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EXCEL - IDEA: XBRL DOCUMENT - CALLIDUS SOFTWARE INCFinancial_Report.xls
EX-32.1 - EXHIBIT 32.1 - CALLIDUS SOFTWARE INCcald-ex321_2014930xq3.htm
EX-10.1 - EXHIBIT 10.1 - CALLIDUS SOFTWARE INCexhibit101.htm
EX-31.1 - EXHIBIT 31.1 - CALLIDUS SOFTWARE INCcald-ex311_2014930xq3.htm
EX-10.2 - EXHIBIT 10.2 - CALLIDUS SOFTWARE INCexhibit102.htm
EX-31.2 - EXHIBIT 31.2 - CALLIDUS SOFTWARE INCcald-ex312_2014930xq3.htm

 
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 September 30, 2014 
OR 
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 48,628,680 shares of the registrant’s common stock, par value $0.001, outstanding on October 31, 2014, the latest practicable date prior to the filing of this report.
 




TABLE OF CONTENTS
 

2


PART I. FINANCIAL INFORMATION
Item 1. Financial Statements
CALLIDUS SOFTWARE INC.
CONDENSED CONSOLIDATED BALANCE SHEETS
(Unaudited, in thousands, except per share data)
 
September 30, 2014
 
December 31, 2013
ASSETS
 

 
 

Current assets:
 

 
 

Cash and cash equivalents
$
37,446

 
$
28,295

Short-term investments
2,774

 
7,866

Accounts receivable, net of allowances of $850 and $650 at September 30, 2014 and December 31, 2013, respectively
32,183

 
29,216

Deferred income taxes
184

 

Prepaid and other current assets
8,455

 
6,232

Total current assets
81,042

 
71,609

Property and equipment, net
12,723

 
11,351

Goodwill
45,684

 
31,207

Intangible assets, net
19,157

 
16,995

Deferred income taxes, noncurrent
437

 
405

Deposits and other noncurrent assets
2,512

 
2,626

Total assets
$
161,555

 
$
134,193

LIABILITIES AND STOCKHOLDERS’ EQUITY
 

 
 

Current liabilities:
 

 
 

Accounts payable
$
3,612

 
$
2,987

Accrued payroll and related expenses
7,275

 
7,377

Accrued expenses
11,785

 
5,395

Deferred income taxes
1,173

 
1,159

Deferred revenue
52,286

 
46,222

Capital lease obligations
1,105

 
1,308

Total current liabilities
77,236

 
64,448

Deferred revenue, noncurrent
11,429

 
10,432

Deferred income taxes, noncurrent
239

 
155

Capital lease obligations, noncurrent
446

 
987

Convertible notes

 
14,197

Revolving line of credit
10,482

 

Other noncurrent liabilities
3,008

 
1,921

Total liabilities
102,840

 
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; 50,952 and 47,817 shares issued and 48,613 and 45,478 shares outstanding at September 30, 2014 and December 31, 2013, respectively
49

 
45

Additional paid-in capital
339,736

 
315,430

Treasury stock; 2,339 shares at September 30, 2014 and December 31, 2013
(14,430
)
 
(14,430
)
Accumulated other comprehensive income (loss)
(31
)
 
165

Accumulated deficit
(266,609
)
 
(259,157
)
Total stockholders’ equity
58,715

 
42,053

Total liabilities and stockholders’ equity
$
161,555

 
$
134,193


See accompanying notes to unaudited condensed consolidated financial statements.

3


CALLIDUS SOFTWARE INC.
CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE LOSS
(Unaudited, in thousands, except per share data)
 
Three Months Ended September 30,
 
Nine Months Ended September 30,
 
2014
 
2013
 
2014
 
2013
Revenue:
 

 
 

 
 
 
 
Recurring
$
25,547

 
$
21,119

 
$
71,481

 
$
60,359

Services and license
9,453

 
9,559

 
27,011

 
21,791

Total revenue
35,000

 
30,678

 
98,492

 
82,150

Cost of revenue:
 

 
 

 
 

 
 

Recurring
8,916

 
7,303

 
23,706

 
21,687

Services and license
6,730

 
4,475

 
17,468

 
14,436

Total cost of revenue
15,646

 
11,778

 
41,174

 
36,123

Gross profit
19,354

 
18,900

 
57,318

 
46,027

 
 
 
 
 
 
 
 
Operating expenses:
 

 
 

 
 

 
 

Sales and marketing
11,153

 
8,981

 
33,688

 
24,516

Research and development
4,920

 
4,146

 
14,838

 
12,984

General and administrative
7,892

 
5,757

 
18,113

 
16,889

Restructuring and other
305

 
141

 
709

 
1,699

Total operating expenses
24,270

 
19,025

 
67,348

 
56,088

Operating loss
(4,916
)
 
(125
)
 
(10,030
)
 
(10,061
)
Interest income and other income (expense), net
(20
)
 
29

 
3,948

 
(92
)
Interest expense
(38
)
 
(860
)
 
(429
)
 
(2,578
)
Loss before provision for income taxes
(4,974
)
 
(956
)
 
(6,511
)
 
(12,731
)
Provision for income taxes
261

 
457

 
941

 
1,700

Net loss
$
(5,235
)
 
$
(1,413
)
 
$
(7,452
)
 
$
(14,431
)
Net loss per share
 

 
 

 
 

 
 

Basic
$
(0.11
)
 
$
(0.04
)
 
$
(0.16
)
 
$
(0.38
)
Diluted
$
(0.11
)
 
$
(0.04
)
 
$
(0.16
)
 
$
(0.38
)
Weighted average shares used in computing net loss per share:
 
 
 
 
 
 
 
Basic
48,564

 
38,648

 
47,061

 
37,873

Diluted
48,564

 
38,648

 
47,061

 
37,873

 
 
 
 
 
 
 
 
Comprehensive loss
 

 
 

 
 
 
 
Net loss
$
(5,235
)
 
$
(1,413
)
 
$
(7,452
)
 
$
(14,431
)
Unrealized gains (loss) on available-for-sale securities
(3
)
 
5

 
(5
)
 
(6
)
Foreign currency translation adjustments
(208
)
 
(64
)
 
(191
)
 
84

Comprehensive loss
$
(5,446
)
 
$
(1,472
)
 
$
(7,648
)
 
$
(14,353
)
 
See accompanying notes to unaudited condensed consolidated financial statements.

4


CALLIDUS SOFTWARE INC.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited, in thousands)
 
Nine Months Ended September 30,
 
2014
 
2013
Cash flows from operating activities:
 

 
 

Net loss
$
(7,452
)
 
$
(14,431
)
Adjustments to reconcile net loss to net cash provided by operating activities:
 

 
 

Depreciation expense
3,953

 
3,278

Amortization of intangible assets
3,667

 
3,621

Gain on sale of intangible assets
(3,862
)
 

Provision for doubtful accounts
729

 
846

Stock-based compensation
7,916

 
8,345

Release of valuation allowance
(149
)
 

Loss on disposal of property and equipment
44

 
2

Amortization of convertible notes issuance cost
58

 
402

Net amortization on investments
21

 
63

Changes in operating assets and liabilities:
 

 
 

Accounts receivable
(2,359
)
 
(1,583
)
Prepaid and other current assets
(1,997
)
 
(1,043
)
Other noncurrent assets
(197
)
 
(773
)
Accounts payable
583

 
(3,250
)
Accrued expenses
5,471

 
1,517

Accrued payroll and related expenses
(627
)
 
462

Accrued restructuring and other expenses
(98
)
 
(476
)
Deferred revenue
4,548

 
10,461

Deferred income taxes
(133
)
 
185

Net cash provided by operating activities
10,116

 
7,626

Cash flows from investing activities:
 

 
 

Purchases of investments
(2,784
)
 
(5,634
)
Proceeds from maturities and sale of investments
7,850

 
9,450

Purchases of property and equipment
(5,135
)
 
(1,714
)
Purchases of intangible assets
(882
)
 
(634
)
Proceeds from sale of intangible assets, net of expenses
4,651

 

Acquisitions, net of cash acquired
(15,409
)
 

Net cash (used in) provided by investing activities
(11,709
)
 
1,468

Cash flows from financing activities:
 

 
 

Proceeds from issuance of common stock
4,003

 
5,375

Repurchase of common stock from employees for payment of taxes on vesting of restricted stock units
(1,553
)
 
(818
)
Proceeds from line of credit
10,482

 

Payment of consideration related to acquisitions
(630
)
 
(3,078
)
Repayment of debt
(645
)
 

Payment of principal under capital leases
(744
)
 
(1,709
)
Net cash provided by (used in) financing activities
10,913

 
(230
)
Effect of exchange rates on cash and cash equivalents
(169
)
 
(72
)
Net increase in cash and cash equivalents
9,151

 
8,792

Cash and cash equivalents at beginning of period
28,295

 
16,400

Cash and cash equivalents at end of period
$
37,446

 
$
25,192

Supplemental disclosures of cash flow information:
 

 
 

Cash paid for interest on convertible debt
$
277

 
$
1,406

Cash paid for interest on capital leases
35

 
56

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.

5


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 September 30, 2014 and the three and nine months ended September 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 Accounting Standards Update No. 2014-09 (ASU 2014-09) "Revenue from Contracts with Customers." ASU 2014-09 supersedes the revenue recognition requirements in “Revenue Recognition (Topic 605)”, and requires entities to recognize revenue when it transfers promised goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled to in exchange for those goods or services. ASU 2014-09 is effective for annual reporting periods beginning after December 15, 2016, including interim periods within that reporting period. Early adoption is not permitted. The Company is currently in the process of evaluating the impact of the adoption of ASU 2014-09 on the 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 $0.3 million and $0.1 million during the three months ended September 30, 2014 and 2013, respectively, and $0.7 million and $1.7 million during the nine months ended September 30, 2014 and 2013, respectively.
The following tables set forth a summary of accrued restructuring expenses for the nine months ended September 30, 2014 and 2013, respectively (in thousands):
 
December 31, 2013
 
Additions
 
Adjustments
 
Cash
Payments
 
September 30, 2014
Severance and termination-related costs
$
141

 
$
70

 
$

 
$
(211
)
 
$

Facilities-related costs
234

 
162

 
20

 
(139
)
 
277

Total accrued restructuring expenses
$
375

 
$
232

 
$
20

 
$
(350
)
 
$
277

During the three and nine months ended September 30, 2014, the Company also incurred $0.3 million and $0.5 million of non-cash expense, respectively, primarily related to incremental depreciation expense as a result of the change in the estimated useful life of assets at the current headquarters in Pleasanton, CA.

6


 
December 31, 2012
 
Additions
 
Adjustments
 
Cash
Payments
 
September 30, 2013
Severance and termination-related costs
$
589

 
$
1,707

 
$
(8
)
 
$
(2,146
)
 
$
142

Facilities related costs
289

 

 

 
(30
)
 
259

Total accrued restructuring expenses
$
878

 
$
1,707

 
$
(8
)
 
$
(2,176
)
 
$
401

Note 3—Acquisitions
Clicktools Ltd.

On September 16, 2014, the Company acquired Clicktools Ltd. (“Clicktools”), a provider of premium, cloud-based survey products and services for businesses. The purchase consideration was $16.4 million, which included $14.8 million paid in cash and $1.6 million as an indemnity holdback payable upon the one year closing anniversary, which remains outstanding as of September 30, 2014.
The preliminary purchase price allocation for Clicktools is summarized as follows (in thousands):
 
Fair Value
Net assets assumed
$
394

Intangible assets
3,100

Goodwill
12,911

Total purchase price
$
16,405

The excess of purchase consideration over the fair value of net tangible assets assumed and identifiable intangible assets acquired was recorded as goodwill. Goodwill is primarily attributed to the anticipated synergies from the acquisition and expanded market opportunities with respect to the integration of Clicktools' business-to-business survey management platform with the Company’s other solutions. The goodwill balance is not deductible for U.S. income tax purposes.
Due to the recent closing of the Clicktools acquisition at quarter-end, the initial allocation of the purchase price is pending the completion of various analysis and finalization of estimates. The Company expects to finalize the valuation, including deferred revenue, as soon as practicable, but no 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 Clicktools acquisition (in thousands):
 
Fair Value
 
Useful Life
Developed technology
$
1,400

 
5 years
Domain names and trademarks
600

 
3 years
Customer relationships
1,100

 
3 years
Total intangible assets subject to amortization
$
3,100

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

7


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 no 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 September 30, 2014 and December 31, 2013, goodwill consisted of the following (in thousands):
Balance as of December 31, 2013
$
31,207

LeadRocket
1,584

Clicktools
$
12,911

Foreign currency translation impact
$
(18
)
Balance as of September 30, 2014
$
45,684

Note 4—Financial Instruments
As of September 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 September 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 September 30, 2014 and December 31, 2013 (in thousands):
September 30, 2014
 
Amortized
Cost
 
Gross
Unrealized
Gains
 
Gross
Unrealized
Losses
 
Other Than
Temporary
Impairment
 
Estimated
Fair value
Cash
 
$
31,144

 
$

 
$

 
$

 
$
31,144

Cash equivalents:
 
 

 
 

 
 

 
 

 
 

Money market funds
 
6,302

 

 

 

 
6,302

Total cash equivalents
 
6,302

 

 

 

 
6,302

Total cash and cash equivalents
 
$
37,446

 
$

 
$

 
$

 
$
37,446

 
 
 
 
 
 
 
 
 
 
 
Short-term investments:
 
 

 
 

 
 

 
 

 
 

Corporate notes and obligations
 
2,778

 

 
(4
)
 

 
2,774

Total short-term investments
 
$
2,778

 
$

 
$
(4
)
 
$

 
$
2,774


8


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 September 30, 2014 were as follows (in thousands):
Contractual maturity
Amortized
Cost
 
Estimated
Fair value
Less than 1 year
$
351

 
$
351

Between 1 and 2 years
2,427

 
2,423

Total
$
2,778

 
$
2,774

At September 30, 2014, the Company had no material unrealized losses on our short-term investments.
The Company had no realized gains or losses on sales of its investments for the three and nine months ended September 30, 2014 and 2013. The Company had proceeds, net of purchases of investments, of $5.1 million and $3.8 million from maturities and sales of investments during the nine months ended September 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 September 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 September 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
September 30, 2014
 
Total
 
(Level 1)
 
(Level 2)
 
(Level 3)
Assets:
 
 

 
 

 
 

 
 

Money market funds (1)
 
$
6,302

 
$
6,302

 
$

 
$

Corporate notes and obligations (2)
 
2,774

 

 
2,774

 

Total
 
$
9,076

 
$
6,302

 
$
2,774

 
$

_____________________________________________________________________________
(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. 
Level 3
As of September 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. 

9


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 September 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. Please also refer to Note 13 - Subsequent Event for additional commitments that the Company has entered into subsequent to September 30, 2014.
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.
During the three months ended September 30, 2014, the Company increased the maximum borrowing amount under the Revolver to $15.0 million.
As of September 30, 2014, the Company had borrowed $10.5 million under the Revolver. The carrying value of total debt approximates fair market value.
Letter of Credit
During the three months ended September 30, 2014, the Company reduced the security deposit from $0.4 million to $0.2 million for its current headquarters office at 6200 Stoneridge Mall Road, Suite 500, Pleasanton, California 94588. As a result, $0.4 million was released to the Company in cash, and the Company obtained a $0.2 million letter of credit in August 2014 for the security deposit. The letter of credit will expire on August 31, 2015.
Financing Arrangement for Equipment Purchase
In September 2014, the Company entered into a financing arrangement for the purchase of storage equipment, primarily for its data centers. The principal amount financed is $3.8 million and is payable in two installments of $2.6 million and $1.2 million in three months and one year, respectively, from November 2014. The financing arrangement does not bear interest. There are no financial covenants associated with the financing arrangement. In the event of default by the Company, the financing company may repossess the equipment and sell it in the in order to offset the Company’s liability to it. As of September 31, 2014, the Company had received, and accrued for, $0.1 million of storage equipment. Any shortfall from the sale of the equipment will be due and payable by the Company to the financing company.
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

10


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. On October 2, 2014, the PTAB instituted covered business method patent review of the remaining claims covered in the second set of petitions for U.S Patent Nos. 7,908,304 and 7,958,024. On October 21, 2014, the Company and Versata engaged in a mediation to settle their present dispute and to reach global settlement to avoid future patent infringement lawsuits. Following the mediation, considering all facts and circumstances, the Company determined that it had incurred a liability as of September 30, 2014 and recorded an estimated potential loss for this case in the amount of $3.0 million. The estimated potential loss was recorded to cost of recurring revenue and to general and administrative expenses in the amounts of $1.2 million and $1.8 million, respectively.
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.
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 September 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 Loss Per Share
Basic net loss per share is calculated by dividing net loss for the period by the weighted average common shares outstanding during the period. Diluted net loss per share is calculated by dividing the net 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. For the three and nine months ended September 30, 2014 and 2013, the diluted net loss per share calculation was the same as the basic net loss per share calculation as all potential common shares were anti-dilutive.
     Diluted net loss per share does not include the effect of the following potential weighted average common shares because to do so would be anti-dilutive for the periods presented (in thousands):
 
Three Months Ended September 30,
 
Nine Months Ended September 30,
 
2014
 
2013
 
2014
 
2013
Restricted Stock Units
2,526

 
1,967

 
2,340

 
2,071

Stock Options
1,557

 
2,558

 
1,745

 
2,622

ESPP Shares
18

 
19

 
6

 
6

Convertible Notes

 
7,680

 
1,108

 
7,680

Total
4,101

 
12,224

 
5,199

 
12,379

The weighted average exercise price of stock options excluded for the three and nine months ended September 30, 2014 were $5.51 and $5.39, respectively. The weighted average exercise price of stock options excluded for the three and nine months ended September 30, 2013 were $4.62 and $4.22, respectively.

11


Note 9—Stock-based Compensation
Expense Summary
The table below sets forth a summary of stock-based compensation expense for the three and nine months ended September 30, 2014 and 2013 (in thousands):
 
Three Months Ended September 30,
 
Nine Months Ended September 30,
 
2014
 
2013
 
2014
 
2013
Stock Options
$
200

 
$
181

 
$
613

 
$
642

Restricted Stock Units
 
 
 
 
 
 
 
Performance Awards
440

 
463

 
1,267

 
984

Service-based Awards
2,064

 
1,750

 
5,354

 
6,263

ESPP Shares
288

 
150

 
682

 
456

Total Stock-based Compensation
$
2,992

 
$
2,544

 
$
7,916

 
$
8,345

 
As of September 30, 2014, there were $2.0 million, $3.5 million, $11.4 million and $0.8 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 2.7 years, 2.0 years, 1.8 years and 0.8 years, respectively.
The table below sets forth the functional classification of stock-based compensation expense for the three and nine months ended September 30, 2014 and 2013 (in thousands):
 
Three Months Ended September 30,
 
Nine Months Ended September 30,
 
2014
 
2013
 
2014
 
2013
Cost of recurring revenue
$
226

 
$
234

 
$
600

 
$
612

Cost of services and other revenue
265

 
218

 
735

 
860

Sales and marketing
925

 
769

 
2,327

 
1,924

Research and development
481

 
384

 
1,393

 
1,317

General and administrative
1,095

 
939

 
2,861

 
3,632

Total stock-based compensation
$
2,992

 
$
2,544

 
$
7,916

 
$
8,345

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 nine months ended September 30, 2014.
 
Three months ended September 30,
 
Nine months ended September 30,
 
2014
 
2013
 
2014
 
2013
Stock Option Plans
 

 
 

 
 
 
 
Expected life (in years)

 
6.0 to 6.1

 

 
5.0 to 6.1

Risk-free interest rate

 
1.69% to 1.93%

 

 
1.41% to 1.93%

Volatility

 
61% to 62%

 

 
61% to 63%

Dividend Yield

 
None

 

 
None


12


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.
 
Nine Months Ended September 30,
 
2014
 
2013
Employee Stock Purchase Plan
 
 
 
Expected life (in years)
0.50 to 1.00

 
0.50 to 1.00

Risk-free interest rate
0.05% to 0.12%

 
0.08% to 0.17%

Volatility
47% to 50%

 
41% to 62%

Dividend yield
None

 
None

Note 10—Income Taxes
Income tax expense for the three and nine months ended September 30, 2014 was $0.3 million and $0.9 million, compared to income tax expense of $0.5 million and $1.7 million for the same periods of 2013. The decrease for the three and nine month periods was primarily due to a decrease in the withholding taxes in the foreign jurisdictions. The decrease for the nine months ended September 30, 2014 was also impacted by the release in the three months ended September 30, 2014 of a portion of the valuation allowance associated with the acquisition of LeadRocket and the mix of foreign earnings and tax rates.
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 nine months ended September 30, 2014 and 2013 by geographic areas (in thousands):
 
Three Months Ended September 30,
 
Nine Months Ended September 30,
 
2014
 
2013
 
2014
 
2013
United States
$
26,352

 
$
22,052

 
$
76,845

 
$
62,616

EMEA
4,098

 
3,050

 
10,845

 
9,227

Asia Pacific
2,551

 
3,273

 
5,793

 
5,783

Other
1,999

 
2,303

 
5,009

 
4,524

 
$
35,000

 
$
30,678

 
$
98,492

 
$
82,150

Substantially all of the Company’s long-lived assets are located in the United States and United Kingdom. Long-lived assets located outside the United States and United Kingdom are not significant.
During the three and nine months ended September 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, which was paid in full during the three months ended September 30, 2014. As of September 30, 2014, approximately $88,000 of the amount remains in prepaid and other current assets.
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 nine months ended September 30, 2014, the Company recognized approximately $26,000 and $77,000, respectively, in revenue under this annual hosting agreement.
During 2013 and 2014, the Company entered into agreements to provide services to Lithium in an aggregate amount of $203,050, of which the Company recognized approximately $10,000 and $50,000 in revenue for the three and nine months ended September 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 nine months ended September 30, 2014, the Company paid approximately $25,000 and $101,000, respectively, to this vendor.

13


Note 13—Subsequent Events
New Headquarters Building Lease
In October 2014, the Company entered into a sublease agreement ("Sublease") with Oracle America, Inc. (“Sublandlord”) for office space located at 4140 Dublin Boulevard, Dublin, California 94568 ("Subleased Premises"), to replace the Company’s current corporate headquarters.
The term of the Sublease commences on the date the Sublandlord delivers possession of the Subleased Premises to the Company and expires on May 15, 2022. The Company expects to receive possession within the next twelve months. Base rent will be abated from the commencement of the Sublease until November 30, 2015. Thereafter, monthly base rent will be $149,928 for 2015 and increase annually as set forth in the Sublease, up to $184,411 in 2022. The total cash obligation for base rent over the term of the Sublease is approximately $15.1 million, without rent abatement. In addition to base rent, the Company will be required to pay its pro rata share of building operating costs including utilities, insurance, repair and personnel costs, along with real estate taxes in excess of the amounts for certain base years.
Amendment to Current Headquarters Lease
In October 2014, in connection with the execution of the Sublease, the Company and the current landlord entered into the Third Amendment to Lease (“Lease Amendment”) to amend the Office Lease Agreement between the Company and current landlord, dated March 30, 2010, as amended (“Current Lease”), for the Company’s current headquarters at 6200 Stoneridge Mall Road, Suite 500, Pleasanton, California 94588 (“Current Premises”). The Current Lease term expires on July 31, 2017 and the Lease Amendment reduces that term so that the Current Lease will expire on the earlier to occur of (1) the date selected by the Company following no less than fourteen days prior written notice to Current Landlord, or (2) February 16, 2015, unless sooner terminated in accordance with the terms and conditions of the Current Lease. The effectiveness of the Lease Amendment was contingent on the Company entering into the Sublease. No material early termination penalties and rent obligations subsequent to exit are expected to be incurred by the Company in connection with the Lease Amendment.
Letter of Credit
In October 2014, the Company obtained a $1.1 million letter of credit to serve as a deposit for the new headquarters in Dublin, CA as required by the Sublease. This letter of credit will expire on October 1, 2015.

14


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 will also 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.
During the three months ended September 30, 2014, we continued to invest in productive sales capacity, marketing personnel and programs, as well retaining our customer relationships through professional services and customer success teams aimed at providing a world class customer experience.
During the nine months ended September 30, 2014, we added more than 1,200 net new SaaS customers, and now as a result of net new SaaS customers and through acquisitions completed in 2014 we have over 3,500 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 $21.6 million for the three months ended September 30, 2014, representing a $4.4 million or 26% increase over the same period in 2013. SaaS revenue grew to $59.3 million for the nine months ended September 30, 2014, representing a $10.7 million or 22% increase over the same period in 2013. Revenue related to overages was immaterial for the three and nine months ended September 30, 2014 and nine months ended September 30, 2013. Revenue related to overages was $1.4 million for the three months ended September 30, 2013.
Acquisition of Clicktools Ltd.
On September 16, 2014, we invested in our Lead to Money suite by acquiring Clicktools Ltd. (“Clicktools”), a provider of premium, cloud-based survey products and services for businesses. The purchase consideration was $16.4 million, which included $14.8 million paid in cash and $1.6 million as indemnity holdback payable upon the one year closing anniversary.
The consolidated unaudited operating results for the three and nine months ended September 30, 2014 include financial data from Clicktools. Due to the recent closing of the Clicktools acquisition at quarter-end, the initial allocation of the purchase price is pending the completion of various analysis and finalization of estimates. We expect to finalize the valuation as soon as practicable, but no later than one-year from the acquisition date.

15


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 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 nine months ended September 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 Nine Months Ended September 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 nine months ended September 30, 2014, compared to the same periods in 2013 (in thousands, except for percentage data):
 
Three Months Ended September 30, 2014
 
Percentage
of Revenue
 
Three Months Ended September 30, 2013
 
Percentage
of Revenue
 
Increase
(Decrease)
 
Percentage
Change
Revenue:
 

 
 
 
 

 
 
 
 

 
 
Recurring
$
25,547

 
73%
 
$
21,119

 
69%
 
$
4,428

 
21%
Services and license
9,453

 
27%
 
9,559

 
31%
 
(106
)
 
(1)%
Total revenue
$
35,000

 
100%
 
$
30,678

 
100%
 
$
4,322

 
14%
 
 
 
 
 
 
 
 
 
 
 
 
Cost of revenue:
 

 
 
 
 

 
 
 
 

 
 
Recurring
$
8,916

 
35%
 
$
7,303

 
35%
 
$
1,613

 
22%
Services and license
6,730

 
71%
 
4,475

 
47%
 
2,255

 
50%
Total cost of revenue
$
15,646

 
45%
 
$
11,778

 
38%
 
$
3,868

 
33%
 
 
 
 
 
 
 
 
 
 
 
 
Gross profit:
 

 
 
 
 

 
 
 
 

 
 
Recurring
$
16,631

 
65%
 
$
13,816

 
65%
 
$
2,815

 
20%
Services and license
2,723

 
29%
 
5,084

 
53%
 
(2,361
)
 
(46)%
Total gross profit
$
19,354

 
55%
 
$
18,900

 
62%
 
$
454

 
2%

16


 
Nine Months Ended September 30, 2014
 
Percentage
of Revenue
 
Nine Months Ended September 30, 2013
 
Percentage
of Revenue
 
Increase
(Decrease)
 
Percentage
Change
Revenue:
 

 
 
 
 

 
 
 
 

 
 
Recurring
$
71,481

 
73%
 
$
60,359

 
73%
 
$
11,122

 
18%
Services and license
27,011

 
27%
 
21,791

 
27%
 
5,220

 
24%
Total revenue
$
98,492

 
100%
 
$
82,150

 
100%
 
$
16,342

 
20%
 
 
 
 
 
 
 
 
 
 
 
 
Cost of revenue:
 

 
 
 
 

 
 
 
 

 
 
Recurring
$
23,706

 
33%
 
$
21,687

 
36%
 
$
2,019

 
9%
Services and license
17,468

 
65%
 
14,436

 
66%
 
3,032

 
21%
Total cost of revenue
$
41,174

 
42%
 
$
36,123

 
44%
 
$
5,051

 
14%
 
 
 
 
 
 
 
 
 
 
 
 
Gross profit:
 

 
 
 
 

 
 
 
 

 
 
Recurring
$
47,775

 
67%
 
$
38,672

 
64%
 
$
9,103

 
24%
Services and license
9,543

 
35%
 
7,355

 
34%
 
2,188

 
30%
Total gross profit
$
57,318

 
58%
 
$
46,027

 
56%
 
$
11,291

 
25%
Revenue
Total Revenue.  Total revenue for the three and nine months ended September 30, 2014 increased compared to the same periods in 2013 primarily due to continued growth in SaaS revenue.
Recurring Revenue.  Recurring revenue consists of SaaS and maintenance revenue. SaaS revenue increased $4.4 million and $10.7 million in the three and nine months ended September 30, 2014, respectively, compared to the same periods in 2013 due to continual growth in bookings. Maintenance revenue remained consistent and increased $0.5 million, respectively, in the three and nine months ended September 30, 2014 compared to the same periods in 2013.
Services and License Revenue.  Services and license revenue consist of integration and configuration services, training and perpetual licenses. For the three and nine months ended September 30, 2014 as compared to the same periods in 2013, services revenue increased $2.4 million and $6.5 million, respectively, resulting from increased SaaS bookings as noted above. Services revenue growth in the three months ended September 30, 2014 was partially offset by a one-time benefit of $0.8 million in the three months ended September 30, 2013 due to a release of deferred revenue, which resulted from a review of outstanding projects. For the three and nine months ended September 30, 2014 as compared to the same periods in 2013, license revenue decreased $2.5 million and $1.3 million, respectively, due to the timing of license contracts.
Cost of Revenue and Gross Margin
Cost of Recurring Revenue.  The increase for the three and nine months ended September 30, 2014 compared to the same periods in 2013 was primarily due to a $1.2 million royalty expense related to a litigation settlement and increased maintenance and depreciation as the Company continued to invest in hosting facility equipments to support our revenue growth and expanding customer base.
Cost of Services and License Revenue.  The increase for the three and nine months ended September 30, 2014 compared to the same periods in 2013 was primarily due to expanded use of third party consultants required resulting from increased implementation services to support our increased SaaS revenue and customer base.
Recurring Revenue Gross Margin. The improvement in our recurring revenue gross margin percentage for the three and nine months ended September 30, 2014 compared to the same periods in 2013 was primarily due to increased SaaS revenue and economies of scale of our on-demand infrastructure costs, offset by $1.2 million royalty expense related to a litigation settlement.
Services and License Revenue Gross Margin. The decrease in services and license revenue gross margin for the three months ended September 30, 2014 compared to the same period in 2013 was attributable to decreased license revenue along with a one-time benefit of $0.8 million in the three months ended September 30, 2013 due to a release of deferred revenue as noted above. The increase in services and license revenue gross margin for the nine months ended September 30, 2014 compared to the same period in 2013 was primarily due to decreased cost of services revenue resulting from higher billable utilization, partially offset by a decrease in license revenue.
Operating Expenses
The following tables outline the changes in operating expenses for the three and nine months ended September 30, 2014, compared to the same periods in 2013 (in thousands, except percentage data): 

17


 
Three Months Ended September 30, 2014
 
Percentage
of Revenue
 
Three Months Ended September 30, 2013
 
Percentage
of Revenue
 
Increase
(Decrease)
 
Percentage
Change
Operating expenses:
 

 
 
 
 

 
 
 
 

 
 
Sales and marketing
$
11,153

 
32%
 
$
8,981

 
29%
 
$
2,172

 
24%
Research and development
4,920

 
14%
 
4,146

 
14%
 
774

 
19%
General and administrative
7,892

 
23%
 
5,757

 
19%
 
2,135

 
37%
Restructuring and other expenses
305

 
1%
 
141

 
—%
 
164

 
116%
Total operating expenses
$
24,270

 
69%
 
$
19,025

 
62%
 
$
5,245

 
28%
 
Nine Months Ended September 30, 2014
 
Percentage
of Revenue
 
Nine Months Ended September 30, 2013
 
Percentage
of Revenue
 
Increase
(Decrease)
 
Percentage
Change
Operating expenses:
 

 
 
 
 

 
 
 
 

 
 
Sales and marketing
$
33,688

 
34%
 
$
24,516

 
30%
 
$
9,172

 
37%
Research and development
14,838

 
15%
 
12,984

 
16%
 
1,854

 
14%
General and administrative
18,113

 
18%
 
16,889

 
21%
 
1,224

 
7%
Restructuring and other expenses
709

 
1%
 
1,699

 
2%
 
(990
)
 
(58)%
Total operating expenses
67,348

 
68%
 
56,088

 
68%
 
11,260

 
20%
Sales and Marketing.  The increase for the three months ended September 30, 2014 compared to the same period in 2013 was primarily due to $1.4 million increase in personnel related cost as a result of increased sales capacity and increased investments in marketing headcount, and $0.5 million increase in marketing activities supporting lead generation, such as the Company's C3 conference in Japan. The increase for the nine months ended September 30, 2014 compared to the same period in 2013 included a $5.7 million increase in personnel related cost as a result of increased sales capacity and increased investments in marketing headcount, $2.0 million of marketing expenses related to our C3 conference in Las Vegas and Japan and lead generation activities, and $0.8 million of increased commission expense from continued channel growth.
Research and Development.  The increase for the three and nine months ended September 30, 2014 compared to the same periods in 2013 was driven primarily by an increase in personnel related costs as we continue to invest in headcount to support product development.
General and Administrative.  The increase for the three months ended September 30, 2014 compared to the same period in 2013 was primarily driven by $1.8 million related to litigation settlement and $0.4 million increase in personnel related costs. The increase for the nine months ended September 30, 2014 compared to the same period in 2013 was primarily driven by $1.8 million related to litigation settlement, and increase corporate insurance, maintenance and travel expenses to support our continued business growth, partially offset by reduction in severance and recruiting fees due to the departure and replacement of our chief financial officer in 2013 and stock-based compensation expense.
Restructuring and other.  The increase for the three months ended September 30, 2014 as compared to the same period in 2013 was due to the incremental depreciation expense as a result of the change in the estimated useful life of assets at current headquarters in Pleasanton, CA. The decrease for the nine months ended September 30, 2014 as compared to the same period in 2013 was due to a larger scale of restructuring activities in 2013, which included the departure of our former general counsel and the realignment of our organization, including consolidation of our office locations.
Stock-based Compensation

18


The following tables set forth a summary of our stock-based compensation expenses for the three and nine months ended September 30, 2014, compared to the same periods in 2013 (in thousands, except percentage data):
 
Three Months Ended September 30, 2014
 
Three Months Ended September 30, 2013
 
Increase
(Decrease)
 
Percentage
Change
Stock-based compensation:
 

 
 

 
 

 
 
Cost of recurring revenue
$
226

 
$
234

 
$
(8
)
 
(3)%
Cost of services revenue
265

 
218

 
47

 
22%
Sales and marketing
925

 
769

 
156

 
20%
Research and development
481

 
384

 
97

 
25%
General and administrative
1,095

 
939

 
156

 
17%
Total stock-based compensation
$
2,992

 
$
2,544

 
$
448

 
18%
 
Nine Months Ended September 30, 2014
 
Nine Months Ended September 30, 2013
 
Increase
(Decrease)
 
Percentage
Change
Stock-based compensation:
 

 
 

 
 

 
 
Cost of recurring revenues
$
600

 
$
612

 
$
(12
)
 
(2)%
Cost of services revenues
735

 
860

 
(125
)
 
(15)%
Sales and marketing
2,327

 
1,924

 
403

 
21%
Research and development
1,393

 
1,317

 
76

 
6%
General and administrative
2,861

 
3,632

 
(771
)
 
(21)%
Total stock-based compensation
$
7,916

 
$
8,345

 
$
(429
)
 
(5)%
The increase for the three months ended September 30, 2014 compared to the same period in 2013 was primarily due to timing of RSU grants, increased stock price and increased ESPP participation. The decrease for the nine months ended September 30, 2014 compared to the same period in 2013 was primarily due to the Company's plan to manage the equity award burn rate, partially offset by increased ESPP participation.
Other Items
The following tables set forth changes in other items for the three and nine months ended September 30, 2014, compared to the same periods in 2013 (in thousands, except percentage data):
 
Three Months Ended September 30, 2014
 
Three Months Ended September 30, 2013
 
Increase
(Decrease)
 
Percentage
Change
Other income (expense), net
 

 
 

 
 

 
 
Interest income and other income (expense), net
$
(20
)
 
$
29

 
$
(49
)
 
(169)%
Interest expense
(38
)
 
(860
)
 
822

 
(96)%
 
$
(58
)
 
$
(831
)
 
$
773

 
(93)%
 
 
 
 
 
 
 
 
Provision (benefit) for income taxes
$
261

 
457

 
(196
)
 
(43)%
 
Nine Months Ended September 30, 2014
 
Nine Months Ended September 30, 2013
 
Increase
(Decrease)
 
Percentage
Change
Other income (expense), net
 

 
 

 
 

 
 
Interest income and other income (expense), net
$
3,948

 
$
(92
)
 
$
4,040

 
(4,391)%
Interest expense
(429
)
 
(2,578
)
 
2,149

 
(83)%
 
$
3,519

 
$
(2,670
)
 
$
6,189

 
(232)%
 
 
 
 
 
 
 
 
Provision (benefit) for income taxes
$
941

 
1,700

 
(759
)
 
(45)%

19


 Interest Income and Other Income (Expense), Net
Interest income and other income (expense) remained consistent for the three months ended September 30, 2014 compared to the same period in 2013. The increase for the nine months ended September 30, 2014, compared to the same period in 2013, was 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
The decrease for the three and nine months ended September 30, 2014, compared to same periods in 2013, 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
The decrease for the three and nine month periods was primarily due to a decrease in the withholding taxes in the foreign jurisdictions. The decrease for the nine months ended September 30, 2014 was also impacted by the release in Q1 2014 of a portion of the valuation allowance associated with the acquisition of LeadRocket and the mix of foreign earnings and tax rates.
Liquidity and Capital Resources
As of September 30, 2014, our principal sources of liquidity were cash and cash equivalents and short-term investments totaling $40.2 million and accounts receivable of $32.2 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 September 30, 2014, the Company had no outstanding Convertible Notes.
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.
During the three months ended September 30, 2014, the Company increased the maximum borrowing amount under the Revolver to $15.0 million. As of September 30, 2014, the Company had borrowed $10.5 million under the Revolver.
Cash provided by operating activities during the nine months ended September 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):
 
Nine Months Ended September 30,
 
2014
 
2013
Net cash provided by operating activities
$
10,116

 
$
7,626

Net cash provided by (used in) investing activities
(11,709
)
 
1,468

Net cash provided by (used in) financing activities
10,913

 
(230
)
Cash Flows During the Nine Months Ended September 30, 2014
Net cash provided by operating activities was $10.1 million in the nine months ended September 30, 2014 compared to $7.6 million provided in the previous period. The increase was primarily driven by lower net loss adjusted for non-cash expenses as net loss was $7.5 million in the nine months ended September 30, 2014, which included adjustments of the gain on sale of intangible asset of $3.9 million, $7.9 million in stock-based compensation and $7.6 million in depreciation and amortization expense. Changes in operating assets and liabilities provided $5.2 million in cash during the quarter, primarily driven by an increase in deferred revenue of $4.5 million from new bookings and renewals, and an increase of accrued expense of $5.5 million. These changes were partially offset by the increase of $2.0 million from prepaid and other current assets, and increase in accounts receivable of $2.4 million.
Net cash used in investing activities was $11.7 million during the nine months ended September 30, 2014, compared to $1.5 million provided by investing activities in the previous period. The net cash used in investing activities related to $15.4 million of cash used for the acquisition of LeadRocket and Clicktools, net of cash acquired, $5.1 million in purchases of property and equipment for data center upgrades and expansion, and $0.9 million in purchase of intangible assets, partially offset by $5.1 million in proceeds from maturities and sale of investments, net of purchases, and $4.7 million in proceeds from sale of intangible asset.
Net cash provided by financing activities was $10.9 million during the nine months ended September 30, 2014, compared to $0.2 million cash used in financing activities in the previous period. The increase in cash provided by financing activities was primarily due to the proceeds withdrawn on the line of credit. The net cash provided by financing activities was primarily due to $10.5 million proceeds from line of credit, and $4.0 million of proceeds from issuance of common stock, partially offset by $1.6 million for the repurchase of common stock

20


from employees for payment of taxes on vesting of restricted stock units, $0.7 million of principal payments for capital leases, $0.6 million payment of acquisition-related holdback, and $0.6 million of debt repayments.
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 and Note 13 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.
Item 3. Quantitative and Qualitative Disclosures About Market Risk
     During the three and nine months ended September 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 September 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 September 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.

21


PART II. OTHER INFORMATION
Item 1. Legal Proceedings
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. On October 2, 2014, the PTAB instituted covered business method patent review of the remaining claims covered in the second set of petitions for U.S Patent Nos. 7,908,304 and 7,958,024. On October 21, 2014, the Company and Versata engaged in a mediation to settle their present dispute and to reach global settlement to avoid future patent infringement lawsuits. Following the mediation, considering all facts and circumstances, the Company determined that it had incurred a liability as of September 30, 2014 and recorded an estimated potential loss for this case in the amount of $3.0 million. The estimated potential loss was recorded to cost of recurring revenue and to general and administrative expenses in the amounts of $1.2 million and $1.8 million, respectively.
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.
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

22


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 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

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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’ 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 have a third-party facility with full redundancy capabilities in Sacramento, California to support our SaaS solutions, as well as a second, fully redundant hosting facility in Virginia. 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 recent acquisitions of LeadRocket, Inc. in February 2014 and Clicktools Ltd. in September 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"). In September 2014, the Company increased the maximum borrowing amount to $15.0 million. 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:
November 5, 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 SEPTEMBER 30, 2014
 
Exhibit
Number
 
Description
2.1
 
Agreement, dated September 15, 2014, between the vendors set forth therein, Callidus Software Inc. and Dorset Acquisition Corp (incorporated by reference to Exhibit 2.1 to the Registrant’s Form 8-K filed with the Commission on September 17, 2014)
10.1
 
Third Amendment to Office Lease Agreement between 6200 Stoneridge Mall Road Investors LLC and Callidus Software Inc. dated October 1, 2014
10.2
 
Sublease between Oracle America, Inc. and Callidus Software Inc. dated October 3, 2014
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 September 30, 2014 and December 31, 2013, (ii) Condensed Consolidated Statements of Comprehensive Loss for the three and nine months ended September 30, 2014 and 2013, (iii) Condensed Consolidated Statements of Cash Flows for the nine months ended September 30, 2014 and 2013 and (iv) Notes to Condensed Consolidated Financial Statements

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