Edgar Filing: Workday, Inc.

Document

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, 2017



¨	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, smaller reporting company, or an emerging growth company. See the definitions of large accelerated filer, accelerated filer, smaller reporting company, and emerging growth 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	¨
		Emerging growth company	¨

If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. ¨

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 July 31, 2017, there were approximately 208 million shares of the registrant’s common stock outstanding.

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Workday, Inc.



		Page No.

PART I. FINANCIAL INFORMATION

Item 1.	Financial Statements (unaudited):

	Condensed Consolidated Balance Sheets as of July 31, 2017 and January 31, 2017	3

	Condensed Consolidated Statements of Operations for the Three and Six Months ended July 31, 2017 and 2016	4

	Condensed Consolidated Statements of Comprehensive Loss for the Three and Six Months ended July 31, 2017 and 2016	5

	Condensed Consolidated Statements of Cash Flows for the Three and Six Months ended July 31, 2017 and 2016	6

	Notes to Condensed Consolidated Financial Statements	8

Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations	26

Item 3.	Quantitative and Qualitative Disclosures About Market Risk	39

Item 4.	Controls and Procedures	40

PART II. OTHER INFORMATION

Item 1.	Legal Proceedings	41

Item 1A.	Risk Factors	42

Item 2.	Unregistered Sales of Equity Securities and Use of Proceeds	58

Item 3.	Defaults Upon Senior Securities	58

Item 4.	Mine Safety Disclosures	58

Item 5.	Other Information	58

Item 6.	Exhibits	59

	Signatures	60

	Exhibit Index	61

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PART I. FINANCIAL INFORMATION

ITEM 1. FINANCIAL STATEMENTS

Workday, Inc.

Condensed Consolidated Balance Sheets

(in thousands)

(unaudited)



	July 31, 2017			January 31, 2017
	July 31, 2017			*As Adjusted
Assets
Current assets:
Cash and cash equivalents	$	748,599		$	539,923
Marketable securities	1,349,191			1,456,822
Trade and other receivables, net	370,557			409,780
Deferred costs	54,015			51,330
Prepaid expenses and other current assets	63,862			66,590
Total current assets	2,586,224			2,524,445
Property and equipment, net	438,754			365,877
Deferred costs, noncurrent	117,736			117,249
Acquisition-related intangible assets, net	39,110			48,787
Goodwill	158,540			158,354
Other assets	66,763			53,570
Total assets	$	3,407,127		$	3,268,282
Liabilities and stockholders’ equity
Current liabilities:
Accounts payable	$	39,948		$	26,824
Accrued expenses and other current liabilities	80,410			61,582
Accrued compensation	105,229			110,625
Unearned revenue	1,118,565			1,086,212
Current portion of convertible senior notes, net	332,422			—
Total current liabilities	1,676,574			1,285,243
Convertible senior notes, net	216,038			534,423
Unearned revenue, noncurrent	104,178			135,331
Other liabilities	39,940			36,677
Total liabilities	2,036,730			1,991,674
Stockholders’ equity:
Common stock	208			202
Additional paid-in capital	2,945,596			2,681,200
Accumulated other comprehensive income (loss)	(22,197		)	2,071
Accumulated deficit	(1,553,210		)	(1,406,865		)
Total stockholders’ equity	1,370,397			1,276,608
Total liabilities and stockholders’ equity	$	3,407,127		$	3,268,282


*	See Note 2 for a summary of adjustments.

See Notes to Condensed Consolidated Financial Statements

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Workday, Inc.

Condensed Consolidated Statements of Operations

(in thousands, except per share data)

(unaudited)



	Three Months Ended July 31,						Six Months Ended July 31,
	2017			2016			2017			2016
	2017			*As Adjusted			2017			*As Adjusted
Revenues:
Subscription services	$	434,527		$	306,070		$	834,263		$	586,238
Professional services	90,793			67,587			170,918			135,096
Total revenues	525,320			373,657			1,005,181			721,334
Costs and expenses ⁽¹⁾:
Costs of subscription services	65,931			51,379			125,729			100,579
Costs of professional services	92,264			66,473			169,177			125,900
Product development	221,103			161,886			417,542			303,664
Sales and marketing	171,952			134,899			327,661			262,518
General and administrative	55,699			45,705			106,901			86,888
Total costs and expenses	606,949			460,342			1,147,010			879,549
Operating loss	(81,629		)	(86,685		)	(141,829		)	(158,215		)
Other income (expense), net	938			(21,193		)	(725		)	(27,031		)
Loss before provision for (benefit from) income taxes	(80,691		)	(107,878		)	(142,554		)	(185,246		)
Provision for (benefit from) income taxes	1,841			(65		)	4,022			1,070
Net loss	$	(82,532	)	$	(107,813	)	$	(146,576	)	$	(186,316	)
Net loss per share, basic and diluted	$	(0.40	)	$	(0.55	)	$	(0.71	)	$	(0.95	)
Weighted-average shares used to compute net loss per share, basic and diluted	207,028			197,223			205,453			195,887



⁽¹⁾ Costs and expenses include share-based compensation expenses as follows:
Costs of subscription services	$	6,580	$	4,968	$	12,271	$	9,365
Costs of professional services	9,301		5,969		17,322		11,262
Product development	56,923		38,314		107,952		71,282
Sales and marketing	25,942		20,844		49,101		39,846
General and administrative	22,777		18,127		42,665		34,702


*	See Note 2 for a summary of adjustments.

See Notes to Condensed Consolidated Financial Statements

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Workday, Inc.

Condensed Consolidated Statements of Comprehensive Loss

(in thousands)

(unaudited)



	Three Months Ended July 31,						Six Months Ended July 31,
	2017			2016			2017			2016
	2017			*As Adjusted			2017			*As Adjusted
Net loss	$	(82,532	)	$	(107,813	)	$	(146,576	)	$	(186,316	)
Other comprehensive income (loss), net of tax:
Net change in foreign currency translation adjustment	1,243			(248		)	966			433
Net change in unrealized gains (losses) on available-for-sale investments	146			382			(629		)	934
Net change in market value of effective foreign currency forward exchange contracts	(23,396		)	6,310			(24,605		)	(4,754		)
Other comprehensive income (loss), net of tax	(22,007		)	6,444			(24,268		)	(3,387		)
Comprehensive loss	$	(104,539	)	$	(101,369	)	$	(170,844	)	$	(189,703	)


*	See Note 2 for a summary of adjustments.

See Notes to Condensed Consolidated Financial Statements

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Workday, Inc.

Condensed Consolidated Statements of Cash Flows

(in thousands)

(unaudited)



	Three Months Ended July 31,						Six Months Ended July 31,
	2017			2016			2017			2016
				*As Adjusted						*As Adjusted
Cash flows from operating activities
Net loss	$	(82,532	)	$	(107,813	)	$	(146,576	)	$	(186,316	)
Adjustments to reconcile net loss to net cash provided by (used in) operating activities:
Depreciation and amortization	34,021			26,662			67,398			52,786
Share-based compensation expenses	121,523			88,222			229,311			166,457
Amortization of deferred costs	14,009			10,917			27,646			21,356
Amortization of debt discount and issuance costs	6,785			6,690			13,735			13,289
Gain on sale of cost method investment	(526		)	(65		)	(526		)	(65		)
Impairment of cost method investment	—			15,000			—			15,000
Other	1,933			1,918			4,611			1,600
Changes in operating assets and liabilities, net of business combinations:
Trade and other receivables, net	(71,422		)	(52,337		)	40,393			45,982
Deferred costs	(19,437		)	(19,541		)	(30,818		)	(28,767		)
Prepaid expenses and other assets	(8,968		)	(10,070		)	(12,018		)	(7,682		)
Accounts payable	10,778			1,542			10,213			(180		)
Accrued expenses and other liabilities	(13,472		)	(6,517		)	(9,383		)	(972		)
Unearned revenue	22,434			51,914			1,162			76,851
Net cash provided by (used in) operating activities	15,126			6,522			195,148			169,339
Cash flows from investing activities
Purchases of marketable securities	(285,197		)	(557,180		)	(898,448		)	(1,191,136		)
Maturities of marketable securities	371,471			539,315			813,341			1,164,903
Sales of available-for-sale securities	180,863			28,652			189,937			28,852
Business combinations, net of cash acquired	—			(3,670		)	—			(3,670		)
Owned real estate projects	(22,996		)	(6,788		)	(52,535		)	(25,774		)
Capital expenditures, excluding owned real estate projects	(38,528		)	(26,539		)	(69,121		)	(61,017		)
Purchases of cost method investments	(5,000		)	(200		)	(5,450		)	(300		)
Sale and maturities of cost method investments	732			315			732			315
Other	—			(684		)	—			(296		)
Net cash provided by (used in) investing activities	201,345			(26,779		)	(21,544		)	(88,123		)
Cash flows from financing activities
Proceeds from issuance of common stock from employee equity plans	32,274			25,395			34,527			28,776
Other	(32		)	195			(76		)	571
Net cash provided by (used in) financing activities	32,242			25,590			34,451			29,347
Effect of exchange rate changes	715			(144		)	583			494
Net increase (decrease) in cash, cash equivalents and restricted cash	249,428			5,189			208,638			111,057
Cash, cash equivalents and restricted cash at the beginning of period	501,104			405,955			541,894			300,087
Cash, cash equivalents and restricted cash at the end of period	$	750,532		$	411,144		$	750,532		$	411,144

* See Note 2 for a summary of adjustments.

See Notes to Condensed Consolidated Financial Statements

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	Three Months Ended July 31,				Six Months Ended July 31,
	2017		2016		2017		2016
Supplemental cash flow data
Cash paid for interest, net of amounts capitalized	$	46	$	2,652	$	46	$	2,656
Cash paid for income taxes	1,262		3,566		2,608		4,147
Non-cash investing and financing activities:
Vesting of early exercise stock options	$	282	$	460	$	564	$	920
Property and equipment, accrued but not paid	33,219		11,426		33,219		11,426
Non-cash additions to property and equipment	485		394		627		915



	July 31, 2017		July 31, 2016
	July 31, 2017		*As Adjusted
Reconciliation of cash, cash equivalents and restricted cash as shown in the statement of cash flows
Cash and cash equivalents	$	748,599	$	405,529
Restricted cash included in Other assets	1,933		1,615
Restricted cash included in Property and equipment, net	—		4,000
Total cash, cash equivalents and restricted cash	$	750,532	$	411,144

See Notes to Condensed Consolidated Financial Statements

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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 quarter ended July 31, 2017 shown in this report are not necessarily indicative of results to be expected for the full year ending January 31, 2018. 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, 2017, filed with the SEC on March 20, 2017.

Effective February 1, 2017, we adopted the requirements of Accounting Standards Update ("ASU") No. 2014-09, Revenue from Contracts with Customers and ASU No. 2016-18, Statement of Cash Flows, Restricted Cash as discussed in Note 2. All amounts and disclosures set forth in this Form 10-Q have been updated to comply with the new standards, as indicated by the "as adjusted" footnote.

Certain prior period amounts reported in our condensed consolidated financial statements and notes thereto have been reclassified to conform to current period presentation.

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 period of benefit for 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 where 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.

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Note 2. Accounting Standards and Significant Accounting Policies

Recently Adopted Accounting Pronouncements

ASU No. 2014-09

In May 2014, the Financial Accounting Standards Board ("FASB") issued ASU No. 2014-09, Revenue from Contracts with Customers ("Topic 606"). Topic 606 supersedes the revenue recognition requirements in Accounting Standards Codification ("ASC") Topic 605, Revenue Recognition ("Topic 605"), and requires the recognition of revenue when promised goods or services are transferred to customers in an amount that reflects the considerations to which the entity expects to be entitled to in exchange for those goods or services. Topic 606 also includes Subtopic 340-40, Other Assets and Deferred Costs - Contracts with Customers, which requires the deferral of incremental costs of obtaining a contract with a customer. Collectively, we refer to Topic 606 and Subtopic 340-40 as the "new standard."

We early adopted the requirements of the new standard as of February 1, 2017, utilizing the full retrospective method of transition. Adoption of the new standard resulted in changes to our accounting policies for revenue recognition, trade and other receivables, and deferred commissions as detailed below. We applied the new standard using a practical expedient where the consideration allocated to the remaining performance obligations or an explanation of when we expect to recognize that amount as revenue for all reporting periods presented before the date of the initial application is not disclosed.

The impact of adopting the new standard on our fiscal 2017 and fiscal 2016 revenues is not material. The primary impact of adopting the new standard relates to the deferral of incremental commission costs of obtaining subscription contracts. Under Topic 605, we deferred only direct and incremental commission costs to obtain a contract and amortized those costs on a straight-line basis over the term of the related subscription contract, which was generally three years or longer. Under the new standard, we defer all incremental commission costs to obtain the contract. We amortize these costs on a straight-line basis over a period of benefit that we have determined to be five years or the related contractual renewal period, depending on whether the contract is an initial or renewal contract, respectively.

ASU No. 2016-09

In March 2016, the FASB issued ASU No. 2016-09, Improvements to Employee Share-Based Payment Accounting (Topic 718), which simplifies the accounting for share-based payment transactions, including accounting for income taxes, forfeitures, and classification in the statement of cash flows. As of February 1, 2017, we adopted the applicable provisions of ASU No. 2016-09 as follows:

•

The guidance requires excess tax benefits and tax deficiencies to be recorded as income tax benefit or expense in the statement of operations when the awards vest or are settled, and eliminates the requirement to reclassify cash flows related to excess tax benefits from operating activities to financing activities on the statement of cash flows. We adopted the guidance prospectively effective February 1, 2017. Amounts previously recorded to Additional paid-in capital related to windfall tax benefits prior to February 1, 2017 remain in Stockholders' equity.

•

The guidance eliminates the requirement that excess tax benefits must be realized (through a reduction in income taxes payable) before companies can recognize them. We have applied the modified retrospective transition method upon adoption. The previously unrecognized excess tax effects were recorded as a deferred tax asset in the amount of $448.0 million, of which $447.8 million was fully offset by a valuation allowance, and the remaining $0.2 million resulted in a cumulative-effect adjustment to Accumulated deficit as of February 1, 2017.

ASU No. 2016-18

In November 2016, the FASB issued ASU No. 2016-18, Statement of Cash Flows, Restricted Cash (Topic 230), which requires that a statement of cash flows explain the change during the period for the total of cash, cash equivalents, and amounts generally described as restricted cash or restricted cash equivalents. The guidance is effective for our fiscal year beginning February 1, 2018. We early adopted ASU No. 2016-18 retrospectively, effective February 1, 2017. As a result of including restricted cash with cash and cash equivalents when reconciling the beginning-of-period and end-of-period total amounts presented on the condensed consolidated statement of cash flows, net cash flows for the three and six months ended July 31, 2016 increased by $4 million and $6 million, respectively.

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We adjusted our condensed consolidated financial statements from amounts previously reported due to the adoption of ASU No. 2014-09 and ASU No. 2016-18. Select condensed consolidated balance sheet line items, which reflect the adoption of the new ASU's are as follows (in thousands):



	January 31, 2017
	As Previously Reported		Adjustments				As Adjusted
Assets
Trade and other receivables, net	$	383,908	$	25,872		a	$	409,780
Prepaid expenses and other current assets	88,336		(21,746		)	a	66,590
Deferred costs	27,537		23,793			a	51,330
Deferred costs, noncurrent	43,310		73,939			a	117,249
Liabilities
Unearned revenue	$	1,097,417	$	(11,205	)	a	$	1,086,212
Unearned revenue, noncurrent	135,970		(639		)	a	135,331

Select unaudited condensed consolidated statement of operations line items, which reflect the adoption of the new ASUs are as follows (in thousands, except per share data):



	Three Months Ended July 31, 2016
	As Previously Reported			Adjustments				As Adjusted
Revenues:
Subscription services	$	306,228		$	(158	)	a	$	306,070
Professional services	71,495			(3,908		)	a	67,587
Total revenues	377,723			(4,066		)	a	373,657
Costs and expenses:
Sales and marketing	139,177			(4,278		)	a	134,899
Operating loss	(86,897		)	212			a	(86,685		)
Net loss	$	(108,025	)	$	212		a	$	(107,813	)
Net loss per share, basic and diluted	$	(0.55	)	$	—		a	$	(0.55	)



	Six Months Ended July 31, 2016
	As Previously Reported			Adjustments				As Adjusted
Revenues:
Subscription services	$	586,231		$	7		a	$	586,238
Professional services	136,922			(1,826		)	a	135,096
Total revenues	723,153			(1,819		)	a	721,334
Costs and expenses:
Sales and marketing	266,668			(4,150		)	a	262,518
Operating loss	(160,546		)	2,331			a	(158,215		)
Net loss	$	(188,647	)	$	2,331		a	$	(186,316	)
Net loss per share, basic and diluted	$	(0.96	)	$	0.01		a	$	(0.95	)

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Select unaudited condensed consolidated statement of cash flows line items, which reflect the adoption of the new ASUs are as follows (in thousands):



	Three Months Ended July 31, 2016
	As Previously Reported			Adjustments				As Adjusted
Cash flows from operating activities
Net loss	$	(108,025	)	$	212		a	$	(107,813	)
Adjustments to reconcile net loss to net cash provided by (used in) operating activities:
Amortization of deferred costs	6,140			4,777			a	10,917
Changes in operating assets and liabilities:
Trade and other receivables, net	(55,992		)	3,655			a	(52,337		)
Deferred costs	(10,486		)	(9,055		)	a	(19,541		)
Prepaid expenses and other assets	(11,902		)	1,832			a, b	(10,070		)
Unearned revenue	53,071			(1,157		)	a	51,914
Net cash provided by (used in) operating activities	6,258			264			b	6,522
Change in restricted cash	(4,000		)	4,000			b	—
Net cash provided by (used in) investing activities	(30,779		)	4,000			b	(26,779		)
Net increase (decrease) in cash and cash equivalents	925			4,264			b	5,189
Cash, cash equivalents and restricted cash at the beginning of period	404,604			1,351			b	405,955
Cash, cash equivalents and restricted cash at the end of period	$	405,529		$	5,615		b	$	411,144



	Six Months Ended July 31, 2016
	As Previously Reported			Adjustments				As Adjusted
Cash flows from operating activities
Net loss	$	(188,647	)	$	2,331		a	$	(186,316	)
Adjustments to reconcile net loss to net cash provided by (used in) operating activities:
Amortization of deferred costs	12,013			9,343			a	21,356
Changes in operating assets and liabilities:
Trade and other receivables, net	45,055			927			a	45,982
Deferred costs	(15,274		)	(13,493		)	a	(28,767		)
Prepaid expenses and other assets	(12,678		)	4,996			a, b	(7,682		)
Unearned revenue	79,340			(2,489		)	a	76,851
Net cash provided by (used in) operating activities	167,724			1,615			b	169,339
Change in restricted cash	(4,000		)	4,000			b	—
Net cash provided by (used in) investing activities	(92,123		)	4,000			b	(88,123		)
Net increase (decrease) in cash and cash equivalents	105,442			5,615			b	111,057
Cash, cash equivalents and restricted cash at the end of period	$	405,529		$	5,615		b	$	411,144


a	Adjusted to reflect the adoption of ASU No. 2014-09, Revenue from Contracts with Customers.


b	Adjusted to reflect the adoption of ASU No. 2016-18, Statement of Cash Flows, Restricted Cash.

Summary of Significant Accounting Policies

Except for the accounting policies for revenue recognition, trade and other receivables, and deferred commissions that were updated as a result of adopting ASU No. 2014-09, there have been no changes to our significant accounting policies described in the Annual Report on Form 10-K for the year ended January 31, 2017, filed with the SEC on March 20, 2017, that have had a material impact on our condensed consolidated financial statements and related notes.

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Revenue Recognition

We derive our revenues primarily from subscription services and professional services. Revenues are recognized when control of these services is transferred to our customers, in an amount that reflects the consideration we expect to be entitled to in exchange for those services.

We determine revenue recognition through the following steps:


•	Identification of the contract, or contracts, with a customer


•	Identification of the performance obligations in the contract


•	Determination of the transaction price


•	Allocation of the transaction price to the performance obligations in the contract


•	Recognition of revenue when, or as, we satisfy a performance obligation

Subscription Services Revenues

Subscription services revenues primarily consist of fees that provide customers access to one or more of our cloud applications for finance, human resources, and analytics, with routine customer support. Revenue is generally recognized over time on a ratable basis over the contract term beginning on the date that our service is made available to the customer. Our subscription contracts are generally three years or longer in length, billed annually in advance, and non-cancelable.

Professional Services Revenues

Professional services revenues primarily consist of fees for deployment and optimization services, as well as training. The majority of our consulting contracts are billed on a time and materials basis and revenue is recognized over time as the services are performed. For contracts billed on a fixed price basis, revenue is recognized over time based on the proportion performed.

Contracts with Multiple Performance Obligations

Some of our contracts with customers contain multiple performance obligations. For these contracts, we account for individual performance obligations separately if they are distinct. The transaction price is allocated to the separate performance obligations on a relative standalone selling price basis. We determine the standalone selling prices based on our overall pricing objectives, taking into consideration market conditions and other factors, including the value of our contracts, the cloud applications sold, customer demographics, geographic locations, and the number and types of users within our contracts.

Trade and Other Receivables

Trade and other receivables are primarily comprised of trade receivables that are recorded at the invoice amount, net of an allowance for doubtful accounts, which is not material. Other receivables represent unbilled receivables related to subscription and professional services contracts.

Deferred Commissions

Sales commissions earned by our sales force are considered incremental and recoverable costs of obtaining a contract with a customer. Sales commissions for initial contracts are deferred and then amortized on a straight-line basis over a period of benefit that we have determined to be five years. We determined the period of benefit by taking into consideration our customer contracts, our technology and other factors. Sales commissions for renewal contracts are deferred and then amortized on a straight-line basis over the related contractual renewal period. Amortization expense is included in Sales and marketing expenses in the accompanying condensed consolidated statements of operations.

Recently Issued Accounting Pronouncements

In February 2016, the FASB issued ASU No. 2016-02, Leases (Topic 842), which requires the recognition of lease assets and lease liabilities on the balance sheet by lessees for those leases currently classified as operating leases under ASC Topic 840 Leases. The guidance is effective for our fiscal year beginning February 1, 2019. Early adoption is permitted. We are evaluating the accounting, transition and disclosure requirements of the standard and cannot currently estimate the financial statement impact of adoption.

In October 2016, the FASB issued ASU No. 2016-16, Intra-Entity Transfers of Assets Other Than Inventory (Topic 740), which requires entities to recognize the income tax consequences of an intra-entity transfer of an asset other than inventory when the transfer occurs. Prior to the issuance of this ASU, existing guidance prohibited the recognition of current and deferred income taxes for an intra-entity asset transfer until the asset had been sold to an outside party. The guidance is effective for our fiscal year beginning February 1, 2018. Early adoption is permitted. We are evaluating the accounting, transition and disclosure requirements of the standard and cannot currently estimate the financial statement impact of adoption.

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In August 2017, the FASB issued ASU No. 2017-12, Derivatives and Hedging (Topic 815), which better aligns an entity’s risk management activities and financial reporting for hedging relationships through changes to both the designation and measurement guidance for qualifying hedging relationships and the presentation of hedge results. The guidance is effective for our fiscal year beginning February 1, 2019. Early adoption is permitted. We are evaluating the accounting, transition and disclosure requirements of the standard and cannot currently estimate the financial statement impact of adoption.

Note 3. Marketable Securities

At July 31, 2017, marketable securities consisted of the following (in thousands):



	Amortized Cost		Unrealized Gains		Unrealized Losses			Aggregate Fair Value
U.S. agency obligations	$	979,868	$	2	$	(995	)	$	978,875
U.S. treasury securities	295,492		3		(140		)	295,355
Corporate bonds	222,987		8		(227		)	222,768
Commercial paper	418,897		—		—			418,897
Money market funds	81,669		—		—			81,669
	$	1,998,913	$	13	$	(1,362	)	$	1,997,564
Included in cash and cash equivalents	$	648,374	$	—	$	(1	)	$	648,373
Included in marketable securities	$	1,350,539	$	13	$	(1,361	)	$	1,349,191

At January 31, 2017, marketable securities consisted of the following (in thousands):



	Amortized Cost		Unrealized Gains		Unrealized Losses			Aggregate Fair Value
U.S. agency obligations	$	908,874	$	179	$	(535	)	$	908,518
U.S. treasury securities	192,028		48		(25		)	192,051
Corporate bonds	290,272		42		(429		)	289,885
Commercial paper	323,106		—		—			323,106
Money market funds	24,425		—		—			24,425
	$	1,738,705	$	269	$	(989	)	$	1,737,985
Included in cash and cash equivalents	$	281,163	$	—	$	—		$	281,163
Included in marketable securities	$	1,457,542	$	269	$	(989	)	$	1,456,822

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, 2017. The unrealized losses on marketable securities which have been in a net loss position for 12 months or greater were not material as of July 31, 2017. 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 consider all marketable securities as available for use in current operations, including those with maturity dates beyond one year, and therefore classify these securities 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 are reflected in cash and cash equivalents. We sold $181 million and $29 million of our marketable securities during the three months ended July 31, 2017 and 2016, respectively, and $190 million and $29 million of our marketable securities during the six months ended July 31, 2017 and 2016, respectively. The realized gains from the sales are immaterial.

Note 4. 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 — Other inputs that are directly or indirectly observable in the marketplace.

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

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Assets and Liabilities Measured at Fair Value on a Recurring Basis

The following table presents information about our assets and liabilities that are measured at fair value on a recurring basis and their assigned levels within the valuation hierarchy as of July 31, 2017 (in thousands):



Description	Level 1		Level 2		Level 3		Total
U.S. agency obligations	$	—	$	978,875	$	—	$	978,875
U.S. treasury securities	295,355		—		—		295,355
Corporate bonds	—		222,768		—		222,768
Commercial paper	—		418,897		—		418,897
Money market funds	81,669		—		—		81,669
Foreign currency derivative assets	—		257		—		257
Total assets	$	377,024	$	1,620,797	$	—	$	1,997,821
Foreign currency derivative liabilities	$	—	$	23,610	$	—	$	23,610
Total liabilities	$	—	$	23,610	$	—	$	23,610



Description	Level 1		Level 2		Level 3		Total
U.S. agency obligations	$	—	$	908,518	$	—	$	908,518
U.S. treasury securities	192,051		—		—		192,051
Corporate bonds	—		289,885		—		289,885
Commercial paper	—		323,106		—		323,106
Money market funds	24,425		—		—		24,425
Foreign currency derivative assets	—		7,909		—		7,909
Total assets	$	216,476	$	1,529,418	$	—	$	1,745,894
Foreign currency derivative liabilities	$	—	$	2,127	$	—	$	2,127
Total liabilities	$	—	$	2,127	$	—	$	2,127

Fair Value Measurements of Other Financial Instruments

The following table presents the carrying amounts and estimated fair values of our financial instruments that are not recorded at fair value in the condensed consolidated balance sheets (in thousands):



	July 31, 2017				January 31, 2017
	Net Carrying Amount Before Unamortized Debt Issuance Costs		Estimated Fair Value		Net Carrying Amount Before Unamortized Debt Issuance Costs		Estimated Fair Value
0.75% Convertible senior notes	$	333,768	$	435,750	$	325,620	$	402,259
1.50% Convertible senior notes	218,030		347,513		213,180		310,470

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 net carrying amount before unamortized debt issuance costs represents the unamortized debt discount (see Note 10). 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 the last trading day of each reporting period.

Based on the closing price of our common stock of $102.11 on July 31, 2017, the if-converted value of the 0.75% convertible senior notes and the if-converted value of the 1.50% convertible senior notes were greater than their respective principal amounts.

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Note 5. Deferred Costs

Deferred costs, which primarily consist of deferred sales commissions, were $172 million and $169 million as of July 31, 2017 and January 31, 2017, respectively. Amortization expense for the deferred costs was $14 million and $11 million for the three months ended July 31, 2017 and 2016, respectively, and $28 million and $21 million for the six months ended July 31, 2017 and 2016, respectively. There was no impairment loss in relation to the costs capitalized for the periods presented.

Note 6. Property and Equipment, Net

Property and equipment, net consisted of the following (in thousands):



	July 31, 2017			January 31, 2017
Land	$	6,592		$	6,592
Buildings	174,262			115,302
Computers, equipment and software	362,979			323,311
Computers, equipment and software acquired under capital leases	14,639			18,298
Furniture and fixtures	28,376			24,462
Leasehold improvements	118,207			108,673
Property and equipment, gross⁽¹⁾	705,055			596,638
Less accumulated depreciation and amortization	(266,301		)	(230,761		)
Property and equipment, net	$	438,754		$	365,877


⁽¹⁾	Property and equipment, gross includes construction-in-progress for owned real estate projects of $147 million and $115 million that has not yet been placed in service as of July 31, 2017 and January 31, 2017, respectively.

Depreciation expense totaled $28 million and $22 million for the three months ended July 31, 2017 and 2016, respectively, and $55 million and $44 million for the six months ended July 31, 2017 and 2016, respectively. Interest costs capitalized to property and equipment totaled $2 million and $0.4 million for the three months ended July 31, 2017 and 2016, respectively, and $3 million and $0.6 million for the six months ended July 31, 2017 and 2016, respectively.

Note 7. Acquisition-related Intangible Assets, Net

Acquisition-related intangible assets, net consisted of the following (in thousands):



	July 31, 2017			January 31, 2017
Acquired developed technology	$	64,900		$	64,900
Customer relationship assets	1,000			1,000
	65,900			65,900
Less accumulated amortization	(26,790		)	(17,113		)
Acquisition-related intangible assets, net	$	39,110		$	48,787

Amortization expense related to acquired developed technology and customer relationship assets was $5 million and $1 million for the three months ended July 31, 2017 and 2016, respectively, and $10 million and $3 million for the six months ended July 31, 2017 and 2016, respectively.

As of July 31, 2017, our future estimated amortization expense related to acquired developed technology and customer relationship assets is as follows (in thousands):



Fiscal Period:
2018	$	9,609
2019	18,904
2020	10,281
2021	316
Total	$	39,110

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Note 8. Other Assets

Other assets consisted of the following (in thousands):



	July 31, 2017		January 31, 2017
Cost method investments	$	19,248	$	14,004
Acquired land leasehold interest, net	9,623		9,676
Deposits	4,081		3,488
Net deferred tax assets	3,753		4,336
Other	30,058		22,066
Total	$	66,763	$	53,570

Our cost method investments include investments in private companies in which we do not have the ability to exert significant influence. The investments are tested for impairment at least annually, and more frequently upon the occurrence of certain events.

Note 9. Derivative Instruments

Derivative Financial Instruments

We conduct business on a global basis in multiple foreign currencies, subjecting Workday 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.

Our foreign currency contracts are classified within Level 2 of the fair value hierarchy 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.

Cash Flow Hedges

We are exposed to foreign currency fluctuations resulting from customer contracts denominated in foreign currencies. We have a hedging program in which we enter 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) ("OCI") on the condensed consolidated balance sheets and will be subsequently reclassified to the related revenue line item on the condensed consolidated statements of operations in the same period that the underlying revenues are earned. The changes in value of these contracts resulting from changes in forward points are excluded from the assessment of hedge effectiveness and are recorded as incurred in Other income (expense), net on the condensed consolidated statements of operations. Cash flows from such forward contracts are classified as operating activities.

As of July 31, 2017 and January 31, 2017, we had outstanding foreign currency forward contracts designated as cash flow hedges with total notional values of $404 million and $252 million, respectively. All contracts have maturities not greater than 25 months. The notional value represents the amount that will be bought or sold upon maturity of the forward contract.

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 income (expense), net on the 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. Cash flows from such forward contracts are classified as operating activities.

As of July 31, 2017 and January 31, 2017, we had outstanding forward contracts with total notional values of $55 million and $51 million, respectively.

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The fair values of outstanding derivative instruments were as follows (in thousands):



	Condensed Consolidated Balance Sheets Location	July 31, 2017		January 31, 2017
Derivative Assets:
Foreign currency forward contracts designated as cash flow hedges	Prepaid expenses and other current assets and Other assets	$	167	$	7,149
Foreign currency forward contracts not designated as hedges	Prepaid expenses and other current assets	90		760
Derivative Liabilities:
Foreign currency forward contracts designated as cash flow hedges	Accrued expenses and other current liabilities and Other liabilities	$	21,925	$	1,605
Foreign currency forward contracts not designated as hedges	Accrued expenses and other current liabilities	1,685		522

Gains (losses) associated with foreign currency forward contracts designated as cash flow hedges were as follows (in thousands):



	Condensed Consolidated Statement of Operations and Statement of Comprehensive Loss Locations	Three Months Ended July 31,					Six Months Ended July 31,
		2017			2016		2017			2016
Gains (losses) recognized in OCI (effective portion) ⁽¹⁾	Net change in market value of effective foreign currency forward exchange contracts	$	(22,923	)	$	6,453	$	(23,898	)	$	(4,501	)
Gains (losses) reclassified from OCI into income (effective portion)	Revenues	473			143		707			253
Gains (losses) recognized in income (amount excluded from effectiveness testing and ineffective portion)	Other income (expense), net	767			165		1,390			316


⁽¹⁾	Of the total effective portion of foreign currency forward contracts designated as cash flow hedges as of July 31, 2017, net losses of $2 million are expected to be reclassified out of OCI within the next 12 months.

Gains (losses) associated with foreign currency forward contracts not designated as cash flow hedges were as follows (in thousands):



	Condensed Consolidated Statement of Operations Location	Three Months Ended July 31,					Six Months Ended July 31,
Derivative Type	Condensed Consolidated Statement of Operations Location	2017			2016		2017			2016
Foreign currency forward contracts not designated as hedges	Other income (expense), net	$	(2,619	)	$	1,098	$	(2,625	)	$	(541	)

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.

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As of July 31, 2017, information related to these offsetting arrangements was as follows (in thousands):



	Gross Amounts of Recognized Assets		Gross Amounts Offset in the Condensed Consolidated Balance Sheets		Net Amounts of Assets Presented in the Condensed Consolidated Balance Sheets		Gross Amounts Not Offset in the Condensed Consolidated Balance Sheets					Net Assets Exposed
	Gross Amounts of Recognized Assets						Financial Instruments			Cash Collateral Received		Net Assets Exposed
Derivative Assets:
Counterparty A	$	11	$	—	$	11	$	(11	)	$	—	$	—
Counterparty B	244		—		244		(244		)	—		—
Counterparty C	2		—		2		(2		)	—		—
Total	$	257	$	—	$	257	$	(257	)	$	—	$	—



	Gross Amounts of Recognized Liabilities		Gross Amounts Offset in the Condensed Consolidated Balance Sheets		Net Amounts of Liabilities Presented in the Condensed Consolidated Balance Sheets		Gross Amounts Not Offset in the Condensed Consolidated Balance Sheets					Net Liabilities Exposed
	Gross Amounts of Recognized Liabilities						Financial Instruments			Cash Collateral Pledged		Net Liabilities Exposed
Derivative Liabilities:
Counterparty A	$	3,804	$	—	$	3,804	$	(11	)	$	—	$	3,793
Counterparty B	17,283		—		17,283		(244		)	—		17,039
Counterparty C	2,486		—		2,486		(2		)	—		2,484
Counterparty D	37		—		37		—			—		37
Total	$	23,610	$	—	$	23,610	$	(257	)	$	—	$	23,353

Note 10. 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.

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 "the 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.

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Holders of the 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:


•	if the last reported sale price of Class A common stock for at least 20 trading days during a period of 30 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 were 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 on a straight-line basis, which approximates the effective interest rate method, 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 Notes on a prorated basis using the aggregate principal balances. In accounting for the issuance costs related to the 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 on a straight-line basis, which approximates the effective interest rate method, to interest expense over the respective terms of the Notes. 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 and $0.7 million for each of the three and six month periods ended July 31, 2017 and 2016, respectively. 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 and $0.3 million for each of the three and six month periods ended July 31, 2017 and 2016, respectively.

The Notes, net consisted of the following (in thousands):



	July 31, 2017						January 31, 2017
	2018 Notes			2020 Notes			2018 Notes			2020 Notes
Principal amounts:
Principal	$	350,000		$	250,000		$	350,000		$	250,000
Unamortized debt discount	(16,232		)	(31,970		)	(24,380		)	(36,820		)
Net carrying amount before unamortized debt issuance costs	333,768			218,030			325,620			213,180
Unamortized debt issuance costs	(1,346		)	(1,992		)	(2,050		)	(2,327		)
Net carrying amount	$	332,422		$	216,038		$	323,570		$	210,853
Carrying amount of the equity component ⁽¹⁾	$	74,892		$	66,007		$	74,892		$	66,007


⁽¹⁾	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, 2017, the 2018 Notes have a remaining life of approximately 11 months and are classified as current on the condensed consolidated balance sheet. The 2020 Notes have a remaining life of 35 months and are classified as non-current on the condensed consolidated balance sheet.

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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 Notes (in thousands):



	Three Months Ended July 31,								Six Months Ended July 31,
	2017				2016				2017				2016
	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		167		352		170		704		335		704		337
Interest cost related to amortization of the debt discount	4,104		2,444		3,873		2,295		8,148		4,850		7,692		4,556

We capitalized interest costs related to the Notes of $2 million and $0.4 million for the three months ended July 31, 2017 and 2016, respectively, and $3 million and $0.6 million for the six months ended July 31, 2017 and 2016, respectively.

Notes Hedges

In connection with the issuance of the 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, respectively, 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.

Note 11. Commitments and Contingencies

Facility and Computing Infrastructure-related Commitments

We have entered into non-cancelable agreements for certain of our offices and data centers 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 17). Our operating 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. This includes payments for office and data center square footage, as well as data center power capacity for certain data centers. We generally recognize these expenses on a straight-line basis over the period in which we benefit from the lease and we have accrued for rent expense incurred but not paid. Total rent expense was $20 million and $17 million for the three months ended July 31, 2017 and 2016, respectively, and $39 million and $34 million for the six months ended July 31, 2017 and 2016, 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.

Additionally, we have entered into a non-cancelable agreement with a computing infrastructure vendor that expires on October 31, 2024.

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Legal Matters

We are a party to various legal proceedings and claims which arise in the ordinary course of business. 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 our opinion, as of July 31, 2017, 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 12. Common Stock and Stockholders’ Equity

Common Stock

As of July 31, 2017, there were 134 million shares of Class A common stock and 74 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 10 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 10 million shares in March 2017, and as of July 31, 2017, we had approximately 62 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 in March 2017. As of July 31, 2017, 7 million shares of Class A common stock were available for issuance under the ESPP.

Stock Options

The Stock Plans provide for the issuance of incentive and nonstatutory options to employees and non-employees. 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, 2017 is as follows:



	Outstanding Stock Options		Weighted- Average Exercise Price		Aggregate Intrinsic Value (in millions)
Balance as of January 31, 2017	9,096,592		$	4.34	$	716
Stock options granted	—		—
Stock options exercised	(1,587,000	)	4.60
Stock options canceled	(7,975	)	7.95
Balance as of July 31, 2017	7,501,617		$	4.28	$	734
Vested and expected to vest as of July 31, 2017	7,501,012		$	4.28	$	734
Exercisable as of July 31, 2017	7,485,406		$	4.25	$	732

As of July 31, 2017, there was a total of $1 million in unrecognized compensation cost related to unvested stock options which is expected to be recognized over a weighted-average period of approximately five months.

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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, 2017 is as follows:



	Number of Shares		Weighted-Average Grant Date Fair Value
Balance as of January 31, 2017	11,502,721		$	78.45
RSUs granted	6,240,657		85.03
RSUs vested	(3,194,939	)	77.38
RSUs forfeited	(582,767	)	76.77
Balance as of July 31, 2017	13,965,672		$	81.71

As of July 31, 2017, there was a total of $1.0 billion in unrecognized compensation cost related to unvested RSUs, which is expected to be recognized over a weighted-average period of approximately three years.

Performance-based Restricted Stock Units

During fiscal 2017, 0.3 million shares of performance-based restricted stock units ("PRSUs") were granted to all employees other than executive management and included both service conditions and performance conditions related to company-wide goals . These performance conditions were met and the PRSUs vested on March 15, 2017. During the six months ended July 31, 2017, we recognized $6 million in compensation cost related to these PRSUs.

Additionally, during the second quarter of fiscal 2018, 0.3 million shares of PRSUs were granted to all employees other than executive management and included both service conditions and performance conditions related to company-wide goals. We expect to grant additional shares related to this program for employees hired in fiscal 2018. These PRSU awards will vest if the performance conditions are achieved for the fiscal year ended January 31, 2018 and if the individual employee continues to provide service through the vesting date of March 15, 2018. During the three and six months ended July 31, 2017, we recognized $6 million in compensation cost related to these PRSUs, and there is a total of $28 million in unrecognized compensation cost which is expected to be recognized over a weighted-average period of approximately seven months.

Note 13. Unearned Revenue and Performance Obligations

$398 million and $282 million of subscription services revenue was recognized during the three months ended July 31, 2017 and 2016, respectively, that was included in the unearned revenue balances at the beginning of the respective periods. $759 million and $533 million of subscription services revenue was recognized during the six months ended July 31, 2017 and 2016, respectively, that was included in the unearned revenue balances at the beginning of the respective periods. Professional services revenue recognized in the same periods from unearned revenue balances at the beginning of the respective periods was not material.

Transaction Price Allocated to the Remaining Performance Obligations

As of July 31, 2017, approximately $4.4 billion of revenue is expected to be recognized from remaining performance obligations for subscription contracts. We expect to recognize revenue on approximately two thirds of these remaining performance obligations over the next 24 months, with the balance recognized thereafter. Revenue from remaining performance obligations for professional services contracts as of July 31, 2017 was not material.

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Note 14. Other Income (Expense), Net

Other income (expense), net consisted of the following (in thousands):



	Three Months Ended July 31,						Six Months Ended July 31,
	2017			2016			2017			2016
Interest income	$	5,051		$	2,897		$	9,080		$	5,111
Interest expense ⁽¹⁾	(6,840		)	(7,914		)	(13,826		)	(15,945		)
Gain from sale of cost method investment	526			65			526			65
Impairment of cost method investment	—			(15,000		)	—			(15,000		)
Other income (expense)	2,201			(1,241		)	3,495			(1,262		)
Other income (expense), net	$	938		$	(21,193	)	$	(725	)	$	(27,031	)


⁽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, net of capitalized interest costs (see Note 10).

Note 15. 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 expense of $4 million and $1 million for the six months ended July 31, 2017 and 2016, respectively. The income tax provision for the six months ended July 31, 2017 was primarily attributable to state taxes and income tax expense in profitable foreign jurisdictions. The income tax provision for the six months ended July 31, 2016 was primarily attributable to $2 million state taxes and income tax expenses in profitable foreign jurisdictions, partially offset by a $1 million benefit from the release of valuation allowances related to certain acquired intangible assets from a business acquisition.

We are subject to income tax audits in the U.S. and foreign jurisdictions. We record liabilities related to uncertain tax positions and 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.

We periodically evaluate the realizability of our net deferred tax assets based on all available evidence, both positive and negative. The realization of net deferred tax assets is dependent on our ability to generate sufficient future taxable income during periods prior to the expiration of tax attributes to fully utilize these assets. As of July 31, 2017, we continue to maintain a full valuation allowance on our deferred tax assets except for certain jurisdictions.

Note 16. 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 units and 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.

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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,
	2017						2016						2017						2016
	2017						* As Adjusted						2017						* As Adjusted
	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	$	(52,997	)	$	(29,535	)	$	(65,950	)	$	(41,863	)	$	(93,625	)	$	(52,951	)	$	(113,315	)	$	(73,001	)
Denominator:
Weighted-average common shares outstanding	132,940			74,088			120,642			76,581			131,232			74,221			119,136			76,751
Basic and diluted net loss per share	$	(0.40	)	$	(0.40	)	$	(0.55	)	$	(0.55	)	$	(0.71	)	$	(0.71	)	$	(0.95	)	$	(0.95	)


*	Adjusted to reflect adoption of ASU No. 2014-09, Revenue from Contracts with Customers. For further information, see Note 2.

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,
	2017	2016
Outstanding common stock options	7,502	10,743
Shares subject to repurchase	30	363
Unvested restricted stock awards, units, and PRSUs	14,414	12,993
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	375	359
	36,843	38,980

Note 17. 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 average term of the agreements is 10 years and the total rent due under the agreements is $9 million for the fiscal year ended January 31, 2018, and $91 million in total. Rent expense under these agreements was $2 million for each of the three month periods ended July 31, 2017 and 2016, and $4 million for each of the six month periods ended July 31, 2017 and 2016.

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Note 18. Geographic Information

Disaggregation of Revenue

We sell our subscription contracts and related services in two primary geographical markets: to customers located in the United States, and to customers located outside of the United States. Revenue by geography is generally based on the address of the customer as specified in our master subscription agreement. The following table sets forth revenue by geographic area (in thousands):