10-Q
Table of Contents

 
 
 
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 July 31, 2015
OR
¨
Transition report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934
Commission File Number: 001-35680
 
 
 
Workday, Inc.
(Exact name of registrant as specified in its charter) 
 
 
 
Delaware
 
20-2480422
(State or other jurisdiction of
incorporation or organization)
 
(IRS Employer
Identification No.)
6230 Stoneridge Mall Road
Pleasanton, California 94588
(Address of principal executive offices)
Telephone Number (925) 951-9000
(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 (the “Exchange Act”) during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days:    Yes  x    No  ¨
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).    Yes  x   No  ¨
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.
Large accelerated filer
x
Accelerated filer
¨
Non-accelerated filer
¨  (Do not check if a smaller reporting company)
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  ¨    No  x
As of August 31, 2015, there were approximately 192 million shares of the registrant’s common stock outstanding.
 
 
 


Table of Contents

Workday, Inc.
 
 
Page No.
 
 
 
 
Item 1.
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Item 2.
 
 
 
Item 3.
 
 
 
Item 4.
 
 
 
 
 
 
Item 1.
 
 
 
Item 1A.
 
 
 
Item 2.
 
 
 
Item 3.
 
 
 
Item 4.
 
 
 
Item 5.
 
 
 
Item 6.
 
 
 
 
 
 
 
 


2

Table of Contents

PART I. FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
Workday, Inc.
Condensed Consolidated Balance Sheets
(in thousands)
(unaudited)
 
July 31,
2015
 
January 31,
2015
 (1)
Assets
 
 
 
Current assets:
 
 
 
Cash and cash equivalents
$
230,578

 
$
298,192

Marketable securities
1,676,351

 
1,559,517

Accounts receivable, net
156,282

 
188,357

Deferred costs
18,905

 
20,471

Prepaid expenses and other current assets
58,412

 
42,502

Total current assets
2,140,528

 
2,109,039

Property and equipment, net
172,701

 
140,136

Deferred costs, noncurrent
20,787

 
20,998

Goodwill and acquisition-related intangible assets, net
42,953

 
34,779

Other assets
66,915

 
53,681

Total assets
$
2,443,884

 
$
2,358,633

Liabilities and stockholders’ equity
 
 
 
Current liabilities:
 
 
 
Accounts payable
$
23,668

 
$
10,623

Accrued expenses and other current liabilities
31,706

 
24,132

Accrued compensation
48,347

 
56,152

Capital leases
743

 
3,207

Unearned revenue
601,807

 
547,151

Total current liabilities
706,271

 
641,265

Convertible senior notes, net
502,045

 
490,501

Unearned revenue, noncurrent
81,281

 
85,593

Other liabilities
22,312

 
15,299

Total liabilities
1,311,909

 
1,232,658

Stockholders’ equity:
 
 
 
Common stock
190

 
186

Additional paid-in capital
2,084,815

 
1,948,300

Accumulated other comprehensive income (loss)
320

 
(140
)
Accumulated deficit
(953,350
)
 
(822,371
)
Total stockholders’ equity
1,131,975

 
1,125,975

Total liabilities and stockholders’ equity
$
2,443,884

 
$
2,358,633

 
(1) 
Amounts as of January 31, 2015 were derived from the January 31, 2015 audited financial statements.
See Notes to Condensed Consolidated Financial Statements.


3

Table of Contents

Workday, Inc.
Condensed Consolidated Statements of Operations
(in thousands, except per share data)
(unaudited)
 
Three Months Ended 
 July 31,
 
Six Months Ended 
 July 31,
 
2015
 
2014
 
2015
 
2014
Revenues:
 
 
 
 
 
 
 
Subscription services
$
223,742

 
$
143,652

 
$
424,735

 
$
267,059

Professional services
58,954

 
43,128

 
108,918

 
79,458

Total revenues
282,696

 
186,780

 
533,653

 
346,517

Costs and expenses(1):
 
 
 
 
 
 
 
Costs of subscription services
35,287

 
24,373

 
67,069

 
45,832

Costs of professional services
56,792

 
41,267

 
102,924

 
77,227

Product development
115,345

 
77,464

 
214,680

 
142,635

Sales and marketing
106,430

 
78,523

 
201,325

 
146,690

General and administrative
36,482

 
26,922

 
68,699

 
47,985

Total costs and expenses
350,336

 
248,549

 
654,697

 
460,369

Operating loss
(67,640
)
 
(61,769
)
 
(121,044
)
 
(113,852
)
Other expense, net
(3,779
)
 
(6,953
)
 
(11,015
)
 
(13,952
)
Loss before provision for (benefit from) income taxes
(71,419
)
 
(68,722
)
 
(132,059
)
 
(127,804
)
Provision for (benefit from) income taxes
(1,998
)
 
493

 
(1,080
)
 
800

Net loss
$
(69,421
)
 
$
(69,215
)
 
$
(130,979
)
 
$
(128,604
)
Net loss per share, basic and diluted
$
(0.37
)
 
$
(0.38
)
 
$
(0.70
)
 
$
(0.70
)
Weighted-average shares used to compute net loss per share, basic and diluted
189,360

 
184,319

 
188,382

 
183,733


(1)      Costs and expenses include share-based compensation expenses as follows:
 
 
 
 
Costs of subscription services
$
3,173


$
1,608


$
5,221


$
2,663

Costs of professional services
5,144


3,519


8,598


5,717

Product development
28,632


16,737


49,443


27,605

Sales and marketing
13,222


7,377


21,587


14,129

General and administrative
14,593


11,541


27,189


19,542


See Notes to Condensed Consolidated Financial Statements.


4

Table of Contents

Workday, Inc.
Condensed Consolidated Statements of Comprehensive Loss
(in thousands)
(unaudited)
 
Three Months Ended 
 July 31,
 
Six Months Ended 
 July 31,
 
2015
 
2014
 
2015
 
2014
Net loss
$
(69,421
)
 
$
(69,215
)
 
$
(130,979
)
 
$
(128,604
)
Other comprehensive income (loss), net of tax:
 
 
 
 
 
 
 
Net change in foreign currency translation adjustment
(227
)
 
(15
)
 
(200
)
 
24

Net change in unrealized gains (losses) on available-for-sale investments
(192
)
 
(503
)
 
(337
)
 
(330
)
Net change in market value of effective foreign currency forward exchange contracts
1,018

 

 
997

 

Other comprehensive income (loss), net of tax
599

 
(518
)
 
460

 
(306
)
Comprehensive loss
$
(68,822
)
 
$
(69,733
)
 
$
(130,519
)
 
$
(128,910
)

See Notes to Condensed Consolidated Financial Statements.


5

Table of Contents

Workday, Inc.
Condensed Consolidated Statements of Cash Flows
(in thousands)
(unaudited)
 
Three Months Ended 
 July 31,
 
Six Months Ended 
 July 31,
 
2015
 
2014
 
2015
 
2014
Cash flows from operating activities
 
 
 
 
 
 
 
Net loss
$
(69,421
)
 
$
(69,215
)
 
$
(130,979
)
 
$
(128,604
)
Adjustments to reconcile net loss to net cash provided by (used in) operating activities:
 
 
 
 
 
 
 
Depreciation and amortization
19,888

 
14,474

 
38,457

 
26,997

Share-based compensation expenses
64,764

 
40,782

 
112,038

 
69,656

Amortization of deferred costs
7,735

 
4,421

 
12,360

 
8,373

Amortization of debt discount and issuance costs
6,336

 
6,002

 
12,586

 
11,922

Gain on sale of cost method investment
(3,220
)
 

 
(3,220
)
 

Other
(2,119
)
 
242

 
(1,382
)
 
846

Changes in operating assets and liabilities, net of business combinations:
 
 
 
 
 
 
 
Accounts receivable
(27,570
)
 
(1,441
)
 
32,147

 
(8,454
)
Deferred costs
(7,082
)
 
(6,433
)
 
(10,583
)
 
(9,896
)
Prepaid expenses and other assets
(7,806
)
 
(2,748
)
 
(15,476
)
 
(10,098
)
Accounts payable
1,428

 
(23
)
 
4,180

 
(2,453
)
Accrued expense and other liabilities
2,913

 
(14,602
)
 
9,098

 
(13,511
)
Unearned revenue
29,665

 
19,530

 
50,344

 
67,908

Net cash provided by (used in) operating activities
15,511

 
(9,011
)
 
109,570

 
12,686

Cash flows from investing activities
 
 
 
 
 
 
 
Purchases of marketable securities
(476,470
)
 
(365,779
)
 
(862,045
)
 
(1,036,185
)
Maturities of marketable securities
429,186

 
414,242

 
710,593

 
767,472

Sales of available-for-sale securities
19,524

 
8,138

 
29,524

 
8,138

Business combinations, net of cash acquired
(7,961
)
 

 
(7,961
)
 
(26,317
)
Purchases of property and equipment
(25,792
)
 
(28,409
)
 
(55,972
)
 
(38,282
)
Purchases of cost method investments
(15,750
)
 
(10,000
)
 
(15,750
)
 
(10,000
)
Sale of cost method investment
3,538

 

 
3,538

 

Other

 

 

 
1,000

Net cash provided by (used in) investing activities
(73,725
)
 
18,192

 
(198,073
)
 
(334,174
)
Cash flows from financing activities
 
 
 
 
 
 
 
Proceeds from issuance of common stock from employee equity plans
19,172

 
15,169

 
22,736

 
18,165

Principal payments on capital lease obligations
(1,016
)
 
(4,418
)
 
(2,464
)
 
(7,162
)
Shares repurchased for tax withholdings on vesting of restricted stock

 
(3,284
)
 

 
(8,291
)
Other
362

 

 
779

 
60

Net cash provided by (used in) financing activities
18,518

 
7,467

 
21,051

 
2,772

Effect of exchange rate changes
(210
)
 
(15
)
 
(162
)
 
24

Net increase (decrease) in cash and cash equivalents
(39,906
)
 
16,633

 
(67,614
)
 
(318,692
)
Cash and cash equivalents at the beginning of period
270,484

 
246,001

 
298,192

 
581,326

Cash and cash equivalents at the end of period
$
230,578

 
$
262,634

 
$
230,578

 
$
262,634

Supplemental cash flow data
 
 
 
 
 
 
 
Cash paid for interest
$
3,211

 
$
3,369

 
$
3,244

 
$
3,558

Cash paid for taxes
418

 
120

 
1,034

 
120

Non-cash investing and financing activities:
 
 
 
 
 
 
 
Vesting of early exercise stock options
$
472

 
$
471

 
$
944

 
$
944

Purchases of property and equipment, accrued but not paid
18,642

 
12,171

 
18,642

 
12,171


See Notes to Condensed Consolidated Financial Statements

6

Table of Contents

Workday, Inc.
Notes to Condensed Consolidated Financial Statements
Note 1. Overview and Basis of Presentation
Company and Background
Workday provides financial management, human capital management, and analytics applications designed for the world's largest companies, educational institutions, and government agencies. We offer innovative and adaptable technology focused on the consumer Internet experience and cloud delivery model. Our applications are designed for global enterprises to manage complex and dynamic operating environments. We provide our customers highly adaptable, accessible and reliable applications to manage critical business functions that enable them to optimize their financial and human capital resources. We were originally incorporated in March 2005 in Nevada and in June 2012, we reincorporated in Delaware. As used in this report the terms "Workday," "registrant," "we," "us," and "our" mean Workday, Inc. and its subsidiaries unless the context indicates otherwise.
Basis of Presentation
The accompanying unaudited condensed consolidated financial statements have been prepared in accordance with generally accepted accounting principles in the United States (GAAP) and applicable rules and regulations of the Securities and Exchange Commission (SEC) regarding interim financial reporting. The condensed consolidated financial statements include the results of Workday, Inc. and its wholly-owned subsidiaries. Certain information and note disclosures normally included in the financial statements prepared in accordance with GAAP have been condensed or omitted pursuant to such rules and regulations. In the opinion of our management, the information contained herein reflects all adjustments necessary for a fair presentation of Workday’s results of operations, financial position and cash flows. All such adjustments are of a normal, recurring nature. The results of operations for the three and six months ended July 31, 2015 shown in this report are not necessarily indicative of results to be expected for the full year ending January 31, 2016. The unaudited condensed consolidated financial statements should be read in conjunction with the audited consolidated financial statements in our Annual Report on Form 10-K for the year ended January 31, 2015, filed on March 25, 2015. There have been no changes to our significant accounting policies described in the annual report that have had a material impact on our condensed consolidated financial statements and related notes.
Certain prior year amounts related to cost method investments have been reclassified within Note 6 of the notes to the condensed consolidated financial statements. The reclassifications had no effect on total Other assets as previously reported.
Use of Estimates
The preparation of condensed consolidated financial statements in conformity with GAAP requires us to make certain estimates, judgments and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities as of the date of the condensed consolidated financial statements, as well as the reported amounts of revenues and expenses during the reporting period. These estimates include, but are not limited to, the determination of the relative selling prices for our services, the recoverability of deferred commissions, certain assumptions used in the valuation of equity awards and the fair value of assets acquired and liabilities assumed through business combinations. Actual results could differ from those estimates and such differences could be material to our condensed consolidated financial position and results of operations.
Segment Information
We operate in one operating segment, cloud applications. Operating segments are defined as components of an enterprise about which separate financial information is evaluated regularly by the chief operating decision maker, who is our chief executive officer, in deciding how to allocate resources and assessing performance. Our chief operating decision maker allocates resources and assesses performance based upon discrete financial information at the consolidated level. Since we operate in one operating segment, all required financial segment information can be found in the condensed consolidated financial statements.
Recent Accounting Pronouncements
On May 28, 2014, the FASB issued ASU 2014-9 regarding ASC Topic 606, Revenue from Contracts with Customers. The standard provides principles for recognizing revenue for the transfer of promised goods or services to customers with the consideration to which the entity expects to be entitled in exchange for those goods or services. The guidance will be effective for our fiscal year beginning February 1, 2018. Early adoption is permitted. We are currently evaluating the accounting, transition and disclosure requirements of the standard and cannot currently estimate the financial statement impact of adoption.

7

Table of Contents

In April 2015, the FASB issued Accounting Standards Update No. 2015-03, Interest - Imputation of Interest (Subtopic 835-30): Simplifying the Presentation of Debt Issuance Costs ("ASU 2015-03"). The amendments in ASU 2015-03 require that debt issuance costs related to a recognized debt liability be presented in the balance sheet as a direct deduction from the carrying amount of that debt liability, consistent with debt discounts. ASU 2015-03 is effective for annual and interim periods beginning on or after December 15, 2015. Early adoption is permitted. As of July 31, 2015, we have $8 million of net deferred financing costs that would be reclassified from a long-term asset to a reduction in the carrying amount of our debt.
Note 2. Marketable Securities
At July 31, 2015, marketable securities consisted of the following (in thousands):
 
Amortized
Cost
 
Unrealized
Gains
 
Unrealized
Losses
 
Aggregate
Fair Value
U.S. agency obligations
$
1,380,038

 
$
258

 
$
(40
)
 
$
1,380,256

U.S. treasury securities
115,274

 
29

 
(12
)
 
115,291

U.S. corporate securities
100,928

 
2

 
(64
)
 
100,866

Commercial paper
79,938

 

 

 
79,938

Money market funds
141,243

 

 

 
141,243

 
$
1,817,421

 
$
289

 
$
(116
)
 
$
1,817,594

Included in cash and cash equivalents
$
141,243

 
$

 
$

 
$
141,243

Included in marketable securities
$
1,676,178

 
$
289

 
$
(116
)
 
$
1,676,351

At January 31, 2015, marketable securities consisted of the following (in thousands):
 
Amortized
Cost
 
Unrealized
Gains
 
Unrealized
Losses
 
Aggregate
Fair Value
U.S. agency obligations
$
1,303,829

 
$
422

 
$
(16
)
 
$
1,304,235

U.S. treasury securities
180,559

 
91

 
(1
)
 
180,649

U.S. corporate securities
99,618

 
27

 
(13
)
 
99,632

Commercial paper
89,984

 

 

 
89,984

Money market funds
142,137

 

 

 
142,137

 
$
1,816,127

 
$
540

 
$
(30
)
 
$
1,816,637

Included in cash and cash equivalents
$
257,120

 
$

 
$

 
$
257,120

Included in marketable securities
$
1,559,007

 
$
540

 
$
(30
)
 
$
1,559,517

We do not believe the unrealized losses represent other-than-temporary impairments based on our evaluation of available evidence, which includes our intent to hold these investments to maturity as of July 31, 2015. The unrealized losses on marketable securities which have been in a net loss position for twelve months or greater were not material as of July 31, 2015. We classify our marketable securities as available-for-sale at the time of purchase and reevaluate such classification as of each balance sheet date. We may sell these securities at any time for use in current operations or for other purposes, such as consideration for acquisitions, even if they have not yet reached maturity. As a result, we classify our investments, including securities with maturities beyond twelve months as current assets in the accompanying condensed consolidated balance sheets. Marketable securities on the condensed consolidated balance sheets consist of securities with original maturities at the time of purchase greater than three months and the remainder of the securities is reflected in cash and cash equivalents. During the three and six months ended July 31, 2015, we sold $20 million and $30 million, respectively, of our marketable securities and the realized gains from the sales are immaterial.

8

Table of Contents

Note 3. Deferred Costs
Deferred costs consisted of the following (in thousands):
 
July 31,
2015
 
January 31,
2015
Current:
 
 
 
Deferred professional service costs
$
915

 
$
3,606

Deferred sales commissions
17,990

 
16,865

Total
$
18,905

 
$
20,471

Noncurrent:
 
 
 
Deferred professional service costs
$
801

 
$
1,254

Deferred sales commissions
19,986

 
19,744

Total
$
20,787

 
$
20,998

Note 4. Property and Equipment, Net
Property and equipment, net consisted of the following (in thousands):
 
July 31,
2015
 
January 31,
2015
Computers, equipment and software
$
178,942

 
$
139,569

Computers, equipment and software acquired under capital leases
32,302

 
34,112

Furniture and fixtures
16,837

 
13,082

Leasehold improvements
69,157

 
47,496

 
297,238

 
234,259

Less accumulated depreciation and amortization
(124,537
)
 
(94,123
)
Property and equipment, net
$
172,701

 
$
140,136

Depreciation expense totaled $17 million and $11 million for the three months ended July 31, 2015 and 2014, respectively, and $33 million and $21 million for the six months ended July 31, 2015 and 2014, respectively.
These amounts include depreciation of assets recorded under capital leases of $1 million and $2 million for the three months ended July 31, 2015 and 2014, respectively, and $2 million and $5 million for the six months ended July 31, 2015 and 2014, respectively.
Note 5. Goodwill and Acquisition-related Intangible Assets, Net
Developed technology from acquisitions is typically amortized over a useful life of three years. The future estimated amortization related to the acquired developed technology is $1 million and $2 million for fiscal 2016 and 2017, respectively. Goodwill amounts are not amortized, but rather tested for impairment at least annually during the last three months of the fiscal year.
Goodwill and acquisition-related intangible assets, net consisted of the following (in thousands):
 
July 31,
2015
 
January 31,
2015
Acquired developed technology
$
5,460

 
$
4,200

Customer relationship assets
338

 
338

 
5,798

 
4,538

Less accumulated amortization
(2,775
)
 
(2,071
)
Acquisition-related intangible assets, net
3,023

 
2,467

Goodwill
39,930

 
32,312

Goodwill and acquisition-related intangible assets, net
$
42,953

 
$
34,779


9

Table of Contents

Note 6. Other Assets
Other assets consisted of the following (in thousands):
 
July 31,
2015
 
January 31,
2015
Cost method investments
$
27,892

 
$
12,910

Acquired land leasehold interest, net
9,833

 
9,886

Issuance costs of convertible senior notes, net
7,502

 
8,543

Technology patents, net
3,481

 
3,942

Other
18,207

 
18,400

Total
$
66,915

 
$
53,681

Amortization expense on our land leasehold interest and technology patents was $0.2 million for the three months ended July 31, 2015, $0.3 million for the three months ended July 31,2014 and $0.5 million for each of the six month periods ended July 31, 2015 and 2014.
Note 7. Fair Value Measurements
We measure our financial assets and liabilities at fair value at each reporting period using a fair value hierarchy that requires that we maximize the use of observable inputs and minimize the use of unobservable inputs when measuring fair value. A financial instrument’s classification within the fair value hierarchy is based upon the lowest level of input that is significant to the fair value measurement. Three levels of inputs may be used to measure fair value:
Level 1 — Observable inputs that reflect quoted prices (unadjusted) for identical assets or liabilities in active markets.
Level 2 — Include other inputs that are directly or indirectly observable in the marketplace.
Level 3 — Unobservable inputs that are supported by little or no market activity.
Financial Assets
We value our marketable securities using quoted prices for identical instruments in active markets when available. If we are unable to value our marketable securities using quoted prices for identical instruments in active markets, we value our investments using independent reports that utilize quoted market prices for comparable instruments. We validate, on a sample basis, the derived prices provided by the independent pricing vendors by comparing their assessment of the fair values of our investments against the fair values of the portfolio balances of another third-party professional’s pricing service. To date, all of our marketable securities can be valued using one of these two methodologies.

10

Table of Contents

Based on our valuation of our marketable securities, we concluded that they are classified in either Level 1 or Level 2 and we have no financial assets or liabilities measured using Level 3 inputs. The following tables present information about our assets that are measured at fair value on a recurring basis using the above input categories (in thousands): 
 
Fair Value Measurements as of
July 31, 2015
Description
Level 1
 
Level 2
 
Total
U.S. agency obligations
$

 
$
1,380,256

 
$
1,380,256

U.S. treasury securities
115,291

 

 
115,291

U.S. corporate securities

 
100,866

 
100,866

Commercial paper

 
79,938

 
79,938

Money market funds
141,243

 

 
141,243

 
$
256,534

 
$
1,561,060

 
$
1,817,594

Included in cash and cash equivalents
 
 
 
 
$
141,243

Included in marketable securities
 
 
 
 
$
1,676,351

 
Fair Value Measurements as of
January 31, 2015
Description
Level 1
 
Level 2
 
Total
U.S. agency obligations
$

 
$
1,304,235

 
$
1,304,235

U.S. treasury securities
180,649

 

 
180,649

U.S. corporate securities

 
99,632

 
99,632

Commercial paper

 
89,984

 
89,984

Money market funds
142,137

 

 
142,137

 
$
322,786

 
$
1,493,851

 
$
1,816,637

Included in cash and cash equivalents
 
 
 
 
$
257,120

Included in marketable securities
 
 
 
 
$
1,559,517

Financial Liabilities
The carrying amounts and estimated fair values of financial instruments not recorded at fair value are as follows (in thousands):
 
July 31, 2015
 
January 31, 2015
 
Carrying
Amount
 
Estimated
Fair Value
 
Carrying
Amount
 
Estimated
Fair Value
0.75% Convertible senior notes
$
302,539

 
$
417,594

 
$
295,276

 
$
407,750

1.50% Convertible senior notes
199,506

 
310,469

 
195,225

 
299,063

The difference between the principal amount of the notes, $350 million for the 0.75% convertible senior notes and $250 million for the 1.50% convertible senior notes, and the carrying value represents the unamortized debt discount (see Note 8). The estimated fair value of the convertible senior notes, which we have classified as Level 2 financial instruments, was determined based on the quoted bid price of the convertible senior notes in an over-the-counter market on July 31, 2015 and January 31, 2015.
Based on the closing price of our common stock of $84.33 on July 31, 2015, the if-converted value of the 0.75% convertible senior notes and the if-converted value of the 1.50% convertible senior notes was greater than their respective principal amounts.
Derivative Financial Instruments
We conduct business on a global basis in multiple foreign currencies, subjecting the Company to foreign currency risk. To mitigate this risk, we utilize hedging contracts as described below. We do not enter into any derivatives for trading or speculative purposes.

11

Table of Contents

We are subject to master netting agreements with certain counterparties of the foreign exchange contracts, under which we are permitted to net settle transactions of the same currency with a single net amount payable by one party to the other. It is our policy to present the derivatives gross in the condensed consolidated balance sheets. Our foreign currency forward contracts are not subject to any credit contingent features or collateral requirements and we do not believe we are subject to significant counterparty concentration risk given the short-term nature, volume, and size of the derivative contracts outstanding.
Cash flow hedges
We are exposed to foreign currency fluctuations resulting from customer contracts denominated in foreign currencies. We initiated a hedging program in the first quarter of the current fiscal year by entering into foreign currency forward contracts related to certain customer contracts. We designate these forward contracts as cash flow hedging instruments as the accounting criteria for such designation have been met. The effective portion of the gains or losses resulting from changes in the fair value of these hedges is recorded in Accumulated other comprehensive income (loss) on the condensed consolidated balance sheets and will be subsequently reclassified to the related revenue line item in the condensed consolidated statements of operations in the same period that the underlying revenues are earned. Interest charges on our forward contracts are excluded from the assessment of hedge effectiveness and are recorded as incurred in Other expense, net in the condensed consolidated statements of operations.
As of July 31, 2015, we had foreign currency forward contracts designed as cash flow hedges with a total notional value of $51 million which have maturities not greater than 15 months. The notional value represents the amount that will be bought or sold upon maturity of the forward contract. As of July 31, 2015, the fair value amount of the derivative assets of $1 million is included in Prepaid expenses and other current assets, and the fair value amount of the derivative liabilities of $0.3 million is included in Accrued expenses and other current liabilities on our condensed consolidated balance sheets.
We recognized an unrealized gain of $1 million in Accumulated other comprehensive income (loss) for the effective portion of our derivative instruments during the three and six months ended July 31, 2015. The realized gains reclassified from Accumulated other comprehensive income (loss) to the related revenue line item in the condensed consolidated statements of operations were immaterial for the three and six months ended July 31, 2015.
During the three and six months ended July 31, 2015, all cash flow hedges were considered effective.
Foreign currency forward contracts not designated as hedges
We also enter into foreign currency forward contracts to hedge a portion of our net outstanding monetary assets and liabilities. These forward contracts are not designated as hedging instruments under applicable accounting guidance, and therefore all changes in the fair value of the forward contracts are recorded in Other expense, net in our condensed consolidated statements of operations. These forward contracts are intended to offset the foreign currency gains or losses associated with the underlying monetary assets and liabilities.
As of July 31, 2015 and January 31, 2015, we had outstanding forward contracts with total notional values of $9 million and $10 million, respectively. All contracts have terms of less than 60 days to maturity. The fair value amount of the derivative assets and derivative liabilities was less than $0.1 million, respectively, as of July 31, 2015. The fair value amount of the derivative assets was $0.4 million and the derivative liabilities was less than $0.1 million as of January 31, 2015. These assets and liabilities are included in Prepaid expenses and other current assets and in Accrued expenses and other current liabilities, respectively, on our condensed consolidated balance sheets.
We recognized a loss of less than $0.1 million and a gain of less than $0.1 million during the three and six months ended July 31, 2015, respectively, on derivative instruments not designated as hedging instruments. We recognized a net gain of less than $0.1 million during the three months and six months ended July 31, 2014 on derivative instruments not designated as hedging instruments. Gains or losses on derivative instruments not designated as hedging instruments are recorded within Other expense, net, in our condensed consolidated statements of operations.
Our foreign currency contracts are classified within Level 2 because the valuation inputs are based on quoted prices and market observable data of similar instruments in active markets, such as currency spot and forward rates.
Note 8. Convertible Senior Notes, Net
Convertible Senior Notes
In June 2013, we issued 0.75% convertible senior notes due July 15, 2018 (2018 Notes) with a principal amount of $350 million. The 2018 Notes are unsecured, unsubordinated obligations, and interest is payable in cash in arrears at a fixed rate of 0.75% on January 15 and July 15 of each year. The 2018 Notes mature on July 15, 2018 unless repurchased or converted in accordance with their terms prior to such date. We cannot redeem the 2018 Notes prior to maturity.

12

Table of Contents

Concurrently, we issued 1.50% convertible senior notes due July 15, 2020 (2020 Notes) with a principal amount of $250 million (together with the 2018 Notes, referred to as Notes). The 2020 Notes are unsecured, unsubordinated obligations, and interest is payable in cash in arrears at a fixed rate of 1.50% on January 15 and July 15 of each year. The 2020 Notes mature on July 15, 2020 unless repurchased or converted in accordance with their terms prior to such date. We cannot redeem the 2020 Notes prior to maturity.
The terms of the Notes are governed by Indentures by and between us and Wells Fargo Bank, National Association, as Trustee (the Indentures). Upon conversion, holders of the Notes will receive cash, shares of Class A common stock or a combination of cash and shares of Class A common stock, at our election.
For the 2018 Notes, the initial conversion rate is 12.0075 shares of Class A common stock per $1,000 principal amount, which is equal to an initial conversion price of approximately $83.28 per share of Class A common stock, subject to adjustment. Prior to the close of business on March 14, 2018, the conversion is subject to the satisfaction of certain conditions as described below. For the 2020 Notes, the initial conversion rate is 12.2340 shares of Class A common stock per $1,000 principal amount, which is equal to an initial conversion price of approximately $81.74 per share of Class A common stock, subject to adjustment. Prior to the close of business on March 13, 2020, the conversion is subject to the satisfaction of certain conditions, as described below.
Holders of the Notes who convert their Notes in connection with certain corporate events that constitute a make-whole fundamental change (as defined in the Indentures) are, under certain circumstances, entitled to an increase in the conversion rate. Additionally, in the event of a corporate event that constitutes a fundamental change (as defined in the Indentures), holders of the Notes may require us to repurchase all or a portion of their Notes at a price equal to 100% of the principal amount of the Notes, plus any accrued and unpaid interest.
Holders of the 2018 Notes and 2020 Notes may convert all or a portion of their Notes prior to the close of business on March 14, 2018 for the 2018 Notes and March 13, 2020 for the 2020 Notes, in multiples of $1,000 principal amount, only under the following circumstances, none of which have occurred to date:
if the last reported sale price of Class A common stock for at least twenty trading days during a period of thirty consecutive trading days ending on the last trading day of the immediately preceding calendar quarter is greater than or equal to 130% of the conversion price of the respective Notes on each applicable trading day;
during the five business day period after any five consecutive trading day period in which the trading price per $1,000 principal amount of the respective Notes for each day of that five day consecutive trading day period was less than 98% of the product of the last reported sale price of Class A common stock and the conversion rate of the respective Notes on such trading day; or
upon the occurrence of specified corporate events, as noted in the Indentures.
In accounting for the issuance of the Notes, we separated each of the Notes into liability and equity components. The carrying amounts of the liability components were calculated by measuring the fair value of similar liabilities that do not have associated convertible features. The carrying amount of the equity components representing the conversion option was determined by deducting the fair value of the liability components from the par value of the respective Notes. These differences represent debt discounts that are amortized to interest expense over the respective terms of the Notes. The equity components are not remeasured as long as they continue to meet the conditions for equity classification.
We allocated the total issuance costs incurred to the 2018 Notes and 2020 Notes on a prorated basis using the aggregate principal balances. In accounting for the issuance costs related to the 2018 Notes and 2020 Notes, we allocated the total amount of issuance costs incurred to liability and equity components. Issuance costs attributable to the liability components are being amortized to interest expense over the respective terms of the Notes, and the issuance costs attributable to the equity components were netted against the respective equity components in additional paid-in capital. For the 2018 Notes, we recorded liability issuance costs of $7 million and equity issuance costs of $2 million. Amortization expense for the liability issuance costs was $0.4 million for each of the three month periods ended July 31, 2015 and 2014, and $0.7 million for each of the six month periods ended July 31, 2015 and 2014. For the 2020 Notes, we recorded liability issuance costs of $5 million and equity issuance costs of $2 million. Amortization expense for the liability issuance costs was $0.2 million for each of the three month periods ended July 31, 2015 and 2014, and $0.3 million for each of the six month periods ended July 31, 2015 and 2014.

13

Table of Contents

The Notes, net consisted of the following (in thousands):
 
July 31, 2015
 
January 31, 2015
 
2018 Notes
 
2020 Notes
 
2018 Notes
 
2020 Notes
Principal amounts:
 
 
 
 
 
 
 
 Principal
$
350,000

 
$
250,000

 
$
350,000

 
$
250,000

Unamortized debt discount(1)
(47,461
)
 
(50,494
)
 
(54,724
)
 
(54,775
)
 Net carrying amount
$
302,539

 
$
199,506

 
$
295,276

 
$
195,225

Carrying amount of the equity component(2)
$
74,892

 
$
66,007

 
$
74,892

 
$
66,007

(1) 
Included in the condensed consolidated balance sheets within Convertible senior notes, net and amortized over the remaining lives of the Notes on the straight-line basis as it approximates the effective interest rate method.
(2) 
Included in the condensed consolidated balance sheets within Additional paid-in capital, net of $2 million and $2 million for the 2018 Notes and 2020 Notes, respectively, in equity issuance costs.
As of July 31, 2015, the remaining life of the 2018 Notes and 2020 Notes is approximately 35 months and 59 months, respectively.
The effective interest rates of the liability components of the 2018 Notes and 2020 Notes are 5.75% and 6.25%, respectively. These interest rates were based on the interest rates of similar liabilities at the time of issuance that did not have associated convertible features. The following table sets forth total interest expense recognized related to the 2018 Notes and 2020 Notes (in thousands):
 
Three Months Ended 
 July 31,
 
Six Months Ended 
 July 31,
 
2015
 
2014
 
2015
 
2014
 
2018
Notes
 
2020
Notes
 
2018
Notes
 
2020
Notes
 
2018
Notes
 
2020
Notes
 
2018
Notes
 
2020
Notes
Contractual interest expense
$
657

 
$
937

 
$
657

 
$
937

 
$
1,313

 
$
1,875

 
$
1,313

 
$
1,875

Interest cost related to amortization of debt issuance costs
352

 
169

 
352

 
169

 
704

 
337

 
704

 
337

Interest cost related to amortization of the debt discount
3,658

 
2,157

 
3,454

 
2,027

 
7,264

 
4,281

 
6,859

 
4,022

Notes Hedges
In connection with the issuance of the 2018 Notes and 2020 Notes, we entered into convertible note hedge transactions with respect to our Class A common stock (Purchased Options). The Purchased Options cover, subject to anti-dilution adjustments substantially identical to those in the Notes, approximately 7.3 million shares of our Class A common stock and are exercisable upon conversion of the Notes. The Purchased Options have initial exercise prices that correspond to the initial conversion prices of the 2018 Notes and 2020 Notes, subject to anti-dilution adjustments substantially similar to those in the Notes. The Purchased Options will expire in 2018 for the 2018 Notes and in 2020 for the 2020 Notes, if not earlier exercised. The Purchased Options are intended to offset potential economic dilution to our Class A common stock upon any conversion of the Notes. The Purchased Options are separate transactions and are not part of the terms of the Notes.
We paid an aggregate amount of $144 million for the Purchased Options, which is included in Additional paid-in capital in the condensed consolidated balance sheets.
Warrants
In connection with the issuance of the Notes, we also entered into warrant transactions to sell warrants (the Warrants) to acquire, subject to anti-dilution adjustments, up to approximately 4.2 million shares in July 2018 and 3.1 million shares in July 2020 of our Class A common stock at an exercise price of $107.96 per share. If the Warrants are not exercised on their exercise dates, they will expire. If the market value per share of our Class A common stock exceeds the applicable exercise price of the Warrants, the Warrants will have a dilutive effect on our earnings per share assuming that we are profitable. The Warrants are separate transactions, and are not part of the terms of the Notes or the Purchased Options.
We received aggregate proceeds of $93 million from the sale of the Warrants, which is recorded in Additional paid-in capital in the condensed consolidated balance sheets.

14

Table of Contents

Note 9. Commitments and Contingencies
Leases
We lease office space under non-cancelable operating leases in the U.S. and other countries with various expiration dates. Certain of our office leases are with an affiliate of our Chairman, David Duffield, who is also a significant stockholder (see Note 14).
The facility lease agreements generally provide for rental payments on a graduated basis and for options to renew, which could increase future minimum lease payments if exercised. We recognize rent expense on a straight-line basis over the period in which we benefit from the lease and have accrued for rent expense incurred but not paid. Rent expense totaled $7 million and $5 million for the three months ended July 31, 2015 and 2014, respectively, and $13 million and $9 million for the six months ended July 31, 2015 and 2014, respectively.
In January 2014, we entered into a 95-year lease for a 6.9-acre parcel of vacant land in Pleasanton, California, under which we paid $2 million for base rent from commencement through December 31, 2020. Annual rent payments of $0.2 million plus increases based on increases in the consumer price index begin on January 1, 2021 and continue through the end of the lease. If construction does not commence by December 31, 2015, we will be required to make additional payments to the lessor, ranging from $0.2 million to $1 million based on the length of the delay.
Legal Matters
We are a party to various legal proceedings and claims which arise in the ordinary course of business. In our opinion, there was not at least a reasonable possibility that we had incurred a material loss, or a material loss in excess of a recorded accrual, with respect to such loss contingencies.
Note 10. Common Stock and Stockholders’ Equity
Common Stock
As of July 31, 2015, there were 111 million shares of Class A common stock and 81 million shares of Class B common stock outstanding. The rights of the holders of Class A common stock and Class B common stock are identical, except with respect to voting and conversion. Each share of Class A common stock is entitled to one vote per share and each share of Class B common stock is entitled to ten votes per share. Each share of Class B common stock can be converted into a share of Class A common stock at any time at the option of the holder.
Employee Equity Plans
Our 2012 Equity Incentive Plan (EIP) serves as the successor to our 2005 Stock Plan (together with the EIP, the Stock Plans). Pursuant to the terms of the EIP, the share reserve increased by 9 million shares on March 25, 2015, and as of July 31, 2015, we had approximately 57 million shares of Class A common stock available for future grants.
We also have a 2012 Employee Stock Purchase Plan (ESPP). Under the ESPP, eligible employees are granted options to purchase shares at the lower of 85% of the fair market value of the stock at the time of grant or 85% of the fair market value at the time of exercise. Options to purchase shares are granted twice yearly on or about June 1 and December 1 and exercisable on or about the succeeding November 30 and May 31, respectively, of each year. Pursuant to the terms of the ESPP, the share reserve increased by 2 million shares on March 25, 2015. On May 29, 2015, 0.2 million shares of Class A common shares were purchased under the ESPP at a weighted-average price of $67.08 per share, resulting in cash proceeds of $17 million. As of July 31, 2015, 5 million shares of Class A common stock were available for issuance under the ESPP.

15

Table of Contents

Stock Options
The Stock Plans provide for the issuance of incentive and nonstatutory options to employees and non-employees. We have also issued nonstatutory options outside of the Stock Plans. Options issued under the Stock Plans generally are exercisable for periods not to exceed 10 years and generally vest over five years. A summary of information related to stock option activity during the six months ended July 31, 2015 is as follows (in millions, except share and per share data):
 
Outstanding
Stock
Options
 
Weighted-
Average
Exercise
Price
 
Aggregate
Intrinsic
Value
Balance as of January 31, 2015
16,663,557

 
$
4.06

 
$
1,256

Stock option grants

 

 
 
Stock options exercised
(1,927,417
)
 
3.22

 
 
Stock options canceled
(113,883
)
 
9.51

 
 
Balance as of July 31, 2015
14,622,257

 
$
4.13

 
$
1,173

Vested and expected to vest as of July 31, 2015
14,445,622

 
$
4.08

 
$
1,159

Exercisable as of July 31, 2015
12,253,357

 
$
3.36

 
$
992

As of July 31, 2015, there was a total of $27 million in unrecognized compensation cost related to unvested stock options which is expected to be recognized over a weighted-average period of approximately 1.7 years.
Common Stock Subject to Repurchase
The Stock Plans allow for the early exercise of stock options for certain individuals as determined by the board of directors. We have the right to purchase at the original exercise price any unvested (but issued) common shares during the repurchase period following termination of services of an employee. The consideration received for an exercise of an option is considered to be a deposit of the exercise price and the related dollar amount is recorded as a liability. The shares and liabilities are reclassified into equity as the awards vest. As of both July 31, 2015 and January 31, 2015, we had $4 million recorded in liabilities related to early exercises of stock options.
Restricted Stock Awards
The Stock Plans provide for the issuance of restricted stock awards to employees. Restricted stock awards generally vest over five years. Under the EIP, 1 million restricted awards of Class B common stock are outstanding with weighted average grant date fair value of $12.93, all of which are subject to forfeiture as of July 31, 2015. During the three months ended July 31, 2015, 0.1 million shares of restricted stock awards vested with weighted average grant date fair value of $12.73.
As of July 31, 2015, there was a total of $8 million in unrecognized compensation cost related to unvested restricted stock awards, which is expected to be recognized over a weighted-average period of approximately 2.3 years.
Restricted Stock Units
The Stock Plans provide for the issuance of restricted stock units ("RSUs") to employees. RSUs generally vest over four years. A summary of information related to RSU activity during the six months ended July 31, 2015 is as follows: 
 
Number of  Shares
 
Weighted-Average
Grant Date Fair Value
Balance as of January 31, 2015
6,409,132

 
$
76.93

RSUs granted
4,330,223

 
87.21

RSUs vested
(1,017,060
)
 
78.02

RSUs forfeited
(259,170
)
 
80.66

Balance as of July 31, 2015
9,463,125

 
$
81.42


As of July 31, 2015, there was a total of $676 million in unrecognized compensation cost related to unvested RSUs, which is expected to be recognized over a weighted-average period of approximately 3.1 years.

16

Table of Contents

Performance-based Restricted Stock Awards
As of July 31, 2015. there are 0.1 million shares of performance-based restricted stock units (PRSUs) outstanding which were granted to all employees and include performance conditions related to company-wide goals and service conditions. We expect to grant additional shares related to this program for employees hired in fiscal 2016. These PRSU awards will vest if the performance conditions are achieved for the fiscal year ended January 31, 2016 and if the individual employee continues to provide service through the vesting date of March 15, 2016.
As of July 31, 2015, there was a total of $8 million in unrecognized compensation cost related to these performance-based restricted stock units, which will be recognized over a weighted-average period of approximately 8 months.
Note 11. Other Expense, Net
Other expense, net consisted of the following (in thousands):
 
Three Months Ended 
 July 31,
 
Six Months Ended 
 July 31,
 
2015
 
2014
 
2015
 
2014
Interest income
$
998

 
$
669

 
$
1,953

 
$
1,364

Interest expense (1)
(7,952
)
 
(7,765
)
 
(15,837
)
 
(15,473
)
Gain from sale of cost method investment
3,220

 

 
3,220

 

Other income (expense)
(45
)
 
143

 
(351
)
 
157

Other expense, net
$
(3,779
)
 
$
(6,953
)
 
$
(11,015
)
 
$
(13,952
)
(1) 
Interest expense includes the contractual interest expense related to the 2018 Notes and 2020 Notes and non-cash interest related to amortization of the debt discount and debt issuance costs (See Note 8).
Note 12. Income Taxes
We compute the year-to-date income tax provision by applying the estimated annual effective tax rate to the year-to-date pre-tax income or loss and adjust for discrete tax items in the period. We reported a tax benefit of $1 million for the six months ended July 31, 2015, and a tax provision of $1 million for the six months ended July 31,2014. The income tax benefit for the six months ended July 31, 2015 consisted of:
$2 million provision primarily resulting from income tax expense in profitable foreign jurisdictions and U.S. income tax expense on estimated taxable income before considering the realization of excess tax benefits from stock based compensation;
$3 million tax benefit from the release of an acquired uncertain tax position including interest and penalties due to the lapse of statute of limitations.
The tax expense of $1 million for the six months ended July 31, 2014 was primarily attributable to the income tax expense in profitable foreign jurisdictions.
We are subject to income tax audits in the U.S. and foreign jurisdictions. We record liabilities related to uncertain tax positions. We believe that we have provided adequate reserves for income tax uncertainties in all open tax years. Due to our history of tax losses, all years remain open to tax audit.
On July 27, 2015, the United States Tax Court issued a taxpayer-favorable opinion with respect to Altera’s litigation with the Internal Revenue Service (“IRS”). The litigation relates to the treatment of share-based compensation expense in an inter-company cost-sharing arrangement with the taxpayer’s foreign subsidiary for fiscal years 2004 through 2007. In its opinion, the Court accepted Altera’s position of excluding share-based compensation in its cost sharing arrangement and concluded that the related IRS Regulations were invalid. The Court has yet to issue its decision, the timing of which is uncertain. Once the Court’s decision is issued, the IRS has 90 days to decide whether to appeal the Court’s decision.
We are monitoring this case and its potential favorable implications to the Company’s cost-sharing arrangement. We currently estimate that this court case will not have a material impact to our effective tax rate and income tax expense due to our current full valuation allowance position. 


17

Table of Contents

Note 13. Net Loss Per Share
Basic net loss per share attributable to common stockholders is computed by dividing the net loss attributable to common stockholders by the weighted-average number of shares of common stock outstanding during the period. Diluted net loss per share is computed by giving effect to all potential shares of common stock, including our outstanding stock options, outstanding warrants, common stock related to unvested early exercised stock options, common stock related to unvested restricted stock awards and convertible senior notes to the extent dilutive, and common stock issuable pursuant to the ESPP. Basic and diluted net loss per share was the same for each period presented, as the inclusion of all potential common shares outstanding would have been anti-dilutive.
The net loss per share attributable to common stockholders is allocated based on the contractual participation rights of the Class A common shares and Class B common shares as if the loss for the year had been distributed. As the liquidation and dividend rights are identical, the net loss attributable to common stockholders is allocated on a proportionate basis.
We consider shares issued upon the early exercise of options subject to repurchase and unvested restricted stock awards to be participating securities because holders of such shares have non-forfeitable dividend rights in the event of our declaration of a dividend for common shares. In future periods, to the extent we are profitable, we will subtract earnings allocated to these participating securities from net income to determine net income attributable to common stockholders.
The following table presents the calculation of basic and diluted net loss attributable to common stockholders per share (in thousands, except per share data):
 
Three Months Ended July 31,
 
Six Months Ended July 31,
 
2015
 
2014
 
2015
 
2014
 
Class A
 
Class B
 
Class A
 
Class B
 
Class A
 
Class B
 
Class A
 
Class B
Net loss per share, basic and diluted:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Numerator:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Allocation of distributed net loss
$
(40,382
)
 
$
(29,039
)
 
$
(36,528
)
 
$
(32,687
)
 
$
(75,376
)
 
$
(55,603
)
 
$
(66,916
)
 
$
(61,688
)
Denominator:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Weighted-average common shares outstanding
110,150

 
79,210

 
97,275

 
87,044

 
108,411

 
79,971

 
95,602

 
88,131

Basic and diluted net loss per share
$
(0.37
)
 
$
(0.37
)
 
$
(0.38
)
 
$
(0.38
)
 
$
(0.70
)
 
$
(0.70
)
 
$
(0.70
)
 
$
(0.70
)
The anti-dilutive securities excluded from the weighted-average shares used to calculate the diluted net loss per common share were as follows (in thousands):
 
As of July 31,
 
2015
 
2014
Outstanding common stock options
14,622

 
18,577

Shares subject to repurchase
892

 
1,435

Unvested restricted stock awards, units, and PRSUs
10,227

 
7,411

Shares related to the convertible senior notes
7,261

 
7,261

Shares subject to warrants related to the issuance of convertible senior notes
7,261

 
7,261

Shares issuable pursuant to the ESPP
264

 
257

 
40,527

 
42,202


Note 14. Related-Party Transactions
We currently lease certain office space from an affiliate of our Chairman, Mr. Duffield, adjacent to our corporate headquarters in Pleasanton, California under various lease agreements. The term of the agreements is 10 years and the total rent due under the agreements is $6 million for the fiscal year ended January 31, 2016, and $65 million in total. Rent expense under these agreements was $2 million and $1 million for the three months ended July 31, 2015 and 2014, and $3 million and $2 million for the six months ended July 31, 2015 and 2014, respectively.

18

Table of Contents

Note 15. Geographic Information
Revenue by geography is generally based on the address of the customer as defined in our master subscription agreement. The following tables set forth revenue by geographic area (in thousands):
 
Three Months Ended 
 July 31,
 
Six Months Ended 
 July 31,
 
2015
 
2014
 
2015
 
2014
United States
$
237,058

 
$
156,288

 
$
447,339

 
$
288,817

International
45,638

 
30,492

 
86,314

 
57,700

Total
$
282,696

 
$
186,780

 
$
533,653

 
$
346,517

No single country other than the United States had revenues greater than 10% of total revenues for the three and six months ended July 31, 2015 and 2014. No customer individually accounted for more than 10% of our accounts receivable, net as of July 31, 2015 or January 31, 2015.


19

Table of Contents

SPECIAL NOTE REGARDING FORWARD-LOOKING STATEMENTS
This report contains forward-looking statements. All statements contained in this report other than statements of historical fact, including statements regarding our future results of operations and financial position, our business strategy and plans, and our objectives for future operations, are forward-looking statements. The words “believe,” “may,” “will,” “estimate,” “continue,” “anticipate,” “intend,” “expect,” “seek,” “strive,” and similar expressions are intended to identify forward-looking statements. We have based these forward-looking statements largely on our current expectations and projections about future events and trends that we believe may affect our financial condition, results of operations, business strategy, short-term and long-term business operations and objectives, and financial needs. These forward-looking statements are subject to a number of risks, uncertainties and assumptions, including those described in the “Risk Factors” section. Moreover, we operate in a very competitive and rapidly changing environment. New risks emerge from time to time. It is not possible for our management to predict all risks, nor can we assess the impact of all factors on our business or the extent to which any factor, or combination of factors, may cause actual results to differ materially from those contained in any forward-looking statements we may make. In light of these risks, uncertainties and assumptions, the future events and trends discussed in this report may not occur and actual results could differ materially and adversely from those anticipated or implied by the forward-looking statements.
You should not rely upon forward-looking statements as predictions of future events. The events and circumstances reflected in the forward-looking statements may not be achieved or occur. Although we believe that the expectations reflected in the forward-looking statements are reasonable, we cannot guarantee future results, levels of activity, performance, or achievements. We are under no duty to update any of these forward-looking statements after the date of this report or to conform these statements to actual results or revised expectations.

20

Table of Contents

ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
You should read the following discussion of our financial condition and results of operations in conjunction with the condensed consolidated financial statements and notes thereto included elsewhere in this report. The following discussion contains forward-looking statements that reflect our plans, estimates and beliefs. Our actual results could differ materially from those discussed in the forward-looking statements. Factors that could cause or contribute to these differences include those discussed below and elsewhere in this report, as well as in the section entitled “Risk Factors.”
Overview
Workday provides financial management, human capital management, and analytics applications designed for the world's largest companies, educational institutions, and government agencies. We offer innovative and adaptable technology focused on the consumer Internet experience and cloud delivery model. Our applications are designed for global enterprises to manage complex and dynamic operating environments. We provide our customers highly adaptable, accessible and reliable applications to manage critical business functions that enable them to optimize their financial and human capital resources.
We were founded in 2005 to deliver cloud applications to global enterprises. Our applications are designed around the way people work today – in an environment that is global, collaborative, fast-paced and mobile. Our cycle of frequent updates has facilitated rapid innovation and the introduction of new applications throughout our history. We began offering our Human Capital Management (HCM) application in 2006. Since then we have continued to invest in innovation and have consistently introduced new services to our customers, including our Financial Management application in 2007, our Procurement and Employee Expense Management applications in 2008, our Payroll and mobile applications in 2009, our Talent Management application in 2010, our native iPad application and Workday integration platform in 2011, our Time Tracking and Grants Management applications in 2012, Recruiting in 2014, and Insight Applications and Professional Services Automation in 2015.
We offer Workday applications to our customers on an enterprise-wide subscription basis, typically with three-year terms and with subscription fees largely based on the size of the customer’s workforce. We generally recognize revenues from subscription fees ratably over the term of the contract. We currently derive a substantial majority of our subscription services revenues from subscriptions to our HCM application. We market our applications through our direct sales force.
We have achieved significant growth in a relatively short period of time. Our diverse customer base includes large, global companies and our direct sales force generally targets organizations with more than 1,000 workers. A substantial majority of our growth comes from new customers. Our current financial focus is on growing our revenues and expanding our customer base. While we are incurring losses today, we strive to invest in a disciplined manner across all of our functional areas to sustain continued near-term revenue growth and support our long-term initiatives. Our operating expenses have increased significantly in absolute dollars in recent periods, primarily due to the significant growth of our employee population. We had approximately 4,500 and approximately 3,150 employees as of July 31, 2015 and 2014, respectively.
We intend to continue investing for long-term growth. We have invested, and expect to continue to invest, heavily in our application development efforts to deliver additional compelling applications and to address customers’ evolving needs. In addition, we plan to continue to expand our ability to sell our applications globally, particularly in Europe and Asia, through investments in product development and customer support to address the business needs of local markets, increasing our sales and marketing organizations, adding new offices, and expanding our ecosystem of services partners to support local deployments. We expect to make further significant investments in our data center infrastructure in fiscal 2016 as we plan for future growth. We are also investing in personnel to service our growing customer base. These investments will increase our costs on an absolute basis in the near-term. Many of these investments will occur in advance of experiencing any direct benefit from them and will make it difficult to determine if we are allocating our resources efficiently. We expect our product development, sales and marketing, and general and administrative expenses as a percentage of total revenues to decrease over time as we grow our revenues, and we anticipate that we will gain economies of scale by increasing our customer base without direct incremental development costs and by utilizing more of the capacity of our data centers.
Since inception, we have invested heavily in our professional services organization to help ensure that customers successfully deploy and adopt our applications. Additionally, we continue to expand our professional services partner ecosystem to further support our customers. We believe our investment in professional services, as well as partners building consulting practices around Workday, will drive additional customer subscriptions and continued growth in revenues. In addition, over time we expect professional services revenues and the cost of professional services as a percentage of total revenues will decline as we increasingly rely on our partners to deploy Workday applications and as the number of our existing customers continues to grow.

21

Table of Contents

Components of Results of Operations
Revenues
We primarily derive our revenues from subscription services fees and professional services fees. Subscription services revenues primarily consist of fees that give our customers access to our cloud applications, which include routine customer support at no additional cost. Professional services fees include deployment services, optimization services, and training.
Subscription services revenues accounted for 79% of our total revenues during the three months ended July 31, 2015 and represented 97% of our total unearned revenue as of July 31, 2015. Subscription services revenues are driven primarily by the number of customers, the number of workers at each customer, the number of applications subscribed to by each customer, and the price of our applications.
The mix of the applications to which a customer subscribes can affect our financial performance due to price differentials in our applications. Compared to our other offerings, our HCM application has been available for a longer period of time, is more established in the marketplace and has benefited from continued enhancements of the functionality over a longer period of time, all of which help us to improve our pricing for that application. However, new products or services offerings by competitors in the future could impact the mix and pricing of our offerings.
Subscription services fees are recognized ratably as revenues over the contract term beginning on the date the application is made available to the customer, which is generally within one week of contract signing. Our subscription contracts typically have a term of three years and are non-cancelable. We generally invoice our customers in advance, in annual installments. Amounts that have been invoiced are initially recorded as unearned revenue. Amounts that have not yet been invoiced represent backlog and are not reflected in our condensed consolidated financial statements.
The majority of our consulting engagements are billed on a time and materials basis, and revenues are typically recognized as the services are performed. We offer a number of training options intended to support our customers in configuring, using and administering our services. In some cases, we supplement our consulting teams by subcontracting resources from our service partners and deploying them on customer engagements. As Workday’s professional services organization and the Workday-related consulting practices of our partner firms continue to develop, we expect the partners to increasingly contract directly with our subscription customers. As a result of this trend, and the increase of our subscription services revenues, we expect professional services revenues as a percentage of total revenues to decline over time.
Costs and Expenses
Costs of subscription services revenues. Costs of subscription services revenues consist primarily of employee-related expenses related to hosting our applications and providing customer support, the costs of data center capacity, and depreciation of computer equipment and software.
Costs of professional services revenues. Costs of professional services revenues consist primarily of employee-related expenses associated with these services, the cost of subcontractors and travel. 
Product development. Product development expenses consist primarily of employee-related costs. We continue to focus our product development efforts on adding new features and applications, increasing the functionality and enhancing the ease of use of our cloud applications.
Sales and marketing. Sales and marketing expenses consist primarily of employee-related costs, sales commissions, marketing programs and travel. Marketing programs consist of advertising, events, corporate communications, brand building and product marketing activities. Commissions earned by our sales force that can be associated specifically with a non-cancelable subscription contract are generally deferred and amortized over the same period that revenues are recognized for the related non-cancelable contract.
General and administrative. General and administrative expenses consist of employee-related costs for finance and accounting, legal, human resources and management information systems personnel, legal costs, professional fees and other corporate expenses.

22

Table of Contents

Results of Operations
Revenues
Our total revenues for the three and six months ended July 31, 2015 and 2014 were as follows: 
 
Three Months Ended 
 July 31,
 
 
Six Months Ended 
 July 31,
 
 
 
2015
 
2014
 
% Change
2015
 
2014
 
% Change
 
(in thousands, except percentages)
 
 
Revenues:
 
 
 
 
 
 
 
 
 
 
Subscription services
$
223,742

 
$
143,652

 
56%
$
424,735

 
$
267,059

 
59%
Professional services
58,954

 
43,128

 
37%
108,918

 
79,458

 
37%
Total revenues
$
282,696

 
$
186,780

 
51%
$
533,653

 
$
346,517

 
54%
Total revenues were $283 million for the three months ended July 31, 2015, compared to $187 million during the prior year period, an increase of $96 million, or 51%. Subscription services revenues were $224 million for the three months ended July 31, 2015, compared to $144 million for the prior year period, an increase of $80 million, or 56%. The increase in subscription services revenues was due primarily to the recognition of revenue for an increased number of customer contracts as compared to the prior year period. Professional services revenues were $59 million for the three months ended July 31, 2015, compared to $43 million for the prior year period, an increase of $16 million, or 37%. The increase in professional services revenues was due primarily to the addition of new customers and a greater number of customers requesting deployment and integration services.
Total revenues were $534 million for the six months ended July 31, 2015, compared to $347 million during the prior year period, an increase of $187 million, or 54%. Subscription services revenues were $425 million for the six months ended July 31, 2015, compared to $267 million for the prior year period, an increase of $158 million, or 59%. The increase in subscription services revenues was due primarily to the recognition of revenue for an increased number of customer contracts as compared to the prior year period. Professional services revenues were $109 million for the six months ended July 31, 2015, compared to $79 million for the prior year period, an increase of $30 million, or 37%. The increase in professional services revenues was due primarily to the addition of new customers and a greater number of customers requesting deployment and integration services.
Core Operating Expenses
We use the non-GAAP financial measure of core operating expenses to understand and compare operating results across accounting periods, for internal budgeting and forecasting purposes, for short- and long-term operating plans, and to evaluate our financial performance and the ability of operations to generate cash. We believe that core operating expenses reflects our ongoing business in a manner that allows for meaningful period-to-period comparisons and analysis of trends in our business, as it excludes expenses that are not reflective of ongoing operating results. We also believe that core operating expenses provide useful information to investors and others in understanding and evaluating our operating results and future prospects in the same manner as management and in comparing financial results across accounting periods and to those of peer companies.
The following discussion of our core operating expenses and the components of our core operating expenses highlights the factors that we focus upon in evaluating our operating margin and operating expenses. The increases or decreases in operating expenses discussed in this section do not include changes relating to share-based compensation expenses, and certain other expenses, which consist of employer payroll tax-related items on employee stock transactions and amortization of acquisition-related intangible assets.

23

Table of Contents

Reconciliation of our core operating expenses to the nearest GAAP measure, total operating expenses, is as follows:
 
Three Months Ended July 31, 2015
 
Core
Operating
Expenses(1)
 
Share-Based
Compensation
Expenses
 
Other
Operating
Expenses
 
Total
Operating
Expenses
 
(in thousands, except percentages)
Costs of subscription services
$
32,038

 
$
3,173

 
$
76

 
$
35,287

Costs of professional services
51,478

 
5,144

 
170

 
56,792

Product development
85,645

 
28,632

 
1,068

 
115,345

Sales and marketing
92,881

 
13,222

 
327

 
106,430

General and administrative
21,373

 
14,593

 
516

 
36,482

Total costs and expenses
$
283,415

 
$
64,764

 
$
2,157

 
$
350,336

Operating loss
$
(719
)
 
$
(64,764
)
 
$
(2,157
)
 
$
(67,640
)
Operating margin
 %
 
(23
)%
 
(1
)%
 
(24
)%
 
 
Three Months Ended July 31, 2014
 
Core
Operating
Expenses(1)
 
Share-Based
Compensation
Expenses
 
Other
Operating
Expenses
 
Total
Operating
Expenses
 
(in thousands, except percentages)
Costs of subscription services
$
22,723

 
$
1,608

 
$
42

 
$
24,373

Costs of professional services
37,702

 
3,519

 
46

 
$
41,267

Product development
59,939

 
16,737

 
788

 
$
77,464

Sales and marketing
70,908

 
7,377

 
238

 
$
78,523

General and administrative
14,614

 
11,541

 
767

 
$
26,922

Total costs and expenses
$
205,886

 
$
40,782

 
$
1,881

 
$
248,549

Operating loss
$
(19,106
)
 
$
(40,782
)
 
$
(1,881
)
 
$
(61,769
)
Operating margin
(10
)%
 
(22
)%
 
(1
)%
 
(33
)%
 
Six Months Ended July 31, 2015
 
Core
Operating
Expenses(1)
 
Share-Based
Compensation
Expenses
 
Other
Operating
Expenses
 
Total
Operating
Expenses
 
(in thousands, except percentages)
Costs of subscription services
$
61,586

 
$
5,221

 
$
262

 
$
67,069

Costs of professional services
93,802

 
8,598

 
524

 
102,924

Product development
161,856

 
49,443

 
3,381

 
214,680

Sales and marketing
178,780

 
21,587

 
958

 
201,325

General and administrative
40,407

 
27,189

 
1,103

 
68,699

Total costs and expenses
$
536,431

 
$
112,038

 
$
6,228

 
$
654,697

Operating loss
$
(2,778
)
 
$
(112,038
)
 
$
(6,228
)
 
$
(121,044
)
Operating margin
(1
)%
 
(21
)%
 
(1
)%
 
(23
)%

24

Table of Contents

 
Six Months Ended July 31, 2014
 
Core
Operating
Expenses(1)
 
Share-Based
Compensation
Expenses
 
Other
Operating
Expenses
 
Total
Operating
Expenses
 
(in thousands, except percentages)
Costs of subscription services
$
43,081

 
$
2,663

 
$
88

 
$
45,832

Costs of professional services
71,375

 
5,717

 
135

 
77,227

Product development
113,560

 
27,605

 
1,470

 
142,635

Sales and marketing
132,050

 
14,129

 
511

 
146,690

General and administrative
28,085

 
19,542

 
358

 
47,985

Total costs and expenses
$
388,151

 
$
69,656

 
$
2,562

 
$
460,369

Operating loss
$
(41,634
)
 
$
(69,656
)
 
$
(2,562
)
 
$
(113,852
)
Operating margin
(12
)%
 
(20
)%
 
(1
)%
 
(33
)%
(1) 
See “Non-GAAP Financial Measures” below for further information.
Core operating margins
Core operating margins, calculated using GAAP revenues and core operating expenses, improved from (10)% for the three months ended July 31, 2014 to (0.3)% for the three months ended July 31, 2015, and from (12)% for the six months ended July 31, 2014 to (0.5)% for the six months ended July 31, 2015. The improvements in our core operating margins in the three and six months ended July 31, 2015 were primarily due to higher subscription services revenues, higher professional services revenues and improvements in operating leverage.
In evaluating our results, we generally focus on core operating expenses. We believe that our core operating expenses reflect our ongoing business in a manner that allows meaningful period-to-period comparisons. Our core operating expenses are reconciled to the most comparable GAAP measure, “total operating expenses,” in the table above.
Core operating expenses increased by $78 million, or 38% and $148 million, or 38% for the three and six months ended July 31, 2015, respectively, compared to the prior year periods. The increases were primarily due to higher employee-related costs driven by higher headcount.
Costs of subscription services
Core operating expenses in costs of subscription services were $32 million for the three months ended July 31, 2015, compared to $23 million for the prior year period, an increase of $9 million, or 39%. The increase was primarily due to an increase of $3 million in employee-related costs driven by higher headcount, an increase of $3 million in depreciation expense related to our data centers, an increase of $1 million in facilities and IT expenses and an increase of $1 million in service contracts expense to expand data center capacity.
Core operating expenses in costs of subscription services were $62 million for the six months ended July 31, 2015, compared to $43 million for the prior year period, an increase of $19 million, or 44%. The increase was primarily due to an increase of $6 million in employee-related costs driven by higher headcount, an increase of $6 million in depreciation expense related to our data centers, an increase of $3 million in facilities and IT expenses and an increase of $2 million in service contracts expense to expand data center capacity.
We expect that core operating expenses in costs of subscription services will continue to increase in absolute dollars as we improve and expand our data center capacity and operations.
Costs of professional services
Core operating expenses in costs of professional services were $51 million for the three months ended July 31, 2015, compared to $38 million for the prior year period, an increase of $13 million, or 34%. This increase was primarily due to increases of $8 million to staff our deployment and integration engagements and $1 million in facility and IT-related expenses.
Core operating expenses in costs of professional services were $94 million for the six months ended July 31, 2015, compared to $71 million for the prior year period, an increase of $23 million, or 32%. This increase was primarily due to increases of $17 million to staff our deployment and integration engagements and $3 million in facility and IT-related expenses.

25

Table of Contents

Over time, we expect costs of professional services as a percentage of total revenues to continue to decline as we increasingly rely on third parties to deploy our applications and as the number of our customers continues to grow. For fiscal 2016, we anticipate professional services margins to be lower than fiscal 2015 as we invest in building our partnership ecosystem in new market segments and geographies.
Product development
Core operating expenses in product development were $86 million for the three months ended July 31, 2015, compared to $60 million for the prior year period, an increase of $26 million, or 43%. The increase was primarily due to increases of $18 million in employee-related costs driven by higher headcount and $5 million in facility and IT-related expenses.
Core operating expenses in product development were $162 million for the six months ended July 31, 2015, compared to $114 million for the prior year period, an increase of $48 million, or 42%. The increase was primarily due to increases of $34 million in employee-related costs driven by higher headcount and $9 million in facility and IT-related expenses.
We expect that product development expenses will continue to increase in absolute dollars as we improve and extend our applications and develop new technologies.
Sales and marketing
Core operating expenses in sales and marketing were $93 million for the three months ended July 31, 2015, compared to $71 million for the prior year period, an increase of $22 million, or 31%. The increase was primarily due to increases of $13 million in employee-related costs driven by higher headcount and higher commissionable sales volume, $4 million in advertising, marketing and event costs and $3 million in facility and IT-related expenses.
Core operating expenses in sales and marketing were $179 million for the six months ended July 31, 2015, compared to $132 million for the prior year period, an increase of $47 million, or 36%. The increase was primarily due to increases of $27 million in employee-related costs driven by higher headcount and higher commissionable sales volume, $10 million in advertising, marketing and event costs, $5 million in facility and IT-related expenses and $3 million in travel expenses.
We expect that sales and marketing expenses will continue to increase in absolute dollars as we continue to invest in the expansion of our domestic and international selling and marketing activities to build brand awareness and attract new customers.
General and administrative
Core operating expenses in general and administrative were $21 million for the three months ended July 31, 2015, compared to $15 million for the prior year period, an increase of $6 million, or 40%. The increase was primarily due to $3 million in higher employee-related costs driven by higher headcount and $3 million in higher consulting fees.
Core operating expenses in general and administrative were $40 million for the six months ended July 31, 2015, compared to the $28 million for the prior year period, an increase of $12 million, or 43%. The increase was primarily due to $7 million in higher employee-related costs driven by higher headcount and $5 million in higher professional fees.
We expect general and administrative expenses will continue to increase in absolute dollars as we further invest in our infrastructure and support our international expansion.
Share-Based Compensation Expenses
Share-based compensation expenses were $65 million and $112 million for the three and six months ended July 31, 2015, respectively, compared to $41 million and $70 million for the prior year periods, respectively. The increase in share-based compensation expenses was primarily due to grants of RSUs to existing and new employees during the six months ended July 31, 2015. During the three and six months ended July 31, 2015, the realized excess tax benefits related to share-based compensation were immaterial.
Other Operating Expenses
Other operating expenses include employer payroll tax-related items on employee stock transactions of $2 million and $6 million for the three and six months ended July 31, 2015, respectively, and $2 million for each of the respective prior year periods. In addition, other operating expenses included amortization of acquisition-related intangible assets of $0.4 million and $0.7 million for the three and six months ended July 31, 2015, respectively, and $0.3 million and $0.5 million for the three and six months ended July 31, 2014, respectively.    

26

Table of Contents

Other Expense, Net
Other expense, net, decreased $3 million for the three and six months ended July 31, 2015 as compared to the respective prior year periods. The decrease is primarily due to the gain on sale of a cost method investment in the current quarter of $3 million. The contractual cash interest expense related to the 2018 and 2020 Notes was $2 million and $3 million for the three and six months ended July 31, 2015, respectively, and $2 million and $3 million for the three and six months ended July 31, 2014, respectively. The non-cash interest expense related to amortization of the debt discount and amortization of debt issuance costs with respect to the 2018 and 2020 Notes was $6 million and $12 million for the three and six months ended July 31, 2015, respectively, and $6 million and $12 million for the three and six months ended July 31, 2014, respectively.
Liquidity and Capital Resources
As of July 31, 2015, our principal sources of liquidity were cash, cash equivalents and marketable securities totaling $1.9 billion, which were held for working capital purposes. Our cash equivalents and marketable securities are comprised primarily of U.S. agency obligations, U.S. treasury securities, U.S. corporate securities, commercial paper, and money market funds.
We have financed our operations primarily through sales of equity securities, customer payments, and issuance of debt. Our future capital requirements will depend on many factors, including our customer growth rate, subscription renewal activity, the timing and extent of development efforts, the expansion of sales and marketing activities, the introduction of new and enhanced services offerings, the continuing market acceptance of our services, the possible construction on the leased land in Pleasanton, California and acquisition activities. We may enter into arrangements to acquire or invest in complementary businesses, services, technologies or intellectual property rights in the future. We also may choose to seek additional equity or debt financing.
Our cash flows for the three and six months ended July 31, 2015 and 2014 were as follows:
 
Three Months Ended 
 July 31,
 
Six Months Ended 
 July 31,
 
2015
 
2014
 
2015
 
2014
 
(in thousands)
Net cash provided by (used in):
 
 
 
 
 
 
 
Operating activities
$
15,511

 
$
(9,011
)
 
$
109,570

 
$
12,686

Investing activities
(73,725
)
 
18,192

 
(198,073
)
 
(334,174
)
Financing activities
18,518

 
7,467

 
21,051

 
2,772

Effect of exchange rate changes
(210
)
 
(15
)
 
(162
)
 
24

Net increase (decrease) in cash and cash equivalents
$
(39,906
)
 
$
16,633

 
$
(67,614
)
 
$
(318,692
)
In evaluating our performance internally, we focus on long-term, sustainable growth in free cash flows. We define free cash flows, a non-GAAP financial measure, as net cash provided by (used in) operating activities minus purchases of property and equipment, property and equipment acquired under capital leases and purchases of other (non-acquisition-related) intangible assets. See “Non-GAAP Financial Measures” below for further information.
 
Three Months Ended 
 July 31,
 
Six Months Ended 
 July 31,
 
2015
 
2014
 
2015
 
2014
 
(in thousands)
Net cash provided by (used in) operating activities
$
15,511

 
$
(9,011
)
 
$
109,570

 
$
12,686

Purchases of property and equipment
(25,792
)
 
(28,409
)
 
(55,972
)
 
(38,282
)
Free cash flows
$
(10,281
)
 
$
(37,420
)
 
$
53,598

 
$
(25,596
)
 
 
 
 
 
 
 
 
 
Trailing Twelve Months Ended
July 31,
 
 
 
 
 
2015
 
2014
 
 
 
 
 
(in thousands)
 
 
 
 
Net cash provided by (used in) operating activities
$
198,887

 
$
54,555

 
 
 
 
Purchases of property and equipment
(121,336
)
 
(67,380
)
 
 
 
 
Purchases of other intangible assets

 
(15,000
)
 
 
 
 
Free cash flows
$
77,551

 
$
(27,825
)
 
 
 
 

27

Table of Contents

Operating Activities
We use net cash provided by operating activities as a key financial metric. Cash provided by operating activities was $16 million for the three months ended July 31, 2015, and cash used in operating activities was $9 million for the three months ended July 31, 2014. The improvement in cash flow provided by operating activities was primarily due to increased cash collections driven by growth in our customer sales contracts, partially offset by increases in our headcount and other operational expenses.
Net cash provided by operating activities was $110 million and $13 million for the six months ended July 31, 2015 and 2014, respectively. The improvement in cash flow was primarily due to increased cash collections driven by growth in our customer sales contracts, partially offset by increases in our headcount and other operational expenses.
Investing Activities
Cash used in investing activities for the three months ended July 31, 2015 was $74 million, which was primarily the result of the timing of purchases and maturities of marketable securities, capital expenditures of $26 million, purchases of cost method investments of $16 million, and a net cash outflow of $8 million related to an acquisition in May 2015. These payments were partially offset by proceeds of $20 million from the sale of available-for-sale securities, and proceeds of $4 million from the sale of a cost method investment. We expect capital expenditures will be approximately $150 million for the year ending January 31, 2016. We expect that these capital outlays will largely be used to expand the infrastructure of our data centers and to build out additional office space to support our growth. We acquired a leasehold interest in land in Pleasanton, California in January 31, 2014. We are actively evaluating construction alternatives for this site and therefore have not yet factored any related development costs into our expected capital expenditures described above.
Cash provided by investing activities for the three months ended July 31, 2014 was $18 million, which was primarily the result of the timing of purchases and maturities of marketable securities and the $8 million proceeds from the sale of one available-for-sale security, partially offset by capital expenditures of $28 million and a $10 million cost method investment.
Cash used in investing activities for the six months ended July 31, 2015 was $198 million, which was primarily the result of the timing of purchases and maturities of marketable securities, capital expenditures of $56 million, purchases of cost method investments of $16 million, and a net cash outflow of $8 million related to an acquisition. These payments were partially offset by proceeds of $30 million from the sale of available-for-sale securities, and proceeds of $4 million from the sale of a cost method investment.
Cash used in investing activities for the six months ended July 31, 2014 was $334 million, which was primarily the result of the timing of purchases and maturities of marketable securities, capital expenditures of $38 million and a $10 million cost method investment. These payments were partially offset by proceeds of $8 million from the sale of available-for-sale securities.
Financing Activities
For the three months ended July 31, 2015, cash provided by financing activities was $19 million, which was primarily due to $19 million of proceeds from the issuance of common stock from employee equity plans, partially offset by $1 million in principal payments on our capital lease obligations.
For the three months ended July 31, 2014, cash provided by financing activities was $7 million, which was primarily due to $15 million of proceeds from the issuance of common stock from employee equity plans, partially offset by $3 million of Class A common share repurchases for tax withholdings on vesting of restricted stock and $4 million in principal payments on our capital lease obligations.
For the six months ended July 31, 2015, cash provided by financing activities was $21 million, which was primarily due to $23 million of proceeds from the issuance of common stock from employee equity plans, partially offset by $2 million in principal payments on our capital lease obligations.
For the six months ended July 31, 2014, cash provided by financing activities was $3 million, which was primarily due to $18 million of proceeds from the issuance of common stock from employee equity plans, partially offset by $8 million of Class A common share repurchases for tax withholdings on vesting of restricted stock and $7 million in principal payments on our capital lease obligations.
Free Cash Flows
In addition to net cash provided by (used in) operating activities, management uses free cash flows as a key financial metric. Free cash flows improved by $27 million to $(10) million for the three months ended July 31, 2015, compared to $(37) million for the prior year period. The improvement was primarily due to increased sales and the related cash collections and decreased capital expenditures resulting from $19 million of property and equipment acquired but not paid for as of July 31, 2015, partially offset by higher operating expenses, driven primarily by increased headcount.

28

Table of Contents

Free cash flows increased by $80 million to $54 million for the six months ended July 31, 2015, compared to $(26) million for the prior year period. The improvement was primarily due to increased sales and the related cash collections, partially offset by increased capital expenditures and higher operating expenses, driven primarily by increased headcount.
Non-GAAP Financial Measures
Regulation S-K Item 10(e), “Use of non-GAAP financial measures in Commission filings,” defines and prescribes the conditions for use of non-GAAP financial information. Our measures of core operating expenses, core operating margin and free cash flows each meet the definition of a non-GAAP financial measure.
Core Operating Expenses
We define core operating expenses as our total operating expenses excluding the following components, which we believe are not reflective of our ongoing operational expenses. In each case, for the reasons set forth below, management believes that excluding the component provides useful information to investors and others in understanding and evaluating our operating results and future prospects in the same manner as management, in comparing financial results across accounting periods and to those of peer companies and to better understand the long-term performance of our core business.
Share-Based Compensation Expenses. Although share-based compensation is an important aspect of the compensation of our employees and executives, management believes it is useful to exclude share-based compensation in order to better understand the long-term performance of our core business and to facilitate comparison of our results to those of peer companies. For restricted stock unit awards, the amount of share-based compensation expenses is not reflective of the value ultimately received by the grant recipients. Moreover, determining the fair value of certain of the share-based instruments we utilize involves a high degree of judgment and estimation and the expense recorded may bear little resemblance to the actual value realized upon the vesting or future exercise of the related share-based awards. Unlike cash compensation, the value of stock options and shares offered under the ESPP, which are elements of our ongoing share-based compensation expenses, is determined using a complex formula that incorporates factors, such as market volatility and forfeiture rates, that are beyond our control.
Other Operating Expenses. Other operating expenses include employer payroll tax-related items on employee stock transactions and amortization of acquisition-related intangible assets. The amount of employer payroll tax-related items on share-based compensation is dependent on our stock price and other factors that are beyond our control and do not correlate to the operation of the business. For business combinations, we generally allocate a portion of the purchase price to intangible assets. The amount of the allocation is based on estimates and assumptions made by management and is subject to amortization. The amount of purchase price allocated to intangible assets and the term of its related amortization can vary significantly and are unique to each acquisition and thus we do not believe it is reflective of our ongoing operations.
Free Cash Flows
We define free cash flows as net cash provided by (used in) operating activities minus purchases of property and equipment, property and equipment acquired under capital leases and purchases of other (non-acquisition-related) intangible assets. We use free cash flows as a measure of financial progress in our business, as it balances operating results, cash management and capital efficiency. When calculating free cash flows, we subtract the gross value of all equipment paid for or acquired under capital leases, so that we can evaluate our progress on free cash flows independent of our capital financing decisions. We believe information regarding free cash flows provides investors and others with an important perspective on the cash available to make strategic acquisitions and investments, to fund ongoing operations and to fund other capital expenditures.
Limitations on the Use of Non-GAAP Financial Measures
A limitation of our non-GAAP financial measures of core operating expenses, core operating margin and free cash flows is that they do not have uniform definitions. Our definitions will likely differ from the definitions used by other companies, including peer companies, and therefore comparability may be limited. Thus, our non-GAAP measures of core operating expenses, core operating margin and free cash flows should be considered in addition to, not as a substitute for, or in isolation from, measures prepared in accordance with GAAP. Additionally, in the case of share-based compensation, if we did not pay out a portion of compensation in the form of share-based compensation and related employer payroll tax-related items, the cash salary expense included in costs of revenues and operating expenses would be higher, which would affect our cash position. Further, the non-GAAP measure of core operating expenses has certain limitations because it does not reflect all items of expense that affect our operations and are reflected in the GAAP measure of total operating expenses.

29

Table of Contents

We compensate for these limitations by reconciling core operating expenses to the most comparable GAAP financial measure and reviewing these measures in conjunction with GAAP financial information. We encourage investors and others to review our financial information in its entirety, not to rely on any single financial measure and to view our non-GAAP financial measures in conjunction with the most comparable GAAP financial measures.
See “Results of Operations—Core Operating Expenses” for a reconciliation of the non-GAAP financial measure of core operating expenses to the most comparable GAAP measure, “total operating expenses,” for the three and six months ended July 31, 2015 and 2014.
See “Liquidity and Capital Resources” for a reconciliation of free cash flows to the most comparable GAAP measure, “Net cash provided by (used in) operating activities,” for the three and six months ended July 31, 2015 and 2014.
Commitments
Our principal commitments primarily consist of obligations under leases for office space and co-location facilities for data center capacity and our development and test data center, as well as computer equipment. As of July 31, 2015, the future non-cancelable minimum payments under operating leases were $198 million. During the remainder of the year ended January 31, 2016, we anticipate leasing additional office space near our headquarters and in various other locations around the world to support our growth. In addition, our existing lease agreements often provide us with an option to renew. We expect our future operating lease obligations will increase as we expand our operations.
In January 2014, we entered into a 95-year lease for a 6.9-acre parcel of vacant land in Pleasanton, California, under which we paid $2 million for base rent from commencement through December 31, 2020. Annual rent payments of $0.2 million plus increases based on increases in the consumer price index begin on January 1, 2021 and continue through the end of the lease. If construction does not commence by December 31, 2015, we will be required to make additional payments to the lessor, ranging from $0.2 million to $1 million based on the length of the delay.
We are not required to make principal payments under the Notes prior to maturity. If the Notes are not converted to Class A common stock prior to their maturity dates, we are required to repay $350 million in principal on July 15, 2018 and $250 million in principal on July 15, 2020. We are also required to make interest payments on a semi-annual basis at the interest rates described in Note 8 of the notes to the condensed consolidated financial statements.
We do not consider outstanding purchase orders to be purchase commitments as they represent authorizations to purchase rather than binding agreements.
Off-Balance Sheet Arrangements
Through July 31, 2015, we did not have any relationships with unconsolidated organizations or financial partnerships, such as structured finance or special purpose entities that would have been established for the purpose of facilitating off-balance sheet arrangements or other contractually narrow or limited purposes.
Critical Accounting Policies and Estimates
Our condensed consolidated financial statements are prepared in accordance with GAAP. The preparation of these condensed consolidated financial statements requires us to make certain estimates and assumptions that affect the reported amounts of assets, liabilities, revenues, costs and expenses, and related disclosures. On an ongoing basis, we evaluate our estimates and assumptions. Our actual results may differ from these estimates under different assumptions or conditions.
During the six months ended July 31, 2015, there were no significant changes to our critical accounting policies and estimates as described in financial statements contained in the Annual Report on Form 10-K for the year ended January 31, 2015 filed with the Securities and Exchange Commission (SEC) on March 25, 2015.

30

Table of Contents

ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Foreign Currency Exchange Risk
We transact business globally in multiple currencies. As a result, our results of operations and cash flows are subject to fluctuations due to changes in foreign currency exchange rates. Our most significant currency exposures are the Euro and British Pound Sterling. Due to the relative size of our international operations to date and the fact that the majority of our international contracts are currently in U.S. dollars, our foreign currency exposure has been fairly limited. We anticipate that our exposure to foreign currency fluctuations will increase over time, and, as a result, we initiated a hedging program focused on certain currencies in fiscal 2015.
Interest Rate Sensitivity
We had cash, cash equivalents and marketable securities totaling $1.9 billion as of July 31, 2015. Cash equivalents and marketable securities were invested primarily in U.S. agency obligations, U.S. treasury securities, corporate securities, commercial paper, and money market funds. The cash, cash equivalents and marketable securities are held for working capital purposes. Our investments are made for capital preservation purposes. We do not enter into investments for trading or speculative purposes.
Our cash equivalents and our portfolio of marketable securities are subject to market risk due to changes in interest rates. Fixed rate securities may have their market value adversely affected due to a rise in interest rates, while floating rate securities may produce less income than expected if interest rates fall. Due in part to these factors, our future investment income may fluctuate due to changes in interest rates or we may suffer losses in principal if we are forced to sell securities that decline in market value due to changes in interest rates. However, because we classify our marketable securities as “available for sale,” no gains or losses are recognized due to changes in interest rates unless such securities are sold prior to maturity or declines in fair value are determined to be other-than-temporary.
An immediate increase of 100-basis points in interest rates would have resulted in a $7 million market value reduction in our investment portfolio as of July 31, 2015. All of our investments earn less than 100-basis points and as a result, an immediate decrease of 100-basis points in interest rates would have increased the market value by $2 million as of July 31, 2015. This estimate is based on a sensitivity model that measures market value changes when changes in interest rates occur. Fluctuations in the value of our investment securities caused by a change in interest rates (gains or losses on the carrying value) are recorded in other comprehensive income, and are realized only if we sell the underlying securities.
Market Risk and Market Interest Risk
In June 2013, we issued $350 million of 2018 Notes and $250 million of 2020 Notes. Holders may convert the Notes prior to maturity upon the occurrence of certain circumstances. Upon conversion, holders of the 2018 Notes and 2020 Notes will receive cash, shares of Class A common stock or a combination of cash and shares of Class A common stock, at our election.
Concurrently with the issuance of the Notes, we entered into separate note hedge and warrant transactions. These separate transactions were completed to reduce the potential economic dilution from the conversion of the Notes.
Our Notes have fixed annual interest rates at 0.75% and 1.50% and, therefore, we do not have economic interest rate exposure on our Notes. However, the values of the Notes are exposed to interest rate risk. Generally, the fair market value of our fixed interest rate Notes will increase as interest rates fall and decrease as interest rates rise. In addition, the fair values of the 2018 Notes and the 2020 Notes are affected by our stock price. The carrying values of our 2018 Notes and 2020 Notes were $303 million and $200 million, respectively, as of July 31, 2015. These represent the liability component of the principal balance of our Notes as of July 31, 2015. The total estimated fair values of the 2018 Notes and 2020 Notes at July 31, 2015 were $418 million and $310 million, respectively, and the fair value was determined based on the quoted bid price of the Notes in an over-the-counter market as of the last day of trading for the three months ended at July 31, 2015, which were $119.31 and $124.19, respectively. For further information, see Note 8 of the notes to condensed consolidated financial statements.

31

Table of Contents

ITEM 4. CONTROLS AND PROCEDURES
(a) Evaluation of Disclosure Controls and Procedures
Under the supervision and with the participation of our management, including our principal executive officer and principal financial officer, we conducted an evaluation of the effectiveness of the design and operation of our disclosure controls and procedures, as defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934, as amended, (the Exchange Act), as of the end of the period covered by this report (Evaluation Date).
In designing and evaluating our disclosure controls and procedures, management recognizes that any disclosure controls and procedures, no matter how well designed and operated, can provide only reasonable assurance of achieving the desired control objectives. In addition, the design of disclosure controls and procedures must reflect the fact that there are resource constraints and that management is required to apply its judgment in evaluating the benefits of possible controls and procedures relative to their costs.
Based on management’s evaluation, our principal executive officer and principal financial officer concluded that our disclosure controls and procedures are designed to, and are effective to, provide assurance at a reasonable level that the information we are required to disclose in reports that we file or submit under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in SEC and forms, and that such information is accumulated and communicated to our management, including our principal executive officer and principal financial officer, as appropriate, to allow timely decisions regarding required disclosures.
(b) Changes in Internal Control Over Financial Reporting
Under the supervision and with the participation of our management, including our principal executive officer and principal financial officer, we conducted an evaluation of any changes in our internal control over financial reporting (as such term is defined in Rules 13a-15(f) and 15d-15(f) under the Exchange Act) that occurred during our most recently completed fiscal quarter. Based on that evaluation, our principal executive officer and principal financial officer concluded that there has not been any material change in our internal control over financial reporting during the quarter covered by this report that materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.

32

Table of Contents

PART II. OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
In the ordinary course of business, we are involved in various legal proceedings and claims related to alleged infringement of third-party patents and other intellectual property rights, commercial, employment and other claims.
We have been, and may in the future be, put on notice and/or sued by third parties for alleged infringement of their proprietary rights, including patent infringement. We evaluate these claims and lawsuits with respect to their potential merits, our potential defenses and counterclaims, and the expected effect on us. Our technologies may be subject to injunction if they are found to infringe the rights of a third party. In addition, many of our subscription agreements require us to indemnify our customers for third-party intellectual property infringement claims, which could increase the cost to us of an adverse ruling on such a claim.
The outcome of any litigation, regardless of its merits, is inherently uncertain. Any intellectual property claims and other lawsuits, and the disposition of such claims and lawsuits, could be time-consuming and expensive to resolve, divert management attention from executing our business plan, lead to attempts on the part of other parties to seek similar claims and, in the case of intellectual property claims, require us to change our technology, change our business practices and/or pay monetary damages or enter into short- or long-term royalty or licensing agreements.
In general, the resolution of a legal matter could prevent us from offering our services to others, could be material to our financial condition or cash flows, or both, or could otherwise adversely affect our operating results.
We make a provision for a liability relating to legal matters when it is both probable that a liability has been incurred and the amount of the loss can be reasonably estimated. These provisions are reviewed at least quarterly and adjusted to reflect the impacts of negotiations, settlements, rulings, advice of legal counsel and other information and events pertaining to a particular matter. In management’s opinion, resolution of these matters is not expected to have a material adverse impact on our condensed consolidated results of operations, cash flows or financial position. However, depending on the nature and timing of any such dispute, an unfavorable resolution of a matter could materially affect our future results of operations or cash flows, or both, of a particular quarter.

33

Table of Contents

ITEM 1A. RISK FACTORS
Investing in our securities involves a high degree of risk. You should consider carefully the risks and uncertainties described below, together with all of the other information in this report, including the condensed consolidated financial statements and the related notes included elsewhere in this report, before making an investment decision. The risks and uncertainties described below are not the only ones we face. Additional risks and uncertainties that we are unaware of, or that we currently believe are not material, may also become important factors that materially and adversely affect our business. If any of the following risks actually occurs, our business operations, financial condition, results of operations, and prospects could be materially and adversely affected. The market price of our securities could decline due to the materialization of these or any other risks, and you could lose part or all of your investment.
Risk Factors Related to Our Business
If our security measures are breached or unauthorized access to customer data is otherwise obtained, our applications may be perceived as not being secure, customers may reduce the use of or stop using our applications and we may incur significant liabilities.
Our applications involve the storage and transmission of our customers’ proprietary information, including personal or identifying information regarding their employees, customers and suppliers, as well as their finance and payroll data. As a result, unauthorized or excessive access or security breaches could result in the loss of information, litigation, indemnity obligations and other liabilities. While we have security measures in place designed to protect customer information and prevent data loss and other security breaches, if these measures are breached as a result of third-party action, employee error, malfeasance or otherwise, and someone obtains unauthorized access to our customers’ data, our reputation could be damaged, our business may suffer and we could incur significant liabilities. Because the techniques used to obtain unauthorized access or sabotage systems change frequently and generally are not identified until they are launched against a target, we may be unable to anticipate these techniques or to implement adequate preventative measures. Any or all of these issues could negatively affect our ability to attract new customers, cause existing customers to elect to terminate or not renew their subscriptions, result in reputational damage, cause us to issue refunds or service credits to customers for prepaid and unused subscription services, or result in lawsuits, regulatory fines or other action or liabilities, which could adversely affect our operating results.
We depend on data centers and computing infrastructure operated by third parties and any disruption in these operations could adversely affect our business.
We host our applications and serve all of our customers from data centers located in Ashburn, Virginia; Lithia Springs, Georgia; Portland, Oregon; Dublin, Ireland; and Amsterdam, the Netherlands. While we control and have access to our servers and all of the components of our network that are located in our external data centers, we do not control the operation of these facilities. The owners of our data center facilities have no obligation to renew their agreements with us on commercially reasonable terms, or at all. If we are unable to renew these agreements on commercially reasonable terms, or if one of our data center operators is acquired, we may be required to transfer our servers and other infrastructure to new data center facilities, and we may incur significant costs and possible service interruption in connection with doing so.
In addition, we rely upon Amazon Web Services (AWS), which provides a distributed computing infrastructure platform for business operations, to operate certain aspects of our services, such as environments for development testing, training and sales demonstrations. Given this, along with the fact that we cannot easily switch our AWS operations to another cloud provider, any disruption of or interference with our use of AWS would impact our operations and our business could be adversely impacted.
Problems faced by our third-party data center operations, with the telecommunications network providers with whom we or they contract, or with the systems by which our telecommunications providers allocate capacity among their customers, including us, or problems faced by AWS, could adversely affect the experience of our customers. Our third-party data center operators could decide to close their facilities without adequate notice. In addition, any financial difficulties, such as bankruptcy, faced by our third-party data center operators or any of the service providers with whom we or they contract may have negative effects on our business, the nature and extent of which are difficult to predict. Additionally, if our data centers or AWS are unable to keep up with our needs for capacity, this could have an adverse effect on our business. Any changes in third-party service levels at our data centers or at AWS or any errors, defects, disruptions, or other performance problems with our applications could adversely affect our reputation and may damage our customers’ stored files or result in lengthy interruptions in our services. Interruptions in our services might adversely affect our reputation and operating results, cause us to issue refunds or service credits to customers for prepaid and unused subscription services, subject us to potential liabilities, result in contract terminations, or adversely affect our renewal rates.

34

Table of Contents

Furthermore, our financial management application is essential to our customers’ financial projections, reporting and compliance programs, particularly customers who are public reporting companies. Any interruption in our service may affect the availability, accuracy or timeliness of these and as a result could damage our reputation, cause our customers to terminate their use of our applications, require us to indemnify our customers against certain losses and prevent us from gaining additional business from current or future customers.
If we fail to manage our technical operations infrastructure, or experience service outages or delays in the deployment of our applications, we may be subject to liabilities and our reputation and operating results may be adversely affected.
We have experienced significant growth in the number of users, transactions and data that our operations infrastructure supports. We seek to maintain sufficient excess capacity in our operations infrastructure to meet the needs of all of our customers. We also seek to maintain excess capacity to facilitate the rapid provision of new customer deployments and the expansion of existing customer deployments. In addition, we need to properly manage our technological operations infrastructure in order to support version control, changes in hardware and software parameters, the evolution of our applications and to reduce infrastructure latency associated with dispersed geographic locations. However, the provision of new hosting infrastructure requires significant lead time. If we do not accurately predict our infrastructure requirements, our existing customers may experience service outages. If our operations infrastructure fails to scale, customers may experience delays as we seek to obtain additional capacity.
We have experienced, and may in the future experience, system disruptions, outages and other performance problems. These problems may be caused by a variety of factors, including infrastructure changes, human or software errors, viruses, security attacks (internal and external), fraud, spikes in customer usage and denial of service issues. In some instances, we may not be able to identify the cause or causes of these performance problems within an acceptable period of time. Our customer agreements typically provide service level commitments on a monthly basis. If we are unable to meet the stated service level commitments or suffer extended periods of unavailability for our applications, we may be contractually obligated to issue refunds or service credits to customers for prepaid and unused subscription services, or we could face contract terminations. Any extended service outages could result in customer losses, and adversely affect our reputation, revenues and operating results.
Catastrophic events may disrupt our business.
Our corporate headquarters are located in Pleasanton, California and we have data centers located in Ashburn, Virginia; Lithia Springs, Georgia; Portland, Oregon; Sacramento, California; Dublin, Ireland; and Amsterdam, the Netherlands. We also rely on AWS’s distributed computing infrastructure platform. The west coast of the United States contains active earthquake zones and the southeast is subject to seasonal hurricanes. Additionally, we rely on our network and third-party infrastructure and enterprise applications, internal technology systems and our website for our development, marketing, operational support, hosted services and sales activities. In the event of a major earthquake, hurricane or catastrophic event such as fire, power loss, telecommunications failure, cyber-attack, war or terrorist attack, we may be unable to continue our operations and may endure system interruptions, reputational harm, delays in our application development, lengthy interruptions in our services, breaches of data security and loss of critical data, all of which could have an adverse effect on our operating results.
Privacy concerns and laws or other domestic or foreign regulations may reduce the effectiveness of our applications and adversely affect our business.
Our customers can use our applications to collect, use and store personal or identifying information regarding their employees, customers and suppliers. National and local governments and agencies in the countries in which our customers operate have adopted, are considering adopting, or may adopt laws and regulations regarding the collection, use, storage and disclosure of personal information obtained from consumers and individuals. These laws are particularly stringent in Europe. If Workday employees fail to adhere to adequate data protection practices around the usage of our customer’s personal data, it may damage our reputation and brand. In addition, the affected customers or government authorities could initiate legal or regulatory action against us in connection with such incidents, which could result in significant fines, penalties and liabilities.
The costs of compliance with, and other burdens imposed by, privacy laws and regulations that are applicable to the businesses of our customers may adversely affect our customers’ ability and willingness to process, handle, store, use and transmit demographic and personal information of their employees, customers and suppliers, which could limit the use, effectiveness and adoption of our applications and reduce overall demand. Even the perception of privacy concerns, whether or not valid, may inhibit market adoption, effectiveness or use of our applications.
In addition to government activity, privacy advocacy groups and the technology and other industries are considering various new, additional or different self-regulatory standards that may place additional burdens on us. If the processing of personal information were to be curtailed in this manner, our software applications would be less effective, which may reduce demand for our applications and adversely affect our business.

35

Table of Contents

We have experienced rapid growth. If we fail to manage our growth effectively, we may be unable to execute our business plan, maintain high levels of service and operational controls or adequately address competitive challenges.
We have experienced, and are continuing to experience, a period of rapid growth in our customers, headcount and operations. In particular, we grew from approximately 300 employees as of December 31, 2008 to approximately 4,500 employees as of July 31, 2015, and have also significantly increased the size of our customer base. We anticipate that we will significantly expand our operations and headcount in the near term, and will continue to expand our customer base. This growth has placed, and future growth will place, a significant strain on our management, general and administrative resources and operational infrastructure. Our success will depend in part on our ability to manage this growth effectively and to scale our operations. To manage the expected growth of our operations and personnel, we will need to continue to improve our operational, financial and management controls and our reporting systems and procedures. As we continue to grow, we also need to ensure that our policies and procedures evolve to reflect our current operations and are appropriately communicated to and observed by employees, and that we appropriately manage our corporate information assets, including confidential and proprietary information. Failure to effectively manage growth could result in difficulty or delays in deploying customers, declines in quality or customer satisfaction, increases in costs, difficulties in introducing new features or other operational difficulties, and any of these difficulties could adversely impact our business performance and results of operations.
We depend on our senior management team and the loss of one or more key employees could adversely affect our business.
Our success depends largely upon the continued services of our executive officers. We also rely on our leadership team in the areas of product development, marketing, sales, services and general and administrative functions, and on mission-critical individual contributors in product development. From time to time, there may be changes in our executive management team resulting from the hiring or departure of executives, which could disrupt our business. We do not have employment agreements with our executive officers or other key personnel that require them to continue to work for us for any specified period and they could terminate their employment with us at any time. The loss of one or more of our executive officers or key employees and any failure to develop an appropriate succession plan for these persons could have a serious adverse effect on our business.
An inability to attract and retain highly skilled employees could adversely affect our business and our future growth prospects.
To execute our growth plan, we must attract and retain highly qualified personnel, and our managers must be successful in hiring employees who are a good cultural fit and have the competencies to succeed at Workday. Competition for these personnel is intense, especially for engineers with high levels of experience in designing and developing software and Internet-related services and senior sales executives. From time to time, we have experienced, and we expect to continue to experience, difficulty in hiring and retaining employees with appropriate qualifications, and may not be able to fill positions in desired geographic areas or at all.
Many of the companies with which we compete for experienced personnel have greater resources than we have and some of these companies may offer greater compensation packages. Particularly in the San Francisco Bay Area, job candidates and existing employees carefully consider the value of the stock awards they receive in connection with their employment. If the perceived value of our stock awards declines, or if the mix of equity and cash compensation that we offer is unattractive, it may adversely affect our ability to recruit and retain highly skilled employees. Job candidates may also be threatened with legal action by their existing employers if we hire them, which could have a chilling effect on hiring and result in a diversion of our time and resources. We must also continue to retain and motivate existing employees through our compensation practices, company culture and career development opportunities. If we fail to attract new personnel or to retain our current personnel, our business and future growth prospects could be adversely affected.
If we cannot maintain our corporate culture, we could lose the innovation, teamwork and passion that we believe contribute to our success, and our business may be harmed.
We believe that a critical component of our success has been our corporate culture, as reflected in our core values: employees, customer service, innovation, integrity and fun. We have invested substantial time and resources in building our team. As we continue to grow and develop the infrastructure associated with being a public company, we will need to maintain our corporate culture among a larger number of employees. Any failure to preserve our culture could negatively affect our future success, including our ability to retain and recruit personnel and to effectively focus on and pursue our corporate objectives.

36

Table of Contents

The markets in which we participate are intensely competitive, and if we do not compete effectively, our operating results could be adversely affecte