Overview of 2012 Results

We are a leading provider of cloud software. CallidusCloud enables organizations to drive performance and productivity across their business with our hiring, learning, marketing and selling clouds. From back office to the field, from desktop to mobile, we ensure organizations have the right tools to be more effective and perform better. We believe the combined power of our clouds, our people, and our partners fuels growth, empowers the work force and delivers real value. CallidusCloud drives performance and productivity for over 1,700 leading organizations. Small, medium and large enterprises across multiple industries and geographies rely on CallidusCloud for quicker hiring, simpler learning, better marketing, and smarter selling. In 2011 we adopted a new brand identity, "CallidusCloud", to more accurately reflect our cloud-based solutions and technology roadmap. We are currently doing business as "CallidusCloud".

Our solution suite has undergone a dramatic expansion since the beginning of 2011 with the acquisitions of ForceLogix (sales coaching), Salesforce Assessments (sales hire testing), iCentera (sales enablement), Litmos (learning management), Rapid Intake (content authoring), Webcom (CPQ), Leadformix (marketing automation and sales enablement), and 6FigureJobs (job advertisements, recruitment media services and other career-related services) as well as the successful launch of our latest release of Sales Selector, an online sales recruiting solution that brings together video interviewing with online temperament assessments. For every company, regardless of size, geography or vertical, we believe there are now one or more CallidusCloud solutions that may enable them to drive productivity in their sales organization.

While we offer our customers a range of purchasing and deployment options, from on-demand subscription to on-premise term or perpetual license, our business and revenue model is focused on recurring revenue. Recurring revenues consist of SaaS revenues and recurring maintenance revenues. SaaS revenues are primarily made up of on-demand hosting revenues, sales operation services and term license revenue.

SaaS Revenue Growth, Customer Expansion and Retention

SaaS revenues continued to drive the growth in recurring revenues and total revenues in 2012. SaaS revenues grew to $55.1 million in 2012 representing a $10.1 million or 23% increase from 2011. Total recurring revenues in 2012 grew by 13% from 2011, reflecting the strong growth in SaaS revenues partially offset by an expected decline in recurring maintenance revenues primarily as a result of customers' continuing to convert from on-premise to on-demand. Recurring revenues account for 75% of our total revenues and we expect this percentage to increase going forward. Total revenues in 2012 were $95.0 million, up $11.2 million, or 13%, from 2011 by driving our expanded product and services offerings, including acquired products. Strong SaaS revenues growth contributed to an increase in recurring revenue gross margins from 48% in 2011 to 58% in 2012 and an increase in overall gross margins from 40% in 2011 to 47% in 2012.

During 2012, we continued to add subscription based customers at historically high rates, adding 665 new customers to the business, including customers added in connection with acquisitions. We now have over 1,700 customers on an annual plan. Strong annual SaaS billings growth of 24% helped drive an increase in our SaaS total annual contract value ("ACV"). Our total SaaS ACV grew 27% from the prior year to $65.8 million. Our core SaaS customer retention rates on a dollar and customer count basis were 95%. We believe our high retention rates are an indication of the quality of service we provide and the quality of our customer base and we strive to maintain these retention rates in a competitive environment.

Operating Results

During 2012, we made substantial investments in expanding our sales force and improving our infrastructure. These investments, combined with the added costs from the acquisitions we completed in 2011 and 2012, contributed to an increase in operating expenses of $17.9 million, or 35%, to $68.5 million in 2012. We believe the investments in our sales force have begun to pay off as evidenced in the growth in our SaaS ACV and revenues. In 2012, we also upgraded a majority of our business systems to cloud-based technology, thereby improving our operating efficiency and positioning us for continued growth. At the end of 2012, we initiated substantial expense reductions and rationalizations that will contribute to greater effectiveness and improved operating results in 2013. We plan to continue to manage our operating expenses carefully in order to maintain proper alignment with the business and take advantage of cost saving measures and efficiencies where possible.

Other Business Highlights

On January 3, 2012 the Company acquired LeadFormix, Inc. ("LeadFormix"), a U.S. based company with operations in India. LeadFormix, a leader in next-generation marketing automation and sales enablement, was acquired for approximately $9.0 million in cash, including $1.5 million for indemnity holdback.

On May 4, 2012, the Company acquired 6FigureJobs.com, Inc. ("6FigureJobs"), a wholly-owned subsidiary of Workstream, Inc., a Canadian corporation, for approximately $1.0 million in cash, including $0.3 million for indemnity holdback. 6FigureJobs provides job advertisement placement, recruitment media services and other career-related services.

In 2008, Callidus entered into a Build, Operate and Transfer agreement with a third-party contractor providing Callidus with the option to transfer the third-party employees to join our internal employee base in exchange for a specified fee. Callidus exercised this option and the transfer occurred during the fourth quarter of 2012, for a fee of $0.9 million, of which $0.4 million was allocated to costs of recurring revenues, $0.2 million was allocated to costs of service revenues, and $0.3 million was allocated to research and development costs. The exercise of this option added 103 employees to our headcount at our new Hyderabad, India office.

Refer to Note 3 of our notes to consolidated financial statements included in this report regarding the 2012 acquisitions.

Challenges and Risks

In response to market demand, over the past few years we have shifted our primary business focus from providing perpetual software licenses to providing on-demand software as a service. Toward the end of 2009 we also began offering our on-premise products under term license arrangements. We believe that these offerings better address the needs of our customers, and at the same time, provide more predictable revenue streams. For customers that prefer to purchase software on a perpetual basis, we continue to offer such licenses, and in the year ended December 31, 2012, we generated $4.1 million in perpetual license revenues. We expect perpetual license revenue to remain a relatively small component of total revenues and to fluctuate from period to period.

While we have a number of sales opportunities in process and additional opportunities coming from our sales pipeline, we continue to experience wide variances in the timing and size of our transactions. We believe one of our major challenges continues to be increasing prospective customers' prioritization of purchasing our solutions over competing projects. As part of our effort to address this challenge, we have set goals that include expanding our sales efforts, promoting our on-demand services and continuing to develop new products and enhancements to our suite of products. During 2011 and 2012, we completed eight acquisitions to expand our product offerings and customer base. In addition, in 2012 we invested in the expansion of our sales force to better exploit the opportunities presented by

our solutions. We also invested in our infrastructure and are in the process of building a new data center to better serve our incoming customer base. These investments have adversely affected our current operating results; however we expect to continue to realize the benefits of these investments going into 2013. Our long term success will depend in part on our ability to realize return on these investments through increased revenues.

In addition to these risks, our future operating performance is subject to the risks and uncertainties described in "Risk Factors" in Section 1A of this Annual Report on Form 10-K.

Application of Critical Accounting Policies and Use of Estimates

The discussion and analysis of our financial condition and results of operations which follows is based upon our consolidated financial statements prepared in accordance with U.S. Generally Accepted Accounting Principles ("GAAP"). The application of GAAP requires our management to make assumptions, judgments and estimates that affect our reported amounts of assets, liabilities, revenues and expenses, and the related disclosures regarding these items. We base our assumptions, judgments and estimates on historical experience and on various other factors that we believe to be reasonable under the circumstances. Actual results could differ significantly from these estimates under different assumptions or conditions. To the extent that there are material differences between these estimates and actual results, our future financial condition or results of operations will be affected. On a regular basis, we evaluate our assumptions, judgments and estimates. We also discuss our critical accounting policies and estimates with our Audit Committee of the Board of Directors.

We believe that the assumptions, judgments and estimates involved in the accounting for revenue recognition, allowance for doubtful accounts and service remediation reserve, stock-based compensation, valuation of acquired intangible assets, goodwill impairment, long-lived asset impairment, contingent consideration and income taxes have the greatest potential impact on our consolidated financial statements. These areas are key components of our results of operations and are based on complex rules which require us to make judgments and estimates. Historically, our assumptions, judgments and estimates in accordance with our critical accounting policies have not materially differed from actual results. For a more detailed discussion of these accounting policies and our use of estimates, refer to Note 1 of our notes to consolidated financial statements included in this report.

Revenue Recognition

We recognize revenue when all four revenue recognition criteria have been met: persuasive evidence of an arrangement exists, we have delivered the product or performed the service, the fee is fixed or determinable and collection is deemed probable. Determining whether and when some of these criteria have been satisfied often involves assumptions and judgments that can have a significant impact on the timing and amount of revenue we recognize. Changes in assumptions or judgments or changes to the elements in a software arrangement could cause a material increase or decrease in the amount of revenue that we report in a particular period. Please refer to the Notes to Consolidated Financial Statements for further discussion on revenue recognition policies.

Allowance for Doubtful Accounts and Service Remediation Reserve

We estimate the uncollectability of accounts receivable, and record an increase in the allowance for doubtful accounts when the prospect of collecting a specific account receivable becomes doubtful. Management specifically analyzes accounts receivable and historical bad debt experience, customer creditworthiness, current economic trends, international situations (such as currency devaluation) and changes in our customer payment history when evaluating the adequacy of the allowance for doubtful accounts. Should any of these factors change, the estimates made by management will also change, which could affect the level of our future provision for doubtful accounts.

We reserve future service claims based upon historical experience of actual remediation service claims as well as current information on remediation service requests as they are the primary indicators for estimating future service claims. If our actual service claims are higher than expected, additional service remediation reserves may be needed and our future results of operations and cash flows could be negatively affected.

Stock-based Compensation

Stock-based compensation expense is measured at the grant date based on the fair value of the award and is recognized on a straight-line basis over the requisite service period, which is generally the vesting period. Stock-based compensation expense for restricted stock units ("RSUs") is estimated based on the closing price of our common stock on the date of grant and the average historical forfeiture rate. We measure the value of stock options and employee stock purchase plan shares using the Black-Scholes-Merton option pricing model. The determination of the fair value of stock-based awards on the date of grant using an option pricing model is affected by our stock price as well as assumptions regarding a number of subjective variables. These variables include:
the expected term of the options, taking into account projected exercises; our expected stock price volatility over the expected term of the awards; the risk-free interest rate; estimated forfeitures and expected dividends. Changes in these variables could materially affect the stock-based compensation in the future.

Goodwill and Intangible Assets

Goodwill is not amortized, but instead goodwill is required to be tested for impairment annually and under certain circumstances. We perform such testing of goodwill in the fourth quarter of each year, or as events occur or circumstances change that would more likely than not reduce the fair value of a reporting unit below its carrying amount. During the fourth quarter of 2011, we early adopted new accounting guidance which simplifies goodwill impairment testing. The new accounting guidance allows us to conduct an assessment of qualitative factors to determine whether it is more likely than not that the fair value of a reporting unit is less than its carrying amount. If we determine that it is more likely than not that the fair value of a reporting unit is less than its carrying amount, we then conduct a two-step test for impairment of goodwill. The first step of the test for goodwill impairment compares the fair value of the applicable reporting unit with its carrying value. If the fair value of a reporting unit is less than the reporting unit's carrying value, we will perform the second step of the test for impairment of goodwill. During the second step of the test for impairment of goodwill, we compare the implied fair value of the reporting unit's goodwill with the carrying value of that goodwill. If the carrying value of the goodwill exceeds the calculated implied fair value, the excess amount will be recognized as an impairment loss. We have one reporting unit and evaluate goodwill for impairment at the entity level. Based upon the results of the step one testing, the Company concluded that no impairment existed as December 31, 2012, and did not perform the second step of the goodwill impairment test.

Intangible assets with finite lives are amortized over their estimated useful lives of one to 12 years. Generally, amortization is based on the higher of a straight-line method or the pattern in which the economic benefits of the intangible asset will be consumed. There was no impairment expense related to intangible assets during, the years ended December 31, 2012 and 2011. During the year ended December 31, 2010, the Company recognized an impairment of $0.2 million.

Impairment of Long-Lived Assets

We assess impairment of our long-lived assets in accordance with the provisions of accounting for the impairment of long-lived assets. Long-lived assets, such as property and equipment and intangible assets subject to amortization are required to be reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset group may not be recoverable. Recoverability of assets to be held and used is measured by a comparison of the carrying amount of an

asset group to the estimated undiscounted future cash flows expected to be generated by the asset group. If the carrying amount of an asset group exceeds its estimated undiscounted future cash flows, an impairment charge is recognized equal to the amount by which the carrying amount of the asset group exceeds the fair value of the asset group.

Business Combinations

The Company recognizes assets acquired, liabilities assumed, and contingent consideration at their fair value on the acquisition date with subsequent changes recognized in earnings; recognizes acquisition related expenses and restructuring costs to be expensed as incurred; and recognizes changes in accounting for deferred tax asset valuation allowances and acquired income tax uncertainties after the measurement period be recognized as a component of provision for taxes. During the measurement period, which may be up to one year from the business combination date, we record adjustments to the assets acquired and liabilities assumed, with the corresponding offset to goodwill. After the measurement period, we record adjustments to the assets acquired or liabilities assumed in our operating results in the period in which the adjustments were determined.

Contingent Consideration

We estimate the fair value of the contingent consideration issued in business combinations using a probability-based income approach. The fair value of our liability-classified contingent consideration is remeasured at each reporting period, with any changes in the fair value recorded as income or expense. Contingent acquisition consideration payable is included in accrued liabilities and on the Company's consolidated balance sheets.

Accounting for Income Taxes

Income tax expense is recognized for the amount of taxes payable or refundable for the current year. In addition, deferred tax assets and liabilities are recognized for the expected future tax consequences of temporary differences between the financial reporting and tax bases of assets and liabilities, and for operating losses and tax credit carryforwards. Management must make assumptions, judgments and estimates to determine our current provision for income taxes and also our deferred tax assets and liabilities and any valuation allowance to be recorded against a deferred tax asset.

Our assumptions, judgments and estimates relative to the current provision for income taxes take into account current tax laws, our interpretation of those laws and possible outcomes of current and future audits conducted by foreign and domestic tax authorities. We have established reserves for income taxes to address potential exposures for tax positions that could be challenged by tax authorities. Although we believe our assumptions, judgments and estimates are reasonable, changes in tax laws or our interpretation of tax laws and the resolution of potential tax audits could significantly impact the amounts provided for income taxes in our consolidated financial statements.

Our assumptions, judgments and estimates relative to the value of a deferred tax asset take into account predictions of the amount and category of future taxable income, such as income from operations or capital gains. Actual operating results and the underlying amount and category of income in future years could render our current assumptions, judgments and estimates of recoverable net deferred taxes inaccurate. Any of the assumptions, judgments and estimates mentioned above could cause our actual income tax obligations to differ from our estimates, thus materially impacting our financial position and results of operations.

Recent Accounting Pronouncements

Refer to Note 1 to our notes to consolidated financial statements for information regarding the effect of newly adopted accounting pronouncements on our financial statements.

Results of Operations

Comparison of the Years Ended December 31, 2012 and 2011

Revenues, Cost of Revenues and Gross Profit

    The table below sets forth the changes in revenues, cost of revenues and
gross profit from 2011 to 2012 (in thousands, except percentage data):

                  Year                            Year
                 Ended         Percentage        Ended         Percentage
              December 31,      of Total      December 31,      of Total       Increase     Percentage
                  2012          Revenues          2011          Revenues      (Decrease)      Change
Revenues:
Recurring     $      70,919             75 %  $      63,002             75 %  $     7,917            13 %
Services
and other            24,033             25 %         20,769             25 %        3,264            16 %

Total
revenues      $      94,952            100 %  $      83,771            100 %  $    11,181            13 %

Cost of
revenues:
Recurring     $      30,039             42 %  $      32,820             52 %  $    (2,781 )          (8 )%
Services
and other            20,301             84 %         16,487             79 %        3,814            23 %
Patent
settlement                -              - %            701              - %         (701 )        (100 )%

Total cost
of
revenues      $      50,340             53 %  $      50,008             60 %  $       332             1 %

Gross
profit:
Recurring     $      40,880             58 %  $      30,182             48 %  $    10,698            35 %
Services
and other             3,732             16 %          4,282             21 %         (550 )         (13 )%
Patent
settlement                -              - %           (701 )            - %          701          (100 )%

Total
gross
profit        $      44,612             47 %  $      33,763             40 %  $    10,849            32 %

Revenues

Total Revenues. Total revenues for 2012 were $95.0 million, an increase of 13% compared to 2011. The increase was primarily due to higher volume of recurring revenue generated by our SaaS business due to our continued emphasis and focus on recurring revenues.

Recurring Revenues. Recurring revenues, which consist of on-demand subscription revenues, term license revenues, and maintenance revenues, increased by $7.9 million, or 13% in 2012 compared to 2011. The increase was primarily due to the growth in our SaaS revenues which increased by 23% in 2012 compared to 2011. SaaS revenue growth is mainly driven by an increase in new business generated from our existing Commissions solution and, new business from our acquired solutions. We believe our investment in expanding the sales force this year has positively impacted the revenue growth. The increase in total recurring revenues were partially offset by maintenance revenues associated with on-premise licenses which decreased by $2.2 million, or 12% compared to 2011, primarily due to our conversion of customers from on-premise license to on-demand subscription service.

Services and Other Revenues. Services and other revenues, which consist of integration and configuration services, training and perpetual licenses, increased by $3.3 million, or 16% in 2012 compared to 2011. This increase was primarily due to $2.4 million or a 14% increase in our revenues generated from integration and configuration services, from $17.5 million in 2011 to $19.9 million in 2012. Additionally, our perpetual license revenues also increased by $0.8 million or 24%, from $3.3 million in 2011 to $4.1 million in 2012. The increases in our revenues generated from integration and configuration services were primarily related to additional services revenues from our recently acquired businesses, Webcom and Rapid Intake. The increase in our perpetual license revenues was primarily due to certain existing perpetual license customers purchasing additional licenses to maintain

compliance under the existing license. We expect our perpetual license revenues to continue to fluctuate from period to period as our primary business focus has shifted to our recurring revenue model.

Cost of Recurring Revenues. Cost of recurring revenues decreased by $2.8 million or 8% in 2012 compared to 2011. The decrease was primarily driven by a decrease in data center costs of $1.2 million related to the insourcing the management of the data center operations previously managed by a third-party provider, a decrease of $1.2 million in professional fees primarily due to a reduction in third-party contractors used to deliver sales operation services, and to a lesser extent, the insourcing of our India operations in the fourth quarter, and a decrease of $1.8 million in stock-based compensation expense as a result of less performance grant related expense and employee transfers out of cost of revenue functions to other company functions. These decreases were partially offset by $1.4 million in additional amortization of intangible assets from our acquisitions, and an increase of $0.5 million in hosting fees and software costs related to our acquisitions.

Cost of Services and Other Revenues. Cost of services and other revenues increased by $3.8 million or 23% in 2012 compared to 2011. The increase was primarily due to $2.7 million in personnel costs and contractors attributable to additional headcount in the U.S., an additional $0.6 million in stock-based compensation expense as a result of increased headcount, and $0.2 million in software and conference costs related to our acquisitions.

Cost of Patent Settlement. On March 5, 2012, we entered into a settlement and patent license agreement with Versata. In exchange for $2.0 million in cash, Versata granted Callidus a nonexclusive, perpetual, irrevocable, fully paid-up, royalty-free, worldwide license, and released, acquitted and forever discharged Callidus from the claims asserted by Versata against Callidus. During the year ended December 31, 2011, we expensed $0.7 million, which represents the amortized expense from the issuance of the patents through December 31, 2011. The remaining value of the license acquired in the settlement was classified in intangibles and is being amortized over an 11 year life.

Gross Profit. Overall gross margin percentage was 47% for 2012 compared to 40% in 2011. Our gross margins improved substantially as a result of higher recurring revenues which were driven by a 23% increase in SaaS revenues for 2012 compared to 2011.

Our recurring revenue gross margin percentage increased to 58% in 2012 from 48% in 2011, while the gross profit dollar value increased by 35% or $10.7 million. The increase in recurring revenue gross margin was primarily the result of improved SaaS margins driven by lower third-party data center and personnel costs as we moved away from outsourcing our data center management activities and used our own internal resources. The transfer of personnel to our in-house facility in India in the fourth quarter also contributed to our margin improvement.

Services and other revenue gross margin percentage was 16% for 2012, a . . .