10-K 1 now-20171231x10k.htm 10-K Document

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

FORM 10-K
x
Annual Report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934
For the fiscal year ended December 31, 2017
OR
 ¨
Transition report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934
Commission File Number: 001-35580

servicenowrlogostandarda03.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

(Address, including zip code, and telephone number, including area code, of registrant’s principal executive offices) 
Securities registered pursuant to Section 12(b) of the Act:
Title of each class
 
Name of each exchange on which registered
Common stock, par value $0.001 per share
 
New York Stock Exchange, Inc.
Securities registered pursuant to Section 12(g) of the Act:
Not applicable
__________________________
Indicate by check mark if the Registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. Yes x No ¨
Indicate by check mark if the Registrant is not required to file reports pursuant to Section 13 or Section 15(d) of Act. Yes ¨ No x
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 if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K (§229.405 of this chapter) is not contained herein, and will not be contained, to the best of Registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K.  ¨
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  ¨ Smaller reporting company  ¨
(Do not check if a 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
Based on the closing price of the Registrant’s Common Stock on the last business day of the Registrant’s most recently completed second fiscal quarter, which was June 30, 2017, the aggregate market value of its shares (based on a closing price of $106.00 per share on June 30, 2017 as reported on the New York Stock Exchange) held by non-affiliates was approximately $12.6 billion.
As of January 31, 2018, there were approximately 174.7 million shares of the Registrant’s Common Stock outstanding.
DOCUMENTS INCORPORATED BY REFERENCE
Portions of the Registrant’s definitive proxy statement for its 2018 Annual Meeting of Stockholders (Proxy Statement) to be filed within 120 days of the Registrant’s fiscal year ended December 31, 2017, are incorporated by reference in Part III of this Report on Form 10-K. Except with respect to information specifically incorporated by reference in this Form 10-K, the Proxy Statement is not deemed to be filed as part of this Form 10-K.





TABLE OF CONTENTS
 
 
 
Page
 
 
Item 1
Item 1A
Item 1B
Item 2
Item 3
Item 4
 
 
 
 
 
Item 5
Item 6
Item 7
Item 7A
Item 8
Item 9
Item 9A
Item 9B
 
 
 
 
 
Item 10
Item 11
Item 12
Item 13
Item 14
 
 
 
 
 
Item 15
Item 16
 
Index to Exhibits
 
   
 
 



PART I

FORWARD-LOOKING STATEMENTS

This Annual Report on Form 10-K, including the “Management's Discussion and Analysis of Financial Condition and Results of Operations,” contains forward-looking statements regarding future events and our future results that are based on our current expectations, estimates, forecasts and projections about our business, our results of operations, the industry in which we operate and the beliefs and assumptions of our management. Words such as “believe,” “may,” “will,” “estimate,” “continue,” “anticipate,” “would,” “could,” “should,” “intend” and “expect,” variations of these words, and similar expressions are intended to identify those forward-looking statements. These forward-looking statements are only predictions and are subject to risks, uncertainties and assumptions that are difficult to predict. Therefore, actual results may differ materially and adversely from those expressed in any forward-looking statements. Factors that might cause or contribute to such differences include, but are not limited to, those discussed in this Report under the section entitled “Risk Factors” in Item 1A of Part I and elsewhere herein, and in other reports we file with the Securities and Exchange Commission (SEC). While forward-looking statements are based on the reasonable expectations of our management at the time that they are made, you should not rely on them. We undertake no obligation to revise or update publicly any forward-looking statements for any reason, whether as a result of new information, future events or otherwise, except as may be required by law.
 
ITEM 1.
BUSINESS


ServiceNow is a leading provider of enterprise cloud computing solutions that define, structure, manage and automate services for global enterprises. We help our customers improve service quality and reduce costs while scaling and automating their businesses.

We offer a comprehensive set of cloud-based services that automate workflow within and between departments in an enterprise. Historically, our focus was on solving challenges found in enterprise information technology (IT) departments, and we pioneered the use of the cloud to deliver IT service management applications. We now provide workflow solutions that go beyond the scope of the IT department to include service management for customer service, human resources, security operations and other enterprise departments where a patchwork of semi-automated and manual processes had been used in the past. Using our cloud services, users can easily request business services from these departments, actions and responses can be automated within the enterprise, the quality of service provided by these departments improves, and overall the business runs more efficiently.

All of our cloud services are built on our proprietary platform, which features one code base and one data model. Our platform also enables customers to easily create, by themselves or with our partners, their own service-oriented business applications across the enterprise. We 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.

We market our services to enterprises in a wide variety of industries, including financial services, consumer products, IT services, health care, government, education and technology. We sell our subscription services primarily through direct sales and, to a lesser extent, through indirect channel sales. We also offer a portfolio of professional and other services, both directly and through our network of partners.

We were incorporated as Glidesoft, Inc. in California in June 2004 and changed our name to Service-now.com in February 2006. In May 2012, we reincorporated in Delaware as ServiceNow, Inc.

Our Cloud Services
 
Now Platform

All of our products are built on a single platform, which is the foundation for all of our cloud-based services. Our platform allows our customers to create a single system of record for their systems and workflows, and it is the foundation of our ability to deliver specific enterprise applications and services. Our single system of record also allows customers to complement their other vertical applications and achieve various business objectives such as better data integrity, faster updates and better responsiveness to user needs. Among the most popular services that our platform supports are workflow automation, electronic service catalogs and portals, configuration management systems, data benchmarking, performance analytics, encryption and collaboration and development tools. Our platform also enables developers in IT and other departments across the enterprise to create, test and deploy their own applications within an integrated development environment while leveraging the single data model and common services of our platform.

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Information Technology (IT)

We have three product suites focused on meeting the challenges of enterprise IT management and operations. Our IT Service Management (ITSM) product suite defines, structures, consolidates, manages and automates IT services that are offered to an enterprise’s employees, customers and partners. Among its capabilities, our ITSM product suite records incidents, remediates problems and automates IT asset management. Our second product suite, IT Operations Management (ITOM), connects a customer's physical and cloud-based IT infrastructure with our applications and platform. It identifies a customer's IT infrastructure components (e.g., servers) and associated business services (e.g., email) which are dependent upon that infrastructure. It also maintains a single data record for all IT configurable items, which allows our customers to exercise control over their on-premises or cloud-based infrastructures and orchestrate key processes and tasks. Finally, our IT Business Management (ITBM) product suite enables customers to manage their IT priorities, including the scope and cost of IT projects, the development of software related to those projects and the overall management of the customer's IT project portfolio.

Customer Service

Our customer service management product defines, structures, consolidates, manages and automates customer service cases and requests. It allows common customer requests such as password resets to be automated with out-of-the-box self-service, and for other cases it routes work from the customer service agent to field service, engineering, operations, finance or legal personnel to resolve the underlying issues. Our field service management application allows field service agents to be effectively assigned, deployed and managed on the same underlying customer service management platform that created and managed the customer incident.

Human Resources (HR) Service Delivery

Our HR service delivery product defines, structures, consolidates, manages and automates HR services related to employee requests. HR service delivery capabilities include HR case management, employee self-service, knowledge management and management of employee lifecycle events such as onboarding, transfers and off-boarding.

Security Operations

Our security operations product defines, structures, consolidates, manages and automates security operations management requirements of third-party and other sources of security alerts from a customer's infrastructure. Security operations management capabilities include security incident management, threat enrichment intelligence, vulnerability response management and security incident intelligence sharing. Our governance, risk and compliance product defines, structures, consolidates, manages and automates cross-functional governance, risk and compliance workflows such as compliance controls and risk mitigation.

Professional Services
 
Our professional services include process design, implementation and configuration, and optimization services to help customers achieve their business objectives and derive value from their ServiceNow investment. We also offer strategic services to customers embarking on significant business transformations to reimagine their service management strategy and roadmap - from first insight to final implementation. Our network of partners also provides professional services and training to our customers.

We provide an expansive portfolio of training and certification programs for service management across IT, HR, customer service, and other departments. Flexible training options, plus topic- and role-based content, help engage our customers' employees, optimize business processes and enhance efficiency.

Customer Support

As part of their subscription, customers receive support 24 hours a day, seven days a week around the globe, from technical resources located in the United States and internationally. We also offer self-service technical support through our support portal, which provides access to documentation, knowledge base articles, online support forums and online incident filing.
 

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Our Technology and Operations

We designed our cloud-based services to support global enterprises. We operate a multi-instance architecture that provides each customer with its own dedicated application logic and database. This architecture is designed to deliver high-availability, scalability, performance, security and ease of upgrading. We have a standardized Java-based development environment, with the majority of our software written in industry-standard software programming languages. Our cloud infrastructure primarily consists of industry-standard servers and network components. Our operating system and databases are Linux, and MySQL and MariaDB.

Our data centers operate in paired configurations to enable replication for high-availability and redundancy. We operate data centers in Australia, Brazil, Canada, Hong Kong, the Netherlands, Singapore, Switzerland, the United Kingdom and the United States.

We offer customers the option to deploy our services on dedicated hardware in our data centers. Our architecture also gives us the added flexibility to deploy our services on-premises at a customer data center in order to support regulatory or security requirements, and a minority of our customers have elected to do so. The customer support we provide for on-premises customers is similar to the support we provide to customers deployed in our own managed data centers.

Sales and Marketing
 
We sell our services primarily through our global direct sales organization. Additionally, we sell our services indirectly through third-party channels by partnering with systems integrators, managed services providers and resale partners, particularly in less developed markets.

Our marketing efforts and lead generation activities consist primarily of customer referrals, Internet advertising (including via our website), trade shows, industry events and press releases. We also host our annual Knowledge user conference, webinars and other user forums where customers and partners both participate in and present on a variety of programs designed to help accelerate success with our services and platform.

We are continuing to expand our sales capabilities in new geographies, including through investments in direct and indirect sales channels, professional services capabilities, customer support resources and implementation partners. In addition to adding new geographies, we also plan to increase our investment in our existing locations in order to achieve scale efficiencies in our sales and marketing efforts.

Customers
 
We primarily sell our services to large enterprise customers. We host and support large enterprise-wide deployments for our customers. As of December 31, 2017, we had approximately 4,400 enterprise customers, including more than 40% of the Global 2000. Our customers operate in a wide variety of industries, including financial services, consumer products, IT services, health care, government, education and technology. No single customer accounted for more than 10% of our revenues for any of the periods presented.
 
Backlog

Backlog represents future unearned revenue amounts to be invoiced under our existing agreements that are not included in the deferred revenue on our consolidated balance sheets. As of December 31, 2017 and 2016, we had backlog of approximately $2.6 billion and $1.9 billion, respectively. We expect backlog to fluctuate from period to period due to a number of factors, including the timing and duration of customer subscription and professional services agreements, variations in the billing cycle of subscription agreements, the timing of customer renewals and foreign exchange rate fluctuations.

Financial Information about Segments and Geographic Areas

We manage our operations and allocate resources as a single organizational entity, and therefore we manage, monitor and report our financials as a single reporting segment. For information regarding our revenue, revenue by geographic area and long-lived assets by geographic area, please refer to Note 2 and Note 17 in the notes to our consolidated financial statements included elsewhere in this Annual Report on Form 10-K. For financial information about our segment, please refer to the section entitled “Management's Discussion and Analysis of Financial Condition and Results of Operations” in Item 7 of Part II and to our consolidated financial statements and the related notes thereto included elsewhere in this Annual Report on Form 10-K. For information regarding risks associated with our international operations, please refer to the section entitled “Risk Factors” in Item 1A of Part I in this Annual Report on Form 10-K.

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Research and Development
 
Our research and development organization is responsible for the design, development, testing and certification of our solutions. We focus on developing new services and core technologies and further enhancing the functionality, reliability and performance of our existing solutions. We focus our efforts on anticipating customer demand and then bringing new services and new versions of existing services to market quickly in order to remain competitive in the marketplace. We have made, and will continue to make, significant investments in research and development to strengthen our existing applications, expand the number of applications on our platform, enhance our user experience, and develop additional mobile, automation and machine intelligence technologies. Total research and development expense was $377.5 million, $285.2 million and $217.4 million for the years ended December 31, 2017, 2016 and 2015, respectively.

Acquisitions and Investments
 
In addition to continuing to invest in our own research and development efforts, we have made acquisitions and investments in the past and will continue to assess opportunities for strategic acquisitions and investments to complement our technology and skill sets and expand our product reach. We are focused on building out the core capabilities of our platform through both acquisitions and investments that will satisfy growing customer needs.

Competition
 
The markets for our solutions generally are rapidly evolving and highly competitive, with relatively low barriers to entry. As the markets in which we operate continue to mature, we expect competition to intensify. We compete primarily with large, well-established, enterprise application software vendors, in-house solutions, large integrated systems vendors, established and emerging cloud vendors and vendors of products and services for development operations. Many prospective customers have invested substantial personnel and financial resources to implement and integrate their current enterprise software into their businesses and therefore may be reluctant or unwilling to migrate away from their current solution to an enterprise cloud solution. Accordingly, we compete with both enterprise application software vendors that provide on-premises software and with vendors providing cloud-based services. Our competitors vary in size and in the breadth and scope of the products and services offered. As we continue to expand the breadth of our services to include offerings for service domains outside of IT, we expect increasing competition from platform and application development vendors focused on these other markets.

Various factors influence purchase decisions in our industry, including total cost of ownership, level of customer satisfaction, breadth and depth of product functionality, security, adherence to industry standards, brand awareness, flexibility and performance. We believe that we compete favorably with our competitors on each of these factors. However, many of our competitors have substantially greater financial, technical and other resources and may be able to respond more quickly and effectively than we can to new or changing opportunities, technologies, standards and customer requirements. An existing competitor or new entrant could introduce new technology that reduces demand for our services. In addition, some of our competitors offer their products or services at a lower price, which has resulted in pricing pressures. Some of our larger competitors also have the operating flexibility to bundle competing products and services with other software offerings, which may enable them to offer such products and services at a lower price as part of a larger sale. As competition intensifies, we expect pricing competition to continue or increase.

Intellectual Property
 
We rely upon a combination of copyright, trade secret, patent and trademark laws in the United States and other jurisdictions as well as confidentiality procedures and contractual restrictions, such as confidentiality and license agreements, to establish, protect and grow our intellectual property (IP) rights. We also enter into confidentiality and proprietary rights agreements with our employees, partners, vendors, consultants and other third parties and control access to our IP and other proprietary information. We also purchase or license technology that we incorporate into our products or services.

We continue to grow our patent portfolio and IP rights around the world that relate to our platform, applications, services, research and development and other activities, and our success depends in part upon our ability to protect our core technology and IP. We have over 350 U.S. and foreign patents, including patents acquired from third parties, and over 250 pending patent applications. We do not believe that our proprietary technology is dependent on any single patent or other IP right or groups of related patents or IP rights. We file patent applications to protect our IP and have in the past and may in the future acquire additional patents, patent portfolios, or patent applications. However, we cannot be certain that any of our patent applications will result in the issuance of a patent or whether the examination process will result in patents of value or applicability. In addition, any patents that have been or may be issued or acquired may be contested, circumvented, found unenforceable or invalidated, and we may not be able to prevent third parties from infringing them.

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Despite our efforts to protect our proprietary rights, unauthorized parties may attempt to copy or obtain and use our technology to develop products and services that provide features and functionality that are similar to our solutions. Policing unauthorized use of our technology is difficult. The laws of the countries in which we market our services may offer little or no effective protection of our proprietary technology. Our competitors could also independently develop services equivalent to ours, and our intellectual property rights may not be broad enough for us to prevent competitors from doing so. Reverse engineering, unauthorized copying or other misappropriation of our proprietary technology could enable third parties to benefit from our technology without paying us for it, which would significantly harm our business.

Our industry is characterized by frequent claims and related litigation regarding patent and other intellectual property rights. From time to time, third parties may assert patent, copyright, trademark and other intellectual property rights against us, our channel partners or our customers. In addition, based on our greater visibility, expanding solutions footprint, and market exposure as a public company, we face a higher risk of being the subject of intellectual property infringement claims from third parties. For example, in 2016 we settled two patent-related litigation matters and recorded a one-time charge of $270.0 million related to aggregate legal settlements. See “Risk Factors–Claims by others that we infringe their proprietary technology or other rights could harm our business” for additional information.

Employees
 
As of December 31, 2017, we had 6,222 full-time employees worldwide, including 1,498 in cloud operations, professional services, training and customer support, 2,413 in sales and marketing, 1,419 in research and development and 892 in general and administrative roles. None of our U.S. employees is represented by a labor union with respect to his or her employment. Employees in certain European countries are represented by workers' councils and also have the benefits of collective bargaining arrangements at the national level. We consider our relations with our employees to be very good and have not experienced interruptions of operations or work stoppages due to labor disagreements.

Available Information

You can obtain copies of our Annual Report on Form 10-K, Quarterly Reports on Form 10-Q, Current Reports on Form 8-K, and other filings with the SEC, and all amendments to these filings, free of charge from our website at www.servicenow.com as soon as reasonably practicable following our filing of any of these reports with the SEC. The public may read and copy any materials we have filed with the SEC at the SEC’s Public Reference Room at 100 F Street, NE, Room 1580, Washington, DC 20549. The public may obtain information on the operation of the Public Reference Room by calling the SEC at 1-800-SEC-0330. The SEC maintains an Internet site that contains reports, proxy and information statements and other information regarding issuers that file electronically with the SEC at www.sec.gov. The contents of these websites are not incorporated into this filing and our references to the URLs for these websites are intended to be inactive textual references only.


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ITEM 1A.
RISK FACTORS



Investing in our securities involves a high degree of risk. You should consider carefully the risks and uncertainties described below, together with all of the other information in this Annual Report on Form 10-K, including our consolidated financial statements and related notes, before making an investment decision. We have identified the following risks and uncertainties that may have a material adverse effect on our business, financial condition, results of operations and future prospects. Our business could be harmed by any of these risks. The trading price of our common stock could decline due to any of these risks, and you may lose all or part of your investment.

Risks Related to Our Business and Industry

We expect our revenue growth rate to continue to decline, and we may continue to incur losses in accordance with U.S. Generally Accepted Accounting Principles (GAAP).

We have experienced significant revenue growth in prior periods; however, our revenue growth rate is declining, and we expect that it will continue to decline into the foreseeable future. We also expect our costs to increase in future periods as we continue to invest in our capacity to support anticipated growth. These investments may not result in increased revenues or growth in our business. Even if our revenues continue to increase, we expect to continue to incur a loss in accordance with GAAP during future periods due to increased costs such as non-cash charges associated with equity awards, business combinations and other expenses. Additionally, we may encounter unforeseen operating expenses, difficulties, complications, delays and other unforeseen or unpredictable factors that may result in increased costs. Furthermore, it is difficult to predict the size and growth rate of our market, customer demand for our products, customer adoption and renewal rates, and the entry of competitive products or the success of existing competitive products. As a result of these and other factors, we may not achieve or maintain profitability in the future, our gross margins may be negatively impacted, and our ability to generate cash flow from operations may be negatively impacted. If we fail to increase our revenues sufficiently to keep pace with our growing investments and other expenses, our business, operating results and growth prospects will be adversely affected.

If we suffer a cyber-security event, we may lose customers and incur significant liabilities, any of which would harm our business and operating results.

Our operations involve the storage, transmission and processing of our customers’ confidential, proprietary and sensitive information, including personally identifiable information, protected health information and credit card and other financial information. While we have security measures in place designed to protect customer information and prevent data loss, these measures may be breached as a result of third-party actions, including intentional misconduct by computer hackers, employee error, malfeasance or otherwise, and result in someone obtaining unauthorized access to our customers’ data or our data, including our intellectual property and other confidential business information. Moreover, computer malware, viruses and hacking, phishing and denial of service attacks by third parties have become more prevalent in our industry, and have occurred on our systems in the past and may occur on our systems in the future. Because techniques used to obtain unauthorized access to or sabotage systems change frequently and generally are not recognized until successfully launched against a target, we may be unable to anticipate these techniques or to implement adequate preventative measures. As cyber-security threats develop and evolve, it may be necessary to make significant further investments to protect data and infrastructure. A security breach or unauthorized access or loss of data could result in a disruption to our service, litigation, the triggering of indemnification and other contractual obligations, regulatory investigations, government fines and penalties, reputational damage, loss of sales and customers, mitigation and remediation expenses and other liabilities. We do not have insurance sufficient to compensate us for the potentially significant losses that may result from security breaches.


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If we do not accurately predict, prepare for, and respond promptly to rapidly evolving technological and market developments, our competitive position and business prospects may be harmed.

The markets in which we compete have evolved rapidly, and the pace of innovation will continue to accelerate, as cloud, mobile, workflow, consumer product-like user experiences, social, collaboration, machine learning, artificial intelligence, internet connected devices, robotic automation, security, cryptography, development tools and other digital technologies increasingly become the basis for customer purchases. At the same time, our customers and prospective customers are facing their own competitive imperatives to adopt digital technologies, resulting in the ongoing disruption of almost every sector of the global economy. Accordingly, to compete effectively in our rapidly changing markets, we must: identify and innovate in the right emerging technologies among the many in which we could make investments knowing that we cannot make substantial investments in all of them; accurately predict our customers’ changing business needs; successfully deliver new platform technologies and products that meet these business needs; efficiently integrate with other technologies within our customers’ digital environments; profitably market and sell new products in markets where our sales and marketing teams have less experience; and effectively deliver, either directly or through our ecosystem of partners, the business process planning, IT systems architecture planning, and product implementation services that our customers require to be successful. If we fail to meet any of these requirements, our competitive position and business prospects may be harmed.

Delays in the release of, or actual or perceived defects in, new or updated products may slow the adoption of our most recent technologies, reduce our ability to efficiently provide our services, decrease customer satisfaction, increase our vulnerability to cyber attacks, and adversely impact sales of additional products to our customers.

We must successfully continue to release new products and updates to existing products. The success of any release depends on a number of factors, including our ability to manage the risks associated with quality or other defects or deficiencies, delays in the timing of releases, and other complications that may arise during the early stages of introduction. If releases are delayed or if customers perceive that our releases contain bugs or other defects, customer adoption of our new products or updates may be adversely impacted, customer satisfaction may decrease, our ability to efficiently provide our services may be reduced, and our growth prospects may be harmed.

Various factors, including our customers’ business, integration, migration and security requirements, or errors by us or our partners, may cause implementations of our products to be delayed, inefficient or otherwise unsuccessful.

Our business depends upon the successful implementation of our products by our customers. Increasingly, we, as well as our customers, rely on our network of partners to deliver implementation services, and there may not be enough qualified implementation partners available to meet customer demand. Further, various factors, including our customers’ business, integration, migration and security requirements, or errors by us or our partners, may cause implementations to be delayed, inefficient or otherwise unsuccessful. For example, changes in the functional requirements of our customers, delays in timeline, or deviation from recommended best practices may occur during the course of an implementation project. As a result of these and other risks, we or our customers may incur significant implementation costs in connection with the purchase and implementation of our products. Some customer implementations may take longer than planned or fail to meet our customers’ expectations, which may delay our ability to upsell additional products or result in customers canceling or failing to renew their subscriptions before our products have been fully implemented. Unsuccessful, lengthy, or costly customer implementation and integration projects could result in claims from customers, harm to our reputation, and opportunities for competitors to displace our products, each of which could have an adverse effect on our business and operating results.


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Disruptions or defects in our services could damage our customers’ businesses, subject us to substantial liability and harm our reputation and financial results.

From time to time, we experience defects in our services, and new defects may be detected in the future. For example, we provide regular updates to our services, which frequently contain undetected defects when first introduced or released. Defects may also be introduced by our use of third-party software, including open source software. Disruptions may result from errors we make in delivering, configuring or hosting our services, or designing, installing, expanding or maintaining our cloud infrastructure. Disruptions in service can also result from incidents that are outside of our control, including denial of service attacks. We currently serve our customers primarily using equipment managed by us and co-located in third-party data center facilities operated by several different providers located around the world. These centers are vulnerable to damage or interruption from earthquakes, floods, fires, power loss and similar events. They may also be subject to break-ins, sabotage, intentional acts of vandalism and similar misconduct, equipment failure and adverse events caused by operator error. Despite precautions taken at these facilities, problems at these facilities could result in lengthy interruptions in our services and the loss of customer data. In addition, our customers may use our services in ways that cause disruptions in service for other customers. Our customers use our services to manage important aspects of their own businesses, and our reputation and business will be adversely affected if our customers and potential customers believe our services are unreliable. Disruptions or defects in our services may reduce our revenues, cause us to issue credits or pay penalties, subject us to claims and litigation, cause our customers to delay payment or terminate or fail to renew their subscriptions, and adversely affect our ability to attract new customers. The occurrence of payment delays, or service credit, warranty, termination for material breach or other claims against us, could result in an increase in our bad debt expense, an increase in collection cycles for accounts receivable, an increase to our service level credit accruals or other increased expenses or risks of litigation. We do not have insurance sufficient to compensate us for the potentially significant losses that may result from claims arising from disruptions in our services.

Our operating results may vary significantly from period to period, and if we fail to meet the financial performance expectations of investors or securities analysts, the price of our common stock could decline substantially.

Our operating results may vary significantly from period to period as a result of various factors, some of which are beyond our control. For any quarterly or annual period, there is a risk that our financial performance will not meet the financial guidance we have previously given for that period, or that we may otherwise fail to meet the financial performance expectations of the securities analysts who issue reports on our company and our common stock price, or of investors in our common stock. There is also a risk that we may issue forward-looking financial guidance for a quarterly or annual period that fails to meet the expectations of such securities analysts or investors. If any of the foregoing occurs, for any reason either within or outside of our control, the price of our common stock could decline substantially and investors in our common stock could incur substantial losses. Some of the important factors that may cause our revenues, operating results and cash flows to vary widely, or cause our forward-looking financial guidance, to fall below the expectations of such securities analysts or investors, include:

our ability to attract new customers, retain and increase sales to existing customers, and satisfy our customers’ requirements;
changes in our mix of products and services;
changes in foreign currency exchange rates and our ability to effectively hedge our foreign currency exposure;
the rate of expansion and productivity of our sales force;
the number of new employees added;
the cost, timing and management effort for our development of new products and services;
general economic conditions that may adversely affect either our customers’ ability or willingness to purchase additional subscriptions, delay a prospective customer’s purchasing decision, reduce the value of new subscription contracts or adversely affect renewal rates;
the amount and timing of operating costs and capital expenditures related to the operation and expansion of our business;
seasonality in terms of when we enter into customer agreements for our services;
the length of the sales cycle for our services;
changes to our management team;
changes in our pricing policies, whether initiated by us or as a result of competition;
significant security breaches, technical difficulties or interruptions of our services;
new solutions, products or changes in pricing policies introduced by our competitors;
changes in effective tax rates;
changes in the average contract term of our customer agreements, changes in timing of renewals and changes in billings duration;
changes in our renewal and upsell rates;
the timing of customer payments and payment defaults by customers;
extraordinary expenses such as litigation costs or damages, including settlement payments;

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the costs associated with acquiring new businesses and technologies and the follow-on costs of integration, including the tax effects of acquisitions;
the impact of new accounting pronouncements, including the new revenue recognition standards that were effective for us beginning January 1, 2018;
changes in laws or regulations impacting the delivery of our services;
our ability to comply with privacy laws and regulations, including the General Data Protection Regulation (GDPR);
the amount and timing of equity awards and the related financial statement expenses; and
our ability to accurately estimate the total addressable market for our products and services.

Changes in our effective tax rate could impact our financial results.

We are subject to income taxes in the United States and various foreign jurisdictions. We believe that our provision for income taxes is reasonable, but the ultimate tax outcome may differ from the amounts recorded in our financial statements and may materially affect our financial results in the period or periods in which such outcome is determined. Our effective tax rate could be adversely affected by changes in the mix of earnings and losses in countries with differing statutory tax rates, certain non-deductible expenses, the valuation of deferred tax assets and liabilities and the effects of acquisitions. Increases in our effective tax rate would reduce our profitability or in some cases increase our losses.

Additionally, our future effective tax rate could be impacted by changes in accounting principles or changes in U.S. federal, state or international tax laws or tax rulings. The U.S. recently enacted significant tax reform, and certain provisions of the new law may adversely affect us. Many countries and organizations such as the Organization for Economic Cooperation and Development are actively considering changes to existing tax laws or have proposed or enacted new laws that could increase our tax obligations in countries where we do business or cause us to change the way we operate our business. Any changes in federal, state or international tax laws or tax rulings may increase our worldwide effective tax rate and harm our financial position and results of operations.

In addition, we may be subject to income tax audits by tax jurisdictions throughout the world, many of which have not established clear guidance on the tax treatment of cloud computing companies. Although we believe our income tax liabilities are reasonably estimated and accounted for in accordance with applicable laws and principles, an adverse resolution of one or more uncertain tax positions in any period could have a material impact on the results of operations for that period.

Uncertainties in the interpretation and application of the 2017 Tax Cuts and Jobs Act could materially affect our tax obligations and effective tax rate.

The 2017 Tax Cuts and Jobs Act (the Tax Act) was enacted on December 22, 2017, and significantly changes how the U.S. imposes income tax on multinational corporations. The U.S. Department of Treasury has broad authority to issue regulations and interpretative guidance that may significantly impact how we will apply the law and affect our results of operations in the period issued.

The Tax Act requires complex computations not previously provided in U.S. tax law. As such, the application of accounting guidance for such items is currently uncertain. Further, compliance with the Tax Act and the accounting for such provisions require accumulation of information not previously required or regularly produced. As a result, we have provided a provisional estimate on the effect of the Tax Act in our financial statements. As additional regulatory guidance is issued by the applicable taxing authorities, accounting treatment is clarified, we perform additional analysis on the application of the law, and we refine estimates in calculating the impact, our final analysis, which will be recorded in the period completed, may be different from our current provisional amounts, which could materially affect our tax obligations and effective tax rate.


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Our financial results may be adversely affected by changes in accounting principles applicable to us.

We prepare our financial statements in accordance with GAAP, which are subject to interpretation or changes by the Financial Accounting Standards Board (FASB), the SEC and other bodies formed to promulgate and interpret appropriate accounting principles. New accounting pronouncements and changes in accounting principles have occurred in the past and are expected to occur in the future, which may have a significant effect on our financial results. For example, in May 2014, the FASB issued Accounting Standards Update (ASU) 2014-09, “Revenue from Contracts with Customers (Topic 606),” which supersedes nearly all existing revenue recognition guidance under GAAP. 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. This new standard is effective for our interim and annual periods beginning January 1, 2018, and we expect this new standard to have a material impact on the timing of revenue and expense recognition for our contracts related to on-premises offerings and on our deferred commissions asset and the related amortization expense. Refer to Note 2 in the notes to our consolidated financial statements included elsewhere in this Annual Report on Form 10-K for additional information on the new guidance and its impact on us. Adoption of this standard and any difficulties in implementation of changes in accounting principles, including the ability to modify our accounting systems and internal controls, could cause us to fail to meet our financial reporting obligations, which could result in regulatory discipline and harm investors’ confidence in us.

Foreign currency exchange rate fluctuations could harm our financial results.

We conduct significant transactions, including revenue transactions and intercompany transactions, in currencies other than the U.S. Dollar or the functional operating currency of the transactional entities. In addition, our international subsidiaries maintain significant net assets that are denominated in currencies other than the functional operating currencies of these entities. Accordingly, changes in the value of currencies relative to the U.S. Dollar may impact our consolidated revenues and operating results due to transactional and translational remeasurement that is reflected in our earnings. It is particularly difficult to forecast any impact from exchange rate movements, so there is risk that unanticipated currency fluctuations could adversely affect our financial results or cause our results to differ from investor expectations or our own guidance in any future periods. In addition, the June 23, 2016 referendum by British voters to exit the European Union adversely impacted global markets, including currencies, and resulted in a decline in the value of the British pound, as compared to the U.S. Dollar and other currencies. Volatility in exchange rates and global financial markets may continue due to a number of factors, including the continued negotiation of the United Kingdom's exit from the European Union and the recent political and economic uncertainty globally.

While we have not engaged in the hedging of our foreign currency transactions to date, in 2018 we expect to begin using derivative instruments, such as foreign currency forwards, swaps and option contracts, to hedge certain exposures to fluctuations in foreign currency exchange rates. These hedging contracts may reduce, but cannot entirely eliminate, the impact of adverse currency exchange rate movements. Further, unanticipated changes in currency exchange rates may result in poorer overall investment performance than if we had not engaged in any such hedging transactions. In addition, the degree of correlation between price movements of the instruments used in a hedging strategy and price movements in the portfolio positions being hedged may vary. Moreover, for a number of reasons, including our limited experience with these hedging contracts, we may not seek or be able to establish a perfect or effective correlation between such hedging instruments and the portfolio holdings being hedged. Any such imperfect correlation may prevent us from achieving the intended hedge and expose us to risk of loss.


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The markets in which we participate are intensely competitive, and if we do not compete effectively our business and operating results will be adversely affected.

The markets for our enterprise cloud solutions are rapidly evolving and highly competitive, with relatively low barriers to entry. As the market for service management matures, we expect competition to intensify. We compete primarily with large, well-established, enterprise application software vendors, in-house solutions, large integrated systems vendors, established and emerging cloud vendors and vendors of products and services for development operations. Many prospective customers have invested substantial personnel and financial resources to implement and integrate their current enterprise software into their businesses and therefore may be reluctant or unwilling to migrate away from their current solution to our enterprise cloud solutions. Many of our competitors and potential competitors are larger, have greater name recognition, longer operating histories, more established customer relationships, larger marketing budgets and greater resources than we do. Further, other potential competitors not currently offering competitive products may expand their services to compete with our services. We have expanded the breadth of our services to include offerings in the markets for IT operations management, customer service management, security operations management, HR service delivery and use of our platform by developers of custom applications. As a result, we expect increasing competition from platform vendors and from application development vendors focused on these other markets. Our competitors may be able to respond more quickly and effectively than we can to new or changing opportunities, technologies, standards and customer requirements. In addition, some of our competitors offer their products or services at a lower price, which has resulted in pricing pressures. Larger competitors with more diverse product and service offerings may reduce the price of products or subscriptions that compete with ours or may bundle them with other products and subscriptions. We expect that smaller competitors and new entrants may accelerate pricing pressures, including in the IT service management market, which is our more mature offering and from which we derive the substantial majority of our revenues. For all of these reasons, we may not be able to compete successfully and competition could result in reduced sales, reduced margins, losses or the failure of our solutions to achieve or maintain market acceptance, any of which could harm our business.

Lawsuits against us by third-parties that allege we infringe their intellectual property rights could harm our business and operating results.

There is considerable patent and other intellectual property development activity in our industry. Many companies in our industry, including our competitors and other third parties, as well as non-practicing entities, own large numbers of patents, copyrights, trademarks and trade secrets, which they may use to assert claims of patent infringement, misappropriation or other violations of intellectual property rights against us.

Moreover, the patent portfolios of most of our competitors are larger than ours. This disparity may increase the risk that our competitors may sue us for patent infringement and may limit our ability to counterclaim for patent infringement or settle through patent cross-licenses. From time to time, our competitors or other third parties, including patent holding companies seeking to monetize patents they have purchased or otherwise obtained, may claim that we are infringing upon their intellectual property rights. For example, we recorded charges for aggregate legal settlements of $270.0 million in our consolidated statement of comprehensive loss during the year ended December 31, 2016. The charge covers the fulfillment by us of all financial obligations under settlement agreements with BMC and HPE, with no remaining financial obligations under either settlement.

In any intellectual property litigation, regardless of the scope or merits of the claims at issue, we may incur substantial attorney’s fees and other litigation expenses and, if the claims are successfully asserted against us and we are found to be infringing upon the intellectual property rights of others, we could be required to: pay substantial damages and make substantial ongoing royalty payments; cease offering our products and services; modify our products and services; comply with other unfavorable terms, including settlement terms; and indemnify our customers and business partners and obtain costly licenses on their behalf and refund fees or other payments previously paid to us. Further, upon expiration of the term of any third-party agreements that allow us to use their intellectual property, we may be unable to renew such agreements on favorable terms, if at all, in which case we may face intellectual property litigation. The mere existence of any lawsuit, or any interim or final outcomes, and the course of its conduct and the public statements related to it (or absence of such statements) by the courts, press, analysts and litigants, could be unsettling to our customers and prospective customers and could cause an adverse impact to our customer satisfaction and related renewal rates and cause us to lose potential sales, and could also be unsettling to investors or prospective investors in our common stock and could cause a substantial decline in the price of our common stock. Accordingly, any claim or litigation against us could be costly, time-consuming and divert the attention of our management and key personnel from our business operations and harm our financial condition and operating results.


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Our intellectual property protections may not provide us with a competitive advantage, and defending our intellectual property may result in substantial expenses that harm our operating results.

Our success depends to a significant degree on our ability to protect our proprietary technology and our brand under a combination of patent and other intellectual property laws of the United States and other jurisdictions. Though we seek patent protection for our technology, we may not be successful in obtaining patent protection, and any patents acquired in the future may not provide us with competitive advantages, or may be successfully challenged by third parties. Furthermore, legal standards relating to the validity, enforceability and scope of protection of intellectual property rights are uncertain. Any of our intellectual property rights may be challenged by others or invalidated through administrative process or litigation. Effective patent, trademark, copyright and trade secret protection may not be available to us in every country in which our services are available. The laws of some foreign countries may not be as protective of intellectual property rights as those in the United States, and mechanisms for enforcement of intellectual property rights may be inadequate. We may be required to spend significant resources to monitor and protect our intellectual property rights. We have, and in the future may, initiate claims or litigation against third parties for infringement of our proprietary rights or to establish the validity of our proprietary rights. Any litigation, whether or not it is resolved in our favor, could result in significant expense to us, divert the efforts of our technical and management personnel and may result in counter-claims with respect to infringement of intellectual property rights by us. If we are unable to prevent third parties from infringing upon or misappropriating our intellectual property, or are required to incur substantial expenses in defending our intellectual property rights, our business and operating results may be adversely affected.

If we are unsuccessful in increasing our penetration of international markets or managing the risks associated with foreign markets, our business and operating results will be adversely affected.

Sales outside of North America represented approximately 33% and 32% of our total revenues for each of the years ended December 31, 2017 and 2016, respectively. Our business and future prospects depend on increasing our international sales as a percentage of our total revenues, and the failure to grow internationally will harm our business. Additionally, operating in international markets requires significant investment and management attention and will subject us to regulatory and economic risks that are different from those in the United States. We have made, and will continue to make, substantial investments in data centers and cloud computing infrastructure, sales, marketing, personnel and facilities as we enter and expand in new geographic markets. When we make these investments, it is typically unclear whether, and when, sales in the new market will justify our investments, and we may significantly underestimate the level of investment and time required to be successful, or whether we will be successful. Our rate of acquisition of new Global 2000 customers, a key factor effecting our growth, has generally been lower in Africa, Asia, Eastern Europe, South America and other markets in which we are less established, as compared to North America, Australia and areas within Western Europe. Over time an increasing proportion of the Global 2000 companies that are not yet our customers are located in emerging markets where we are less established. We have experienced, and may continue to experience, difficulties in some of our investments in geographic expansion, including in hiring qualified sales management personnel and managing foreign operations.

Risks inherent with international sales include without limitation:

compliance with multiple, conflicting and changing governmental laws and regulations, including employment, tax, competition, privacy and data protection laws and regulations;
compliance by us and our business partners with international bribery and anti-corruption laws, including the UK Bribery Act and the Foreign Corrupt Practices Act;
the risk that illegal or unethical activities of our business partners will be attributed to or result in liability to us;
longer and potentially more complex sales cycles;
longer accounts receivable payment cycles and other collection difficulties;
tax treatment of revenues from international sources and changes to tax codes, including being subject to foreign tax laws and being liable for paying withholding, income or other taxes in foreign jurisdictions;
different pricing and distribution environments;
foreign currency fluctuations which may cause transactional and translational remeasurement losses;
potential changes in international trade policies and agreements;
local business practices and cultural norms that may favor local competitors; and
localization of our services, including translation into foreign languages and associated expenses.

If we are unable to manage these risks, if our required investments in these international markets are greater than anticipated, or if we are unsuccessful in increasing sales in emerging markets, our revenue growth rate, business and operating results will be adversely affected.


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If we lose key employees or are unable to attract and retain the employees we need, our business and operating results will be adversely affected.

Our success depends largely upon the continued services of our management team, including our Chief Executive Officer, and many key individual contributors. From time to time, there may be changes in our management team resulting from the hiring or departure of executives. For example, in 2017, Frank Slootman stepped down as our President and Chief Executive Officer, and John J. Donahoe was appointed as his successor. Such changes may result in a loss of institutional knowledge and cause disruptions to our business.

In the technology industry, there is substantial and continuous competition for engineers with high levels of experience in designing, developing and managing software and Internet-related solutions, as well as competition for sales executives and operations personnel. We may not be successful in attracting and retaining qualified personnel. We have from time to time experienced, and we may continue to experience, difficulty in hiring and retaining highly skilled employees with appropriate qualifications, and may not be able to fill positions in desired geographic areas or at all. In particular, competition for experienced software and cloud computing infrastructure engineers in the San Francisco Bay area, San Diego, Seattle, London and Amsterdam, our primary operating locations, is intense. Our employees, including our executive officers, are employed by us on an “at-will” basis, which means they may terminate their employment with us at any time. If we fail to attract new personnel or fail to retain and motivate our current personnel, our business and future growth prospects could be adversely affected.

Privacy laws and concerns, evolving regulation of cloud computing, cross-border data transfer restrictions, other foreign and domestic regulations and standards related to personal data and the Internet may adversely affect our business.

National and local governments or agencies have in the past adopted, and may in the future adopt, laws and regulations affecting data privacy, the use of the Internet as a commercial medium, and data sovereignty requirements concerning the location of data centers that store and process data. Changing laws, regulations and standards applying to the collection, transfer, processing, storage or use of personal data could affect our customers’ ability to use and share data, potentially restricting our ability to store, process and share data with our customers in connection with providing our services, and in some cases, could impact our ability to offer our services in certain locations or our customers’ ability to deploy our services globally. For example, the European Union (EU) and United States agreed to a framework to facilitate the transfer of data from the EU to the United States, called Privacy Shield, but this new framework has been challenged by private parties and may face additional challenges by national regulators or private parties. Additionally, in 2016 the EU adopted a new regulation governing data privacy called the General Data Protection Regulation (GDPR), which takes effect in May 2018. Further, laws such as the EU’s proposed e-Privacy Regulation are increasingly aimed at the use of personal information for marketing purposes, and the tracking of individuals’ online activities.
 
The costs of compliance with, and other burdens imposed by, GDPR, the e-Privacy Regulation and other privacy laws, regulations and standards may cause us to incur substantial operational costs or require us to modify our data handling practices, may limit the use and adoption of our services and reduce overall demand for our services. In addition, non-compliance could result in proceedings against us by governmental entities or others, significant fines, and may otherwise adversely impact our business, financial condition and operating results.

In addition to government activity, privacy advocacy groups and the technology and other industries have established or may establish various new, additional or different self-regulatory standards that may place additional burdens on us. Our customers may expect us to meet voluntary certifications or adhere to other standards established by third parties. If we are unable to maintain these certifications or meet these standards, it could reduce demand for our applications and adversely affect our business.

Because we generally recognize revenues from our subscription service over the subscription term, a decrease in new or renewed subscriptions during a reporting period may not be immediately reflected in our operating results for that period.

We generally recognize revenues from customers ratably over the terms of their subscriptions. As a result, most of the revenues we report in each period are derived from the recognition of deferred revenues relating to subscriptions entered into during previous periods. Consequently, a decrease in new or renewed subscriptions in any single reporting period will have a limited impact on our revenues for that period. In addition, our ability to adjust our cost structure in the event of a decrease in new or renewed subscriptions may be limited.


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Further, a decline in new or renewed subscriptions in a given period will negatively affect our revenues in future periods. Accordingly, the effect of significant downturns in sales and market acceptance of our services, and changes in our rate of renewals, may not be fully reflected in our results of operations until future periods. Our subscription model also makes it difficult for us to rapidly increase our revenues through additional sales in any period, as revenues from new customers are generally recognized over the applicable subscription term. Additionally, due to the complexity of certain of our customer contracts, the actual revenue recognition treatment required under Topic 606 will depend on contract-specific terms and may result in greater variability in revenues from period to period.

A decrease in new or renewed subscriptions in a reporting period may not be immediately reflected in our billings results for that period due to factors that may offset the decrease.

A decrease in new or renewed subscriptions in a reporting period may not have an immediate impact on billings for that period due to factors that may offset the decrease, such as an increase in billings duration, the dollar value of contracts with future start dates, or the dollar value of collections in the current period related to contracts with future start dates.

As we acquire or invest in companies and technologies, we may not realize the expected business or financial benefits and the acquisitions and investments may divert our management’s attention and result in additional dilution to our stockholders.

We have acquired or invested in companies and technologies in the past as part of our business strategy and may continue to evaluate potential strategic transactions, including acquisitions of, or investments in, businesses, technologies, services, products and other assets in the future. We also may enter into relationships with other businesses to expand our service offerings, functionality or our ability to provide services in international locations, which could involve preferred or exclusive licenses, additional channels of distribution, discount pricing or investments in other companies. Acquisitions and investments involve numerous risks, including:

assimilating or integrating the businesses, technologies, products, personnel or operations of the acquired companies;
failing to achieve the expected benefits of the acquisition or investment;
potential loss of key employees of the acquired company;
inability to maintain relationships with customers and partners of the acquired business;
unanticipated expenses related to acquired technology and its integration into our existing technology;
potential adverse tax consequences;
inability to generate sufficient revenue to offset acquisition or investment costs;
disruption to our business and diversion of management attention and other resources;
potential financial and credit risks associated with acquired customers;
dependence on acquired technologies or licenses for which alternatives may not be available to us without significant cost or complexity;
in the case of foreign acquisitions, the challenges associated with integrating operations across different cultures and languages and any currency and regulatory risks associated with specific countries; and
potential unknown liabilities associated with the acquired businesses.

In addition, we may have to pay cash, incur debt, or issue equity or equity-linked securities to pay for any future acquisitions, each of which could adversely affect our financial condition or the market price of our common stock. Furthermore, if we finance acquisitions by issuing equity or convertible or other debt securities or loans, our existing stockholders may be diluted, or we could face constraints related to the terms of and repayment obligation related to the incurrence of indebtedness that could affect the market price of our common stock. The occurrence of any of these risks could harm our business, operating results and financial condition.


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A portion of our revenues are generated by sales to government entities and heavily regulated organizations, which are subject to a number of challenges and risks.

A portion of our sales are to governmental agencies. Additionally, many of our current and prospective customers, such as those in the financial services and health care industries, are highly regulated and may be required to comply with more stringent regulations in connection with subscribing to and implementing our services. Selling to these entities can be highly competitive, expensive and time consuming, often requiring significant upfront time and expense without any assurance that we will successfully complete a sale. Furthermore, engaging in sales activities to foreign governments introduces additional compliance risks specific to the Foreign Corrupt Practices Act, the UK Bribery Act and other similar statutory requirements prohibiting bribery and corruption in the jurisdictions in which we operate. Government and highly regulated entities often require contract terms that differ from our standard arrangements and impose compliance requirements that are complicated, require preferential pricing or “most favored nation” terms and conditions, or are otherwise time consuming and expensive to satisfy. If we undertake to meet special standards or requirements and do not meet them, we could be subject to increased liability from our customers or regulators. Even if we do meet them, the additional costs associated with providing our services to government and highly regulated customers could harm our margins. Moreover, changes in the underlying regulatory conditions that affect these types of customers could harm our ability to efficiently provide our services to them and to grow or maintain our customer base.

Our use of open source software could harm our ability to sell our services and subject us to possible litigation.

Our products incorporate software licensed to us by third-party authors under open source licenses, and we may continue to incorporate open source software into other services in the future. We attempt to monitor our use of open source software in an effort to avoid subjecting our services to adverse licensing conditions. However, there can be no assurance that our efforts have been or will be successful. There is little or no legal precedent governing the interpretation of the terms of open source licenses, and therefore the potential impact of these terms on our business is uncertain and enforcement of these terms may result in unanticipated obligations regarding our services and technologies. For example, depending on which open source license governs open source software included within our services or technologies, we may be subjected to conditions requiring us to offer our services to users at no cost; make available the source code for modifications and derivative works based upon, incorporating or using the open source software; and license such modifications or derivative works under the terms of the particular open source license. Moreover, if an author or other third party that distributes such open source software were to allege that we had not complied with the conditions of one or more of these licenses, we could be required to incur significant legal costs defending ourselves against such allegations, be subject to significant damages or be enjoined from the distribution of our services.

If we are unable to maintain effective internal control over financial reporting, the accuracy and timeliness of our financial reporting may be adversely affected.

The Sarbanes-Oxley Act requires us, among other things, to assess and report on the effectiveness of our internal control over financial reporting annually and disclosure controls and procedures quarterly. In addition, our independent registered public accounting firm is required to audit the effectiveness of our internal control over financial reporting pursuant to Section 404(b) of the Sarbanes-Oxley Act annually. Our independent registered public accounting firm may issue a report that is adverse in the event it is not satisfied with the level at which our controls are documented, designed or operating. Moreover, our testing, or the subsequent testing by our independent registered public accounting firm, may reveal material weaknesses. If material weaknesses are identified or we are not able to comply with the requirements of Section 404 in a timely manner, our reported financial results could be materially misstated or could subsequently require restatement, we could receive an adverse opinion regarding our internal control over financial reporting from our independent registered public accounting firm, we could be subject to investigations or sanctions by regulatory authorities and we could incur substantial expenses. New accounting principles, such as the new revenue recognition standards that became effective for us beginning January 1, 2018, require significant changes to our existing processes and controls. We may not be able to effectively implement system and process changes required for new standards on a timely basis. Any delays or failure to update our systems and processes could also lead to a material weakness.
 

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Global economic conditions may harm our industry, business and results of operations.

We operate globally and as a result our business and revenues are impacted by global macroeconomic conditions. Global financial developments seemingly unrelated to us or the software industry may harm us. From time to time, the United States and other key international economies have been impacted by geopolitical instability, high levels of bad debt globally, falling demand for a variety of goods and services, high levels of persistent unemployment and wage and income stagnation in some geographic markets, restricted credit, poor liquidity, reduced corporate profitability, volatility in credit, equity and foreign exchange markets, bankruptcies and overall uncertainty with respect to the economy. These conditions can arise suddenly and affect the rate of information technology spending and could adversely affect our customers’ ability or willingness to purchase our services, delay prospective customers’ purchasing decisions, reduce the value or duration of their subscriptions, or affect renewal rates, all of which could harm our operating results. In addition, the effects, if any, of global financial conditions on our business can be difficult to distinguish from the effects on our business from product, pricing, and other developments in the markets specific to our products and our relative competitive strength. If we make incorrect judgments about our business for this reason our business and results of operations could be adversely affected.  

Natural disasters and other events beyond our control could harm our business.

Natural disasters or other catastrophic events may cause damage or disruption to our operations, international commerce and the global economy, and thus could have a negative effect on us. Our business operations are subject to interruption by natural disasters, flooding, fire, power shortages, pandemics, terrorism, political unrest and other events beyond our control. Although we maintain crisis management and disaster response plans, such events could make it difficult or impossible for us to deliver our services to our customers, could decrease demand for our services, and could cause us to incur substantial expense. Our insurance may not be sufficient to cover losses or additional expense that we may sustain in connection with any natural disaster. The majority of our research and development activities, corporate offices, information technology systems, and other critical business operations are located near major seismic faults in California and Washington. Customer data could be lost, significant recovery time could be required to resume operations and our financial condition and operating results could be adversely affected in the event of a major natural disaster or catastrophic event.

Risks Related to Our 0% Convertible Senior Notes Due 2022 (2022 Notes) and Our 0% Convertible Senior Notes Due 2018 (2018 Notes)

We may not have the ability to raise the funds necessary to settle conversions of the convertible senior notes in cash or to repurchase the convertible senior notes upon a fundamental change, and our future debt may contain limitations on our ability to pay cash upon conversion or repurchase of the convertible senior notes.

Holders of the 2022 Notes and 2018 Notes have the right to require us to repurchase all or a portion of their 2022 Notes and 2018 Notes upon the occurrence of a fundamental change (as defined in the indenture for each of the 2022 Notes and 2018 Notes, as applicable) at a repurchase price equal to 100% of the principal amount of the 2022 Notes and 2018 Notes to be repurchased, plus accrued and unpaid special interest, if any. In addition, if a make-whole fundamental change (as defined in the indenture for each of the 2022 Notes and 2018 Notes, as applicable) occurs prior to the maturity date of the 2022 Notes or 2018 Notes, we will in some cases be required to increase the conversion rate for a holder that elects to convert its 2022 Notes or 2018 Notes in connection with such make-whole fundamental change. Upon conversion of the 2022 Notes or 2018 Notes, unless we elect to deliver solely shares of our common stock to settle such conversion (other than paying cash in lieu of delivering any fractional share), we will be required to make cash payments in respect of the 2022 Notes or 2018 Notes being converted. However, we may not have enough available cash or be able to obtain financing at the time we are required to make repurchases of the 2022 Notes or 2018 Notes surrendered therefor or pay cash with respect to the 2022 Notes or 2018 Notes being converted.

We and our subsidiaries may incur substantial additional debt in the future, subject to the restrictions contained in our future debt instruments, some of which may be secured debt. We are not restricted under the terms of the indentures governing each of the 2022 Notes and 2018 Notes from incurring additional debt, securing existing or future debt, recapitalizing our debt or taking a number of other actions that could have the effect of diminishing our ability to make payments on the 2022 Notes and 2018 Notes when due. Furthermore, the indentures for each of the 2022 Notes and 2018 Notes prohibit us from engaging in certain mergers or acquisitions unless, among other things, the surviving entity assumes our obligations under the 2022 Notes and 2018 Notes and their respective indentures. These and other provisions in each of the indentures could deter or prevent a third party from acquiring us even when the acquisition may be favorable to holders of the 2022 Notes and 2018 Notes.


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In addition, our ability to repurchase or to pay cash upon conversion of the 2022 Notes or 2018 Notes may be limited by law, regulatory authority or agreements governing our future indebtedness. Our failure to repurchase 2022 Notes or 2018 Notes at a time when the repurchase is required by each indenture or to pay cash upon conversion of the 2022 Notes or 2018 Notes as required by each indenture would constitute a default. A default under each indenture or the fundamental change itself could also lead to a default under agreements governing our future indebtedness. Moreover, the occurrence of a fundamental change under each indenture could constitute an event of default under any such agreements. If the payment of the related indebtedness were to be accelerated after any applicable notice or grace periods, we may not have sufficient funds to repay the indebtedness and repurchase the 2022 Notes or 2018 Notes, or to pay cash upon conversion of the 2022 Notes or 2018 Notes.

The conditional conversion feature of the 2022 Notes and 2018 Notes, if triggered, may adversely affect our financial condition and operating results.

The holders of the 2022 Notes and 2018 Notes may elect to convert their notes during any calendar quarter (and only during such calendar quarter) if the last reported sale price of our common stock for at least 20 trading days 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 $175.18, in the case of the 2022 Notes, or $96.04, in the case of the 2018 Notes (in each case, the Conversion Condition). The Conversion Condition was met for the 2018 Notes during the three months ended June 30, 2017, September 30, 2017, and December 31, 2017, respectively. Accordingly, the 2018 Notes were convertible at the holders’ option during each of the three months ended September 30, 2017 and December 31, 2017 and will continue to be convertible at the holders’ option through the three months ending March 31, 2018. During the year ended December 31, 2017, we paid cash to settle an immaterial principal amount of the 2018 Notes. Based on additional conversion requests we have received through the filing date, we expect to settle in cash an aggregate of $37.3 million in principal amount of the 2018 Notes during the first quarter of 2018 and $7.3 million in principal amount of the 2018 Notes during the second quarter of 2018. We may receive additional conversion requests that require settlement in the second quarter or the remainder of the year 2018. If one or more holders elect to convert their 2018 Notes (or 2022 Notes, if the Conversion Condition is triggered) in future periods, unless we elect to satisfy our conversion obligation by delivering solely shares of our common stock (other than paying cash in lieu of delivering any fractional share), we may settle all or a portion of our conversion obligation in cash, which could adversely affect our liquidity and result in a material adverse effect on our financial position, results of operations and cash flows. In addition, to the extent we receive conversion requests, we may also record a loss on extinguishment of the 2018 Notes (or 2022 Notes, if the Conversion Condition is triggered) converted by noteholders based on the difference between the fair market value allocated to the liability component on the settlement date and the net carrying amount of the liability component and unamortized debt issuance on the settlement date.

The convertible note hedge and warrant transactions may affect the value of the 2022 Notes and 2018 Notes and our common stock.

In connection with the sale of the 2022 Notes and 2018 Notes, we entered into convertible note hedge (the 2022 Note Hedge and 2018 Note Hedge, respectively) transactions with certain financial institutions (option counterparties). We also entered into warrant transactions with the option counterparties pursuant to which we sold warrants for the purchase of our common stock (the 2022 Warrants and 2018 Warrants, respectively). The 2022 Note Hedge and 2018 Note Hedge transactions are expected generally to reduce the potential dilution upon any conversion of the 2022 Notes or 2018 Notes and/or offset any cash payments we are required to make in excess of the principal amount of converted 2022 Notes or 2018 Notes, as the case may be. The warrant transactions could separately have a dilutive effect to the extent that the market price per share of our common stock exceeds the exercise price of the 2022 Warrants or 2018 Warrants, which is $203.40 and $107.46, respectively.

The option counterparties and/or their respective affiliates may modify their hedge positions by entering into or unwinding various derivatives with respect to our common stock and/or purchasing or selling our common stock in secondary market transactions prior to the maturity of the 2022 Notes or 2018 Notes (and are likely to do so during any observation period related to a conversion of 2022 Notes or 2018 Notes, or following any repurchase of 2022 Notes or 2018 Notes by us on any fundamental change repurchase date (as defined in the indentures for the 2022 Notes and 2018 Notes) or otherwise). This activity could also cause or avoid an increase or a decrease in the market price of our common stock or the 2022 Notes or 2018 Notes, which could affect note holders’ ability to convert the 2022 Notes or 2018 Notes and, to the extent the activity occurs during any observation period related to a conversion of the 2022 Notes or 2018 Notes, it could affect the amount and value of the consideration that note holders will receive upon conversion of the 2022 Notes or 2018 Notes.


17


The potential effect, if any, of these transactions and activities on the market price of our common stock or the 2022 Notes or 2018 Notes will depend in part on market conditions and cannot be ascertained at this time. Any of these activities could adversely affect the value of our common stock and the value of the 2022 Notes and 2018 Notes (and as a result, the value of the consideration, the amount of cash and/or the number of shares, if any, that note holders would receive upon the conversion of any 2022 Notes or 2018 Notes) and, under certain circumstances, the ability of the note holders to convert the 2022 Notes or 2018 Notes.

We do not make any representation or prediction as to the direction or magnitude of any potential effect that the transactions described above may have on the price of the 2022 Notes or 2018 Notes or our common stock. In addition, we do not make any representation that the option counterparties will engage in these transactions or that these transactions, once commenced, will not be discontinued without notice.

We are subject to counterparty risk with respect to the 2022 Note Hedge and 2018 Note Hedge transactions.

The option counterparties are financial institutions, and we will be subject to the risk that any or all of them may default under the 2022 Note Hedge or 2018 Note Hedge transactions. Our exposure to the credit risk of the option counterparties will not be secured by any collateral. Recent global economic conditions have resulted in the actual or perceived failure or financial difficulties of many financial institutions. If an option counterparty becomes subject to insolvency proceedings, we will become an unsecured creditor in those proceedings, with a claim equal to our exposure at that time under our transactions with that option counterparty. Our exposure will depend on many factors but, generally, an increase in our exposure will be correlated to an increase in the market price and in the volatility of our common stock. In addition, upon a default by an option counterparty, we may suffer adverse tax consequences and more dilution than we currently anticipate with respect to our common stock. We can provide no assurances as to the financial stability or viability of the option counterparties.
 
Risks Related to Ownership of Our Common Stock

The market price of our common stock has historically been and is likely to continue to be volatile and could subject us to litigation.

The trading price of our common stock has been, and is likely to continue to be, volatile and could be subject to wide fluctuations in response to various factors, some of which are beyond our control. In addition, the trading prices of the securities of technology companies in general have been highly volatile, and the volatility in market price and trading volume of securities is often unrelated or disproportionate to the financial performance of the companies issuing the securities. Factors affecting the market price of our common stock, some of which are beyond our control, include:

changes in the estimates of our operating results or changes in recommendations by securities analysts that elect to follow our common stock;
announcements of new products, services or technologies, new applications or enhancements to services, strategic alliances, acquisitions, or other significant events by us or by our competitors;
fluctuations in the valuation of companies perceived by investors to be comparable to us, such as high-growth or cloud companies;
changes to our management team;
trading activity by directors, executive officers and significant stockholders, or the perception in the market that the holders of a large number of shares intend to sell their shares;
the size of our market float;
the volume of trading in our common stock, including sales upon exercise of outstanding options or vesting of equity awards or sales and purchases of any common stock issued upon conversion of the 2022 Notes or 2018 Notes or in connection with the 2022 Note Hedge and 2022 Warrant transactions relating to the 2022 Notes, or 2018 Note Hedge and 2018 Warrant transactions relating to the 2018 Notes;
the economy as a whole, market conditions in our industry, and the industries of our customers; and
overall performance of the equity markets.

Following periods of volatility in the market price of a company’s securities, securities class action litigation has often been brought against that company. Securities litigation could result in substantial costs and divert our management’s attention and resources from our business. This could have a material adverse effect on our business, operating results, and financial condition.


18


We do not intend to pay dividends on our common stock so any returns will be limited to changes in the value of our common stock.

We have never declared or paid any cash dividends on our common stock. We currently anticipate that we will retain future earnings for the development, operation and expansion of our business and do not anticipate declaring or paying any cash dividends for the foreseeable future. In addition, our ability to pay cash dividends on our common stock may be prohibited or limited by the terms of any future debt financing arrangement. Any return to stockholders will therefore be limited to the increase, if any, of our stock price.

Provisions in our charter documents, Delaware law, our 2022 Notes and our 2018 Notes might discourage, delay or prevent a change of control of our company or changes in our management and, therefore, depress the market price of our common stock.
 
Our restated certificate of incorporation and restated bylaws contain provisions that could depress the market price of our common stock by acting to discourage, delay or prevent a change in control of our company or changes in our management that the stockholders of our company may deem advantageous. These provisions among other things:
 
establish a classified board of directors so that not all members of our board are elected at one time;
permit the board of directors to establish the number of directors;
provide that directors may only be removed “for cause” and only with the approval of 66 2/3% of our stockholders;
require super-majority voting to amend some provisions in our restated certificate of incorporation and restated bylaws;
authorize the issuance of “blank check” preferred stock that our board could use to implement a stockholder rights plan;
eliminate the ability of our stockholders to call special meetings of stockholders;
prohibit stockholder action by written consent, which requires all stockholder actions to be taken at a meeting of our stockholders;
provide that the board of directors is expressly authorized to make, alter or repeal our restated bylaws; and
establish advance notice requirements for nominations for election to our board or for proposing matters that can be acted upon by stockholders at annual stockholder meetings (though our restated bylaws have implemented stockholder proxy access).

In addition, Section 203 of the Delaware General Corporation Law may discourage, delay or prevent a change in control of our company. Section 203 imposes certain restrictions on merger, business combinations and other transactions between us and holders of 15% or more of our common stock.

Further, the fundamental change provisions of our 2022 Notes or 2018 Notes may delay or prevent a change in control of our company, because those provisions allow note holders to require us to repurchase such notes upon the occurrence of a fundamental change.


19


ITEM 1B.
UNRESOLVED STAFF COMMENTS



None.

ITEM 2.
PROPERTIES


Our principal office is located in Santa Clara, California.

We also maintain offices in various North American, South American, European and Asian countries. All of our properties are currently leased. We believe our existing facilities are adequate to meet our current requirements. See Note 16 in the notes to our consolidated financial statements included elsewhere in this Annual Report on Form 10-K for more information about our lease commitments. We expect to expand our facilities capacity as our employee base grows. We believe we will be able to obtain such space on acceptable and commercially reasonable terms.

ITEM 3.
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, we are not presently a party to any legal proceedings that, if determined adversely to us, would individually or taken together have a material adverse effect on our business, financial position, results of operations or cash flows.

ITEM 4.
MINE SAFETY DISCLOSURES



Not applicable.


20



PART II

ITEM 5.
MARKET FOR REGISTRANT'S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES




Market Information for Common Stock

Our common stock is listed on the New York Stock Exchange under the symbol “NOW.”

The following table sets forth for the indicated periods the high and low sales prices of our common stock as reported by the New York Stock Exchange.
 
High
 
Low
Year ended December 31, 2017
 
 
 
           First Quarter
$
94.72

 
$
74.63

           Second Quarter
$
110.66

 
$
84.03

           Third Quarter
$
118.64

 
$
103.00

           Fourth Quarter
$
131.26

 
$
112.84

 
 
 
 
Year ended December 31, 2016
 
 
 
           First Quarter
$
85.67

 
$
46.00

           Second Quarter
$
77.76

 
$
60.05

           Third Quarter
$
80.31

 
$
64.31

           Fourth Quarter
$
89.79

 
$
72.80


Dividend Policy

We have never paid any cash dividends on our common stock. Our board of directors currently intends to retain any future earnings to support operations and to finance the growth and development of our business, and therefore does not intend to pay cash dividends on our common stock for the foreseeable future. Any future determination related to our dividend policy will be made at the discretion of our board of directors.

Stockholders

As of December 31, 2017, there were 11 registered stockholders of record (not including an indeterminate number of beneficial holders of stock held in street name through brokers and other intermediaries) of our common stock.

Securities Authorized for Issuance under Equity Compensation Plans

The information required by this item will be included in an amendment to this Annual Report on Form 10-K or incorporated by reference from our definitive proxy statement to be filed with the SEC pursuant to Regulation 14A.

Stock Performance Graph

The following shall not be deemed incorporated by reference into any of our other filings under the Securities Exchange Act of 1934, as amended (the Exchange Act) or the Securities Act except to the extent we specifically incorporate it by reference into such filing.

The graph below compares the cumulative total stockholder return on our common stock with the cumulative total return on the NYSE Composite Index and the Standard & Poor Systems Software Index for each of the last five fiscal years ended December 31, 2013 through December 31, 2017, assuming an initial investment of $100. Data for the NYSE Composite Index and the Standard & Poor Systems Software Index assume reinvestment of dividends.


21


The comparisons in the graph below are based upon historical data and are not indicative of, nor intended to forecast, future performance of our common stock.

a126totalreturngraph.jpg

 
Base Period
 
 
 
 
 
 
 
 
 
 
 
Dec 31, 2012
 
Dec 31, 2013
 
Dec 31, 2014
 
Dec 31, 2015
 
Dec 31, 2016
 
Dec 31, 2017
ServiceNow, Inc.
$
100.00

 
$
186.51

 
$
225.94

 
$
288.25

 
$
247.55

 
$
434.20

NYSE Composite
100.00

 
126.28

 
134.81

 
129.29

 
144.73

 
171.83

S&P Systems Software
100.00

 
132.90

 
163.47

 
180.59

 
204.49

 
280.92


Unregistered Sales of Equity Securities

There were no unregistered sales of equity securities which have not been previously disclosed in a quarterly report on Form 10-Q or a current report on Form 8-K during the year ended December 31, 2017.

Issuer Purchases of Equity Securities

During the quarter ended December 31, 2017, we did not purchase any of our equity securities that are registered under Section 12 of the Exchange Act.


22


ITEM 6.
SELECTED CONSOLIDATED FINANCIAL DATA



The following selected consolidated financial data should be read together with our consolidated financial statements and accompanying notes and “Management’s Discussion and Analysis of Financial Condition and Results of Operations” appearing elsewhere in this filing. The selected consolidated financial data in this section are not intended to replace our consolidated financial statements and the related notes. Our historical results are not necessarily indicative of our future results.
 
The selected consolidated statements of operations data for each of the years ended December 31, 2017, 2016 and 2015, and the selected consolidated balance sheet data as of December 31, 2017 and 2016 are derived from our audited consolidated financial statements and are included in this Form 10-K. The consolidated statements of operations data for the year ended December 31, 2014, and 2013, and the selected consolidated balance sheet data as of December 31, 2015, 2014, and 2013 are derived from our audited consolidated financial statements which are not included in this Annual Report on Form 10-K. The consolidated financial information below reflects the impact of the Company’s acquisitions.

 
Year Ended December 31,
 
2017
 
2016
 
2015
 
2014
 
2013
 
(in thousands, except share and per share data)
Consolidated Statements of Operations Data:
 
 
 
 
 
 
 
 
 
Revenues:
 
 
 
 
 
 
 
 
 
Subscription
$
1,739,795

 
$
1,221,639

 
$
848,278

 
$
567,217

 
$
349,804

Professional services and other
193,231

 
168,874

 
157,202

 
115,346

 
74,846

Total revenues
1,933,026

 
1,390,513

 
1,005,480

 
682,563

 
424,650

Cost of revenues (1):
 
 
 
 
 
 
 
 
 
Subscription
315,570

 
235,414

 
183,400

 
142,687

 
87,928

Professional services and other
184,202

 
163,268

 
146,013

 
106,089

 
67,331

Total cost of revenues
499,772

 
398,682

 
329,413

 
248,776

 
155,259

Gross profit
1,433,254

 
991,831

 
676,067

 
433,787

 
269,391

Operating expenses (1):
 
 
 
 
 
 
 
 
 
Sales and marketing
946,617

 
700,464

 
498,439

 
341,119

 
195,190

Research and development
377,518

 
285,239

 
217,389

 
148,258

 
78,678

General and administrative
210,533

 
158,936

 
126,604

 
96,245

 
61,790

Legal settlements (2)

 
270,000

 

 

 

Total operating expenses
1,534,668

 
1,414,639

 
842,432

 
585,622

 
335,658

Loss from operations
(101,414
)
 
(422,808
)
 
(166,365
)
 
(151,835
)
 
(66,267
)
Interest expense
(53,394
)
 
(33,278
)
 
(31,097
)
 
(29,059
)
 
(3,498
)
Interest income and other income (expense), net
5,804

 
6,035

 
4,450

 
5,354

 
(1,432
)
Loss before income taxes
(149,004
)
 
(450,051
)
 
(193,012
)
 
(175,540
)
 
(71,197
)
Provision for income taxes
126

 
1,753

 
5,414

 
3,847

 
2,511

Net loss
$
(149,130
)
 
$
(451,804
)
 
$
(198,426
)
 
$
(179,387
)
 
$
(73,708
)
Net loss per share - basic and diluted
$
(0.87
)
 
$
(2.75
)
 
$
(1.27
)
 
$
(1.23
)
 
$
(0.54
)
Weighted-average shares used to compute net loss per share - basic and diluted
171,175,577

 
164,533,823

 
155,706,643

 
145,355,543

 
135,415,809




23


(1)
Stock-based compensation included in the statements of operations data above was as follows:
 
Year Ended December 31,
 
2017
 
2016
 
2015
 
2014
 
2013
 
(in thousands)
Cost of revenues:
 
 
 
 
 
 
 
 
 
Subscription
$
35,334

 
$
28,420

 
$
23,416

 
$
14,988

 
$
8,434

Professional services and other
27,475

 
26,442

 
23,265

 
13,116

 
4,749

Sales and marketing
170,527

 
131,571

 
102,349

 
54,006

 
21,609

Research and development
92,025

 
81,731

 
70,326

 
42,535

 
16,223

General and administrative
68,717

 
49,416

 
38,357

 
29,674

 
14,566

Total stock-based compensation
$
394,078

 
$
317,580

 
$
257,713

 
$
154,319

 
$
65,581

 
(2)
For details regarding the legal settlements expenses of $270.0 million included in the year ended December 31, 2016, refer to Note 16 in the notes to our consolidated financial statements included elsewhere in this Annual Report on Form 10-K.

 
As of December 31,
 
2017
 
2016
 
2015
 
2014
 
2013
 
(in thousands)
Consolidated Balance Sheet Data:
 
 
 
 
 
 
 
 
 
Cash and cash equivalents and investments
$
2,170,740

 
$
1,162,020

 
$
1,223,917

 
$
935,563

 
$
889,910

Working capital, excluding current portion of deferred revenue and convertible senior notes, net
2,133,850

 
1,132,819

 
947,002

 
809,660

 
722,214

Total assets
3,397,904

 
2,033,767

 
1,807,052

 
1,424,752

 
1,168,077

Deferred revenue, current and non-current portion
1,320,383

 
895,101

 
603,754

 
422,238

 
266,722

Convertible senior notes, net, current and non-current portion
1,173,436

 
507,812

 
474,534

 
443,437

 
414,378

Total stockholders’ equity
584,132

 
386,961

 
566,814

 
428,675

 
394,259



24


ITEM 7.
MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS



You should read the following discussion and analysis of our financial condition and results of operations together with our consolidated financial statements and the related notes appearing under “Consolidated Financial Statements and Supplementary Data” in Item 8 of this filing. Some of the information contained in this discussion and analysis or set forth elsewhere in this filing, including information with respect to our plans and strategy for our business, includes forward-looking statements that involve risks and uncertainties. You should carefully read the “Risk Factors” section of this filing for a discussion of important 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 contained in the following discussion and analysis.

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 encourage investors to carefully consider our results under GAAP, as well as our supplemental non-GAAP results, to more fully understand our business.


25


Overview
 
ServiceNow is a leading provider of enterprise cloud computing solutions that define, structure, manage and automate services for global enterprises. We help our customers improve service quality and reduce costs while scaling and automating their businesses.

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 subscription 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 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 6,222 as of December 31, 2017 from 4,801 as of December 31, 2016.

New Revenue Recognition Standard under Topic 606

In May 2014, the Financial Accounting Standards Board issued a new standard related to revenue recognition from contracts with customers (Topic 606), which is effective beginning January 1, 2018. Topic 606 supersedes the prior revenue recognition standard (Topic 605) for periods beginning January 1, 2018. The most significant impacts of the standard relate to the timing of revenue recognition related to our on-premises offerings, in which we grant customers the right to deploy our software on the customer’s own servers without significant penalty, the accounting for incremental costs to obtain a contract and the classification of proceeds from Knowledge and other user forums as a reduction in sales and marketing expenses instead of professional services and other revenues.

Our results of operations below are presented under Topic 605. Our expectations for 2018 revenues, cost of revenues and operating expenses, including the comparison period amounts used to derive the expected trends, are based on Topic 606. In addition, our expectations for 2018 revenues, cost of revenues and operating expenses are based on foreign exchange rates as of December 31, 2017. Refer to Note 2 in the notes to our consolidated financial statements included elsewhere in this Annual Report on Form 10-K for details regarding Topic 606, including adjusted amounts for historical periods.

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 500350 and 231 customers with ACV greater than $1 million as of December 31, 2017, 2016 and 2015, 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) number 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.


26


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. 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 840, 737 and 637 as of December 31, 2017, 2016 and 2015, 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. Prior G2K customer counts used in calculating ACV per G2K are adjusted for the most recent Forbes Global 2000 list for comparability purposes. Our average ACV per G2K customer was approximately $1.3 million$1.1 million and $0.9 million as of December 31, 2017, 2016 and 2015, 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 the year ended December 31, 2017 and 98% for the years ended December 31, 2016 and 2015. 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 consolidated statements of cash flows. The change in total deferred revenue as presented on the 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.

A calculation of billings is provided below:
 
Year Ended December 31,
 
2017
 
2016
 
2015
 
(dollars in thousands)
Billings:
 
 
 
 
 
Total revenues
$
1,933,026

 
$
1,390,513

 
$
1,005,480

Change in deferred revenue from the consolidated statements of cash flows
381,562

 
300,167

 
195,900

Total billings
$
2,314,588

 
$
1,690,680

 
$
1,201,380

Year-over-year percentage change in total billings
37
%
 
41
%
 
41
%

Billings consists of amounts invoiced for subscription contracts with existing customers, renewals, upsells and new customers, and contracts for professional services, training, and our Knowledge and other user forum events. Factors that may cause our billings results to vary from period to period include the following:

Billings duration. While we typically bill customers annually for our subscription services, customers sometimes request, and we accommodate, billings with durations less than or greater than the typical 12-month term.


27


Contract start date. From time to time, we enter into contracts with a contract start date in the future, and we exclude these amounts from billings as these amounts are not included in our consolidated balance sheets, unless such amounts have been paid as of the balance sheet date.

Foreign currency exchange rates. While a majority of our billings have historically been in U.S. Dollars, an increasing percentage of our billings in recent periods has been in foreign currencies, particularly the Euro and British Pound Sterling.

Timing of contract renewals. While customers typically renew their contracts at the end of the contract term, from time to time customers may do so either before or after the scheduled expiration date. For example, in cases where we are successful in upselling additional products or services, a customer may decide to renew its existing contract early to ensure that all its contracts expire on the same date. In other cases, prolonged negotiations or other factors may result in a contract not being renewed until after it has expired.

Accordingly, while we believe billings is a useful leading indicator regarding the performance of our business, an increase or decrease in new or renewed subscriptions in a reporting period may not have an immediate impact on billings for that reporting period.

To facilitate greater year-over-year comparability in our billings results, we disclose the impact that foreign currency rate fluctuations and fluctuations in billings duration had on our billings. The impact of foreign currency rate fluctuations is calculated by translating the current period results for entities reporting in currencies other than U.S. Dollars into U.S. Dollars at the average exchange rates in effect during the prior period presented, rather than the actual exchange rates in effect during the current period. The impact of fluctuations in billings duration is calculated by replacing the portion of multi-year billings in excess of 12 months during the current period with the portion of multi-year billings in excess of 12 months during the prior period presented. Notwithstanding the adjustments described above, the comparability of billings results from period to period remains subject to the impact of variations in the dollar value of contracts with future start dates and the timing of contract renewals, for which no adjustments have been presented.

Foreign currency rate fluctuations had a favorable impact of $8.3 million and an unfavorable impact of $8.4 million on billings for the years ended December 31, 2017 and 2016, respectively. Changes in billings duration had a favorable impact of $1.6 million and $16.3 million for the years ended December 31, 2017 and 2016, respectively.

In May 2014, the Financial Accounting Standards Board issued a new standard related to revenue recognition from contracts with customers (Topic 606), which is effective beginning on January 1, 2018. Under Topic 606, due to the change in timing of revenue recognition under certain of our contracts, our definition of billings will be revenues recognized plus the change in total deferred revenue, unbilled receivables, and customer deposits as presented on or derived from our consolidated statements of cash flows. Refer to Note 2 in the notes to our consolidated financial statements included elsewhere in this Annual Report on Form 10-K for details regarding Topic 606.

Free cash flow. We define free cash flow, a non-GAAP financial measure, as GAAP net cash provided by operating activities reduced by purchases of property and equipment. Purchases of property and equipment are otherwise included in cash used in investing activities under GAAP. We believe information regarding free cash flow provides useful information to investors because it is an indicator of the strength and performance of our business operations. However, our calculation of free cash flow may not be comparable to similar measures used by other companies. A calculation of free cash flow is provided below:
 
Year Ended December 31,
 
2017
 
2016
 
2015
 
(dollars in thousands)
Free cash flow:
 
 
 
 
 
Net cash provided by operating activities
$
642,825

 
$
159,921

 
$
317,754

Purchases of property and equipment
(150,510
)
 
(105,562
)
 
(87,481
)
Free cash flow (1)
$
492,315

 
$
54,359

 
$
230,273


(1) Free cash flow includes the effect of a $267.5 million payment for aggregate legal settlements for the year ended December 31, 2016. Refer to Note 16 in the notes to our consolidated financial statements included elsewhere in this Annual Report on Form 10-K for further details.


28


Average contract term. We calculate the average contract term for new customers, upsells and renewals based on the term of those contracts entered into during the period weighted by their ACV. The average new customer contract term was 32 months for the years ended December 31, 2017, 2016 and 2015. The average upsell contract term was 26 months for the years ended December 31, 2017, 2016 and 2015. The average renewal contract term was 27 months, 28 months, and 25 months for the years ended December 31, 2017, 2016 and 2015, respectively.

 Components of Results of Operations
 
Revenues

Subscription revenues. Subscription revenues are primarily comprised of fees that give customers access to the ordered subscription service, and related support and updates, if any, to the subscription service during the subscription term. Pricing includes multiple instances, hosting and support services, data backup and disaster recovery services, as well as future updates, when and if available, offered during the subscription term. We typically invoice our customers for subscription fees in annual increments upon execution of the initial contract or subsequent renewal. Our contracts are generally non-cancelable during the subscription term, though a customer can terminate for breach if we materially fail to perform.

Professional services and other revenues. Professional services revenues consist of fees associated with professional services. Our arrangements for professional services are primarily on a time-and-materials basis. We generally invoice our professional services monthly in arrears based on actual hours and expenses incurred. Other revenues primarily consist of fees from customer training delivered on-site or through publicly available classes and registration and sponsorship fees for our annual Knowledge user conference and other user forums. Typical payment terms require our customers to pay us within 30 days of invoice.

We generate sales directly through our sales team and, to a lesser extent, through our resale partners. Revenues from our direct sales organization represented 88% of our total revenues for the years ended December 31, 2017 and 2016 and 89% of our total revenues for the year ended December 31, 2015. We make sales to our resale partners at a discount and record those revenues at the discounted price when all revenue recognition criteria have been met. From time to time, other third parties provide us referrals for which we pay a referral fee. We include revenues associated with these referrals as part of revenues from our direct sales organization. Referral fees paid to these third parties are between 5% and 15% of the customer's ACV, depending on the level of activity these third parties perform in the sales process. We include these fees in sales and marketing expense.

Allocation of Overhead Costs

Overhead costs associated with office facilities, IT and certain depreciation related to infrastructure that is not dedicated for customer use or research and development use are allocated to cost of revenues and operating expenses based on headcount.

Cost of Revenues

Cost of subscription revenues. Cost of subscription revenues consists primarily of expenses related to hosting our services and providing support to our customers. These expenses are comprised of data center capacity costs, which include facility costs associated with our data centers as well as interconnectivity between data centers, depreciation related to our infrastructure hardware equipment dedicated for customer use, amortization of intangible assets and personnel-related costs directly associated with data center operations and customer support, including salaries, benefits, bonuses and stock-based compensation and allocated overhead.

Cost of professional services and other revenues. Cost of professional services and other revenues consists primarily of personnel-related costs directly associated with our professional services and training departments, including salaries, benefits, bonuses and stock-based compensation, the costs of contracted third-party partners, travel expenses and allocated overhead.

Professional services are performed directly by our services team, as well as by contracted third-party partners. Fees paid to third-party partners are primarily recognized as cost of revenues as the professional services are delivered. Cost of revenues associated with our professional services engagements contracted with third-party partners as a percentage of professional services and other revenues was 19% for the years ended December 31, 2017 and 2016 and 21% for the year ended December 31, 2015.

 Sales and Marketing

Sales and marketing expenses consist primarily of personnel-related expenses directly associated with our sales and marketing staff, including salaries, benefits, bonuses, commissions and stock-based compensation. Sales and marketing expenses also include third-party referral fees, expenses related to our annual Knowledge user conference, other marketing program expenses, which include events other than Knowledge, and costs associated with purchasing advertising and marketing data, and allocated overhead.

29



Research and Development
 
Research and development expenses consist primarily of personnel-related expenses directly associated with our research and development staff, including salaries, benefits, bonuses and stock-based compensation and allocated overhead. Research and development expenses also include data center capacity costs, costs associated with outside services contracted for research and development purposes, amortization of intangible assets and depreciation of infrastructure hardware equipment that is used solely for research and development purposes.
 
General and Administrative
 
General and administrative expenses consist primarily of personnel-related expenses for our executive, finance, legal, human resources, facilities and administrative personnel, including salaries, benefits, bonuses and stock-based compensation, external legal, accounting and other professional services fees, other corporate expenses, amortization of intangible assets and allocated overhead.
 
Legal Settlements

Legal settlements consist of one-time aggregate charges related to the settlement agreements with Hewlett Packard Enterprise Company (HPE) and BMC Software, Inc. (BMC). Refer to Note 16 in the notes to our consolidated financial statements included elsewhere in this Annual Report on Form 10-K for further details regarding these matters.

Provision for Income Taxes

Provision for income taxes consists of federal, state and foreign income taxes. Due to cumulative losses, we maintain a valuation allowance against our U.S. deferred tax assets as of December 31, 2017 and 2016. We consider all available evidence, both positive and negative, including but not limited to earnings history, projected future outcomes, industry and market trends and the nature of each of the deferred tax assets in assessing the extent to which a valuation allowance should be applied against our U.S. deferred tax assets.


30


Results of Operations
 
To enhance comparability, the following table sets forth our results of operations for the periods presented. The period-to-period comparison of financial results is not necessarily indicative of future results.

 
Year Ended December 31,
 
2017
 
2016
 
2015
 
(in thousands)
Revenues:




 
Subscription
$
1,739,795


$
1,221,639


$
848,278

Professional services and other
193,231


168,874


157,202

Total revenues
1,933,026


1,390,513


1,005,480

Cost of revenues (1):




 
Subscription
315,570


235,414


183,400

Professional services and other
184,202


163,268


146,013

Total cost of revenues
499,772


398,682


329,413

Gross profit
1,433,254


991,831


676,067

Operating expenses (1):




 
Sales and marketing
946,617


700,464


498,439

Research and development
377,518


285,239


217,389

General and administrative
210,533


158,936


126,604

Legal settlements (2)

 
270,000

 

Total operating expenses
1,534,668


1,414,639


842,432

Loss from operations
(101,414
)

(422,808
)

(166,365
)
Interest expense
(53,394
)
 
(33,278
)
 
(31,097
)
Interest income and other income (expense), net
5,804


6,035


4,450

Loss before income taxes
(149,004
)

(450,051
)

(193,012
)
Provision for income taxes
126


1,753


5,414

Net loss
$
(149,130
)

$
(451,804
)

$
(198,426
)
 
(1)
Stock-based compensation included in the statements of operations data above was as follows:
 
Year Ended December 31,
 
2017
 
2016
 
2015
 
(in thousands)
Cost of revenues:
 
 
 
 
 
Subscription
$
35,334

 
$
28,420

 
$
23,416

Professional services and other
27,475

 
26,442

 
23,265

Sales and marketing
170,527

 
131,571

 
102,349

Research and development
92,025

 
81,731

 
70,326

General and administrative
68,717

 
49,416

 
38,357

Total stock-based compensation
$
394,078

 
$
317,580

 
$
257,713


(2)
For details regarding the legal settlements expenses of $270.0 million included in the year ended December 31, 2016, refer to Note 16 in the notes to our consolidated financial statements included elsewhere in this Annual Report on Form 10-K.


31


 
Year Ended December 31,
 
2017
 
2016
 
2015
Revenues:
 
 
 
 
 
Subscription
90
 %
 
88
 %
 
84
 %
Professional services and other
10

 
12

 
16

Total revenues
100

 
100

 
100

Cost of revenues (1):

 

 
 
Subscription
16

 
17

 
18

Professional services and other
10

 
12

 
15

Total cost of revenues
26

 
29

 
33

Gross profit
74

 
71

 
67

Operating expenses (1):

 

 
 
Sales and marketing
49

 
50

 
50

Research and development
19

 
21

 
22

General and administrative
11

 
11

 
12

Legal settlements (2)

 
19

 

Total operating expenses
79

 
101

 
84

Loss from operations
(5
)
 
(30
)
 
(17
)
Interest expense
(3
)
 
(2
)
 
(3
)
Interest income and other income (expense), net

 

 
1

Loss before income taxes
(8
)
 
(32
)
 
(19
)
Provision for income taxes

 

 
1

Net loss
(8
)%
 
(32
)%
 
(20
)%
 
(1)
Stock-based compensation included in the statements of operations above as a percentage of revenues was as follows:
 
Year Ended December 31,
 
2017
 
2016
 
2015
 
(in thousands)
Cost of revenues:
 
 
 
 
 
Subscription
2
%
 
2
%
 
2
%
Professional services and other
1

 
2

 
2

Sales and marketing
9

 
9

 
10

Research and development
5

 
6

 
8

General and administrative
3

 
4

 
4

Total stock-based compensation
20
%
 
23
%
 
26
%
 
(2)
For details regarding the legal settlements expenses of $270.0 million included in the year ended December 31, 2016, refer to Note 16 in the notes to our consolidated financial statements included elsewhere in this Annual Report on Form 10-K.


32


Comparison of the years ended December 31, 2017 and 2016

As described above under the section entitled “New Revenue Recognition Standard under Topic 606,” the results of operations below are presented under Topic 605. Our expectations for 2018 revenues, cost of revenues and operating expenses, including the comparison period amounts used to derive the expected trends are based on the new Topic 606 revenue recognition standard. In addition, our expectations for 2018 revenues, cost of revenues and operating expenses are based on foreign exchange rates as of December 31, 2017. Refer to Note 2 in the notes to our consolidated financial statements included elsewhere in this Annual Report on Form 10-K for details regarding Topic 606, including adjusted amounts for historical periods.

Revenues
 
 
Year Ended December 31,
 
% Change    
 
2017
 
2016
 
 
(dollars in thousands)
 
 
Revenues:
 
 
 
 
 
Subscription
$
1,739,795

 
$
1,221,639

 
42
%
Professional services and other
193,231

 
168,874

 
14
%
Total revenues
$
1,933,026

 
$
1,390,513

 
39
%
Percentage of revenues:
 
 
 
 
 
Subscription
90
%
 
88
%
 
 
Professional services and other
10

 
12

 
 
Total
100
%
 
100
%
 
 
 
Subscription revenues increased $518.2 million during the year ended December 31, 2017, compared to the prior year, driven by our upsells and an increase in customer count. We expect subscription revenues to grow in absolute dollars and as a percentage of total revenues in the year ended December 31, 2018 as we continue to add new customers and upsell to existing customers.

Subscription revenues consist of the following:
 
Year Ended December 31,
 
% Change    
 
2017
 
2016
 
 
(dollars in thousands)
 
 
Service management products
$
1,526,382

 
$
1,108,846

 
38
%
ITOM products
213,413

 
112,793

 
89
%
Total subscription revenues
$
1,739,795

 
$
1,221,639

 
42
%

Our service management products include our platform, ITSM, ITBM, customer service management, HR service delivery and security operations, which have similar features and functions and are generally priced on a per user basis. Our ITOM products, which improve visibility, availability and agility of enterprise services, are generally priced on a per node basis.

Professional services and other revenues increased $24.4 million during the year ended December 31, 2017, compared to the prior year, due to an increase in the services provided to our growing customer base. Included within our total professional services and other revenues are the revenues from our annual Knowledge user conference, which increased to $17.1 million during the year ended December 31, 2017, compared to $12.8 million in the prior year, due to an increase in registration and sponsorship fees in the current year.

We expect professional services and other revenues under Topic 606 for the year ending December 31, 2018 to remain flat in absolute dollar terms when compared to professional services and other revenues for the year ended December 31, 2017, as adjusted for Topic 606. This reflects our plan to focus on deploying our internal professional services organization as a strategic resource while relying on our partner ecosystem to contract directly with customers for service delivery. As described above under the section entitled “New Revenue Recognition Standard under Topic 606,” with the adoption of Topic 606, proceeds from Knowledge and other user forums will be classified as a reduction in sales and marketing expense instead of as professional services and other revenues.


33


Our international operations have provided and will continue to provide a significant portion of our total revenues. Revenues outside North America represented 33% and 32% of total revenues for the years ended December 31, 2017 and 2016, respectively. Because we primarily transact in foreign currencies for sales outside of the United States, the general weakening of the U.S. Dollar relative to other major foreign currencies (primarily the Euro and British Pound Sterling) from the year ended December 31, 2016 to the year ended December 31, 2017 had a favorable impact on our revenues. For entities reporting in currencies other than the U.S. Dollar, if we had translated our results for the year ended December 31, 2017 at the average exchange rates in effect for the year ended December 31, 2016 rather than the actual exchange rates in effect during the period, our reported subscription revenues would have been $6.3 million lower. The impact from the foreign currency movements from the year ended December 31, 2016 to the year ended December 31, 2017 is not material to professional services and other revenues.

Cost of Revenues and Gross Profit Percentage
 
 
Year Ended December 31,
 
% Change    
 
2017
 
2016
 
 
(dollars in thousands)
 
 
Cost of revenues:
 
 
 
 
 
Subscription
$
315,570

 
$
235,414

 
34
%
Professional services and other
184,202

 
163,268

 
13
%
Total cost of revenues
$
499,772

 
$
398,682

 
25
%
Gross profit percentage:
 
 
 
 
 
Subscription
82
%
 
81
%
 
 
Professional services and other
5
%
 
3
%
 
 
Total gross profit percentage
74
%
 
71
%
 
 
Gross profit:
$
1,433,254

 
$
991,831

 
45
%
Headcount (at period end)
 
 
 
 
 
Subscription
936

 
729

 
28
%
Professional services and other
562

 
496

 
13
%
Total headcount
1,498

 
1,225

 
22
%
 
Cost of subscription revenues increased $80.2 million during the year ended December 31, 2017, compared to the prior year, primarily due to increased headcount resulting in an increase of $30.8 million in personnel-related costs excluding stock-based compensation, an increase of $8.0 million in other overhead expenses and an increase of $6.9 million in stock-based compensation. In addition, there was an increase of $17.8 million in depreciation expense primarily due to purchases of infrastructure hardware equipment for our data centers, an increase of $7.2 million in data center capacity costs primarily due to the addition of new data centers and the expansion of existing data centers, and an increase of $2.3 million in amortization of intangibles as a result of acquisitions. Service and technical support agreement and software subscription costs increased $5.0 million, and outside service costs increased $1.2 million during year ended December 31, 2017 compared to the prior year.

Our subscription gross profit percentage increased to 82% for the year ended December 31, 2017, from 81% for the year ended December 31, 2016, due to improved data center utilization and economies of scale. We expect our cost of subscription revenues to increase in absolute dollar terms as we provide subscription services to more customers and increase the number of users within our customer instances, but we expect such increase to be at a slower rate than the increase in our subscription revenues, leading to a slight increase in our subscription gross profit percentage for the year ended December 31, 2018 as we continue to leverage the investments we have made in our existing data center infrastructure. To the extent future acquisitions are consummated, our cost of subscription revenues may increase due to additional non-cash charges associated with the amortization of intangible assets acquired.

Cost of professional services and other revenues increased $20.9 million during the year ended December 31, 2017 compared to the prior year, primarily due to increased headcount resulting in an increase of $11.7 million in personnel-related costs excluding stock-based compensation, an increase of $2.1 million in overhead expenses, and an increase of $1.0 million in stock-based compensation. Outside service costs increased $4.6 million during year ended December 31, 2017 compared to the prior year, primarily due to increased utilization of contracted third-party partners for the implementation and configuration of our subscription services.


34


Our professional services and other gross profit percentage increased to 5% during the year ended December 31, 2017, compared to 3% in the prior year, primarily due to the increase in revenues from our annual Knowledge user conference. Costs associated with Knowledge are included in sales and marketing expense. Knowledge contributed $17.1 million, or 10 percentage points, to the professional services and other gross profit percentage for the year ended December 31, 2017. Knowledge contributed $12.8 million, or 8 percentage points, to the professional services and other gross profit percentage for the year ended December 31, 2016.

The impact from the foreign currency movements from the year ended December 31, 2016 to the year ended December 31, 2017 is not material to cost of revenues.
 
Sales and Marketing

 
Year Ended December 31
 
% Change    
 
2017
 
2016
 
 
(dollars in thousands)
 
 
Sales and marketing
$
946,617

 
$
700,464

 
35
%
Percentage of revenues
49
%
 
50
%
 
 
Headcount (at period end)
2,413

 
1,875

 
29
%
 
Sales and marketing expenses increased $246.2 million during the year ended December 31, 2017, compared to the prior year, primarily due to increased headcount resulting in an increase of $120.7 million in personnel-related costs excluding stock-based compensation, an increase of $39.0 million in stock-based compensation, an increase of $22.0 million in overhead expenses, and an increase of $30.2 million in commission expense. Commissions and referral fee expenses amounted to 7% of subscription revenues for each of the years ended December 31, 2017 and 2016. Expenses related to our annual Knowledge user conference increased $8.2 million, from $24.0 million for the year ended December 31, 2016 to $32.2 million for the year ended December 31, 2017, due to a 29% increase in registrations year-over-year. Other marketing program expenses, which include expenses related to events other than Knowledge and costs associated with purchasing advertising and marketing data, increased $17.4 million for the year ended December 31, 2017 compared to the prior year. Outside services increased $7.0 million primarily due to an increase in contractors and professional fees to support our sales and marketing functions.

Because we primarily transact in foreign currencies for sales and marketing expenses outside of the United States, the general weakening of the U.S. Dollar relative to other major foreign currencies from the year ended December 31, 2016 to the year ended December 31, 2017 had an unfavorable impact on our sales and marketing expenses. For entities reporting in currencies other than the U.S. Dollar, if we had translated our results for the year ended December 31, 2017 at the average exchange rates in effect for the year ended December 31, 2016 rather than the actual exchange rates in effect during the period, our sales and marketing expenses would have been $2.5 million lower.

We expect sales and marketing expenses to increase for the year ended December 31, 2018 in absolute dollar terms when compared to sales and marketing expenses for the year ended December 31, 2017, as adjusted for Topic 606, but decrease slightly as a percentage of total revenues as we continue to expand our direct sales force, increase our marketing activities, grow our international operations, build brand awareness and sponsor additional marketing events. As described above under the section entitled “New Revenue Recognition Standard under Topic 606,” with the adoption of Topic 606, proceeds from Knowledge and other user forums will be classified as a reduction in sales and marketing expense instead of professional services and other revenues.


35


Research and Development
 
Year Ended December 31
 
% Change    
 
2017
 
2016
 
 
(dollars in thousands)
 
 
Research and development
$
377,518

 
$
285,239

 
32
%
Percentage of revenues
19
%
 
21
%
 
 
Headcount (at period end)
1,419

 
1,054

 
35
%
 
Research and development expenses increased $92.3 million during the year ended December 31, 2017, compared to the prior year, primarily due to increased headcount resulting in an increase of $60.2 million in personnel-related costs excluding stock-based compensation, an increase of $14.4 million in overhead expenses, and an increase of $10.3 million in stock-based compensation. Outside services increased $3.6 million primarily due to an increase in contractors and consultants that support our research and development functions. Research and development expenses also increased $1.8 million due to depreciation of infrastructure hardware equipment that are used solely for research and development purposes.

Because we primarily transact in foreign currencies for research and development expenses outside of the United States, the general weakening of the U.S. Dollar relative to other major foreign currencies from the year ended December 31, 2016 to the year ended December 31, 2017 had an unfavorable impact on our research and development expenses. For entities reporting in currencies other than the U.S. Dollar, if we had translated our results for the year ended December 31, 2017 at the average exchange rates in effect for the year ended December 31, 2016 rather than the actual exchange rates in effect during the period, our research and development expenses would have been $1.3 million lower.

 We expect research and development expenses to increase for the year ended December 31, 2018 in absolute dollar terms, but decrease slightly as a percentage of total revenues as we continue to improve the existing functionality of our services, develop new applications to fill market needs and enhance our core platform.


36


General and Administrative

 
Year Ended December 31
 
% Change    
 
2017
 
2016
 
 
(dollars in thousands)
 
 
General and administrative
$
210,533

 
$
158,936

 
32
%
Percentage of revenues
11
%
 
11
%
 
 
Headcount (at period end)
892

 
647

 
38
%
 
General and administrative expenses increased $51.6 million during the year ended December 31, 2017, compared to the prior year, primarily due to increased headcount resulting in an increase of $22.4 million in personnel-related costs excluding stock-based compensation, an increase of $19.3 million in stock-based compensation, and an increase of $2.3 million in overhead expenses. Software subscription costs increased $4.6 million, and outside services costs, which include costs related to contractors and consultants, increased $2.3 million to support our administrative function. Amortization of intangibles increased $1.5 million, and acquisition-related costs increased $1.4 million from acquisitions in 2017.

The impact from the foreign currency movements from the year ended December 31, 2016 to the year ended December 31, 2017 is not material to general and administrative expenses.

We expect general and administrative expenses to increase for the year ended December 31, 2018 in absolute dollar terms as we continue to hire new employees, but remain relatively flat as a percentage of total revenues as we continue to grow.

Legal Settlements

 
Year Ended December 31
 
% Change    
 
2017
 
2016
 
 
(dollars in thousands)
 
 
Legal settlements
$

 
$
270,000

 
NM
Percentage of revenues
%
 
19
%
 
 

NM - Not meaningful. 

Legal settlements expense decreased $270.0 million during the year ended December 31, 2017 compared to the prior year, reflecting the legal settlement agreements with HPE and BMC in the prior year. Refer to Note 16 in the notes to our consolidated financial statements included elsewhere in this Annual Report on Form 10-K for further details.
                                                                                                                                                                                                                                                                                               

37


Stock-based Compensation
 
 
Year Ended December 31
 
% Change    
 
2017
 
2016
 
 
(dollars in thousands)
 
 
Cost of revenues:
 
 
 
 
 
Subscription
$
35,334

 
$
28,420

 
24
%
Professional services and other
27,475

 
26,442

 
4
%
Sales and marketing
170,527

 
131,571

 
30
%
Research and development
92,025

 
81,731

 
13
%
General and administrative
68,717

 
49,416

 
39
%
Total stock-based compensation
$
394,078

 
$
317,580

 
24
%
Percentage of revenues
20
%
 
23
%
 
 

Stock-based compensation expense increased $76.5 million during the year ended December 31, 2017, compared to the prior year, primarily due to increased headcount and increased weighted-average grant date fair value of equity awards.

Stock-based compensation expense is inherently difficult to forecast due to fluctuations in our stock price. Based upon our stock price as of December 31, 2017, we expect stock-based compensation expense to continue to increase for the year ended December 31, 2018 in absolute dollar terms, but decrease as a percentage of total revenues as we continue to grow. 

Interest Expense

 
Year Ended December 31
 
% Change    
 
2017
 
2016
 
 
(dollars in thousands)
 
 
Interest expense
$
(53,394
)
 
$
(33,278
)
 
60
%
Percentage of revenues
(3
)%
 
(2
)%
 
 

Interest expense increased $20.1 million during the year ended December 31, 2017, compared to the prior year, due to the increase in amortization expense of debt discount and issuance costs related to our convertible senior notes, including the 2022 Notes issued in the three months ended June 30, 2017. During the year ended December 31, 2018, we expect to incur approximately $63.3 million in amortization expense of debt discount and issuance costs related to the convertible notes.

Interest Income and Other Income (Expense), net
 
 
Year Ended December 31
 
% Change    
 
2017
 
2016
 
 
(dollars in thousands)
 
 
Interest income
$
16,677

 
$
8,528

 
96
 %
Foreign currency exchange loss
(11,117
)
 
(2,248
)
 
NM

Other
244

 
(245
)
 
NM

Interest income and other income (expense), net
$
5,804

 
$
6,035

 
(4
)%
Percentage of revenues
%
 
%
 
 

NM - Not meaningful. 

Interest income and other income (expense), net decreased $0.2 million during the year ended December 31, 2017, compared to the prior year, primarily due to increased foreign exchange loss, partially offset by increased interest income. Foreign exchange losses increased $8.9 million for the year ended December 31, 2017 compared to the prior year as a result of fluctuations in foreign currency exchange rates. Interest income increased $8.1 million due to the higher cash balances and higher yields on our invested balances during the year ended December 31, 2017 compared to the prior year.

38



Our expanding international operations will continue to increase our exposure to currency risks, though we cannot presently predict the impact of this exposure on our consolidated financial statements. While we have not engaged in the hedging of our foreign currency transactions to date, we currently expect to initiate a hedging program to hedge selected significant transactions denominated in currencies other than the U.S. Dollar in 2018.
 
 Provision for Income Taxes
 
 
Year Ended December 31
 
% Change    
 
2017
 
2016
 
 
(dollars in thousands)
 
 
Loss before income taxes
$
(149,004
)
 
$
(450,051
)
 
(67
)%
Provision for income taxes
126

 
1,753

 
(93
)%
Effective tax rate
 %
 
 %
 
 
 
Our effective tax rate was 0% for the year ended December 31, 2017 and 2016. Our tax expense decreased $1.6 million during the year ended December 31, 2017, compared to the prior year, primarily due to the tax effects of unrealized gains in investment securities. See Note 15 in the notes to our consolidated financial statements included elsewhere in this Annual Report on Form 10-K for our reconciliation of income taxes at the statutory federal rate to the provision for income taxes.

On December 22, 2017, the 2017 Tax Cuts and Jobs Act (the Tax Act) was enacted into law, changing how the U.S. imposes income tax on multinational corporations. Significant changes include, but are not limited to, a reduction of the corporate income tax rate from 35% to 21%, a transition tax on accumulated foreign earnings, and a transition from a worldwide to a territorial tax system. We are required to recognize the effect of the Tax Act in the period of enactment, such as remeasuring our U.S. deferred tax assets and liabilities as well as reassessing the net realizability of our deferred tax assets and liabilities.

In December 2017, the SEC staff issued Staff Accounting Bulletin No. 118, Income Tax Accounting Implications of the Tax Cuts and Jobs Act (SAB 118), which allows us to record provisional amounts during a measurement period not to extend more than one year beyond the Tax Act enactment date. Since the Tax Act was passed late in the fourth quarter of 2017, and ongoing guidance and accounting interpretation are expected over the next 12 months, we consider the accounting for deferred tax remeasurements, the impact of the transition of U.S. international taxation from a worldwide tax system to a territorial system, and other provisions to be incomplete due to the forthcoming guidance and our ongoing analysis. We expect to complete our analysis within the measurement period in accordance with SAB 118.

We continue to maintain a full valuation allowance on our U.S. federal and state deferred tax assets, and the significant components of the tax expense recorded are current cash taxes payable in various jurisdictions. The cash tax expenses are impacted by each jurisdiction’s individual tax rates, laws on timing of recognition of income and deductions, and availability of net operating losses and tax credits. Given the full valuation allowance, sensitivity of current cash taxes to local rules and our foreign structuring, we expect that our effective tax rate could fluctuate significantly on a quarterly basis and could be adversely affected to the extent earnings are lower than anticipated in countries that have lower statutory rates and higher than anticipated in countries that have higher statutory rates. Prior to the enactment of the Tax Act, we considered earnings from foreign operations to be indefinitely reinvested outside of the United States. We are currently evaluating whether to change our indefinite reinvestment assertion in light of the Tax Act and consider that assessment to be incomplete as permitted under guidance issued by the SEC. We expect to reach a final determination within the measurement period described above.


39


Net Loss

 
Year Ended December 31
 
% Change    
 
2017
 
2016
 
 
(dollars in thousands)
 
 
Net loss
$
(149,130
)
 
$
(451,804
)
 
(67
)%
Percentage of revenues
(8
)%
 
(32
)%
 
 

Net loss decreased $302.7 million during the year ended December 31, 2017, primarily reflecting the settlement agreements we entered into with HPE and BMC during the prior year. Refer to Note 16 in the notes to our consolidated financial statements included elsewhere in this Annual Report on Form 10-K for further details. We expect to continue to incur a GAAP loss for the year ended December 31, 2018, due to increased costs and expenses including non-cash charges associated with equity awards, amortization of purchased intangibles from acquisitions, and other expenses. 

Comparison of the years ended December 31, 2016 and 2015
 
Revenues
 
 
Year Ended December 31,
 
% Change    
 
2016
 
2015
 
 
(dollars in thousands)
 
 
Revenues:
 
 
 
 
 
Subscription
$
1,221,639

 
$
848,278

 
44
%
Professional services and other
168,874

 
157,202

 
7
%
Total revenues
$
1,390,513

 
$
1,005,480

 
38
%
Percentage of revenues:
 
 
 
 
 
Subscription
88
%
 
84
%
 
 
Professional services and other
12

 
16

 
 
Total
100
%
 
100
%
 
 
 
Subscription revenues increased $373.4 million during the year ended December 31, 2016, compared to the prior year, driven by upsells and an increase in customer count.

Subscription revenues consist of the following:
 
Year Ended December 31,
 
% Change    
 
2016
 
2015
 
 
(dollars in thousands)
 
 
Service management products
$
1,108,846

 
$
783,603

 
42
%
ITOM products
112,793

 
64,675

 
74
%
Total subscription revenues
$
1,221,639

 
$
848,278

 
44
%

Our service management products include our platform, ITSM, ITBM, customer service management, HR service delivery and security operations, which have similar features and functions and are generally priced on a per user basis. Our ITOM products, which improve visibility, availability and agility of enterprise services, are generally priced on a per node basis.

Professional services and other revenues increased $11.7 million during the year ended December 31, 2016, compared to the prior year, due to an increase in the services provided to our growing customer base. In addition, revenues from our annual Knowledge user conference increased to $12.8 million during the year ended December 31, 2016, compared to $10.9 million in the prior year, due to increased sponsorship and paid registrations in the current year.


40


Our international operations have provided and will continue to provide a significant portion of our total revenues. Revenues outside North America represented 32% and 30% of total revenues for the year ended December 31, 2016 and 2015, respectively. Because we primarily transact in foreign currencies for sales outside of the United States, the general strengthening of the U.S. Dollar relative to other major foreign currencies (primarily Euro and the British Pound Sterling) from the year ended December 31, 2015 to the year ended December 31, 2016 had an unfavorable impact on our revenues. For entities reporting in currencies other than the U.S. Dollar, if we had translated our results for the year ended December 31, 2016 at the average exchange rates in effect for the year ended December 31, 2015 rather than the actual exchange rates in effect during the period, our subscription revenues would have increased by an additional $6.3 million. The impact from the foreign currency movements from the year ended December 31, 2015 to the year ended December 31, 2016 is not material to professional services and other revenues.

Cost of Revenues and Gross Profit Percentage
 
 
Year Ended December 31,
 
% Change    
 
2016
 
2015
 
 
(dollars in thousands)
 
 
Cost of revenues:
 
 
 
 
 
Subscription
$
235,414

 
$
183,400

 
28
%
Professional services and other
163,268

 
146,013

 
12
%
Total cost of revenues
$
398,682

 
$
329,413

 
21
%
Gross profit percentage:
 
 
 
 
 
Subscription
81
%
 
78
%
 
 
Professional services and other
3
%
 
7
%
 
 
Total gross profit percentage
71
%
 
67
%
 
 
Gross profit:
$
991,831

 
$
676,067

 
47
%
Headcount (at period end)
 
 
 
 
 
Subscription
729

 
579

 
26
%
Professional services and other
496

 
486

 
2
%
Total headcount
1,225

 
1,065

 
15
%
 
Cost of subscription revenues increased $52.0 million during the year ended December 31, 2016, compared to the prior year, primarily due to increased headcount resulting in an increase of $17.3 million in personnel-related costs excluding stock-based compensation, an increase of $5.0 million in stock-based compensation, and an increase of $7.2 million in other overhead expenses. In addition, there was an increase of $10.3 million in depreciation expense primarily due to purchases of infrastructure hardware equipment for our data centers, an increase of $5.3 million in data center capacity costs primarily due to the expansion of our data centers, and an increase of $1.5 million in amortization of intangible assets as a result of acquisitions in 2016.

Our subscription gross profit percentage increased to 81% for the year ended December 31, 2016, from 78% for the year ended December 31, 2015, due to improved data center utilization and economies of scale.

Cost of professional services and other revenues increased $17.3 million during the year ended December 31, 2016, compared to the prior year, primarily due to increased headcount resulting in an increase of $8.0 million in personnel-related costs excluding stock-based compensation, an increase of $3.2 million in stock-based compensation, and an increase of $3.4 million in overhead expenses.

Our professional services and other gross profit percentage decreased to 3% during the year ended December 31, 2016, compared to 7% in the prior year, due to lower utilization rates as we invested in specialized resources to support our newer products and higher growth rate in our stock-based compensation of 14% compared to the growth rate in our professional services and other revenues of 7%, partially offset by the increase in revenues from our annual Knowledge user conference. Costs associated with Knowledge are included in sales and marketing expense. Knowledge contributed $12.8 million, or 8 percentage points, to the professional services and other gross profit percentage for the year ended December 31, 2016. Knowledge contributed $10.9 million, or 7 percentage points, to the professional services and other gross profit percentage for the year ended December 31, 2015.


41


Because we primarily transact in foreign currencies for cost of revenues outside of the United States, the general strengthening of the U.S. Dollar relative to other major foreign currencies from the year ended December 31, 2015 to the year ended December 31, 2016 had a favorable impact on our cost of revenues. For entities reporting in currencies other than the U.S. Dollar, if we had translated our results for the year ended December 31, 2016 at the average exchange rates in effect for the year ended December 31, 2015 rather than the actual exchange rates in effect during the year ended December 31, 2016, our cost of subscription revenues would have increased by an additional $3.3 million and our cost of professional services and other revenues would have increased by an additional $1.6 million.
 
Sales and Marketing
 
 
Year Ended December 31
 
% Change    
 
2016
 
2015
 
 
(dollars in thousands)
 
 
Sales and marketing
$
700,464

 
$
498,439

 
41
%
Percentage of revenues
50
%
 
50
%
 
 
Headcount (at period end)
1,875

 
1,416

 
32
%
 
Sales and marketing expenses increased $202.0 million during the year ended December 31, 2016, compared to the prior year, primarily due to increased headcount resulting in an increase of $106.4 million in personnel-related costs excluding stock-based compensation, an increase of $29.2 million in stock-based compensation, an increase of $23.2 million in overhead expenses, and an increase of $15.7 million in commission expense. Commissions and referral fee expenses amounted to 7% and 8% of subscription revenues for the years ended December 31, 2016 and 2015, respectively. Outside services expenses increased $3.7 million primarily due to an increase in contractors and professional fees to support our sales and marketing functions

In addition, expenses related to our annual Knowledge user conference increased $3.0 million, from $21.0 million for the year ended December 31, 2015 to $24.0 million for the year ended December 31, 2016, due to a 35% increase in registration year-over-year. All other marketing program expenses, which include expenses related to events other than Knowledge and costs associated with purchasing advertising and marketing data, increased $18.6 million for the year ended December 31, 2016 compared to the prior year.

Because we primarily transact in foreign currencies for sales and marketing expenses outside of the United States, the general strengthening of the U.S. Dollar relative to other major foreign currencies from the year ended December 31, 2015 to the year ended December 31, 2016 had a favorable impact on our sales and marketing expenses. For entities reporting in currencies other than the U.S. Dollar, if we had translated our results for the year ended December 31, 2016 at the average exchange rates in effect for the year ended December 31, 2015 rather than the actual exchange rates in effect during the period, our sales and marketing expenses would have increased by an additional $6.3 million.

Research and Development
 
 
Year Ended December 31
 
% Change    
 
2016
 
2015
 
 
(dollars in thousands)
 
 
Research and development
$
285,239

 
$
217,389

 
31
%
Percentage of revenues
21
%
 
22
%
 
 
Headcount (at period end)
1,054

 
756

 
39
%
 
Research and development expenses increased $67.9 million during the year ended December 31, 2016, compared to the prior year, primarily due to increased headcount resulting in an increase of $39.9 million in personnel-related costs excluding stock-based compensation, an increase of $11.4 million in stock-based compensation, and an increase of $10.2 million in overhead expenses. Outside services expenses increased $2.0 million primarily due to increase in professional fees to support our research and development functions. Research and development expenses also increased $2.5 million due to an increase in data center capacity costs and depreciation of infrastructure hardware equipment that are used solely for research and development purposes. Amortization of intangible assets increased $1.2 million as a result of acquisitions in 2016.


42


The impact from the foreign currency movements from the year ended December 31, 2015 to the year ended December 31, 2016 is not material to research and development expenses.
 
General and Administrative
 
 
Year Ended December 31
 
% Change    
 
2016
 
2015
 
 
(dollars in thousands)
 
 
General and administrative
$
158,936

 
$
126,604

 
26
%
Percentage of revenues
11
%
 
12
%
 
 
Headcount (at period end)
647

 
449

 
44
%
 
General and administrative expenses increased $32.3 million during the year ended December 31, 2016, compared to the prior year, primarily due to increased headcount resulting in an increase of $13.3 million in personnel-related costs excluding stock-based compensation, an increase of $11.1 million in stock-based compensation, and an increase of $6.1 million in overhead expenses.

The impact from the foreign currency movements from the year ended December 31, 2015 to the year ended December 31, 2016 is not material to general and administrative expenses.

Legal Settlements

 
Year Ended December 31
 
% Change    
 
2016
 
2015
 
 
(dollars in thousands)
 
 
Legal settlements
$
270,000

 
$

 
NM
Percentage of revenues
19
%
 
NM

 
 

NM - Not meaningful. 

Legal settlements expenses increased $270.0 million during the year ended December 31, 2016, compared to the prior year, related to the settlement agreements with HPE and BMC. Refer to Note 16 in the notes to our consolidated financial statements included elsewhere in this Annual Report on Form 10-K for further details regarding these matters.
                                                                                                                                                                                                                                                                                               
Stock-based Compensation
 
 
Year Ended December 31
 
% Change    
 
2016
 
2015
 
 
(dollars in thousands)
 
 
Cost of revenues:
 
 
 
 
 
Subscription
$
28,420

 
$
23,416

 
21
%
Professional services and other
26,442

 
23,265

 
14
%
Sales and marketing
131,571

 
102,349

 
29
%
Research and development
81,731

 
70,326

 
16
%
General and administrative
49,416

 
38,357

 
29
%
Total stock-based compensation
$
317,580

 
$
257,713

 
23
%
Percentage of revenues
23
%
 
26
%
 
 

Stock-based compensation expenses increased $59.9 million during the year ended December 31, 2016, compared to the prior year, primarily due to equity grants to new employees and additional grants to current employees.


43


Interest Expense

 
Year Ended December 31
 
% Change    
 
2016
 
2015
 
 
(dollars in thousands)
 
 
Interest expense
$
(33,278
)
 
$
(31,097
)
 
7
%
Percentage of revenues
(2
)%
 
(3
)%
 
 

Interest expense increased $2.2 million during the year ended December 31, 2016, compared to the prior year, due to the increase in amortization expense of debt discount and issuance costs related to our convertible senior notes issued in November 2013.

Interest Income and Other Income (Expense), net
 
 
Year Ended December 31
 
% Change    
 
2016
 
2015
 
 
(dollars in thousands)
 
 
Interest income
$
8,528

 
$
4,858

 
76
 %
Foreign currency exchange gain (loss)
(2,248
)
 
51

 
NM

Other
(245
)
 
(459
)
 
(47
)%
Interest income and other income (expense), net
$
6,035

 
$
4,450

 
36
 %
Percentage of revenues
%
 
1
%
 
 

NM - Not meaningful.

Interest income and other income (expense), net increased $1.6 million during the year ended December 31, 2016, compared to the prior year, primarily due to increased interest income, partially offset by increased foreign exchange losses. We had foreign exchange losses of $2.2 million for the year ended December 31, 2016, compared to gains of $0.1 million for the year ended December 31, 2015, as a result of fluctuations in foreign currency exchange rates. Interest income increased $3.7 million due to the higher yields during the year ended December 31, 2016 compared to the prior year.

 Provision for Income Taxes
 
 
Year Ended December 31
 
% Change    
 
2016
 
2015
 
 
(dollars in thousands)
 
 
Loss before income taxes
$
(450,051
)
 
$
(193,012
)
 
133
 %
Provision for income taxes
1,753

 
5,414

 
(68
)%
Effective tax rate
 %
 
(3
)%
 
 
 
Our effective tax rate was 0% for the year ended December 31, 2016 compared to (3)% for the prior year. Our tax expense decreased $3.7 million during the year ended December 31, 2016, compared to the prior year, primarily due to a partial release of valuation allowance in connection with business combinations. See Note 15 in the notes to our consolidated financial statements included elsewhere in this Annual Report on Form 10-K for our reconciliation of income taxes at the statutory federal rate to the provision for income taxes.


44