employees and integration-related professional services, were recorded as general and administrative expense in accordance with the current accounting guidance for business combinations.  M-Factor’s operating results have been included in our condensed consolidated financial statements from the date of the acquisition. In the quarter ended May 31, 2011, approximately $930,000 of our revenue was derived from former M-Factor solutions.  The incremental operating loss from M-Factor was not separately identifiable due to our integration.

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Unaudited Pro Forma Financial Information

The unaudited pro forma financial information in the table below presents the combined results of operations of the Company and M-Factor, as if the acquisition had occurred on March 1, 2010.  The unaudited pro forma results presented include amortization expense for purchased intangible assets, eliminations of intercompany transactions, and nonrecurring adjustments, such as acquisition-related costs.  The unaudited pro forma financial information for the three months ended May 31, 2011 reflects the operating results of the combined company and the effects of the pro forma adjustments.  The unaudited pro forma financial information for the three months ended May 31, 2010 combines our historical operating results for the three months ended May 31, 2010 and M-Factor’s historical operating results for the three months ended March 31, 2010 (due to differences in reporting periods) and reflects the pro forma adjustments.

The unaudited pro forma financial information is presented for informational purposes only and is not indicative of the consolidated results of operations or financial condition of the combined company that would have been reported had the acquisition been completed as of the dates presented and should not be taken as representative of our future consolidated results of operations or financial condition. 

Applied Intelligence Solutions, LLC

In December 2010, we acquired substantially all of the assets of Applied Intelligence Solutions, LLC (“AIS”), a provider of intelligent software solutions for retail enterprises, for approximately $3.2 million in cash.  We accounted for the transaction as a business combination.  We recorded approximately $2.2 million of goodwill and $950,000 of identifiable intangible assets.  Intangible assets are being amortized on a straight-line basis over a period of two to four years. Because this was an asset acquisition, the goodwill is tax deductible.  Pro forma results of the acquired business have not been presented as it was not material to our consolidated financial statements for all periods presented.

3. Balance Sheet Components

Marketable Securities

Marketable securities consisted of the following as of the dates indicated (in thousands):

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The following table summarizes the book value of our investments in marketable debt securities classified by the contractual maturity date of the security as of the dates indicated (in thousands):

We classify all investments as held-to-maturity and, accordingly, record them on our balance sheet at amortized cost. We monitor our investments for impairment on a periodic basis and record an impairment charge if the carrying value of an investment exceeds its fair value and the decline in value is determined to be other-than-temporary.  For the purposes of this impairment evaluation, we determine fair value based on the quoted market rate for the instrument or similar instruments.  We have the ability and intent to hold our marketable securities to maturity and do not believe any of the marketable securities were impaired based on our evaluation of available evidence at the current balance sheet date and through the time of filing of this quarterly report on Form 10-Q.  We expect to receive all principal and interest on all of our investment securities.

Accounts Payable and Accrued Expenses

Accounts payable and accrued expenses consisted of the following as of the dates indicated (in thousands):

4. Goodwill and Purchased Intangible Assets

We record as goodwill the excess of the acquisition purchase price over the fair value of the tangible and identifiable intangible assets acquired. We do not amortize goodwill, but perform an annual impairment review of our goodwill during our third fiscal quarter, or more frequently if indicators of potential impairment arise. We have a single operating segment and consequently evaluate goodwill for impairment based on an evaluation of the fair value of our company as a whole.  As of February 28, 2011, we had approximately $18.8 million of goodwill from our acquisitions of AIS in December 2010, and pre-fiscal 2010 acquisitions of Connect3 and TradePoint.  In the quarter ended May 31, 2011, we recorded approximately $7.2 million of goodwill associated with our acquisition of M-Factor in March 2011.

We record purchased intangible assets at their respective estimated fair values at the date of acquisition. Purchased intangible assets are being amortized using the straight-line method over their estimated useful lives of approximately one to seven years, with a remaining weighted average useful life of 3.0 years at May 31, 2011. We evaluate the remaining useful lives of intangible assets on a periodic basis to determine whether events or circumstances warrant a revision to the remaining estimated amortization period. Amortization expense related to the purchased intangible assets was approximately $932,000 and $757,000 in the three months ended May 31, 2011 and 2010, respectively.

We recognized no impairment charges as a result of our most recent impairment review. Additionally, we observed no impairment indicators for goodwill or intangible assets through the filing of this Quarterly Report on Form 10-Q.

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5. Commitments and Contingencies

Commitments

We lease office space in various locations throughout the United States, Europe, and India.  In September 2009, we entered into a lease agreement for office space in San Mateo, California, under which the total lease term is eight years with an initial non-cancellable lease term of five years commencing December 1, 2009.  We use the office space as our corporate headquarters. The aggregate minimum lease commitment was approximately $10.1 million at the inception of the lease and $8.1 million as of May 31, 2011.  To secure our obligations under the lease, we have provided the lessor a $223,000 cash security deposit and a $917,000 letter of credit, secured by using our existing revolving line of credit as described in Note 6.  Additionally, the lessor provided us with a tenant improvement allowance of $265,000 and assumed our payment obligations (equal to approximately $200,000) under the previous sublease for our then-existing corporate headquarters in San Carlos, California for the period from December 1, 2009 through February 28, 2010, the expiration date of such sublease.  The tenant improvement allowance and the $200,000 of assumed sublease obligations have been deferred and are being recognized on a straight-line basis over the lease term as reductions of rent expenses. The leasehold improvements are being amortized on a straight-line basis over the lesser of the lease term or the estimated useful lives of the assets.

In fiscal 2010 and fiscal 2011, we entered into equipment and facility operating leases associated with our new data center in Mesa, Arizona, with minimum lease terms of two years for the equipment lease and three years for the facility lease.  The aggregate minimum lease payments are approximately $1.5 million.

Legal Proceedings

We have from time to time become involved in legal matters that arise in the normal course of business and otherwise. There can be no assurance that third party claims and litigation that may arise in the future will not have a material adverse effect on our business, financial position, results of operations, or cash flows, including a loss of customers, or subject us to significant financial or other remedies.

6. Debt

In May 2009, we amended our revolving line of credit that we had entered in April 2008 to, among other things, extend the maturity date of the loan agreement and to increase the revolving line of credit from $15.0 million to $20.0 million. The amended revolving line of credit can be used to (a) borrow revolving loans, (b) issue letters of credit, and (c) enter into foreign exchange contracts. Revolving loans may be borrowed, repaid, and reborrowed until May 2012. Amounts borrowed will bear interest, at our option, at either (1) a floating per annum rate equal to the financial institution’s prime rate, or (2) the greater of (A) the LIBOR rate plus 250 basis points or (B) a per annum rate equal to 4.0%. A default interest rate shall apply during an event of default at a rate per annum equal to 500 basis points above the otherwise applicable interest rate. The line of credit is collateralized by substantially all of our assets and requires us to comply with working capital, net worth, and other non-financial covenants, including limitations on indebtedness and restrictions on dividend distributions, among others. In September 2009, the available balance was reduced by approximately $917,000 to $19.1 million to secure a new operating lease commitment. There were no outstanding amounts under the line of credit at May 31, 2011. Through the filing of this Quarterly Report on Form 10-Q, we were in compliance with all loan covenants.

7. Stock-Based Compensation

Equity Incentive Plans

1999 Equity Incentive Plan

In December 1999, our Board of Directors adopted the 1999 Equity Incentive Plan (the “1999 Plan”).  The 1999 Plan provided for incentive or nonstatutory stock options, stock bonuses, and rights to acquire restricted stock to be granted to employees, outside directors, and consultants. We ceased issuing awards under the 1999 Plan upon the completion of our Initial Public Offering (“IPO”) in August 2007.  As of May 31, 2011, options to purchase 3,004,899 shares were outstanding under the 1999 Plan.  Such options are exercisable as specified in each option agreement, generally vest over four years, and expire no more than ten years from the date of grant.  If options awarded under the 1999 Plan are forfeited or repurchased, then shares underlying those options will no longer be available for awards.

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2007 Equity Incentive Plan

In May 2007, our Board of Directors adopted, and in July 2007 our stockholders approved, the 2007 Equity Incentive Plan (the “2007 Plan”).  The 2007 Plan became effective upon our IPO.  The 2007 Plan, which is administered by the Compensation Committee of our Board of Directors, provides for stock options, stock units, restricted shares, and stock appreciation rights to be granted to employees, outside directors and consultants.  We initially reserved 3.0 million shares of our common stock for issuance under the 2007 Plan.  In addition, on the first day of each fiscal year commencing with fiscal year 2009, the aggregate number of shares reserved for issuance under the 2007 Plan is automatically increased by a number equal to the lowest of a) 5% of the total number of shares of common stock then outstanding, b) 3,750,000 shares, or c) a number determined by our Board of Directors.  As of May 31, 2011, 8,791,510 shares were reserved for issuance under the 2007 Plan.

Stock Options

Options granted under the 2007 Plan may be either incentive stock options or nonstatutory stock options and are exercisable as determined by the Compensation Committee and as specified in each option agreement.  Options vest over a period of time as determined by the Compensation Committee, generally four years, and generally expire seven years (but in any event no more than ten years) from the date of grant.  The exercise price of any stock option granted under the 2007 Plan may not be less than the fair market value of our common stock on the date of grant.  The term of the 2007 Plan is ten years.  As of May 31, 2011, options to purchase 3,510,478 shares were outstanding under the 2007 Plan.

Performance Stock Units (“PSUs”)

PSUs are awards under our 2007 Plan that entitle the recipient to receive shares of our common stock upon vesting and settlement of the awards pursuant to certain performance and time-based vesting criteria set by our Compensation Committee.

In May and June 2009, our Compensation Committee granted 901,000 and 25,000 PSUs, respectively, to certain of our executive officers and other employees.  These PSU grants related to fiscal 2010 company performance objectives and subsequent individual service requirements over a period of approximately 23 months, subject to each grantee’s continued service.  As of May 31, 2011, 106 of these PSUs remained outstanding.

In May 2010, our Compensation Committee granted 314,250 PSUs to our executive officers, which relate to fiscal 2011 company performance objectives and subsequent individual service requirements over a period of approximately 17 months, subject to each grantee’s continued service.  In April 2011, our Compensation Committee granted 159,375 PSUs to certain of our executive officers, which relate to fiscal 2012 company performance objectives and subsequent service requirements over a period of approximately 17 months.  Additionally, in April 2011, our Compensation Committee granted 839,800 PSUs to certain of our executive officers and other employees.  These PSU grants relate to fiscal 2012 company performance objectives and subsequent individual service requirements over a period of approximately 33 months.  As of May 31, 2011, there were approximately 1,122,528 shares subject to outstanding PSUs from grants in May 2010 and April 2011.

Restricted Stock Units (“RSUs”)

RSUs are awards under the 2007 Plan that entitle the recipient to receive shares of our common stock upon vesting and settlement of the awards pursuant to time-based vesting criteria set by our Compensation Committee.

In January 2010, our Compensation Committee granted 100,000 RSUs that vest over a period of approximately four years, subject to the grantee’s continued services.  In fiscal 2011, our Compensation Committee granted 1,322,000 RSUs to certain of our executive officers, other employees, and consultants.  Such RSUs will vest over a period of approximately 24 to 27 months, subject to each grantee’s continued service.  In August 2010, our Compensation Committee granted a total of 79,317 RSUs to the non-employee members of our board of directors, which will be fully vested on the earlier of a) the date of our 2011 Annual Meeting of Stockholders, or b) one year from the date of grant.  In April 2011, our Compensation Committee granted 98,750 RSUs to certain employees.  These RSUs will vest over a period of approximately 27 months, subject to each grantee’s continued service.  As of May 31, 2011, there were approximately 1,445,567 shares subject to outstanding RSUs from these grants.

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A summary of equity award activity during fiscal 2011 and the three months ended May 31, 2011 follows (shares in thousands):

(1)       Under the terms of the 1999 Plan, shares underlying cancelled or forfeited options are no longer available for awards.

A summary of PSU activity during fiscal 2011 and the three months ended May 31, 2011 follows (in thousands):

A summary of RSU activity during fiscal 2011 and the three months ended May 31, 2011 follows (in thousands):

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Employee Stock Purchase Plan (“ESPP”)

In May 2007 our Board of Directors adopted, and in July 2007 our stockholders approved, the 2007 Employee Stock Purchase Plan.  We subsequently amended the ESPP in March 2010.  Under the ESPP, eligible employees may purchase shares of common stock at a price per share equal to 85% of the lesser of the fair market values of our common stock at the beginning or end of the applicable offering period.  Each offering period lasts for six months.  We initially reserved 500,000 shares of our common stock for issuance under the ESPP.  In addition, on the first day of each fiscal year commencing with fiscal year 2009, the aggregate number of shares reserved for issuance under the ESPP is automatically increased by a number equal to the lowest of a) 1% of the total number of shares of common stock then outstanding, b) 375,000 shares, or c) a number determined by our Board of Directors.  In the three months ended May 31, 2011, employees purchased 138,602 shares under the ESPP, and the weighted average per share fair value of the options to purchase those shares was approximately $3.06.  As of May 31, 2011, a total of 919,169 shares were available for issuance under the ESPP.

Stock-Based Compensation Expense Associated with Awards to Employees

We have issued employee stock-based awards in the form of stock options, PSUs, RSUs, and shares subject to the ESPP.  We measure the value of stock options and shares subject to the ESPP based on their grant date fair value using the Black- Scholes pricing model.  Stock-based compensation expense for PSUs and RSUs granted to employees is based on the closing price of our common stock on the grant date.

The determination of the fair value of stock options and shares subject to the ESPP on the date of grant is affected by our stock price, as well as by assumptions regarding a number of complex and subjective variables.  These variables include our expected stock price volatility over the term of the options and awards, actual and projected employee stock option exercise behaviors, risk-free interest rates, and expected dividends, which are set forth in the table below:

We amortize the fair value of the awards granted, net of estimated forfeitures, as stock-based compensation expense on a straight-line basis over the vesting period.  We estimate forfeitures for our stock options, PSUs, and RSUs at the time of grant.  At the end of each reporting period, we evaluate the probability of the service condition being met and revise those estimates based on actual results, taking into account cancellations related to terminations, as applicable to each award.  In addition, for PSUs granted, we evaluate the probability of meeting the performance criteria at the end of each reporting period to determine how much compensation expense to record.  The estimation of whether the performance targets and service periods will be achieved requires judgment.  To the extent actual results or updated estimates differ from our current estimates, either (a) the cumulative effect on current and prior periods of those changes will be recorded in the period those estimates are revised or (b) the change in estimate will be applied prospectively, depending on whether the change affects the estimate of total stock-based compensation expense to be recognized or merely affects the period over which such expense will be recognized.  The cumulative adjustment in the three months ended May 31, 2011 and 2010 was not material.

Stock-Based Compensation for Non-Employees

Stock-based compensation expense related to stock awards granted to non-employees is recognized as the awards vest.  We believe that the fair value of the stock-based awards granted is more reliably measurable than the fair value of the services received. The fair value of the stock options granted is calculated using the Black-Scholes option pricing model.  The fair value of RSUs granted is based on the closing price of our common stock on each reporting date.  The fair value of the award is remeasured at each reporting date until the earlier of (a) the performance commitment date or (b) the date the services required under the arrangement have been

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completed. Stock-based compensation expense related to awards granted to non-employees for the three months ended May 31, 2011 was approximately $112,000, and was not material for the three months ended May 31, 2010 were not material.

The fair values of unvested options granted to non-employees were calculated using the following assumptions for the periods presented:

The following table sets forth the stock-based compensation expense for equity awards recorded in the condensed consolidated statements of operations for the periods presented (in thousands):

The following table summarizes gross unrecognized stock-based compensation expense as of May 31, 2011, excluding estimated forfeitures:

8. Income Taxes

In the three months ended May 31, 2011, we recorded income tax expense of approximately $95,000 compared to income tax expense of $23,000 in the corresponding period of the prior year.  The effective tax rate for the three months ended May 31, 2011 was less than 2% based on our estimated taxable income for the year.  We recorded tax expense primarily for foreign taxes and state minimum taxes.

There were no material changes to our unrecognized tax benefits in the three months ended May 31, 2011 and we do not expect to have any significant changes to unrecognized tax benefits over the next twelve months.  Because of our history of operating losses, all years remain open to audit.

9. Derivative Financial Instruments

We maintain a foreign currency risk management strategy that includes the use of derivative financial instruments designed to protect our economic value from the possible adverse effects of currency fluctuations.  We do not enter into derivative financial instruments for speculative or trading purposes.  Our hedging relationships are formally documented at the inception of the hedge, and

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hedges must be highly effective in offsetting changes to future cash flows on hedged transactions both at the inception of a hedge and on an ongoing basis.  We record the ineffective portion of hedging instruments, if any, to other income (expense) in the consolidated statements of operations.

As of May 31, 2011, we had two outstanding forward contracts with an aggregate notional principal of approximately $2.5 million, which are summarized as follows (in thousands):

(1)    Related to a three-year customer arrangement, under which we separately hedge each equal annual billing amount.  The forward contract related to the first annual billing amount matured in December 2010 and the remaining two mature in December 2011 and 2012, respectively.

We designated these forward contracts as cash flow hedges of foreign currency denominated firm commitments.  Our objective in purchasing these forward contracts was to negate the impact of currency exchange rate movements on our operating results.  We record effective spot-to-spot changes in these cash flow hedges in accumulated other comprehensive income until the hedged transaction takes place.  Combined implied interest on all forward contracts was excluded from effectiveness testing and is being recorded using the straight-line method over the terms of the forward contracts to interest expense and accumulated other comprehensive income.  We did not incur any hedge ineffectiveness in the three months ended May 31, 2011 and 2010.

We expect to ratably reclassify an approximately $37,000 gain associated with the forward contracts that matured in December 2010 and February 2011 from accumulated other comprehensive income into revenue over the twelve-month period ending May 31, 2012.

10. Fair Value Measurements

The accounting standards for fair value measurements clarify that fair value is an exit price, representing the amount that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants. As such, fair value is a market-based measurement that should be determined based on assumptions that market participants would use in pricing an asset or a liability. As a basis for considering such assumptions, the accounting standards establish a three-tier value hierarchy, which prioritizes the inputs used in the valuation methodologies in measuring fair value:

Level 1 — Observable inputs that reflect quoted prices (unadjusted) for identical assets or liabilities in active markets.

Level 2 — Include other inputs that are directly or indirectly observable in the marketplace.

Level 3 — Unobservable inputs which are supported by little or no market activity.

The fair value hierarchy requires an entity to maximize the use of observable inputs and minimize the use of unobservable inputs when measuring fair value.

We measure our foreign currency forward contracts at fair value using Level 2 inputs, as the valuation inputs are based on quoted prices of similar instruments in active markets and do not involve management judgment.

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The following table summarizes the amounts measured at fair value (in thousands):

(1)      At May 31, 2011, $78 was included in other current liabilities and $59 was included in other long-term liabilities on our condensed consolidated balance sheet.  At February 28, 2011, $24 was included in other current liabilities and $9 was included in other long-term liabilities on our condensed consolidated balance sheet.

11. Comprehensive Loss

The following table summarizes the calculation and components of comprehensive loss, net of taxes (in thousands):

12. Restructuring Charges

In the quarter ended May 31, 2011, we recorded approximately $451,000 of expenses associated with the reduction of our workforce as part of our M-Factor post-acquisition integration process to achieve cost savings and operating efficiencies.   Expenses associated with these actions were primarily for severance payments and remaining M-Factor operating lease obligations.  As of May 31, 2011, accrued restructuring charges were approximately $361,000, which will be paid in the quarter ending August 31, 2011.

Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations

This quarterly report on Form 10-Q contains “forward-looking statements” within the meaning of Section 21E of the Securities Exchange Act of 1934, as amended. In addition, we may make other written and oral communications from time to time that contain such statements. Forward-looking statements include statements as to industry trends and future expectations of ours and other matters that do not relate strictly to historical facts. These statements are often identified by the use of words such as “may,” “will,” “expect,” “believe,” “anticipate,” “intend,” “could,” “estimate,” or “continue,” and similar expressions or variations. These statements are based on the beliefs and assumptions of our management based on information currently available to management. Such forward-looking statements are subject to risks, uncertainties and other factors that could cause actual results and the timing of certain events to differ materially from future results expressed or implied by such forward-looking statements. These forward-looking statements include statements in this Item 2, “Management’s Discussion and Analysis of Financial Condition and Results of Operations.” Factors that could cause or contribute to such differences include, but are not limited to, those identified below, and those discussed in the section titled “Risk Factors” included elsewhere in this Form 10-Q and in our other Securities and Exchange Commission filings, including our Annual Report on Form 10-K for the fiscal year ended February 28, 2011. Furthermore, such forward-looking statements speak only as of the date of this report. We undertake no obligation to update any forward-looking statements to reflect events or circumstances after the date of such statements.

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The following discussion and analysis of our financial condition and results of operations should be read in conjunction with the condensed consolidated financial statements and related notes thereto appearing elsewhere in this Form 10-Q and with the consolidated financial statements and notes thereto and management’s discussion and analysis of financial condition and results of operation appearing in our Annual Report on Form 10-K for the fiscal year ended February 28, 2011.

Overview

We provide a collaborative optimization network of software services connecting retail and CP companies, enabling them to define category, brand, and shopper marketing strategies based on a scientific understanding of consumer behavior and make actionable pricing, promotion, assortment, space and other merchandising and marketing recommendations to achieve their revenue, profitability, sales volume, and customer loyalty objectives. We provide our applications by means of a software-as-a-service, or SaaS, model, which allows us to capture and analyze the most recent retailer and market-level data and enhance our software services rapidly to address our customers’ ever-changing merchandising and marketing needs, and connect retailers and CP companies online to enable improved, more collaborative business processes between trading partners.

Our solutions consist of software services and complementary analytical services and analytical insights derived from the same platform that supports our software services. We offer our solutions individually or as a suite of integrated software services. Our solutions for the retail and CP industries include DemandTec Lifecycle Price Optimization™, DemandTec End-to-End Promotion Management™, DemandTec Assortment & Space™, DemandTec Shopper Insights™, DemandTec Targeted Marketing™, DemandTec Marketing Plan Optimization™, DemandTec Total Trade Optimization™, DemandTec Shopper Marketing Optimization™, and DemandTec Connect™. The DemandTec network connects our solutions for the retail and CP industries. We sell our solutions through our direct sales force and receive a number of customer prospect introductions through third parties, such as systems integrators, strategic consulting firms, and a data syndication company.

We were incorporated in November 1999 and began selling our software in fiscal 2001. Our revenue has grown from $43.5 million in fiscal 2007 to $82.4 million in fiscal 2011, and was $22.5 million in the three months ended May 31, 2011.  Our operating expenses have also increased significantly during these same periods.  We have incurred losses to date and had an accumulated deficit of approximately $109.9 million as of May 31, 2011.  We sell our software to retailers and CP companies under agreements with initial terms that generally are one to three years in length and provide a variety of services associated with our customers’ use of our software.  Our software service agreements with retailers and CP companies are often large contracts.  The annual contract value for each retail and CP company customer agreement is largely related to the size of the customer.  Our Advanced Deal Management agreements with CP companies that leverage the DemandTec network are principally one year in length and much smaller in annual and aggregate contract value than our other CP company customer software services contracts and our retail customer contracts.  Generally, the agreements we have signed in the first fiscal quarter of a fiscal year have had an aggregate annual contract value less than that of the agreements signed in the preceding fiscal fourth quarter.  In addition, the aggregate contract value of agreements signed can fluctuate significantly on a quarterly basis within any given fiscal year.  A significant percentage of our new and existing customer add-on agreements are entered into during the last month, weeks, or even days of each quarter.  We generally recognize the revenue from each agreement ratably over the term of the agreement.  Our ability to maintain or increase revenues depends on our attracting new customers, renewing agreements with our existing customers at comparable prices, and selling add-on software services to existing customers as well as successfully incorporating shopper segmentation and analytics into our offerings.  Historically, some customers or potential customers have elected not to enter into new or renewal contracts and some other customers have renewed at lower prices or for shorter terms.  Further, our revenue will be directly affected by the continued acceptance of our software solutions in the marketplace, as well as the timing, size and term length of our customer agreements.  If we are unable to successfully develop or acquire new software and enhance our existing applications, we may not be able to attract and retain customers or increase or maintain our revenue.

We are headquartered in San Mateo, California. We have sales and marketing offices in North America and Europe, and conduct research and development operations in India, Russia, and China.  In each of the quarters ended May 31, 2011 and 2010, approximately 86% of our revenue was attributable to sales of our software to companies located in the United States.  Our ability to achieve profitability will be affected by our revenue as well as by the level of our operating expenses associated with growing our business. Our largest category of operating expenses is research and development expenses, and the largest component of our operating expenses is personnel costs.

In March 2011, we acquired M-Factor, Inc. (“M-Factor”), a provider of predictive analytics software for CP companies that optimizes marketing mix and trade investment spending.  M-Factor is a software-as-a-service company that enables consumer products companies to continuously analyze, forecast, and optimize marketing investments and trade spend.  The services deliver

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optimized action plans, reliable forecasts for plans and “what-if” scenarios, and reports that decompose the drivers of sales volume to explain why results came out as they did.  The aggregate purchase price was $9.5 million in cash, of which $9.0 million was paid to M-Factor investors upon closing.  The remaining $500,000 will be held by the Company to secure potential indemnification obligations of M-Factor investors and will be released approximately sixteen months after the closing, to the extent not used to satisfy the indemnity obligations.  We accounted for the M-Factor acquisition as a business combination.  See Note 2 of the Notes to Condensed Consolidated Financial Statements.  After the M-Factor acquisition we reduced our workforce and consolidated facilities to achieve cost savings and operating efficiencies, and consequently recorded approximately $451,000 of restructuring charges in the three months ended May 31, 2011.  In addition, we incurred approximately $1.0 million of personnel-related costs for transitional employees, redundant facility costs, and integration related professional services fees in the three months ended May 31, 2011. Those non-recurring costs would not have otherwise been incurred in the period presented as a part of our continuing operations and will not be incurred in future periods.

As of June 23, 2011, we had approximately 32.5 million shares of common stock outstanding, excluding approximately 9.1 million shares subject to outstanding options, performance stock units, restricted stock units, and rights under our employee stock purchase program. The issuance of shares upon the exercise of these options and settlement of these units, as well as the grant of additional options and units pursuant to our equity compensation plans, would result in additional dilution and may adversely impact our earnings per share.  See Note 7 of Notes to Condensed Consolidated Financial Statements.

Critical Accounting Policies and Estimates

We prepare our consolidated financial statements in accordance with accounting principles generally accepted in the United States. These accounting principles require us to make certain estimates and judgments that can affect the reported amounts of assets and liabilities as of the date of our consolidated financial statements, as well as the reported amounts of revenue and expenses during the periods presented. We believe that our estimates and judgments were reasonable based upon information available to us at the time that these estimates and judgments were made.  We evaluate our estimates and judgments on an ongoing basis.  To the extent that there are material differences between these estimates and actual results, our consolidated financial statements could be adversely affected.  The accounting policies that we believe reflect our more significant estimates, judgments and assumptions and which we believe are the most critical to aid in fully understanding and evaluating our reported financial results include the following:

·              Revenue Recognition

·              Stock-Based Compensation

·              Goodwill and Intangible Assets

·              Impairment of Long-Lived Assets

In many cases, the accounting treatment of a particular transaction is specifically dictated by GAAP and does not require management’s judgment in its application. There are also areas in which management’s judgment in selecting among available accounting policy alternatives would not produce a materially different result.

During the three months ended May 31, 2011, there were no significant changes in our critical accounting policies.  Please refer to Management’s Discussion and Analysis of Financial Condition and Results of Operations contained in our Annual Report on Form 10-K for the fiscal year ended February 28, 2011 and Note 1 of Notes to Condensed Consolidated Financial Statements included herein for a more complete discussion of our critical accounting policies and estimates.

Results of Operations

Revenue

We derive all of our revenue from customer agreements that cover the use of our software and various services associated with our customers’ use of our software.  We generally recognize all revenue ratably over the term of the agreement.  Our agreements have generally been non-cancellable, but customers typically have the right to terminate their agreement for cause if we materially breach our obligations under the agreement and, in certain situations, may have the ability to extend the duration of their agreement on pre-negotiated terms.  We invoice our customers in accordance with contractual terms, which generally have provided that our customers

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are invoiced in advance for annual use of our software services.  We have provided certain implementation services on a fixed fee basis and have generally invoiced our customers in advance.  In addition, we also have provided implementation and training services on a time and materials basis and have invoiced our customers monthly in arrears.  Our payment terms typically require our customers to pay us within 30 days of the invoice date.

Three Months Ended May 31, 2011 Compared to the Three Months Ended May 31, 2010.  Revenue for the three months ended May 31, 2011 increased approximately $4.4 million, or 24%, compared to the corresponding period of the prior year, primarily due to a $2.5 million increase in revenue from existing customers and $1.9 million of revenue from new customers, of which approximately $930,000 was derived from former M-Factor solutions, in the three months ended May 31, 2011.  New customers are those that did not contribute any revenue in the three months ended May 31, 2010.  Existing customers are those that contributed revenue in each of the periods presented.

Our revenue growth depends on our ability to attract new customers and to retain the existing revenues from our current customers over time.  In addition, revenue from new customers in any given period can fluctuate depending upon the period in which the contract is signed, the number of new customer contracts, and the size of the new retailer or CP customer.  In the short term we expect that our revenue may remain flat or decrease slightly.  With the existing uncertainties in the global economic environment, we believe long-term revenue growth is more difficult to predict.

Percentages of total revenue by customer type and geographic region for the periods presented were as follows:

Revenue from CP companies continued to increase as a percentage of total revenue in the three months ended May 31, 2011 compared to the corresponding period of the prior year, largely as a result of incremental revenue from former M-Factor customers, all of which are CP companies.  Revenue from customers located outside the United States remained flat as a percentage of total revenue in the three months ended May 31, 2011 compared to the corresponding period of the prior year.  Over the long term, we expect that revenue from CP companies and international customers will increase as a percentage of total revenue on an annual basis.

Cost of Revenue

Cost of revenue includes expenses related to data centers, depreciation expenses associated with computer equipment and software, compensation and related expenses of operations, technical customer support, production operations and professional services personnel, amortization of purchased intangible assets, and allocated overhead expenses. We have contracts with three third parties for the use of their data center facilities, and our data center costs principally consist of the amounts we pay to these third parties for rack space, power and similar items. We amortize purchased intangible assets, principally for developed technology. We allocate overhead costs, such as rent and occupancy costs, employee benefits, information management costs, and legal and other costs, to all departments predominantly based on headcount. As a result, we include allocated overhead expenses in cost of revenue and each operating expense category.

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Three Months Ended May 31, 2011 Compared to the Three Months Ended May 31, 2010.  Cost of revenue in the three months ended May 31, 2011 increased approximately $1.8 million, or 25%, over the corresponding period of the prior year, primarily due to increased personnel costs, data center costs, and amortization of purchased intangible assets associated with the AIS and M-Factor acquisitions.

Personnel costs increased $843,000 compared to the corresponding period of the prior year, as average headcount increased by about 29, primarily due to the M-Factor acquisition.  In addition, stock-based compensation expense, which is a component of personnel costs, increased $302,000 compared to the corresponding period of the prior year as we granted additional PSUs and RSUs during the three months ended May 31, 2011.   Expenses associated with our data center in Mesa, Arizona increased $366,000, as we expanded our infrastructure to handle the increased level of customer data processed and analyzed to embed shopper segments and insights in our service offerings.  Amortization of purchased intangible assets increased $257,000 from the corresponding period of the prior year due to the purchased developed technologies associated with the AIS and M-Factor acquisitions.  Additionally, allocated overhead costs increased $165,000 over the corresponding period of the prior year, primarily due to increased facility-related and IT costs.  Travel expense increased $159,000 over the corresponding period of the prior year as a result of increased headcount and international travel.

Our gross margin decreased to 60% in the three months ended May 31, 2011 compared to 61% in the corresponding period of the prior year, primarily due to increased amortization of intangible assets associated with the AIS and M-Factor acquisitions. We anticipate that, in the short term, our gross margin will increase slightly as a result of post-acquisition synergies achieved through restructuring actions and facilities consolidation.

Research and Development Expenses

Research and development expenses include personnel costs for our research, product management and software development personnel, and allocated overhead expenses. We devote substantial resources to extending our existing software applications as well as to developing new software.

Three Months Ended May 31, 2011 Compared to the Three Months Ended May 31, 2010.  Research and development expenses in the three months ended May 31, 2011 increased approximately $1.8 million, or 24%, from the corresponding period of the prior year, primarily due to increased personnel costs and consulting expenses.

Personnel costs increased $1.1 million in the three months ended May 31, 2011 from the corresponding period of the prior year as average headcount increased by 26, primarily due to the M-Factor acquisition and our recently established development presence in India.  Stock-based compensation expense, which is a component of personnel costs, increased approximately $477,000 in the three months ended May 31, 2011 compared to the corresponding period of the prior year, primarily due to additional PSUs and RSUs granted during the three months ended May 31, 2011.  In addition, consulting expenses increased $584,000 in the three months ended May 31, 2011 from the corresponding period of the prior year, as we expanded our outsourced research services in China, brought on third-party consulting services in Russia as part of the AIS acquisition, and supplemented our development efforts related to apparel retailing by using outside consultants.

We intend to continue to invest significantly in our research and development efforts because we believe these efforts are essential to maintaining our competitive position over the long-term.  In the short term, however, we expect that our research and development costs will decrease slightly in absolute dollars, as a result of post-acquisition synergies achieved through restructuring actions and facilities consolidation.

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Sales and Marketing Expenses

Sales and marketing expenses include personnel costs for our sales and marketing personnel, including commissions and incentives, travel and entertainment expenses, marketing programs such as product marketing, events, corporate communications and other brand building expenses, and allocated overhead expenses.

Three Months Ended May 31, 2011 Compared to the Three Months Ended May 31, 2010.  Sales and marketing expenses in the three months ended May 31, 2011 increased approximately $1.2 million, or 18%, over the corresponding period of the prior year, primarily due to increased personnel costs, marketing-related program expenses, and outside consulting costs, partially offset by decreased bad debt expense.

Personnel costs increased $1.1 million in the three months ended May 31, 2011 from the corresponding period of the prior year, as a result of increased headcount, bonus expense, and commission expense.  Average sales and marketing headcount increased by about nine in the three months ended May 31, 2011 compared to the corresponding period of the prior year.  Bonus and commission expenses increased as a result of increased headcount and revenue since May 31, 2010.  Consulting and marketing-related program expenses increased $397,000, primarily attributable to the consulting services associated with developing our collaborative optimization network, as well as increased spending on our annual DemandBetter user conference and other marketing initiatives.  Additionally, travel expense increased $145,000 over the corresponding period of the prior year, as a result of increased headcount and international travel.  Partially offsetting the increases in sales and marketing expense was a $460,000 decrease in bad debt expense, as we fully reserved for a customer invoice that was in dispute in the three months ended May 31, 2010 and had no similar charges in the three months ended May 31, 2011.

We expect that, in the short term, sales and marketing expenses will decrease in absolute dollars and as a percentage of revenue as a result of post-acquisition synergies achieved through restructuring actions and facilities consolidation.

General and Administrative Expenses

General and administrative expenses include personnel costs for our executive, finance and accounting, human resources, legal and information management personnel, third-party professional services, travel and entertainment expenses, other corporate expenses and overhead not allocated to cost of revenue, research and development expenses, or sales and marketing expenses. Third-party professional services primarily include outside legal, audit and tax-related consulting costs.

Three Months Ended May 31, 2011 Compared to the Three Months Ended May 31, 2010.  General and administrative expenses in the three months ended May 31, 2011 increased $392,000, or 16%, from the corresponding period of the prior year, primarily due to an increase in personnel costs and accounting fees.

Personnel costs increased $116,000 in the three months ended May 31, 2011 from the corresponding period of the prior year, as average headcount increased by about four.  Accounting and other outside services expenses increased $130,000 compared to the corresponding period of the prior year, primarily attributable to professional services related to the AIS and M-Factor acquisitions.

We expect that, in the short term, general and administrative expenses may increase slightly or remain flat, in absolute dollars, and may decrease slightly as a percentage of revenue.

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Amortization of Purchased Intangible Assets