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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549 

FORM 10-Q
x
Quarterly Report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934
For the quarterly period ended March 31, 2017
OR
 ¨
Transition report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934
Commission File Number: 001-35580

sncrlogostandarda01.jpg
SERVICENOW, INC.
(Exact name of registrant as specified in its charter) 
Delaware
 
20-2056195
(State or other jurisdiction of
incorporation or organization)
 
(I.R.S. Employer
Identification Number)


ServiceNow, Inc.
2225 Lawson Lane
Santa Clara, California 95054
(408) 501-8550
(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  ¨
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 x No  ¨
Indicate by check mark whether the Registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company” and "emerging growth company" in Rule 12b-2 of the Exchange Act. (Check one):
Large accelerated filer x
Accelerated filer ¨
Non-accelerated filer ¨ (Do not check if a smaller reporting company)
Smaller reporting company  ¨
 
Emerging growth company  ¨
If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. ¨
Indicate by check mark whether the Registrant is a shell company (as defined in Rule 12b-2 of the Act). Yes  ¨ No x
As of March 31, 2017, there were approximately 169.7 million shares of the Registrant’s Common Stock outstanding.




TABLE OF CONTENTS

 
 
 
Page
 
 
Item 1.
 
Condensed Consolidated Balance Sheets as of March 31, 2017 (unaudited) and December 31, 2016
 
Condensed Consolidated Statements of Comprehensive Loss for the Three Months Ended March 31, 2017 and 2016 (unaudited)
 
Condensed Consolidated Statements of Cash Flows for the Three Months Ended March 31, 2017 and 2016 (unaudited)
 
Item 2.
Item 3.
Item 4.
 
 
 
 
 
Item 1.
Item 1A.
Item 2.
Item 3.
Item 4.
Item 5.
Item 6.
 
 
 
 
 
   
 
 

i



PART I

ITEM 1.     FINANCIAL STATEMENTS

SERVICENOW, INC.
CONDENSED CONSOLIDATED BALANCE SHEETS
(in thousands)
(unaudited)

 
March 31,
 
December 31,
 
2017
 
2016
Assets
 
 
 
Current assets:
 
 
 
Cash and cash equivalents
$
439,915

 
$
401,238

Short-term investments
535,399

 
498,124

Accounts receivable, net
278,107

 
322,757

Current portion of deferred commissions
78,786

 
76,780

Prepaid expenses and other current assets
64,048

 
43,636

Total current assets
1,396,255

 
1,342,535

Deferred commissions, less current portion
61,648

 
61,990

Long-term investments
326,261

 
262,658

Property and equipment, net
189,659

 
181,620

Intangible assets, net
67,755

 
65,854

Goodwill
96,914

 
82,534

Other assets
31,771

 
36,576

Total assets
$
2,170,263

 
$
2,033,767

Liabilities and Stockholders’ Equity
 
 
 
Current liabilities:
 
 
 
Accounts payable
$
33,658

 
$
38,080

Accrued expenses and other current liabilities
144,594

 
171,636

Current portion of deferred revenue
961,553

 
861,782

Total current liabilities
1,139,805

 
1,071,498

Deferred revenue, less current portion
50,440

 
33,319

Convertible senior notes, net
516,490

 
507,812

Other long-term liabilities
36,189

 
34,177

Total liabilities
1,742,924

 
1,646,806

Stockholders’ equity:
 
 
 
Common stock
170

 
167

Additional paid-in capital
1,476,899

 
1,405,317

Accumulated other comprehensive loss
(11,678
)
 
(21,133
)
Accumulated deficit
(1,038,052
)
 
(997,390
)
Total stockholders’ equity
427,339

 
386,961

Total liabilities and stockholders’ equity
$
2,170,263

 
$
2,033,767

 
See accompanying notes to condensed consolidated financial statements

1



SERVICENOW, INC.
CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE LOSS
(in thousands, except share and per share data)
(unaudited)
 
 
Three Months Ended March 31,
 
2017
 
2016
Revenues:
 
 
 
Subscription
$
376,135

 
$
267,422

Professional services and other
40,648

 
38,457

Total revenues
416,783

 
305,879

Cost of revenues(1):
 
 
 
Subscription
70,375

 
52,781

Professional services and other
46,072

 
41,479

Total cost of revenues
116,447

 
94,260

Gross profit
300,336

 
211,619

Operating expenses(1):
 
 
 
Sales and marketing
212,086

 
158,610

Research and development
84,489

 
65,924

General and administrative
46,251

 
41,237

Legal settlements

 
270,000

Total operating expenses
342,826

 
535,771

Loss from operations
(42,490
)
 
(324,152
)
Interest expense
(8,678
)
 
(8,109
)
Interest income and other income (expense), net
7,716

 
702

Loss before income taxes
(43,452
)
 
(331,559
)
Provision for (benefit from) income taxes
(2,790
)
 
1,773

Net loss
$
(40,662
)
 
$
(333,332
)
Net loss per share - basic and diluted
$
(0.24
)
 
$
(2.06
)
Weighted-average shares used to compute net loss per share - basic and diluted
168,742,366

 
162,067,108

Other comprehensive income:
 
 
 
Foreign currency translation adjustments
$
1,872

 
$
680

Unrealized gain on investments, net of tax
7,583

 
1,633

Other comprehensive income, net of tax
9,455

 
2,313

Comprehensive loss
$
(31,207
)
 
$
(331,019
)
 
(1)
Includes stock-based compensation as follows:
 
Three Months Ended March 31,
 
2017
 
2016
Cost of revenues:
 
 
 
Subscription
$
7,938

 
$
6,607

Professional services and other
6,949

 
6,759

Sales and marketing
38,401

 
30,998

Research and development
21,801

 
20,533

General and administrative
14,854

 
10,411


 
See accompanying notes to condensed consolidated financial statements

2


SERVICENOW, INC.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(in thousands)
(unaudited)



 
Three Months Ended March 31,
 
2017
 
2016
 
 
 
 
Cash flows from operating activities:
 
 
 
Net loss
$
(40,662
)
 
$
(333,332
)
Adjustments to reconcile net loss to net cash provided by operating activities:
 
 
 
Depreciation and amortization
25,226

 
17,452

Amortization of premiums on investments
945

 
1,490

Amortization of deferred commissions
26,180

 
18,033

Amortization of debt discount and issuance costs
8,678

 
8,109

Stock-based compensation
89,943

 
75,308

Deferred income tax
(3,291
)
 

Other
(2,218
)
 
(330
)
Changes in operating assets and liabilities, net of effect of business combinations:
 
 
 
Accounts receivable
47,021

 
15,811

Deferred commissions
(27,195
)
 
(23,971
)
Prepaid expenses and other assets
(22,772
)
 
(19,808
)
Accounts payable
675

 
3,387

Deferred revenue
112,447

 
70,803

Accrued expenses and other liabilities
(27,553
)
 
245,735

Net cash provided by operating activities
187,424

 
78,687

Cash flows from investing activities:
 
 
 
Purchases of property and equipment
(33,186
)
 
(29,077
)
Business combinations, net of cash acquired
(15,035
)
 
(500
)
Purchases of other intangibles

 
(5,750
)
Purchases of investments
(222,596
)
 
(180,365
)
Purchases of strategic investment
(1,000
)
 

Sales of investments
21,789

 
92,885

Maturities of investments
122,263

 
91,858

Restricted cash
(689
)
 
(457
)
Net cash used in investing activities
(128,454
)
 
(31,406
)
Cash flows from financing activities:
 
 
 
Proceeds from employee stock plans
34,807

 
19,873

Taxes paid related to net share settlement of equity awards
(53,023
)
 
(28,453
)
Payments on financing obligation
(1,415
)
 
(110
)
Net cash used in financing activities
(19,631
)
 
(8,690
)
Foreign currency effect on cash and cash equivalents
(662
)
 
2,554

Net increase in cash and cash equivalents
38,677

 
41,145

Cash and cash equivalents at beginning of period
401,238

 
412,305

Cash and cash equivalents at end of period
$
439,915

 
$
453,450

Non-cash investing and financing activities:
 
 
 
Property and equipment included in accounts payable and accrued expenses
8,857

 
8,393


See accompanying notes to condensed consolidated financial statements

3



SERVICENOW, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)
 
Unless the context requires otherwise, references in this report to “ServiceNow,” the "Company", “we,” “us,” and “our” refer to ServiceNow, Inc. and its consolidated subsidiaries.

(1)    Description of the Business

ServiceNow is a leading provider of enterprise cloud computing solutions that define, structure, manage and automate services for global enterprises. Our mission is to help our customers improve service levels and reduce costs while scaling and automating their businesses. We typically deliver our software via the Internet as a service, through an easy-to-use, consumer product-like interface, which means it can be easily configured and rapidly deployed. In a minority of cases, we deploy our service on-premise at a customer data center to support a customer's unique regulatory or security requirements.

(2)    Summary of Significant Accounting Policies

Basis of Presentation

The accompanying unaudited condensed consolidated financial statements and condensed footnotes have been prepared in accordance with the applicable rules and regulations of the Securities and Exchange Commission (SEC) regarding interim financial reporting. Accordingly, they do not include all of the information and footnotes required by U.S. generally accepted accounting principles, or GAAP, for complete financial statements. In the opinion of management, all adjustments (consisting of normal recurring items) considered necessary for fair statement of results for the interim periods presented have been included. The results of operations for the three months ended March 31, 2017 are not necessarily indicative of the results to be expected for the year ended December 31, 2017 or for other interim periods or for future years. The condensed consolidated balance sheet as of December 31, 2016 is derived from audited financial statements as of that date; however, it does not include all of the information and footnotes required by GAAP for complete financial statements. These condensed consolidated financial statements should be read in conjunction with the audited consolidated financial statements and related notes included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2016, which was filed with the SEC on February 28, 2017.

Principles of Consolidation

The condensed consolidated financial statements have been prepared in conformity with GAAP, and include our accounts and the accounts of our wholly-owned subsidiaries. All intercompany transactions and balances have been eliminated upon consolidation.

Prior Period Reclassification

Certain reclassifications of prior period amounts have been made in Note 16 to conform to the current period presentation.

Use of Estimates

The preparation of condensed consolidated financial statements in conformity with GAAP requires management to make certain estimates and assumptions. These estimates and assumptions affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the condensed consolidated financial statements, as well as reported amounts of revenues and expenses during the reporting period. Such management estimates and assumptions include, but are not limited to, the best estimate of selling price of the deliverables included in multiple elements revenue arrangements, the fair value of assets acquired and liabilities assumed for business combinations, stock-based compensation expenses, the assessment of the useful life and recoverability of our property and equipment, goodwill and identifiable intangible assets, future taxable income and legal contingencies. Actual results could differ from those estimates.


4



New Accounting Pronouncements Pending Adoption

In March 2017, the FASB issued ASU 2017-08, "Receivables—Nonrefundable Fees and Other Costs (Subtopic 310-20) - Premium Amortization on Purchased Callable Debt Securities," which shortens the amortization period for certain callable debt securities held at a premium to require such premiums to be amortized to the earliest call date unless applicable guidance related to certain pools of securities is applied to consider estimated prepayments. This new standard is effective for our interim and annual periods beginning January 1, 2019, and early adoption is permitted. We do not anticipate that this standard will have a material impact on our condensed consolidated financial statements.

In January 2017, the FASB issued ASU 2017-04, "Intangibles—Goodwill and Other (Topic 350): Simplifying the Test for Goodwill Impairment," which eliminates Step 2 from the goodwill impairment test. This standard requires an entity to perform its annual, or interim, goodwill impairment test by comparing the fair value of a reporting unit with its carrying amount. An entity should recognize an impairment charge for the amount by which the carrying amount exceeds the reporting unit’s fair value. In addition, this new standard eliminates the requirements for any reporting unit with a zero or negative carrying amount to perform a qualitative assessment. This new standard is effective for our interim and annual periods beginning January 1, 2020, and early adoption is permitted. We do not anticipate that this standard will have a material impact on our condensed consolidated financial statements.

In January 2017, the FASB issued ASU 2017-01, “Business Combinations (Topic 805): Clarifying the Definition of a Business,” which clarifies the definition of a business with the objective of adding guidance to assist entities with evaluating whether transactions should be accounted for as acquisitions (or disposals) of assets or businesses. The definition of a business affects many areas of accounting including acquisitions, disposals, goodwill and consolidation. This new standard is effective for our interim and annual periods beginning January 1, 2018, and early adoption is permitted. We are currently evaluating the impact of this standard on our condensed consolidated financial statements.

In November 2016, the FASB issued ASU 2016-18, "Statement of Cash Flows (Topic 230): Restricted Cash (a consensus of the FASB Emerging Issues Task Force)," which requires that amounts generally described as restricted cash or restricted cash equivalents be included with cash and cash equivalents when reconciling the beginning-of-period and end-of-period total amounts shown on the statement of cash flows. This new standard is effective for our interim and annual periods beginning January 1, 2018, and early adoption is permitted. We do not anticipate that this standard will have a material impact on our condensed consolidated financial statements.

In October 2016, the FASB issued ASU 2016-16, "Income Taxes (Topic 740): Intra-Entity Transfers of Assets Other Than Inventory," which includes a revision of the accounting for the income tax consequences of intra-entity transfers of assets other than inventory to reduce the complexity in accounting standards. This new standard is effective for our interim and annual periods beginning January 1, 2018, and early adoption is permitted. We are currently evaluating the impact of this standard on our condensed consolidated financial statements.

In August 2016, the FASB issued ASU 2016-15, "Statement of Cash Flows (Topic 230): Classification of Certain Cash Receipts and Cash Payments," which provides guidance on eight specific cash flow issues. Among these issues, this standard requires, at the settlement of zero-coupon debt instruments or other debt instruments with coupon interest rates that are insignificant in relation to the effective interest rate of the borrowings, the portion of the cash payment attributable to the accreted interest related to the debt discount to be classified as cash flows for operating activities, and the portion of the cash payments attributable to the principal to be classified as cash outflows for financing activities. This new standard is effective for our interim and annual periods beginning January 1, 2018, and early adoption is permitted. We are currently evaluating the impact of this standard on our condensed consolidated financial statements.

In June 2016, the FASB issued ASU 2016-13, "Financial Instruments—Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments," which requires a financial asset measured at amortized cost basis to be presented at the net amount expected to be collected. Credit losses relating to available-for-sale debt securities should be recorded through an allowance for credit losses. This new standard is effective for our interim and annual periods beginning January 1, 2020. We are currently evaluating the impact of this standard on our condensed consolidated financial statements.


5



In February 2016, the FASB issued ASU 2016-02, "Leases (Topic 842)," which requires lessees to generally recognize on the balance sheet operating and financing lease liabilities and corresponding right-of-use assets, and to recognize on the income statement the expenses in a manner similar to current practice. This new standard is effective for our interim and annual periods beginning January 1, 2019, and early adoption is permitted. While we are currently evaluating the impact of this standard on our condensed consolidated financial statements, we anticipate that this standard will have a material impact on our condensed consolidated balance sheets given that we had operating lease commitments of approximately $353 million as of March 31, 2017. However, we do not anticipate that this standard will have a material impact on our condensed consolidated statements of comprehensive loss since the expense recognition under this new standard will be similar to current practice.

In January 2016, the FASB issued ASU 2016-01, "Financial Instruments—Overall (Subtopic 825-10): Recognition and Measurement of Financial Assets and Financial Liabilities," which addresses certain aspects of recognition, measurement, presentation, and disclosure of financial instruments. This new standard is effective for our interim and annual periods beginning January 1, 2018. We are currently evaluating the impact of this standard on our condensed consolidated financial statements.

In May 2014, the FASB issued ASU 2014-09, "Revenue from Contracts with Customers (Topic 606)." Under this new standard, revenue is recognized when a customer obtains control of promised goods or services and is recognized in an amount that reflects the consideration which the entity expects to receive in exchange for those goods or services. In addition, this standard requires disclosure of the nature, amount, timing, and uncertainty of revenue and cash flows arising from contracts with customers. The FASB has recently issued several amendments to the standard, including clarification on accounting for licenses of intellectual property and identifying performance obligations. This new standard is effective for our interim and annual periods beginning January 1, 2018, and early adoption beginning January 1, 2017 is permitted. We will adopt this new standard beginning January 1, 2018.

The Topic 606 guidance permits two methods of adoption: retrospectively to each prior reporting period presented (full retrospective method) or retrospectively with the cumulative effect of initially applying the guidance recognized at the date of initial application (modified retrospective method). We currently anticipate adopting the standard using the full retrospective method to restate each prior reporting period presented.

Given the scope of work required to implement the recognition and disclosure requirements under the Topic 606 standard, we began our assessment process in 2014 and have since made significant progress, including the identification of necessary changes to our policies, processes, systems and controls.

We do not expect the new standard to have a material impact on the timing of revenue recognition related to our cloud-based subscription offerings. However, we expect the new standard to have a material impact on the timing of revenue and expense recognition for our contracts related to on-premises offerings, in which we grant customers the right to deploy our subscription service on the customer’s own servers, without significant penalty. Under this new standard, the requirement to have vendor specific objective evidence (VSOE) for undelivered elements is eliminated. As such, we may be required to recognize as revenue a portion of the sales price upon delivery of the software, compared to the current practice of recognizing the entire sales price ratably over an estimated subscription period due to the lack of VSOE. To the extent the amounts recognized as revenue have not been billed, the accrued revenue will be recorded as unbilled receivables on our condensed consolidated balance sheets. We currently believe that our total revenues reported for the year ended December 31, 2016 would have increased by approximately $22 to $27 million on a pro forma basis if the new standard had been applied for the entire 2016 fiscal year starting on January 1, 2016.

In addition, we expect the new standard to change the way we account for commissions paid on both our on-premises offerings and our cloud-based subscription offerings. Our current practice is to defer only direct and incremental commission costs to obtain a contract and amortize those costs over the contract term for both our on-premises offerings and our cloud-based subscription offerings. Under the new standard, we will defer all incremental commission costs to obtain customer contracts for both our on-premises offerings and our cloud-based subscription offerings. Commissions allocated to the software element of our on-premise offerings will be expensed immediately under the new standard, while commissions allocated to the support element of our on-premise offerings as well as commissions paid on our cloud-based subscription offerings will be amortized over an expected period of benefit, which we have determined to be approximately five years. As a result, we currently expect the deferred commissions asset to increase and the related amortization expense in each reporting period to decrease under the new standard. The aggregate impact resulting from changes in the way we account for commission expense for both our cloud-based subscription offerings and our on-premise offerings is expected to reduce our sales and marketing expenses by approximately $22 to $27 million for the year ended December 31, 2016.

We are continuing to evaluate the impact of the adoption of this standard on our condensed consolidated financial statements, including our footnotes, and our preliminary assessments are subject to change.

6




(3)    Investments
 
Marketable Securities

The following is a summary of our available-for-sale investment securities, excluding those securities classified within cash and cash equivalents on the condensed consolidated balance sheets (in thousands):
 
 
March 31, 2017
 
Amortized
Cost
 
Gross
Unrealized
Gains
 
Gross
Unrealized
Losses
 
Estimated
Fair Value
Available-for-sale securities:
 
 
 
 
 
 
 
Commercial paper
$
66,672

 
$

 
$

 
$
66,672

Corporate notes and bonds
679,589

 
143

 
(1,197
)
 
678,535

Certificates of deposit
44,251

 

 

 
44,251

U.S. government agency securities
50,638

 
1

 
(107
)
 
50,532

Marketable equity securities
10,000

 
11,670

 

 
21,670

Total available-for-sale securities
$
851,150

 
$
11,814

 
$
(1,304
)
 
$
861,660



 
December 31, 2016
 
Amortized
Cost
 
Gross
Unrealized
Gains
 
Gross
Unrealized
Losses
 
Estimated
Fair Value
Available-for-sale securities:
 
 
 
 
 
 
 
Commercial paper
$
56,839

 
$

 
$

 
$
56,839

Corporate notes and bonds
628,054

 
91

 
(1,590
)
 
626,555

Certificates of deposit
35,355

 

 

 
35,355

U.S. government agency securities
42,088

 
7

 
(62
)
 
42,033

Total available-for-sale securities
$
762,336

 
$
98

 
$
(1,652
)
 
$
760,782



As of March 31, 2017, the contractual maturities of our available-for-sale investment securities, excluding marketable equity securities, did not exceed 24 months. The fair values of these securities, by remaining contractual maturity, are as follows (in thousands):
 
March 31, 2017
Due in 1 year or less
$
513,729

Due in 1 year through 2 years
326,261

Total
$
839,990



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The following table shows the fair values and the gross unrealized losses of our available-for-sale investment securities, classified by the length of time that the securities have been in a continuous unrealized loss position, and aggregated by investment types (in thousands): 
 
 
March 31, 2017
 
Less than 12 Months
 
12 Months or Greater
 
Total
 
Fair Value
 
Gross
Unrealized
Losses
 
Fair Value
 
Gross
Unrealized
Losses
 
Fair Value
 
Gross
Unrealized
Losses
Corporate notes and bonds
$
537,276

 
$
(1,171
)
 
$
26,908

 
$
(26
)
 
$
564,184

 
$
(1,197
)
U.S. government agency securities
48,536

 
(107
)
 

 

 
48,536

 
(107
)
Total
$
585,812

 
$
(1,278
)
 
$
26,908

 
$
(26
)
 
$
612,720

 
$
(1,304
)


 
December 31, 2016
 
Less than 12 Months
 
12 Months or Greater
 
Total
 
Fair Value
 
Gross
Unrealized
Losses
 
Fair Value
 
Gross
Unrealized
Losses
 
Fair Value
 
Gross
Unrealized
Losses
Corporate notes and bonds
$
492,503

 
$
(1,530
)
 
$
47,940

 
$
(60
)
 
$
540,443

 
$
(1,590
)
U.S. government agency securities
30,033

 
(62
)
 

 

 
30,033

 
(62
)
Total
$
522,536

 
$
(1,592
)
 
$
47,940

 
$
(60
)
 
$
570,476

 
$
(1,652
)


There were no impairments considered "other-than-temporary" as it is more likely than not we will hold the securities until maturity or a recovery of the cost basis.

Strategic Investments

We account for our investments in non-marketable debt and equity securities of certain privately-held companies under the cost method, as we have less than a 20% ownership interest and we do not have the ability to exercise significant influence over the operations of these companies. We utilize Level 3 inputs as part of our impairment analysis, including pre- and post-money valuations of recent financing events and the impact of those on its fully diluted ownership percentages, as well as other available information such as the issuer's financial results and earnings trends to identify indicators of other-than-temporary impairment. We have not recorded any impairment charges for any of our investments in privately-held companies and the carrying value of these investments included in Other assets on the condensed consolidated balance sheets was $2.0 million and $11.0 million as of March 31, 2017 and December 31, 2016, respectively. During the three months ended March 31, 2017, we reclassified $10.0 million of non-marketable equity securities (at cost) to Short-term investments on our condensed consolidated balance sheets due to an initial public offering by the investee, and recorded an unrealized gain of $11.7 million within other comprehensive income in our consolidated statements of comprehensive loss.


8



(4)    Fair Value Measurements
 
The following table presents our fair value hierarchy for our assets measured at fair value on a recurring basis at March 31, 2017 (in thousands): 
 
Level 1
 
Level 2
 
Total
Cash equivalents:
 
 
 
 
 
Money market funds
$
96,840

 
$

 
$
96,840

Certificates of deposit

 
1,500

 
1,500

Short-term investments:
 
 
 
 
 
Commercial paper

 
66,672

 
66,672

Corporate notes and bonds

 
381,042

 
381,042

Certificates of deposit

 
37,655

 
37,655

U.S. government agency securities

 
28,360

 
28,360

Marketable equity securities
21,670

 

 
21,670

Long-term investments:
 
 
 
 
 
Corporate notes and bonds

 
297,493

 
297,493

Certificates of deposit

 
6,596

 
6,596

U.S. government agency securities

 
22,172

 
22,172

Total
$
118,510

 
$
841,490

 
$
960,000

 
The following table presents our fair value hierarchy for our assets measured at fair value on a recurring basis at December 31, 2016 (in thousands): 

 
Level 1
 
Level 2
 
Total
Cash equivalents:
 
 
 
 
 
Money market funds
$
165,627

 
$

 
$
165,627

Short-term investments:
 
 
 
 
 
Commercial paper

 
56,839

 
56,839

Corporate notes and bonds

 
388,429

 
388,429

Certificates of deposit

 
35,355

 
35,355

U.S. government agency securities

 
17,501

 
17,501

Long-term investments:
 
 
 
 
 
Corporate notes and bonds

 
238,125

 
238,125

U.S. government agency securities

 
24,533

 
24,533

Total
$
165,627

 
$
760,782

 
$
926,409



We determine the fair value of our security holdings based on pricing from our service provider and market prices from industry-standard independent data providers. Such market prices may be quoted prices in active markets for identical assets (Level 1 inputs) or pricing determined using inputs other than quoted prices that are observable either directly or indirectly (Level 2 inputs), such as yield curve, volatility factors, credit spreads, default rates, loss severity, current market and contractual prices for the underlying instruments or debt, broker and dealer quotes, as well as other relevant economic measures.

See Note 9 for the fair value measurement of our convertible senior notes.


9



(5)    Business Combinations
 
2017 Business Combination

DxContinuum

On January 20, 2017, we completed the acquisition of a privately-held company, DxContinuum, Inc. (DxContinuum), by acquiring all issued and outstanding common shares of DxContinuum for approximately $15.0 million in an all-cash transaction to enhance the predictive capabilities of our solutions.

The following table summarizes the allocation of the purchase price to the fair value of the tangible and intangible assets acquired and liabilities assumed as of the acquisition date:

 
Purchase Price Allocation
(in thousands)
 
Useful Life
(in years)
Net tangible assets acquired
$
37

 
 
Intangible assets:
 
 
 
Developed technology
6,400

 
5
Goodwill
11,159

 
 
Net deferred tax liabilities(1)
(2,561
)
 
 
Total purchase price
$
15,035

 
 

(1)
Deferred tax liabilities, net primarily relates to purchased identifiable intangible assets and is shown net of deferred tax assets.

The excess of purchase consideration over the fair value of net tangible and identifiable intangible assets acquired was recorded as goodwill. We believe the goodwill represents the synergies expected from expanded market opportunities when integrating DxContinuum technologies with our offerings. The goodwill balance is not deductible for income tax purposes.

The results of operations of DxContinuum have been included in our condensed consolidated financial statements from the date of purchase. The business combination did not have a material impact on our condensed consolidated financial statements, and therefore historical and pro forma disclosures have not been presented.

2016 Business Combinations

BrightPoint Security

On June 3, 2016, we completed the acquisition of a privately-held company, BrightPoint Security, Inc. (BrightPoint), by acquiring all issued and outstanding common shares of BrightPoint for approximately $19.6 million in an all-cash transaction to expand our Security Operations solutions. The following table summarizes the allocation of the purchase price to the fair value of the tangible and intangible assets acquired and liabilities assumed as of the acquisition date:

 
Purchase Price Allocation
(in thousands)
 
Useful Life
(in years)
Intangible assets:
 
 
 
Developed technology
$
8,100

 
6
Customer contracts and related relationships
500

 
1.5
Goodwill
15,258

 
 
Net tangible liabilities acquired
(1,339
)
 
 
Net deferred tax liabilities(1)
(2,890
)
 
 
Total purchase price
$
19,629

 
 

(1)
Deferred tax liabilities, net primarily relates to purchased identifiable intangible assets and is shown net of deferred tax assets.


10



ITapp

On April 8, 2016, we completed the acquisition of a privately-held company, ITapp Inc. (ITapp), by acquiring all issued and outstanding common shares of ITapp for approximately $14.5 million in an all-cash transaction to expand our IT Operations Management solutions. The following table summarizes the allocation of the purchase price to the fair value of the tangible and intangible assets acquired and liabilities assumed as of the acquisition date:

 
Purchase Price Allocation
(in thousands)
 
Useful Life
(in years)
Net tangible assets acquired
$
140

 
 
Intangible assets:
 
 
 
Developed technology
4,700

 
5
Customer contracts and related relationships
200

 
1.5
Goodwill
11,437

 
 
Net deferred tax liabilities
(2,015
)
 
 
Total purchase price
$
14,462

 
 

(1)
Deferred tax liabilities, net primarily relates to purchased identifiable intangible assets and is shown net of deferred tax assets.

For both business combinations, the excess of purchase consideration over the fair value of net tangible and identifiable intangible assets acquired was recorded as goodwill. We believe the goodwill represents the synergies expected from expanded market opportunities when integrating the acquired technologies with our offerings. The goodwill balance for both business combinations is not deductible for income tax purposes. Aggregate acquisition-related costs of $1.0 million are included in general and administrative expenses in our condensed consolidated statements of comprehensive loss.

The results of operations of both BrightPoint and ITapp have been included in our condensed consolidated financial statements from their respective dates of purchase. The following unaudited pro forma consolidated financial information combines the results of operations from us, BrightPoint and ITapp for the three months ended March 31, 2016, as if the acquisitions of BrightPoint and ITapp had occurred on January 1, 2016 (in thousands, except share and per share data):

 
Three Months Ended March 31, 2016
 
(unaudited)
Revenue
$
306,268

Net loss
$
(335,625
)
Weighted-average shares used to compute net loss per share - basic and diluted
162,067,108

Net loss per share - basic and diluted
$
(2.07
)


The pro forma results as presented above are based on estimates and assumptions, which we believe are reasonable. They are not necessarily indicative of our condensed consolidated results of operations in future periods or the results that actually would have been realized had we been a combined company during the periods presented. The pro forma results include adjustments primarily related to amortization of acquired intangible assets and acquisition-related costs.


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(6) Goodwill and Intangible Assets
Goodwill balances are presented below (in thousands):
 
Carrying Amount
Balance as of December 31, 2016
$
82,534

Goodwill acquired
11,159

Foreign currency translation adjustments
3,221

Balance as of March 31, 2017
$
96,914



Intangible assets consist of the following (in thousands):
 
March 31, 2017
 
Gross Carrying Amount
 
Accumulated Amortization
 
Net Carrying Amount
Developed technology
$
85,899

 
$
(34,981
)
 
$
50,918

Patents
17,610

 
(1,369
)
 
16,241

Other
1,775

 
(1,179
)
 
596

Total intangible assets
105,284

 
(37,529
)
 
67,755


 
December 31, 2016
 
Gross Carrying Amount
 
Accumulated Amortization
 
Net Carrying Amount
Developed technology
$
79,206

 
$
(30,858
)
 
$
48,348

Patents
17,610

 
(867
)
 
16,743

Other
1,775

 
(1,012
)
 
763

Total intangible assets
$
98,591

 
$
(32,737
)
 
$
65,854


Amortization expense for intangible assets for the three months ended March 31, 2017 and 2016 was approximately $4.7 million and $2.9 million, respectively.

The following table presents the estimated future amortization expense related to intangible assets held at March 31, 2017 (in thousands):
Years Ending December 31,
2017
 
$
13,503

2018
 
17,091

2019
 
17,011

2020
 
7,363

2021
 
5,458

Thereafter
 
7,329

Total future amortization expense
 
$
67,755




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(7)    Property and Equipment
 
Property and equipment, net consists of the following (in thousands):
 
March 31,
 
December 31,
 
2017
 
2016
Computer equipment
$
240,617

 
$
222,648

Leasehold improvements
37,357

 
37,095

Computer software
34,879

 
32,132

Furniture and fixtures
33,556

 
31,574

Building
6,788

 
6,379

Construction in progress
3,431

 
2,535

 
356,628

 
332,363

Less: Accumulated depreciation
(166,969
)
 
(150,743
)
Total property and equipment, net
$
189,659

 
$
181,620



Construction in progress consists primarily of leasehold improvements and in-process software development costs. Depreciation expense for the three months ended March 31, 2017 and 2016 was $20.4 million and $14.6 million, respectively.

(8)    Accrued Expenses and Other Current Liabilities

Accrued expenses and other current liabilities consist of the following (in thousands):
 
March 31,
 
December 31,
 
2017
 
2016
Taxes payable
$
19,360

 
$
19,472

Bonuses and commissions
43,803

 
67,259

Accrued compensation
37,490

 
30,816

Other employee related liabilities
20,081

 
28,812

Other
23,860

 
25,277

Total accrued expenses and other current liabilities
$
144,594

 
$
171,636



(9)    Convertible Senior Notes

In November 2013, we issued 0% convertible senior notes due November 1, 2018 with an aggregate principal amount of $575 million, or the Notes. The Notes do not bear interest. The Notes mature on November 1, 2018 unless converted or repurchased in accordance with their terms prior to such date. We cannot redeem the Notes prior to maturity.

The Notes are unsecured obligations and do not contain any financial covenants or restrictions on the payments of dividends, the incurrence of indebtedness or the issuance or repurchase of securities by us or any of our subsidiaries.

Upon conversion, we may choose to pay or deliver, as the case may be, cash, shares of our common stock or a combination of cash and shares of our common stock. We intend to settle the principal amount of the Notes with cash.

The Notes are convertible into up to 7.8 million shares of our common stock at an initial conversion rate of approximately 13.54 shares of common stock per $1,000 principal amount, which is equal to an initial conversion price of approximately $73.88 per share of common stock, subject to adjustment. Holders of the Notes may convert their Notes at their option at any time prior to the close of business on the business day immediately preceding July 1, 2018, only under the following circumstances:

during any calendar quarter commencing after the calendar quarter ending on March 31, 2014 (and only during such calendar quarter), if the last reported sale price of the common stock for at least 20 trading days (whether or not consecutive) during the period of 30 consecutive trading days ending on the last trading day of the immediately preceding calendar quarter is greater than or equal to 130% of the conversion price on each applicable trading day;


13



during the five business day period after any five-consecutive trading day period, or the measurement period, in which the trading price per $1,000 principal amount of the Notes for each trading day of the measurement period was less than 98% of the product of the last reported sale price of our common stock and the conversion rate on each such trading day; or

upon the occurrence of specified corporate events.

On or after July 1, 2018, a holder may convert all or any portion of its notes at any time prior to the close of business on the second scheduled trading day immediately preceding the maturity date regardless of the foregoing conditions. Upon conversion, we will pay or deliver, as the case may be, cash, shares of our common stock or a combination of cash and shares of our common stock, at our election.

The conversion price will be subject to adjustment in some events. Holders of the Notes who convert their notes in connection with certain corporate events that constitute a “make-whole fundamental change” are, under certain circumstances, entitled to an increase in the conversion rate. Additionally, in the event of a corporate event that constitutes a “fundamental change,” holders of the Notes may require us to purchase with cash all or a portion of the Notes upon the occurrence of a fundamental change, at a purchase price equal to 100% of the principal amount of the Notes plus any accrued and unpaid interest.

In accounting for the issuance of the Notes, we separated the Notes into liability and equity components. The carrying cost of the liability component was calculated by measuring the fair value of a similar liability that does not have an associated convertible feature. The carrying amount of the equity component representing the conversion option was determined by deducting the fair value of the liability component from the par value of the Notes. The difference between the principal amount of the Notes and the proceeds allocated to the liability component, or the debt discount, is amortized to interest expense using the effective interest method over the term of the Notes. The equity component is not remeasured as long as it continues to meet the conditions for equity classification.

In accounting for the transaction costs related to the issuance of the Notes, we allocated the total amount incurred to the liability and equity components based on their relative fair values. Transaction costs attributable to the liability component are being amortized to interest expense over the term of the Notes, and transaction costs attributable to the equity component were netted with the equity component of the Notes in stockholders’ equity. The Notes consisted of the following (in thousands):
 
March 31, 2017
 
December 31, 2016
Liability:
 
 
 
Principal
$
575,000

 
$
575,000

Less: debt issuance cost and debt discount, net of amortization
(58,510
)
 
(67,188
)
Net carrying amount
$
516,490

 
$
507,812



We consider the fair value of the Notes at March 31, 2017 and December 31, 2016 to be a Level 2 measurement. The estimated fair values of the Notes were $743.8 million and $681.4 million at March 31, 2017 and December 31, 2016, respectively (based on the closing trading price per $100 of the Notes on March 31, 2017 and December 31, 2016, respectively). The Notes were not convertible as of March 31, 2017 and December 31, 2016.

As of March 31, 2017, the remaining life of the Notes is 19 months. The following table sets forth total interest expense recognized related to the Notes (in thousands):
 
Three Months Ended March 31,
 
2017
 
2016
Amortization of debt issuance cost
$
465

 
$
435

Amortization of debt discount
8,213

 
7,674

Total
$
8,678

 
$
8,109

Effective interest rate of the liability component
6.5%



14



Note Hedge

To minimize the impact of potential economic dilution upon conversion of the Notes, we entered into convertible note hedge transactions, or the Note Hedge, with respect to our common stock concurrent with the issuance of the Notes. The Note Hedge covers approximately 7.8 million shares of our common stock at a strike price per share that corresponds to the initial conversion price of the Notes, subject to adjustment, and is exercisable upon conversion of the Notes. We paid an aggregate amount of $135.8 million for the Note Hedge. The Note Hedge will expire upon maturity of the Notes. The Note Hedge is intended to reduce the potential economic dilution upon conversion of the Notes in the event that the fair value per share of our common stock at the time of exercise is greater than the conversion price of the Notes. The Note Hedge is a separate transaction and is not part of the terms of the Notes. The Note Hedge does not impact earnings per share, as it was entered into to offset any dilution from the Notes.

Warrants

Separately, we entered into warrant transactions, or the Warrants, whereby we sold warrants to acquire up to 7.8 million shares of our common stock, at a strike price of $107.46 per share, subject to adjustment. We received aggregate proceeds of $84.5 million from the sale of the Warrants. If the average market value per share of our common stock for the reporting period, as measured under the Warrants, exceeds the strike price of the Warrants, the Warrants will have a dilutive effect on our earnings per share. The Warrants are separate transactions and are not remeasured through earnings each reporting period. The Warrants are not part of the Notes or the Note Hedge, and have been accounted for as part of additional paid-in capital.

(10)    Accumulated Other Comprehensive Loss

The components of accumulated other comprehensive loss, net of tax, consist of the following (in thousands):
 
March 31,
 
December 31,
 
2017
 
2016
Foreign currency translation adjustment
$
(17,405
)
 
$
(19,277
)
Net unrealized gain (loss) on investments, net of tax
5,727

 
(1,856
)
        Accumulated other comprehensive loss
$
(11,678
)
 
$
(21,133
)


Reclassification adjustments out of accumulated other comprehensive loss into net loss were immaterial for all periods presented.

(11)    Stockholders' Equity
 
Common Stock

We were authorized to issue 600,000,000 shares of common stock as of March 31, 2017. Holders of our common stock are not entitled to receive dividends unless declared by our board of directors. As of March 31, 2017, we had 169,721,359 shares of common stock outstanding and had reserved shares of common stock for future issuance as follows: 
 
March 31, 2017
Stock plans:
 
Options outstanding
5,649,375

RSUs
14,129,353

Shares of common stock available for future grants:
 
2012 Equity Incentive Plan(1)
25,617,438

2012 Employee Stock Purchase Plan(1)
9,868,010

Total reserved shares of common stock for future issuance
55,264,176

 
(1)
Refer to Note 12 for a description of these plans.

During the three months ended March 31, 2017 and 2016, we issued a total of 2,290,586 shares and 2,062,399 shares, respectively, from stock option exercises, vesting of restricted stock units, or RSUs, net of employee payroll taxes and purchases from the employee stock purchase plan, or ESPP.


15


(12)    Equity Awards

We currently have two equity incentive plans, our 2005 Stock Option Plan, or 2005 Plan, and our 2012 Equity Incentive Plan, or 2012 Plan. Our 2005 Plan was terminated in connection with our initial public offering in 2012 but continues to govern the terms of outstanding stock options that were granted prior to the termination of the 2005 Plan. We no longer grant equity awards pursuant to our 2005 Plan.
 
Our 2012 Plan provides for the grant of incentive stock options, nonqualified stock options, stock appreciation rights, RSUs, performance-based stock awards and other forms of equity compensation, or collectively, equity awards. In addition, the 2012 Plan provides for the grant of performance cash awards. Incentive stock options may be granted only to employees. All other awards may be granted to employees, including officers, as well as directors and consultants. The share reserve may increase to the extent outstanding stock options under the 2005 Plan expire or terminate unexercised. The share reserve also automatically increases on January 1 of each year until January 1, 2022, by up to 5% of the total number of shares of common stock outstanding on December 31 of the preceding year as determined by the board of directors. On January 1, 2017, 8,371,539 shares of common stock were automatically added to the 2012 Plan pursuant to the provision described in the preceding sentence.

Our 2012 Employee Stock Purchase Plan, or 2012 ESPP, authorizes the issuance of shares of common stock pursuant to purchase rights granted to our employees. The price at which common stock is purchased under the 2012 ESPP is equal to 85% of the fair market value of the common stock on the first or last day of the offering period, whichever is lower. Offering periods are six months long and begin on February 1 and August 1 of each year. The number of shares of common stock reserved for issuance automatically increases on January 1 of each year until January 1, 2022, by up to 1% of the total number of shares of common stock outstanding on December 31 of the preceding year as determined by the board of directors. On January 1, 2017, 1,674,308 shares of common stock were automatically added to the 2012 ESPP pursuant to the provision described in the preceding sentence.

Stock Options

A summary of the stock option activity for the three months ended March 31, 2017 is as follows:
 
Number of
Shares
 
Weighted-
Average
Exercise
Price
 
Weighted-
Average
Remaining
Contractual
Term (Years)
 
Aggregate
Intrinsic Value
(in thousands)
Outstanding at December 31, 2016
5,818,435

 
$
20.57

 
 
 
 
Granted
566,720

 
84.81

 
 
 
 
Exercised
(697,446
)
 
15.77

 
 
 
$
51,560

Canceled
(38,334
)
 
71.68

 
 
 
 
Outstanding at March 31, 2017
5,649,375

 
$
27.26

 
5.67
 
$
340,134

Vested and expected to vest as of March 31, 2017
5,569,939

 
26.63

 
5.63
 
$
338,864

Vested and exercisable as of March 31, 2017
4,375,490

 
$
12.95

 
4.63
 
$
326,059

 
Aggregate intrinsic value represents the difference between the estimated fair value of our common stock and the exercise price of outstanding, in-the-money options. The weighted-average grant date fair value per share of options granted was $37.55 for the three months ended March 31, 2017. The total fair value of stock options vested during the three months ended March 31, 2017 was $2.5 million.

Included in the number of options granted during the three months ended March 31, 2017 are 396,720 options with both service and market-based criteria, which were granted to our new President and Chief Executive Officer, who started his employment with us during the quarter. The fair values of the options granted and the corresponding derived service periods were calculated using a Monte Carlo simulation, which estimates the potential outcome of reaching the market condition based on simulated future stock prices. The stock-based compensation expense associated with these options are recorded on a graded vesting basis.
 
As of March 31, 2017, total unrecognized compensation cost, adjusted for estimated forfeitures, related to unvested stock options was approximately $36.1 million. The weighted-average remaining vesting period of unvested stock options at March 31, 2017 was 3.73 years.


16


RSUs

A summary of RSU activity for the three months ended March 31, 2017 is as follows:
 
Number of
Shares
 
Weighted Average Grant Date Fair Value
(Per Share)
 
Aggregate
Intrinsic Value
(in thousands)
Non-vested at December 31, 2016
12,222,282

 
$
63.66

 
 
Granted
4,216,410

 
88.05

 
 
Vested
(1,801,659
)
 
55.73

 
$
164,367

Forfeited
(507,680
)
 
73.14

 
 
Non-vested at March 31, 2017
14,129,353

 
71.60

 
$
1,235,895



RSUs granted to employees under the 2012 Plan generally vest over a four-year period. As of March 31, 2017, total unrecognized compensation cost, adjusted for estimated forfeitures, related to unvested RSUs was approximately $772.6 million and the weighted-average remaining vesting period was 3 years.

(13)    Net Loss Per Share
 
Basic net loss per share attributable to common stockholders is computed by dividing net loss attributable to common stockholders by the weighted-average number of shares of common stock outstanding during the period. Diluted net loss per share is computed by dividing net loss attributable to common stockholders by the weighted-average number of shares of common stock outstanding during the period, adjusted for the effects of dilutive shares of common stock, which are comprised of outstanding common stock options, RSUs, shares of common stock subject to repurchase, ESPP obligations, convertible senior notes and warrants. The dilutive potential shares of common stock are computed using the treasury stock method or the as-if converted method, as applicable. The effects of outstanding common stock options, RSUs, ESPP obligations, convertible senior notes and warrants are excluded from the computation of diluted net loss per share in periods in which the effect would be antidilutive.

The following table presents the calculation of basic and diluted net loss per share (in thousands, except share and per share data): 
 
Three Months Ended March 31,
 
2017
 
2016
Numerator:
 
 
 
Net loss
$
(40,662
)
 
$
(333,332
)
Denominator:
 
 
 
Weighted-average shares outstanding—basic and diluted
168,742,366

 
162,067,108

Net loss per share—basic and diluted:
$
(0.24
)
 
$
(2.06
)

 
Potentially dilutive securities that are not included in the calculation of diluted net loss per share because doing so would be antidilutive are as follows:
 
 
March 31,
 
2017
 
2016
Common stock options
5,649,375

 
7,718,715

Restricted stock units
14,129,353

 
14,161,913

ESPP obligations
290,102

 
292,689

Convertible senior notes
7,783,023

 
7,783,023

Warrants related to the issuance of convertible senior notes
7,783,023

 
7,783,023

Total potentially dilutive securities
35,634,876

 
37,739,363


 

17



(14)    Income Taxes

We compute our provision for income taxes by applying the estimated annual effective tax rate to year-to-date loss from recurring operations and adjust the provision for discrete tax items recorded in the period.

Our effective tax rate was 6% for the three months ended March 31, 2017, which was lower than the U.S. federal statutory tax rate of 34%. The lower tax rate was primarily attributable to our loss from operations, the foreign tax rate differential, a release of the valuation allowance in connection with an acquisition, excess tax benefits of stock-based compensation and the tax effects of unrealized gains in investment securities.

Our effective tax rate was (1)% for the three months ended March 31, 2016, which was lower than the U.S. federal statutory tax rate of 34%. The lower tax rate was primarily attributable to our loss from operations, the foreign tax rate differential, and non-deductible expenses arising from stock-based compensation.

We are subject to taxation in the United States and foreign jurisdictions. As of March 31, 2017, our tax years 2005 to 2016 remain subject to examination in most jurisdictions.

There are differing interpretations of tax laws and regulations, and as a result, disputes may arise with tax authorities involving issues of the timing and amount of deductions and allocations of income among various tax jurisdictions. We periodically evaluate our exposures associated with our tax filing positions. We believe that adequate amounts have been reserved for any adjustments that may ultimately result from these examinations, and we do not anticipate a significant impact to our gross unrecognized tax benefits within the next 12 months related to these years. Although the timing of the resolution, settlement, and closure of any audit is highly uncertain, it is reasonably possible that the balance of gross unrecognized tax benefits could significantly change in the next 12 months. However, given the number of years that remain subject to examination, we are unable to estimate the full range of possible adjustments to the balance of gross unrecognized tax benefits.

(15)    Commitments and Contingencies

Operating Leases and Other Contractual Commitments

For some of our offices and data centers, we have entered into non-cancelable operating lease agreements with various expiration dates. Future minimum payments under our non-cancelable operating leases and other contractual commitments outstanding as of March 31, 2017 are presented in the table below (in thousands):
 
Leases, net of Sublease Income
 
Purchase
Obligations(1)
 
Other
 
Total
Years Ending December 31,
 
 
 
 
 
 
 
Remainder of 2017
$
27,659

 
$
15,217

 
$
413

 
$
43,289

2018
40,873

 
18,735

 
550

 
60,158

2019
42,716

 
8,783

 
550

 
52,049

2020
42,419

 
4,022

 
550

 
46,991

2021
42,358

 
2,128

 
550

 
45,036

Thereafter
156,965

 

 
1,558

 
158,523

Total
$
352,990

 
$
48,885

 
$
4,171

 
$
406,046

 
(1)
Consists of future minimum payments under non-cancelable purchase commitments primarily related to data center and IT operations. Not included in the table above are certain purchase commitments related to our future Knowledge user conferences. If we were to cancel these contractual commitments as of March 31, 2017, we would have been obligated to pay cancellation penalties of approximately $15.8 million in aggregate.

In addition to the amounts above, the repayment of our 0% convertible senior notes with an aggregate principal amount of $575 million is due on November 1, 2018. Refer to Note 9 for further information regarding our convertible senior notes.


18



Legal Proceedings

From time to time, we are party to litigation and other legal proceedings in the ordinary course of business. While the results of any litigation or other legal proceedings are uncertain, management does not believe the ultimate resolution of any pending legal matters is likely to have a material adverse effect on our financial position, results of operations or cash flows, except for those matters for which we have recorded a loss contingency. We accrue for loss contingencies when it is both probable that we will incur the loss and when we can reasonably estimate the amount of the loss or range of loss.

Generally, our subscription agreements require us to defend our customers for third-party intellectual property infringement and other claims. Any adverse determination related to intellectual property claims or other litigation could prevent us from offering our services and adversely affect our financial condition and results of operations.

On February 6, 2014, Hewlett-Packard Company (Hewlett-Packard) filed a lawsuit against us in the U.S. District Court for the Northern District of California. The lawsuit alleged patent infringement and sought damages and an injunction. On or about November 1, 2015, Hewlett Packard Enterprise Company (HPE) separated from Hewlett-Packard as an independent company, and Hewlett-Packard assigned to HPE all right, title, and interest in the eight Hewlett-Packard patents in the lawsuit and HPE was substituted as plaintiff in the litigation. On March 4, 2016, we entered into a confidential settlement agreement resolving the lawsuit with HPE (HPE Settlement). As a result, on March 9, 2016, the lawsuit was dismissed.

BMC Software, Inc. (BMC) filed lawsuits against us in the U.S. District Court for the Eastern District of Texas on September 23, 2014 and February 12, 2016, and in the Dusseldorf (Germany) Regional Court, Patent Division, on March 2, 2016. Each of the lawsuits alleged patent infringement and sought damages and an injunction. On April 8, 2016, we entered into a confidential settlement agreement resolving all the lawsuits with BMC (BMC Settlement). As a result, the second Texas lawsuit was dismissed on April 14, 2016, and each of the initial Texas lawsuit and the German lawsuit was dismissed on April 25, 2016.

These settlements are considered multiple element arrangements for accounting purposes. We evaluated the accounting treatment of these settlements by identifying each element of the arrangements, which included amongst other elements, a release of past infringement claims and a covenant not to sue for a specified term of years. The primary benefit we received from the arrangements was the settlement and termination of all existing litigation, the avoidance of future litigation expenses and the avoidance of future management and customer disruptions. We determined that none of the elements of the settlement agreements have identifiable future benefits that would be capitalized as an asset. Accordingly, we recorded charges for aggregate legal settlements of $270.0 million in our condensed consolidated statement of comprehensive loss during the three months ended March 31, 2016. The charge covers the fulfillment by us of all financial obligations under both the BMC Settlement and HPE Settlement with no remaining financial obligations under either settlement.

(16)   Information about Geographic Areas and Products

Revenues by geographic area, based on the location of our users, were as follows for the periods presented (in thousands):
 
Three Months Ended March 31,
 
2017
 
2016
North America (1)
$
285,581

 
$
210,517

EMEA (2)
98,866

 
74,281

Asia Pacific and other
32,336

 
21,081

Total revenues
$
416,783

 
$
305,879



19



Property and equipment, net by geographic area were as follows (in thousands):
 
March 31,
 
December 31,
 
2017
 
2016
North America(3)
$
136,427

 
$
132,671

EMEA(2)
39,445

 
37,449

Asia Pacific and other
13,787

 
11,500

Total property and equipment, net
$
189,659

 
$
181,620


(1)
Revenues attributed to the United States were approximately 94% and 95% of North America revenues for each of the three months ended March 31, 2017 and 2016, respectively.
(2)
Europe, the Middle East and Africa
(3)
Property and equipment, net attributed to the United States were approximately 91% and 92% of property and equipment, net attributable to North America as of March 31, 2017 and December 31, 2016, respectively.
 
Subscription revenues consist of the following (in thousands):
 
Three Months Ended March 31,
 
2017
 
2016
Service Management solutions
$
333,636

 
$
244,606

IT Operations Management solutions
42,499

 
22,816

Total subscription revenues
$
376,135

 
$
267,422



Our Service Management solutions include ServiceNow Platform, IT Service Management, IT Business Management, Customer Service Management, Human Resources Management and Security Operations Management, which have similar features and functions, and are generally priced on a per user basis. Our IT Operations Management solutions, which improve visibility, availability and agility of enterprise services, are generally priced on a per node basis.

(17)    Subsequent Event
 
John J. Donahoe commenced employment with the Company on February 27, 2017 and was appointed as our President and Chief Executive Officer and as a member of our board of directors effective as of April 3, 2017.



20



ITEM 2.     MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
 
The following discussion and analysis of our financial condition, results of operations and cash flows should be read in conjunction with the (1) unaudited condensed consolidated financial statements and the related notes thereto included elsewhere in this Quarterly Report on Form 10-Q, and (2) the audited consolidated financial statements and notes thereto and management’s discussion and analysis of financial condition and results of operations for the year ended December 31, 2016 included in the Annual Report on Form 10-K dated as of, and filed with the Securities and Exchange Commission, or the SEC, on February 28, 2017 (File No. 001-35580). This Quarterly Report on Form 10-Q contains “forward-looking statements” within the meaning of Section 21E of the Securities Exchange Act of 1934, as amended, or the Exchange Act. These statements are often identified by the use of words such as “may,” “will,” “expect,” “believe,” “anticipate,” “intend,” “could,” “estimate,” or “continue,” and similar expressions or variations. Such forward-looking statements are subject to risks, uncertainties and other factors that could cause actual results and the timing of certain events to differ materially from future results expressed or implied by the forward-looking statements. Factors that could cause or contribute to such differences include, but are not limited to, those identified herein, and those discussed in the section titled “Risk Factors,” set forth in Part II, Item 1A of this Quarterly Report on Form 10-Q and in our other SEC filings. We disclaim any obligation to update any forward-looking statements to reflect events or circumstances after the date of such statements.

Our billings and free cash flow measures included in the sections entitled “—Key Business Metrics—Billings,” and “—Key Business Metrics—Free Cash Flow” are not in accordance with U.S. Generally Accepted Accounting Principles (GAAP). These non-GAAP financial measures are not intended to be considered in isolation or as a substitute for, or superior to, financial information prepared and presented in accordance with GAAP. These measures may be different from non-GAAP financial measures used by other companies, limiting their usefulness for comparison purposes. We believe investors should consider these non-GAAP financial measures in evaluating our results as they are indicative of our ongoing performance and reflect how management evaluates our operational results and trends. 
 
Overview

ServiceNow is a leading provider of enterprise cloud computing solutions that define, structure, manage and automate services for global enterprises. Our mission is to help our customers improve service levels and reduce costs while scaling and automating their businesses. We typically deliver our software via the Internet as a service, through an easy-to-use, consumer product-like interface, which means it can be easily configured and rapidly deployed. In a minority of cases, we deploy our service on-premise at a customer data center to support a customer's unique regulatory or security requirements.

We generally offer our services on an annual subscription fee basis which includes access to the ordered subscription service and related support, including updates to the subscribed service during the subscription term. We provide a scaled pricing model based on the duration of the subscription term, and we frequently extend discounts to our customers based on the number of users. We generate sales through our direct sales team and, to a lesser extent, indirectly through resale partners and third-party referrals. We also generate revenues from professional services for implementation and configuration services and for training of customer and partner personnel. We generally bill our customers annually in advance for subscription services and monthly in arrears for our professional services as the work is performed.
 
A majority of our revenues come from large global enterprise customers. We continue to invest in the development of our services, infrastructure and sales and marketing to drive long-term growth. We increased our overall employee headcount to 5,223 as of March 31, 2017 from 3,991 as of March 31, 2016.


21



Key Business Metrics

Number of customers with ACV greater than $1 million. We count the total number of customers with annualized contract value (ACV) greater than $1 million as of the end of the period. We had 370 and 245 customers with ACV greater than $1 million as of March 31, 2017 and 2016, respectively. For purposes of customer count, a customer is defined as an entity with a unique Dunn & Bradstreet Global Ultimate (GULT), Data Universal Numbering System (DUNS) and an active subscription contract as of the measurement date. The DUNS number is a global standard for business identification and tracking. We make exceptions for holding companies, government entities and other organizations for which the GULT, in our judgment, does not accurately represent the ServiceNow customer. For example, while all U.S. government agencies roll up to "Government of the United States" under the GULT, we count each government agency that we contract with as a separate customer. Our customer count is subject to adjustments for acquisitions, spin-offs and other market activity. Previously disclosed number of customers with ACV greater than $1 million as well as our average contract term calculations are restated to allow for comparability. ACV is calculated based on the foreign exchange rate in effect at the time the contract was signed. Foreign exchange rate fluctuations could cause some variability in the number of customers with ACV greater than $1 million.

G2K customer count. The Global 2000 (G2K) customer count is defined as the total number of G2K companies in our customer base as of the end of the period. The Forbes Global 2000 is an annual ranking of the top 2,000 public companies in the world by Forbes magazine. The ranking is based on a mix of four metrics: sales, profit, assets, and market value. The Forbes Global 2000 is updated annually in the second quarter of the calendar year. Current and prior period G2K customer counts are based on the most recent list for comparability purposes. We adjust the G2K count for acquisitions, spin-offs and other market activity to ensure the G2K customer count is accurately captured. For example, we add a G2K customer when a G2K company that is not our customer acquires a company in our existing customer base that is not a G2K company. When we enter into a contract with a G2K parent company, or any of its related subsidiaries, or any combination of entities within a G2K company, we count only one G2K customer. We do not count further penetration into entities within a given G2K as a new customer in the G2K customer count. Our G2K customer count also excludes customers that have only purchased our Express product offering, which is our entry-level IT service management solution. Our G2K customer count was 763 and 657 as of March 31, 2017 and 2016, respectively.

Average ACV per G2K customer. We calculate average ACV for our G2K customers by taking aggregate ACV from G2K customers as of the end of the period divided by the total number of G2K customers as of the end of the period. ACV is calculated based on the foreign exchange rate in effect at the time the contract was entered into, and as a result, foreign currency rate fluctuations could cause variability in the average ACV per G2K customer. Our average ACV per G2K customer was approximately $1.1 million and $0.9 million as of March 31, 2017 and 2016, respectively.

Renewal rate. We calculate our renewal rate by subtracting our attrition rate from 100%. Our attrition rate for a period is equal to the ACV from customers lost during the period, divided by the total ACV from all customers that renewed during the period, excluding changes in price or users, and total ACV from all customers lost during the period. Accordingly, our renewal rate is calculated based on ACV and is not based on the number of customers that have renewed. A lost customer is a customer that did not renew an expiring contract and that, in our judgment, will not be renewed. Typically, a customer that reduces its subscription upon renewal is not considered a lost customer. However, in instances where the subscription decrease represents the majority of the customer's ACV, we may deem the renewal as a lost customer. For our renewal rate calculation, we define a customer as an entity with a separate production instance of our service and an active subscription contract as of the measurement date, instead of an entity with a unique GULT or DUNS number. Our renewal rate was 97% for each of the three months ended March 31, 2017 and 2016. As our renewal rate is impacted by the timing of renewals, which could occur in advance of, or subsequent to the original contract end date, period-to-period comparison of renewal rates may not be meaningful.

Billings. We define billings, a non-GAAP financial measure, as revenues recognized plus the change in total deferred revenue as presented on the condensed consolidated statements of cash flows. The change in total deferred revenue as presented on the condensed consolidated statements of cash flows represents the change in deferred revenues in local currencies translated into U.S. dollars using an average foreign currency exchange rate, and aligns actual billings with the exchange rates in effect at the time of the billings. We believe billings is a useful leading indicator regarding the performance of our business.


22



A calculation of billings is provided below:
 
Three Months Ended March 31,
 
% Change
 
2017
 
2016
 
 
(dollars in thousands)
 
 
Billings:
 
 
 
 
 
Total revenues
$
416,783

 
$
305,879

 
36
%
Change in deferred revenue from the condensed consolidated statements of cash flows
112,447