4.30.2015 10Q
Table of Contents

 
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
 
FORM 10-Q
 (MARK ONE)
 
ý      QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
 
FOR THE QUARTERLY PERIOD ENDED APRIL 30, 2015
 
OR
 
o         TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
 
FOR THE TRANSITION PERIOD FROM              TO
 
COMMISSION FILE NUMBER 001-35498
 ____________________________________________________

SPLUNK INC.
(Exact name of registrant as specified in its charter)
_____________________________________________________
Delaware
 
86-1106510
(State or other jurisdiction of
 
(I.R.S. Employer
incorporation or organization)
 
Identification No.)
250 Brannan Street
San Francisco, California 94107
(Address of principal executive offices)
(Zip Code)
 
(415) 848-8400
(Registrant’s telephone number, including area code)
 
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. YES ý NO o
 
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data file required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). YES ý NO o
 
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer,” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):
Large accelerated filer x
 
Accelerated filer o
 
 
 
Non-accelerated filer o
 
Smaller reporting company o
(Do not check if a smaller reporting company)
 
 
 
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). YES o NO ý

There were 125,711,976 shares of the registrant’s Common Stock issued and outstanding as of June 3, 2015.
 


Table of Contents

TABLE OF CONTENTS
 
 
 
Page
No.
 
 
 
 
 
 
 
 
 
 
 
 
 


Table of Contents

PART I. FINANCIAL INFORMATION
 Item 1. Financial Statements (Unaudited)


Splunk Inc.
CONDENSED CONSOLIDATED BALANCE SHEETS
(In thousands, except share and per share amounts)
(Unaudited)
 
 
 
April 30, 2015

January 31, 2015
ASSETS
 
 

 
 

Current assets
 
 

 
 

Cash and cash equivalents
 
$
413,507

 
$
387,315

Investments, current portion
 
451,636

 
462,849

Accounts receivable, net
 
81,341

 
128,413

Prepaid expenses and other current assets
 
19,961

 
21,256

Total current assets
 
966,445

 
999,833

Investments, non-current
 
177,923

 
165,082

Property and equipment, net
 
62,315

 
50,374

Intangible assets, net
 
9,285

 
10,416

Goodwill
 
19,070

 
19,070

Other assets
 
4,957

 
3,016

Total assets
 
$
1,239,995

 
$
1,247,791

LIABILITIES AND STOCKHOLDERS’ EQUITY
 
 

 
 

Current liabilities
 
 

 
 

Accounts payable
 
$
3,964

 
$
3,726

Accrued payroll and compensation
 
46,865

 
65,220

Accrued expenses and other liabilities
 
27,503

 
27,819

Deferred revenue, current portion
 
249,372

 
249,883

Total current liabilities
 
327,704

 
346,648

Deferred revenue, non-current
 
55,931

 
54,202

Other liabilities, non-current
 
42,266

 
33,620

Total non-current liabilities
 
98,197

 
87,822

Total liabilities
 
425,901

 
434,470

Commitments and contingencies (Note 3)
 


 


Stockholders’ equity
 
 

 
 

Common stock: $0.001 par value; 1,000,000,000 shares authorized; 125,336,202 shares issued and outstanding at April 30, 2015, and 123,538,492 shares issued and outstanding at January 31, 2015
 
125

 
123

Accumulated other comprehensive loss
 
(847
)
 
(837
)
Additional paid-in capital
 
1,272,825

 
1,200,858

Accumulated deficit
 
(458,009
)
 
(386,823
)
Total stockholders’ equity
 
814,094

 
813,321

Total liabilities and stockholders’ equity
 
$
1,239,995

 
$
1,247,791

 
The accompanying notes are an integral part of these condensed consolidated financial statements.

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Splunk Inc.
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(In thousands, except per share amounts)
(Unaudited)
 
 
 
Three Months Ended April 30,
 
 
2015
 
2014
Revenues
 
 

 
 

License
 
$
71,872

 
$
51,274

Maintenance and services
 
53,793

 
34,633

Total revenues
 
125,665

 
85,907

Cost of revenues (1)
 
 

 
 

License
 
1,161

 
78

Maintenance and services
 
21,924

 
14,109

Total cost of revenues
 
23,085

 
14,187

Gross profit
 
102,580

 
71,720

Operating expenses (1)
 
 

 
 

Research and development
 
44,698

 
29,742

Sales and marketing
 
101,989

 
71,078

General and administrative
 
26,872

 
21,003

Total operating expenses
 
173,559

 
121,823

Operating loss
 
(70,979
)
 
(50,103
)
Interest and other income (expense), net
 
 

 
 

Interest income, net
 
360

 
130

Other income (expense), net
 
89

 
(220
)
Total interest and other income (expense), net
 
449

 
(90
)
Loss before income taxes
 
(70,530
)
 
(50,193
)
Income tax provision
 
656

 
562

Net loss
 
$
(71,186
)
 
$
(50,755
)
 
 
 

 
 

Basic and diluted net loss per share
 
$
(0.57
)
 
$
(0.43
)
 
 
 

 
 

Weighted-average shares used in computing basic and diluted net loss per share
 
124,548

 
117,290

 
(1)      Amounts include stock-based compensation expense, as follows:  
Cost of revenues
 
$
6,532


$
3,806

Research and development
 
20,075


12,587

Sales and marketing
 
29,610


19,120

General and administrative
 
9,892


7,726


The accompanying notes are an integral part of these condensed consolidated financial statements.

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Splunk Inc.
CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE LOSS
(In thousands)
(Unaudited)
 
 
 
Three Months Ended April 30,
 
 
2015
 
2014
Net loss
 
$
(71,186
)
 
$
(50,755
)
Other comprehensive income (loss)
 
 

 
 

Net unrealized gain (loss) on investments
 
(25
)
 
6

Foreign currency translation adjustments
 
15

 
29

Total other comprehensive income (loss)
 
(10
)
 
35

Comprehensive loss
 
$
(71,196
)
 
$
(50,720
)
 
The accompanying notes are an integral part of these condensed consolidated financial statements.

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Splunk Inc.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(In thousands)
(Unaudited)
 
 
 
Three Months Ended April 30,
 
 
2015
 
2014
Cash flows from operating activities
 
 

 
 

Net loss
 
$
(71,186
)

$
(50,755
)
Adjustments to reconcile net loss to net cash provided by operating activities:
 
 
 
 
Depreciation and amortization
 
3,466


2,651

Amortization of investment premiums
 
361

 

Stock-based compensation
 
66,109


43,239

Deferred income taxes
 
(319
)

(285
)
Excess tax benefits from employee stock plans
 
(466
)

(479
)
Changes in operating assets and liabilities
 
 
 
 
Accounts receivable, net
 
47,072


31,235

Prepaid expenses, other current and non-current assets
 
(327
)

524

Accounts payable
 
402


386

Accrued payroll and compensation
 
(18,355
)

(13,757
)
Accrued expenses and other liabilities
 
640


4,461

Deferred revenue
 
1,218


1,691

Net cash provided by operating activities
 
28,615


18,911

Cash flows from investing activities
 
 
 
 

Purchases of investments
 
(160,514
)
 
(250,883
)
Maturities of investments
 
160,000



Purchases of property and equipment
 
(6,415
)
 
(4,238
)
Other investment activities
 
(1,500
)


Net cash used in investing activities
 
(8,429
)

(255,121
)
Cash flows from financing activities
 
 
 
 
Proceeds from the exercise of stock options
 
5,366

 
5,836

Excess tax benefits from employee stock plans
 
466

 
479

Net cash provided by financing activities
 
5,832


6,315

Effect of exchange rate changes on cash and cash equivalents
 
174


189

Net increase (decrease) in cash and cash equivalents
 
26,192


(229,706
)
Cash and cash equivalents
 
 

 
 

Beginning of period
 
387,315


897,453

End of period
 
$
413,507


$
667,747

Supplemental disclosures
 
 

 
 

Cash paid for income taxes
 
$
489

 
$
482

Non-cash investing and financing activities
 
 

 
 

Change in accrued purchases of property and equipment
 
647

 
1,239

Vesting of early exercised options
 
28

 
28

Change in capitalized construction costs related to build-to-suit lease
 
8,508

 

 
The accompanying notes are an integral part of these condensed consolidated financial statements.

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NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
 
(1)  Description of the Business and Significant Accounting Policies
 
Business
 
Splunk Inc. (“we,” "us," "our") provides innovative software products that enable organizations to gain real-time operational intelligence by harnessing the value of their data. Our products enable users to collect, index, search, explore, monitor and analyze data regardless of format or source. Our products address large and diverse data sets, commonly referred to as big data, and are specifically tailored for machine-generated data. Machine data is produced by nearly every software application and electronic device and contains a definitive, time-stamped record of various activities, such as transactions, customer and user activities and security threats. Our products help users derive new insights from machine data that can be used to, among other things, improve service levels, reduce operational costs, mitigate security risks, demonstrate and maintain compliance, and drive better business decisions. We were incorporated in California in October 2003 and reincorporated in Delaware in May 2006.
 
Fiscal Year
 
Our fiscal year ends on January 31. References to fiscal 2016 or fiscal year 2016, for example, refer to the fiscal year ending January 31, 2016.
 
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. 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. The condensed consolidated balance sheet data as of January 31, 2015 was derived from audited financial statements, but does not include all disclosures required by GAAP. Therefore, these condensed consolidated financial statements should be read in conjunction with the consolidated financial statements and notes included in the Annual Report on Form 10-K for the fiscal year ended January 31, 2015, filed with the SEC on March 31, 2015. There have been no changes in the significant accounting policies from those that were disclosed in the audited consolidated financial statements for the fiscal year ended January 31, 2015 included in the Annual Report on Form 10-K.
 
In the opinion of management, the accompanying unaudited condensed consolidated financial statements reflect all normal recurring adjustments necessary to state fairly the financial position, results of operations, comprehensive loss and cash flows for the interim periods, but are not necessarily indicative of the results of operations to be anticipated for the full fiscal year 2016.

Recently Issued Accounting Pronouncements

In May 2014, the Financial Accounting Standards Board (the "FASB") issued Accounting Standards Update ("ASU") No. 2014-09, Revenue from Contracts with Customers (Topic 606), which supersedes the revenue recognition requirements in Accounting Standards Codification 605, Revenue Recognition. This ASU is based on the principle that revenue is recognized to depict the transfer of goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods or services. The ASU also requires additional disclosure about the nature, amount, timing and uncertainty of revenues and cash flows arising from customer contracts, including significant judgments and changes in judgments and assets recognized from costs incurred to obtain or fulfill a contract. In April 2015, the FASB proposed a one-year deferral in the effective date of the new standard. In accordance with the deferral, the effective date applicable to us will be the first quarter of fiscal 2019. We have not yet selected a transition method and we are currently evaluating the effect that the updated standard will have on our condensed consolidated financial statements and related disclosures.

Use of Estimates
 
The preparation of financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and reported amounts of revenues and expenses during the reporting periods covered by the

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financial statements and accompanying notes. In particular, we make estimates with respect to the fair value of multiple elements in revenue recognition, uncollectible accounts receivable, the assessment of the useful life and recoverability of long-lived assets (property and equipment, goodwill and identified intangibles), stock-based compensation expense, the fair value of assets acquired and liabilities assumed for business combinations, income taxes and contingencies. Actual results could differ from those estimates.

Segments

We operate our business as one operating segment: the development and marketing of software products that enable our customers to gain real-time operational intelligence by harnessing the value of their data. Our chief operating decision maker is our Chief Executive Officer, who reviews financial information presented on a consolidated basis for purposes of making operating decisions, assessing financial performance and allocating resources.

Principles of Consolidation
 
The accompanying unaudited condensed consolidated financial statements include the accounts of Splunk Inc. and its direct and indirect wholly-owned subsidiaries. All intercompany balances and transactions have been eliminated upon consolidation.

Foreign Currency

The functional currency of our foreign subsidiaries is the respective local currency. Translation adjustments arising from the use of differing exchange rates from period to period are included in Accumulated Other Comprehensive Loss within Stockholders' Equity. Foreign currency transaction gains and losses are included in Other Income (Expense), Net and were not material for the three months ended April 30, 2015 and 2014. All assets and liabilities denominated in a foreign currency are translated into U.S. dollars at the exchange rate on the balance sheet date. All of our revenues are generated in U.S. dollars. Our expenses are generally denominated in the currencies in which our operations are located and are translated at the average exchange rate during the period. Equity and property, plant and equipment related transactions are translated using historical exchange rates.

Foreign Currency Contracts

In the first quarter of fiscal 2016, we began to use foreign currency forward contracts as a part of our strategy to manage exposure related to foreign currency denominated monetary assets and liabilities. These contracts typically have maturities of one month. They are not designated as cash flow or fair value hedges under ASC Topic 815, Derivatives and Hedging. These contracts hedge assets and liabilities that are denominated in foreign currencies and are carried at fair value as either assets or liabilities on the condensed consolidated balance sheets with changes in the fair value recorded to Other income (expense), net in the condensed consolidated statement of operations.

Investments

We determine the appropriate classification of our investments at the time of purchase and reevaluate such determination at each balance sheet date. Securities are classified as available-for-sale and are carried at fair value, with the change in unrealized gains and losses, net of tax, reported as a separate component on the consolidated statements of comprehensive income (loss). Fair value is determined based on quoted market rates when observable or utilizing data points that are observable, such as quoted prices, interest rates and yield curves. Declines in fair value judged to be other-than-temporary on securities available for sale are included as a component of investment income. In order to determine whether a decline in value is other-than-temporary, we evaluate, among other factors, the duration and extent to which the fair value has been less than the carrying value and our intent and ability to retain the investment for a period of time sufficient to allow for any anticipated recovery in fair value. The cost of securities sold is based on the specific-identification method. Interest on securities classified as available-for-sale is included as a component of interest income.

(2)  Investments and Fair Value Measurements
 
The carrying amounts of certain of our financial instruments including cash equivalents, accounts receivable, accounts payable and accrued liabilities approximate fair value due to their short-term maturities.
 

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Assets and liabilities recorded at fair value in the financial statements are categorized based upon the level of judgment associated with the inputs used to measure their fair value. Hierarchical levels that are directly related to the amount of subjectivity associated with the inputs to the valuation of these assets or liabilities are as follows:
 
Level 1—Observable inputs, such as quoted prices in active markets for identical assets or liabilities.
 
Level 2—Observable inputs other than Level 1 prices such as quoted prices for similar assets or liabilities, quoted prices in markets that are not active, or other inputs that are observable or can be corroborated by observable market data for substantially the full term of the assets or liabilities.
 
Level 3—Unobservable inputs that are supported by little or no market activity and that are significant to the fair value of the assets or liabilities.
 
Assets and liabilities measured at fair value are classified in their entirety based on the lowest level of input that is significant to the fair value measurement. Our assessment of the significance of a particular input to the fair value measurement in its entirety requires management to make judgments and consider factors specific to the asset or liability.

The following table sets forth the fair value of our financial assets and liabilities that were measured on a recurring basis as of April 30, 2015 and January 31, 2015 (in thousands):
 
 
 
April 30, 2015
 
January 31, 2015
 
 
Level 1
 
Level 2
 
Level 3
 
Total
 
Level 1
 
Level 2
 
Level 3
 
Total
Assets:
 
 

 
 

 
 

 
 

 
 

 
 

 
 

 
 

Money market funds
 
$
404,858

 
$

 
$

 
$
404,858

 
$
374,682

 
$

 
$

 
$
374,682

U.S. treasury securities
 

 
628,059

 

 
628,059

 

 
627,931

 

 
627,931

Other
 

 

 
1,500

 
1,500

 

 

 

 

Reported as:
 
 

 
 

 
 

 
 

 
 

 
 

 
 

 
 

Assets:
 
 

 
 

 
 

 
 

 
 

 
 

 
 

 
 

Cash and cash equivalents
 
 

 
 

 
 

 
$
404,858

 
 

 
 

 
 

 
$
374,682

Investments, current portion
 
 
 
 
 
 
 
451,636

 
 
 
 
 
 
 
462,849

Investments, non-current
 
 
 
 
 
 
 
177,923

 
 
 
 
 
 
 
165,082

Total
 
 

 
 

 
 

 
$
1,034,417

 
 

 
 

 
 

 
$
1,002,613


The following table represents our investments in U.S. treasury securities, which we have classified as available-for-sale investments as of April 30, 2015 (in thousands): 

 
 
April 30, 2015
 
 
Amortized Cost
 
Unrealized Gains
 
Unrealized Losses
 
Fair Value
Cash and cash equivalents:
 
 
 
 
 
 
 
 
U.S. treasury securities
 
$

 
$

 
$

 
$

Investments, current portion:
 
 
 
 
 
 
 
 
U.S. treasury securities
 
451,580

 
74

 
(18
)
 
451,636

Investments, non-current:
 
 
 
 
 
 
 
 
U.S. treasury securities
 
176,501

 
32

 
(110
)
 
176,423

Total available-for-sale investments in U.S. treasury securities
 
$
628,081

 
$
106

 
$
(128
)
 
$
628,059


As of April 30, 2015, the following marketable securities were in an unrealized loss position (in thousands):

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Less than 12 Months
 
12 Months or Greater
 
Total
 
 
Fair Value
 
Unrealized Losses
 
Fair Value
 
Unrealized Losses
 
Fair Value
 
Unrealized Losses
U.S. treasury securities
 
$
270,489

 
$
(128
)
 
$
8,001

 
$

 
$
278,490

 
$
(128
)

As of April 30, 2015, we did not consider any of our investments to be other-than-temporarily impaired.

The contractual maturities of our investments in U.S. treasury securities are as follows (in thousands):
 
 
April 30, 2015
Due within one year
 
$
451,636

Due within one to two years
 
176,423

Total
 
$
628,059


Investments with maturities of less than 12 months from the balance sheet date are classified as current assets, which are available for use to fund current operations. Investments with maturities greater than 12 months from the balance sheet date are classified as long-term assets.

 
Assets Measured at Fair Value on a Recurring Basis Using Significant Unobservable Inputs

We invested in a two-year convertible promissory note of a privately-held company that we have classified as an available-for-sale investment and is included in investments, non-current, on our condensed consolidated balance sheets. This investment is recorded at fair value using significant unobservable inputs or data in an inactive market and the valuation requires our judgment due to the absence of quoted prices in active markets and inherent lack of liquidity. Unrealized gains and losses on our available-for-sale investment are excluded from earnings and reported, net of tax, as a separate component on the consolidated statements of comprehensive income (loss). During the three months ended April 30, 2015, we have not recognized any unrealized gains or losses or an other-than-temporary impairment charge on our investment. The carrying value of our convertible promissory note investment was $1.5 million as of April 30, 2015.

(3)  Commitments and Contingencies
 
Office Lease Commitments
 
We lease our office spaces under non-cancelable leases with rent expense recognized on a straight-line basis over the lease term. Rent expense was $2.9 million and $2.2 million for the three months ended April 30, 2015 and 2014, respectively.
 
On April 29, 2014, we entered into an office lease (the "Lease") for approximately 182,000 square feet located at 270 Brannan Street, San Francisco, California (the "Premises"). The Premises will be allocated to approximately 95,000 square feet of rentable space (the "Initial Premises") which we expect to occupy in January 2016 and approximately 87,000 square feet of rentable space (the "Must-Take Premises"), which we expect to occupy one year thereafter. The Initial Premises and the Must-Take Premises each have a term of 84 months, subject to the completion of certain pre-occupancy improvements by our landlord. Our total obligation for the base rent is approximately $92.0 million. On May 13, 2014, we entered into an irrevocable, standby letter of credit with Silicon Valley Bank for $6.0 million to serve as a security deposit for the Lease.

As a result of our involvement during the construction period, whereby we have certain indemnification obligations related to the construction, we are considered for accounting purposes only, the owner of the construction project under build-to-suit lease accounting. We have recorded estimated project construction costs incurred by the landlord as an asset and a corresponding long term liability in “Property and equipment, net” and “Other liabilities, non-current” respectively, on our condensed consolidated balance sheets. We will increase the asset and corresponding long term liability as additional building costs are incurred by the landlord during the construction period. Once the landlord completes the construction of the Initial Premises, which is estimated to be in January 2016, we will evaluate the Lease in order to determine whether or not the Lease meets the criteria for “sale-leaseback” treatment.

The following summarizes our contractual commitments and obligations as of April 30, 2015:

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Payments Due by Period*
 
 
Total
 
Less Than 1
year
 
1-3 years
 
3-5 years
 
More Than 5
years
 
 
(in thousands)
Office lease obligations
 
$
143,870

 
$
13,544

 
$
42,172

 
$
38,012

 
$
50,142

 _________________________
*We entered into a sublease agreement on November 16, 2012 for a portion of our office space in the United Kingdom, and the future sublease rental income of $2.1 million has been included as an offset to our future minimum rental payments.

Legal Proceedings
 
We are subject to certain routine legal and regulatory proceedings, as well as demands and claims that arise in the normal course of our 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 impact of negotiations, estimated settlements, legal rulings, advice of legal counsel and other information and events pertaining to a particular matter. In our opinion, resolution of any pending claims (either individually or in the aggregate) is not expected to have a material adverse impact on our consolidated results of operations, cash flows or financial position, nor is it possible to provide an estimated amount of any such loss. 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, in a particular quarter.

Indemnification Arrangements
 
During the ordinary course of business, we may indemnify, hold harmless and agree to reimburse for losses suffered or incurred, our customers, vendors, and each of their affiliates for certain intellectual property infringement and other claims by third parties with respect to our products and services, in connection with our commercial license arrangements or related to general business dealings with those parties.

As permitted under Delaware law, we have entered into indemnification agreements with our officers, directors and certain employees, indemnifying them for certain events or occurrences while they serve as our officers or directors or those of our direct and indirect subsidiaries.
 
To date, there have not been any costs incurred in connection with such indemnification obligations; therefore, there is no accrual of such amounts at April 30, 2015.  We are unable to estimate the maximum potential impact of these indemnifications on our future results of operations.

(4)  Property and Equipment
 
Property and equipment are stated at cost, net of accumulated depreciation and amortization. These assets are depreciated and amortized using the straight-line method over their estimated useful lives. Property and equipment consisted of the following (in thousands):
 
 
 
As of
 
 
April 30, 2015
 
January 31, 2015
Computer equipment and software
 
$
31,197

 
$
28,342

Furniture and fixtures
 
8,146

 
7,707

Leasehold improvements
 
12,633

 
10,146

Construction in progress (1)
 
37,868

 
29,360

 
 
89,844

 
75,555

Less: accumulated depreciation and amortization
 
(27,529
)
 
(25,181
)
Property and equipment, net
 
$
62,315

 
$
50,374

 
(1) This relates to the capitalization of construction costs in connection with our build-to-suit lease obligation, where we are considered the owner of the asset during the construction period, for accounting purposes only. There is a corresponding long-

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term liability for this obligation on our condensed consolidated balance sheets under “Other liabilities, non-current.” Refer to Note 3 “Commitments and Contingencies” for details.

Depreciation and amortization expense on Property and Equipment, net was $2.3 million and $1.7 million for the three months ended April 30, 2015 and 2014, respectively.

(5)  Acquisitions, Goodwill and Intangible Assets
 
BugSense

On September 25, 2013, we acquired BugSense, a privately-held Delaware corporation, which developed and offered as a service an analytics solution for machine data generated by mobile devices. This acquisition has been accounted for as a business combination. The purchase price of $9.0 million paid in cash was allocated as follows: $4.7 million to identifiable intangible assets, $0.7 million to net deferred tax liability recorded and $0.7 million to net liabilities assumed, and the excess $5.7 million of the purchase price over the fair value of net assets acquired was recorded as goodwill allocated to our one operating segment.

Cloudmeter

On December 6, 2013, we acquired Cloudmeter, a privately-held Delaware corporation, which developed technology that enables users to capture machine data directly from network traffic. This acquisition has been accounted for as a business combination. The purchase price of $21.0 million paid in cash was allocated as follows: $8.5 million to identifiable intangible assets, $0.6 million to net deferred tax liability recorded and $0.2 million to net liabilities assumed, and the excess $13.3 million of the purchase price over the fair value of net assets acquired was recorded as goodwill allocated to our one operating segment.

Intangible Assets

Intangible assets subject to amortization obtained from acquisitions as of April 30, 2015 are as follows (in thousands, except Useful Life):
 
 
Gross Fair Value
 
Accumulated Amortization
 
Net Book Value
 
Weighted Average Remaining Useful Life
(months)
Developed technology
 
$
12,770

 
$
(4,565
)
 
$
8,205

 
28
Customer relationships
 
1,620

 
(846
)
 
774

 
17
Other acquired intangible assets
 
810

 
(504
)
 
306

 
15
Total intangible assets subject to amortization
 
$
15,200

 
$
(5,915
)
 
$
9,285

 
 

Amortization expense from acquired intangible assets during the three months ended April 30, 2015 was $1.1 million.

The expected future amortization expense for acquired intangible assets as of April 30, 2015 is as follows (in thousands):
Fiscal Period:
 
 
Remaining nine months of fiscal 2016
 
$
3,331

Fiscal 2017
 
3,802

Fiscal 2018
 
2,152

Total amortization expense
 
$
9,285


(6)  Debt Financing Facilities

On May 9, 2013 we entered into a Loan Agreement with Silicon Valley Bank, which was most recently amended in May 2015. As amended, the agreement provides for a revolving line of credit facility, which expires May 9, 2017. Under the agreement, we are able to borrow up to $25 million. Interest on any drawdown under the revolving line of credit accrues either at the prime rate (3.25% in April 2015) or the LIBOR rate plus 2.75%. As of April 30, 2015, we had no balance outstanding

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under this agreement. The agreement contains customary financial covenants and other affirmative and negative covenants. We were in compliance with all covenants as of April 30, 2015.

(7)  Stock Compensation Plans
 
The following table summarizes the stock option, restricted stock unit ("RSU") and performance unit ("PSU") award activity during the three months ended April 30, 2015:
 
 
 
 
 
Options Outstanding
 
RSUs and PSUs
Outstanding
 
 
 
Shares Available
for Grant
 
Shares
 
Weighted-
Average
Exercise
Price
Per Share
 
Weighted-
Average
Remaining
Contractual
Term
 
Aggregate
Intrinsic
Value (1)
 
Shares
 
 
 
 
 
 
 
 
 
 
 
(in thousands)
 
 
 
Balances as of January 31, 2015
 
6,718,878

 
6,536,855

 
$
5.76

 
5.59
 
$
301,532

 
12,480,368

 
Additional shares authorized
 
6,176,924

 


 


 

 


 


 
Options exercised
 


 
(978,405
)
 
5.48

 

 


 


 
Options forfeited and expired
 
71,638

 
(71,638
)
 
43.32

 

 


 


 
RSUs and PSUs granted
 
(965,055
)
 


 


 

 


 
965,055

 
RSUs vested
 


 


 


 

 


 
(819,305
)
 
RSUs forfeited and canceled
 
464,591

 


 


 

 


 
(464,591
)
 
Balances as of April 30, 2015
 
12,466,976

 
5,486,812

 
$
5.32

 
5.26
 
$
335,149

 
12,161,527

 
Vested and expected to vest
 
 
 
5,484,133

 
$
5.32

 
5.26
 
$
335,000

 
11,825,460

 
Exercisable as of April 30, 2015
 
 
 
4,245,897

 
$
3.81

 
4.81
 
$
265,745

 
 
 

(1) The intrinsic value is calculated as the difference between the exercise price of the underlying stock option award and the closing market price of our common stock as of April 30, 2015.

During fiscal 2016, we granted PSUs to certain executives under our 2012 Equity Incentive Plan. The number of PSUs earned and eligible to vest will be determined after a one year performance period, based on achievement of certain company financial performance measures and the recipient's continued service with us. The number of shares of our stock to be received at vesting can range from 0% to 200% of the target amount. Compensation expense for PSUs is measured using the fair value at the date of grant and recorded over the vesting period under the graded-vesting attribution method, and may be adjusted over the vesting period based on interim estimates of performance against the pre-set objectives.

During the three months ended April 30, 2015, $0.5 million of tax benefits have been realized from exercised stock options. At April 30, 2015, there was a total unrecognized compensation cost of $6.3 million related to these stock options, adjusted for estimated forfeitures, which is expected to be recognized over a weighted-average period of 0.74 years. At April 30, 2015, total unrecognized compensation cost was $580.3 million related to RSUs, adjusted for estimated forfeitures, which is expected to be recognized over the next 2.91 years. At April 30, 2015, total unrecognized compensation cost was $13.6 million related to PSUs, adjusted for estimated forfeitures, which is expected to be recognized over the next 3.86 years.
 
The total intrinsic value of options exercised during the three months ended April 30, 2015 was $56.2 million. The weighted-average grant date fair value of RSUs granted was $61.82 per share for the three months ended April 30, 2015. The weighted-average grant date fair value of PSUs granted was $61.83 per share for the three months ended April 30, 2015.

(8)  Geographic Information
 
Revenues

Revenues by geography are based on the shipping address of the customer. The following table presents our revenues by geographic region for the periods presented (in thousands):
 

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Three Months Ended April 30,
 
 
2015

2014
United States
 
$
95,187

 
$
64,679

International
 
30,478

 
21,228

Total revenues
 
$
125,665

 
$
85,907

 
Other than the United States, no other individual country exceeded 10% of total revenues during any of the periods presented. During the three months ended April 30, 2015 and 2014, one channel partner represented approximately 11% and 10% of total revenues, respectively. The revenues from this channel partner is comprised of a number of customer transactions, none of which were individually greater than 10% of total revenues for the three months ended April 30, 2015 and 2014. At April 30, 2015, there was one channel partner that represented approximately 10% of total accounts receivable and at January 31, 2015, no customer or channel partner represented greater than 10% of total accounts receivable.

Property and Equipment

The following table presents our property and equipment by geographic region for the periods presented (in thousands):

 
 
As of
 
 
April 30, 2015
 
January 31, 2015
United States
 
$
58,776

 
$
47,236

International
 
3,539

 
3,138

Total property and equipment, net
 
$
62,315

 
$
50,374


Other than the United States, no other country represented 10% or more of our total property and equipment as of April 30, 2015 or January 31, 2015.

(9)  Income Taxes
 
For the three months ended April 30, 2015 and 2014, we recorded $0.7 million and $0.6 million in income tax expense, respectively. The increase in income tax expense was primarily due to an increase in taxable income in our international jurisdictions and state franchise tax.

There were no material changes to our unrecognized tax benefits in the three months ended April 30, 2015, and we do not expect to have any significant changes to unrecognized tax benefits through the end of the fiscal year. Because of our history of tax losses, all years remain open to tax audit.

(10)  Net Loss Per Share
 
Basic net loss per share is computed by dividing the net loss by the weighted-average number of shares of common stock outstanding during the period, less the weighted-average unvested common stock subject to repurchase or forfeiture. Diluted net loss per share is computed by giving effect to all potential shares of common stock, including preferred stock, stock options, RSUs and PSUs to the extent dilutive.
 
The following table sets forth the computation of historical basic and diluted net loss per share (in thousands, except per share data):
 

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Three Months Ended April 30,
 
 
2015
 
2014
Numerator:
 
 

 
 

Net loss
 
$
(71,186
)
 
$
(50,755
)
Denominator:
 
 

 
 

Weighted-average common shares outstanding
 
124,563

 
117,343

Less: Weighted-average unvested common shares subject to repurchase or forfeiture
 
(15
)
 
(53
)
Weighted-average shares used to compute net loss per share, basic and diluted
 
124,548

 
117,290

Net loss per share, basic and diluted
 
$
(0.57
)
 
$
(0.43
)
 
Since we were in a net loss position for all periods presented, basic net loss per share is the same as diluted net loss per share for all periods as the inclusion of all potential common shares outstanding would have been anti-dilutive. Potentially dilutive securities that were not included in the diluted per share calculations because they would be anti-dilutive were as follows (in thousands):
 
 
 
As of April 30,
 
 
2015
 
2014
Shares subject to outstanding common stock options
 
5,487

 
9,229

Shares subject to outstanding RSUs and PSUs
 
12,162

 
10,136

Employee stock purchase plan
 
316

 
250

Total
 
17,965

 
19,615

 
(11)  Related Party Transactions
 
Certain members of our board of directors ("Board") serve on the board of directors of and/or are executive officers of, and, in some cases, are investors in, companies that are customers or vendors of ours. Certain of our executive officers also serve on the board of directors of companies that are customers or vendors of ours.  We believe the transactions between these companies and us were carried out on terms that are consistent with similar transactions with our other similarly situated customers or vendors. We recognized revenues from sales to these companies of $1.1 million and $0.7 million for the three months ended April 30, 2015 and 2014, respectively. We also recorded $0.5 million and $0.5 million in expenses related to purchases from these companies during the three months ended April 30, 2015 and 2014, respectively. We had $0.1 million and $1.8 million of accounts receivable from these companies as of April 30, 2015 and January 31, 2015, respectively. There were no accounts payable to these companies as of April 30, 2015 or January 31, 2015.
 
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations
 
The following discussion and analysis of our financial condition and results of operations should be read in conjunction with our condensed consolidated financial statements and related notes appearing elsewhere in this Quarterly Report on Form 10-Q. The following discussion and analysis contains forward-looking statements that involve risks and uncertainties, as well as assumptions that, if they never materialize or prove incorrect, could cause our results to differ materially from those expressed or implied by such forward-looking statements. Statements that are not purely historical are forward-looking statements within the meaning of Section 27A of the Securities Act, and Section 21E of the Securities Exchange Act of 1934, as amended (the “Exchange Act”). Forward-looking statements are often identified by the use of words such as, but not limited to, “anticipate,” “believe,” “can,” “continue,” “could,” “estimate,” “expect,” “intend,” “may,” “might,” “plan,” “project,” “seek,” “should,” “target,” “will,” “would” and similar expressions or variations intended to identify forward-looking statements. Such statements include, but are not limited to, statements concerning our market opportunity, our future financial and operating results; our planned investments, particularly in our product development efforts; our planned expansion of our sales and marketing organization; our growth and integration strategies; our continued efforts to market and sell both domestically and internationally; our expectations about seasonal trends; our expectations regarding our revenues mix; use of non-GAAP financial measures; our expectations regarding our operating expenses, including increases in research and development, sales and marketing, and general and administrative expenses; sufficiency of cash to meet cash needs for at least the next 12 months; exposure to interest rate changes; inflation; anticipated income tax rates; our expectations regarding our leases; exposure to exchange rate fluctuations and our ability to manage such exposure; and our expected capital expenditures, cash flows and liquidity.


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These statements are based on the beliefs and assumptions of our management based on information currently available to us. Such forward-looking statements are subject to risks, uncertainties and other important factors that could cause actual results and the timing of certain events to differ materially from future results expressed or implied by such forward-looking statements. Factors that could cause or contribute to such differences include, but are not limited to, those identified below, and those discussed in the section titled “Risk Factors” included under Part II, Item 1A below. Furthermore, such forward-looking statements speak only as of the date of this report. Except as required by law, we undertake no obligation to update any forward-looking statements to reflect events or circumstances that occur after the date of this report.

Overview

Splunk provides innovative software products that enable organizations to gain real-time operational intelligence by harnessing the value of their data. Our products enable users to collect, index, search, explore, monitor and analyze data regardless of format or source. Our products address large and diverse data sets, commonly referred to as big data, and are specifically tailored for machine-generated data. Machine data is produced by nearly every software application and electronic device and contains a definitive, time-stamped record of various activities, such as transactions, customer and user activities and security threats. Beyond an organization's traditional IT and security infrastructure, every processor-based system, including HVAC controllers, smart electrical meters, GPS devices and radio-frequency identification tags, and many consumer-oriented systems, such as electronic wearables, many manufacturing systems, mobile devices, automobiles and medical devices that contain embedded electronic devices, are also continuously generating machine data. Our products help organizations gain value from all of these different sources and forms of machine data.

We believe the market for products that provide operational intelligence presents a substantial opportunity as data grows in volume and diversity, creating new risks, opportunities and challenges for organizations. Since our inception, we have invested a substantial amount of resources developing our products and technology to address this market, specifically with respect to machine data.
 
Our products are designed to accelerate return-on-investment for our customers. They generally do not require customization, long deployment cycles or extensive professional services commonly associated with traditional enterprise software applications. Users can simply download and install the software, typically in a matter of hours, to connect to their relevant machine data sources. Alternatively, they can sign up for our Splunk Cloud service and avoid the need to provision, deploy and manage internal infrastructure. They can also provision a compute instance on Amazon Web Services via a pre-built Amazon Machine Image, which delivers a pre-configured virtual machine instance with our Splunk Enterprise software. We also offer support, training and professional services to our customers to assist in the deployment of our software.

For Splunk Enterprise, we base our license fees on the estimated daily data indexing capacity our customers require. Prospective customers can download a trial version of our software that provides a full set of features but limited data indexing capacity. Following the 60-day trial period, prospective customers can purchase a license for our product or continue using our product with reduced features and limited data indexing capacity. A majority of our license revenues consist of revenues from perpetual licenses, whereby we generally recognize the license fee portion of these arrangements upfront. As a result, the timing of when we enter into large perpetual licenses may lead to fluctuations in our revenues and operating results because our expenses are largely fixed in the short-term. Additionally, we license our software under term licenses, which are generally recognized ratably over the contract term. From time to time, we also enter into transactions that are designed to enable broad adoption of our software within an enterprise, referred to as enterprise adoption agreements. These agreements often include provisions that require revenue deferral and recognition over time.

Our Splunk Cloud service delivers the core functionalities of Splunk Enterprise as a scalable, reliable cloud service. Our Splunk Cloud customers pay an annual subscription fee based on the combination of the volume of data indexed per day and the length of the data retention period. Our product, Hunk: Splunk Analytics for Hadoop and NoSQL Data Stores, is a software product that enables exploration, analysis and visualization of data in Hadoop and NoSQL data stores. Our Splunk MINT product enables customers to gain greater operational intelligence from mobile apps and enables Splunk Enterprise customers to analyze their mobile data, establish alerts and searches based on mobile data, and correlate mobile data with other machine data.

We intend to continue investing for long-term growth. We have invested and expect to continue to invest heavily in our product development efforts to deliver additional compelling features, address customer needs and enable solutions that can address new end markets. For example, in March 2015, we introduced Splunk Light, a product designed for smaller IT environments. In addition, we expect to continue to aggressively expand our sales and marketing organizations to market and sell our software both in the United States and internationally.
 

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Our goal is to make our software the platform for delivering operational intelligence and real-time business insights from machine data. The key elements of our growth strategy are to:
 
Extend our technological capabilities.

Continue to expand our direct and indirect sales organization, including our channel relationships, to increase our sales capacity and enable greater market presence.

Further penetrate our existing customer base and drive enterprise-wide adoption.

Enhance our value proposition through a focus on solutions which address core and expanded use cases.

Grow our user communities and partner ecosystem to increase awareness of our brand, target new use cases, drive operational leverage and deliver more targeted, higher value solutions.

Continue to deliver a rich developer environment to enable rapid development of enterprise applications that leverage machine data and the Splunk platform.
 
We believe the factors that will influence our ability to achieve our goals include, among other things, our ability to deliver new products as well as additional product functionality; acquire new customers across geographies and industries; cultivate incremental sales from our existing customers by driving increased use of our software within organizations; provide additional solutions that leverage our core machine data engine to help organizations understand and realize the value of their machine data in specific end markets and use cases; add additional OEM and strategic relationships to enable new sales channels for our software as well as extend our integration with third party products; and help software developers leverage the functionality of our machine data engine through SDKs and APIs.
 
For the three months ended April 30, 2015 and 2014, our total revenues were $125.7 million and $85.9 million, respectively. For the three months ended April 30, 2015 and 2014, approximately 24% and 25% of our total revenues, respectively, were derived from customers located outside the United States. Our customers and end-users represent the public sector and a wide variety of industries, including financial services, manufacturing, retail and technology, among others. As of April 30, 2015, we had over 9,500 customers, including 80 of the Fortune 100 companies.

For the three months ended April 30, 2015 and 2014, our GAAP operating loss was $71.0 million and $50.1 million, respectively. Our non-GAAP operating loss was $0.7 million and $3.6 million for the three months ended April 30, 2015 and 2014, respectively.

For the three months ended April 30, 2015 and 2014, our GAAP net loss was $71.2 million and $50.8 million, respectively. Our non-GAAP net loss was $0.9 million and $4.2 million for the three months ended April 30, 2015 and 2014, respectively.
 
Our quarterly results reflect seasonality in the sale of our products and services. Historically, a pattern of increased license sales in the fourth fiscal quarter as a result of industry buying patterns has positively impacted sales activity in that period, which can result in lower sequential revenues in the following first fiscal quarter. Our gross margins and operating losses have been affected by these historical trends because the majority of our expenses are relatively fixed in the short-term. The majority of our expenses are personnel-related and include salaries, stock-based compensation, benefits and incentive-based compensation plan expenses. As a result, we have not experienced significant seasonal fluctuations in the timing of expenses from period to period.

Non-GAAP Financial Results
 
To supplement our condensed consolidated financial statements, which are prepared and presented in accordance with GAAP, we provide investors with certain non-GAAP financial measures, including non-GAAP gross margin, non-GAAP operating loss, non-GAAP operating margin, non-GAAP net loss and non-GAAP net loss per share (collectively the “non-GAAP financial measures”). These non-GAAP financial measures exclude all or a combination of the following (as reflected in the following reconciliation tables): stock-based compensation expense, employer payroll tax expense related to employee stock plans, amortization of acquired intangible assets and ground lease expense related to a build-to-suit lease obligation. In addition, non-GAAP financial measures include free cash flow, which represents cash from operations less purchases of property and equipment. The presentation of the non-GAAP financial measures is not intended to be considered in isolation or as a substitute for, or superior to, the financial information prepared and presented in accordance with GAAP. We use these

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non-GAAP financial measures for financial and operational decision-making purposes and as a means to evaluate period-to-period comparisons. We believe that these non-GAAP financial measures provide useful information about our operating results, enhance the overall understanding of past financial performance and future prospects and allow for greater transparency with respect to key metrics used by our management in its financial and operational decision making. In addition, these non-GAAP financial measures facilitate comparisons to competitors’ operating results.

We exclude stock-based compensation expense from our non-GAAP financial measures because it is non-cash in nature and excluding this expense provides meaningful supplemental information regarding our operational performance. In particular, because of varying available valuation methodologies, subjective assumptions and the variety of award types that companies can use under FASB ASC Topic 718, we believe that providing non-GAAP financial measures that exclude this expense allows investors the ability to make more meaningful comparisons between our operating results and those of other companies. We exclude employer payroll tax expense related to employee stock plans in order for investors to see the full effect that excluding that stock-based compensation expense had on our operating results. These expenses are tied to the exercise or vesting of underlying equity awards and the price of our common stock at the time of vesting or exercise, which may vary from period to period independent of the operating performance of our business. We also exclude amortization of acquired intangible assets and ground lease expense related to a build-to-suit lease obligation from our non-GAAP financial measures because these are considered by management to be outside of our core operating results. Accordingly, we believe that excluding these expenses provides investors and management with greater visibility of the underlying performance of our business operations, facilitates comparison of our results with other periods and may also facilitate comparison with the results of other companies in our industry. We consider free cash flow to be a liquidity measure that provides useful information to management and investors about the amount of cash generated by the business that can be used for strategic opportunities, including investing in our business, making strategic acquisitions and strengthening our balance sheet.
    
There are limitations in using non-GAAP financial measures because the non-GAAP financial measures are not prepared in accordance with GAAP, may be different from non-GAAP financial measures used by our competitors and exclude expenses that may have a material impact upon our reported financial results. Further, stock-based compensation expense has been and will continue to be for the foreseeable future a significant recurring expense in our business and an important part of the compensation provided to our employees. The non-GAAP financial measures are meant to supplement and be viewed in conjunction with GAAP financial measures.

The following table reconciles net cash provided by operating activities to free cash flow for the three months ended April 30, 2015 and 2014 (in thousands):
 
 
 
Three Months
Ended April 30,
 
 
2015

2014
Net cash provided by operating activities
 
$
28,615

 
$
18,911

Less purchases of property and equipment
 
(6,415
)
 
(4,238
)
Free cash flow (Non-GAAP)
 
$
22,200

 
$
14,673

Net cash used in investing activities
 
$
8,429

 
$
(255,121
)
Net cash provided by financing activities
 
$
5,832

 
$
6,315


The following table reconciles GAAP gross margin to non-GAAP gross margin for the three months ended April 30, 2015 and 2014:
 
 
 
Three Months
Ended April 30,
 
 
2015

2014
GAAP gross margin
 
81.6
%
 
83.5
%
Stock-based compensation expense
 
5.2

 
4.4

Employer payroll tax on employee stock plans
 
0.2

 
0.2

Amortization of acquired intangible assets
 
0.8

 
0.8

Non-GAAP gross margin
 
87.8
%
 
88.9
%

The following table reconciles GAAP operating loss to non-GAAP operating loss for the three months ended April 30, 2015 and 2014 (in thousands):

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Three Months
Ended April 30,
 
 
2015
 
2014
GAAP operating loss
 
$
(70,979
)
 
$
(50,103
)
Stock-based compensation expense
 
66,109

 
43,239

Employer payroll tax on employee stock plans
 
2,822

 
2,388

Amortization of acquired intangible assets
 
1,130

 
903

Ground lease expense related to build-to-suit lease obligation
 
222

 

Non-GAAP operating loss
 
$
(696
)
 
$
(3,573
)

The following table reconciles GAAP operating margin to non-GAAP operating margin for the three months ended April 30, 2015 and 2014:
 
 
 
Three Months
Ended April 30,
 
 
2015
 
2014
GAAP operating margin
 
(56.5
)%
 
(58.3
)%
Stock-based compensation expense
 
52.6

 
50.3

Employer payroll tax on employee stock plans
 
2.2

 
2.7

Amortization of acquired intangible assets
 
0.9

 
1.1

Ground lease expense related to build-to-suit lease obligation
 
0.2

 

Non-GAAP operating margin
 
(0.6
)%
 
(4.2
)%
 
The following table reconciles GAAP net loss to non-GAAP net loss for the three months ended April 30, 2015 and 2014 (in thousands):
 
 
 
Three Months
Ended April 30,
 
 
2015
 
2014
GAAP net loss
 
$
(71,186
)
 
$
(50,755
)
Stock-based compensation expense
 
66,109

 
43,239

Employer payroll tax on employee stock plans
 
2,822

 
2,388

Amortization of acquired intangible assets
 
1,130

 
903

Ground lease expense related to build-to-suit lease obligation
 
222

 

Non-GAAP net loss
 
$
(903
)
 
$
(4,225
)
 
The following table reconciles the GAAP basic and diluted net loss per share to the non-GAAP basic and diluted net loss per share for the three months ended April 30, 2015 and 2014 (in thousands, except per share amounts):

 
 
Three Months
Ended April 30,
 
 
2015
 
2014
GAAP basic and diluted net loss per share
 
$
(0.57
)
 
$
(0.43
)
Stock-based compensation expense
 
0.53

 
0.36

Employer payroll tax on employee stock plans
 
0.02

 
0.02

Amortization of acquired intangible assets
 
0.01

 
0.01

Ground lease expense related to build-to-suit lease obligation
 
0.00

 

Non-GAAP basic and diluted net loss per share
 
$
(0.01
)
 
$
(0.04
)
 
 
 
 
 
Weighted-average shares used in computing Non-GAAP basic and diluted net loss per share
 
124,548

 
117,290


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Components of Operating Results
 
Revenues
 
License revenues.  License revenues reflect the revenues recognized from sales of licenses to new customers and additional licenses to existing customers. We are focused on acquiring new customers and increasing revenues from our existing customers as they realize the value of our software by indexing higher volumes of machine data and expanding the use of our software through additional use cases and broader deployment within their organizations. A majority of our license revenues consists of revenues from perpetual licenses, under which we generally recognize the license fee portion of the arrangement upfront, assuming all revenue recognition criteria are satisfied. Customers can also purchase term license agreements, under which we recognize the license fee ratably, on a straight-line basis, over the term of the license. Due to the differing revenue recognition policies applicable to perpetual and term licenses, shifts in the mix between perpetual and term licenses from quarter to quarter could produce substantial variation in revenues recognized even if our sales remain consistent. In addition, seasonal trends that contribute to increased sales activity in the fourth fiscal quarter often result in lower sequential revenues in the first fiscal quarter, and we expect this trend to continue. Comparing our revenues on a period-to-period basis may not be meaningful, and you should not rely on our past results as an indication of our future performance.
 
Maintenance and services revenues.  Maintenance and services revenues consist of revenues from maintenance agreements and, to a lesser extent, professional services and training. Typically, when purchasing a perpetual license, a customer also purchases one year of maintenance service for which we charge a percentage of the license fee. When a term license is purchased, maintenance service is typically bundled with the license for the term of the license period. Customers with maintenance agreements are entitled to receive support and unspecified upgrades and enhancements when and if they become available during the maintenance period. We recognize the revenues associated with maintenance agreements ratably, on a straight-line basis, over the associated maintenance period. In arrangements involving a term license, we recognize both the license and maintenance revenues over the contract period. We have a professional services organization focused on helping some of our largest customers deploy our software in highly complex operational environments and train their personnel. We recognize the revenues associated with these professional services on a time and materials basis as we deliver the services or provide the training. We expect maintenance and services revenues to become a larger percentage of our total revenues as our installed customer base grows.
 
Professional services and training revenues as a percentage of total revenues were 8% for the three months ended April 30, 2015 and 2014. We have experienced continued growth in our professional services revenues primarily due to the deployment of our software with some customers that have large, highly complex IT environments.
 
Cost of Revenues
 
Cost of license revenues.  Cost of license revenues includes all direct costs to deliver our product, including salaries, benefits, stock-based compensation and related expenses such as employer taxes, allocated overhead for facilities and IT and amortization of acquired intangible assets. We recognize these expenses as they are incurred.

Cost of maintenance and services revenues.  Cost of maintenance and services revenues includes salaries, benefits, stock-based compensation and related expenses such as employer taxes for our maintenance and services organization, allocated overhead for depreciation of equipment, facilities and IT, and amortization. We recognize expenses related to our maintenance and services organization as they are incurred.
 
Operating Expenses

Our operating expenses are classified into three categories: research and development, sales and marketing and general and administrative. For each category, the largest component is personnel costs, which include salaries, employee benefit costs, bonuses, commissions as applicable, stock-based compensation and related expenses such as employer taxes. Operating expenses also include allocated overhead costs for depreciation of equipment, facilities and IT. Allocated costs for facilities consist of leasehold improvements and rent. Our allocated costs for IT include costs for compensation of our IT personnel and costs associated with our IT infrastructure. Operating expenses are generally recognized as incurred.
 
Research and development.  Research and development expenses primarily consist of personnel and facility-related costs attributable to our research and development personnel. We have devoted our product development efforts primarily to enhancing the functionality and expanding the capabilities of our software and services. We expect that our research and

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development expenses will continue to increase, in absolute dollars, as we increase our research and development headcount to further strengthen and enhance our software and services and invest in the development of our solutions and apps.

Sales and marketing.  Sales and marketing expenses primarily consist of personnel and facility-related costs for our sales, marketing and business development personnel, commissions earned by our sales personnel, and the cost of marketing and business development programs. We expect that sales and marketing expenses will continue to increase, in absolute dollars, as we continue to hire additional personnel and invest in marketing programs.
 
General and administrative.  General and administrative expenses primarily consist of personnel and facility-related costs for our executive, finance, legal, human resources and administrative personnel; our legal, accounting and other professional services fees; and other corporate expenses. We anticipate continuing to incur additional expenses due to growing our operations and being a publicly traded company, including higher legal, corporate insurance and accounting expenses and costs related to maintaining compliance with Section 404 of the Sarbanes-Oxley Act and related regulations.
 
Interest and other income (expense), net
 
Interest and other income (expense), net consists primarily of foreign exchange gains and losses, interest income on our investments and cash and cash equivalents balances, changes in the fair value of forward exchange contracts and interest expense on outstanding debt.
 
Provision for income taxes

The provision for income taxes consists of federal, state and foreign income taxes. We recognize deferred tax assets and liabilities for the expected tax consequences of temporary differences between the tax basis of assets and liabilities and their reported amounts using enacted tax rates in effect for the year in which we expect the differences to reverse.  We record a valuation allowance to reduce the deferred tax assets to the amount that we are more-likely-than-not to realize.  Because of our history of U.S. net operating losses, we have established, in prior years, a full valuation allowance against potential future benefits for U.S. deferred tax assets including loss carry-forwards and research and development and other tax credits.  We regularly assess the likelihood that our deferred income tax assets will be realized based on the realization guidance available. To the extent that we believe any amounts are not more-likely-than-not to be realized, we record a valuation allowance to reduce the deferred income tax assets. We regularly assess the need for the valuation allowance on our deferred tax assets, and to the extent that we determine that an adjustment is needed, such adjustment will be recorded in the period that the determination is made.

Results of Operations
 
The following tables set forth our results of operations for the periods presented and as a percentage of our total revenues for those periods. The period-to-period comparison of financial results is not necessarily indicative of financial results to be achieved in future periods.
 

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Three Months
Ended April 30, 2015
Three Months
Ended April 30, 2014
 
 
Amount
 
% of Revenues
 
Amount
 
% of Revenues
 
 
($ amounts in thousands)
Condensed Consolidated Statement of Operations Data:
 
 

 
 
 
 
 
 
Revenues
 
 
 
 
 
 
 
 
License
 
$
71,872

 
57.2
 %
 
$
51,274

 
59.7
 %
Maintenance and services
 
53,793

 
42.8

 
34,633

 
40.3

Total revenues
 
125,665

 
100.0

 
85,907

 
100.0

Cost of revenues
 
 
 
 
 
 

 
 
License (1)
 
1,161

 
1.6

 
78

 
0.2

Maintenance and services (1)
 
21,924

 
40.8

 
14,109

 
40.7

Total cost of revenues
 
23,085

 
18.4

 
14,187

 
16.5

Gross profit
 
102,580

 
81.6

 
71,720

 
83.5

Operating expenses
 
 

 
 
 
 

 
 
Research and development
 
44,698

 
35.6

 
29,742

 
34.6

Sales and marketing
 
101,989

 
81.2

 
71,078

 
82.7

General and administrative
 
26,872

 
21.3

 
21,003

 
24.4

Total operating expenses
 
173,559

 
138.1

 
121,823

 
141.8

Operating loss
 
(70,979
)
 
(56.5
)
 
(50,103
)
 
(58.3
)
Interest and other income (expense), net
 
 
 


 
 
 
 
Interest income
 
360

 
0.3

 
130

 
0.2

Other income (expense), net
 
89

 
0.1

 
(220
)
 
(0.3
)
Total interest and other income (expense), net
 
449

 
0.4

 
(90
)
 
(0.1
)
Loss before income taxes
 
(70,530
)
 
(56.1
)
 
(50,193
)
 
(58.4
)
Income tax provision
 
656

 
0.5

 
562

 
0.7

Net loss
 
$
(71,186
)
 
(56.6
)%
 
$
(50,755
)
 
(59.1
)%

(1) Calculated as a percentage of the associated revenues.

Comparison of the Three Months Ended April 30, 2015 and 2014
 
Revenues
 
 
 
Three Months
Ended April 30,
 
 
 
 
2015

2014
 
% Change
 
 
($ amounts in thousands)
 
 
Revenues
 
 
 
 

 
 

License
 
$
71,872

 
$
51,274

 
40.2
%
Maintenance and services
 
53,793

 
34,633

 
55.3
%
Total revenues
 
$
125,665

 
$
85,907

 
46.3
%
Percentage of revenues
 
 

 


 
 

License
 
57.2
%
 
59.7
%
 
 
Maintenance and services
 
42.8

 
40.3

 
 
Total
 
100.0
%
 
100.0
%
 
 
 
The increase in license revenues of $20.6 million was primarily driven by increases in our total number of customers, sales to existing customers and an increase in the number of large orders. For example, we had 226 and 167 orders greater than $100,000 for the three months ended April 30, 2015 and 2014, respectively. Our total number of customers increased from approximately 7,400 at April 30, 2014 to more than 9,500 at April 30, 2015. The increase in maintenance and services revenues

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of $19.2 million was due to increases in sales of maintenance agreements as well as sales of professional services resulting from the growth of our installed customer base.

Cost of Revenues and Gross Margin
 
 
 
Three Months
Ended April 30,
 
 
 
 
2015

2014
 
% Change
 
 
($ amounts in thousands)
 
 
Cost of revenues
 
 

 
 

 
 

License
 
$
1,161

 
$
78

 
1,388.5
%
Maintenance and services
 
21,924

 
14,109

 
55.4
%
Total cost of revenues
 
$
23,085

 
$
14,187

 
62.7
%
Gross margin
 
 
 

 
 
License
 
98.4
%
 
99.8
%
 


Maintenance and services
 
59.2
%
 
59.3
%
 
 

Total gross margin
 
81.6
%
 
83.5
%
 
 

 
Total cost of revenues increased $8.9 million primarily due to a $7.8 million increase in cost of maintenance and services revenues. The increase in cost of maintenance and services revenues was primarily related to an increase of $5.5 million in salaries and benefits expense, which includes a $2.7 million increase in stock-based compensation expense, due to increased headcount, an increase of $0.7 million related to overhead costs, an increase of $0.5 million related to third-party consulting services and an increase of $0.5 million related to travel, other operating and employment-related expenses. The $1.1 million increase in cost of license revenues was primarily due to a $0.7 million increase in amortization expense related to acquired intangible assets. Total gross margin decreased slightly primarily due to the higher mix of maintenance and services revenues, which have lower margins than license revenues.

Operating Expenses
 
 
 
Three Months
Ended April 30,
 
 
 
 
2015
 
2014
 
% Change
 
 
($ amounts in thousands)
 
 
Operating expenses (1)
 
 

 
 

 
 

Research and development
 
$
44,698

 
$
29,742

 
50.3
%
Sales and marketing
 
101,989

 
71,078

 
43.5
%
General and administrative
 
26,872

 
21,003

 
27.9
%
Total operating expenses
 
$
173,559

 
$
121,823

 
42.5
%
Percentage of revenues
 
 
 


 
 
Research and development
 
35.6
%
 
34.6
%
 
 
Sales and marketing
 
81.2

 
82.7

 
 
General and administrative
 
21.3

 
24.4

 
 
Total
 
138.1
%
 
141.8
%
 
 
 
 
 
 
 
 
 
(1) Includes stock-based compensation expense:
 
 

Research and development
 
$
20,075

 
$
12,587

 
 

Sales and marketing
 
29,610

 
19,120

 
 

General and administrative
 
9,892

 
7,726

 
 

Total stock-based compensation expense
 
$
59,577

 
$
39,433

 
 

 
Research and development expense.  Research and development expense increased $15.0 million primarily due to a $12.7 million increase in salaries and benefits, which includes a $7.5 million increase in stock-based compensation expense, as we increased headcount as part of our focus on further developing and enhancing our products. We also had an increase of $1.6 million related to overhead costs.

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Sales and marketing expense.  Sales and marketing expense increased $30.9 million primarily due to a $21.8 million increase in salaries and benefits, which includes a $10.5 million increase in stock-based compensation expense, as we increased headcount to expand our field sales organization and experienced higher commission expense as a result of increased customer orders. We experienced an increase of $3.9 million in expenses due to increased facilities and overhead, as well as an increase of $1.6 million in marketing program fees, marketing events and advertising. Additionally, we had an increase of $2.1 million in travel expenses due to increased travel from our growing field sales organization and an increase of $1.3 million related to our sales kickoff.

General and administrative expense.  General and administrative expense increased $5.9 million due primarily to an increase of $4.6 million related to salaries and benefits, which includes a $2.2 million increase in stock-based compensation expense, due to increased headcount. Additionally, we had a $1.1 million increase due to IT related consulting expenses.

Interest and Other Income (Expense), net
 
 
 
Three Months
Ended April 30,
 
 
2015
 
2014
 
 
(in thousands)
Interest and other income (expense), net:
 
 
 
 
Interest income, net
 
$
360

 
$
130

Other income (expense), net
 
89

 
(220
)
Total interest and other income (expense), net
 
$
449

 
$
(90
)
 
Interest and other income (expense), net reflects a net increase in income primarily due to an increase in interest income from our investments.
 
Income Tax Provision
 
 
 
Three Months
Ended April 30,
 
 
2015
 
2014
 
 
(in thousands)
Income tax provision
 
$
656

 
$
562

 
For the three months ended April 30, 2015, we recorded an income tax expense that was primarily attributable to an increase in tax expense from increased activity in our foreign operations and state franchise tax.

Liquidity and Capital Resources
 
 
April 30, 2015
 
January 31, 2015
 
 
(in thousands)
Cash and cash equivalents
 
$
413,507

 
$
387,315

 
 
 
 
 
 
 
Three Months
Ended April 30,
 
 
2015
 
2014
 
 
(in thousands)
Cash provided by operating activities
 
$
28,615

 
$
18,911

Cash used in investing activities
 
(8,429
)
 
(255,121
)
Cash provided by financing activities
 
5,832

 
6,315

 
Since fiscal 2010 we have funded our operations primarily through cash generated from operations. At April 30, 2015, our cash and cash equivalents of $413.5 million were held for working capital purposes, a majority of which was invested in money market funds. We intend to increase our capital expenditures for the remainder of fiscal 2016, consistent with the growth in our business and operations. We believe that our existing cash and cash equivalents will be sufficient to meet our anticipated cash needs for at least the next 12 months. Our future capital requirements will depend on many factors including our growth

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rate, the timing and extent of spending to support development efforts, the expansion of sales and marketing activities, the introduction of new and enhanced software and services offerings, the continuing market acceptance of our products and our planned investments, particularly in our product development efforts or acquisitions of complementary businesses, applications or technologies.

In the event that additional financing is required from outside sources, we may not be able to raise it on terms acceptable to us if at all. If we are unable to raise additional capital when desired, our business, operating results and financial condition could be adversely affected.
 
Operating Activities
 
In the three months ended April 30, 2015, cash inflows from our operating activities were $28.6 million, which reflects our net loss of $71.2 million, adjusted by non-cash charges of $69.2 million, consisting primarily of $66.1 million for stock-based compensation, $3.5 million for depreciation and amortization and $0.4 million for amortization of investment premiums, partially offset by $0.5 million for excess tax benefits from employee stock plans and $0.3 million for deferred income taxes. Sources of cash inflows were from changes in our working capital, including a $47.1 million decrease in accounts receivable due to strong collections, a $1.2 million increase in deferred revenue due to increased sales of our license and subscription products and the related product support agreements, a $0.6 million increase in accrued expenses and other liabilities due to the overall growth of our business and a $0.4 million increase in accounts payable. These cash inflows were offset by an $18.4 million decrease in accrued payroll and compensation and a $0.3 million increase in prepaid expense and other current and non-current assets.

In the three months ended April 30, 2014, cash inflows from our operating activities were $18.9 million, which reflects our net loss of $50.8 million, adjusted by non-cash charges of $45.1 million, consisting primarily of $43.2 million for stock-based compensation, $2.7 million for depreciation and amortization, partially offset by $0.3 million for deferred income taxes and $0.5 million for excess tax benefits from employee stock plans. Sources of cash inflows were from changes in our working capital, including a $31.2 million decrease in accounts receivable due to strong collections, a $1.7 million increase in deferred revenue, a $4.5 million increase in accrued expenses and other liabilities, $0.5 million decrease in prepaid expense and other current and non-current assets and $0.4 million increase in accounts payable. These cash inflows were offset by a $13.8 million decrease in accrued payroll and compensation.

Investing Activities
 
In the three months ended April 30, 2015, cash used in investing activities of $8.4 million was primarily attributable to $160.5 million of investments in U.S. treasury securities, $6.4 million of capital expenditures for the purchase of technology and hardware as well as purchases related to our facilities and infrastructure and $1.5 million related to other investment activities. These cash outflows were partially offset by $160.0 million cash inflow due to the maturities of our investments.

In the three months ended April 30, 2014, cash used in investing activities of $255.1 million was primarily attributable to $250.9 million of investments in U.S. treasury securities and $4.2 million of capital expenditures for the purchase of technology and hardware as well as purchases related to our facilities and infrastructure.

Financing Activities
 
In the three months ended April 30, 2015, cash provided by financing activities of $5.8 million consisted primarily of $5.4 million of proceeds from the exercise of stock options and $0.5 million of proceeds from excess tax benefits from employee stock plans.

In the three months ended April 30, 2014, cash provided by financing activities of $6.3 million consisted primarily of $5.8 million of proceeds from the exercise of stock options and $0.5 million of proceeds from excess tax benefits from employee stock plans.

Loan and Security Agreement

On May 9, 2013 we entered into a Loan Agreement with Silicon Valley Bank, which was most recently amended in May 2015. As amended, the agreement provides for a revolving line of credit facility, which expires May 9, 2017. Under the agreement, we are able to borrow up to $25 million. Interest on any drawdown under the revolving line of credit accrues either at the prime rate (3.25% in April 2015) or the LIBOR rate plus 2.75%. As of April 30, 2015, we had no balance outstanding under this agreement. The agreement includes restrictive covenants, in each case subject to certain exceptions, that limit our

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ability to: sell or otherwise dispose of our business or property; change our business, liquidate or dissolve or undergo a change in control; enter into mergers, consolidations and acquisitions; incur indebtedness; create liens; pay dividends or make distributions; make investments; enter into material transactions with affiliates; pay any subordinated debt or amend certain terms thereof; or become an investment company.

In addition, the agreement contains customary financial covenants and other affirmative and negative covenants. We were in compliance with all covenants as of April 30, 2015.

Contractual Payment Obligations
 
We lease our office spaces under non-cancelable leases with rent expense recognized on a straight-line basis over the lease term. Rent expense was $2.9 million and $2.2 million for the three months ended April 30, 2015 and 2014, respectively.

On April 29, 2014, we entered into an office lease (the "Lease") for approximately 182,000 square feet located at 270 Brannan Street, San Francisco, California (the "Premises"). The Premises will be allocated to approximately 95,000 square feet of rentable space (the "Initial Premises") which we expect to occupy in January 2016 and approximately 87,000 square feet of rentable space (the "Must-Take Premises"), which we expect to occupy one year thereafter. The Initial Premises and the Must-Take Premises each have a term of 84 months, subject to the completion of certain pre-occupancy improvements by our landlord. Our total obligation for the base rent is approximately $92.0 million. On May 13, 2014, we entered into an irrevocable, standby letter of credit with Silicon Valley Bank for $6.0 million to serve as a security deposit for the Lease.

As a result of our involvement during the construction period, whereby we have certain indemnification obligations related to the construction, we are considered for accounting purposes only, the owner of the construction project under build-to-suit lease accounting. We have recorded estimated project construction costs incurred by the landlord as an asset and a corresponding long-term liability in “Property and equipment, net” and “Other liabilities, non-current” respectively, on our condensed consolidated balance sheets. We will increase the asset and corresponding long term liability as additional building costs are incurred by the landlord during the construction period. Once the landlord completes the construction of the Initial Premises, which is estimated to be in January 2016, we will evaluate the Lease in order to determine whether or not the Lease meets the criteria for “sale-leaseback” treatment.

The following summarizes our contractual commitments and obligations as of April 30, 2015:
 
 
Payments Due by Period*
 
 
Total
 
Less Than 1
year
 
1-3 years
 
3-5 years
 
More Than 5
years
 
 
(in thousands)
Office lease obligations
 
$
143,870

 
$
13,544

 
$
42,172

 
$
38,012

 
$
50,142

 _________________________
*We entered into a sublease agreement on November 16, 2012 for a portion of our office space in the United Kingdom, and the future sublease rental income of $2.1 million has been included as an offset to our future minimum rental payments.

Off-Balance Sheet Arrangements
 
During the three months ended April 30, 2015 and 2014, we did not have any relationships with unconsolidated organizations or financial partnerships, such as structured finance or special purpose entities, that have been established for the purpose of facilitating off-balance sheet arrangements or other contractually narrow or limited purposes.

 Indemnification Arrangements
 
During the ordinary course of business, we may indemnify, hold harmless and agree to reimburse for losses suffered or incurred, our customers, channel partners, vendors and each of their affiliates for certain intellectual property infringement and other claims by third parties with respect to our products and services, in connection with our commercial license arrangements or related to general business dealings with those parties.

 As permitted under Delaware law, we have entered into indemnification agreements with our officers, directors and certain employees, indemnifying them for certain events or occurrences while they serve as our officers or directors.
 

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To date, there have not been any costs incurred in connection with such indemnification obligations; therefore, there is no accrual of any amounts at April 30, 2015.  We are unable to estimate the maximum potential impact of these indemnifications on our future results of operations.

Critical Accounting Policies and Estimates
 
We prepare our condensed consolidated financial statements in accordance with U.S. GAAP. The preparation of condensed consolidated financial statements also requires us to make estimates and assumptions that affect the reported amounts of assets, liabilities, revenues, costs and expenses and related disclosures. We base our estimates on historical experience and on various other assumptions that we believe to be reasonable under the circumstances. Actual results could differ significantly from the estimates made by our management. To the extent that there are differences between our estimates and actual results, our future financial statement presentation, financial condition, results of operations and cash flows will be affected.
 
There have been no material changes to our critical accounting policies and estimates as compared to the critical accounting policies and estimates described in our Annual Report on Form 10-K, filed with the SEC on March 31, 2015.
 
Item 3. Quantitative and Qualitative Disclosures about Market Risk

Interest Rate Risk

We hold our cash, cash equivalents and investments for working capital purposes. Some of the securities we invest in are subject to market risk. This means that a change in prevailing interest rates may cause the principal amount of the investment to fluctuate. To minimize this risk, we maintain our portfolio of cash, cash equivalents and investments in a variety of securities, including money market funds and government debt securities. The risk associated with fluctuating interest rates is limited to our investment portfolio. Due to the short-term nature of these instruments, we believe that we do not have any material exposure to changes in the fair value of our investment portfolio as a result of changes in interest rates. Declines in interest rates, however, would reduce future interest income.
        
The primary objective of our investment activities is to preserve principal while maximizing yields without significantly increasing risk. This objective is accomplished by making diversified investments, consisting primarily of investment grade securities. The effect of a hypothetical 10% increase or decrease in overall interest rates would not have had a material impact on our operating results or the total fair value of the portfolio.

Any draws under our revolving credit facility bear interest at a variable rate tied to the prime rate or the LIBOR rate. As of April 30, 2015, we had no balance outstanding under this agreement.

Foreign Currency Exchange Risk

Our results of operations and cash flows are subject to fluctuations due to changes in foreign currency exchange rates. All of our revenues are generated in U.S. dollars. Our expenses are generally denominated in the currencies in which our operations are located, which is primarily in the United States and to a lesser extent in Europe and Asia. Our results of operations and cash flows are, therefore, subject to fluctuations due to changes in foreign currency exchange rates and may be adversely affected in the future due to changes in foreign exchange rates. We seek to minimize the impact of certain foreign currency fluctuations by hedging certain balance sheet exposures with foreign currency forward contracts. Any gain or loss from settling these contracts is offset by the loss or gain derived from the underlying balance sheet exposures. We do not enter into any hedging contracts for trading or speculative purposes. The effect of a hypothetical 10% change in foreign currency exchange rates applicable to our business would not have a material impact on our historical consolidated financial statements. As our international operations grow, we will continue to reassess our approach to manage our risk relating to fluctuations in currency rates.

Inflation

We do not believe that inflation had a material effect on our business, financial condition or results of operations in the three months ended April 30, 2015 and 2014. If our costs were to become subject to significant inflationary pressures, we may not be able to fully offset such higher costs through price increases. Our inability or failure to do so could harm our business, financial condition and results of operations. 

Item 4. Controls and Procedures

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Evaluation of Disclosure Controls and Procedures
 
Our management, with the participation of our Chief Executive Officer and our Chief Financial Officer, evaluated the effectiveness of our disclosure controls and procedures as of April 30, 2015. The term “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"), means controls and other procedures of a company that are designed to ensure that information required to be disclosed by a company in the reports that it files or submits under the Exchange Act is recorded, processed, summarized and reported, within the time periods specified in the SEC’s rules and forms. Disclosure controls and procedures include, without limitation, controls and procedures designed to ensure that information required to be disclosed by a company in the reports that it files or submits under the Exchange Act is accumulated and communicated to the company’s management, including its principal executive and principal financial officers, as appropriate to allow timely decisions regarding required disclosure. Based on the evaluation of our disclosure controls and procedures as of April 30, 2015, our Chief Executive Officer and Chief Financial Officer concluded that, as of such date, our disclosure controls and procedures were effective at the reasonable assurance level.

Changes in Internal Control over Financial Reporting
 
There was no change in our internal control over financial reporting identified in connection with the evaluation required by Rule 13a-15(d) and 15d-15(d) of the Exchange Act that occurred during the period covered by this Quarterly Report on Form 10-Q that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.
 
Inherent Limitations on Effectiveness of Controls
 
Our management, including our Chief Executive Officer and Chief Financial Officer, believes that our disclosure controls and procedures and internal control over financial reporting are designed to provide reasonable assurance of achieving their objectives and are effective at the reasonable assurance level. However, our management does not expect that our disclosure controls and procedures or our internal control over financial reporting will prevent all errors and all fraud. A control system, no matter how well conceived and operated, can provide only reasonable, not absolute, assurance that the objectives of the control system are met. Further, the design of a control system must reflect the fact that there are resource constraints, and the benefits of controls must be considered relative to their costs. Because of the inherent limitations in all control systems, no evaluation of controls can provide absolute assurance that all control issues and instances of fraud, if any, have been detected. These inherent limitations include the realities that judgments in decision-making can be faulty, and that breakdowns can occur because of a simple error or mistake. Additionally, controls can be circumvented by the individual acts of some persons, by collusion of two or more people or by management override of the controls. The design of any system of controls also is based in part upon certain assumptions about the likelihood of future events, and there can be no assurance that any design will succeed in achieving its stated goals under all potential future conditions; over time, controls may become inadequate because of changes in conditions, or the degree of compliance with policies or procedures may deteriorate. Because of the inherent limitations in a cost-effective control system, misstatements due to error or fraud may occur and not be detected.
 
PART II. OTHER INFORMATION
 
Item 1. Legal Proceedings
 
The information set forth above under Legal Proceedings in Note 3 contained in the “Notes to Condensed Consolidated Financial Statements” is incorporated herein by reference.

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Item 1A. Risk Factors
 
Our operations and financial results are subject to various risks and uncertainties including those described below. 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, also may become important factors that affect us. If any of the following risks or others not specified below materialize, our business, financial condition and results of operations could be materially adversely affected. In that case, the trading price of our common stock could decline.
 
The market for our products is new and unproven and may not grow.

We believe our future success will depend in large part on the growth, if any, in the market for products that provide operational intelligence, particularly from machine data. We market our products as targeted solutions for specific use cases and as an enterprise solution for machine data. In order to grow our business, we intend to expand the functionality of our products to increase their acceptance and use by the broader market as well as develop new products. It is difficult to predict customer adoption and renewal rates, customer demand for our products, the size and growth rate of this market, the entry of competitive products or the success of existing competitive products. Any expansion in our market depends on a number of factors, including the cost, performance and perceived value associated with our products. If our products do not achieve widespread adoption or there is a reduction in demand for products in our market caused by a lack of customer acceptance or expansion, technological challenges, decreases in accessible machine data, competing technologies and products, pricing pressure, decreases in corporate or information technology spending, weakening economic conditions, or otherwise, it could result in reduced customer orders, early terminations, reduced renewal rates or decreased revenues, any of which would adversely affect our business operations and financial results. We believe that these are inherent risks and difficulties in this new and unproven market.

Our future operating results may fluctuate significantly, and our recent operating results may not be a good indication of our future performance.
 
Our revenues and operating results could vary significantly from period to period as a result of various factors, many of which are outside of our control. For example, we have historically generated a majority of our revenues from perpetual license agreements, whereby we generally recognize the license fee portion of the arrangement upfront, assuming all revenue recognition criteria are satisfied. Our customers also have the choice of entering into agreements for term licenses and/or our cloud services, for use of our software, whereby the fee is recognized ratably over the term, and, in combination with our introduction of enterprise adoption agreements, or transactions that are designed to enable broad adoption of our software within an enterprise, we have seen the proportion of our customer orders where revenues will be recognized ratably increase steadily as a percentage of total orders. At the beginning of each quarter, we do not know the ratio between perpetual licenses and ratably recognized agreements that we will enter into during the quarter. In the first quarter of fiscal 2016, the percentage of license and cloud orders that will be recognized ratably was 43%. As a result, our operating results could be significantly impacted by unexpected shifts in the ratio between perpetual licenses and ratably recognized agreements. In addition, the size of our licenses varies greatly, and a single, large perpetual license in a given period could distort our operating results. The timing and size of large transactions are often hard to predict in any particular period. Further, a portion of revenue recognized in any given quarter is a result of agreements entered into during previous quarters from ratably recognized agreements, including maintenance agreements. Consequently, a decline in business from ratably recognized agreements or maintenance agreements in any quarter may not be reflected in our revenue results for that quarter. Any such decline, however, will negatively affect our revenues in future quarters.  Accordingly, the effect of downturns in sales and market acceptance of our products and services may not be fully reflected in our results of operations until future periods. Comparing our revenues and operating results on a period-to-period basis may not be meaningful, and you should not rely on our past results as an indication of our future performance.

We may not be able to accurately predict our future revenues or results of operations. In particular, approximately half of the revenues we currently recognize each quarter has been attributable to sales made in that same quarter with the balance of the revenues being attributable to sales made in prior quarters in which the related revenues were not recognized upfront. As a result, our ability to forecast revenues on a quarterly or longer-term basis is extremely limited. We base our current and future expense levels on our operating plans and sales forecasts, and our operating costs are expected to be relatively fixed in the short-term. As a result, we may not be able to reduce our costs sufficiently to compensate for an unexpected shortfall in revenues, and even a small shortfall in revenues could disproportionately and adversely affect our financial results for that quarter.
 

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In addition to other risk factors described elsewhere in this “Risk Factors” section, factors that may cause our financial results to fluctuate from quarter to quarter include:
 
the timing of our sales during the quarter, particularly because a large portion of our sales occur toward the end of the quarter, or the loss or delay of a few large contracts;

the mix of revenues attributable to larger transactions as opposed to smaller transactions and the impact that a change in mix may have on the overall average selling price of our products;
 
the mix of revenues attributable to perpetual licenses and term licenses, subscriptions, enterprise adoption agreements, maintenance and professional services and training, which may impact our revenue, deferred revenue, gross margins and operating income;

the renewal and usage rates of our customers;
 
changes in the competitive dynamics of our market;
 
changes in customers’ budgets and in the timing of their purchasing decisions;
 
customers delaying purchasing decisions in anticipation of new products or software enhancements by us or our competitors;
 
customer acceptance of and willingness to pay for new versions of our products or new solutions for specific product and end markets;
 
our ability to successfully introduce and monetize new products and licensing and service models for our new products, such as Hunk: Splunk Analytics for Hadoop and NoSQL Data Stores (“Hunk”), Splunk Cloud, Splunk MINT and Splunk Light;
 
our ability to control costs, including our operating expenses;

the amount and timing of our stock-based compensation expenses;

the timing of satisfying revenue recognition criteria;

our ability to qualify and successfully compete for government contracts;
 
the collectability of receivables from customers and resellers, which may be hindered or delayed; and
 
general economic conditions, both domestically and internationally, as well as economic conditions specifically affecting industries in which our customers participate.
 
Many of these factors are outside our control, and the variability and unpredictability of such factors could result in our failing to meet or exceed our financial expectations for a given period. We believe that quarter-to-quarter comparisons of our revenues, operating results and cash flows may not necessarily be indicative of our future performance.
  
We have a short operating history, which makes it difficult to evaluate our future prospects and may increase the risk that we will not be successful.
 
We have a short operating history, which limits our ability to forecast our future operating results and subjects us to a number of uncertainties, including our ability to plan for and model future growth. We have encountered and will continue to encounter risks and uncertainties frequently experienced by growing companies in developing industries. If our assumptions regarding these uncertainties, which we use to plan our business, are incorrect or change in reaction to changes in our markets, or if we do not address these risks successfully, our operating and financial results could differ materially from our expectations and our business could suffer. Moreover, although we have experienced rapid growth historically, we may not continue to grow as rapidly in the future. Any success that we may experience in the future will depend in large part on our ability to, among other things:
 
improve the performance and capabilities of our products and technology through research and development;

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continue to develop, enhance, expand adoption of and globally deliver our cloud-based services, including Splunk Cloud, and comply with applicable laws in each jurisdiction in which we offer such services;

successfully develop, introduce and expand adoption of new products, such as Hunk, Splunk MINT and Splunk Light;

increase revenues from existing customers through increased or broader use of our products within their organizations;

successfully expand our business domestically and internationally;

maintain and expand our customer base and the ways in which our customers use our products;
 
successfully compete with other companies, open source projects and custom development efforts that are currently in, or may in the future enter, the markets for our products;

successfully provide our customers a compelling business case to purchase our products in a time frame that matches our and our customers’ sales and purchase cycles and at a compelling price point;

respond timely and effectively to competitor offerings and pricing models;

appropriately price our products and services;

generate leads and convert users of the trial versions of our products to paying customers;

prevent users from circumventing the terms of their licenses and subscriptions;

continue to invest in our application development platform to deliver additional content for our platform products and to foster an ecosystem of developers and users to expand the use cases of our products;

maintain and enhance our website and cloud services infrastructure to minimize interruptions when accessing our software or cloud services;

process, store and use our customers’ data in compliance with applicable governmental regulations and other legal obligations related to data privacy, data transfer, data residency, encryption and security; and

hire, integrate and retain world-class professional and technical talent.
 
If we fail to address the risks and difficulties we face, including those described elsewhere in this “Risk Factors” section, our business will be adversely affected and our business operations and financial results will suffer.

If we fail to effectively manage our growth, our business and operating results could be adversely affected.
 
Although our business has experienced significant growth, we cannot provide any assurance that our business will continue to grow at the same rate or at all. We have experienced and may continue to experience rapid growth in our headcount and operations, which has placed and will continue to place significant demands on our management and our operational and financial infrastructure. As of April 30, 2015, approximately 35% of our employees had been with us for less than one year. As we continue to grow, we must effectively integrate, develop and motivate a large number of new employees, while maintaining the effectiveness of our business execution and the beneficial aspects of our corporate culture. In particular, we intend to continue to make directed and substantial investments to expand our research and development, sales and marketing, and general and administrative organizations, as well as our international operations.

To effectively manage growth, we must continue to improve our operational, financial and management controls, and our reporting systems and procedures by, among other things:
 
improving our key business applications, processes and IT infrastructure to support our business needs;
 
enhancing information and communication systems to ensure that our employees and offices around the world are well-coordinated and can effectively communicate with each other and our growing base of customers and channel partners;

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enhancing our internal controls to ensure timely and accurate reporting of all of our operations and financial results; and
 
appropriately documenting our IT systems and our business processes.
 
These systems enhancements and improvements will require significant capital expenditures and allocation of valuable management and employee resources. If we fail to implement these improvements effectively, our ability to manage our expected growth, ensure uninterrupted operation of key business systems and comply with the rules and regulations that are applicable to public reporting companies will be impaired. Additionally, if we do not effectively manage the growth of our business and operations, the quality of our products could suffer, which could negatively affect our brand, financial results and overall business.

We face intense competition in our markets, and we may be unable to compete effectively for sales opportunities.
 
Although our products target the new and emerging market for software and cloud services that provide operational intelligence, we compete against a variety of large software vendors and smaller specialized companies, open source projects and custom development efforts, which provide solutions in the specific markets we address. Our principal competitors include:
 
IT departments of potential customers which have undertaken custom software development efforts to analyze and manage their machine data;

companies targeting the big data market by commercializing open source software, such as the various Hadoop distributions and NoSQL data stores, including Elastic;

security, systems management and other IT vendors, including BMC Software, CA Technologies, HP, IBM, Intel, Microsoft, Dell Software and VMware;
 
business intelligence vendors, analytics and visualization vendors, including IBM and Oracle; and
 
small, specialized vendors that provide complementary and competitive solutions in enterprise data analytics, log aggregation and management, data warehousing and big data technologies that may compete with our products or cloud services.
 
The principal competitive factors in our markets include features, performance and support, scalability and flexibility, ease of deployment and use, total cost of ownership and time to value. Some of our actual and potential competitors have advantages over us, such as longer operating histories, significantly greater financial, technical, marketing or other resources, stronger brand and business user recognition, larger intellectual property portfolios and broader global distribution and presence. Further, competitors may be able to offer products or functionality similar to ours at a more attractive price than we can, such as by integrating or bundling their software products with their other product offerings. In addition, our industry is evolving rapidly and is becoming increasingly competitive. Larger and more established companies may focus on operational intelligence and could directly compete with us. For example, companies may commercialize open source software, such as Hadoop, in a manner that competes with our products or causes potential customers to believe that such product and our products perform the same function. If companies move a greater proportion of their data and computational needs to the cloud, new competitors may emerge that offer services comparable to ours or that are better suited for cloud-based data, and the demand for our products may decrease. Smaller companies could also launch new products and services that we do not offer and that could gain market acceptance quickly.
 
In recent years, there have been significant acquisitions and consolidation by and among our actual and potential competitors. We anticipate this trend of consolidation will continue, which will present heightened competitive challenges to our business. In particular, consolidation in our industry increases the likelihood of our competitors offering bundled or integrated products, and we believe that it may increase the competitive pressures we face with respect to our products. If we are unable to differentiate our products from the integrated or bundled products of our competitors, such as by offering enhanced functionality, performance or value, we may see decreased demand for those products, which would adversely affect our business operations, financial results and growth prospects. Further, it is possible that continued industry consolidation may impact customers’ perceptions of the viability of smaller or even medium-sized software firms and consequently their willingness to use software solutions from such firms. Similarly, if customers seek to concentrate their software license purchases in the product portfolios of a few large providers, we may be at a competitive disadvantage regardless of the performance and features of our products. We believe that in order to remain competitive at the large enterprise level, we will

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need to develop and expand relationships with resellers and large system integrators that provide a broad range of products and services. If we are unable to compete effectively, our business operations and financial results could be materially and adversely affected.

Because we derive substantially all of our revenues and cash flows from sales of licenses of one software product, failure of this product to satisfy customer demands or to achieve increased market acceptance would adversely affect our business, results of operations, financial condition and growth prospects.
 
Although we have recently introduced several new product offerings, we derive and expect to continue to derive substantially all of our license revenues and cash flows from sales of licenses and maintenance of Splunk Enterprise. As such, the market acceptance of Splunk Enterprise is critical to our continued success. Demand for licenses to Splunk Enterprise is affected by a number of factors beyond our control, including continued market acceptance of Splunk Enterprise by referenceable accounts for existing and new use cases, the timing of development and release of new products by our competitors, technological change, and growth or contraction in our market. In addition, users of software that provides operational intelligence may seek a cloud-based service, and only recently we began to offer a cloud service with the features and functionality of Splunk Enterprise. Our cloud-based services currently represent a de minimis percentage of our overall revenues. We expect the proliferation of machine data to lead to an increase in the data analysis demands of our customers, and our products may not be able to scale and perform to meet those demands or may not be chosen by users for those needs. If we are unable to continue to meet customer demands or to achieve more widespread market acceptance of Splunk Enterprise, our business operations, financial results and growth prospects will be materially and adversely affected.
 
We have a history of losses, and we may not be profitable in the future.
 
We have incurred net losses in each year since our inception. As a result, we had an accumulated deficit of $458.0 million at April 30, 2015. Because the market for our products is rapidly evolving and has not yet reached widespread adoption, it is difficult for us to predict our future operating results. We expect our operating expenses to increase over the next several years as we hire additional personnel, expand and improve the effectiveness of our distribution channels, and continue to develop features and functionality for our products. In addition, as we grow as a public company, we have incurred and will continue to incur significant legal, accounting and other operating expenses, including compliance with the auditor attestation requirements of Section 404 of the Sarbanes-Oxley Act. If our revenues do not increase to offset these increases in our operating expenses, we may not be profitable in future periods. Our historical revenue growth has been inconsistent and should not be considered indicative of our future performance. Further, in future periods, our revenue growth could slow or our revenues could decline for a number of reasons, including slowing demand for our products, increasing competition, a decrease in the growth of our overall market, or our failure, for any reason, to continue to capitalize on growth opportunities. Any failure by us to achieve, sustain or increase profitability on a consistent basis could cause the value of our common stock to decline.
 
If customers do not expand their use of our products beyond the current predominant use cases, our ability to grow our business and operating results may be adversely affected.
 
Most of our customers currently use our products to support application management, IT operations, security and compliance functions. Our ability to grow our business depends in part on our ability to persuade current and future customers to expand their use of our products to additional use cases, such as facilities management, supply chain management, business analytics and customer analytics. If we fail to achieve market acceptance of our products for these applications, or if a competitor establishes a more widely adopted solution for these applications, our ability to grow our business and financial results will be adversely affected.
 
We employ multiple, unique and evolving pricing models, which subject us to various pricing and licensing challenges that could make it difficult for us to derive value from our customers and may adversely affect our operating results.
 
We employ multiple, unique and evolving pricing models for our products and services. For example, we generally charge our customers for their use of Splunk Enterprise and Splunk Light based on their estimated peak daily indexing capacity. In addition, Splunk Cloud is generally priced based on peak daily indexing capacity and data storage and Hunk licenses are priced based on the number of Hadoop data nodes. We offer both perpetual and term licensing options, which have different payment schedules, and depending on the mix of such licenses, our revenues or deferred revenues could be adversely affected. Our pricing models may ultimately result in a higher total cost to our customers generally as data volumes increase over time, or may cause our customers to limit data volumes in order to stay within the limits of their existing licenses, making it more difficult for us to compete in our markets. As the amount of machine data within our customers’ organizations grows, we face downward pressure from our customers regarding our pricing, which could adversely affect our revenues and operating margins. In addition, our unique pricing models may allow competitors with different pricing models to attract customers

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unfamiliar or uncomfortable with our pricing models, which would cause us to lose business or modify our pricing models, both of which could adversely affect our revenues and operating margins. While we recently introduced unlimited enterprise-wide licenses of Splunk Enterprise to provide pricing predictability to our customers, we have limited experience selling this type of license, and our customers may not find this type of license attractive.

Furthermore, while our products can measure and limit customer usage, such limitations may be improperly circumvented or otherwise bypassed by certain users. Similarly, we provide our customers with an encrypted key for enabling their use of our products. There is no guarantee that users of our products will abide by the terms of these encrypted keys, and if they do not, we may not be able to capture the full value for the use of our products. For example, our enterprise license is generally meant for our customers’ internal use only. If our internal use customers improperly make our products available to their customers, for example, through a cloud or managed service offering, it may displace our end user sales. Additionally, if an internal use customer that has received a volume discount from us improperly makes available our products to its end customers, we may experience price erosion and be unable to capture the appropriate value from those end customers.

During fiscal 2015, we increased the license capacity of our entry-level licenses for Splunk Enterprise and decreased the price of our Splunk Cloud service. Although we believe that this price reduction will enable our customers to more rapidly increase their ability to adopt our product and services, there is no guarantee this will occur. It is possible that such price reduction will not be offset by an increase in order volume, which would have the effect of lowering our revenues and negatively impacting our financial results.
 
Our license agreements generally provide that we can audit our customers’ use of our products or require them to certify their actual usage to ensure compliance with the terms of our license agreement. However, a customer may resist or refuse to allow us to audit their usage, in which case we may have to pursue legal recourse to enforce our rights under the license agreement, which would require us to spend money, distract management and potentially adversely affect our relationship with our customers and users.

If we do not effectively expand and train our sales force, we may be unable to add new customers or increase sales to our existing customers and our business will be adversely affected.
 
We continue to be substantially dependent on our sales force to obtain new customers and to drive additional use cases and adoption among our existing customers. We believe that there is significant competition for sales personnel with the skills and technical knowledge that we require. Our ability to achieve significant revenue growth will depend, in large part, on our success in recruiting, training and retaining sufficient numbers of sales personnel to support our growth. New hires require significant training and may take significant time before they achieve full productivity. Our recent hires and planned hires may not become productive as quickly as we expect, and we may be unable to hire or retain sufficient numbers of qualified individuals in the markets where we do business or plan to do business. In addition, as we continue to grow rapidly, a large percentage of our sales force is new to the company and our products. Our growth creates additional challenges and risks with respect to attracting, integrating and retaining qualified employees, particularly sales personnel. If we are unable to hire and train sufficient numbers of effective sales personnel, or the sales personnel are not successful in obtaining new customers or increasing sales to our existing customer base, our business will be adversely affected.
 
Our sales cycle is long and unpredictable, particularly with respect to large customers, and our sales efforts require considerable time and expense.
 
Our operating results may fluctuate, in part, because of the resource intensive nature of our sales efforts, the length and variability of the sales cycle of our software licensing offerings and the short-term difficulty in adjusting our operating expenses. Our operating results depend in part on sales to large customers and conversions of users of the trial versions of our products into paying customers. The length of our sales cycle, from initial evaluation to delivery of and payment for the software license, varies substantially from customer to customer. In addition, the introduction of our cloud-based service Splunk Cloud has generated interest from our customers who are also considering purchasing and deploying Splunk Enterprise, our on-premises solution. In some cases, our customers may wish to consider a combination of these products, potentially further slowing our sales cycle. Our sales cycle can extend to more than a year for certain customers, particularly large customers. It is difficult to predict exactly when, or even if, we will make a sale with a potential customer or if a user of a trial version of one of our products will upgrade to the paid version of that product. As a result, large individual sales have, in some cases, occurred in quarters subsequent to those we anticipated, or have not occurred at all. The loss or delay of one or more large transactions in a quarter could impact our operating results for that quarter and any future quarters for which revenues from that transaction is delayed. As a result of these factors, it is difficult for us to forecast our revenues accurately in any quarter. Because a substantial portion of our expenses are relatively fixed in the short-term, our operating results will suffer if revenues fall below our expectations in a particular quarter, which could cause the price of our common stock to decline.

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Our business and growth depend substantially on customers renewing their term licenses and maintenance agreements with us. Any decline in our customer renewals could adversely affect our future operating results.
 
While much of our software is sold under perpetual license agreements, all of our maintenance and support agreements are sold on a term basis. In addition, we also enter into term license agreements for our software and cloud services. In order for us to improve our operating results, it is important that our existing customers renew their term licenses, if applicable, and maintenance and support agreements when the initial contract term expires. Our customers have no obligation to renew their term licenses or maintenance and support contracts with us after the initial terms have expired. Our customers’ renewal rates may decline or fluctuate as a result of a number of factors, including their satisfaction or dissatisfaction with our software, our cloud services, our pricing, the effects of economic conditions, competitive offerings or alterations or reductions in our customers’ spending levels. If our customers do not renew their agreements with us or renew on terms less favorable to us, our revenues may decline.
 
Our international sales and operations subject us to additional risks that can adversely affect our business operations and financial results.
 
During the three months ended April 30, 2015, we derived approximately 24% of our total revenues from customers outside the United States, and we are continuing to expand our international operations as part of our growth strategy. We currently have sales personnel and sales and support operations in the United States and certain countries around the world. However, our sales organization outside the United States is substantially smaller than our sales organization in the United States, and we rely heavily on our sales channel for non-U.S. sales. Our ability to convince customers to expand their use of our products or renew their maintenance agreements with us is directly correlated to our direct engagement with the customer. To the extent we are unable to engage with non-U.S. customers effectively with our limited sales force capacity or our indirect sales model, we may be unable to grow sales to existing customers to the same degree we have experienced in the United States.
 
Our international operations subject us to a variety of risks and challenges, including:
 
increased management, travel, infrastructure and legal compliance costs associated with having multiple international operations;
 
reliance on channel partners;
 
longer payment cycles and difficulties in collecting accounts receivable or satisfying revenue recognition criteria, especially in emerging markets;
 
increased financial accounting and reporting burdens and complexities;

general economic conditions in each country or region;
 
economic and political uncertainty around the world;
 
compliance with multiple and changing foreign laws and regulations, including those governing employment, tax, privacy and data protection, data transfer and the risks and costs of non-compliance with such laws and regulations;
 
compliance with laws and regulations for foreign operations, including the United States Foreign Corrupt Practices Act, the United Kingdom Bribery Act, import and export control laws, tariffs, trade barriers, economic sanctions and other regulatory or contractual limitations on our ability to sell our products in certain foreign markets, and the risks and costs of non-compliance;
 
heightened risks of unfair or corrupt business practices in certain geographies and of improper or fraudulent sales arrangements that may impact financial results and result in restatements of financial statements and irregularities in financial statements;
 
fluctuations in currency exchange rates and the related effect on our financial results;
 
difficulties in repatriating or transferring funds from or converting currencies in certain countries;
 

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the need for localized software and licensing programs;
 
reduced protection for intellectual property rights in some countries and practical difficulties of enforcing intellectual property and contract rights abroad; and
 
compliance with the laws of numerous foreign taxing jurisdictions and overlapping of different tax regimes.
 
Any of these risks could adversely affect our international operations, reduce our international revenues or increase our operating costs, adversely affecting our business operations, financial results and growth prospects.
 
In addition, compliance with laws and regulations applicable to our international operations increases our cost of doing business in foreign jurisdictions. We may be unable to keep current with changes in foreign government requirements and laws as they change from time to time. Failure to comply with these regulations could have adverse effects on our business. In many foreign countries it is common for others to engage in business practices that are prohibited by our internal policies and procedures or United States regulations applicable to us. In addition, although we have implemented policies and procedures designed to ensure compliance with these laws and policies, there can be no assurance that all of our employees, contractors, channel partners and agents will comply with these laws and policies. Violations of laws or key control policies by our employees, contractors, channel partners or agents could result in delays in revenue recognition, financial reporting misstatements, fines, penalties, or the prohibition of the importation or exportation of our products and cloud services and could have a material adverse effect on our business operations and financial results.

If we are unable to maintain successful relationships with our channel partners, our business operations, financial results and growth prospects could be adversely affected.
 
In addition to our direct sales force, we use indirect channel partners, such as distributors and resellers, to license and support our products. We derive a portion of our revenues from sales of our products through our channel partners, particularly in the Europe, Middle East and Africa, or EMEA, and Asia Pacific, or APAC, regions and for sales to government agencies. We expect that sales through channel partners in all regions will continue to grow as a portion of our revenues for the foreseeable future.
 
Our agreements with our channel partners are generally non-exclusive, meaning our channel partners may offer customers the products of several different companies, including products that compete with ours. If our channel partners do not effectively market and sell our products, choose to use greater efforts to market and sell their own products or those of our competitors, or fail to meet the needs of our customers, our ability to grow our business and sell our products may be adversely affected. Our channel partners may cease marketing our products with limited or no notice and with little or no penalty. The loss of a substantial number of our channel partners, our possible inability to replace them, or the failure to recruit additional channel partners could materially and adversely affect our results of operations. In addition, sales by channel partners are more likely than direct sales to involve collectability concerns, in particular sales by our channel partners in developing markets, and accordingly, variations in the mix between revenues attributable to sales by channel partners and revenues attributable to direct sales may result in fluctuations in our operating results.
 
Our ability to achieve revenue growth in the future will depend in part on our success in maintaining successful relationships with our channel partners, and to help our channel partners enhance their ability to independently sell and deploy our products. If we are unable to maintain our relationships with these channel partners, or otherwise develop and expand our indirect distribution channel, our business, results of operations, financial condition or cash flows could be adversely affected.

Incorrect or improper implementation or use of our software could result in customer dissatisfaction or customer data loss and negatively affect our business, operations, financial results and growth prospects.
 
Our software is deployed in a wide variety of technology environments. Increasingly, our software has been deployed in large scale, complex technology environments, and we believe our future success will depend on our ability to increase sales of our software licenses for use in such deployments. We often must assist our customers in achieving successful implementations for large, complex deployments. If we or our customers are unable to implement our software successfully, are unable to do so in a timely manner or if an improper implementation or change in system configuration results in errors or loss of data, customer perceptions of our company may be impaired, our reputation and brand may suffer, and customers may choose not to increase their use of our products. In addition, our software imposes server load and index storage requirements for implementation. If our customers do not have the server load capacity or the storage capacity required, they may not be able to effectively implement and use our software and, therefore, may not choose to increase their use of our products.
 

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Our customers and third-party partners may need training in the proper use of and the variety of benefits that can be derived from our software to maximize its potential. If our software is not implemented or used correctly or as intended, inadequate performance, errors or data loss may result. Because our customers rely on our software and maintenance and support services to manage a wide range of operations, the incorrect or improper implementation or use of our software, our failure to train customers on how to efficiently and effectively use our software, or our failure to provide maintenance services to our customers, may result in negative publicity or legal claims against us. Also, as we continue to expand our customer base, any failure by us to properly provide these services will likely result in lost opportunities for follow-on sales of our software and services.

Interruptions or performance problems associated with our technology and infrastructure, and our reliance on Software-as-a-Service, or SaaS, technologies from third parties, may adversely affect our business operations and financial results.
 
Our continued growth depends in part on the ability of our existing and potential customers to use and access our cloud services or our website in order to download our on-premises software or encrypted access keys for our software within an acceptable amount of time. We have experienced, and may in the future experience, website and service disruptions, outages and other performance problems due to a variety of factors, including infrastructure changes, human or software errors, capacity constraints due to an overwhelming number of users accessing our website and services simultaneously and denial of service or fraud or security attacks. In some instances, we may not be able to identify the cause or causes of these website and service performance problems within an acceptable period of time. It may become increasingly difficult to maintain and improve our website and service performance, especially during peak usage times and as our products become more complex and our user traffic increases. If our website or cloud services are unavailable or if our users are unable to download our software or encrypted access keys within a reasonable amount of time or at all, our business would be negatively affected. We expect to continue to make significant investments to maintain and improve website and service performance and to enable rapid releases of new features and apps for our software and cloud services. To the extent that we do not effectively address capacity constraints, upgrade our systems as needed and continually develop our technology and network architecture to accommodate actual and anticipated changes in technology, our business and operating results may be adversely affected.
 
In addition, we rely heavily on hosted SaaS technologies from third parties in order to operate critical functions of our business, including enterprise resource planning services and customer relationship management services.  Further, our cloud-based services, such as Splunk Cloud, are hosted exclusively by third parties. We recently introduced a 100% uptime service level agreement ("SLA") for Splunk Cloud. If any of these services fail or become unavailable due to extended outages, interruptions or because they are no longer available on commercially reasonable terms or prices, or if we are unable to deliver 100% uptime under our SLAs, our revenues could be reduced, our reputation could be damaged, we could be exposed to legal liability, expenses could increase, our ability to manage our finances could be interrupted and our processes for managing sales of our products and supporting our customers could be impaired until equivalent services, if available, are identified, obtained and implemented, all of which could adversely affect our business.
 
Our systems and third-party systems upon which we rely are also vulnerable to damage or interruption from catastrophic occurrences such as earthquakes, floods, fires, power loss, telecommunication failures, terrorist attacks, geopolitical events and similar events. Our United States corporate offices and certain of the facilities we lease to house our computer and telecommunications equipment are located in the San Francisco Bay Area, a region known for seismic activity. Despite any precautions we may take, the occurrence of a natural disaster or other unanticipated problems at our and third parties’ hosting facilities could result in interruptions, performance problems or failure of our infrastructure.

We are subject to governmental export and import controls that could impair our ability to compete in international markets or subject us to liability if we violate the controls.
 
Our products are subject to United States export controls, and we incorporate encryption technology into certain of our products. These encryption products and the underlying technology may be exported outside of the United States only with the required export authorizations, including by license.
 
Furthermore, our activities are subject to the U.S. economic sanctions laws and regulations that prohibit the shipment of certain products and services without the required export authorizations or export to countries, governments, and persons targeted by U.S. sanctions. While we take precautions to prevent our products and services from being exported in violation of these laws, including obtaining authorizations for our encryption products, implementing IP address blocking and screenings against U.S. Government and international lists of restricted and prohibited persons, we cannot guarantee that the precautions we take will prevent violations of export control and sanctions laws.
 

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We also note that if our channel partners fail to obtain appropriate import, export or re-export licenses or permits, we may also be adversely affected, through reputational harm as well as other negative consequences including government investigations and penalties. We presently incorporate export control compliance requirements in our channel partner agreements. Complying with export control and sanctions regulations for a particular sale may be time-consuming and may result in the delay or loss of sales opportunities.

While we have extensive procedures in place, we recently determined that downloads of our free software may have been made in potential violation of the export control and economic sanctions laws. We filed Initial Voluntary Self Disclosures in October 2014 with the U.S. Commerce Department's Bureau of Industry and Security ("BIS") and the U.S. Treasury Department's Office of Foreign Assets Control ("OFAC") and we are currently in the process of preparing the Final Voluntary Disclosures for submission to BIS and OFAC.

Violations of U.S. sanctions or export control laws can result in fines or penalties, including civil penalties of up to $250,000 or twice the value of the transaction, whichever is greater, per violation. In the event of criminal knowing and willful violations of these laws, fines of up to $1 million and possible incarceration for responsible employees and managers could be imposed.
 
Also, various countries, in addition to the United States, regulate the import and export of certain encryption and other technology, including import and export permitting and licensing requirements, and have enacted laws that could limit our ability to distribute our products or could limit our customers’ ability to implement our products in those countries. Changes in our products or future changes in export and import regulations may create delays in the introduction of our products in international markets, prevent our customers with international operations from deploying our products globally or, in some cases, prevent the export or import of our products to certain countries, governments, or persons altogether. Any change in export or import regulations, economic sanctions or related legislation, or change in the countries, governments, persons or technologies targeted by such regulations, could result in decreased use of our products by, or in our decreased ability to export or sell our products to, existing or potential customers with international operations. Any decreased use of our products or limitation on our ability to export or sell our products would likely adversely affect our business operations and financial results.

If our new products, including cloud services, and product enhancements do not achieve sufficient market acceptance, our financial results and competitive position will suffer.
 
We spend substantial amounts of time and money to research and develop new product offerings, including cloud services, and enhanced versions of our existing products to incorporate additional features, improve functionality or other enhancements in order to meet our customers’ rapidly evolving demands. In addition, we continue to invest in solutions that can be deployed on top of our core platform to target specific use cases and to cultivate our community of application developers and users. When we develop a new or enhanced version of an existing product, we typically incur expenses and expend resources upfront to market, promote and sell the new offering. Therefore, when we develop and introduce new or enhanced products, they must achieve high levels of market acceptance in order to justify the amount of our investment in developing and bringing them to market. For example, if our cloud-based services such as Splunk Cloud do not garner widespread market adoption and implementation, our financial results and competitive position could suffer.
 
Further, we may make changes to our products that our customers do not like, find useful or agree with. We may also discontinue certain features, begin to charge for certain features that are currently free or increase fees for any of our features or usage of our products.

Our new products or product enhancements and changes to our existing products could fail to attain sufficient market acceptance for many reasons, including:
 
our failure to predict market demand accurately in terms of product functionality and to supply products that meet this demand in a timely fashion;
 
defects, errors or failures;
 
negative publicity about their performance or effectiveness;
 
delays in releasing to the market our new products or enhancements to our existing products to the market;
 
introduction or anticipated introduction of competing products by our competitors;

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poor business conditions for our end-customers, causing them to delay IT purchases; and
 
reluctance of customers to purchase products incorporating open source software.
 
If our new products, including cloud services, or enhancements and changes do not achieve adequate acceptance in the market, our competitive position will be impaired, and our revenues will be diminished. The adverse effect on our financial results may be particularly acute because of the significant research, development, marketing, sales and other expenses we will have incurred in connection with the new products or enhancements.
 
Our business depends, in part, on sales to the public sector, and significant changes in the contracting or fiscal policies of the public sector could have a material adverse effect on our business.
 
We derive a portion of our revenues from contracts with federal, state, local and foreign governments, and we believe that the success and growth of our business will continue to depend on our successful procurement of government contracts. Factors that could impede our ability to maintain or increase the amount of revenues derived from government contracts, include:
 
changes in fiscal or contracting policies;
 
decreases in available government funding;
 
changes in government programs or applicable requirements;

the adoption of new laws or regulations or changes to existing laws or regulations;
 
potential delays or changes in the government appropriations or other funding authorization processes; and
 
delays in the payment of our invoices by government payment offices.
 
The occurrence of any of the foregoing could cause governments and governmental agencies to delay or refrain from purchasing licenses of our products in the future or otherwise have an adverse effect on our business operations and financial results.
 
Failure to comply with laws or regulations applicable to our business could cause us to lose customers in the public sector, subject us to fines and penalties or negatively impact our ability to contract with the public sector.
 
We must comply with laws and regulations relating to the formation, administration and performance of contracts with the public sector, including United States federal, state and local governmental bodies, which affect how our channel partners and we do business with governmental agencies. These laws and regulations may impose added costs on our business, and failure to comply with these or other applicable regulations and requirements, including non-compliance in the past, could lead to claims for damages from our channel partners, penalties, termination of contracts, loss of exclusive rights in our intellectual property, and temporary suspension or permanent debarment from government contracting. Any such damages, penalties, disruptions or limitations in our ability to do business with the public sector could have a material adverse effect on our business operations and financial results.

The cloud services version of our Splunk Enterprise product, Splunk Cloud, is a relatively new product offering, and market adoption of this cloud service offering could adversely affect our business.
 
SaaS is a model of software deployment in which a software provider typically licenses an application to customers for use as a service on demand through web browser technologies. Delivering under these SaaS models typically results in higher costs and expenses when compared to sales of perpetual licenses for similar functionality. In October 2013, we released Splunk Cloud, our cloud-based service that provides a fully functional version of Splunk Enterprise. In recent years, companies have begun to expect that key software, such as customer relationship management and enterprise resource planning systems, be provided through a SaaS model. In order to provide Splunk Cloud via a SaaS deployment, we have made and will continue to make capital investments and incur substantial costs to implement and maintain this alternative business model, which could negatively affect our financial results.  Even with these investments and costs, the SaaS business model for Splunk Cloud may not be successful. Moreover, sales of Splunk Cloud could displace sales of our Splunk Enterprise software licenses. Alternatively, subscriptions to Splunk Cloud that exceed our expectations may unexpectedly increase our costs, lower our

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margins, lower our profits or increase our losses and otherwise negatively affect our projected financial results. In addition, the change to a SaaS model results in changes in the manner in which we recognize revenues. Changes in revenue recognition would affect our operating results and could have an adverse effect on our business operations and financial results.

Real or perceived errors, failures or bugs in our products could adversely affect our financial results and growth prospects.
 
Because our products are complex, undetected errors, failures or bugs may occur, especially when new products, versions or updates are released. Our on-premises software is often installed and used in large-scale computing environments with different operating systems, system management software, and equipment and networking configurations, which may cause errors or failures of our software or other aspects of the computing environment into which it is deployed. In addition, deployment of our software into complicated, large-scale computing environments may expose undetected errors, failures or bugs in our software. Despite testing by us, errors, failures or bugs may not be found in our products until they are released to our customers. In the past, we have discovered errors, failures and bugs in some of our offerings after their introduction. Real or perceived errors, failures or bugs in our products could result in negative publicity, loss of or delay in market acceptance of our products, loss of competitive position or claims by customers for losses sustained by them. In such an event, we may be required, or may choose, for customer relations or other reasons, to expend additional resources in order to help correct the problem.
 
In addition, if an actual or perceived failure of our on-premises software occurs in a customer’s deployment, regardless of whether the failure is attributable to our software, the market perception of the effectiveness of our products could be adversely affected. Alleviating any of these problems could require significant expenditures of our capital and other resources and could cause interruptions, delays or cessation of our licensing, which could cause us to lose existing or potential customers and could adversely affect our financial results and growth prospects.

Failure to protect our intellectual property rights could adversely affect our business.
 
Our success depends, in part, on our ability to protect proprietary methods and technologies that we develop under patent and other intellectual property laws of the United States and other jurisdictions outside of the United States so that we can prevent others from using our inventions and proprietary information. If we fail to protect our intellectual property rights adequately, our competitors might gain access to our technology, and our business might be adversely affected. However, defending our intellectual property rights might entail significant expenses. Any of our patent rights, copyrights, trademarks or other intellectual property rights may be challenged by others or invalidated through administrative process or litigation. Our issued patents and any patents issued in the future may not provide us with any competitive advantages, and our patent applications may never be granted. Additionally, the process of obtaining patent protection is expensive and time-consuming, and we may not be able to file and prosecute all necessary or desirable patent applications, or we may not be able to do so at a reasonable cost or in a timely manner. Even if issued, there can be no assurance that these patents will adequately protect our intellectual property, as the legal standards relating to the infringement, validity, enforceability and scope of protection of patent and other intellectual property rights are complex and often uncertain.
 
Any patents that are issued may subsequently be invalidated or otherwise limited, allowing other companies to develop offerings that compete with ours, which could adversely affect our competitive business position, business prospects and financial condition. In addition, issuance of a patent does not guarantee that we have a right to practice the patented invention. Patent applications in the United States are typically not published until 18 months after filing or, in some cases, not at all, and publications of discoveries in industry-related literature lag behind actual discoveries. We cannot be certain that we were the first to use the inventions claimed in our issued patents or pending patent applications or otherwise used in our products, that we were the first to file patent applications, or that third parties do not have blocking patents that could be used to prevent us from marketing or practicing our products or technology. Effective patent, trademark, copyright and trade secret protection may not be available to us in every country in which our products are available. The laws of some foreign countries may not be as protective of intellectual property rights as those in the United States (in particular, some foreign jurisdictions do not permit patent protection for software), and mechanisms for enforcement of intellectual property rights may be inadequate. Additional uncertainty may result from recent and future changes to intellectual property legislation in the United States (including the “America Invents Act”) and other countries and from interpretations of the intellectual property laws of the United States and other countries by applicable courts and agencies. Accordingly, despite our efforts, we may be unable to prevent third parties from infringing upon or misappropriating our intellectual property.

We rely in part on trade secrets, proprietary know-how and other confidential information to maintain our competitive position. We generally enter into confidentiality agreements with our employees, consultants, vendors and customers, and generally limit access to and distribution of our proprietary information. Although we endeavor to enter into non-disclosure agreements with our employees, licensees and others who may have access to this information, we cannot assure you that these

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agreements or other steps we have taken will prevent unauthorized use, disclosure or reverse engineering of our technology. In addition, the laws of some foreign countries do not protect our proprietary rights to as great an extent as the laws of the United States, and many foreign countries do not enforce these laws as diligently as government agencies and private parties in the United States. Moreover, third parties may independently develop technologies or products that compete with ours, and we may be unable to prevent this competition.
 
We might be required to spend significant resources to monitor and protect our intellectual property rights. We may initiate claims or litigation against third parties for infringement of our proprietary rights or to establish the validity of our proprietary rights. Litigation also puts our patents at risk of being invalidated or interpreted narrowly. Additionally, we may provoke third parties to assert counterclaims against us. We may not prevail in any lawsuits that we initiate, and the damages or other remedies awarded, if any, may not be adequate to compensate us for the harm suffered. Any litigation, whether or not it is resolved in our favor, could result in significant expense to us and divert the efforts of our technical and management personnel, which may adversely affect our business operations or financial results.