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UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

For the quarterly period ended November 30, 2011

OR

For the transition period from              to              

Commission file number: 001-33634

DemandTec, Inc.

(Exact name of registrant as specified in its charter)

One Franklin Parkway, Building 910

San Mateo, California 94403

(Address of Principal Executive Offices including Zip Code)

(650) 645-7100

(Registrant’s Telephone Number, Including Area Code)

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes x No o

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate website, if any, every interactive data file required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes x No 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):

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

The number of shares of the registrant’s common stock, par value $0.001, outstanding as of December 30, 2011 was: 33,815,217.

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DEMANDTEC, INC.

FORM 10-Q

TABLE OF CONTENTS

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PART I. FINANCIAL INFORMATION

Item 1. Financial Statements

DemandTec, Inc.

Condensed Consolidated Balance Sheets

(In thousands, except par value data)

See Notes to Condensed Consolidated Financial Statements.

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DemandTec, Inc.

Condensed Consolidated Statements of Operations

(In thousands, except per share data)

(Unaudited)

See Notes to Condensed Consolidated Financial Statements.

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DemandTec, Inc

Condensed Consolidated Statements of Cash Flows

(In thousands)

(Unaudited)

See Notes to Condensed Consolidated Financial Statements.

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DemandTec, Inc.

Notes to Condensed Consolidated Financial Statements

1. Business Summary and Significant Accounting Policies

Description of Business

DemandTec, Inc. (the “Company” or “We”) was incorporated in Delaware on November 1, 1999.  We provide a collaborative optimization network of software services connecting retail and consumer products, or CP,  companies, enabling them to define category, brand, and shopper marketing strategies based on a scientific understanding of consumer behavior and make actionable pricing, promotion, assortment, space, and other merchandising and marketing decisions to achieve their revenue, profitability, sales volume, and customer loyalty objectives.  We provide our applications by means of a software-as-a-service, or SaaS, model, which allows us to capture and analyze the most recent retailer and market-level data, enhance our software services rapidly to address our customers’ ever-changing merchandising and marketing needs, and connect retailers and CP companies online to enable improved, more collaborative business processes between trading partners.  We are headquartered in San Mateo, California, with additional sales presence in North America, Europe, and South America, and research and development personnel in India, China, and Russia.

On December 7, 2011, we entered into a definitive agreement and plan of merger (the “Merger Agreement”) with International Business Machines Corporation (“IBM”) and Cudgee Acquisition Corp. (“Sub”), a wholly-owned subsidiary of IBM.  Subject to the terms of the Merger Agreement and subject to the conditions thereof, Sub will merge with and into DemandTec, and DemandTec will become a wholly owned subsidiary of IBM (the “Merger”).  If the Merger is completed, DemandTec’s stockholders will be entitled to receive $13.20 in cash (the “Merger Consideration”) for each share of DemandTec’s common stock owned by them as of the date of the Merger.  See Note 13-Subsequent Event.

Basis of Presentation

Our condensed consolidated financial statements include our accounts and those of our wholly-owned subsidiaries. All significant intercompany balances and transactions have been eliminated in consolidation.  Our fiscal year ends on the last day in February. References to fiscal 2012, for example, refer to our fiscal year ending February 29, 2012.  The accompanying condensed consolidated balance sheet as of November 30, 2011, the condensed consolidated statements of operations for the three and nine months ended November 30, 2011 and 2010, and the condensed consolidated statements of cash flows for the nine months ended November 30, 2011 and 2010 are unaudited.  The consolidated balance sheet data as of February 28, 2011 was derived from the audited consolidated financial statements included in our Annual Report on Form 10-K for the fiscal year ended February 28, 2011 (the “Form 10-K”) filed with the Securities and Exchange Commission, or SEC, on April 21, 2011.  The accompanying statements should be read in conjunction with the audited consolidated financial statements and related notes contained in the Form 10-K, as well as subsequent filings with the SEC.

The accompanying unaudited condensed consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States, or GAAP, for interim financial information and with the instructions to Form 10-Q and Article 10 of Regulation S-X.  Accordingly, certain information and footnote disclosures normally included in consolidated financial statements prepared in accordance with GAAP have been condensed or omitted pursuant to such rules and regulations.  The unaudited condensed consolidated financial statements have been prepared on the same basis as the audited consolidated financial statements and, in the opinion of our management, include all adjustments necessary, all of which are of a normal recurring nature, for the fair presentation of our statements of financial position and our results of operations for the periods included in this Quarterly Report on Form 10-Q.  The results for the three and nine months ended November 30, 2011 are not necessarily indicative of the results to be expected for any subsequent quarter or for the fiscal year ending February 29, 2012.

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 as of the date of the condensed consolidated financial statements, as well as the reported amounts of revenue and expenses during the periods presented. Significant estimates and assumptions made by management include the determination of the fair value of share-based payments, the fair value and estimated useful lives of purchased intangible assets, the recoverability of long-lived assets, the allowance for doubtful accounts, and the provision for income taxes.  We believe that the estimates and judgments upon which we rely are reasonable, based upon information available to us at the time that these estimates and judgments are made.  To the extent there are material differences between these estimates and actual results, our condensed consolidated financial statements will be affected.

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Revenue Recognition

We generate our revenue from providing access to hosted software and delivering related services to retailers and CP companies.  Our customers generally do not have the contractual right to take possession of the software we host.  Our agreements typically have initial contractual terms of one to three years and contain multiple elements, which include the use of our software, SaaS delivery services, professional services, maintenance, and customer support.  Professional services consist of implementation, training, data modeling, and analytical services related to our customers’ use of our software. We have determined that the elements within our agreements generally do not qualify for treatment as separate units of accounting because our elements do not have stand-alone value.  Software subscription, SaaS delivery services, maintenance, and customer support do not have stand-alone value because we do not sell these elements separately or without professional services due to their nature and complexity.  Our professional services do not have stand-alone value because we do not sell these services separately and no third party vendors provide the complete set of professional services required to support our customers. Therefore, we account for all fees received under our agreements as a single unit of accounting and recognize them ratably over the term of the related agreement, commencing upon the later of the agreement start date or the date access to the application is provided to the customers, and when all of the following conditions are also met:

·       there is persuasive evidence of an arrangement;

·       the service has been provided to the customer;

·       the collection of the fees is probable; and

·       the amount of fees to be paid by the customer is fixed or determinable.

Deferred Revenue

Deferred revenue consists of amounts billed or payments received in advance of revenue recognition.  Contracts under which we advance bill customers have generally been non-cancellable.  For agreements with terms over one year, we generally invoice our customers in annual installments.  Accordingly, the deferred revenue balance associated with such multi-year, non-cancellable agreements does not represent the total contract value.  Deferred revenue to be recognized in the succeeding twelve-month period is included in current deferred revenue on our consolidated balance sheets, with the remaining amounts included in non-current deferred revenue.

Concentrations of Credit Risk, Significant Customers and Suppliers and Geographic Information

Our financial instruments that are exposed to concentrations of credit risk consist primarily of cash and cash equivalents, marketable securities, accounts receivable, and a line of credit.  Although we deposit our cash with multiple financial institutions, our deposits, at times, may exceed federally insured limits.  Collateral is not required for accounts receivable.

As of November 30, 2011 and February 28, 2011, long-lived assets located outside the United States were not significant.  As of November 30, 2011, two customers accounted for 25% and 17%, respectively, of our accounts receivable balance.  As of February 28, 2011, two customers accounted for 22% and 13%, respectively, of our accounts receivable balance.

In each of the three and nine months ended November 30, 2011, one customer accounted for 22% of total revenue. In the three months ended November 30, 2010, two customers accounted for 23% and 12%, respectively, of total revenue.  In the nine months ended November 30, 2010, two customers accounted for 20% and 11%, respectively, of total revenue.

Revenue by geographic region, based on the billing address of the customer, was as follows (in thousands):

The equipment hosting our software is in three third-party data center facilities located in San Jose and Sacramento, California, and Mesa, Arizona.  We do not control the operation of these facilities, and our operations are vulnerable to damage or interruption in the event any one of these third-party data center facilities fails.

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Marketable Securities

We consider all highly liquid investments purchased with original maturities of three months or less to be cash equivalents.  Cash and cash equivalents, which primarily consist of cash on deposit with banks and money market funds, are recorded at cost, which approximates fair value.

Our primary objectives when investing excess cash, in order of priority, are capital preservation, short-term liquidity, and achieving a reasonable rate of return.  A significant portion of our marketable securities mature within one year and we limit the amount of credit exposure to any one issuer.  We invest excess cash primarily in the securities of high credit quality issuers, such as highly liquid debt instruments of government-sponsored enterprises, commercial paper, corporate bonds, certificate of deposit, and money market instruments.

We classify our investments as held-to-maturity at the time of purchase and reevaluate the classification at each balance sheet date. We further classify them as current or non-current based on the maturity dates of the individual debt securities at each reporting date.

We monitor our investments in marketable securities for impairment on a periodic basis. For the purpose of impairment evaluation, we determine fair value based on the quoted market rate for the instrument or similar instruments.  In the event that the carrying value of an investment exceeds its fair value and the decline in value is determined to be other-than-temporary, we record an impairment charge and establish a new cost basis for the investment.  In order to determine whether a decline in value is other-than-temporary, we evaluate, among other things, the duration and extent to which the fair value has been less than the carrying value, current market conditions, and our intent and ability to retain the investment for a period of time sufficient to allow for any anticipated recovery in fair market value.  We did not record any impairment adjustments in the current and prior year periods.

Business Combinations

We allocate the total cost of an acquisition to the underlying net assets based on their respective estimated fair values and recognize the identifiable assets acquired and liabilities assumed in accordance with business combination accounting standards.  As part of the allocation process, we identify and attribute values and estimated useful lives to the intangible assets acquired.  These determinations involve significant estimates and assumptions regarding multiple, highly subjective variables, including those with respect to future cash flows, discount rates, asset lives, and the use of different valuation models.  We base our fair value estimates on assumptions we believe to be reasonable but are inherently uncertain.  Depending on the purchase price of a particular acquisition as well as the mix of intangible assets acquired, our financial results could be materially impacted by the application of a different set of assumptions and estimates.

Impairment of Long-Lived Assets

Long-lived assets are reviewed for possible impairment whenever events or circumstances indicate that the carrying amount of these assets may not be recoverable. We evaluate the recoverability of each of our long-lived assets, including purchased intangible assets and property, equipment, and leasehold improvements, by comparison of its carrying amount to the future undiscounted cash flows we expect the asset to generate. If we consider the asset to be impaired, we measure the amount of any impairment as the difference between the carrying amount and the fair value of the impaired asset.  We observed no impairment indicators through the filing of this Quarterly Report on Form 10-Q.

Stock-Based Compensation

We account for and recognize all share-based payments as an expense in our statements of operations.  Grants of stock options to employees generally vest over four years.  We measure the value of stock options based on the grant date fair value using the Black-Scholes pricing model.  Performance-based stock units, or PSUs, vest pursuant to certain performance and time-based vesting criteria set by our Compensation Committee.  We evaluate the probability of meeting the performance criteria at the end of each reporting period to determine how much compensation expense to record.  Because the actual number of shares to be issued is not known until the end of the performance period, the actual compensation expense related to these awards could differ from our current expectations.  We also have time-based restricted stock units, or RSUs, outstanding that entitle the recipient to receive shares of our common stock upon vesting and settlement of the awards pursuant to time-based vesting criteria set by our Compensation Committee.  Stock-based compensation expense for PSUs and RSUs is based on the closing price of our common stock on the grant date.  We amortize the fair value of those awards, net of estimated forfeitures, as stock-based compensation expense over the vesting period of the awards.

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Net Loss per Common Share

Basic net loss per share is computed using the weighted average number of common shares outstanding during the period.  Potential common shares consist of the incremental common shares issuable upon the exercise of stock options or upon the settlement of PSUs and RSUs, and shares subject to issuance under our 2007 Employee Stock Purchase Program, or ESPP.  The dilutive effect of such potential common shares is reflected in diluted loss per share by application of the treasury stock method and on an if-converted basis from the date of issuance.  In the three months ended November 30, 2011 and 2010, weighted average outstanding shares subject to options to purchase common stock, PSUs and RSUs, and shares subject to issuance under our ESPP were approximately 1,776,000 shares and 3,828,000 shares, respectively. In the nine months ended November 30, 2011 and 2010, weighted average outstanding shares subject to options to purchase common stock, PSUs and RSUs, and shares subject to issuance under our ESPP were approximately 2,757,000 shares and 3,189,000 shares, respectively.  Because the Company has been in a loss position in all periods shown, shares used in computing basic and diluted net loss per common share were the same for all periods presented, as the impact of all potentially dilutive securities outstanding was anti-dilutive.

Recent Accounting Pronouncements

In September 2011, the Financial Accounting Standards Board (the “FASB”) issued revised guidance regarding testing goodwill for impairment.  The revised guidance is intended to reduce the cost and complexity of the annual goodwill impairment test by providing entities an option to perform a “qualitative” assessment to determine whether further impairment testing is necessary.  An entity has the option to first assess qualitative factors to determine whether it is necessary to perform the current two-step test.  If an entity believes, as a result of its qualitative assessment, that it is more likely than not that the fair value of a reporting unit is less than its carrying amount, the quantitative impairment test is required.  Otherwise, no further testing is required.  The guidance is effective for annual and interim goodwill impairment tests performed for fiscal years beginning after December 15, 2011.  Early adoption is permitted.  We expect to adopt the revised guidance in our first quarter ending May 31, 2012 and do not expect the adoption of this guidance to have an impact on our consolidated operating results or financial condition.

In June and December 2011, the FASB issued new guidance regarding the presentation of comprehensive income.  The new guidance requires the presentation of the total of comprehensive income, the components of net income and the components of other comprehensive income either in a single continuous statement of comprehensive income or in two separate but consecutive statements, eliminating the option to present other comprehensive income as part of the statement of stockholder’s equity.  The guidance is effective prospectively for fiscal years beginning after December 15, 2011 and interim periods within those years.  Early adoption is permitted.  We expect to adopt the new presentation guidance in our first fiscal quarter ending May 31, 2012.

In May 2011, the FASB issued additional guidance on fair value measurements.  The updated guidance provides a consistent definition of fair value and aligns the fair value measurement and disclosure requirements between U.S. GAAP and International Financial Reporting Standards (“IFRS”), amends certain guidance primarily related to fair value measurements for financial instruments, and enhances disclosure requirements particularly for level 3 fair value measurements.  The guidance is effective prospectively for fiscal years beginning after December 15, 2011 and interim periods within those years.  Early adoption is permitted.  We do not expect the adoption of this guidance to have a significant impact on our consolidated operating results or financial condition.

In December 2010, the FASB issued guidance to amend the disclosure requirements for supplementary pro forma information for business combinations. The guidance improves consistency in how pro forma revenue and earnings are calculated. The amendments also expand the supplemental pro forma disclosures to include a description of the nature and amount of material, nonrecurring pro forma adjustments directly attributable to the business combination included in the reported pro forma revenue and earnings. The amendments are effective prospectively for business combinations for which the acquisition date is on or after the beginning of the first annual reporting period beginning on or after December 15, 2010. We adopted this new standard in the quarter ended May 31, 2011 and disclosed the required supplementary pro forma information in our condensed consolidated financial statements associated with the M-Factor acquisition. See Note 2-Acquisitions.

In October 2009, the FASB issued a new accounting standard for revenue recognition for arrangements with multiple deliverables. The new standard impacts the determination of when the individual deliverables included in a multiple-element arrangement may be treated as separate units of accounting. Additionally, the new standard modifies the manner in which the transaction consideration is allocated across the separately identified deliverables by no longer permitting the residual method of allocating arrangement consideration. The new standard is effective for fiscal years beginning on or after June 15, 2010.  We adopted this new standard in the quarter ended May 31, 2011 and there was no impact on our condensed consolidated operating results or financial condition.

In October 2009, the FASB issued a new accounting standard for the accounting for certain revenue arrangements that include software elements. The new standard amends the scope of pre-existing software revenue guidance by removing from the guidance

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non-software components of tangible products and certain software components of tangible products. The new standard is effective for fiscal years beginning on or after June 15, 2010.  We adopted this new standard in the quarter ended May 31, 2011 and there was no impact on our condensed consolidated operating results or financial condition.

2. Acquisitions

M-Factor, Inc.

On March 11, 2011, we acquired all of the outstanding equity interests of privately-held M-Factor, Inc. (“M-Factor”) for $9.5 million in cash.  M-Factor is a software-as-service company that enables consumer products companies to continuously analyze, forecast, and optimize marketing investments and trade spending.  We paid $9.0 million of the purchase consideration in the nine months ended November 30, 2011.  The remaining $500,000, less any amounts used to satisfy any claims for indemnification obligations, will be distributed to the former M-Factor investors within sixteen months of the consummation of the acquisition.

Purchase Price Accounting

We accounted for the M-Factor acquisition as a business combination.  We allocated the purchase price to the tangible and identifiable intangible assets acquired and liabilities assumed based on their estimated fair values as of the date of acquisition.  We engaged an independent third-party valuation firm to assist us in the determination of the value of the purchased intangible assets.  The excess of the purchase price over the fair value of net tangible and identifiable intangible assets acquired was recorded as goodwill. Although we believe the purchase price allocation is substantially complete, the finalization of certain liabilities, or the settlement of tax-related issues, among other things, could result in a future adjustment to the purchase price allocation.

The following table summarizes the estimated fair values of the assets acquired and liabilities assumed at the acquisition date (in thousands):

Goodwill will not be amortized and is not deductible for tax purposes.  As part of the purchase accounting, we recorded $1.6 million of non-current deferred tax liabilities to reflect the tax effect of the temporary difference between the $4.0 million in fair value assigned to intangible assets acquired and their tax bases.  We also recorded $1.6 million of deferred tax assets (approximately $383,000 in current assets and $1.2 million in non-current assets) to reflect the tax effect of the temporary differences on certain liabilities assumed and future tax deductible expenses, as well as a portion of M-Factor’s pre-acquisition cumulative net operating loss.  Approximately $1.2 million of the total $1.6 million of non-current deferred tax liabilities were offset by the non-current portion of the deferred tax assets.

Purchased Intangible Assets

The following table sets forth the estimated fair value of the purchased intangible assets and their estimated useful lives:

Intangible assets are being amortized on a straight-line basis over a weighted average period of 4.0 years.  In the three months ended November 30, 2011, amortization expense related to the purchased intangible assets was approximately $307,000, of which

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$210,000 was included in cost of revenue and $97,000 was included in operating expenses.  In the nine months ended November 30, 2011, amortization expense related to the purchased intangible assets was approximately $922,000, of which $630,000 was included in cost of revenue and $292,000 was included in operating expenses.

Acquisition-Related Costs and M-Factor’s Post-Acquisition Operating Results

Acquisition-related costs associated with our acquisition of M-Factor were approximately $324,000, of which $194,000 was recorded in our condensed consolidated statements of operations for the nine months ended November 30, 2011 and the remaining costs were incurred prior to fiscal 2012.  Acquisition-related costs, including legal fees and personnel costs for transitional and certain other employees and integration-related professional services, were recorded as operating expenses in accordance with the accounting guidance for business combinations.  M-Factor’s operating results have been included in our condensed consolidated financial statements from the date of the acquisition.  In the three and nine months ended November 30, 2011, we derived approximately $514,000 and $2.4 million, respectively, of our revenue from acquired M-Factor customer contracts.  The incremental operating loss from M-Factor was not separately identifiable due to our integration.

Unaudited Pro Forma Financial Information

The unaudited pro forma financial information in the table below presents the combined results of operations of the Company and M-Factor, as if the acquisition had occurred on March 1, 2010.  The unaudited pro forma results presented include amortization expense for purchased intangible assets, elimination of intercompany transactions, and nonrecurring adjustments such as acquisition-related and restructuring costs.  The unaudited pro forma financial information for the three and nine months ended November 30, 2010 combines our historical operating results for the three and nine months ended November 30, 2010 and M-Factor’s historical operating results for the three and nine months ended September 30, 2010 (due to differences in reporting periods).  The unaudited pro forma financial information for the nine months ended November 30, 2011 reflects the operating results of the combined company for the nine months ended November 30, 2011.

The unaudited pro forma financial information is presented for informational purposes only and is not indicative of the consolidated results of operations or financial condition of the combined company that would have been reported had the acquisition been completed as of the dates presented and should not be taken as representative of our future consolidated results of operations or financial condition.

Applied Intelligence Solutions, LLC

In December 2010, we acquired substantially all of the assets of Applied Intelligence Solutions, LLC (“AIS”), a provider of intelligent software solutions for retail enterprises, for approximately $3.2 million in cash.  We accounted for the transaction as a business combination and recorded approximately $2.2 million of goodwill and $950,000 of identifiable intangible assets.  Intangible assets are being amortized on a straight-line basis over a period of two to four years. Because this was an asset acquisition, the goodwill is tax deductible.  Pro forma results of the acquired business have not been presented as it was not material to our consolidated financial statements for all periods presented.

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3. Balance Sheet Components

Marketable Securities

Marketable securities consisted of the following as of the dates indicated (in thousands):

The following table summarizes the book value of our investments in marketable debt securities classified by the contractual maturity date of the security as of the dates indicated (in thousands):

We classify all investments as held-to-maturity and, accordingly, record them on our balance sheet at amortized cost. We monitor our investments for impairment on a periodic basis and record an impairment charge if the carrying value of an investment exceeds its fair value and the decline in value is determined to be other-than-temporary.  For the purposes of this impairment evaluation, we determine fair value based on the quoted market rate for the instrument or similar instruments.  We have the ability and intent to hold our marketable securities to maturity and do not believe any of the marketable securities were impaired based on our evaluation of available evidence at the current balance sheet date and through the time of filing of this quarterly report on Form 10-Q.  We expect to receive all principal and interest on all of our investment securities.

Accounts Payable and Accrued Expenses

Accounts payable and accrued expenses consisted of the following as of the dates indicated (in thousands):

4. Goodwill and Purchased Intangible Assets

We record as goodwill the excess of the acquisition purchase price over the fair value of the tangible and identifiable intangible assets acquired. We do not amortize goodwill, but perform an annual impairment review of our goodwill during our third fiscal quarter, or more frequently if indicators of potential impairment arise. We have a single operating segment and consequently evaluate goodwill for impairment based on an evaluation of the fair value of our company as a whole.  As of February 28, 2011, we had approximately $18.8 million of goodwill from our acquisition of AIS in December 2010 and our pre-fiscal 2010 acquisitions of Connect3 and TradePoint.  In the nine months ended November 30, 2011, we recorded approximately $7.2 million of goodwill associated with our acquisition of M-Factor in March 2011.

We record purchased intangible assets at their respective estimated fair values at the date of acquisition. Purchased intangible assets are being amortized using the straight-line method over their estimated useful lives of approximately one to seven years, with a remaining weighted average useful life of 2.9 years at November 30, 2011. We evaluate the remaining useful lives of intangible assets on a periodic basis to determine whether events or circumstances warrant a revision to the remaining estimated amortization period. Amortization expense related to the purchased intangible assets was approximately $568,000 and $683,000 in the three months ended

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November 30, 2011 and 2010, respectively, and was approximately $2.4 million and $2.2 million in the nine months ended November 30, 2011 and 2010, respectively.

We recognized no impairment charges as a result of our most recent impairment review. Additionally, we observed no impairment indicators for goodwill or intangible assets through the filing of this Quarterly Report on Form 10-Q.

5. Commitments and Contingencies

Commitments

We lease office space in various locations throughout the United States, Europe, and India.  In September 2009, we entered into a lease agreement for office space in San Mateo, California, under which the total lease term is eight years with an initial non-cancellable lease term of five years commencing December 1, 2009.  We use the office space as our corporate headquarters. The aggregate minimum lease commitment was approximately $10.1 million at the inception of the lease and $7.3 million as of November 30, 2011.  To secure our obligations under the lease, we have provided the lessor a $223,000 cash security deposit and a $917,000 letter of credit, secured by using our existing revolving line of credit as described in Note 6.  Additionally, the lessor provided us with a tenant improvement allowance of $265,000 and assumed our payment obligations (equal to approximately $200,000) under the previous sublease for our then-existing corporate headquarters in San Carlos, California for the period from December 1, 2009 through February 28, 2010, the expiration date of such sublease.  The tenant improvement allowance and the $200,000 of assumed sublease obligations have been deferred and are being recognized on a straight-line basis over the lease term as reductions of rent expense. The leasehold improvements are being amortized on a straight-line basis over the lesser of the lease term or the estimated useful lives of the assets.

In fiscal 2010 and fiscal 2011, we entered into equipment and facility operating leases associated with our new data center in Mesa, Arizona, with minimum lease terms of two years for the equipment lease and three years for the facility lease.  The aggregate minimum lease payments were approximately $1.5 million at the inception of the leases.

Legal Proceedings

We are aware of one purported class action lawsuit filed in the Superior Court of the State of California in and for the County of Santa Clara that an alleged DemandTec stockholder has filed against us, each member of our board of directors, IBM and Cudgee Acquisition Corp. in connection with the Merger. The complaint asserts claims for breach of fiduciary duty and aiding and abetting breach of fiduciary duty and seeks equitable relief, including an injunction preventing the consummation of the Merger, rescission in the event the Merger is consummated, and an award of damages. The outcome of any such litigation is uncertain. If a dismissal is not granted or a settlement is not reached, this lawsuit could prevent or delay completion of the Merger and result in substantial costs to us, including any costs associated with the indemnification of our directors and officers. Other DemandTec shareholders may also file additional lawsuits against us, IBM, and/or our directors and officers in connection with the Merger.

In addition, we have from time to time become involved in legal matters that arise in the normal course of business and otherwise.  For example, we are currently involved in arbitration proceedings with an M-Factor customer associated with that customer’s failure to pay amounts due under, and purported termination of, their agreement with M-Factor relating to certain services which is in the second year of a three year committed term.  Beginning in our quarter ended November 30, 2011, that customer began withholding quarterly amounts, currently $573,000, due under the agreement.  We are continuing to assess the impact of this dispute.  There can be no assurance that this matter or other third party claims and litigation that may arise in the future will not have a material adverse effect on our business, financial position, results of operations, or cash flows, including a loss of customers, or subject us to significant financial or other remedies.

6. Debt

In May 2009, we amended our revolving line of credit that we had entered in April 2008 to, among other things, extend the maturity date of the loan agreement and to increase the revolving line of credit from $15.0 million to $20.0 million. The amended revolving line of credit can be used to (a) borrow revolving loans, (b) issue letters of credit, and (c) enter into foreign exchange contracts. Revolving loans may be borrowed, repaid, and reborrowed until May 2012. Amounts borrowed will bear interest, at our option, at either (1) a floating per annum rate equal to the financial institution’s prime rate, or (2) the greater of (A) the LIBOR rate plus 250 basis points or (B) a per annum rate equal to 4.0%. A default interest rate shall apply during an event of default at a rate per annum equal to 500 basis points above the otherwise applicable interest rate. The line of credit is collateralized by substantially all of our assets and requires us to comply with working capital, net worth, and other non-financial covenants, including limitations on indebtedness and restrictions on dividend distributions, among others. In September 2009, the available balance was reduced by approximately $917,000 to $19.1 million to secure a new operating lease commitment. There were no outstanding amounts under the line of credit at November 30, 2011. Through the filing of this Quarterly Report on Form 10-Q, we were in compliance with all loan covenants.

7. Stock-Based Compensation

Equity Incentive Plans

1999 Equity Incentive Plan

In December 1999, our Board of Directors adopted the 1999 Equity Incentive Plan (the “1999 Plan”).  The 1999 Plan provided for incentive or nonstatutory stock options, stock bonuses, and rights to acquire restricted stock to be granted to employees, outside directors, and consultants. We ceased issuing awards under the 1999 Plan upon the completion of our Initial Public Offering (“IPO”) in August 2007.  As of November 30, 2011, options to purchase 2,893,222 shares were outstanding under the 1999 Plan.  Such options

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are exercisable as specified in each option agreement, generally vest over four years, and expire no more than ten years from the date of grant.  If options awarded under the 1999 Plan are forfeited or repurchased, then shares underlying those options will no longer be available for awards.

2007 Equity Incentive Plan

In May 2007, our Board of Directors adopted, and in July 2007 our stockholders approved, the 2007 Equity Incentive Plan (the “2007 Plan”).  The 2007 Plan became effective upon our IPO.  The 2007 Plan, which is administered by the Compensation Committee of our Board of Directors, provides for stock options, stock units, restricted shares, and stock appreciation rights to be granted to employees, outside directors and consultants.  We initially reserved 3.0 million shares of our common stock for issuance under the 2007 Plan.  In addition, on the first day of each fiscal year commencing with fiscal year 2009, the aggregate number of shares reserved for issuance under the 2007 Plan is automatically increased by a number equal to the lowest of a) 5% of the total number of shares of common stock then outstanding, b) 3,750,000 shares, or c) a number determined by our Board of Directors.  As of November 30, 2011, 8,791,510 shares were reserved for issuance under the 2007 Plan.

Stock Options

Options granted under the 2007 Plan may be either incentive stock options or nonstatutory stock options and are exercisable as determined by the Compensation Committee and as specified in each option agreement.  Options vest over a period of time as determined by the Compensation Committee, generally four years, and generally expire seven years (but in any event no more than ten years) from the date of grant.  The exercise price of any stock option granted under the 2007 Plan may not be less than the fair market value of our common stock on the date of grant.  The term of the 2007 Plan is ten years.  As of November 30, 2011, options to purchase 3,266,666 shares were outstanding under the 2007 Plan.

Performance Stock Units (“PSUs”)

PSUs are awards under our 2007 Plan that entitle the recipient to receive shares of our common stock upon vesting and settlement of the awards pursuant to certain performance and time-based vesting criteria set by our Compensation Committee.

In May 2010, our Compensation Committee granted 314,250 PSUs to our executive officers, which related to fiscal 2011 company performance objectives and subsequent individual service requirements over a period of approximately 17 months, subject to each grantee’s continued service.  In April 2011, our Compensation Committee granted 159,375 PSUs to certain of our executive officers, which relate to fiscal 2012 company performance objectives and subsequent service requirements over a period of approximately 17 months.  Those PSUs were granted in lieu of all or a portion of the annual variable cash compensation opportunity for certain executives.  In September 2011, the Compensation Committee waived the performance objectives with respect to 12,500 of those PSUs that had been granted to one of our officers, such that those units will vest solely based on the officer’s time-based service requirement (subject to certain change-in-control acceleration provisions).  The modification had an immaterial impact on the stock-based compensation expense for the three months ended November 30, 2011.

As part of our annual equity incentive program, our Compensation Committee granted 839,800 PSUs to certain of our executive officers and other employees in April 2011, which relate to fiscal 2012 company performance objectives and subsequent individual service requirements over a period of approximately 33 months.  The performance objectives associated with those PSUs were subsequently modified in June 2011 for all optionees, except with respect to our executive officers and certain other employees, as approved by our Compensation Committee.  Had the performance objectives associated with those PSUs not been modified, stock-based compensation costs would have been approximately $633,000 lower in the nine months ended November 30, 2011.  In addition, in September 2011, the Compensation Committee waived the performance objectives with respect to 20,000 of those PSUs that had been granted to one of our officers, such that those units will vest solely based on the officer’s time-based service requirement (subject to certain change-in-control acceleration provisions).  This modification had an immaterial impact on the stock-based compensation expense for the three months ended November 30, 2011.

As of November 30, 2011, there were approximately 959,150 shares subject to outstanding PSUs from grants in May 2010 and April 2011.

Restricted Stock Units (“RSUs”)

RSUs are awards under the 2007 Plan that entitle the recipient to receive shares of our common stock upon vesting and settlement of the awards pursuant to time-based vesting criteria set by our Compensation Committee.

In January 2010, our Compensation Committee granted 100,000 RSUs that vest over a period of approximately four years, subject to the grantee’s continued services.  In fiscal 2011, our Compensation Committee granted 1,322,000 RSUs to certain of our executive officers, other employees, and consultants.  Such RSUs will vest over a period of approximately 24 to 27 months, subject to each

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grantee’s continued service.  In the nine months ended November 30, 2011, our Compensation Committee granted 305,250 RSUs to certain employees.  These RSUs will vest over periods of approximately two to three years, subject to each grantee’s continued service.  Additionally, in August 2011, our Compensation Committee granted a total of 79,093 RSUs to the non-employee members of our board of directors, which will be fully vested on the earlier of a) the date of our 2012 Annual Meeting of Stockholders, or b) one year from the date of grant.  As of November 30, 2011, there were approximately 1,053,122 shares subject to outstanding RSUs from these grants.

A summary of equity award activity during fiscal 2011 and the nine months ended November 30, 2011 follows (shares in thousands):

(1)      Under the terms of the 1999 Plan, shares underlying cancelled or forfeited options are no longer available for awards.

A summary of PSU activity during fiscal 2011 and the nine months ended November 30, 2011 follows (in thousands):

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A summary of RSU activity during fiscal 2011 and the nine months ended November 30, 2011 follows (in thousands):

Employee Stock Purchase Plan (“ESPP”)

In May 2007 our Board of Directors adopted, and in July 2007 our stockholders approved, the 2007 Employee Stock Purchase Plan.  We subsequently amended the ESPP in March 2010.  Under the ESPP, eligible employees may purchase shares of common stock at a price per share equal to 85% of the lesser of the fair market values of our common stock at the beginning or end of the applicable offering period.  Each offering period lasts for six months.  We initially reserved 500,000 shares of our common stock for issuance under the ESPP.  In addition, on the first day of each fiscal year commencing with fiscal year 2009, the aggregate number of shares reserved for issuance under the ESPP is automatically increased by a number equal to the lowest of a) 1% of the total number of shares of common stock then outstanding, b) 375,000 shares, or c) a number determined by our Board of Directors.  In the nine months ended November 30, 2011, employees purchased 316,859 shares under the ESPP, and the weighted average per share fair value of the options to purchase those shares was approximately $2.43.  As of November 30, 2011, a total of 740,912 shares were available for issuance under the ESPP.

Stock-Based Compensation Expense Associated with Awards to Employees

We have issued employee stock-based awards in the form of stock options, PSUs, RSUs, and shares subject to the ESPP.  We measure the value of stock options and shares subject to the ESPP based on their grant date fair value using the Black-Scholes pricing model.  Stock-based compensation expense for PSUs and RSUs granted to employees is based on the closing price of our common stock on the grant date.

The determination of the fair value of stock options and shares subject to the ESPP on the date of grant is affected by our stock price, as well as by assumptions regarding a number of complex and subjective variables.  These variables include our expected stock price volatility over the term of the options and awards, actual and projected employee stock option exercise behaviors, risk-free interest rates, and expected dividends, which are set forth in the table below:

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We amortize the fair value of the awards granted, net of estimated forfeitures, as stock-based compensation expense on a straight-line basis over the vesting period.  We estimate forfeitures for our stock options, PSUs, and RSUs at the time of grant.  At the end of each reporting period, we evaluate the probability of the service condition being met and revise those estimates based on actual results, taking into account cancellations related to terminations, as applicable to each award.  In addition, for PSUs granted, we evaluate the probability of meeting the performance criteria at the end of each reporting period to determine how much compensation expense to record.  The estimation of whether the performance targets and service periods will be achieved requires judgment.  To the extent actual results or updated estimates differ from our current estimates, either (a) the cumulative effect on current and prior periods of those changes will be recorded in the period those estimates are revised or (b) the change in estimate will be applied prospectively, depending on whether the change affects the estimate of total stock-based compensation expense to be recognized or merely affects the period over which such expense will be recognized.  The cumulative adjustments in the three and nine months ended November 30, 2011 decreased stock-based compensation expense by approximately $247,000 and $534,000, respectively. The cumulative adjustments in the three and nine months ended November 30, 2010 were not material.

Stock-Based Compensation for Non-Employees

Stock-based compensation expense related to stock awards granted to non-employees is recognized as the awards vest.  We believe that the fair value of the stock-based awards granted is more reliably measurable than the fair value of the services received. The fair value of the stock options granted is calculated using the Black-Scholes option pricing model.  The fair value of RSUs granted is based on the closing price of our common stock on each reporting date.  The fair value of the award is remeasured at each reporting date until the earlier of (a) the performance commitment date or (b) the date the services required under the arrangement have been completed.  Stock-based compensation expense related to awards granted to non-employees for the three and nine months ended November 30, 2011 was approximately $141,000 and $262,000, respectively, and was not material for the three and nine months ended November 30, 2010.

The fair values of unvested options granted to non-employees were calculated using the following assumptions for the periods presented:

Stock-Based Compensation Expense Summary

The following table sets forth the stock-based compensation expense for equity awards recorded in the condensed consolidated statements of operations for the periods presented (in thousands):

The following table summarizes gross unrecognized stock-based compensation expense as of November 30, 2011, excluding estimated forfeitures:

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8. Income Taxes

In the three and nine months ended November 30, 2011, we recorded income tax expense of approximately $148,000 and $318,000, respectively, compared to income tax expense of $29,000 and $105,000, respectively, in the corresponding periods of the prior year.  The effective tax rate for the three and nine months ended November 30, 2011 was approximately 3% and 2%, respectively, based on our estimated taxable income for the year.  We recorded tax expense primarily for foreign taxes and state minimum taxes.

There were no material changes to our unrecognized tax benefits in the three months ended November 30, 2011 and we do not expect to have any significant changes to unrecognized tax benefits over the next twelve months.  Because of our history of operating losses, all years remain open to audit.

9. Derivative Financial Instruments

We maintain a foreign currency risk management strategy that includes the use of derivative financial instruments designed to protect our economic value from the possible adverse effects of currency fluctuations.  We do not enter into derivative financial instruments for speculative or trading purposes.  Our hedging relationships are formally documented at the inception of the hedge, and hedges must be highly effective in offsetting changes to future cash flows on hedged transactions both at the inception of a hedge and on an ongoing basis.  We record the ineffective portion of hedging instruments, if any, to other income (expense) in the consolidated statements of operations.

As of November 30, 2011, we had three outstanding forward contracts with an aggregate notional principal of approximately $2.8 million, which are summarized as follows (in thousands):

(1)     Related to multi-year customer arrangements, under which we separately hedge each equal annual billing amount.

We designated these forward contracts as cash flow hedges of foreign currency denominated firm commitments.  Our objective in purchasing these forward contracts was to negate the impact of currency exchange rate movements on our operating results.  We record effective spot-to-spot changes in these cash flow hedges in accumulated other comprehensive income until the hedged transaction takes place.  Combined implied interest on all forward contracts was excluded from effectiveness testing and is being recorded using the straight-line method over the terms of the forward contracts to interest expense and accumulated other comprehensive income.  We did not incur any hedge ineffectiveness in the three and nine months ended November 30, 2011 and 2010.

We expect to ratably reclassify an approximately $5,000 net gain associated with the forward contracts that matured in December 2010, February and November 2011 from accumulated other comprehensive income into revenue over the twelve-month period ending November 30, 2012.

10. Fair Value Measurements

The accounting standards for fair value measurements clarify that fair value is an exit price, representing the amount that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants. As such, fair value is a market-based measurement that should be determined based on assumptions that market participants would use in pricing an asset or a

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liability. As a basis for considering such assumptions, the accounting standards establish a three-tier value hierarchy, which prioritizes the inputs used in the valuation methodologies in measuring fair value:

Level 1 — Observable inputs that reflect quoted prices (unadjusted) for identical assets or liabilities in active markets.

Level 2 — Include other inputs that are directly or indirectly observable in the marketplace.

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

The fair value hierarchy requires an entity to maximize the use of observable inputs and minimize the use of unobservable inputs when measuring fair value.

We measure our foreign currency forward contracts at fair value using Level 2 inputs, as the valuation inputs are based on quoted prices of similar instruments in active markets and do not involve management judgment.

The following table summarizes the amounts measured at fair value (in thousands):

(1)     At November 30, 2011, $46 was included in other current assets and $38 was included in other assets on our condensed consolidated balance sheet.  At February 28, 2011, $24 was included in other current liabilities and $9 was included in other long-term liabilities on our condensed consolidated balance sheet.

11. Comprehensive Loss

The following table summarizes the calculation and components of comprehensive loss, net of taxes (in thousands):