CALLIDUS SOFTWARE INC - FORM 10-Q

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UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

(Mark One)

x QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended June 30, 2014

o TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the transition period from to .

Commission file number: 000-50463

Callidus Software Inc.

(Exact name of registrant as specified in its charter)



Delaware		77-0438629
(State or Other Jurisdiction of		(I.R.S. Employer
Incorporation or Organization)		Identification Number)

Callidus Software Inc.

6200 Stoneridge Mall Road, Suite 500

Pleasanton, California 94588

(Address of principal executive offices, including zip code)

(925) 251-2200

(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 o

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes x No o

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



Large accelerated filer o		Accelerated filer x
Non-accelerated filer o		Smaller reporting company o
(Do not check if a smaller reporting company)

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

There were 48,103,761 shares of the registrant’s common stock, par value $0.001, outstanding on July 28, 2014, the latest practicable date prior to the filing of this report.

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TABLE OF CONTENTS



PART I. FINANCIAL INFORMATION	Page
Item 1. Financial Statements	3
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations	14
Item 3. Quantitative and Qualitative Disclosures About Market Risk	20
Item 4. Controls and Procedures	20
PART II. OTHER INFORMATION
Item 1. Legal Proceedings	21
Item 1A. Risk Factors	21
Item 6. Exhibits	32
Signatures	32
Exhibit Index	33

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PART I. FINANCIAL INFORMATION

Item 1. Financial Statements

CALLIDUS SOFTWARE INC.

CONDENSED CONSOLIDATED BALANCE SHEETS

(Unaudited, in thousands, except per share data)



	June 30, 2014			December 31, 2013
ASSETS
Current assets:
Cash and cash equivalents	$	37,914		$	28,295
Short-term investments	4,008			7,866
Accounts receivable, net of allowances of $981 and $650 at June 30, 2014 and December 31, 2013, respectively	29,366			29,216
Deferred income taxes	187			—
Prepaid and other current assets	6,523			6,232
Total current assets	77,998			71,609
Property and equipment, net	13,637			11,351
Goodwill	32,791			31,207
Intangible assets, net	17,066			16,995
Deferred income taxes, noncurrent	498			405
Deposits and other noncurrent assets	1,913			2,626
Total assets	$	143,903		$	134,193
LIABILITIES AND STOCKHOLDERS’ EQUITY
Current liabilities:
Accounts payable	$	2,250		$	2,987
Accrued payroll and related expenses	6,218			7,377
Accrued expenses	8,266			5,395
Deferred income taxes	1,159			1,159
Deferred revenue	49,066			46,222
Capital lease obligations	1,211			1,308
Total current liabilities	68,170			64,448
Deferred revenue, noncurrent	11,100			10,432
Deferred income taxes, noncurrent	196			155
Capital lease obligations, noncurrent	668			987
Convertible notes	—			14,197
Revolving line of credit	2,982			—
Other noncurrent liabilities	1,532			1,921
Total liabilities	84,648			92,140
Commitments and contingencies (Note 7)
Stockholders’ equity:
Preferred stock, $0.001 par value; 5,000 shares authorized; no shares issued or outstanding	—			—
Common stock, $0.001 par value; 100,000 shares authorized; 50,438 and 47,817 shares issued and 48,099 and 45,478 shares outstanding at June 30, 2014 and December 31, 2013, respectively	48			45
Additional paid-in capital	334,831			315,430
Treasury stock; 2,339 shares at June 30, 2014 and December 31, 2013	(14,430		)	(14,430		)
Accumulated other comprehensive income	180			165
Accumulated deficit	(261,374		)	(259,157		)
Total stockholders’ equity	59,255			42,053
Total liabilities and stockholders’ equity	$	143,903		$	134,193

See accompanying notes to unaudited condensed consolidated financial statements.

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CALLIDUS SOFTWARE INC.

CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (LOSS)

(Unaudited, in thousands, except per share data)



	Three Months Ended June 30,						Six Months Ended June 30,
	2014			2013			2014			2013
Revenue:
Recurring	$	23,684		$	19,616		$	45,934		$	39,240
Services and license	8,831			6,314			17,558			12,232
Total revenue	32,515			25,930			63,492			51,472
Cost of revenue:
Recurring	7,502			6,931			14,790			14,384
Services and license	5,628			4,739			10,738			9,961
Total cost of revenue	13,130			11,670			25,528			24,345
Gross profit	19,385			14,260			37,964			27,127

Operating expenses:
Sales and marketing	11,808			7,891			22,535			15,535
Research and development	5,045			4,409			9,918			8,838
General and administrative	5,135			5,946			10,221			11,132
Restructuring and other	404			315			404			1,558
Total operating expenses	22,392			18,561			43,078			37,063
Operating loss	(3,007		)	(4,301		)	(5,114		)	(9,936		)
Interest income and other income (expense), net	3,941			(131		)	3,968			(121		)
Interest expense	(154		)	(864		)	(391		)	(1,718		)
Income (loss) before provision for income taxes	780			(5,296		)	(1,537		)	(11,775		)
Provision for income taxes	530			1,119			680			1,243
Net income (loss)	$	250		$	(6,415	)	$	(2,217	)	$	(13,018	)
Net income (loss) per share
Basic	$	—		$	(0.17	)	$	(0.05	)	$	(0.35	)
Diluted	$	—		$	(0.17	)	$	(0.05	)	$	(0.35	)
Weighted average shares used in computing net income (loss) per share:
Basic	46,648			37,813			46,298			37,478
Diluted	48,061			37,813			46,298			37,478

Comprehensive income (loss)
Net income (loss)	$	250		$	(6,415	)	$	(2,217	)	$	(13,018	)
Unrealized gains (loss) on available-for-sale securities	—			6			(2		)	11
Foreign currency translation adjustments	(18		)	(98		)	17			(148		)
Comprehensive income (loss)	$	232		$	(6,507	)	$	(2,202	)	$	(13,155	)

See accompanying notes to unaudited condensed consolidated financial statements.

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CALLIDUS SOFTWARE INC.

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(Unaudited, in thousands)



	Six Months Ended June 30,
	2014			2013
Cash flows from operating activities:
Net loss	$	(2,217	)	$	(13,018	)
Adjustments to reconcile net loss to net cash provided by operating activities:
Depreciation expense	2,564			2,109
Amortization of intangible assets	2,525			2,414
Gain on sale of intangible assets	(3,862		)	—
Provision for doubtful accounts	480			314
Stock-based compensation	4,924			5,801
Release of valuation allowance	(149		)	—
Loss on disposal of property and equipment	—			3
Amortization of convertible notes issuance cost	58			268
Net amortization on investments	15			46
Changes in operating assets and liabilities:
Accounts receivable	(243		)	86
Prepaid and other current assets	(291		)	(272		)
Other noncurrent assets	401			(472		)
Accounts payable	(706		)	(3,201		)
Accrued expenses	1,553			986
Accrued payroll and related expenses	(1,149		)	(431		)
Accrued restructuring and other expenses	(50		)	(578		)
Deferred revenue	2,832			8,203
Deferred income taxes	(239		)	118
Net cash provided by operating activities	6,446			2,376
Cash flows from investing activities:
Purchases of investments	(1,209		)	(5,634		)
Proceeds from maturities and sale of investments	5,050			9,450
Purchases of property and equipment	(4,018		)	(1,356		)
Purchases of intangible assets	(743		)	(364		)
Proceeds from sale of intangible assets, net of expenses	4,651			—
Acquisitions, net of cash acquired	(2,402		)	—
Net cash provided by investing activities	1,329			2,096
Cash flows from financing activities:
Proceeds from issuance of common stock	1,975			2,168
Repurchase of common stock from employees for payment of taxes on vesting of restricted stock units	(1,439		)	(490		)
Proceeds from line of credit	2,982			—
Payment of consideration related to acquisitions	(630		)	(3,078		)
Repayment of debt	(645		)	—
Payment of principal under capital leases	(416		)	(1,047		)
Net cash (used in) provided by financing activities	1,827			(2,447		)
Effect of exchange rates on cash and cash equivalents	17			(126		)
Net increase in cash and cash equivalents	9,619			1,899
Cash and cash equivalents at beginning of period	28,295			16,400
Cash and cash equivalents at end of period	$	37,914		$	18,299
Supplemental disclosures of cash flow information:
Cash paid for interest on convertible debt	$	277		$	1,406
Cash paid for interest on capital leases	24			44
Non-cash investing and financing activities:
Conversion of convertible debt to equity	$	14,197		$	—
Reclassification of unamortized debt issuance cost to additional paid-in capital as a result of debt conversion	$	253		$	—
Non-cash financing of fixed assets acquired under capital lease	—			2,627

See accompanying notes to unaudited condensed consolidated financial statements.

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CALLIDUS SOFTWARE INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

Note 1—Summary of Significant Accounting Policies

Basis of Presentation and Summary of Accounting Policies

All amounts included herein related to the condensed consolidated financial statements as of June 30, 2014 and the three and six months ended June 30, 2014 and 2013 are unaudited and should be read in conjunction with the audited consolidated financial statements and the notes thereto included in Callidus Software Inc.'s ("the Company") Annual Report on Form 10-K for the year ended December 31, 2013. Certain information and footnote disclosures normally included in annual financial statements prepared in accordance with accounting principles generally accepted in the United States of America ("GAAP") have been condensed or omitted pursuant to the Securities and Exchange Commission ("SEC") rules and regulations regarding interim financial statements.

In the opinion of management, the accompanying condensed consolidated financial statements include all necessary adjustments for the fair presentation of the Company’s financial position, results of operations and cash flows. The results of operations for the interim periods presented are not necessarily indicative of the operating results to be expected for any subsequent interim period or for the full fiscal year ending December 31, 2014.

The condensed consolidated financial statements include the accounts of the Company and its wholly-owned subsidiaries, which include wholly-owned subsidiaries in Australia, Canada, Germany, Hong Kong, India, Japan, Malaysia, Mexico, New Zealand, Netherlands, Serbia, Singapore, and the United Kingdom. All intercompany transactions and balances have been eliminated upon consolidation.

Use of Estimates

Preparation of the condensed consolidated financial statements in conformity with GAAP and the rules and regulations of the SEC requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities, disclosure of contingent assets and liabilities at the date of the condensed consolidated financial statements, the reported amounts of revenue and expenses during the reporting period and the accompanying notes. Estimates are used for, but not limited to, uncertain tax liabilities, allowances for doubtful accounts, the useful lives of fixed assets and intangible assets, goodwill and intangible asset impairments, stock-based compensation forfeiture rates, accrued liabilities, the allocation of the value of purchase consideration for business acquisitions, and other contingencies. These estimates and assumptions are based on management’s best estimates and judgment. Management evaluates such estimates and assumptions on an ongoing basis for continued reasonableness, using historical experience and other factors, including the current economic environment. Appropriate adjustments, if any, to the estimates used are made prospectively based upon such evaluation. Illiquid credit markets, volatile equity and foreign currency markets and declines in information technology spending by prospective customers have combined to increase the uncertainty inherent in such estimates and assumptions. As future events and their effects cannot be determined with precision, actual results could differ materially from those estimates. Changes in those estimates, if any, resulting from continuing changes in the economic environment, will be reflected in the condensed consolidated financial statements in future periods.

Recent Accounting Pronouncements

In May 2014, the FASB issued an accounting standard update “Revenue from Contracts with Customers” that replaces existing revenue recognition guidance and convergences with the international accounting standards. The accounting standard update removes the current inconsistencies and weaknesses with existing revenue recognition guidance, provides a more robust framework to address revenue recognition issues, communicates more useful information through improved disclosure requirements, and simplifies financial statement preparation by reducing the number of revenue recognition requirements. This accounting standard update will be effective for the Company beginning in the first quarter of fiscal 2017. The Company is currently evaluating the impact of this accounting standard update on its Consolidated Financial Statements.

Note 2—Restructuring and Other

During the three months ended June 30, 2014, management approved and initiated restructuring plans to realign our resources to improve cost efficiencies. Restructuring and other expenses primarily consist of costs associated with exit of excess facilities, employee terminations and incremental depreciation expense as a result of the change in the estimated useful life of assets to be abandoned. The Company incurred restructuring and other expense of $0.4 million and $0.3 million during the three months ended June 30, 2014 and 2013, respectively, and $0.4 million and $1.6 million during the six months ended June 30, 2014 and 2013, respectively.

The following table sets forth a summary of accrued restructuring expenses for the six months ended June 30, 2014 and 2013, respectively (in thousands):



	December 31, 2013		Cash Payments			Additions		Adjustments		June 30, 2014
Severance and termination-related costs	$	141	$	(203	)	$	70	$	—	$	8
Facilities-related costs	234		(79		)	162		—		317
Total accrued restructuring expenses	$	375	$	(282	)	$	232	$	—	$	325

During the three months ended June 30, 2014, the Company has also incurred $0.2 million of non-cash expense primarily related to incremental depreciation expense as a result of the change in the estimated useful life of assets to be abandoned.

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	December 31, 2012		Cash Payments			Additions		Adjustments			June 30, 2013
Severance and termination-related costs	$	589	$	(2,115	)	$	1,566	$	(8	)	$	32
Facilities related costs	289		(20		)	—		—			269
Total accrued restructuring expenses	$	878	$	(2,135	)	$	1,566	$	(8	)	$	301

Note 3—Acquisitions

LeadRocket, Inc.

On February 4, 2014, the Company acquired all of the common stock of LeadRocket, Inc. (“LeadRocket”), a privately-held company providing marketing automation and demand generation solutions that enable both marketing and sales users to identify and connect with leads efficiently. The Company acquired LeadRocket to strengthen its social engagement and digital marketing platform. The purchase consideration was $3.0 million, which included $2.5 million paid in cash and $0.5 million as indemnity holdback payable upon the one year closing anniversary. As of June 30, 2014, $0.4 million of the indemnity holdback remains accrued for potential indemnification claims, and the timing and amount of any additional indemnification items under the holdback is unknown.

The preliminary purchase price allocation for LeadRocket is summarized as follows (in thousands):



	Fair Value
Net liabilities assumed	$	(1,075	)
Intangible assets	2,640
Goodwill	1,584
Deferred tax liabilities	(149		)
Total purchase price	$	3,000

The excess of purchase consideration over the fair value of net tangible liabilities assumed and identifiable intangible assets acquired was recorded as goodwill. The fair values assigned to tangible and identifiable intangible assets acquired and liabilities assumed are based on management’s estimates and assumptions. The estimated fair values of assets acquired and liabilities assumed, specifically current and noncurrent income taxes payable and deferred taxes, may be subject to change as additional information is received and certain tax returns are finalized. Thus the provisional measurements of fair value set forth above are subject to change. The Company expects to finalize the valuation as soon as practicable, but not later than one-year from the acquisition date.

The following table sets forth the components of identifiable intangible assets acquired and their estimated useful lives as of the date of the LeadRocket acquisition (in thousands):



	Fair Value		Useful Life
Developed technology	$	570	2-4 years
Patents	1,060		10 years
Domain names and trademarks	850		5 years
Customer relationships	160		3 years
Total intangible assets subject to amortization	$	2,640

The goodwill balance is primarily attributed to the anticipated synergies from the acquisition and expanded market opportunities with respect to the integration of LeadRocket’s digital marketing platform with the Company’s other solutions. The goodwill balance is not deductible for U.S. income tax purposes.

Pro forma results of operations for the LeadRocket acquisition have not been presented because the acquisition is not material.

Goodwill

Goodwill represents the excess of the purchase price in a business combination over the fair value of net tangible and intangible assets acquired. Goodwill amounts are not amortized, but rather tested for impairment at least annually or as events occur or circumstances change that would more likely than not reduce the fair value of a reporting unit below its carrying amount.

As of June 30, 2014 and December 31, 2013, goodwill consisted of the following (in thousands):



Balance as of December 31, 2013	$	31,207
LeadRocket	1,584
Balance as of June 30, 2014	$	32,791

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Note 4—Financial Instruments

As of June 30, 2014 and December 31, 2013, all investment debt securities are classified as available-for-sale and carried at estimated fair value, which is determined based on the inputs discussed below.

The Company classifies all highly liquid instruments with an original maturity on the date of purchase of three months or less as cash and cash equivalents. The Company classifies available-for-sale securities that have a maturity date longer than three months as short-term investments, including those investments with a maturity date of longer than one year that are highly liquid and which the Company does not intend to hold to maturity.

Realized gains and losses are calculated using the specific identification method. As of June 30, 2014 and December 31, 2013, the Company had no short-term investments in a material unrealized loss position.

The components of the Company’s cash, cash equivalents, and investments classified as available-for-sale were as follows at June 30, 2014 and December 31, 2013 (in thousands):



June 30, 2014	Amortized Cost		Gross Unrealized Gains		Gross Unrealized Losses			Other Than Temporary Impairment		Estimated Fair value
Cash	$	32,843	$	—	$	—		$	—	$	32,843
Cash equivalents:
Money market funds	5,071		—		—			—		5,071
Total cash equivalents	5,071		—		—			—		5,071
Total cash and cash equivalents	$	37,914	$	—	$	—		$	—	$	37,914

Short-term investments:
U.S. government and agency obligations	2,802		—		—			—		2,802
Corporate notes and obligations	1,207		—		(1		)	—		1,206
Total short-term investments	$	4,009	$	—	$	(1	)	$	—	$	4,008



December 31, 2013	Amortized Cost		Gross Unrealized Gains		Gross Unrealized Losses		Other Than Temporary Impairment		Estimated Fair value
Cash	$	21,989	$	—	$	—	$	—	$	21,989
Cash equivalents:
Money market funds	6,306		—		—		—		6,306
Total cash equivalents	6,306		—		—		—		6,306
Total cash and cash equivalents	$	28,295	$	—	$	—	$	—	$	28,295

Short-term investments:
U.S. government and agency obligations	6,115		—		—		—		6,115
Corporate notes and obligations	1,751		—		—		—		1,751
Total short-term investments	$	7,866	$	—	$	—	$	—	$	7,866

The market value and the amortized cost of available-for-sale debt securities by contractual maturities as of June 30, 2014 were as follows (in thousands):



Contractual maturity	Amortized Cost		Estimated Fair value
Less than 1 year	$	2,802	$	2,802
Between 1 and 2 years	1,207		1,206
Total	$	4,009	$	4,008

At June 30, 2014, the Company had no material unrealized losses on our short-term investments.

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The Company had no realized gains or losses on sales of its investments for the three and six months ended June 30, 2014 and 2013. The Company had proceeds, net of purchases of investments, of $3.8 million and $3.8 million from maturities and sales of investments during the six months ended June 30, 2014 and 2013, respectively.

The short-term investments in government obligations or highly rated credit securities generally have minor to moderate fluctuations in the fair values from period to period. The Company monitors credit ratings, downgrades and significant events surrounding these securities so as to assess if any of the impairments will be considered other-than-temporary. The Company did not identify any government obligations or highly rated credit securities held as of June 30, 2014 or as of December 31, 2013 for which the fair value declined significantly below amortized cost and were considered other-than-temporary impairments.

Note 5—Fair Value Measurements

The Company measures financial assets at fair value on an ongoing basis. The estimated fair value of the Company’s financial assets was determined using the following inputs at June 30, 2014 (in thousands):



	Fair Value Measurements at Reporting Date Using
			Quoted Prices in Active Markets for Identical Assets		Significant Other Observable Inputs		Significant Unobservable Inputs
June 30, 2014	Total		(Level 1)		(Level 2)		(Level 3)
Assets:
Money market funds (1)	$	5,071	$	5,071	$	—	$	—
U.S. government and agency obligations (2)	2,802		—		2,802		—
Corporate notes and obligations (2)	1,206		—		1,206		—
Total	$	9,079	$	5,071	$	4,008	$	—

_____________________________________________________________________________

(1) Included in cash and cash equivalents on the condensed consolidated balance sheet.

(2) Included in short-term investments on the condensed consolidated balance sheet.

The estimated fair value of the Company’s financial assets was determined using the following inputs at December 31, 2013 (in thousands):



	Fair Value Measurements at Reporting Date Using
			Quoted Prices in Active Markets for Identical Assets		Significant Other Observable Inputs		Significant Unobservable Inputs
December 31, 2013	Total		(Level 1)		(Level 2)		(Level 3)
Assets:
Money market funds (1)	$	6,306	$	6,306	$	—	$	—
U.S. government and agency obligations (2)	6,115		—		6,115		—
Corporate notes and obligations (2)	1,751		—		1,751		—
Total	$	14,172	$	6,306	$	7,866	$	—

_____________________________________________________________________________

(1) Included in cash and cash equivalents on the consolidated balance sheet.

(2) Included in short-term investments on the consolidated balance sheet.

Valuation of Investments

Level 1 and Level 2

The Company’s available-for-sale securities include money market funds, corporate notes and obligations, and U.S. government and agency obligations. The Company values these securities using a pricing matrix from a pricing service provider, who may use quoted prices in active markets for identical assets (Level 1 inputs) or inputs other than quoted prices that are observable either directly or indirectly (Level 2 inputs). The Company classifies all of its available-for-sale securities, except for money market funds, as having Level 2 inputs. The Company validates the estimated fair value of certain securities from a pricing service provider on a quarterly basis. The valuation techniques used to measure the fair value of the financial instruments having Level 2 inputs, all of which have counterparties with high credit ratings, were derived from the following: non-binding market consensus prices that are corroborated by observable market data, quoted market prices for similar instruments or pricing models, such as discounted cash flow techniques, with all significant inputs derived from or corroborated by observable market data.

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Level 3

As of June 30, 2014, the Company had no Level 3 instruments. The Company did not have any transfers between Level 1, Level 2 and Level 3 fair value measurements during the periods presented as there were no changes in the composition in Level 1, 2 or 3.

Note 6—Convertible Notes

During the three months ended June 30, 2014, an aggregate principal amount of $14.2 million of the Company's 4.75% Convertible Senior Notes (“Convertible Notes”) was converted into 1,840,770 shares of common stock. Additionally, the Company paid accrued interest of $0.3 million and reclassified $0.3 million of deferred debt issuance costs to additional paid-in capital in connection with the conversion of the Convertible Notes. As of June 30, 2014, the Company had no outstanding Convertible Notes or related deferred debt issuance costs.

Note 7—Commitments and Contingencies

Except as discussed below, there were no material changes in the Company's commitments under contractual obligations as disclosed in the Company’s audited consolidated financial statements for the year ended December 31, 2013.

Revolving Line of Credit

In May 2014, the Company entered into a credit agreement with Wells Fargo Bank, National Association ("Lender"), under which the Lender agreed to make a revolving loan ("Revolver") to the Company in an amount not to exceed $10.0 million, with an accordion feature that allows the Company to increase the maximum borrowing amount by not less than $5.0 million and not more than $10.0 million. The Revolver matures in May 2019. Outstanding borrowings under the Revolver bear interest, at the Company's option, at a base rate plus an applicable margin. The applicable margin ranges between 0.75% and 2.25% depending on the Company's leverage ratio. Interest is payable every three months.

As of June 30, 2014, the Company has borrowed $3.0 million under the Revolver and repaid in full the indebtedness incurred pursuant to the term note entered into in January 2014.

Warranties and Indemnification

The Company generally warrants that its software will perform in accordance with its standard documentation. Under the Company’s standard warranty, should a software product not perform as specified in the documentation within the warranty period, the Company will repair or replace the software or refund the license fee paid. To date, the Company has not incurred any incremental costs related to warranty obligations for its software.

The Company’s product license and on-demand agreements typically include a limited indemnification provision for claims by third parties relating to the Company’s intellectual property. To date, the Company has not incurred material costs, and has not accrued any costs related to such indemnification provisions.

Intellectual Property Litigation

Versata Software, Inc. and Versata Development Group, Inc. v. Callidus Software, Inc. - Ongoing

On July 19, 2012, Versata Software, Inc. and Versata Development Group, Inc. (collectively, “Versata”) filed suit against Callidus in the United States District Court for the District of Delaware (“Delaware District Court”). The suit asserts that the Company infringes U.S. Patent Nos. 7,904,326, 7,908,304 and 7,958,024. The Company believes that the claims are without merit and intends to vigorously defend against these claims. On May 30, 2013, the Company answered the complaint and filed a counterclaim against Versata in the Delaware District Court. The Company's counterclaim asserts that Versata infringes U.S. Patent Nos. 6,269,355, 6,850,924 and 6,473,748. On August 30, 2013, the Company filed petitions with the United States Patent and Trademark Office Patent Trial and Appeal Board (“PTAB”) for covered business method (“CBM”) patent review of U.S. Patent Nos. 7,904,326, 7,908,304 and 7,958,024, which Versata filed responses to on December 12, 2013. The Company also filed a motion with the Delaware District Court on August 30, 2013 to stay the litigation pending completion of the patent review proceedings with the PTAB (“Motion to Stay”). On January 8, 2014, the Company was granted leave by the Delaware District Court to add Versata Inc. as a counterclaim defendant. On March 4, 2014, the PTAB instituted covered business method patent review of each of Versata’s patents, namely, U.S. Patent Nos. 7,904,326, 7,908,304 and 7,958,024, finding that it is more likely than not that the Company will prevail in establishing that the challenged claims are not patentable. After requesting that the PTAB reconsider its decision to institute, which was denied, Versata filed a petition for writ of mandamus with the Court of Appeals for the Federal Circuit (“CAFC”) on April 11, 2014 asking that Court to deny institution of CBM patent review by the PTAB. The CAFC denied Versata’s petition for writ of mandamus on May 5, 2014. On April 17, 2014, the Company filed additional petitions with the PTAB for CBM patent review to address all of the remaining claims not previously covered in the prior petitions with respect to U.S Patent Nos. 7,908,304 and 7,958,024. On May 8, 2014, the Delaware District Court: (i) granted the Company’s Motion to Stay in part with respect to U.S. Patent No. 7,904,326, and (ii) denied the Company’s Motion to Stay in part with respect to U.S. Patent Nos. 7,908,304 and 7,958,024. On May 8, 2014, the Company appealed to the CAFC the Delaware District Court’s denial of the Motion to Stay with respect to U.S. Patent Nos. 7,908,304 and 7,958,024. At this stage in the case, the Company is not in a position to assess whether any loss or adverse effect on the Company's financial condition is probable, or to estimate the range of potential loss, if any.

Other Matters

In addition to the above litigation matter, the Company is from time to time a party to other various litigation and customer disputes incidental to the conduct of its business. At the present time, the Company believes that none of these matters are likely to have a material adverse effect on the Company’s future financial results.

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The Company records a liability when it is both probable that a liability has been incurred and the amount of the loss can be reasonably estimated. The Company reviews the need for any such liability on a quarterly basis and records any necessary adjustments to reflect the effect of ongoing negotiations, contract disputes, settlements, rulings, advice of legal counsel, and other information and events pertaining to a particular case in the period they become known. At June 30, 2014, the Company had not recorded any such liabilities in accordance with accounting for contingencies. However, litigation and other disputes are subject to inherent uncertainties and the Company's view on these matters may change in the future.

Note 8—Net Income (Loss) Per Share

Basic net income (loss) per share is calculated by dividing net income (loss) for the period by the weighted average common shares outstanding during the period. Diluted net income (loss) per share is calculated by dividing the net income (loss) for the period by the weighted average common shares outstanding, adjusted for all dilutive potential common shares, which includes shares issuable for the period of time the Convertible Notes were outstanding, the exercise of outstanding common stock options, the release of restricted stock units, and purchases of shares pursuant to our employee stock purchase plan ("ESPP"), to the extent these shares are dilutive.

The following table presents the calculation of basic and diluted net income per share (in thousands, except per share data):



	Three Months Ended June 30,					Six Months Ended June 30,
	2014		2013			2014			2013
Numerator:
Net income (loss)	250		(6,415		)	(2,217		)	(13,018		)
Denominator:
Weighted-average shares used in computing net income (loss) per share:
Basic	46,648		37,813			46,298			37,478
Weighted-average effect of potentially dilutive shares:
Restricted Stock Units	689		—			—			—
Stock Options	690		—			—			—
ESPP Shares	34		—			—			—
Convertible Notes	—		—			—			—
Diluted	48,061		37,813			46,298			37,478
Net income (loss) per share
Basic	$	—	$	(0.17	)	$	(0.05	)	$	(0.35	)
Diluted	$	—	$	(0.17	)	$	(0.05	)	$	(0.35	)

The following table summarizes the weighted-average potential shares that were excluded from the diluted per share calculation because to include them would have been anti-dilutive for the period (in thousands):



	Three Months Ended June 30,		Six Months Ended June 30,
	2014	2013	2014	2013
Restricted Stock Units	1,395	2,008	2,245	2,122
Stock Options	236	2,513	1,841	2,655
ESPP Shares	31	155	65	115
Convertible Notes	1,507	7,680	1,674	7,680
Total	3,169	12,356	5,825	12,572

The weighted average exercise price of stock options excluded for the three and six months ended June 30, 2014 were $7.96 and $5.34, respectively. The weighted average exercise price of stock options excluded for the three and six months ended June 30, 2013 were $4.04 and $4.02, respectively.

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Note 9—Stock-based Compensation

Expense Summary

The table below sets forth a summary of stock-based compensation expense for the three and six months ended June 30, 2014 and 2013 (in thousands):



	Three Months Ended June 30,				Six Months Ended June 30,
	2014		2013		2014		2013
Stock Options	$	210	$	382	$	413	$	461
Restricted Stock Units
Performance Awards	435		394		827		521
Service-based Awards	1,798		2,294		3,290		4,513
ESPP Shares	189		140		394		306
Total Stock-based Compensation	$	2,632	$	3,210	$	4,924	$	5,801

As of June 30, 2014, there were $2.2 million, $3.9 million, $11.9 million and $0.2 million of total unrecognized compensation expense related to stock options, performance awards, service-based awards and ESPP shares, respectively. The expenses related to stock options, performance awards, service-based awards and ESPP shares are expected to be recognized over a weighted average period of 2.9 years, 2.3 years, 1.8 years and 0.5 years, respectively.

The table below sets forth the functional classification of stock-based compensation expense for the three and six months ended June 30, 2014 and 2013 (in thousands):



	Three Months Ended June 30,				Six Months Ended June 30,
	2014		2013		2014		2013
Cost of recurring revenue	$	192	$	204	$	374	$	378
Cost of services and other revenue	256		236		470		642
Sales and marketing	810		582		1,402		1,155
Research and development	474		467		912		933
General and administrative	900		1,721		1,766		2,693
Total stock-based compensation	$	2,632	$	3,210	$	4,924	$	5,801

Performance Awards

In 2014, the Company granted performance awards with vesting contingent on absolute SaaS revenue growth over the three year period from 2014 through 2016, and the Company’s relative total stockholder return over the three year period from 2014 through 2016 versus an index of 17 SaaS companies.

In 2013, the Company granted performance awards with vesting contingent on successful attainment of pre-set SaaS revenue growth and recurring revenue gross profit targets.

Determination of Fair Value

The fair value of service-based awards is estimated based on the market value of the Company’s stock on the date of grant. A portion of the performance awards granted during 2014 are based on relative stockholder return and therefore, are subject to a market condition. As a result, the fair value of performance awards is calculated using a Monte Carlo simulation model that estimates the distribution of the potential outcomes of the grants of performance awards based on simulated future index of the peer companies.

The fair value of each stock option is estimated on the date of grant using the Black-Scholes valuation model and the assumptions noted in the following table. No stock options were granted during the three and six months ended June 30, 2014.



	Three months ended June 30,			Six months ended June 30,
	2014		2013	2014		2013
Stock Option Plans
Expected life (in years)	—		5.0 to 6.0	—		5.0 to 6.0
Risk-free interest rate	—	%	1.41% to 1.69%	—	%	1.41% to 1.69%
Volatility	—	%	61% to 63%	—	%	61% to 63%
Dividend Yield	—		None	—		None

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The fair value of each ESPP share is estimated on the enrollment date of the offering period using the Black-Scholes valuation model and the assumptions noted in the following table.



	Six Months Ended June 30,
	2014	2013
Employee Stock Purchase Plan
Expected life (in years)	0.49 to 1.00	0.50 to 1.00
Risk-free interest rate	0.08% to 0.12%	0.13% to 0.17%
Volatility	47% to 50%	52% to 62%
Dividend yield	None	None

Note 10—Income Taxes

Income tax expense for the three and six months ended June 30, 2014 was $0.5 million and $0.7 million, compared to income tax expense of $1.1 million and $1.2 million for the same periods of 2013. The decrease in the tax expense for the three and six month periods was primarily due to withholding taxes in foreign jurisdictions, partially offset by the release in Q1 2014 of a portion of the valuation allowance associated with the acquisition of LeadRocket.

Note 11—Segment, Geographic and Customer Information

The accounting principles guiding disclosures about segments of an enterprise and related information establishes standards for the reporting by business enterprises of information about operating segments, products and services, geographic areas, and major customers. The method of determining which information is reported is based on the way that management organizes the operating segments within the Company for making operational decisions and assessments of financial performance. The Company’s chief operating decision maker is considered to be the Company’s chief executive officer ("CEO"). The CEO reviews financial information presented on a consolidated basis for purposes of making operating decisions and assessing financial performance. By this definition, the Company operates in one business segment, which is the development, marketing and sale of sales and marketing effectiveness cloud software and related services.

The following table summarizes revenue for the three and six months ended June 30, 2014 and 2013 by geographic areas (in thousands):



	Three Months Ended June 30,				Six Months Ended June 30,
	2014		2013		2014		2013
United States	$	25,178	$	20,489	$	50,493	$	40,564
EMEA	3,785		2,984		6,747		6,177
Asia Pacific	1,916		1,451		3,242		2,510
Other	1,636		1,006		3,010		2,221
	$	32,515	$	25,930	$	63,492	$	51,472

Substantially all of the Company’s long-lived assets are located in the United States. Long-lived assets located outside the United States are not significant.

During the three and six months ended June 30, 2014 and 2013, no customer accounted for more than 10% of total revenue.

Note 12—Related-Party Transactions

In June 2014, in the normal course of business, the Company entered into agreements with Lithium Technologies, Inc. (“Lithium”), whose Chief Financial Officer is a member of the Company's Board of Directors. The Company purchased an annual subscription for Lithium's social media management solutions in the amount of $120,000.

In June 2013, Lithium entered into a two-year hosting agreement with the Company for an annual amount of $113,000. During the three and six months ended June 30, 2014, the Company recognized approximately $25,000 and $51,000, respectively, in revenue under the $113,000 annual hosting agreement.

During 2013 and 2014, the Company entered into agreements with Lithium to provide services in an aggregate amount of $173,550, of which the Company recognized approximately $3,000 and $40,000 for the three and six months ended June 30, 2014, respectively.

Webcom, Inc., a wholly-owned subsidiary of the Company, engages the services of a third-party vendor to perform product modeling and maintenance of certain equipment. The third-party vendor is owned by a relative of Webcom’s senior management. For the three and six months ended June 30, 2014, the Company paid approximately $25,000 and $76,000, respectively, to this vendor.

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

The following discussion of financial condition and results of operations should be read in conjunction with Management’s Discussion and Analysis of Financial Condition and Results of Operations and the Consolidated Financial Statements and the notes thereto included in our Annual Report on Form 10-K for the year ended December 31, 2013 and with the unaudited condensed consolidated financial statements and the related notes thereto contained elsewhere in this Quarterly Report on Form 10-Q. This section of this Quarterly Report on Form 10-Q contains forward-looking statements within the meaning of Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934, as amended. These statements relate to our future plans, objectives, expectations, prospects, intentions and financial performance and the assumptions that underlie these statements. Generally, the words “believe,” “expect,” “intend,” “estimate,” “anticipate,” “project,” "may," “will,” and similar expressions and the negatives thereof identify forward-looking statements, which generally are not historical in nature. These forward-looking statements include, but are not limited to, statements concerning the following: levels of recurring revenue, levels of SaaS revenue, changes in and expectations with respect to revenue, revenue growth and gross profits, operating expense levels, the impact of quarterly fluctuations of revenue and operating results, staffing and expense levels, expected cash and investment balances, the impact of foreign exchange rates and interest rate fluctuations, projected future financial performance, our anticipated growth and trends in our businesses, our business strategy, and other characterizations of future events or circumstances. As and when made, management believes that these forward-looking statements are reasonable. However, caution should be taken not to place undue reliance on any such forward-looking statements because such statements speak only as of the date when made and may be based on assumptions that do not prove to be accurate. In addition, forward-looking statements are subject to certain risks and uncertainties that could cause actual results to differ materially from our historical experience and our present expectations or projections. Many of these risks and uncertainties are described in “Risk Factors” set forth in our Annual Report on Form 10-K for the year ended December 31, 2013 and elsewhere in this Quarterly Report on Form 10-Q. We undertake no obligation to publicly update or revise any forward-looking statements, whether as a result of new information, future events or circumstances occurring after the date of this Quarterly Report on Form 10-Q, except as required by law.

Overview

Callidus Software Inc. (which we refer to as "CallidusCloud", "Callidus", "we", "our" and "Company") is the leading provider of sales and marketing effectiveness and management cloud software and related services. CallidusCloud® enables organizations to accelerate, streamline and maximize their Lead to Money process with a comprehensive suite of solutions that identify promising leads, ensure proper territory and quota distribution, train sales forces, automate quote and proposal generation, and streamline sales compensation.

"Lead to Money" is a process designed to enable companies to respond to the changing role of sales and marketing in the redefined buying cycle. In the last decade, the ubiquity of social networks, mobile devices and e-commerce has transformed the traditional sales cycle into a buyer-lead journey. The core of our mission is to accelerate and maximize effectiveness along this Lead to Money process.

We provide a suite of Software-as-a-Service ("SaaS") solutions which generate revenue from cloud subscriptions, sales operation services and term licenses. Our SaaS customers typically purchase annual subscriptions, but occasionally will purchase multi-year subscriptions.

Revenue Growth and Customer Expansion

We offer our customers a range of purchasing and deployment options, from on-demand subscriptions to on-premise term or perpetual licenses. Our business and revenue model is focused on recurring revenue. From time to time, we will invoice for overages to customers that have used payees and/or storage capacity in excess of the agreed-upon contractual levels. If such overages pertain to SaaS customer arrangements, the overage revenue is recognized in SaaS revenue in the period of settlement.

We now have over 2,500 customers. Our enterprise SaaS customer retention rates were in excess of 90% based upon number of contracts over the past twelve months. We believe our rapid customer growth and high retention rates are indicators of the quality of our products and the strength of our customer base.

SaaS revenue grew to $19.6 million for the three months ended June 30, 2014, representing a $3.8 million or 24% increase over the same period in 2013. SaaS revenue grew to $37.7 million for the six months ended June 30, 2014, representing a $6.2 million or 20% increase over the same period in 2013. Revenue related to overages was immaterial for the three and six months ended June 30, 2014 and 2013.

Application of Critical Accounting Policies and Use of Estimates

The discussion and analysis of our financial condition and results of operations which follows are based upon our condensed consolidated financial statements prepared in accordance with the generally accepted accounting principles in the United States of America ("GAAP"). The application of GAAP requires management to make assumptions, judgments and estimates that affect our reported amounts of assets, liabilities, revenue and expenses, and the related disclosures regarding these items. We base our assumptions, judgments and estimates on historical experience and on various other factors that we believe to be reasonable under the circumstances. Actual results could differ significantly from these estimates under different assumptions or conditions. To the extent that there are material differences between these estimates and actual results, our future financial condition or results of operations will be affected. We evaluate our assumptions, judgments and estimates on a regular basis. We also discuss our critical accounting policies and estimates with the Audit Committee of our Board of Directors.

We believe that the assumptions, judgments and estimates involved in the accounting for revenue recognition, allowance for doubtful accounts, stock-based compensation, valuation of acquired intangible assets, goodwill impairment, long-lived asset impairment, contingent consideration and income taxes have the greatest potential impact on our condensed consolidated financial statements. These areas

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are key components of our results of operations and are based on complex rules which require us to make judgments and estimates and we consider these to be our critical accounting policies. There were no significant changes in our critical accounting policies and estimates during the three and six months ended June 30, 2014 as compared to the critical accounting policies and estimates disclosed in Management’s Discussion and Analysis of Financial Condition and Results of Operations included in our Annual Report on Form 10-K for the year ended December 31, 2013.

Recent Accounting Pronouncements

Refer to Note 1 to the notes to our condensed consolidated financial statements for information regarding the effect of recent accounting pronouncements on our financial statements.

Results of Operations

Comparison of the Three and Six Months Ended June 30, 2014 and 2013

Revenue, Cost of Revenue and Gross Profit

The following tables set forth the changes in revenue, cost of revenue and gross profit for the three and six months ended June 30, 2014, compared to the same periods in 2013 (in thousands, except for percentage data):



	Three Months Ended June 30, 2014		Percentage of Revenue	Three Months Ended June 30, 2013		Percentage of Revenue	Increase (Decrease)		Percentage Change
Revenue:
Recurring	$	23,684	73%	$	19,616	76%	$	4,068	21%
Services and license	8,831		27%	6,314		24%	2,517		40%
Total revenue	$	32,515	100%	$	25,930	100%	$	6,585	25%

Cost of revenue:
Recurring	$	7,502	32%	$	6,931	35%	$	571	8%
Services and license	5,628		64%	4,739		75%	889		19%
Total cost of revenue	$	13,130	40%	$	11,670	45%	$	1,460	13%

Gross profit:
Recurring	$	16,182	68%	$	12,685	65%	$	3,497	28%
Services and license	3,203		36%	1,575		25%	1,628		103%
Total gross profit	$	19,385	60%	$	14,260	55%	$	5,125	36%



	Six Months Ended June 30, 2014		Percentage of Revenue	Six Months Ended June 30, 2013		Percentage of Revenue	Increase (Decrease)		Percentage Change
Revenue:
Recurring	$	45,934	72%	$	39,240	76%	$	6,694	17%
Services and license	17,558		28%	12,232		24%	5,326		44%
Total revenue	$	63,492	100%	$	51,472	100%	$	12,020	23%

Cost of revenue:
Recurring	$	14,790	32%	$	14,384	37%	$	406	3%
Services and license	10,738		61%	9,961		81%	777		8%
Total cost of revenue	$	25,528	40%	$	24,345	47%	$	1,183	5%

Gross profit:
Recurring	$	31,144	68%	$	24,856	63%	$	6,288	25%
Services and license	6,820		39%	2,271		19%	4,549		200%
Total gross profit	$	37,964	60%	$	27,127	53%	$	10,837	40%

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Revenue

Total Revenue. Total revenue for the three months ended June 30, 2014 was $32.5 million, an increase of 25% or $6.6 million compared to the same period in 2013. Total revenue for the six months ended June 30, 2014 was $63.5 million, an increase of 23% or $12.0 million compared to the same period in 2013.

Recurring Revenue. Recurring revenue, which consists of SaaS revenue and maintenance revenue, increased $4.1 million or 21% to $23.7 million in the three months ended June 30, 2014 compared to $19.6 million in the same period in 2013. Recurring revenue increased $6.7 million or 17% to $45.9 million in the six months ended June 30, 2014 compared to $39.2 million in the same period in 2013. SaaS revenue increased $3.8 million and $6.2 million in the three and six months ended June 30, 2014, respectively, compared to the same period in 2013, while maintenance revenue increased $0.3 million and $0.5 million, respectively. The increase in SaaS revenue was attributable to the expansion of our sales force and revenue recognized from the growth in SaaS bookings.

Services and License Revenue. Services and license revenue, which consists of integration and configuration services, training and perpetual licenses, increased $2.5 million or 40% to $8.8 million in the three months ended June 30, 2014 compared to $6.3 million in the same period in 2013. Services and license revenue increased $5.3 million or 44% to $17.6 million in the six months ended June 30, 2014 compared to $12.2 million in the same period in 2013. The increase for the three and six months ended June 30, 2014 was primarily due to increases in service revenue of $2.4 million and $4.2 million, respectively, as a direct result of SaaS revenue growth, and increases in license revenue of $0.1 million and $1.1 million, respectively.

Cost of Revenue and Gross Profit

Cost of Recurring Revenue. Cost of recurring revenue increased $0.6 million or 8% to $7.5 million in the three months ended June 30, 2014 from $6.9 million in the same period in 2013. Cost of recurring revenue increased $0.4 million or 3% to $14.8 million in the six months ended June 30, 2014 from $14.4 million in the same period in 2013. The increase was primarily due to increased maintenance and depreciation due to the Company's investments in hosting facility equipments.

Cost of Services and License Revenue. Cost of services and license revenue increased $0.9 million or 19% to $5.6 million during the three months ended June 30, 2014 from $4.7 million in the same period in 2013. Cost of services and license revenue increased $0.8 million or 8% to $10.7 million during the three months ended June 30, 2014 from $10.0 million in the same period in 2013. The increase was primarily due to increased consultant expenses required to support increased service revenue.

Gross Profit. Overall gross margin percentage was 60% for the three months ended June 30, 2014, compared to 55% during the same period in 2013. Overall gross margin percentage was 60% for the six months ended June 30, 2014, compared to 53% during the same period in 2013.

Our recurring revenue gross margin percentage increased to 68% for the three months ended June 30, 2014, compared to 65% in the same period in 2013, while recurring revenue gross profit increased $3.5 million. Our recurring revenue gross margin percentage increased to 68% for the six months ended June 30, 2014, compared to 63% in the same period in 2013, and the recurring revenue gross profit increased $6.3 million. The improvement in our recurring revenue gross margin percentage was primarily due to increased SaaS revenue and the associated economies of scale of our on-demand infrastructure costs.

Services and license revenue gross margin percentage was 36% for the three months ended June 30, 2014, compared to 25% in the same period in 2013, while services and license revenue gross profit increased $1.6 million. Services and license revenue gross margin percentage was 39% for the six months ended June 30, 2014, compared to 19% in the same period in 2013, while services and license revenue gross profit increased $4.5 million. The increase in services and license revenue gross margin percentage was primarily due to higher billable utilization and higher perpetual license revenue.

Operating Expenses

The following tables outline the changes in operating expenses for the three and six months ended June 30, 2014, compared to the same periods in 2013 (in thousands, except percentage data):



	Three Months Ended June 30, 2014		Percentage of Revenue	Three Months Ended June 30, 2013		Percentage of Revenue	Increase (Decrease)			Percentage Change
Operating expenses:
Sales and marketing	$	11,808	36%	$	7,891	30%	$	3,917		50%
Research and development	5,045		16%	4,409		17%	636			14%
General and administrative	5,135		16%	5,946		23%	(811		)	(14)%
Restructuring and other expenses	404		1%	315		1%	89			28%
Total operating expenses	$	22,392	69%	$	18,561	72%	$	3,831		21%

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	Six Months Ended June 30, 2014		Percentage of Revenue	Six Months Ended June 30, 2013		Percentage of Revenue	Increase (Decrease)			Percentage Change
Operating expenses:
Sales and marketing	$	22,535	35%	$	15,535	30%	$	7,000		45%
Research and development	9,918		16%	8,838		17%	1,080			12%
General and administrative	10,221		16%	11,132		22%	(911		)	(8)%
Restructuring and other expenses	404		1%	1,558		3%	(1,154		)	(74)%
Total operating expenses	43,078		68%	37,063		72%	6,015			16%

Sales and Marketing. Sales and marketing expenses increased $3.9 million or 50% in the three months ended June 30, 2014 compared to the same period in 2013. The increase reflects a $2.4 million increase in personnel related cost as a result of our sales force expansion, $0.4 million of increased commission expense from continued channel growth, $0.8 million of marketing expenses related to our C3 conference, and $0.2 million of increased facilities and rent expense. Sales and marketing expenses increased $7.0 million or 45% in the six months ended June 30, 2014 compared to the same period in 2013. The increase reflects a $4.4 million increase in personnel related cost as a result of the sales force expansion, $0.7 million of increased commission expense from continued channel growth, $1.4 million of marketing and advertising expenses related to our C3 conference, and $0.2 million of increased facilities and rent expense.

Research and Development. Research and development expenses increased $0.6 million or 14% for the three months ended June 30, 2014 compared to the same period in 2013. The increase was driven primarily by an increase in personnel related costs due to higher headcount. Research and development expenses increased $1.1 million or 12% for the six months ended June 30, 2014 compared to the same period in 2013. The increase was driven primarily by an increase in personnel related costs of $0.7 million due to higher headcount and professional fees of $0.2 million related to a project and product development.

General and Administrative. General and administrative expenses decreased $0.8 million or 14% during the three months ended June 30, 2014 compared to the same period in 2013. The decrease was primarily driven by a reduction in personnel cost and stock-based compensation expense. General and administrative expenses decreased $0.9 million or 8% during the six months ended June 30, 2014 compared to the same period in 2013. The decrease was primarily driven by a reduction in personnel cost due to the departure and replacement of our chief financial officer in 2013 and stock-based compensation expense, partially offset by an increase in corporate insurance, patent litigation cost and bad debt expense.

Restructuring and other. Restructuring and other expenses increased by $0.1 million during the three months ended June 30, 2014 as compared to the same period in 2013 due to the increased restructuring activities for the three months ended June 30, 2014. Restructuring and other expenses decreased by $1.2 million during the six months ended June 30, 2014 as compared to the same period in 2013 because of our larger scale of restructuring activities, including the departure of our former general counsel and alignment of our organization that occurred during the six months ended June 30, 2013.

Stock-based Compensation

The following tables set forth a summary of our stock-based compensation expenses for the three and six months ended June 30, 2014, compared to the same periods in 2013 (in thousands, except percentage data):



	Three Months Ended June 30, 2014		Three Months Ended June 30, 2013		Increase (Decrease)			Percentage Change
Stock-based compensation:
Cost of recurring revenue	$	192	$	204	$	(12	)	(6)%
Cost of services revenue	256		236		20			8%
Sales and marketing	810		582		228			39%
Research and development	474		467		7			1%
General and administrative	900		1,721		(821		)	(48)%
Total stock-based compensation	$	2,632	$	3,210	$	(578	)	(18)%

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	Six Months Ended June 30, 2014		Six Months Ended June 30, 2013		Increase (Decrease)			Percentage Change
Stock-based compensation:
Cost of recurring revenues	$	374	$	378	$	(4	)	(1)%
Cost of services revenues	470		642		(172		)	(27)%
Sales and marketing	1,402		1,155		247			21%
Research and development	912		933		(21		)	(2)%
General and administrative	1,766		2,693		(927		)	(34)%
Total stock-based compensation	$	4,924	$	5,801	$	(877	)	(15)%

Total stock-based compensation expenses decreased $0.6 million or 18% during the three months ended June 30, 2014 compared to the same period in 2013. Total stock-based compensation expenses decreased $0.9 million or 15% during the six months ended June 30, 2014 compared to the same period in 2013. The decrease in stock-based compensation during the three and six months ended June 30, 2014 was primarily due to the timing of restricted stock unit grants, and fewer outstanding awards in accordance with the Company's plan to reduce the equity award burn rate.

Other Items

The following tables set forth changes in other items for the three and six months ended June 30, 2014, compared to the same periods in 2013 (in thousands, except percentage data):



	Three Months Ended June 30, 2014			Three Months Ended June 30, 2013			Increase (Decrease)			Percentage Change
Other income (expense), net
Interest income and other income (expense), net	$	3,941		$	(131	)	$	4,072		(3,108)%
Interest expense	(154		)	(864		)	710			(82)%
	$	3,787		$	(995	)	$	4,782		(481)%

Provision (benefit) for income taxes	$	530		1,119			(589		)	(53)%



	Six Months Ended June 30, 2014			Six Months Ended June 30, 2013			Increase (Decrease)			Percentage Change
Other income (expense), net
Interest income and other income (expense), net	$	3,968		$	(121	)	$	4,089		(3,379)%
Interest expense	(391		)	(1,718		)	1,327			(77)%
	$	3,577		$	(1,839	)	$	5,416		(295)%

Provision (benefit) for income taxes	$	680		1,243			(563		)	(45)%

Interest Income and Other Income (Expense), Net

Interest income and other income (expense) increased by $4.1 million in the three and six months ended June 30, 2014 due to a $3.9 million gain on sale of select domain names and trademarks during the three months ended June 30, 2014.

Interest Expense

Interest expense decreased by $0.7 million and $1.3 million in the three and six months ended June 30, 2014, respectively, compared to the same periods in 2013. The decrease was primarily due to the early conversion of $45.0 million of the Company's Convertible Notes during the three months ended December 31, 2013 and conversion of the remaining $14.2 million of Convertible Notes during the three months ended June 30, 2014.

Provision (Benefit) for Income Taxes

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Liquidity and Capital Resources

As of June 30, 2014, our principal sources of liquidity were cash and cash equivalents and short-term investments totaling $41.9 million and accounts receivable of $29.4 million, compared to $36.2 million and $29.2 million at December 31, 2013, respectively.

During the three months ended June 30, 2014, an aggregate principal amount of $14.2 million of the Company's 4.75% Convertible Notes was converted into 1,840,770 shares of common stock. As of June 30, 2014, the Company had no outstanding Convertible Notes.

Cash provided by operating activities during the six months ended June 30, 2014 improved significantly compared to cash provided by operating activities during the previous year period, primarily due to lower net losses, and collections commensurate with increased billings.

The following table summarizes, for the periods indicated, selected items in our condensed consolidated statements of cash flows (in thousands):



	Six Months Ended June 30,
	2014		2013
Net cash provided by operating activities	$	6,446	$	2,376
Net cash provided by investing activities	1,329		2,096
Net cash provided by (used in) financing activities	1,827		(2,447		)

Cash Flows During the Six Months Ended June 30, 2014

Net cash provided by operating activities was $6.4 million in the six months ended June 30, 2014 compared to $2.4 million provided in the previous period. Net loss was $2.2 million in the six months ended June 30, 2014, which included adjustments of the gain on sale of intangible asset of $3.9 million, $4.9 million in stock-based compensation and $5.1 million in depreciation and amortization expense. Changes in operating assets and liabilities provided $2.1 million in cash during the quarter, primarily driven by an increase in deferred revenue of $2.8 million from new bookings and renewals, and an increase of accrued expense of $1.6 million. These changes were partially offset by the net decrease of $1.1 million from accrued payroll, as a result of the payments of bonus and commission related to 2013, and decrease in accounts payable of $0.7 million.

Net cash provided by investing activities was $1.3 million during the six months ended June 30, 2014, compared to $2.1 million provided by investing activities in the previous period. The net cash provided by investing activities related to $3.8 million in proceeds from maturities and sale of investments, net of purchases, and $4.7 million in proceeds from sale of intangible asset, partially offset by $4.0 million in purchases of property and equipment for data center upgrades and expansion, $2.4 million of cash used for the acquisition of LeadRocket, net of cash acquired, and $0.7 million in purchase of intangible assets.

Net cash provided by financing activities was $1.8 million during the three months ended June 30, 2014, compared to $2.4 million cash used in financing activities in the previous period. The net cash provided by financing activities was primarily due to $2.0 million of proceeds from issuance of common stock, and $3.0 million proceeds from line of credit, partially offset by $1.4 million for the repurchase of common stock from employees for payment of taxes on vesting of restricted stock units, $0.6 million payment of acquisition-related holdback, $0.6 million of debt repayments, and $0.4 million of principal payments for capital leases.

Forward-Looking Cash Commitments

Our future capital requirements depend on many factors, including the amount of revenue we generate, the timing and extent of spending to support product development efforts, the expansion of sales and marketing activities, the timing of new product introductions and enhancements to existing products, our ability to offer SaaS service on a consistently profitable basis, the continuing market acceptance of our products and future acquisitions or other capital expenditures we may make. However, based upon our current business plan and revenue projections, we believe that our current working capital and anticipated cash flows from operations will be adequate to meet our cash needs for daily operations and capital expenditures for at least the next twelve months, and we intend to continue to manage our cash in a manner designed to ensure that we have adequate cash and cash equivalents to fund our operations as well as future commitments.

Contractual Obligations and Commitments

Refer to Note 7 of our notes to condensed consolidated financial statements contained in this Quarterly Report on Form 10-Q for further information. For additional information on existing unconditional purchase commitments, please refer to our Annual Report on Form 10-K for the year ended December 31, 2013.

Off-Balance Sheet Arrangements

With the exception of the above contractual obligations, we have no material off-balance sheet arrangements that have not been recorded in our condensed consolidated financial statements.

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Item 3. Quantitative and Qualitative Disclosures About Market Risk

During the three and six months ended June 30, 2014, there were no significant changes to our quantitative and qualitative disclosures about market risk. Please refer to Part II, Item 7A. Quantitative and Qualitative Disclosures About Market Risk included in our Annual Report on Form 10-K for the year ended December 31, 2013 for a more complete discussion on the market risks we encounter.

Item 4. Controls and Procedures

Evaluation of Disclosures Controls and Procedures

Our Chief Executive Officer ("CEO") and our Chief Financial Officer ("CFO"), after evaluating the effectiveness of our “disclosure controls and procedures” (as defined in the Securities Exchange Act of 1934, as amended, Rules 13a-15(e) or 15d-15(e)) as of June 30, 2014, have concluded that our disclosure controls and procedures are effective based on their evaluation of these controls and procedures.

Changes in Internal Control Over Financial Reporting

In connection with their evaluation of our disclosure controls and procedures as of the end of the period covered by this report, our CEO and CFO did not identify any changes in our internal control over financial reporting during the three months ended June 30, 2014 that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

Limitations on Effectiveness of Controls and Procedures

Our management, including our CEO and CFO, does not expect that our disclosure controls and procedures or our internal controls will prevent all error and all fraud. A control system, no matter how well conceived and operated, can provide only reasonable, not absolute, assurance that the objectives of the control system are met. Because of the inherent limitations in all control systems, no evaluation of controls can provide absolute assurance that all control issues and instances of fraud, if any, within the Company have been detected.

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PART II. OTHER INFORMATION

Item 1. Legal Proceedings

Versata Software, Inc. and Versata Development Group, Inc. v. Callidus Software, Inc. - Ongoing

We are, from time to time, a party to other various litigation and customer disputes incidental to the conduct of our business. At the present time, the Company believes that none of these matters are likely to have a material adverse effect on our future financial results.

Item 1A. Risk Factors

Factors That Could Affect Future Results

We operate in a dynamic and rapidly changing environment that involves numerous risks and uncertainties that could cause actual results to differ materially from the results contemplated by the forward-looking statements contained in this Quarterly Report on Form 10-Q. Because of the factors discussed below, as well as other variables affecting our operating results, past financial performance should not be considered a reliable indicator of future performance, and investors should not use historical trends to anticipate results or trends in future periods. The risks discussed in this Quarterly Report on Form 10-Q are not the only risks facing us. Additional risks and uncertainties not currently known to us or that we currently deem to be immaterial also may adversely affect our business, financial condition or operating results.

RISKS RELATED TO OUR BUSINESS

We have a history of losses, and we cannot assure you that we will return to or maintain non-GAAP profitability.

We incurred net losses of $21.4 million in 2013, $27.7 million in 2012, and $15.8 million in 2011. To achieve profitability, we must further increase our total revenue, principally by growing our recurring revenue offerings by entering into more and/or larger transactions, maintaining or reducing the rate of existing customer cancellations, and ensuring that our cost structure is aligned with our recurring revenue model. If we cannot increase our recurring revenue and manage costs, our future results of operations and financial condition will be adversely affected and we may be unable to continue operating.

We continue to monitor and manage our costs in an effort to further optimize our performance for the long-term. However, there is no assurance that these steps will be adequate, and unforeseen expenses, difficulties or delays may prevent us from realizing our goals. We may need to incur restructuring expenses or implement other cost reduction efforts in the future and, even with these or any future actions, we cannot be sure that we will achieve or sustain profitability on a quarterly or annual basis in the future. In addition, we cannot be certain the steps we have taken to control our costs in the near term will not adversely affect our prospects for long-term revenue growth. If we cannot increase our total revenue, continue to improve our gross margins, and control our costs, our future operating results and financial condition will be negatively affected.

A majority of our revenue are derived from a single solution, and a decline in sales of that solution could adversely affect our operating results and financial condition.

We derive, and expect to continue to derive, majority of our product revenue from a single solution, and are particularly vulnerable to fluctuations in demand for that solution. If demand for that solution declines significantly and we can’t replace the revenue with revenue from our other offerings, our business and operating results will be adversely affected as our financial performance and business outlook depends on continued market acceptance of that solution. We cannot ensure that our current levels of market penetration and revenue will continue in the future. If market conditions or increased competition result in customer cancellations or reductions in our subscription service, or if we are unable to successfully introduce new solutions or keep pace with technological advancements, our revenue may decline.

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Our revenue and operating results have fluctuated in the past and are likely to fluctuate in the future, harming our results of operations, and because we recognize revenue from subscriptions over a period of time, downturns or upturns in revenue may not be immediately reflected in our operating results.

Because we generally recognize SaaS revenue and maintenance revenue from customers ratably over the terms of their subscription and maintenance support agreements, most of the revenue we report in each quarter result from the recognition of deferred revenue relating to agreements entered into during previous quarters. Consequently, a decline in new or renewed subscriptions and maintenance in any one quarter will not necessarily be fully reflected in revenue for that quarter but will harm our revenue in future quarters. In addition, we may be unable to adjust our operating costs and capital expenditures to reflect the changes in revenue. Accordingly, the effect of significant downturns in sales of our SaaS offerings and increases in customer attrition may not be fully reflected in our results of operations until future periods. Our on-demand subscription model also makes it more difficult for us to rapidly increase our revenue through additional sales in any period, as revenue from new customers must be recognized over the applicable subscription term. In addition, although our revenue is primarily focused on recurring revenue, we anticipate continuing to recognize perpetual license revenue, particularly with international customers. Perpetual license revenue is difficult to forecast and is likely to fluctuate, sometimes significantly, from quarter to quarter due to a number of factors, many of which are wholly or partially beyond our control. Accordingly, we believe that period-to-period comparisons of our results of operations should not be relied upon as definitive indicators of future performance.

Other factors that may cause our quarterly revenue and operating results to fluctuate include:


•	the discretionary nature of customer spending levels and budget cycles as well as the priority our customers place on our products compared to other business investments;


•	varying size, timing and contractual terms of orders for our products, which may delay the recognition of revenue;


•	competitive factors, including new product introductions, upgrades and discounted pricing or special payment terms offered by our competitors;


•	technical difficulties, errors or interruptions in our solutions which may result in customer dissatisfaction with our products and services;


•	pricing changes and general economic conditions, including the ongoing after-effects of the global economic crisis;


•	unpredictable and often lengthy sales cycles;


•	strategic actions by us or our competitors, such as acquisitions, divestitures, spin-offs, joint ventures, strategic investments or changes in business strategy;


•	consolidation among our customers, which may alter their buying patterns, or business failures that may reduce demand for our products and services;


•	increased operating expenses associated with expansion of our sales force or business, and increased product development efforts;


•	extraordinary expenses such as litigation or other payments related to settlement of disputes; and


•	cost, timing and management effort related to the introduction of new features to our solutions.

With respect to general economic conditions, our business may be adversely impacted by: (i) reduced bookings and revenue, as a result of longer sales cycles, reduced, deferred or cancelled customer purchases, and lower average selling prices; (ii) increased operating losses and reduced cash flows from operations; (iii) greater than anticipated uncollectible accounts receivable and increased allowances for doubtful accounts receivable; and (iv) impairment in the value of our financial and non-financial assets resulting in non-cash impairment charges. Any of these developments, or the combination thereof, may adversely affect our revenue, operating results and financial condition in future periods. Furthermore, we maintain an allowance for doubtful accounts for estimated losses resulting from the inability of our customers to make required payments. In such cases, we may be required to defer revenue recognition on sales to affected customers, any of which could adversely affect our operating results. In the future, we may have to record additional reserves or write-offs and/or defer revenue on certain sales transactions which could negatively impact our financial results.

Interruption of our operations, infrastructure or systems upon which we rely could prevent us from delivering our products and services to our customers, which could significantly harm our business.

Our business is primarily conducted over the Internet and, therefore, it depends on our ability to protect our computer equipment and the information stored in our computer equipment, offices and hosting facilities against damage from natural disasters, power loss, telecommunications failures, unauthorized intrusion and other events. There can be no assurance that our disaster preparedness will prevent significant interruption of our operations. Interruptions in the services provided by these facilities may result in unexpected and possibly lengthy service interruptions. Any service interruptions, regardless of the cause, may result in material liability claims against us for breach of service-level commitments to our customers, customer terminations and damage to our reputation.

In addition, we engage third-party service providers for our hosting facilities and related infrastructure that is essential for our subscription services. Our service to customers could be interrupted in the event of a natural disaster, by a hosting provider decision to close a facility or terminate operations or by other unanticipated problems. Similarly, we use third-party telecommunications providers for Internet and other telecommunication services. We also rely heavily on our own and third-party financial, accounting, and other data processing systems. Any of these third-party providers may fail to perform their obligations adequately, and any of these third-party systems may fail to operate properly or become disabled for varying periods of time, causing business interruption or system damage, which could reduce our

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revenue, cause us to issue credits or pay penalties, cause customers to terminate their subscriptions, cause other liability to customers, or cause regulatory intervention or damage to our reputation.

Errors or interruptions in our solutions could be costly to correct and time consuming to repair, and adversely affect our reputation and impair our ability to sell our solutions.

Our solutions are complex and, accordingly, they may contain errors, or "bugs." Any errors or vulnerabilities could be extremely costly to correct, materially and adversely affect our reputation and impair our ability to sell our solutions. Moreover, customers relying on our solutions to calculate and pay incentive compensation may have a greater sensitivity to errors, security vulnerabilities and interruptions than in other applications. If we incur substantial costs to correct any errors or repair availability issues, our operating margins will be adversely affected. Because our customers depend on our solutions for their critical business functions, any interruptions could result in lost or delayed market acceptance and sales of our solutions, product liability suits against us, diversion of development resources and substantially greater service-level credits and warranty costs than anticipated or accrued. Further, our efforts to reduce costs by employing more subcontracting personnel to perform product development, technical support, professional services and application hosting tasks may make it more difficult for us to timely respond to errors or interruptions.

Companies and solutions added through acquisition may be temporarily served through alternate facilities. We do not control the operation of any of these facilities. Despite precautions taken at these facilities or by us, the occurrence of a natural disaster or an act of terrorism, a decision to close the facilities without adequate notice or other unanticipated problems at these facilities could result in lengthy interruptions in our service. In addition, we may move or transfer our data and our customers’ data. Despite precautions taken during this process, any unsuccessful data transfers may impair the delivery of our service and damage our reputation.

If we are unable to maintain the profitability of our recurring revenue products and services, our operating results could be adversely affected.

We have invested, and expect to continue to invest, substantial resources to expand, market and refine our recurring revenue products and services offerings. If we are unable to continue increasing the volume of our on-demand business or improving gross margins, we may not be able to achieve or sustain profitability and our operating results and financial condition will be adversely affected. Factors that could harm our ability to improve our gross margins include:


•	significant attrition as customers decide not to renew for their own economic or other reasons;


•	our inability to maintain or increase the prices customers pay for our products and services based on competitive pricing pressures and limited customer demand;


•	increased cost of third-party services providers, including hosting facilities for our SaaS operations and professional services contractors performing implementation and technical support services as well as inefficiencies, delays and unacceptable quality from such vendors;


•	increased costs that relate to integration of acquired products or personnel;


•	increased cost to license and maintain third-party software embedded in our solution or the cost to create or substitute such third-party software if it can no longer be licensed on commercially reasonable terms;


•	the inability to implement, or delays in implementing, technology-based efficiencies and efforts to streamline and consolidate processes to reduce operating costs; and


•	higher wage and benefits costs for our existing personnel or the need to increase the number of our employees to support increasing customer demands for our professional services, technical support or general operations.

Breaches of security or failure to safeguard customer data could create the perception that our products and services are not secure, causing customers to discontinue or reject the use of our products or services and potentially subject us to significant liability. Implementing, monitoring and maintaining adequate security safeguards may be costly.

Our on-demand service allows customers to access our solutions and transmit confidential data, including personally identifiable individual data of their employees, agents and customers over the Internet. We also store data provided to us by our customers on servers in our hosting facilities. In addition, we may have access to confidential and private individual data as part of our professional services organization activities, including implementation, maintenance and support of our software for term and perpetual license customers.

Moreover, many of our customers are subject to heightened security obligations regarding the personally identifiable information of their downstream customers. In the United States, these heightened obligations particularly affect the financial services, healthcare and insurance sectors, which are subject to stringent controls over personal information under various state and federal laws and regulations. In addition, the European Union Directive on Data Protection as well as the laws and regulations of the Member States of the European Union implementing the directive create international obligations on the protection of personal data that typically exceed security requirements mandated in the United States. The security measures we have implemented and may need to implement, monitor and maintain in the future to satisfy the requirements of our customers may be substantial and involve significant time and effort, which are typically not chargeable to our customers.

In addition, these security measures may be breached due to third-party action, including intentional misconduct or malfeasance, employee error or otherwise, and result in unauthorized disclosure of or access to our customers’ data or our data, including our intellectual property and other confidential business information, or our IT systems. Third parties also may attempt to fraudulently induce employees or customers into disclosing sensitive information such as user names, passwords or other information in order to gain access to our customers’

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data or our data or IT systems. Because the techniques used to obtain unauthorized access, or to sabotage systems, change frequently and generally are not recognized until launched against a target, we may be unable to anticipate these techniques or to implement adequate preventative measures. In addition, our customers may authorize third-party technology providers to access their customer data. Because we do not control our customers and third-party technology providers, or the processing of such data by third-party technology providers, we cannot ensure the integrity or security of such transmissions or processing. Malicious third-parties may also conduct attacks designed to temporarily deny customers access to our services.

If we do not adequately safeguard the information imported into our solutions or otherwise provided to us by our customers, or if third parties penetrate our systems or security and misappropriate our customers' confidential information, it may damage our reputation, result in a loss of confidence in the security of our service, negatively impact our future sales, disrupt our business, and we may be sued and incur substantial damages in connection with such events. Even if it is determined that our security measures were adequate, the damage to our reputation may cause customers and potential customers to reconsider the use of our products and services, which may have a material adverse effect on our results of operations.

Decreases in retention rates for customer on-demand subscription or on-premise maintenance arrangements could materially impact our future revenue or operating results.

Our customers have no obligation to renew our on-demand service or maintenance support transactions after the expiration of the subscription or maintenance period, which is typically 12 to 24 months, and some customers have elected not to renew. Our customers may renew for fewer payees or renew for shorter contract lengths. In addition, we offer a pay-as-you-go model, whereby customers can pay for our on-demand service on a monthly basis without a long-term commitment, which may unexpectedly increase the rate of customer non-renewals and thus negatively and unpredictably affect our recurring revenue during a particular reporting period. Our customer retention rates, including the retention of customers gained from the addition of acquired products, may decline and we cannot accurately predict renewal rates. If our customers' renewal rates decline or fluctuate as a result of a number of factors, including reduced budgets, insourcing decisions, or dissatisfaction with our service, our revenue will be adversely affected and our business will suffer.

If we do not compete effectively, our revenue may not grow and could decline.

We have experienced, and expect to continue to experience, intense competition from a number of software companies and internally-developed solutions as the market for sales effectiveness products is rapidly evolving. We believe one of our key challenges is to be able to demonstrate the benefit of our products and services to prospective customers such that they place purchases of our products and services at a higher priority relative to other projects. Our financial performance depends in large part on continued growth in the number of organizations adopting sales effectiveness and other related solutions to manage the performance of their sales organizations. The market for sales effectiveness solutions may not develop as we expect, or at all. Moreover, our competitors may be more successful than we are in capturing the market. In either case, our business and operating results will be adversely affected.

We compete principally with vendors of sales effectiveness software, Enterprise Incentive Management ("EIM") software, enterprise resource planning software and customer relationship management software. Our competitors may announce new products, services or enhancements that better meet the needs of prospects, customers and/or changing industry standards. Increased competition may cause price reductions, reduced gross margins and loss of market share, any of which could have a material adverse effect on our business, results of operations and financial condition.

Many of our enterprise resource planning competitors and other potential competitors have longer operating histories with significantly greater financial, technical, marketing, service and other resources. Many also have a larger installed base of users, larger marketing budgets and relationships, established distribution agreements, and greater name recognition. Some of our competitors' products may also be more effective at performing particular sales effectiveness or EIM system functions or may be more customized for particular customer needs in a given market. Even if our competitors provide products with less sales performance management or EIM system functionality than our products, their products may incorporate other capabilities, such as recording and accounting for transactions, customer orders or inventory management data. A product that performs these functions, as well as some of the functions of our solutions, may be appealing to some customers because it would reduce the number of applications used to run their business.

Our products generally must be integrated with software provided by existing or potential competitors. These competitors could alter their products in ways that inhibit integration with ours, or they could deny or delay our access to advance software releases, which would restrict our ability to adapt our products for integration with their new releases and could result in the loss of both sales opportunities and renewals of on-demand services and maintenance.

In addition, if one or more of our competitors were to merge or partner with another of our competitors, the change in the competitive landscape could adversely affect our ability to compete effectively. Increased competition may cause price reductions, reduced gross margins and loss of market share.

Some potential customers have already made substantial investments in third-party or internally developed solutions designed to model, administer, analyze and report on pay-for-performance programs. These companies may be reluctant to abandon such investments in favor of our products and services. In addition, information technology departments of potential customers may resist purchasing our solutions for a variety of reasons, particularly the potential displacement of their historical role in creating and running software and concerns that packaged and hosted product offerings are not sufficiently customizable and/or pose data security concerns for their enterprises.

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The use and adoption of our solutions may be limited by privacy concerns and laws, including cross-border data transfers and other domestic or foreign regulations which could have an adverse effect on our future revenue or operating results.

We expect federal, state and foreign governments to continue to increase regulation of Internet commerce, including data privacy. The laws and regulations that relate to the solicitation, collection, processing, use, and disclosure of personal information, as well as those that apply to cross-border transfers of personal information, could affect demand for our solutions. For example, our customers can use our service to store compensation and other personal or identifying information about their sales personnel.

The costs of compliance with, and other burdens imposed by, such laws and regulations that are applicable to our customers’ businesses may limit the use and adoption of our service and reduce overall demand, or lead to significant fines, penalties or liabilities for any noncompliance with such privacy laws. As a result, certain industries may not adopt our services based on perceived privacy concerns, regardless of the validity of such concerns.

The transfer of our on demand infrastructure may result in interruptions to service or other difficulties which may negatively impact our customers.

We deliver our solutions by using an integrated architecture environment, which has previously been provided through third-party facilities. We transitioned to a new third-party facility with full redundancy capabilities in Sacramento, California to support our SaaS solutions, and the establishment of a second, fully redundant hosting facility in Virginia is ongoing. Our systems, procedures or controls might not be adequate to support this functionality. Further, these functions are complex and disruptions to the environment could occur during the transfer of customers to the new data center, which may result in increased exposure to remediation efforts and liability claims against us for breach of service-level commitments, customer terminations and damage to our reputation and future business prospects.

Acquisitions and investments present many risks. We may not realize the anticipated financial and strategic benefits of such transactions, and may not be able to successfully integrate and manage the acquired businesses. In addition, we may not be able to manage our operations with the acquired businesses efficiently or profitably.

As part of our business strategy, we evaluate opportunities to expand and enhance our product and services offerings to meet our customers' needs, increase our market opportunities and grow revenue, both through internal development efforts and external acquisitions and partnerships. We have completed a number of acquisitions since 2010, including our most recent acquisition of LeadRocket, Inc. in February 2014, and we may continue to acquire or make investments in other companies, products, services and technologies in the future. Acquisitions and investments may cause disruptions in or add complexity to our operations and involve a number of risks, including the following:


•	the benefits that we anticipated from an acquisition, such as an increase in revenue, may not materialize if, for example, a larger number of customers than expected choose not to renew or if we are not able to cross-sell the acquired company's products and services to our existing customer base;


•	we may have difficulty integrating and managing the acquired technologies or products with our existing product lines, and in maintaining uniform standards, controls, procedures and policies across locations;


•	we may experience challenges in, and have difficulty penetrating, new markets where we have little or no prior experience and where competitors have stronger market positions;


•	we may have difficulty integrating the financial systems and personnel of the acquired business and in retaining the key employees, and to the extent we issue shares of stock or other rights to purchase stock, including options, to such individuals, existing stockholders may be diluted;


•	our ongoing business and management's attention may be disrupted or diverted by transition or integration issues and the complexity of overseeing geographically and culturally diverse locations;


•	we may find that the acquired business or assets do not further our business strategy, or that we overpaid for the business or assets, or that we do not realize the expected operating efficiencies or product integration benefits;


•	we may fail to uncover or realize the significance of, or otherwise become exposed to, certain liabilities and other issues assumed from an acquired business, such as claims from terminated employees or third-parties and unfavorable revenue recognition or other accounting practices;


•	we may experience customer confusion as a result of product overlap, particularly when we offer, price and support various product lines differently and/or on varying contractual terms;


•	our use of cash consideration for one or more significant acquisitions may require us to use a substantial portion of our available cash or incur substantial debt, and if we incur substantial debt, it could result in material limitations on the conduct of our business.

These factors could have a material adverse effect on our business, results of operations and financial condition or cash flows. Furthermore, during periods of operational expansion, we often need to expand the size of our staff, grow and manage our related operations and third-party partnerships, and potentially amplify our financial and accounting controls to ensure they remain effective. Such changes may increase our expenses, and there is no assurance that our infrastructure will be sufficiently scalable to efficiently manage any growth that we may experience. If we are unable to leverage our operating cost investments as a percentage of revenue, our ability to generate or increase profits will be adversely impacted. In addition, from time to time, we may enter into negotiations for acquisitions investments that are not ultimately consummated, which could result in significant diversion of management time, as well as out-of-pocket expenses.

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Some of our products rely on third-party software licenses to operate, and the loss or inability to maintain these licenses and/or errors, discontinuations, or updates in or to such software, could result in increased costs, delayed sales, or customer claims against, or termination of, our existing agreements.

We license technology from several software providers for our reporting, analytics, and integration applications, and we anticipate that we may continue to license some of these technologies from these or other providers in connection with future products. We also rely on generally available third-party software to run our applications. Any of these software applications may not continue to be available on commercially reasonable terms, if at all, or new versions may be released that are incompatible with our offerings. Some of the products could be difficult to replace, and developing or integrating new software with our products could require months or years of design and engineering work. The loss or modification of any of these technologies could result in delays in providing our products until equivalent technology is developed or, if available, is identified, licensed and integrated. Acquisitions of third-party technologies by other companies, including our competitors, may have a material adverse impact on us if the acquirer seeks to cancel or change the terms of our license.

In addition, we depend upon the successful operation of certain third-party products in conjunction with our products or services. As a result, undetected errors in these products could prevent the implementation or impair the functionality of our products, delay new product introductions, limit the availability of our products via our on-demand service, and/or injure our reputation. Our use of additional or alternative third-party products could result in new or higher royalty payments if we are required to enter into license agreements for such products.

Our success depends upon our ability to develop new products and services and enhance our existing products and services rapidly and cost-effectively. Failure to successfully introduce new or enhanced products and services may adversely affect our operating results.

SaaS sales effectiveness solutions and cloud computing markets are generally characterized by:


•	rapid technological advances;


•	changing customer needs; and


•	frequent new product introductions and enhancements.

To keep pace with technological developments, satisfy increasingly sophisticated customer requirements, achieve market acceptance and effectively respond to competition, we must quickly identify emerging trends and requirements, accurately define and design enhancements and improvements for existing products and services, and introduce new products and services that satisfy our customers’ changing demands. Accelerated introductions for products and services require high levels of expenditures for research and development that could adversely affect our operating results. Further, any new products or services we develop may not be introduced in a timely manner or be available in a distribution model acceptable to our target markets, and may therefore not achieve the broad market acceptance necessary to generate significant revenue. If we are unable to quickly and successfully develop or acquire and distribute new products and services cost-effectively, or enhance existing products and services, or if we fail to position and price our products and services to meet market demand, our business and operating results will be adversely affected.

Our offshore product development, support and professional services may prove difficult to manage or of inadequate quality to allow us to realize our cost reduction goals and produce new products and services and provide professional services to drive growth.

Our use of offshore resources to perform new product and services development, and provide support and professional consulting efforts has required, and will continue to require, detailed technical and logistical coordination. We must ensure that international resources are aware of and understand development specifications and customer support, as well as implementation and configuration requirements and that they can meet applicable timelines or, if they are not met, that any delays are not significant.

We may not be able to maintain acceptable standards of quality in support, product development and professional services. If we are unable to successfully maintain the quality of services provided by our international third-party service providers, our attempts to reduce costs and drive growth through new products and margin improvements in technical support and professional services may be negatively impacted, which would adversely affect our results of operations. Outsourcing services to offshore providers may expose us to misappropriation of our intellectual property or that of our customers, or make it more difficult to defend our rights in our technology.

The loss of key personnel, higher than normal employee attrition in key departments, or the inability of replacements to quickly and successfully perform in their new roles could adversely affect our business.

Our success depends to a significant extent on the abilities and effectiveness of our personnel, and, in particular, our chief executive officer and other executive officers. All of our existing personnel, including our executive officers, are employed on an "at-will" basis. If we lose or terminate the services of one or more of our current executives or key employees or if one or more of our current or former executives or key employees joins a competitor or otherwise competes with us, or if we do not have an effective succession or development plan in place for such individuals, our ability to successfully implement our business plan could be impaired. Likewise, if a number of employees from specific departments were to depart, our short-term ability to maintain business may be adversely affected. Additionally, if we are unable to quickly hire qualified replacements for our executives, other key positions or employees within specific departments, our ability to execute our business plan could be harmed. Even if we can quickly hire qualified replacements, we would expect to experience operational disruptions and inefficiencies during any transition.

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If we are unable to hire and retain qualified employees and contractors, including sales, professional services, and engineering personnel, our growth may be impaired.

To scale our business successfully, increase productivity, maintain a high level of quality and meet the needs of our customers, we need to recruit, retain and motivate highly skilled employees and subcontractors in all areas of our business, including sales, professional services and engineering. In particular, if we are unable to hire or subcontract for and retain talented personnel with the skills, and in the locations, we require, we might need to redeploy existing personnel or increase our reliance on subcontractors to fill certain labor needs. Furthermore, we intend to continue increasing our sales force and, if we are not successful in attracting and retaining qualified personnel, or if new sales personnel are unable to achieve desired productivity levels within a reasonable time period, we may not be able to increase our revenue and realize the anticipated benefits of these investments.

As our customer base increases and as we continue to evaluate and modify our organizational structure to increase efficiency, we are likely to experience staffing constraints in connection with the deployment of trained and experienced professional services and support resources capable of implementing, configuring, maintaining and supporting our products and related services. Moreover, as a company focused on the development of complex products and the provision of online services, we are often in need of additional software developers and engineers. We have relied on our ability to grant equity compensation as one mechanism for recruiting, retaining and motivating such highly skilled personnel. Our ability to provide equity compensation depends, in part, upon receiving stockholder approval for new equity compensation plans. If we are not able to secure such approval from our stockholders, our ability to recruit, retain and motivate our personnel may be adversely impacted, which would negatively impact our operating results.

Our credit agreement contains restrictive and financial covenants that may limit our operational flexibility. Furthermore, if we default on our obligations under the credit agreement, our operations may be interrupted and our business and financial results could be adversely affected.

In May 2014, we entered into a credit agreement with Wells Fargo Bank, National Association (“Lender”), under which Lender agreed to make a revolving loan to the Company in an amount not to exceed $10.0 million that we may draw upon to finance our operations or other corporate purposes, with an accordion feature that allows the Company to increase the maximum borrowing amount by not less than $5.0 million and not more than $10.0 million ("Revolver"). The Revolver contains a number of restrictive covenants, and its terms may restrict our current and future operations, including:


•	our flexibility to plan for, or react to, changes in our business and industry conditions;


•	our ability to use our cash flows, or obtain additional financing, for future working capital, capital expenditures, acquisitions, or other general corporate purposes;


•	place us at a competitive disadvantage compared to our less leveraged competitors; and


•	increase our vulnerability to the impact of adverse economic and industry conditions.

In addition, a failure by us to comply with the covenants or payment obligations specified in our credit agreement could result in an event of default and Lender may have the right to terminate its commitment to provide additional loans under the Revolver and to declare all borrowings outstanding, together with accrued and unpaid interest and fees, to be immediately due and payable. In addition, Lender would have the right to proceed against the Revolver collateral, which consists of substantially all our assets. If the debt under the Revolver were to be accelerated, we may not have sufficient cash or be able to sell sufficient collateral to repay this debt, which would have an immediate material adverse effect on our business, results of operations and financial condition.

Changes in the terms of our current or future indebtedness or our credit rating may adversely affect our financial condition and results of operations.

There can be no assurances that additional borrowing capacity will be available under the Revolver, including pursuant to the accordion feature, or that future indebtedness will be obtainable on terms as favorable as the Revolver. As a result, in the future, we may be subject to higher interest rates and our interest expense may increase, which may have an adverse effect on our financial results. In addition, changes by any rating agency to our outlook or credit rating could negatively affect the value of both our debt and equity securities and increase the interest amounts we pay on outstanding or future debt. These risks could adversely affect our financial condition and results.

If we are unable to maintain effective internal control over financial reporting, investors may lose confidence in the accuracy and completeness of our financial reports and the trading price of our common stock may be negatively affected.

We are required to maintain internal controls over financial reporting and to report any material weaknesses in such internal controls. Effective planning and management processes are necessary to meet these requirements, and we expect that we will need to continue to improve existing, and implement new, operational and financial systems, procedures, and controls to manage our business effectively in the future. We are also required to furnish a report by management on the effectiveness of our internal control over financial reporting pursuant to Section 404 of the Sarbanes-Oxley Act. If we identify material weaknesses in our internal control over financial reporting, if we are unable to comply with the requirements of Section 404 in a timely manner or assert that our internal control over financial reporting is effective, or if our independent registered public accounting firm is unable to express an opinion as to the effectiveness of our internal control over financial reporting, investors may lose confidence in the accuracy and completeness of our financial reports and the trading price of our common stock could be negatively affected, and we could become subject to investigations by The Nasdaq Stock Market LLC, the Securities and Exchange Commission or other regulatory authorities, which could require additional financial and management resources.

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If we fail to adequately protect our proprietary rights and intellectual property, we may lose valuable assets, experience reduced revenue and incur costly litigation to protect our rights.

Our success and ability to compete is dependent on the proprietary technology embedded in our products and services. We rely on a combination of patents, trademarks, copyrights, service marks, trade secrets, contractual provisions and other similar measures to establish and protect our proprietary rights. We cannot protect our intellectual property if we are unable to enforce our rights or if we do not detect its unauthorized use. Despite our precautions, it may be possible for unauthorized third parties to copy and/or reverse engineer our products and services and use information that we regard as proprietary to create products and services that compete with ours. The provisions in our license agreements prohibiting unauthorized use, copying, transfer and disclosure of our licensed programs and services may be unenforceable under the laws of certain jurisdictions. Further, the laws of some countries do not protect proprietary rights to the same extent as the laws of the United States. To the extent that we engage in international activities, our exposure to unauthorized copying and use of our products, services and proprietary information increases.

We enter into confidentiality and license agreements, as applicable, with our employees and consultants and with customers and third parties with whom we have strategic relationships. We cannot ensure that these agreements will be effective in controlling access to and distribution of our products, services and proprietary information. Further, these agreements do not prevent our competitors from independently developing technologies that are substantially equivalent or superior to our products and services. Litigation may be necessary to enforce our intellectual property rights and protect our trade secrets. Litigation, whether successful or unsuccessful, could result in substantial costs and diversion of management resources, either of which could seriously harm our business.

Our results of operations may be adversely affected if we are subject to a protracted infringement claim or one that results in a significant damage award.

From time to time, we receive claims that our products, services offerings or business infringe or misappropriate the intellectual property rights of third parties, including the ongoing suit brought against us by Versata Software, Inc. and Versata Development Group, Inc. and our competitors or other third parties may challenge the validity or scope of our intellectual property rights. In addition, we have in the past and may continue in the future to assert claims of infringement against third parties on such bases, including the case we brought and ultimately settled in 2013 that involved Xactly Corporation and its President and Chief Executive Officer. For more information, see "Item 3. Legal Proceedings". We believe that claims of infringement are likely to increase as the functionality of our products and services expand and we introduce new products and services. Claims may also be made relating to technology that we acquire or license from third parties. Any infringement claim, whether offensive or defensive, could:


•	require costly litigation to resolve;


•	absorb significant management time;


•	cause us to enter into unfavorable royalty or license agreements;


•	require us to discontinue the sale of all or a portion of our products or services;


•	require us to indemnify our customers and/or third-party service providers; and/or


•	require us to expend additional development resources to redesign our products or services.

Inclusion of open source software in our products may expose us to liability or require release of our source code.

We currently use a limited amount of open source software in our products and may use more in the future. We could be subject to suits by parties claiming ownership of what we believe to be open source software that has been incorporated into our products. In addition, some open source software is provided under licenses that require that proprietary software, when combined in specific ways with open source software, become subject to the open source license and thus freely available. While we take steps to minimize the risk that our products, when incorporating open source software, would become subject to open source licenses, few courts have interpreted open source licenses. As a result, the enforcement of these licenses is unclear. If our products were to become subject to open source licenses, our ability to commercialize our products and services and consequently, our operating results would be materially and adversely affected.

Sales to customers in international markets pose risks and challenges for which we may not achieve the expected results.

We continue to invest substantial time and resources to grow our international operations. If we fail to do so successfully, our business and operating results could be seriously harmed. Such expansion may require substantial financial resources and a significant amount of attention from our management. International operations involve a variety of risks, particularly:


•	greater difficulty in supporting and localizing our products and services;


•	compliance with numerous regulatory requirements, taxes, trade laws and tariffs that may conflict and/or change unexpectedly, including labor, tax, privacy and data protection;


•	use of international resellers and compliance with anti-bribery and anti-corruption laws including the U.S. Foreign Corrupt Practices Act;


•	greater difficulty in establishing, staffing and managing foreign operations;


•	greater difficulty in maintaining acceptable standards of quality in support, product development and professional services by our international third-party service providers;


•	differing abilities to protect our intellectual property rights;

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•	possible political and economic instability; and


•	fluctuating exchange rates.

Our services revenue produce substantially lower gross margins than our recurring and license revenue, and periodic variations in the proportional relationship between services revenue and higher margin recurring and license revenue have harmed, and may continue to harm, our overall gross margins.

Our services revenue, which include fees for consulting, implementation and training, represented 20% of our revenue in 2013. Our services revenue have substantially lower gross margins than our recurring and license revenue.

Historically, services revenue as a percentage of total revenue have varied significantly from period to period due to a number of circumstances including fluctuations in licensing and, to a lesser extent, recurring revenue, changes in the average selling prices for our products and services, and the effectiveness and appeal of competitive service providers. More recently, the extent of the fluctuations has diminished, primarily due to decreased need for consulting services in light of fewer perpetual license transactions. However, while the fluctuation in the percentage of services revenue as compared to total revenue has moderated on a quarterly basis, we continue to expect wider variability in services revenue itself from quarter-to-quarter, principally as the number of new recurring revenue customer transactions varies from quarter to quarter.

In addition, the volume and profitability of services can depend in large part upon:


•	competitive pricing pressure for professional services;


•	increases or decreases in the number of services projects being performed on a fixed bid or acceptance basis that may defer recognition of revenue;


•	the priority and resources customers place on implementation projects;


•	the timing of milestone acceptance contracts;


•	the timing and amount of any remediation services related to professional services warranty claims;


•	the complexity of the customers' information technology environments; and


•	the extent to which outside consulting organizations provide services directly to customers.

Deployment of certain products and services may require substantial technical implementation and support by us or third-party service providers. We may lose sales opportunities and our business may be harmed if we do not successfully meet these requirements and/or develop and maintain strategic relationships to implement and sell our products and services, which may cause a decline or delay in revenue recognition and an increase in our expenses.

Certain products and services we deploy may require a substantial degree of technical and logistical expertise. Moreover, some of our customers require large, enterprise-wide deployments. It may be difficult for us to manage these deployments, including the timely allocation of personnel and resources by us and our customers. Failure to successfully manage the process could harm our reputation both generally and with specific customers and may cause us to lose existing customers, face potential customer disputes or reduce the number of new customers that purchase our products, each of which could adversely affect our revenue and increase our technical support and litigation costs. If actual remediation services exceed our accrued estimates, we could be required to take additional charges, which could be material.

We have relationships with third-party partners, systems integrators and software vendors. These third parties may provide customer referrals, cooperate with us in the design, sales and/or marketing of our products and services, provide valuable insights into market demands, and provide our customers with systems implementation services or overall program management. However, in some cases we may not have formal agreements governing our ongoing relationship with certain of these third-party providers and the agreements we do have generally do not include specific obligations with respect to generating sales opportunities or cooperating on future business.

We also, from time to time, consider strategic relationships that are new or unusual for us and which can pose additional risks. For example, while reseller arrangements offer the advantage of leveraging larger sales organizations than our own to sell our products, they also require considerable time and effort on our part to train and support the reseller's personnel, and require the reseller to properly motivate and incentivize its sales force. Also, if we enter into an exclusive reseller arrangement, the exclusivity may prevent us from pursuing the applicable market ourselves; if the reseller is not successful in the particular location, our results of operations may be adversely affected.

Should any of these third-parties go out of business, perform unsatisfactory services or choose not to work with us, we may be forced to develop new capabilities internally, which may cause significant delays and expense, thereby adversely affecting our operating results. These third-party providers may offer products of other companies, including products and services that compete with ours. If we do not successfully or efficiently establish, maintain and expand our industry relationships with influential market participants, we could lose sales and service opportunities, which would adversely affect our results of operations.

If we change prices, alter our payment terms or modify our products or services in order to compete successfully, our margins and operating results may be adversely affected.

The intensely competitive market in which we do business may require us to change our prices and/or modify our pricing strategies in ways that may adversely affect our operating results. If our competitors offer deep discounts on competitive products or services, we may need to lower prices or offer other terms more favorable to existing and prospective customers in order to compete successfully. Alternatively, if we choose to raise prices based upon our own evaluation of the value of our products, such increases may not be well received by customers, which may impact our sales volumes. Some of our competitors may bundle their products with their other products and services

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for promotional purposes or as a long-term pricing strategy, or provide guarantees of prices and product implementations. These practices could, over time, limit the prices that we can charge for our products or services or cause us to modify our existing market strategies accordingly. If we cannot offset price reductions and other terms more favorable to our customers with a corresponding increase in sales or decrease in spending, then the reduced revenue resulting from lower prices would adversely affect our margins and operating results.

Our products have unpredictable sales cycles, making it difficult to plan our expenses and forecast our results.

It is difficult to determine how long the sales cycles for our solutions will be, thereby making it difficult to predict the quarter in which a particular sale will close and to plan expenditures accordingly. Moreover, to the extent that sales are completed in the final two weeks of a quarter, the impact of recurring revenue transactions is typically not reflected in our financial statements until subsequent quarters. In addition, the period between our initial contact with a potential customer and ultimate sale of our products and services is relatively long due to several factors, which may include:


•	the complex nature of some of our products;


•	the need to educate potential customers about the uses and benefits of our products and services;


•	budget cycles of our potential customers that affect the timing of purchases;


•	customer requirements for competitive evaluation and often lengthy internal approval processes (particularly of large organizations) before purchasing our products and services; and


•	potential delays of purchases due to announcements or planned introductions of new products and services by us or our competitors.

The failure to complete sales of our on-demand solutions in a particular quarter will impact revenue in subsequent quarters as revenue from our on-demand services are recognized ratably over the term of the applicable agreement.

Our latest product features and functionality may require existing on-premise customers to migrate to our on-demand solution. Moreover, we may choose or be compelled to discontinue maintenance support for older versions of our software products, forcing our on-premise customers to upgrade their software in order to continue receiving maintenance support. If existing on-premise customers fail to migrate or delay migration to our on-demand solution, our revenue may be harmed.

We continue to promote our on-demand product offerings to existing customers who currently have on-premise perpetual and term licenses. Customers with on-premise licenses may need to migrate to our on-demand solutions to take full advantage of the features and functionality in those products and services. We also expect to periodically terminate maintenance support on older versions of our on-premise products for various reasons including, without limitation, termination of support by third-party software vendors whose products complement ours or upon which we are dependent. Regardless of the reason, a migration is likely to involve additional cost, which our customers may delay or decline to incur. If a sufficient number of customers do not migrate to our on-demand product offerings, our continued maintenance support opportunities and our ability to sell additional products to these customers, and as a result, our revenue and operating income, may be harmed.

RISKS RELATED TO OUR STOCK

Our stock price is likely to remain volatile.

The trading price of our common stock has in the past, and may in the future, be subject to wide fluctuations in response to a number of factors, including those described in this section. We receive limited attention by securities analysts and we frequently experience an imbalance between supply and demand in the public trading market for our common stock due to limited trading volumes. Investors should consider an investment in our common stock as risky and should purchase our common stock only if they can withstand significant losses. Other factors that affect the volatility of our stock include:


•	our operating performance and the performance of other similar companies;


•	significant sales or distributions by existing investors coupled with a lack of trading volume for our stock;


•	announcements by us or our competitors of significant contracts, results of operations, projections, new technologies, acquisitions, commercial relationships, joint ventures or capital commitments;


•	changes in our management team;


•	failure to meet published operating estimates or expectations of securities analysts and investors;


•	publication of research reports, particularly those that are inaccurate or unfavorable, about us or our industry by securities analysts; and


•	developments with respect to intellectual property rights.

Additionally, some companies with volatile market prices for their securities have been the subject of securities class action lawsuits. Any such suit could have a material adverse effect on our business, results of operations, financial condition and the price of our common stock.

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Future sales of substantial amounts of our common stock, including securities convertible into or exchangeable for shares of our common stock, by us or our existing stockholders could cause our stock price to fall.

We are not restricted from issuing additional shares of our common stock, including securities convertible into or exchangeable for, or that represent the right to receive, shares of our common stock.

Issuances of shares of our common stock or convertible securities, including outstanding options, restricted stock units and warrants, will dilute the ownership interest of our shareholders and could adversely affect the market price of our common stock. We cannot predict the effect that future sales of shares of our common stock or other equity-related securities would have on the market price of our common stock.

In addition, sales by existing stockholders of a large number of shares of our common stock in the public trading market (or in private transactions), including sales by our executive officers, directors or institutional investors, or the perception that such additional sales could occur, could cause the market price of our common stock to drop.

We do not intend to pay dividends for the foreseeable future.

We have never declared or paid cash dividends on our capital stock. We currently intend to retain any future earnings to finance the operation and expansion of our business, and we do not expect to declare or pay any dividends in the foreseeable future. Consequently, stockholders must rely on sales of their common stock after price appreciation, which may never occur, as the only way to realize any future gains on their investment.

Provisions in our charter documents, Delaware law and the indenture may delay or prevent an acquisition of our company.

Our certificate of incorporation and bylaws contain provisions that could make it harder for a third-party to acquire us without the consent of our board of directors. For example, if a potential acquirer were to make a hostile bid for us, the acquirer would not be able to call a special meeting of stockholders to remove our board of directors or act by written consent without a meeting. In addition, our board of directors has staggered terms, which means that replacing a majority of our directors would require at least two annual meetings. A potential acquirer would also be required to provide advance notice of its proposal to replace directors at any annual meeting, and would not be able to accumulate votes at a meeting, which would require such potential acquirer to hold more shares to gain representation on the board of directors than if cumulative voting were permitted. Furthermore, Section 203 of the Delaware General Corporation Law limits business combination transactions with 15% stockholders that have not been approved by the board of directors. All of these factors make it more difficult for a third-party to acquire us without negotiation. These provisions may apply even if the offer may be considered beneficial by some stockholders. Our board of directors could choose not to negotiate with a potential acquirer that it does not believe is in our strategic interests. If a potential acquirer is discouraged from offering to acquire us or prevented from successfully completing a hostile acquisition by these or other measures, under certain circumstances, this could reduce the market price of our common stock.

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Item 6. Exhibits

Please refer to the Exhibit Index following the signature page to this Quarterly Report on Form 10-Q for a list of exhibits filed or furnished with this report, which Exhibit Index is incorporated herein by reference.

SIGNATURES

Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.



		CALLIDUS SOFTWARE INC.

Date:	August 1, 2014	By:	/s/ BOB L. COREY
			Bob L. Corey
			Senior Vice President, Chief Financial Officer
			(duly authorized officer)

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EXHIBIT INDEX TO

CALLIDUS SOFTWARE INC.

QUARTERLY REPORT ON FORM 10-Q

FOR THE QUARTER ENDED June 30, 2014



Exhibit Number		Description
10.1		Credit Agreement by and among Wells Fargo Bank, National Association, as administrative agent, the lender that is a party thereto, and Callidus Software Inc., dated as of May 13, 2014 (incorporated by reference to Exhibit 99.1 to the Registrant’s Form 8-K filed with the Commission on May 13, 2014)
10.2		Form of Non-Employee Director Offer Letter
31.1		Certification of Chief Executive Officer Pursuant to Rule 13a-14(a) of the Securities Exchange Act of 1934, as adopted by Section 302 of the Sarbanes-Oxley Act of 2002
31.2		Certification of Chief Financial Officer Pursuant to Rule 13a-14(a) of the Securities Exchange Act of 1934, as adopted by Section 302 of the Sarbanes-Oxley Act of 2002
32.1		Certifications of Chief Executive Officer and Chief Financial Officer Pursuant to 18 U.S.C. Section 1350, as adopted by Section 906 of the Sarbanes-Oxley Act of 2002
101		Interactive Data Files Pursuant to Rule 405 of Regulation S-T: (i) Condensed Consolidated Balance Sheets as of June 30, 2014 and December 31, 2013, (ii) Condensed Consolidated Statements of Comprehensive Income (Loss) for the three and six months ended June 30, 2014 and 2013, (iii) Condensed Consolidated Statements of Cash Flows for the six months ended June 30, 2014 and 2013 and (iv) Notes to Condensed Consolidated Financial Statements

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